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0000950168-96-000039	0000950168-96-000039_0007.txt	Average Annual Total Return and Total Return for First Investors Funds are calculated using the following standardized formula: Total Return = ((ERV (divided sign) P) - 1 Total Return = ((ERV - P) (divided sign) P) WHERE: ERV = Ending redeemable value of a hypothetical $1,000 investment made at the beginning of 1, 5, or 10 year periods (or fractional P = a hypothetical initial investment of $1,000 N = number of years The following table lists the information used to calculate the average annual total return and total return for First Investors Series Fund II, Inc. (Class B shares) as of October 31, 1995. Class B ERV P N TOTAL RETURN RETURN Life of Fund: $1,177.84 $1,000.00 .80 N/A 17.78% Made In The U.S.A. Fund Life of Fund: $1,158.01 $1,000.00 .80 N/A 15.80% Life of Fund: $1,170.24 $1,000.00 .80 N/A 17.02% Average Annual Total Return and Total Return for First Investors Funds are calculated using the following standardized formula: Total Return = ((ERV (divided sign) P) - 1 Total Return = ((ERV - P) (divided sign) P) WHERE: ERV = Ending redeemable value of a hypothetical $1,000 investment made at the beginning of 1, 5, or 10 year periods (or fractional P = a hypothetical initial investment of $1,000 N = number of years The following table lists the information used to calculate the average annual total return and total return for First Investors Series Fund II, Inc. (Class A shares) as of October 31, 1995. Class A ERV P N TOTAL RETURN RETURN 1 year: $1,191.81 $1,000.00 1.00 11.98% 11.98% Life of Fund: $1,161.97 $1,000.00 2.07 7.51% 16.20% Made In The U.S.A. Fund 1 year: $1,167.61 $1,000.00 1.00 16.76% 16.76% Life of Fund: $1,201.89 $1,000.00 3.19 5.91% 20.09% 1 year: $1,137.38 $1,000.00 1.00 13.74% 13.74% Life of Fund: $1,102.50 $1,000.00 2.69 3.70% 10.25%	485BPOS	EX-99.B16	1996-01-12T00:00:00	1996-01-12T09:22:27
0000201533-96-000009	0000201533-96-000009_0000.txt	<DESCRIPTION>BODY OF POST EFFECT. AMENDMENT As filed with the Securities and Exchange Commission on January 12, 1996 THE SECURITIES ACT OF 1933 (Exact name of registrant as specified in its charter) (State or other jurisdiction of incorporation or organization) (Primary Standard Industrial (I.R.S. Employer Classification Code Number) Identification No.) Fairlane Plaza South, Suite 1100 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) Senior Vice President and Chief Financial Officer Fairlane Plaza South, Suite 1100 (Name, address, including zip code, and telephone number, including area code, of agent for service) It is respectfully requested that the Commission send copies of all notices, orders and communications to: Approximate date of commencement of proposed sale to the public: From time to time after the effective date of the Registration Statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. Title of each Amount Proposed Proposed Amount of class of securities being maximum maximum registration to be registered registered (2) offering aggregate fee Common Stock 3,000,000 $24.5625(1) $73,687,500(1) $25,409.48 (1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(c) based upon the average high and low sale price per share of CMS Energy's Common Stock, par value $.01 per share, as reported in the consolidated reporting system on June 2, 1995. (2) Pursuant to Rule 429 of the Securities Act of 1933, as amended, the prospectus contained herein also relates to the 2,000,000 shares of Common Stock $.01 par value of the registrant contained in the Registration Statement on Form S-4 (No. 33-55805) of which 851,000 shares remain outstanding and are being carried forward. The filing fee associated with the securities carried forward and previously paid with the earlier registration statement is $6199.09. This Post-Effective Amendment to the Registration Statement shall become effective in accordance with Section 8(c) of the Securities Act of 1933 or on such date as the Commission, acting pursuant to said Section 8(c), may determine. ITEMS IN FORM S-4 AND LOCATION IN PROSPECTUS Form S-4 Item Number and Caption Location in Prospectus A. Information About the Transaction Cover of Prospectus . . . . . . Facing Page; Cross-Reference Sheet; Outside Front Cover Page 2. Inside Front and Outside Prospectus . . . . . . . . . . . Inside Front and Outside Back 3. Risk Factors, Ratio of and Other Information . . . . . Documents Incorporated by 4. Terms of the Transaction . . . . * 5. Pro Forma Financial Information * 6. Material Contracts with the Company Being Acquired . . . . . * for Reoffering by Persons and Parties Deemed to be Underwriters * 8. Interests of Named Experts and Counsel . . . . . . . . . . . . * 9. Disclosure of Commission Position Act Liabilities . . . . . . . . * B. Information About the Registrant 10. Information with Respect to S-3 Registrants . . . . . . . . . . Documents Incorporated by Dividends and Price Range of Information by Reference . . . . Documents Incorporated by 12. Information with Respect to S-2 or S-3 Registrants . . . . . . . * Information by Reference . . . . * 14. Information with Respect to or S-2 Registrants . . . . . . . * C. Information About the Company Being Acquired 15. Information with Respect to S-3 Companies . . . . . . . . . * 16. Information with Respect to S-2 or S-3 Companies . . . . . . * 17. Information with Respect to Companies Other Than S-2 or S-3 Companies . . . . . . . . . * D. Voting and Management Information Are to be Solicited . . . . . . * Are Not to be Solicited or in an Exchange Offer . . . . . . * * Omitted since the answer is negative or the Item is not applicable upon the date of filing of this Registration Statement. The Registrant may be required to provide information (or further information) in response to one or more of such Items under certain circumstances by means of a post-effective amendment to this Registration Statement or supplement to the prospectus contained herein. INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY JURISDICTION IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH JURISDICTION. This Prospectus relates to 3,851,000 shares of common stock, par value $.01 per share (the "CMS Energy Common Stock"), which may be offered and issued by CMS Energy Corporation ("CMS Energy" or the "Company") from time to time in connection with acquisitions of other businesses or properties. As of January 11, 1996, 2,531,556 shares of CMS Energy Common Stock were issued pursuant to this Prospectus. It is anticipated that such acquisitions will consist principally of businesses (or the assets thereof) complementary to and related to the Company's current businesses. The consideration for acquisitions will consist of shares of CMS Energy Common Stock, cash, notes or other evidences of indebtedness, guarantees, assumption of liabilities or a combination thereof, as determined from time to time by negotiations between the Company and the owners or controlling persons of the businesses or properties to be acquired. In addition, the Company may lease property from and enter into management or consulting agreements and non-competition agreements with the former owners and key executive personnel of the businesses to be acquired. It is contemplated that the terms of an acquisition will be determined by negotiations between the Company's representatives and the owners or controlling persons of the businesses or properties to be acquired. Factors taken into account in acquisitions include, among other relevant factors, the quality and reputation of the business, its management and personnel, earning power, cash flow, growth potential, patents, licenses, equipment, locations of the business to be acquired and the market value of the CMS Energy Common Stock when pertinent. It is anticipated that shares of CMS Energy Common Stock issued in any such acquisition will be valued at a price reasonably related to the current market value of the CMS Energy Common Stock, either at the time the terms of the acquisition are tentatively agreed upon, or at or about the time of closing, or during the period or periods prior to delivery of the shares. The CMS Energy Common Stock offered hereby is expected to be listed on the New York Stock Exchange. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The date of this Prospectus is , 1996. It is not expected that underwriting discounts or commissions will be paid by CMS Energy except that finders fees may be paid to persons from time to time in connection with specific acquisitions. Any person receiving any such fees may be deemed to be an underwriter within the meaning of the Securities Act of 1933. No person is authorized to give any information or to make any representation not contained in this Prospectus, and, if given or made, such information or representation should not be relied upon as having been authorized by the Company. This Prospectus does not constitute an offer to sell, or a solicitation of an offer to purchase, the securities offered by this Prospectus in any jurisdiction in which, or to or from any person to or from whom, it is unlawful to make such an offer, or solicitations of an offer. Neither the delivery of this Prospectus nor any distribution of the securities offered pursuant to this Prospectus shall, under any circumstances, create any implication that there has been no change in the information set forth herein or in the affairs of the Company since the date of this Prospectus or that the information herein is correct as of any time subsequent to its date. CMS Energy is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"). Such reports, proxy statements and other information may be inspected and copied at the public reference facilities maintained by the Commission at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's Regional Offices located at 500 West Madison, 14th Floor, Chicago, Illinois 60661 and at 7 World Trade Center, 13th Floor, New York, New York 10048. Copies of such materials can be obtained by mail from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates. The CMS Energy Common Stock is listed on the New York Stock Exchange and reports, proxy statements and other information concerning CMS Energy may also be inspected and copied at the offices of such exchange at 20 Broad Street, New York, New York 10005. INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following documents filed by CMS Energy with the Commission (File No. 1-9513) pursuant to the Exchange Act are hereby incorporated by reference in this Prospectus and shall be deemed to be a part hereof: (1) CMS Energy's Annual Report on Form 10-K for the year ended (2) CMS Energy's Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 1995, June 30, 1995 and September 30, (3) CMS Energy's Current Reports on Form 8-K dated January 10, 1995, February 2, 1995 and dated September 11, 1995. All documents subsequently filed by CMS Energy pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act and prior to the termination of the offering made by this Prospectus shall be deemed to be incorporated by reference herein and shall be deemed to be a part hereof from the date of filing of such documents (such documents, and the documents enumerated above, being hereinafter referred to as "Incorporated Documents"). Any statement contained in an Incorporated Document shall be deemed to be modified or superseded for purposes of this Prospectus to the extent that a statement contained herein or in any other subsequently filed Incorporated Document modifies or supersedes such statement. Any such statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of this Prospectus. AS INDICATED ABOVE, THIS PROSPECTUS INCORPORATES DOCUMENTS BY REFERENCE WHICH ARE NOT PRESENTED HEREIN OR DELIVERED HEREWITH. CMS ENERGY UNDERTAKES TO PROVIDE WITHOUT CHARGE TO EACH PERSON, INCLUDING ANY BENEFICIAL OWNER, TO WHOM A COPY OF THIS PROSPECTUS HAS BEEN DELIVERED, UPON THE WRITTEN OR ORAL REQUEST OF ANY SUCH PERSON, A COPY OF ANY OR ALL OF THE DOCUMENTS REFERRED TO ABOVE WHICH HAVE BEEN OR MAY BE INCORPORATED IN THIS PROSPECTUS BY REFERENCE, OTHER THAN EXHIBITS TO SUCH DOCUMENTS (UNLESS SUCH EXHIBITS ARE SPECIFICALLY INCORPORATED BY REFERENCE INTO SUCH DOCUMENTS). REQUESTS FOR SUCH COPIES SHOULD BE DIRECTED TO CMS ENERGY CORPORATION AT ITS PRINCIPAL EXECUTIVE OFFICES LOCATED AT FAIRLANE PLAZA SOUTH, SUITE 1100, 330 TOWN CENTER DRIVE, DEARBORN, MICHIGAN 48126, ATTENTION: INVESTOR RELATIONS DEPARTMENT, TELEPHONE: (517) 788-2590. IN ORDER TO ENSURE TIMELY DELIVERY OF THE DOCUMENTS, ANY REQUEST SHOULD BE MADE BY FIVE BUSINESS DAYS PRIOR TO THE DATE TO WHICH THE FINAL INVESTMENT DECISION MUST BE MADE. Certain information contained in this Prospectus summarizes, is based upon, or refers to information and financial statements contained in one or more Incorporated Documents; accordingly, such information contained herein is qualified in its entirety by reference to such documents and should be read in conjunction therewith. Available Information 3 Dividends and Price Range of Incorporation of Certain CMS Energy Common Stock 7 Documents by Reference 3 Selected Consolidated Financial The Company 5 Data 8 Offered Securities 6 Description of Capital Stock 6 Use of Proceeds 6 Legal Opinions 13 CMS Energy, incorporated in 1987, is the parent holding company of Consumers Power Company ("Consumers") and CMS Enterprises Company ("Enterprises"). Consumers, a combination electric and gas utility company serving most of Michigan's Lower Peninsula, is CMS Energy's largest subsidiary. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry. Enterprises is engaged in several non-utility energy- related businesses including: (i) oil and gas exploration and production, (ii) development and operation of independent power production facilities, (iii) gas marketing services to utility, commercial and industrial customers and (iv) transmission and storage of natural gas. CMS Energy conducts its principal operations through the following five business segments: (i) electric utility operations; (ii) natural gas utility operations; (iii) gas transmission and marketing; (iv) oil and gas exploration and production operations; and (v) independent power production. Consumers or Consumers' subsidiaries are engaged in two segments: electric operations and gas operations. Consumers' electric and gas businesses are principally regulated utility operations. At December 31, 1994, CMS Energy had total consolidated assets of $7,384 million. CMS Energy's 1994 consolidated operating revenue was $3,619 million. This consolidated operating revenue was derived from Consumers' sales of electric energy (approximately 61% or $2,189 million), Consumers' gas operations (approximately 32% or $1,151 million), gas transmission and marketing (approximately 4% or $145 million), oil and gas exploration and production activities (approximately 2% or $85 million) and independent power production activities (approximately 1% or $45 million). Consumers' consolidated operations in the electric and gas utility businesses account for the major share of CMS Energy's total assets, revenue and income. CMS Energy's share of 1994 unconsolidated non-utility independent power production revenue was $385 million. On May 30, 1995, Nomeco Oil & Gas Co. ("NOMECO"), an indirect wholly- owned subsidiary of CMS Energy, executed a non-binding letter of intent which called for a newly formed subsidiary of CMS Energy to merge with and into Terra Energy, Ltd., a Michigan corporation ("Terra"). Terra was formerly a privately held corporation primarily engaged in U.S. gas and oil exploration and production and activities related thereto. This transaction was completed in August 1995, making Terra a wholly owned subsidiary of NOMECO. In connection with the acquisition, CMS Energy delivered $62.3 million of CMS Energy Common, or 2,531,556 shares, and is expected to deliver an additional $1.3 million of CMS Energy Common Stock, subject to post-closing adjustments. This acquisition was not material to CMS Energy. The foregoing information concerning CMS Energy and its subsidiaries does not purport to be comprehensive. For additional information concerning CMS Energy and its subsidiaries' business and affairs, including their capital requirements and external financing plans, pending legal and regulatory proceedings and descriptions of certain laws and regulations to which those companies are subject, prospective purchasers should refer to the Incorporated Documents. See "Incorporation of Certain Documents by Reference." The securities of CMS Energy which may be offered from time to time by this Prospectus consist of up to 3,851,000 shares of CMS Energy Common Stock, which CMS Energy proposes to issue in connection with acquisitions of other businesses or properties. As of January 11, 1996, 2,531,556 shares of CMS Energy Common Stock were issued pursuant to this Prospectus. The CMS Energy Common Stock to be issued hereunder will be freely transferable under the Securities Act of 1933, as amended (the "Securities Act"), except for shares of CMS Energy Common Stock issued in connection with an acquisition to any person deemed to be an affiliate of any acquired company for purposes of Rule 145 under the Securities Act at the time of any such acquisition. Generally, such affiliates may not sell their shares of CMS Energy Common Stock acquired in connection with an acquisition except pursuant to an effective registration statement under the Securities Act covering such shares, or in compliance with Rule 145 under the Securities Act or another applicable exemption from the registration requirements of the Securities Act. The consideration for any acquisition may consist of cash, notes or other evidences of debt, assumptions of liabilities, equity securities, or a combination thereof, as determined from time to time by negotiations between CMS Energy and the owners of businesses or properties to be acquired. CMS Energy will attempt to make acquisitions which are complementary to its present operations. In general, the terms of any acquisitions will be determined by direct negotiations between the representatives of CMS Energy and the owners of the businesses or properties to be acquired or, in the case of entities more widely held, through exchange offers to stockholders or documents soliciting approval of statutory mergers, consolidations or sales of assets. Underwriting discounts or commissions will generally not be paid by CMS Energy. However, under some circumstances, the Company may issue CMS Energy Common Stock covered by this Prospectus to pay brokers' commissions incurred in connection with acquisitions. This Prospectus relates to shares of CMS Energy Common Stock which may be offered and issued by the Company from time to time in the acquisition of other businesses or properties. Other than the business or properties acquired, there will be no proceeds to the Company from these offerings. DIVIDENDS AND PRICE RANGE OF CMS ENERGY COMMON STOCK CMS Energy Common Stock is listed on the New York Stock Exchange under the symbol "CMS". CMS Energy has paid dividends on its Common Stock each year since its inception except 1988. Future dividends will depend upon CMS Energy's earnings, financial condition and other factors. Reference is made to "Description of Capital Stock" regarding limitations upon payment of dividends on the Company's Common Stock. The following table indicates the high and low sales prices of the CMS Energy Common Stock for the calendar quarters indicated, as reported in The Wall Street Journal under "New York Stock Exchange Composite Transactions," and the quarterly cash dividends declared per share of the CMS Energy Common Stock, for the calendar quarters indicated. Calendar Period High Low Dividend First Quarter . . . . . . . . . . . $33 $26 1/2 $.12 Second Quarter . . . . . . . . . . 30 3/4 23 3/4 .12 Third Quarter . . . . . . . . . . . 25 7/8 18 .12 Fourth Quarter . . . . . . . . . . 19 3/4 16 5/8 .12 First Quarter . . . . . . . . . . . $22 3/4 $17 7/8 $.12 Second Quarter . . . . . . . . . . 21 7/8 14 7/8 .12 Third Quarter . . . . . . . . . . . 17 1/2 15 1/4 .12 Fourth Quarter . . . . . . . . . . 18 3/8 16 3/4 .12 First Quarter . . . . . . . . . . . $20 7/8 $17 7/8 $.12 Second Quarter . . . . . . . . . . 25 1/2 19 1/2 .12 Third Quarter . . . . . . . . . . . 27 1/2 24 7/8 .18 Fourth Quarter . . . . . . . . . . 27 1/8 23 .18 First Quarter . . . . . . . . . . . $25 $21 1/8 $.18 Second Quarter . . . . . . . . . . 22 7/8 19 5/8 .18 Third Quarter . . . . . . . . . . . 23 3/8 20 5/8 .21 Fourth Quarter . . . . . . . . . . 23 1/4 20 7/8 .21 First Quarter . . . . . . . . . . . $24 3/4 $22 5/8 $.21 Second Quarter . . . . . . . . . . 25 3/8 22 1/2 .21 Third Quarter . . . . . . . . . . . 26 3/8 23 3/8 .24 Fourth Quarter. . . . . . . . . . . 30 26 .24 First Quarter . . . . . . . . . . . 30 1/2 29 1/2 --- On January 10, 1996, the closing price of the CMS Energy Common Stock on The New York Stock Exchange was $29 1/2 per share. On January 10, 1996, there were 59,058 record holders of CMS Energy Common Stock. The following is a summary of certain financial information of the Company and its consolidated subsidiaries and is qualified in its entirety by, and should be read in conjunction with, the detailed information and consolidated financial statements, including notes thereto, included in the Company's Annual Report on Form 10-K for the year ended December 31, 1994, and its Quarterly Report on Form 10-Q for the quarter ended September 30, 1995. The unaudited consolidated interim period financial statement includes, in the opinion of the Company's management, all adjustments necessary to present fairly the data for such period. The results of operations for interim periods are not necessarily indicative of results to be achieved for full fiscal years. The following outline of certain rights of the holders of CMS Energy capital stock does not purport to be complete and is qualified in its entirety by express reference to Article III of the Restated Articles of Incorporation of CMS Energy (the "Articles of Incorporation"), the CMS Energy Indenture dated as of September 15, 1992, as amended and supplemented (the "Senior Debt Indenture") to NBD Bank, N.A., as Trustee, the Credit Agreement dated as of November 21, 1995 (the "Credit Facility") among CMS Energy, Citibank, N.A. and Union Bank, as co-agents, and certain banks named therein, the Term Loan Agreement dated as of November 21, 1995 ("Term Loan") among CMS Energy, Citibank, N.A. and Union Bank as Co-Agents and certain banks named therein, and CMS Energy's Indenture dated as of January 15, 1994 (the "GTN Indenture") to The Chase Manhattan Bank, N.A., as Trustee, copies of which are filed as exhibits to the Registration Statement of which this Prospectus is a part. The Articles of Incorporation currently authorize 320 million shares of capital stock, of which 250 million are shares of CMS Energy Common Stock, par value $.01 per share, 60 million are shares of Class G Common Stock, no par value ("Class G Common Stock"), and 10 million are shares of preferred stock, $.01 par value ("Preferred Stock"). The CMS Energy Common Stock and the Class G Common Stock are together referred to herein as the "Common Stock." As of January 11, 1996, 91,642,501 shares of CMS Energy Common Stock and 7,618,602 shares of Class G Common Stock were issued and outstanding and there were no shares of Preferred Stock issued or outstanding. The outstanding shares of the CMS Energy Common Stock are fully paid and non- assessable, and the additional CMS Energy Common Stock offered hereby, when issued and paid for, will be fully paid and non-assessable. The shares of Common Stock may be issued from time to time as the Board of Directors shall determine for such consideration as shall be fixed by the Board of Directors. Class G Common Stock is intended to reflect the separate performance of the gas distribution, storage and transportation businesses conducted by Consumers and Michigan Gas Storage, a subsidiary of Consumers (such businesses, collectively, will be attributed to the "Consumers Gas Group"). Effective January 1, 1995, the management and operations of the Consumers Gas Group were reorganized as a business unit separate from the electric utility operations of the Consumers. CMS Energy Common Stock reflects the performance of all of the businesses of CMS Energy and its subsidiaries, including the business of the Consumers Gas Group, except for the interest in the Consumers Gas Group attributable to the outstanding shares of Class G Common Stock. PREFERRED STOCK. The authorized Preferred Stock may be issued without the approval of the holders of Common Stock in one or more series, from time to time, with each such series to have such designation, powers, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions thereof, as shall be stated in a resolution providing for the issue of any such series adopted by the Board of Directors. The specific terms of Preferred Stock will be described in a prospectus supplement relating thereto if, and when, issued. Unless otherwise provided in a prospectus supplement, the holder of any shares of any series of Preferred Stock shall be entitled to vote in the election of directors or in respect of any other matter except as may be required by the Michigan Business Corporation Act, as amended. Unless otherwise provided in a prospectus supplement, holders of Preferred Stock will not have any preemptive rights to subscribe for or purchase any additional shares of the capital stock of CMS Energy of any class now or hereafter authorized, or any Preferred Stock or other securities or other right or option convertible into or exchangeable for or entitling the holder or owner to subscribe for or purchase any shares of capital stock. The future issuance of Preferred Stock may have the effect of delaying, deterring or preventing a change in control of CMS Energy. Dividends on the CMS Energy Common Stock will be paid at the discretion of the Board of Directors based primarily upon the earnings and financial condition of CMS Energy, including the Consumers Gas Group, except for the interest in the Consumers Gas Group attributable to the outstanding shares of the Class G Common Stock, and other factors. The holders of the Company's Common Stock are entitled to receive dividends when and as declared by the Board of Directors of the Company out of funds legally available therefor, subject to the terms of any CMS Energy Preferred Stock which may in the future be issued and at the time be outstanding. CMS Energy, in the sole discretion of its Board of Directors, could pay dividends exclusively to the holders of CMS Energy Common Stock, exclusively to the holders of Class G Common Stock, or to the holders of both of such classes in equal or unequal amounts. CMS Energy is a legal entity separate and distinct from its various subsidiaries. As a holding company with no significant operations of its own, the principal sources of its funds are dividends or other distributions from its operating subsidiaries, in particular, Consumers, borrowings and sales of equity. The ability of Consumers and other subsidiaries of CMS Energy to pay dividends or make distributions to CMS Energy, and accordingly, the ability of CMS Energy to pay dividends on its capital stock will depend on the earnings, financial requirements, contractual restrictions of the subsidiaries of CMS Energy, in particular, Consumers, and other factors. See "Primary Source of Funds of CMS Energy; Restrictions on Sources of Dividends" below. There are restrictions on CMS Energy's ability to pay dividends contained in its Credit Facility, the Senior Debt Indenture and the GTN Indenture. The Credit Facility and the Term Loan each provide that CMS Energy will not, and will not permit certain of its subsidiaries, directly or indirectly, to (i) declare or pay any cash dividend or distribution on the capital stock of CMS Energy or such subsidiaries, or (ii) purchase, redeem, retire or otherwise acquire for value any such capital stock (a" Restricted Payment"), unless: (1) no event of default under the Credit Facility, or event that with the lapse of time or giving of notice would constitute such an event of default, has occurred and is continuing, and (2) after giving effect to any such Restricted Payment, the aggregate amount of all such Restricted Payments, since September 30, 1993 shall not have exceeded the sum of: (a) $120,000,000, (b) 100% of CMS Energy's consolidated net income (as defined in the Senior Debt Indenture) since September 30, 1993 to the end of the most recent fiscal quarter ending at least 45 days prior to the date of such Restricted Payment (or, in case such sum shall be a deficit, minus 100% of the deficit), and (c) any net proceeds (as defined in the Senior Debt Indenture) received by CMS Energy for the issuance or sale of its capital stock subsequent to September 30, 1993. At September 30, 1995, CMS Energy could pay cash dividends of $731 million pursuant to this restriction. The First and Second Supplemental Indentures to the Senior Debt Indenture, pursuant to which CMS Energy's Series A Senior Deferred Coupon Notes due October 1, 1997 and Series B Senior Deferred Coupon Notes due October 1, 1999 were issued, provide that so long as any of such Notes are outstanding, CMS Energy will not, and will not permit certain of its subsidiaries, directly or indirectly, to make a Restricted Payment, unless: (1) no event of default under the Senior Debt Indenture, or event that with the lapse of time or giving of notice would constitute such an event of default, has occurred and is continuing, and (2) after giving effect to any such Restricted Payment, the aggregate amount of all such Restricted Payments since September 30, 1992 shall not have exceeded the sum of: (a) $40,000,000, (b) 100% of CMS Energy's consolidated net income (as defined in the Senior Debt Indenture) since September 30, 1992 to the end of the most recent fiscal quarter ending at least 45 days prior to the date of such Restricted Payment (or, in case such sum shall be a deficit, minus 100% of the deficit), and (c) any net proceeds (as defined in the Senior Debt Indenture) received by CMS Energy for the issuance or sale of its capital stock subsequent to September 15, 1992. At September 30, 1995, CMS Energy could pay cash dividends of $737 million pursuant to this restriction. The GTN Indenture provides that, so long as any of the General Term Notes, Series A (the "GTNs") issued thereunder are outstanding and are rated below BBB- by Standard & Poor's or by Duff & Phelps, CMS Energy will not, and will not permit certain of its subsidiaries, directly or indirectly, to make any Restricted Payments, if at any time CMS Energy or such subsidiary makes such Restricted Payment: (1) an Event of Default (as defined in the GTN Indenture), or an event that with the lapse of time or the giving of notice or both would constitute such an Event of Default, has occurred and is continuing (or would result therefrom), or (2) the aggregate amount of such Restricted Payment and all other Restricted Payments made since September 30, 1993, would exceed the sum of: (a) $120,000,000 plus 100% of consolidated net income from September 30, 1993 to the end of the most recent fiscal quarter ending at least 45 days prior to the date of such Restricted Payment (or, in case such sum shall be a deficit, minus 100% of the deficit) and (b) the aggregate net proceeds received by CMS Energy from the issue or sale of or contribution with respect to its capital stock after September 30, 1993. At September 30, 1995, CMS Energy could pay cash dividends of $731 million pursuant to this restriction. The foregoing provisions do not prohibit: (i) dividends or other distributions paid by CMS Energy in respect of the capital stock issued in connection with the acquisition of any business or assets by CMS Energy where such payments are payable solely from the net earnings of such business or assets; (ii) any purchase or redemption of capital stock made by exchange for, or out of the proceeds of the substantially concurrent sale of, capital stock; (iii) dividends paid within 60 days after the date of declaration thereof if at such date of declaration such dividends would have complied with the aforementioned limitations; or (iv) payments pursuant to the tax sharing agreement among CMS Energy and its subsidiaries. In addition, Michigan law prohibits payment of a dividend if, after giving it effect, CMS Energy would not be able to pay its debts as they become due in the usual course of business, or its total assets would be less than the sum of its total liabilities plus, unless the articles permit otherwise, the amount that would be needed, if CMS Energy were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. CMS Energy's net assets available for payment of dividends under the Michigan Business Corporation Act at September 30, 1995 were $1,437 million. The holders of CMS Energy Common Stock will vote with the holders of Class G Common Stock as a single class, except on matters which would be required by law or the Articles of Incorporation to be voted on by class. Each holder of Common Stock is entitled to one vote for each share of Common Stock held by such holder on each matter voted upon by the shareholders. Such right to vote is not cumulative. A majority of the votes cast by the holders of shares entitled to vote thereon is sufficient for the adoption of any question presented, except that certain provisions of the Articles of Incorporation relating to special shareholder meetings, the removal, indemnification and liability of the Board of Directors and the requirements for amending these provisions may not be amended, altered, changed or repealed unless such amendment, alteration, change or repeal is approved by the affirmative vote of at least 75% of the outstanding shares entitled to vote thereon. Under Michigan law, the approval of the holders of a majority of the outstanding shares of a class of Common Stock, voting as a separate class, would be necessary for authorizing, effecting or validating the merger or consolidation of CMS Energy into or with any other corporation if such merger or consolidation would adversely affect the powers of special rights of such class of stock, and to authorize any amendment to the Articles of Incorporation that would increase or decrease the aggregate number of authorized shares of such class or alter or change the powers, preferences or special rights of the shares of such class so as to affect them adversely. The Articles of Incorporation also provide that unless the vote or consent of a greater number of shares shall then be required by law, the vote or consent of the holders of a majority of all the shares of either class of Common Stock then outstanding, voting as a separate class, will be necessary for authorizing, effecting or validating the merger or consolidation of CMS Energy into or with any other entity if such merger or consolidation would adversely affect the powers or special rights of such class of Common Stock, either directly by amendment to the Articles of Incorporation or indirectly by requiring the holders of such class to accept or retain, in such merger or consolidation, anything other than (i) shares of such class or (ii) shares of the surviving or resulting corporation, having, in either case, powers and special rights identical to those of such class prior to such merger or consolidation. In the event that there is more than one class of Common Stock, the effect of these provisions may be to permit the holders of a majority of the outstanding shares of either class of Common Stock to block any such merger or amendment which would adversely affect the powers or special rights of holders of such class of Common Stock. Holders of Common Stock have no preemptive rights to subscribe for or purchase any additional shares of the capital stock of CMS Energy of any class now or hereafter authorized, or Preferred Stock, bonds, debentures, or other obligations or rights or options convertible into or exchangeable for or entitling the holder or owner to subscribe for or purchase any shares of capital stock, or any rights to exchange shares issued for shares to be issued. In the event of the dissolution, liquidation or winding up of the Company, whether voluntary or involuntary, after payment or provision for payment of the debts and other liabilities of the Company and after there shall have been paid or set apart for the holders of Preferred Stock the full preferential amounts (including any accumulated and unpaid dividends) to which they are entitled, the holders of Class G Common Stock and CMS Energy Common Stock shall be entitled to receive, on a per share basis, the same portion of all of the assets of the Corporation remaining for distribution to the holders of Common Stock, regardless of whether or not any of such assets were attributed to the Consumers Gas Group. Neither the merger or consolidation of the Company into or with any other corporation, nor the merger or consolidation of any other corporation into or with the Company nor any sale, transfer or lease of all or any part of the assets of the Company, shall be deemed to be a dissolution, liquidation or winding up. Because the Company has subsidiaries which have debt obligations and other liabilities of their own, the Company's rights and the rights of its creditors and its stockholders to participate in the distribution of assets of any subsidiary upon the latter's liquidation or recapitalization will be subject to prior claims of the subsidiary's creditors, except to the extent that the Company may itself be a creditor with recognized claims against the subsidiary. CMS Energy Common Stock is transferrable at Consumers Power Company, 212 W. Michigan Avenue, Jackson, MI 49201. The registrar for CMS Energy Common Stock is Consumers Power Company. PRIMARY SOURCE OF FUNDS FOR THE COMPANY'S COMMON STOCK; RESTRICTIONS ON The ability of CMS Energy to pay (i) dividends on its capital stock and (ii) its indebtedness depends and will depend substantially upon timely receipt of sufficient dividends or other distributions from its subsidiaries, in particular Consumers. Consumers' ability to pay dividends on its common stock depends upon its revenues, earnings and other factors. Consumers' revenues and earnings will depend substantially upon rates authorized by the Michigan Public Service Commission (the "MPSC"). Consumers' ability to pay dividends is restricted by its First Mortgage Bond Indenture (the"Mortgage Indenture") and its Articles of Incorporation (the "Articles"). The Mortgage Indenture provides that Consumers can only pay dividends on its common stock out of retained earnings accumulated subsequent to September 30, 1945, provided that upon such payment, there shall remain of such retained earnings an amount equivalent to any deficiency in maintenance and replacement expenditures as compared with maintenance and replacement requirements since December 31, 1945. Because of restrictions in its Articles and Mortgage Indenture, Consumers was prohibited from paying dividends on its common stock from June 1991 to December 31, 1992. However, as of December 31, 1992, Consumers effected a quasi-reorganization in which Consumers' accumulated deficit of $574 million was eliminated against other paid-in capital. With the accumulated deficit eliminated, Consumers satisfied the requirements under its Mortgage Indenture and resumed paying dividends on its common stock in May 1993. Consumers' Articles also provide two restrictions on its payment of dividends on its common stock. First, prior to the payment of any common stock dividend, Consumers must reserve retained earnings after giving effect to such dividend payment of at least (i) $7.50 per share on all then outstanding shares of its preferred stock; (ii) in respect to its Class A Preferred Stock, 7.5% of the aggregate amount established by its Board of Directors to be payable on the shares of each series thereof in the event of involuntary liquidation of Consumers; and (iii) $7.50 per share on all then outstanding shares of all other stock over which its preferred stock and Class A Preferred Stock do not have preference as to the payment of dividends and as to assets. Second, dividend payments during the 12 month period ending with the month the proposed payment is to be paid are limited to: (i) 50% of net income available for the payment of dividends during the base period (hereinafter defined) if the ratio of common stock and surplus to total capitalization and surplus for 12 consecutive calendar months within the 14 calendar months immediately preceding the proposed dividend payment (the "base period"), adjusted to reflect the proposed dividend, is less than 20%; and (ii) 75% of net income available for the payment of dividends during the base period if the ratio of common stock and surplus to total capitalization and surplus for the base period, adjusted to reflect the proposed dividend, is at least 20% but less than 25%. Consumers' Articles also prohibit the payment of cash dividends on its common stock if Consumers is in arrears on preferred stock dividend payments. In addition, Michigan law prohibits payment of a dividend if, after giving it effect, Consumers would not be able to pay its debts as they become due in the usual course of business, or its total assets would be less than the sum of its total liabilities plus, unless the articles permit otherwise, the amount that would be needed, if Consumers were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. Consumers' net assets available for payment of dividends under the Michigan Business Corporation Act at September 30, 1995 were $1,531 million. Under the most restrictive of these conditions, at September 30, 1995, $75 million of Consumers' retained earnings were available to pay cash dividends on its common stock. Currently it is Consumers' policy to pay annual dividends equal to 80% of its annual consolidated net income. Consumers' Board of Directors reserves the right to change this policy at any time. Consumers paid dividends on its common stock of $69.9 million on May 19, 1995. An opinion as to the legality of the CMS Energy Common Stock will be rendered for CMS Energy by Denise M. Sturdy, Esq., Assistant General Counsel of CMS Energy. The consolidated financial statements and schedule of CMS Energy as of December 31, 1994 and 1993, and for each of the five years in the period ended December 31, 1994 incorporated by reference in this Prospectus, have been audited by Arthur Andersen LLP (formerly Arthur Andersen & Co.), independent public accountants, as indicated in their reports with respect thereto, and are included herein in reliance upon the authority of said firm as experts in accounting and auditing in giving said reports. With respect to the unaudited interim consolidated financial information for the quarterly periods ended March 31, June 30, and September 30, 1994 and 1995, incorporated by reference in this Prospectus, Arthur Andersen LLP has applied limited procedures in accordance with professional standards for a review of such information. However, their separate report thereon states that they did not audit and they did not express an opinion on that interim consolidated financial information. Accordingly, the degree of reliance on their report on that information should be restricted in light of the limited nature of the review procedures applied. In addition, the accountants are not subject to the liability provisions of Section 11 of the Securities Act, for their report on the unaudited interim consolidated financial information because that report is not a "report" or a "part" of the registration statement prepared or certified by the accountants within the meaning of Sections 7 and 11 of the Securities Act. Future consolidated financial statements of CMS Energy and the reports thereon of Arthur Andersen LLP also will be incorporated by reference in this Prospectus in reliance upon the authority of that firm as experts in giving those reports to the extent that said firm has audited said consolidated financial statements and consented to the use of their reports thereon. PART II. INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS. The following resolution was adopted by the Board of Directors of CMS Energy on May 6, 1987: RESOLVED: That effective March 1, 1987 the Corporation shall indemnify to the full extent permitted by law every person (including the estate, heirs and legal representatives of such person in the event of the decease, incompetency, insolvency or bankruptcy of such person) who is or was a director, officer, partner, trustee, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against all liability, costs, expenses, including attorneys' fees, judgments, penalties, fines and amounts paid in settlement, incurred by or imposed upon the person in connection with or resulting from any claim or any threatened, pending or completed action, suit or proceeding whether civil, criminal, administrative, investigative or of whatever nature, arising from the person's service or capacity as, or by reason of the fact that the person is or was, a director, officer, partner, trustee, employee or agent of the Corporation or is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee or agent of another corporation, partnership, joint venture, trust or other enterprise. Such right of indemnification shall not be deemed exclusive of any other rights to which the person may be entitled under statute, bylaw, agreement, vote of shareholders or otherwise. The Corporation may purchase and maintain liability insurance, to the full extent permitted by law, on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against such person and incurred by such person in any such capacity. Article VIII of the Articles of Incorporation reads: A director shall not be personally liable to the Corporation or its shareholders for monetary damages for breach of duty as a director except (i) for a breach of the director's duty of loyalty to the Corporation or its shareholders, (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) for a violation of Section 551(1) of the Michigan Business Corporation Act, and (iv) any transaction from which the director derived an improper personal benefit. No amendment to or repeal of this Article VIII, and no modification to its provisions by law, shall apply to, or have any effect upon, the liability or alleged liability of any director of the Corporation for or with respect to any acts or omissions of such director occurring prior to such amendment, repeal or modification. Article IX of the Articles of Incorporation reads: Each director and each officer of the Corporation shall be indemnified by the Corporation to the fullest extent permitted by law against expenses (including attorneys' fees), judgments, penalties, fines and amounts paid in settlement actually and reasonably incurred by him or her in connection with the defense of any proceeding in which he or she was or is a party or is threatened to be made a party by reason of being or having been a director or an officer of the Corporation. Such right of indemnification is not exclusive of any other rights to which such director or officer may be entitled under any now or thereafter existing statute, any other provision of these Articles, bylaw, agreement, vote of shareholders or otherwise. If the Business Corporation Act of the State of Michigan is amended after approval by the shareholders of this Article IX to authorize corporate action further eliminating or limiting the personal liability of directors, then the liability of a director of the Corporation shall be eliminated or limited to the fullest extent permitted by the Business Corporation Act of the State of Michigan, as so amended. Any repeal or modification of this Article IX by the shareholders of the Corporation shall not adversely affect any right or protection of a director of the Corporation existing at the time of such repeal or modification. Sections 561 through 571 of the Michigan Business Corporation Act provide as follows: Sec. 561. A corporation has the power to indemnify a person who was or is a party or is threatened to be made a party to a threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative, or investigative and whether formal or informal, other than an action by or in the right of the corporation, by reason of the fact that he or she is or was a director, officer, employee, or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, or other enterprise, whether for profit or not, against expenses, including attorneys' fees, judgments, penalties, fines, and amounts paid in settlement actually and reasonably incurred by him or her in connection with the action, suit, or proceeding, if the person acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the corporation or its shareholders, and with respect to a criminal action or proceeding, if the person had no reasonable cause to believe his or her conduct was unlawful. The termination of an action, suit, or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, does not, of itself, create a presumption that the person did not act in good faith and in a manner which he or she reasonably believed to be in or not opposed to the best interests of the corporation or its shareholders, and, with respect to a criminal action or proceeding, had reasonable cause to believe that his or her conduct was unlawful. Sec. 562. A corporation has the power to indemnify a person who was or is a party or is threatened to be made a party to a threatened, pending, or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that he or she is or was a director, officer, employee, or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, or other enterprise, whether for profit or not, against expenses, including attorneys' fees, and amounts paid in settlement actually and reasonably incurred by the person in connection with the action or suit, if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation or its shareholders. Indemnification shall not be made for a claim, issue, or matter in which the person has been found liable to the corporation except to the extent authorized in Section 564c. Sec. 563. To the extent that a director, officer, employee, or agent of a corporation has been successful on the merits or otherwise in defense of an action, suit, or proceeding referred to in Section 561 or 562, or in defense of a claim, issue, or matter in the action, suit, or proceeding, he or she shall be indemnified against actual and reasonable expenses, including attorneys' fees, incurred by him or her in connection with the action, suit, or proceeding and an action, suit, or proceeding brought to enforce the mandatory indemnification provided in this section. Section 564a. (1) An indemnification under Section 561 or 562, unless ordered by the court, shall be made by the corporation only as authorized in the specific case upon a determination that indemnification of the director, officer, employee, or agent is proper in the circumstances because he or she has met the applicable standard of conduct set forth in Sections 561 and 562 and upon an evaluation of the reasonableness of expenses and amounts paid in settlement. This determination and evaluation shall be made in any of the following ways: (a) By a majority vote of a quorum of the board consisting of directors who are not parties or threatened to be made parties to the action, suit, or proceeding. (b) If a quorum cannot be obtained under subdivision (a), by majority vote of a committee duly designated by the board and consisting solely of 2 of more directors not at the time parties or threatened to be made parties to the action, suit, or proceeding. (c) By independent legal counsel in a written opinion, which counsel shall be selected in 1 of the following ways: (i) By the board or its committee in the manner prescribed in subdivision (a) or (b). (ii) If a quorum of the board cannot be obtained under subdivision (a) and a committee cannot be designated under subdivision (b), by the board. (d) By all independent directors who are not parties or threatened to be made parties to the action, suit, or proceeding. (e) By the shareholders, but shares held by directors, officers, employees, or agents who are parties or threatened to be made parties of the action, suit, or proceeding may not be voted. (2) In the designation of a committee under subsection (1)(b) or in the selection of independent legal counsel under subsection (1)(c)(ii), all directors may participate. (3) If a person is entitled to indemnification under Section 561 or 562 for a portion of expenses, including reasonable attorneys' fees, judgments, penalties, fines, and amounts paid in settlement, but not for the total amount, the corporation may indemnify the person for the portion of the expenses, judgments, penalties, fines, or amounts paid in settlement for which the person is entitled to be indemnified. Sec. 564b. (1) A corporation may pay or reimburse the reasonable expenses incurred by a director, officer, employee, or agent who is a party or threatened to be made a party to an action, suit, or proceeding in advance of final disposition of the proceeding if all of the following apply: (a) The person furnishes the corporation a written affirmation of his or her good faith belief that he or she has met the applicable standard of conduct set forth in Sections 561 and 562. (b) The person furnishes the corporation a written undertaking, executed personally or on his or her behalf, to repay the advance if it is ultimately determined that he or she did not meet the standard of conduct. (c) A determination is made that the facts then known to those making the determination would not preclude indemnification under this act. (2) The undertaking required by subsection (1)(b) must be an unlimited general obligation of the person but need not be secured. (3) Determinations and evaluations under this section shall be made in the manner specified in Section 564a. Section 564c. A director, officer, employee, or agent of the corporation who is a party or threatened to be made a party to an action, suit, or proceeding may apply for indemnification to the court conducting the proceeding or to another court of competent jurisdiction. On receipt of an application, the court after giving any notice it considers necessary may order indemnification if it determines that the person is fairly and reasonably entitled to indemnification in view of all the relevant circumstances, whether or not he or she met the applicable standard of conduct set forth in Sections 561 and 562 or was adjudged liable as described in Section 562, but if he or she was adjudged liable, his or her indemnification is limited to reasonable expenses incurred. Sec. 565. (1) The indemnification or advancement of expenses provided under Sections 561 to 564c is not exclusive of other rights to which a person seeking indemnification or advancement of expenses may be entitled under the articles of incorporation, bylaws, or a contractual agreement. The total amount of expenses advanced or indemnified from all sources combined shall not exceed the amount of actual expenses incurred by the person seeking indemnification or advancement of expenses. (2) The indemnification provided for in Sections 561 to 565 continues as to a person who ceases to be a director, officer, employee, or agent and shall inure to the benefit of the heirs, personal representatives, and administrators of the person. Sec. 567. A corporation shall have power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee, or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, partner, trustee, employee, or agent of another corporation, partnership, joint venture, trust, or other enterprise against any liability asserted against him or her and incurred by him or her in any such capacity or arising out of his or her status as such, whether or not the corporation would have power to indemnify him or her against liability under Sections 561 to 565. Sec. 569. For purposes of Sections 561 to 567, "corporation" includes all constituent corporations absorbed in a consolidation or merger and the resulting or surviving corporation, so that a person who is or was a director, officer, partner, trustee, employee, or agent of the constituent corporation or is or was serving at the request of the constituent corporation as a director, officer, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, or other enterprise whether for profit or not shall stand in the same position under the provisions of this section with respect to the resulting or surviving corporation as the person would if he or she had served the resulting or surviving corporation in the same capacity. Sec. 571. For the purposes of Sections 561 to 567: (a) "Fines" shall include any excise taxes assessed on a person with respect to an employee benefit plan. (b) "Other enterprises" shall include employee benefit plans. (c) "Serving at the request of the corporation" shall include any service as a director, officer, employee, or agent of the corporation which imposes duties on, or involves services by, the director, officer, employee, or agent with respect to an employee benefit plan, its participants, or its beneficiaries. (d) A person who acted in good faith and in a manner he or she reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be considered to have acted in a manner "not opposed to the best interests of the corporation or its shareholders" as referred to in Sections 561 and 562. Officers and directors are covered within specified monetary limits by insurance against certain losses arising from claims made by reason of their being directors or officers of the Corporation or of the Corporation's subsidiaries and the Corporation's officers and directors are indemnified against such losses by reason of their being or having been directors or officers of another corporation, partnership, joint venture, trust or other enterprise at the Corporation's request. In addition, the Corporation has indemnified each of its present directors by contracts that contain affirmative provisions essentially similar to those in Sections 561 through 571 of the Michigan Business Corporation Act cited above. * (3)(i) - Restated Articles of Incorporation of CMS Energy, as filed with the Michigan Department of Commerce on June 6, 1995. (3)(ii) - Copy of the By-Laws of CMS Energy. (Designated in CMS Energy's Form 10-K for the year ended December 31, 1994, File No. 1-9513, as Exhibit (3)(b).) (4)(i) - Indenture dated as of September 15, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form S-3 Registration Statement filed May 1, 1992, File No. (4)(i)(A) - First Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4)(i)(B) - Second Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4)(ii) - Credit Agreement dated as of November 21, 1995, among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent, the Operational Agent and the Co- Manager, all as defined therein, and the Exhibits thereto. (4)(ii)(A) - Term Loan Agreement dated as of November 21, 1995 among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent, the Operational Agent and the Co- Managers, all as defined therein, and the Exhibits thereto. (4)(iii) - Indenture dated as of January 15, 1994 between CMS Energy and The Chase Manhattan Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated March 29, 1994, File No. 1-9513, as Exhibit (4)(a).) (4)(iii)(A) - First Supplemental Indenture dated as of January 20, 1994 between CMS Energy and The Chase Manhattan Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated March 29, 1994, File No. 1-9513, as Exhibit (5) - Opinion of Counsel. (15) - Letter on unaudited interim financial information. (21) - Subsidiaries of the registrant. (Designated in CMS Energy's Form 10-K for the year ended December 31, 1994, File No. 1-9513 as Exhibit (21)(a).) (23)(i) - Consent of Arthur Andersen LLP. (23)(ii) - Consent of Counsel is contained in Exhibit 5 hereto. (24) - Powers of Attorney. * Previously filed. Exhibits listed above which have been filed with the Securities and Exchange Commission are incorporated herein by reference with the same effect as if filed with this registration statement. (a) The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement; Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement; provided, however, that (i) and (ii) do not apply if the registration statement is on Form S-3 or Form S-8, and the information required to be included in a post-effective amendment by those paragraphs is contained in periodic reports filed by the registrant pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 that are incorporated by reference in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (b) The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933, each filing of the registrant's annual report pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 that is incorporated by reference in this registration statement shall be deemed to be a new registration statement relating to the securities offered herein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (c) The undersigned registrant hereby undertakes as follows: prior to any public reoffering of the securities registered hereunder through use of a prospectus which is a part of this registration statement, by any person or party who is deemed to be an underwriter within the meaning of Rule 145(c), the issuer undertakes that such reoffering prospectus will contain the information called for by the applicable registration form with respect to reofferings by persons who may be deemed underwriters, in addition to the information called for by the other Items of the applicable form. (d) The undersigned registrant undertakes that every prospectus (i) that is filed pursuant to the immediately preceding paragraph or (ii) that purports to meet the requirements of Section 10(a)(3) of the Securities Act and is used in connection with the offering of securities subject to Rule 415 will be filed as a part of an amendment to the registration statement and will not be used until such amendment is effective, and that, for purposes of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the bona fide offering thereof. (e) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the provisions described under Item 20 above, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (f) The undersigned registrant hereby undertakes to respond to requests for information that is incorporated by reference into the prospectus pursuant to Items 4, 10(b), 11, or 13 of this Form, within one business day of receipt of such request, and to send the incorporated documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent to the effective date of the registration statement through the date of responding to the request. (g) The undersigned registrant hereby undertakes to supply by means of a post-effective amendment all information concerning a transaction, and the company being acquired involved therein, that was not the subject of and included in the registration statement when it became effective, except where the transaction in which the securities being offered pursuant to this registration statement (i) would itself qualify for an exemption from Section 5 of the Securities Act of 1993, absent the existence of other similar (prior or subsequent) transactions, and (ii) would not be material to the Registrant. Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Dearborn, and State of Michigan, on the 10th day of January, 1996. Chief Financial Officer and Treasurer Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities indicated on the 10th day of January, 1996. (i) Principal executive officer: Chairman of the Board, /s/William T. McCormick, Jr. and Director /s/A. M. Wright Chief Financial Officer /s/P. D. Hopper and Chief Accounting Officer THE SECURITIES ACT OF 1933 * (3)(i) - Restated Articles of Incorporation of CMS Energy, as filed with the Michigan Department of Commerce on June 6, 1995. (3)(ii) - Copy of the By-Laws of CMS Energy. Form 10-K for the year ended December 31, 1994, File No. 1-9513, (4)(i) - Indenture dated as of September 15, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Statement filed May 1, 1992, File No. 33-47629, as Exhibit (4)(a).) (4)(i)(A) - First Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).) (4)(i)(B) - Second Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).) (4)(ii) - Credit Agreement dated as of November 21, 1995, among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent, the Operational Agent and the Co-Manager, all as defined therein, and the Exhibits thereto. (4)(ii)(A) - Term Loan Agreement dated as of November 21, 1995 among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent, the Operational Agent and the Co-Managers, all as defined therein, and the Exhibits thereto. (4)(iii) - Indenture dated as of January 15, 1994 between CMS Energy and The Chase Manhattan Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated March 29, 1994, File No. 1-9513, as (4)(iii)(A)- First Supplemental Indenture dated as of January 20, 1994 between CMS Energy and The Chase Manhattan Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated March 29, 1994, File No. 1-9513, as Exhibit (4)(b).) (5) - Opinion of Counsel. (15) - Letter on unaudited interim financial information. (21) - Subsidiaries of the registrant. (Designated in CMS Energy's Form 10-K for the year ended December 31, 1994, File No. 1-9513 as Exhibit (21)(a).) (23)(i) - Consent of Arthur Andersen LLP. (23)(ii) - Consent of Counsel is contained in Exhibit 5 hereto. (24) - Powers of Attorney. * Previously filed. Exhibits listed above which have been filed with the Securities and Exchange Commission are incorporated herein by reference with the same effect as if filed with this registration statement.	POS AM	POS AM	1996-01-12T00:00:00	1996-01-12T15:11:58
0000950005-96-000008	0000950005-96-000008_0000.txt	<DESCRIPTION>POST-EFFECTIVE AMENDMENT ON FORM N-1A As filed with the Securities and Exchange Commission on January 12, 1996 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 (Exact Name of Registrant as Specified in its Charter) (Address of Principal Executive Office) (Registrant's Telephone Number, Including Area Code) (Name and Address of Agent for Service) It is proposed that this filing will become effective: X immediately upon filing pursuant to Rule 485(b) ___ on ________________ pursuant to Rule 485(b) ___ 60 days after filing pursuant to Rule 485(a)(1) ___ 75 days after filing pursuant to Rule 485(a)(2) ___ on _________________ pursuant to Rule 485(a) Pursuant to Rule 24f-2 under the Investment Company Act of 1940, the Registrant has registered an indefinite number of securities under the Securities Act of 1933. The Rule 24f-2 Notice for the Registrant's fiscal year ended June 30, 1995 was filed on August 28, 1995. Please Send Copy of Communications to: Heller, Ehrman, White & McAuliffe Total number of pages 66. Exhibit Index appears at 64. This post-effective amendment to the registration statement of the Registrant contains the following documents: Cross-Reference Sheet for Montgomery Equity Income Fund, Montgomery Small Cap Fund and Montgomery Emerging Markets Fund Part A - Additional Prospectus for Class P Shares of Montgomery Equity Income Fund, Montgomery Small Cap Fund and Montgomery Part C - Other Information This Amendment does not relate to the following documents: existing effective prospectuses and Statements of Additional Information for the Class R shares, Class P shares and Class L shares for Montgomery Growth Fund, Montgomery Equity Income Fund, Montgomery Small Cap Fund, Montgomery Micro Cap Fund, Montgomery Global Opportunities Fund, Montgomery Global Communications Fund, Montgomery International Small Cap Fund, Montgomery International Growth Fund, Montgomery Emerging Markets Fund, Montgomery Select 50 Fund, Montgomery Short Government Bond Fund, Montgomery Government Reserve Fund, Montgomery California Tax-Free Intermediate Bond Fund, Montgomery California Tax-Free Money Fund, Montgomery Advisors Emerging Markets Fund, Montgomery Small Cap II Fund and Montgomery Technology Fund. ADDITIONAL PROSPECTUS FOR CLASS P SHARES The following three mutual funds (individually, a "Fund" and, collectively, the "Funds") are offered in this Prospectus: o Montgomery Equity Income Fund o Montgomery Small Cap Fund o Montgomery Emerging Markets Fund Each Fund's shares offered in this Prospectus (the Class P shares) are sold at net asset value with no sales load, no commissions and no redemption or exchange fees. The Class P shares are subject to a Rule 12b-1 distribution fee as described in this Prospectus. In general, the minimum initial investment in each Fund is $500, and subsequent investments must be at least $100. The Manager or the Distributor, in either's discretion, may waive these minimums. See "How to Invest in the Funds." Each Fund is a separate series of The Montgomery Funds, an open-end management investment company, and managed by Montgomery Asset Management, L.P. (the "Manager"), an affiliate of Montgomery Securities (the "Distributor"). Each Fund has its own investment objective and policies designed to meet different investment goals. As is the case for all mutual funds, attainment of each Fund's investment objective cannot be assured. Please read this Prospectus before investing and retain it for future reference. A Statement of Additional Information dated December 29, 1995, as may be revised, has been filed with the Securities and Exchange Commission, is incorporated by this reference and is available without charge by calling (800) 572-FUND. If you are viewing the electronic version of this prospectus through an on-line computer service, you may request a printed version free of charge by calling (800) 572-FUND. The Internet address for The Montgomery Funds is http://www.xperts.montgomery.com/1. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. Fees and Expenses of the Funds 4 The Funds' Investment Objectives and Policies 7 Management of the Funds 15 How To Invest in the Funds 18 How To Redeem an Investment in the Funds 21 Exchange Privileges and Restrictions 22 Brokers and Other Intermediaries 23 How Net Asset Value is Determined 23 The Funds' investment objectives are summarized below. See "The Funds' Investment Objectives and Policies" beginning on page 7, "Portfolio Securities" beginning on page 9, "Other Investment Practices" beginning on page 11 and "Risk Considerations" beginning on page 14 for more detailed information. Seeks current income and capital appreciation by investing primarily in income-producing equity securities of domestic companies, with the goal to provide significantly greater yield than the average yield offered by the stocks of the Standard and Poor's 500 Composite Price Index ("S&P 500") and a low level of price volatility. Seeks capital appreciation by investing primarily in equity securities, usually common stocks, of small-capitalization domestic companies, which the Fund currently considers to be companies having total market capitalizations of less than $1 billion. Seeks capital appreciation by investing primarily in equity securities of companies in countries having economies and markets generally considered by the World Bank or the United Nations to be emerging or developing. The Funds offer other classes of shares to investors eligible to purchase those shares. The other classes of shares may have different fees and expenses than the class of shares offered in this Prospectus, and those different fees and expenses may affect performance. To obtain information concerning the other classes of shares not offered in this Prospectus, call The Montgomery Funds at (800) 572-FUND or contact sales representatives or financial intermediaries who offer those classes. FEES AND EXPENSES OF THE FUNDS The previous tables are intended to assist the investor in understanding the various direct and indirect costs and expenses of each Fund. Operating expenses are paid out of a Fund's assets and are factored into the Fund's share price. Each Fund estimates that it will have the expenses listed (expressed as a percentage of average net assets) for the current fiscal year. Because Rule 12b-1 distribution charges are accounted for on a class-level basis (and not on an individual shareholder-level basis), individual long-term investors in the Class P shares of a Fund may over time pay more than the economic equivalent of the maximum front-end sales charge permitted by the National Association of Securities Dealers, Inc. ("NASD"), even though all shareholders of that Class in the aggregate will not. This is recognized and permitted by the NASD. + Shareholders effecting redemptions via wire transfer may be required to pay fees, including the wire fee and other fees, that will be directly deducted from redemption proceeds. THE MONTGOMERY FUNDS RESERVE THE RIGHT UPON 60 DAYS' ADVANCE NOTICE TO SHAREHOLDERS TO IMPOSE A REDEMPTION FEE OF UP TO 1.00% ON SHARES REDEEMED WITHIN 90 DAYS OF PURCHASE. See "How to Redeem an Investment in the Funds." * Expenses for the Funds are based on actual expenses and expense limitations for the fiscal year ended June 30, 1995 for another class of shares (but adjusted to include the Rule 12b-1 fee for the Class P shares) because the Class P shares were not offered that year. The Manager will reduce its fees and may absorb or reimburse a Fund for certain expenses to the extent necessary to limit total annual fund operating expenses to the lesser of the amount indicated in the table for a Fund or the maximum allowed by applicable state expense limitations. A Fund is required to reimburse the Manager for any reductions in the Manager's fee only during the two years following that reduction and only if such reimbursement can be achieved within the foregoing expense limits. The Manager generally seeks reimbursement for the oldest reductions and waivers before payment for fees and expenses for the current year. Absent reduction and including the Rule 12b-1 fee for the Class P shares, actual total Fund operating expenses for the period ended June 30, 1995 (annualized) would have been as follows for the Montgomery Equity Income Fund, 3.41% (2.81% other expenses). The Manager may terminate these voluntary reductions at any time. See "Management of the Funds." This example is to help potential investors understand the effect of expenses. Investors should understand that this example does not represent past or future expenses or returns and that actual expenses and returns may vary. THE FUNDS' INVESTMENT OBJECTIVES AND POLICIES The investment objective and general investment policies of each Fund are described below. Specific portfolio securities that may be purchased by the Funds are described in "Portfolio Securities" beginning on page 9. Specific investment practices that may be employed by the Funds are described in "Other Investment Practices" beginning on page 11. Certain risks associated with investments in the Funds are described in those sections as well as in "Risk Considerations" beginning on page 14. o MONTGOMERY EQUITY INCOME FUND The investment objective of Montgomery Equity Income Fund (the "Equity Income Fund") is to provide current income and capital appreciation primarily through investments in equity securities of domestic companies, with the goal that the Fund provide a significantly greater yield than the average yield offered by the stocks of the S&P 500 and a low level of price volatility. Under normal market conditions, the Equity Income Fund will invest at least 65% of the value of its total assets in income-producing equity securities of domestic companies, which include common stocks, preferred stocks and other securities, and debt securities convertible into common stocks. The Fund's equity investments emphasize common stock of U.S. corporations that regularly pay dividends. The Fund normally invests in companies having a total market capitalization of more than $1 billion, targeting companies with favorable long-term fundamental characteristics with current relative yields at the upper end of their historical ranges. The Fund initially identifies a universe of investment candidates by screening companies based on relative yield and targeting companies with a minimum yield of 140% of the average yield of the S&P 500. The Fund uses this relative yield strategy to assist in identifying undervalued securities. The companies are usually in the maturing stages of development or operating in slower growth areas of the economy, and have conservative accounting, strong cash flows to maintain dividends, low financial leverage and market leadership. The Fund usually holds companies for a period of two to four years, resulting in relatively low turnover. The Fund will usually begin to reduce its position in a company as the price moves up and yield drops to the lower end of its historical range. In addition, the Fund will usually reduce or sell its holdings in a company that reduces or eliminates its dividend, or upon a significant fundamental change impairing a company's ability to pay dividends. See "Portfolio Securities." Although the Fund normally invests more than 65% of its assets in income-producing equity securities as described above, under normal market conditions it may invest up to 35% of its total assets in debt instruments, emphasizing cash equivalents in an effort to provide income at money market rates while minimizing the risk of decline in value. Cash equivalents are short-term, interest bearing instruments or deposits and may include, for example, commercial paper, certificates of deposit, repurchase agreements, bankers' acceptances, U.S. Treasury Bills, bank money market deposit accounts, master demand notes and money market mutual funds. These consist of high-quality debt obligations, certificates of deposit and bankers' acceptances rated at least A-1 by Standard and Poor's Corporation ("S&P") or Prime-1 by Moody's Investors Services, Inc. ("Moody's"), or the issuer has an outstanding issue of debt securities rated at least A by S&P or Moody's, or are of comparable quality in the opinion of the Manager. (See Appendix in the Statement of Additional Information.) The Fund attempts to achieve low price volatility through its investment in mature companies and by investing in cash and cash equivalents. In addition, the Fund may invest up to 20% of its total assets in the equity or debt securities of foreign issuers. See "Portfolio Securities." John H. Brown is responsible for managing the Equity Income Fund's portfolio. See "Management of the Funds." o MONTGOMERY SMALL CAP FUND The investment objective of Montgomery Small Cap Fund (the "Small Cap Fund") is capital appreciation, which under normal conditions it seeks by investing at least 65% of its total assets in equity securities of small-capitalization domestic companies, which the Fund currently considers to be companies having total market capitalizations of less than $1 billion. The Small Cap Fund generally invests the remaining 35% of its total assets in a similar manner but may invest those assets in companies having total market capitalizations of $1 billion or more. Generally, the Small Cap Fund invests at least 80% of its total assets in common stock. It also may invest in other types of equity and equity derivative securities (including options on equity securities, warrants and futures contracts on equity securities) but limits to 5% of its total assets any single other type of security. Any debt securities purchased by this Fund must be rated within the three highest grades by S&P (AAA to A), Moody's (Aaa to A) or Fitch Investor Services, Inc. ("Fitch") (AAA to A), or in unrated debt securities deemed to be of comparable quality by the Manager using guidelines approved by the Board of Trustees. See "Portfolio Securities." Current income from dividends, interest and other sources is only incidental. The Small Cap Fund seeks to identify potential growth companies at an early stage or a transitional point of the companies' developments, such as the introduction of new products, favorable management changes, new marketing opportunities or increased market share for existing product lines. Using fundamental research, the Fund targets businesses having positive internal dynamics that can outweigh unpredictable macro-economic factors, such as interest rates, commodity prices, foreign currency rates and overall stock market volatility. The Fund searches for companies with potential to gain market share within their respective industries; achieve and maintain high and consistent profitability; produce increases in quarterly earnings; and provide solutions to current or impending problems in their respective industries or society at large. Early identification of potential investments is a key to the Fund's investment style. Heavy emphasis is placed on in-house research, which includes discussions with company management. The Fund also draws on the expertise of brokerage firms, including Montgomery Securities and regional firms that closely follow smaller capitalization companies within their geographic regions. The Small Cap Fund was closed to new investors in its Class R shares on March 6, 1992, but is open for investment through certain plans and financial intermediaries in its Class P shares. Stuart O. Roberts is responsible for managing the Small Cap Fund's portfolio. See "Management of the Funds." The Equity Income and Small Cap Funds together are the "Domestic Equity Funds." o MONTGOMERY EMERGING MARKETS FUND The investment objective of Montgomery Emerging Markets Fund (the "Emerging Markets Fund") is capital appreciation, which under normal conditions it seeks by investing at least 65% of its total assets in equity securities of companies in countries having emerging markets. For these purposes, this Fund defines an emerging market country as having an economy and market that are or would be considered by the World Bank or the United Nations to be emerging or developing. This Fund currently limits its investments to the following emerging market countries: Latin America (Argentina, Brazil, Chile, Colombia, Costa Rica, Jamaica, Mexico, Peru, Trinidad and Tobago, Uruguay, Venezuela); Asia (China, India, Indonesia, Korea, Malaysia, Pakistan, Philippines, Singapore, Sri Lanka, Taiwan, Thailand, Vietnam); Southern and Eastern Europe (Czech Republic, Greece, Hungary, Poland, Portugal, Turkey); Mid-East (Israel, Jordan); and Africa (Egypt, Ghana, Ivory Coast, Kenya, Morocco, Nigeria, South Africa, Tunisia, Zimbabwe). In the future, the Fund may invest in other emerging market countries. Under normal conditions, the Emerging Markets Fund maintains investments in at least six emerging market countries at all times and invests no more than 35% of its total assets in any one emerging market country. This Fund considers a company to be an emerging market company if its securities are principally traded in the capital market of an emerging market country; it derives at least 50% of its total revenue from either goods produced or services rendered in emerging market countries or from sales made in such emerging market countries, regardless of where the securities of such companies are principally traded; or it is organized under the laws of, and with a principal office in, an emerging market country. This Fund uses a proprietary, quantitative asset allocation model created by the Manager. This model employs mean-variance optimization, a process used in developed markets based on modern portfolio theory and statistics. Mean-variance optimization helps determine the percent of assets to invest in each country to maximize expected returns for a given risk level. The Fund's aims are to invest in those countries that are expected to have the highest risk/reward trade-off when incorporated into a total portfolio context and to construct a portfolio of emerging market investments approximating the risk level of an internationally diversified portfolio of securities in developed markets. This "top-down" country selection is combined with "bottom-up" fundamental industry analysis and stock selection based on original research and publicly available information and company visits. This Fund invests primarily in common stock but also may invest in other types of equity and equity derivative securities. It may invest up to 35% of its total assets in debt securities, including up to 5% in debt securities rated below investment grade. See "Portfolio Securities," "Risk Considerations" and the Appendix in the Statement of Additional Information. This Fund may invest in certain debt securities issued by the governments of emerging market countries that are, or may be eligible for, conversion into investments in emerging market companies under debt conversion programs sponsored by such governments. If such securities are convertible to equity investments, the Fund deems them to be equity derivative securities. This Fund may invest no more than 20% of its total assets in the equity securities of companies constituting the Morgan Stanley Capital International Europe, Australia, Far East Index (the "EAFE Index"). See "Portfolio Securities." These companies typically have larger average market capitalizations than the emerging market companies in which this Fund generally invests. Accordingly, subject to its investment objective, this Fund invests in EAFE Index companies for temporary defensive strategies. Josephine Jimenez, CFA, Bryan L. Sudweeks, Ph.D., CFA, Thomas R. Haslett, CFA and Angeline Ee, are jointly responsible for managing the Emerging Markets Fund's portfolio. See "Management of the Funds." In seeking their respective investment objectives, the Funds emphasize investments in common stock. The Funds may also invest in other types of equity securities and equity derivative securities such as preferred stocks, convertible securities, warrants, units, rights, options on securities and on securities indices. The Funds may invest in both sponsored and unsponsored American Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") and other similar global instruments. ADRs typically are issued by a U.S. bank or trust company and evidence ownership of underlying securities issued by a foreign corporation. EDRs, sometimes called Continental Depositary Receipts, are issued in Europe, typically by foreign banks and trust companies, and evidence ownership of either foreign or domestic underlying securities. Unsponsored ADR and EDR programs are organized without the cooperation of the issuer of the underlying securities. As a result, available information concerning the issuer may not be as current as for sponsored ADRs and EDRs, and the prices of unsponsored ADRs and EDRs may be more volatile. The Funds may invest in convertible securities. A convertible security is a fixed-income security (a bond or preferred stock) that may be converted at a stated price within a specified period of time into a certain quantity of the common stock of the same or a different issuer. Convertible securities are senior to common stock in a corporation's capital structure but are usually subordinated to similar non-convertible securities. Through their conversion feature, they provide an opportunity to participate in capital appreciation resulting from a market price advance in the underlying common stock. The price of a convertible security is influenced by the market value of the underlying common stock and tends to increase as the common stock's market value rises and decrease as the common stock's market value declines. For purposes of allocating Fund investments, the Manager regards convertible securities as a form of equity security. The Funds may invest up to 5% of their net assets in warrants, including up to 2% of net assets for those not listed on a securities exchange. A warrant typically is a long-term option that generally permits the holder to buy a specified number of shares of the issuer's underlying common stock at a specified exercise price by a particular expiration date. Stock index warrants entitle the holder to receive, upon exercise, an amount in cash determined by reference to fluctuations in the level of a specified stock index. A warrant not exercised or disposed of by its expiration date expires worthless. The Emerging Markets Fund believes that foreign government programs of selling interests in government-owned or controlled enterprises ("privatizations") may represent opportunities for significant capital appreciation, and the Fund may invest in privatizations. The ability of U.S. entities, such as the Fund, to participate in privatizations may be limited by local law, or the terms for participation may be less advantageous than for local investors. There can be no assurance that privatization programs will be successful. The Emerging Markets Fund believes that carefully selected investments in joint ventures, cooperatives, partnerships, private placements, unlisted securities and similar vehicles (collectively, "special situations") could enhance its capital appreciation potential. This Fund also may invest in certain types of vehicles or derivative securities that represent an indirect investment in foreign markets or securities in which it is impracticable for the Fund to directly invest. Investments in special situations may be illiquid, as determined by the Manager based on criteria reviewed by the Board. The Fund does not invest more than 15% of its net assets in illiquid investments, including special situations. Each Fund may invest up to 10% of its total assets in shares of other investment companies investing exclusively in securities in which it may otherwise invest. Because of restrictions on direct investment by U.S. entities in certain countries, other investment companies may provide the most practical or only way for the Emerging Markets Fund to invest in certain markets. Such investments may involve the payment of substantial premiums above the net asset value of those portfolio securities and are subject to limitations under the Investment Company Act. The Emerging Markets Fund also may incur tax liability to the extent it invests in the stock of a foreign issuer that is a "passive foreign investment company" regardless of whether such "passive foreign investment company" makes distributions to the Fund. See the Statement of Additional Information. The Funds do not intend to invest in other investment companies unless, in the Manager's judgment, the potential benefits exceed associated costs. As a shareholder in an investment company, the Funds bear their ratable share of that investment company's expenses, including advisory and administration fees. In accordance with applicable state regulatory provisions, the Manager has agreed to waive its own management fee with respect to the portion of the Funds' assets invested in other open-end (but not closed-end) investment companies. The Emerging Markets Fund may purchase debt securities that complement its objective of capital appreciation through anticipated favorable changes in relative foreign exchange rates, in relative interest rate levels, or in the creditworthiness of issuers. Debt securities may constitute up to 35% of the Equity Income Fund's total assets. In selecting debt securities, the Manager seeks out good credits and analyzes interest rate trends and specific developments that may affect individual issuers. As an operating policy which may be changed by the Board, the Emerging Markets Fund will not invest more than 5% of its total assets in debt securities rated lower than BBB by S&P, Baa by Moody's or BBB by Fitch, or in unrated debt securities deemed to be of comparable quality by the Manager using guidelines approved by its Board of Trustees, and the Domestic Equity Funds will not invest more than 5% of their total assets in debt securities rated lower than A by S&P, A by Moody's and A by Fitch, or in unrated securities deemed to be of comparable quality by the Manager using guidelines approved by the Board. Subject to this limitation, the Emerging Markets Fund may invest in any debt security, including securities in default. After its purchase by a Fund a debt security may cease to be rated or its rating may be reduced below that required for purchase by the Fund. Neither event would require elimination of that security from the Fund's portfolio. However, a security downgraded below the Fund's minimum credit levels generally would be retained only if retention was determined by the Manager and subsequently by the Board to be in the best interests of the Fund. See "Risk Considerations." The debt instruments in which the Equity Income Fund invests are primarily cash equivalents intended to provide income at money market rates while minimizing risk of decline in value. Cash equivalents are short-term, interest-bearing instruments or deposits and may include, for example, commercial paper certificates of deposit, repurchase agreements, bankers acceptances, U.S. Treasury Bills, bank money market deposit accounts, master demand notes and money market funds. In addition to traditional corporate, government and supranational debt securities, each of the Emerging Markets and Equity Income Funds may invest in external (i.e., to foreign lenders) debt obligations issued by the governments, governmental entities and companies of emerging market countries. The percentage distribution between equity and debt will vary from country to country. The following factors, among others, will influence the proportion of each of these Funds' assets to be invested in equity securities versus debt securities: levels and anticipated trends in inflation and interest rates; expected rates of economic growth and corporate profits growth; changes in government policy, including regulations governing industry, trade, financial markets, and foreign and domestic investment; stability, solvency and expected trends of government finances; and conditions of the balance of payments and changes in the terms of trade. All Funds may invest in fixed rate and floating or variable rate U.S. Government securities. Certain of the obligations, including U.S. Treasury Bills, Notes and Bonds, and mortgage-related securities of the Government National Mortgage Association ("GNMA"), are issued or guaranteed by the U.S. Government. Other securities issued by U.S. Government agencies or instrumentalities are supported only by the credit of the agency or instrumentality, for example those issued by the Federal Home Loan Bank, while others, such as those issued by the Federal National Mortgage Association ("FNMA"), Farm Credit System and Student Loan Marketing Association, have an additional line of credit with the U.S. Treasury. Short-term U.S. Government securities generally are considered to be among the safest short-term investments. However, the U.S. Government does not guarantee the net asset value of the Funds' shares. With respect to U.S. Government securities supported only by the credit of the issuing agency or instrumentality or by an additional line of credit with the U.S. Treasury, there is no guarantee that the U.S. Government will provide support to such agencies or instrumentalities. Accordingly, such U.S. Government securities may involve risk of loss of principal and interest. STRUCTURED NOTES AND INDEXED SECURITIES The Funds may invest in structured notes and indexed securities. Structured notes are debt securities, the interest rate or principal of which is determined by an unrelated indicator. Indexed securities include structured notes as well other than debt securities, the interest rate or principal of which is determined by an unrelated indicator. Index securities may include a multiplier that multiplies the indexed element by a specified factor and, therefore, the value of such securities may be very volatile. To the extent a Fund invests in these securities, however, the Manager analyzes these securities in its overall assessment of the effective duration of the Fund's portfolio in an effort to monitor the Fund's interest rate risk. Each of the Funds may invest up to 5% of its total assets in asset-backed securities, which represent a direct or indirect participation in, or are secured by and payable from, pools of assets, such as motor vehicle installment sales contracts, installment loan contracts, leases of various types of real and personal property and receivables from revolving credit (e.g., credit card) agreements. Payments or distributions of principal and interest on asset-backed securities may be supported by credit enhancements, such as various forms of cash collateral accounts or letters of credit. Like mortgage-related securities, these securities are subject to the risk of prepayment. See "Risk Considerations." The Funds also may engage in the investment practices described below, each of which may involve certain special risks. The Statement of Additional Information, under the heading "Investment Objectives and Policies of the Funds," contains more detailed information about certain of these practices, including limitations designed to reduce risks. The Funds may enter into repurchase agreements. Pursuant to a repurchase agreement, a Fund acquires a U.S. Government security or other high-grade liquid debt instrument from a financial institution that simultaneously agrees to repurchase the same security at a specified time and price. The repurchase price reflects an agreed-upon rate of return not determined by the coupon rate on the underlying security. Under the Investment Company Act, repurchase agreements are considered to be loans by a Fund and must be fully collateralized by cash, letters of credit, U.S. Government securities or other high-grade liquid debt securities ("Segregable Assets"), either placed in a segregated account or separately identified and rendered unavailable for investment. If the seller defaults on its obligation to repurchase the underlying security, a Fund may experience delay or difficulty in exercising its rights to realize upon the security, may incur a loss if the value of the security declines and may incur disposition costs in liquidating the security. See the Statement of Additional Information for further information. The Small Cap and Emerging Markets Funds may borrow money from banks, each in an aggregate amount not to exceed 10%, and the Equity Income Fund may borrow money from banks, in an aggregate amount not to exceed one-third, of the value of the Fund's total assets to meet temporary or emergency purposes, and the Funds may pledge their assets in connection with such borrowings. A Fund will not purchase any securities while any such borrowings exceed 5% of its total assets, except that the Equity Income Fund may not purchase securities if such borrowings exceed 10% of its total assets. The Equity Income and Emerging Markets Funds may enter into reverse repurchase agreements. In a reverse repurchase agreement, a Fund sells to a financial institution a security that it holds and agrees to repurchase the same security at an agreed-upon price and date. If a Fund fully collateralizes a reverse repurchase agreement with Segregable Assets, it does not aggregate that transaction with its bank borrowings in applying its borrowing limit. See the Statement of Additional Information for further information. The Funds may lend securities to brokers, dealers and other financial organizations. These loans may not exceed 10% of the value of a Fund's total assets (30% of the Equity Income Fund's total assets). Each securities loan is collateralized with Segregable Assets in an amount at least equal to the current market value of the loaned securities, plus accrued interest. If the seller should default on its obligation to repurchase the underlying security, the Fund may experience delay or difficulty in exercising its rights to realize upon the security, may incur a loss if the security declines in value and may incur disposition costs in liquidating the security. See the Statement of Additional Information for further information. WHEN-ISSUED AND FORWARD COMMITMENT SECURITIES The Funds may purchase U.S. Government or other securities on a "when-issued" basis and may purchase or sell securities on a "forward commitment" or "delayed delivery" basis. The price is fixed at the time the commitment is made, but delivery and payment for the securities take place at a later date, normally 7 to 15 days or, in the case of certain CMO issues, 45 to 60 days later. When-issued securities and forward commitments may be sold prior to the settlement date, but a Fund will enter into when-issued and forward commitments only with the intention of actually receiving or delivering the securities, as the case may be. No income accrues on securities that have been purchased pursuant to a forward commitment or on a when-issued basis prior to delivery to a Fund. If a Fund disposes of the right to acquire a when-issued security prior to its acquisition or disposes of its right to deliver or receive against a forward commitment, it may incur a gain or loss. At the time a Fund enters into a transaction on a when-issued or forward commitment basis, it causes its custodian to segregate Segregable Assets equal to the value of the when-issued or forward commitment securities and causes the Segregable Assets to be marked to market daily. There is a risk that the securities may not be delivered and that the Fund may incur a loss. HEDGING AND RISK MANAGEMENT PRACTICES In seeking to protect against the effect of adverse changes in financial markets or against currency exchange rate or interest rate changes that are adverse to the present or prospective positions of the Funds, each of the Funds may employ certain risk management practices using the following derivative securities and techniques (known as "derivatives"): forward currency exchange contracts, stock options, currency options, and stock and stock index options, futures contracts, swaps and options on futures contracts on U.S. Government and foreign government securities and currencies. The Board has adopted derivative guidelines that require the Board to review each new type of derivative that may be used by the Funds. Markets in some countries currently do not have instruments available for hedging transactions relating to currencies or to securities denominated in such currencies or to securities of issuers domiciled or principally engaged in business in such countries. To the extent that such markets do not exist, the Manager may not be able to hedge its investment effectively in such countries. Furthermore, a Fund engages in hedging activities only when the Manager deems it to be appropriate and does not necessarily engage in hedging transactions with respect to each investment. See the Statement of Additional Information for further information on related risks and other special considerations. FORWARD CURRENCY CONTRACTS. A forward currency contract is individually negotiated and privately traded by currency traders and their customers and creates an obligation to purchase or sell a specific currency for an agreed-upon price at a future date. A Fund normally conducts its foreign currency exchange transactions either on a spot (i.e., cash) basis at the spot rate in the foreign currency exchange market at the time of the transaction, or through entering into forward contracts to purchase or sell foreign currencies at a future date. The Funds generally do not enter into forward contracts with terms greater than one year. A Fund generally enters into forward contracts only under two circumstances. First, if a Fund enters into a contract for the purchase or sale of a security denominated in a foreign currency, it may desire to "lock in" the U.S. dollar price of the security by entering into a forward contract to buy the amount of a foreign currency needed to settle the transaction. Second, if the Manager believes that the currency of a particular foreign country will substantially rise or fall against the U.S. dollar, it may enter into a forward contract to buy or sell the currency approximating the value of some or all of a Fund's portfolio securities denominated in such currency. A Fund will not enter into a forward contract if, as a result, it would have more than one-third of total assets committed to such contracts (unless it owns the currency that it is obligated to deliver or has caused its custodian to segregate Segregable Assets having a value sufficient to cover its obligations). Although forward contracts are used primarily to protect a Fund from adverse currency movements, they involve the risk that currency movements will not be accurately predicted. OPTIONS ON SECURITIES, SECURITIES INDICES AND CURRENCIES. The Funds may purchase put and call options on securities and currencies traded on U.S. exchanges and, to the extent permitted by law, foreign exchanges. A Fund may purchase call options on securities which it intends to purchase (or on currencies in which those securities are denominated) in order to limit the risk of a substantial increase in the market price of such security (or an adverse movement in the applicable currency). A Fund may purchase put options on particular securities (or on currencies in which those securities are denominated) in order to protect against a decline in the market value of the underlying security below the exercise price less the premium paid for the option (or an adverse movement in the applicable currency relative to the U.S. dollar). Put options allow a Fund to protect unrealized gain in an appreciated security that it owns without selling that security. Prior to expiration, most options are expected to be sold in a closing sale transaction. Profit or loss from the sale depends upon whether the amount received is more or less than the premium paid plus transaction costs. The Funds also may purchase put and call options on stock indices in order to hedge against risks of stock market or industry-wide stock price fluctuations. A Fund may purchase options on currencies in order to hedge its positions in a manner similar to its use of forward foreign exchange contracts and futures contracts on currencies. The Domestic Equity Funds may seek to enhance income or hedge against a decrease in their portfolio value by writing (i.e., selling) covered call options. A call option is "covered" if the Fund owns the optioned securities or has the right to acquire such securities without additional consideration, a Fund causes its custodian to segregate Segregable Assets having a value sufficient to meet its obligations under the option, or a Fund owns an offsetting call option. FUTURES AND OPTIONS ON FUTURES. To protect against the effect of adverse changes in interest rates, a Fund may purchase and sell interest rate futures contracts. An interest rate futures contract is an agreement to purchase or sell debt usually U.S. Government securities, at a specified date and price. A Fund may sell interest rate futures contracts (i.e., enter into a futures contract to sell the underlying debt security) in an attempt to hedge against an anticipated increase in interest rates and a corresponding decline in debt securities it owns. Conversely, a Fund may purchase an interest rate futures contract (i.e., enter into a futures contract to purchase an underlying security) to hedge against interest rate decreases and corresponding increases in the value of debt securities it anticipates purchasing. In addition, a Fund may purchase and sell put and call options on interest rate futures contracts in lieu of entering into the underlying interest rate futures contracts. Each Fund segregates Segregable Assets equal to the purchase price of the portfolio securities represented by the underlying interest rate futures contracts it has an obligation to purchase. A Fund does not enter into any futures contracts or related options if the sum of initial margin deposits on futures contracts, related options (including options on securities, securities indices and currencies) and premiums paid for any such related options would exceed 5% of its total assets. A Fund does not purchase futures contracts or related options if, as a result, more than one-third of its total assets would be so invested. HEDGING CONSIDERATIONS. There can be no assurance that hedging transactions by the Funds will be successful, and a Fund may be exposed to risk if it is unable to close out its futures or options positions due to an illiquid secondary market. Futures, options and options on futures have effective durations that, in general, are closely related to the effective duration of their underlying securities. Holding purchased futures or call option positions (backed by Segregable Assets) lengthens the effective duration of a Fund's portfolio. While the utilization of options, futures contracts and related options and similar instruments may be advantageous to a Fund, its performance will be impaired if the Manager is unsuccessful in employing such instruments or in predicting market changes. In addition, a Fund pays commissions and other costs in connection with such investments. Further discussion of the possible risks is contained in the Statement of Additional Information. No Fund may invest more than 15% (5% for the Small Cap Fund) of its net assets in illiquid securities. The Funds treat any securities subject to restrictions on repatriation for more than seven days and securities issued in connection with foreign debt conversion programs that are restricted as to remittance of invested capital or profit as illiquid. The Funds also treat repurchase agreements with maturities in excess of seven days as illiquid. Illiquid securities do not include securities that are restricted from trading on formal markets for some period of time but for which an active formal market exists or securities that meet the requirements of Rule 144A under the Securities Act of 1933 and that, subject to the review by the Board and guidelines adopted by the Board, the Manager has determined to be liquid. State securities laws may impose further limitations on the amount of illiquid or restricted securities a Fund may purchase. DEFENSIVE INVESTMENTS AND PORTFOLIO TURNOVER Notwithstanding its investment objective, each Fund may adopt up to a 100% cash or cash equivalent position for temporary defensive purposes to protect against erosion of its capital base. Depending upon the Manager's analysis of the various markets and other considerations, all or part of the assets of a Fund may be held in cash and cash equivalents (denominated in U.S. dollars or foreign currencies), such as U.S. Government securities or obligations issued or guaranteed by the government of a foreign country or by an international organization designed or supported by multiple foreign governmental entities to promote economic reconstruction or development, high-quality commercial paper, time deposits, savings accounts, certificates of deposit, bankers' acceptances and repurchase agreements with respect to all of the foregoing. Such investments also may be made for temporary purposes pending investment in other securities and following substantial new investment in a Fund. Portfolio securities are sold whenever the Manager believes it appropriate, regardless of how long the securities have been held. The Manager therefore changes a Fund's investments whenever it believes doing so will further the Fund's investment objective or when it appears that a position of the desired size cannot be accumulated. Portfolio turnover generally involves some expense to a Fund, including brokerage commissions, dealer mark-ups and other transaction costs, and may result in the recognition of capital gains that may be distributed to shareholders. Portfolio turnover in excess of 100% is considered high and increases such costs. For the fiscal year ended June 30, 1995, the portfolio turnover for the Equity Income Fund was 29%; Small Cap Fund, 85% (95% for 1994); Emerging Markets Fund, 92% (64% for 1994). However, even when portfolio turnover exceeds 100% for a Fund that Fund does not regard portfolio turnover as a limiting factor. The investment objective of each Fund is fundamental and may not be changed without shareholder approval but, unless otherwise stated, each Fund's other investment policies may be changed by the Trust's Board. If there is a change in the investment objective or policies of any Fund, shareholders should consider whether that Fund remains an appropriate investment in light of their then-current financial positions and needs. The Funds are subject to additional investment policies and restrictions described in the Statement of Additional Information, some of which are fundamental. The Equity Income Fund has reserved the right, if approved by the Board, to convert in the future to a "feeder" fund that would invest all of its assets in a "master" fund having substantially the same investment objective, policies and restrictions. At least 30 days' prior written notice of any such action would be given to all shareholders if and when such a proposal is approved, although no such action has been proposed as of the date of this Prospectus. The Small Cap and Emerging Markets Funds may make investments in smaller companies that may benefit from the development of new products and services. Such smaller companies may present greater opportunities for capital appreciation but may involve greater risk than larger, mature issuers. Such smaller companies may have limited product lines, markets or financial resources, and their securities may trade less frequently and in more limited volume than those of larger, more mature companies. As a result, the prices of their securities may fluctuate more than those of larger issuers. Shareholders should understand that all investments involve risk and there can be no guarantee against loss resulting from an investment in the Funds. The Funds have the right to purchase securities in foreign countries. Accordingly, shareholders should consider carefully the substantial risks involved in investing in securities issued by companies and governments of foreign nations, which are in addition to the usual risks inherent in domestic investments. The Emerging Markets Fund may invest in securities of companies domiciled in, and in markets of, so-called "emerging market countries." These investments may be subject to higher risks than investments in more developed countries. Foreign investments involve the possibility of expropriation, nationalization or confiscatory taxation, taxation of income earned in foreign nations (including, for example, withholding taxes on interest and dividends) or other taxes imposed with respect to investments in foreign nations, foreign exchange controls (which may include suspension of the ability to transfer currency from a given country and repatriation of investments), default in foreign government securities, and political or social instability or diplomatic developments that could adversely affect investments. In addition, there is often less publicly available information about foreign issuers than those in the U.S. Foreign companies are often not subject to uniform accounting, auditing and financial reporting standards. Further, the Funds may encounter difficulties in pursuing legal remedies or in obtaining judgments in foreign courts. Additional risk factors, including use of domestic and foreign custodian banks and depositories, are described elsewhere in the Prospectus and in the Statement of Additional Information. Brokerage commissions, fees for custodial services and other costs relating to investments by the Funds in other countries are generally greater than in the U.S. Foreign markets have different clearance and settlement procedures from those in the U.S., and certain markets have experienced times when settlements did not keep pace with the volume of securities transactions and resulted in settlement difficulty. The inability of a Fund to make intended security purchases due to settlement difficulties could cause it to miss attractive investment opportunities. Inability to sell a portfolio security due to settlement problems could result in loss to the Fund if the value of the portfolio security declined or result in claims against the Fund if it had entered into a contract to sell the security. In certain countries, there is less government supervision and regulation of business and industry practices, stock exchanges, brokers, and listed companies than in the U.S. The securities markets of many of the countries in which the Funds may invest may also be smaller, less liquid, and subject to greater price volatility than those in the U.S. Because the securities owned by the Funds may be denominated in foreign currencies, the value of such securities will be affected by changes in currency exchange rates and in exchange control regulations, and costs will be incurred in connection with conversions between currencies. A change in the value of a foreign currency against the U.S. dollar results in a corresponding change in the U.S. dollar value of a Fund's securities denominated in the currency. Such changes also affect the Fund's income and distributions to shareholders. A Fund may be affected either favorably or unfavorably by changes in the relative rates of exchange between the currencies of different nations, and a Fund may therefore engage in foreign currency hedging strategies. Such strategies, however, involve certain transaction costs and investment risks, including dependence upon the Manager's ability to predict movements in exchange rates. Some countries in which one of the Funds may invest may also have fixed or managed currencies that are not freely convertible at market rates into the U.S. dollar. Certain currencies may not be internationally traded. A number of these currencies have experienced steady devaluation relative to the U.S. dollar, and such devaluations in the currencies may have a detrimental impact on the Fund. Many countries in which a Fund may invest have experienced substantial, and in some periods extremely high, rates of inflation for many years. Inflation and rapid fluctuation in inflation rates may have negative effects on certain economies and securities markets. Moreover, the economies of some countries may differ favorably or unfavorably from the U.S. economy in such respects as the rate of growth of gross domestic product, rate of inflation, capital reinvestment, resource self-sufficiency and balance of payments. The Emerging Markets Fund is authorized to invest in medium-quality (rated or equivalent to BBB by S&P or Fitch's or Baa by Moody's) and in limited amounts of high-risk, lower quality debt securities (i.e., securities rated below BBB or Baa) or, if unrated, deemed to be of equivalent investment quality as determined by the Manager. Medium quality debt securities have speculative characteristics, and changes in economic conditions or other circumstances are more likely to lead to a weakened capacity to make principal and interest payments than with higher grade debt securities. As an operating policy, which may be changed by the Board without shareholder approval, the Fund does not invest more than 5% of its total assets in debt securities rated lower than BBB by S&P or Baa by Moody's or, if unrated, deemed to be of comparable quality as determined by the Manager using guidelines approved by the Board. The Board may consider a change in this operating policy if, in its judgment, economic conditions change such that a higher level of investment in high- risk, lower quality debt securities would be consistent with the interests of the Fund and its shareholders. Unrated debt securities are not necessarily of lower quality than rated securities but may not be attractive to as many buyers. Regardless of rating levels, all debt securities considered for purchase (whether rated or unrated) are analyzed by the Manager to determine, to the extent reasonably possible, that the planned investment is sound. From time to time, the Fund may purchase defaulted debt securities if, in the opinion of the Manager, the issuer may resume interest payments in the near future. The market value of debt securities that are sensitive to prevailing interest rates is inversely related to actual changes in interest rates. That is, an interest rate decline produces an increase in a security's market value and an interest rate increase produces a decrease in value. The longer the remaining maturity of a security, the greater the effect of interest rate change. Changes in the ability of an issuer to make payments of interest and principal and in the market's perception of its creditworthiness also affect the market value of that issuer's debt securities. Prepayments of principal of mortgage-related securities by mortgagors or mortgage foreclosures affect the average life of the mortgage-related securities in a Fund's portfolio. Mortgage prepayments are affected by the level of interest rates and other factors, including general economic conditions and the underlying location and age of the mortgage. In periods of rising interest rates, the prepayment rate tends to decrease, lengthening the average life of a pool of mortgage-related securities. In periods of falling interest rates, the prepayment rate tends to increase, shortening the average life of a pool. Reinvestment of prepayments may occur at higher or lower interest rates than the original investment, affecting a Fund's yield. Thus, mortgage-related securities may have less potential for capital appreciation in periods of falling interest rates than other fixed-income securities of comparable duration, although they may have a comparable risk of decline in market value in periods of rising interest rates. Duration is one of the fundamental tools used by the Manager in managing interest rate risks including prepayment risks. Fixed-income securities with effective durations of three years are more responsive to interest rate fluctuations than those with effective durations of one year. If interest rates rise by 1%, the value of securities having an effective duration of three years will decrease by 3%. See "The Funds' Investment Objectives and Policies." The Montgomery Funds (the "Trust") has a Board of Trustees that establishes its Funds' policies and supervises and reviews their management. Day-to-day operations of the Funds are administered by the officers of the Trust and by the Manager pursuant to the terms of an investment management agreement with each Fund. Montgomery Asset Management, L.P., is the Funds' Manager. The Manager, a California limited partnership, was formed in 1990 as an investment adviser registered as such with the SEC under the Investment Advisers Act of 1940, as amended, and since then has advised private accounts as well as the Funds. Its general partner is Montgomery Asset Management, Inc., and its sole limited partner is Montgomery Securities, the Funds' Distributor. Under the Investment Company Act, both Montgomery Asset Management, Inc. and Montgomery Securities may be deemed control persons of the Manager. Although the operations and management of the Manager are independent from those of Montgomery Securities, the Manager may draw upon the research and administrative resources of Montgomery Securities in its discretion and consistent with applicable regulations. Founded in 1969, Montgomery Securities is a fully integrated and highly focused investment banking partnership specializing in emerging growth companies. The firm's areas of expertise include research, corporate finance, sales and trading, and venture capital. Its research department is one of the largest, most experienced groups headquartered outside the East Coast. Through its corporate finance department, Montgomery Securities is a well recognized underwriter of public offerings and provides broad distribution of securities through its sales and trading organization. John H. Brown, CFA, is a Managing Director and Senior Portfolio Manager. Preceding his arrival at the Manager in May 1994, Mr. Brown was an analyst and portfolio manager at Merus Capital Management in San Francisco, California from June 1986. Stuart O. Roberts is a Managing Director and Senior Portfolio Manager. For the five years preceding this Fund's inception in 1990, Mr. Roberts was a portfolio manager and analyst at Founders Asset Management in Denver, Colorado, where he managed three public mutual funds. Josephine S. Jimenez, CFA, is a Managing Director and Portfolio Manager. From 1988 through 1991, Ms. Jimenez worked at Emerging Markets Investors Corporation/Emerging Markets Management in Washington, D.C. as senior analyst and portfolio manager. Bryan L. Sudweeks, Ph.D., CFA, is a Managing Director and Portfolio Manager. Before joining the Manager, he was a senior analyst and portfolio manager at Emerging Markets Investors Corporation/Emerging Markets Management in Washington, D.C. Previously, he was a Professor of International Finance and Investments at George Washington University and served as Adjunct Professor of International Investments from 1988 until May 1991. Thomas R. Haslett, CFA, is a Vice President and Portfolio Manager. From 1987 until joining the Manager in April 1992, Mr. Haslett was a Portfolio Manager at Gannett, Welsh and Kotler in Boston, Massachusetts. Angeline Ee is a Vice President and Portfolio Manager. From 1990 until joining the Manager in July, 1994, Ms. Ee was an Investment Manager with AIG Investment Corp. in Hong Kong. From June, 1989 until September, 1990, Ms. Ee was a co- manager of a portfolio of Asian equities and bonds at Chase Manhattan Bank in Singapore. MANAGEMENT FEES AND OTHER EXPENSES The Manager provides the Funds with advice on buying and selling securities, manages the Funds' investments, including the placement of orders for portfolio transactions, furnishes the Funds with office space and certain administrative services, and provides personnel needed by the Funds with respect to the Manager's responsibilities under the Manager's Investment Management Agreement with each Fund. The Manager also compensates the members of the Trust's Board of Trustees who are interested persons of the Manager, and assumes the cost of printing prospectuses and shareholder reports for dissemination to prospective investors. As compensation, each Fund pays the Manager a management fee (accrued daily but paid when requested by the Manager) based upon the value of the average daily net assets of that Fund, according to the following table. The Manager also serves as the Funds' Administrator (the "Administrator"). The Administrator performs services with regard to various aspects of each Fund's administrative operations. As compensation, the Funds pay the Administrator a monthly fee at the following annual rates: Equity Income Fund pays seven one-hundredths of one percent (0.07%) of average daily net assets (0.06% of average daily net assets over $500 million); each of the Small Cap and Emerging Markets Funds pays seven one-hundredths of one percent (0.07%) of average daily net assets (0.06% of daily net assets over $250 million). Each Fund is responsible for its own operating expenses including, but not limited to: the Manager's fees; taxes, if any; brokerage and commission expenses, if any; interest charges on any borrowings; transfer agent, administrator, custodian, legal and auditing fees; shareholder servicing fees including fees to third party servicing agents; fees and expenses of Trustees who are not interested persons of the Manager; salaries of certain personnel; costs and expenses of calculating its daily net asset value; costs and expenses of accounting, bookkeeping and recordkeeping required under the Investment insurance premiums; trade association dues; fees and expenses of registering and maintaining registration of its shares for sale under federal and applicable state securities laws; all costs associated with shareholders meetings and the preparation and dissemination of proxy materials, except for meetings called solely for the benefit of the Manager or its affiliates; printing and mailing prospectuses, statements of additional information and reports to shareholders; and other expenses relating to that Fund's operations, plus any extraordinary and nonrecurring expenses that are not expressly assumed by the Manager. Rule 12b-1 adopted by the Securities and Exchange Commission (the "SEC") under the Investment Company Act permits an investment company directly or indirectly to pay expenses associated with the distribution of its shares ("distribution expenses") in accordance with a plan adopted by the investment company's Board of Trustees and approved by its shareholders. Pursuant to that Rule, the Trust's Board of Trustees and the initial shareholder of the Class P shares of each Fund have approved, and each Fund has entered into, a Share Marketing Plan (the "Plan") with the Manager, as the distribution coordinator, for the Class P shares. Under the Plan, each Fund will pay distribution fees to the Manager at an annual rate of 0.25% of the Fund's aggregate average daily net assets attributable to its Class P shares, to reimburse the Manager for its distribution costs with respect to that Class. The Plan provides that the Manager may use the distribution fees received from the Class to pay for the distribution expenses of that Class, including, but not limited to (i) incentive compensation paid to the directors, officers and employees of, agents for and consultants to, the Manager or any other broker-dealer or financial institution that engages in the distribution of that Class; and (ii) compensation to broker-dealers, financial institutions or other persons for providing distribution assistance with respect to that Class. Distribution fees may also be used for (i) marketing and promotional activities, including, but not limited to, direct mail promotions and television, radio, newspaper, magazine and other mass media advertising for that Class; (ii) costs of printing and distributing prospectuses, statements of additional information and reports of the Funds to prospective investors in that Class; (iii) costs involved in preparing, printing and distributing sales literature pertaining to the Funds and that Class; and (iv) costs involved obtaining whatever information, analysis and reports with respect to marketing and promotional activities that the Funds may, from time to time, deem advisable with respect to the distribution of that Class. Distribution fees are accrued daily and paid monthly, and are charged as expenses of the Class P shares as accrued. In adopting the Plan, the Board of Trustees determined that there was a reasonable likelihood that the Plan would benefit the Funds and the shareholders of Class P shares. Information with respect to distribution revenues and expenses is presented to the Board of Trustees quarterly for their consideration in connection with their deliberations as to the continuance of the Plan. In their review of the Plan, the Board of Trustees are asked to take into consideration expenses incurred in connection with the separate distribution of the Class P shares. The Class P shares are not obligated under the Plan to pay any distribution expenses in excess of the distribution fee. Thus, if the Plan was terminated or otherwise not continued, no amounts (other than current amounts accrued but not yet paid) would be owed by the Class to the Manager. The distribution fee attributable to the Class P shares is designed to permit an investor to purchase Class P shares through financial planners, retirement and pension plan administrators, broker-dealers and other financial intermediaries without the assessment of a front-end sales charge and at the same time to permit the Manager to compensate those persons on an ongoing basis in connection with the sale of the Class P shares. The Plan provides that it shall continue in effect from year to year provided that a majority of the Board of Trustees of the Trusts, including a majority of the Trustees who are not "interested persons" of the Trusts (as defined in the Investment Company Act) and who have no direct or indirect financial interest in the operation of the Plan or any agreement related to the Plan (the "Independent Trustees"), vote annually to continue the Plan. The Plan may be terminated at any time by vote of a majority of the Independent Trustees or of a majority of the outstanding shares (as defined in the Investment Company Act) of the Class P shares. All distribution fees paid by the Funds under the Plan will be paid in accordance with Article III, Section 26 of the Rules of Fair Practice of the NASD, as such Section may change from time to time. For certain Funds, the Manager has agreed to reduce its management fee if necessary to keep total annual operating expenses at or below the lesser of the maximum allowable by applicable state expense limitations or the following percentages of each Fund's average net assets: the Equity Income Fund, one and one-tenth of one percent (1.10%); the Small Cap Fund one and sixty-five one hundredths of one percent (1.65%); and the Emerging Markets Fund, two and fifteen one-hundredths of one percent (2.15%). The Manager also may voluntarily reduce additional amounts to increase the return to a Fund's investors. The Manager may terminate these voluntary reductions at any time. Any reductions made by the Manager in its fees are subject to reimbursement by that Fund within the following two years, provided that the Fund is able to effect such reimbursement and remain in compliance with applicable expense limitations. The Manager generally seeks reimbursement for the oldest reductions and waivers before payment by the Funds for fees and expenses for the current year. In addition, the Manager may elect to absorb operating expenses that a Fund is obligated to pay in order to increase the return to that Fund's investors. To the extent the Manager performs a service or assumes an operating expense for is obligated to pay and the performance of such service or payment of such expense is not an obligation of the Manager under the Investment Management Agreement, the Manager is entitled to seek reimbursement from that Fund for the Manager's costs incurred in rendering such service or assuming such expense. The Manager, out of its own funds, also may compensate broker-dealers and other intermediaries that distribute a Fund's shares as well as other service providers of shareholder and administrative services. In addition, the Manager, out of its own funds, may sponsor seminars and educational programs on the Funds for financial intermediaries and shareholders. The Manager considers a number of factors in determining which brokers or dealers to use for each Fund's portfolio transactions. While these factors are more fully discussed in the Statement of Additional Information, they include, but are not limited to, reasonableness of commissions, quality of services and execution and availability of research that the Manager may lawfully and appropriately use in its investment management and advisory capacities. Provided the Funds receive prompt execution at competitive prices, the Manager also may consider sale of a Fund's shares as a factor in selecting broker-dealers for that Fund's portfolio transactions. It is anticipated that Montgomery Securities may act as one of the Funds' brokers in the purchase and sale of portfolio securities and, in that capacity, will receive brokerage commissions from the Funds. The Funds will use Montgomery Securities as its broker only when, in the judgment of the Manager and pursuant to review by the Board, Montgomery Securities will obtain a price and execution at least as favorable as that available from other qualified brokers. See "Execution of Portfolio Transactions" in the Statement of Additional Information for further information regarding Fund policies concerning execution of portfolio transactions. Investors Fiduciary Trust Company, 127 West 10th Street, Kansas City, Missouri 64105, serves as the master transfer agent for the Funds (the "Master Transfer Agent") and performs certain recordkeeping and accounting functions. The Master Transfer Agent delegates certain transfer agent functions to DST Systems, Inc., P.O. Box 419073, Kansas City, Missouri 64141-6073, the Funds' transfer agent (the "Transfer Agent"). Morgan Stanley Trust Company, located at One Pierrepont Plaza, Brooklyn, New York 11201, serves as the Funds' principal custodian (the "Custodian"). HOW TO INVEST IN THE FUNDS The Funds' shares are offered directly to the public, with no sales load, at their next-determined net asset value after receipt of an order with payment. The Funds' shares are offered for sale by Montgomery Securities, the Funds' Distributor, 600 Montgomery Street, San Francisco, California 94111, (800) 572-3863, and through selected securities brokers and dealers. If an order, together with payment in proper form, is received by the Transfer Agent or Montgomery Securities by 4:00 p.m., New York time, on any day that the New York Stock Exchange ("NYSE") is open for trading, Fund shares will be purchased at the Fund's next-determined net asset value. Orders for Fund shares received after 4:00 p.m., New York time, will be purchased at the next-determined net asset value after receipt of the order. The minimum initial investment in each Fund is $500 (including IRAs) and $100 for subsequent investments. Keogh plans, 401(k) plans and other retirement plans may also be opened for $500, although the Funds do not act as custodians for those accounts. The Manager or the Distributor, in its discretion, may waive these minimums. Purchases may also be made in certain circumstances by payment of securities. See the Statement of Additional Information for further details. Complete information regarding your account must be included in all wire instructions in order to facilitate the prompt and accurate handling of investments. Investors may obtain further information from their own banks about wire transfers and any fees that may be imposed. The Funds and the Distributor each reserve the right to reject any purchase order in whole or in part. Minimum Initial Investment (including IRAs): $500 Mail your completed application and any checks to: c/o DST Systems, Inc. o Complete the Account Application. o Tell us in which Funds you want to invest and make your check payable to THE MONTGOMERY FUNDS. o We do not accept third party checks or cash investments. Checks must be made in U.S. dollars and, to avoid fees and delays, drawn only on banks located in the U.S. o A charge may be imposed on checks that do not clear. o Notify the Transfer Agent at (800) 572-3863 that you intend to make your initial investment by wire. Provide the Transfer Agent with your name, dollar amount to be invested and Fund(s) in which you want to invest. They will provide you with further instructions to complete your purchase. o Request your bank to transmit immediately available funds by wire for purchase of shares in your name to the following: For Credit to: (shareholder(s) name) Shareholder Account Number: (shareholder(s) account number) Name of Fund: (Montgomery Fund name) o Your bank may charge a fee for any wire transfers. Minimum Subsequent Investment (including IRAs): $100 Mail any checks and investment instructions to: c/o DST Systems, Inc. o Make your check payable to The Montgomery Funds. o Enclose an investment stub from your confirmation statement. o If you do not have an investment stub, mail your check with written instructions indicating the Fund name and account number to which your investment should be credited. o We do not accept third party checks or cash investments. Checks must be made in U.S. dollars and, to avoid fees and delays, drawn only on banks located in the U.S. o A charge may be imposed on checks that do not clear. o You do not need to contact the Transfer Agent prior to making subsequent investments by wire. Instruct your bank to wire funds to the Transfer Agent's affiliated bank by using the bank wire information under "Initial Investments by Wire." o Shareholders are automatically eligible to make telephone purchases by calling the Transfer Agent at (800) 572-3863 before the Fund cutoff time. o The maximum telephone purchase is an amount up to five times your account value on the previous day. o Payments for shares purchased must be received by the Transfer Agent within three business days after the purchase request. o You should do one of the following to ensure payment is received in time: o Transfer funds directly from your bank account by sending a letter and a voided check or deposit slip (for a savings account) to the Transfer Agent. o Send a check by overnight or 2nd day courier service. Address courier packages to THE MONTGOMERY FUNDS, C/O DST SYSTEMS, INC., 1004 BALTIMORE ST., KANSAS CITY, MO 64105. o Instruct your bank to wire funds to the Transfer Agent's affiliated bank by using the bank wire information under the section titled "Initial Investments by Wire." Under the Automatic Account Builder plan, a shareholder may arrange to make additional purchases (minimum $100) of shares automatically on a monthly or quarterly basis by electronic funds transfer from a checking or savings account, if the bank at which the account is maintained is a member of the Automated Clearing House, or by preauthorized checks drawn on the shareholder's bank account. A shareholder may terminate the program at any time with seven business days' notice by delivering a written instruction to the Transfer Agent. The Account Application contains the requirements for this program. An initial investment in check form of at least $500 must be submitted to the Transfer Agent to initiate this program. You agree to reimburse the Funds for any expenses or losses that they may incur in connection with transfers from your accounts, including any caused by your bank's failure to act in accordance with your request or its failure to honor your debit. If your bank makes erroneous payments or fails to make payment after shares are purchased on your behalf, any such purchase may be canceled and this privilege terminated immediately. This privilege may be discontinued at any time by the Funds upon 30-days' written notice or at any time by you by written notice to the Funds. Your request will be processed upon receipt. Write your confirmed purchase number on any check. Although Fund shares are priced at the net asset value next-determined after receipt of a purchase request, shares are not purchased until payment is received. Should payment not be received when required, the Transfer Agent will cancel the telephone purchase request and you may be responsible for any losses incurred by a Fund. The Funds employ reasonable procedures in an effort to confirm the authenticity of telephone instructions, such as requiring the caller to give a special authorization number. Provided these procedures are followed, the Funds and the Transfer Agent shall not be responsible for any loss, expense or cost arising out of any telephone instruction. Shares of the Funds are available for purchase by any retirement plan, including Keogh plans, 401(k) plans, 403(b) plans and IRAs. None of the Funds or the Manager administers retirement account plans. Certain of the Funds are available for purchase through administrators for retirement plans. Investors who purchase shares as part of a retirement plan should address inquiries and seek investment servicing from their plan administrators. Plan administrators may receive compensation from the Funds for performing shareholder services. Share certificates will not be issued by the Funds. All shares are held in non-certificated form registered on the books of the Funds and the Transfer Agent for the account of the shareholder. HOW TO REDEEM AN INVESTMENT IN THE FUNDS The Funds will redeem all or any portion of an investor's outstanding shares upon request. Redemptions can be made on any day that the NYSE is open for trading. The redemption price is the net asset value per share next determined after the shares are validly tendered for redemption and such request is received by the Transfer Agent or, in the case of repurchase orders, Montgomery Securities or other securities dealers. Payment of redemption proceeds is made promptly regardless of when redemption occurs and normally within three days after receipt of all documents in proper form, including a written redemption order with appropriate signature guarantee. Redemption proceeds will be mailed or wired in accordance with the shareholder's instructions. The Funds may suspend the right of redemption under certain extraordinary circumstances in accordance with the rules of the SEC. In the case of shares purchased by check and redeemed shortly after the purchase, the Transfer Agent will not mail redemption proceeds until it has been notified that the monies used for the purchase have been collected, which may take up to 15 days from the purchase date. Shares tendered for redemptions through brokers or dealers (other than the Distributor) may be subject to a service charge by such brokers or dealers. Procedures for requesting a redemption are set forth below. SHAREHOLDERS SHOULD NOTE THAT THE FUNDS RESERVE THE RIGHT UPON 60 DAYS' ADVANCE NOTICE TO SHAREHOLDERS TO IMPOSE A REDEMPTION FEE OF UP TO 1.00% ON SHARES REDEEMED WITHIN 90 DAYS OF PURCHASE. o Write a letter indicating your name, account number, the name of the Fund from which you wish to redeem and the dollar amount or number of shares you wish to redeem. o Signature guarantee your letter if you want the redemption proceeds to go to a party other than the account owner(s), your predesignated bank account or if the dollar amount of the redemption exceeds $50,000. Signature guarantees may be provided by an eligible guarantor institution such as a commercial bank, an NASD member firm such as a stock broker, a savings association or national securities exchange. Contact the Transfer Agent if you need more information. o If you do not have a predesignated bank account and want to wire your redemption proceeds, include a voided check or deposit slip with your letter. The minimum amount that may be wired is $500 (wire charges, if any, will be deducted from redemption proceeds). The Fund reserves the right to permit lesser wire amounts or fees in the Manager's discretion. o Mail your instructions to: c/o DST Systems, Inc. o Unless you have declined telephone redemption privileges on your account application, you may redeem shares up to $50,000 by calling the Transfer Agent before the Fund cutoff time. o If you included bank wire information on your account application or made subsequent arrangements to accommodate bank wire redemptions, you may request that the Transfer Agent wire your redemption proceeds to your bank account. Allow at least two business days for redemption proceeds to be credited to your bank account. If you want to wire your redemption proceeds to arrive at your bank on the same business day (subject to bank cutoff times), there is a $10.00 fee. By establishing telephone redemption privileges, a shareholder authorizes the Funds and the Transfer Agent to act upon the instruction of the shareholder or his or her designee by telephone to redeem from the account for which such service has been authorized and transfer the proceeds to a bank or other account designated in the Authorization. When a shareholder appoints a designee on the Account Application or by other written authorization, the shareholder agrees to be bound by the telephone redemption instructions given by the shareholder's designee. Telephone redemption privileges will be suspended for 30 days after any address change. All redemption requests during this period must be submitted in writing with the signature guaranteed. The Funds may change, modify or terminate these privileges at any time upon 60 days' notice to shareholders. The Funds will not be responsible for any loss, damage, cost or expense arising out of any transaction that appears on the shareholder's confirmation after 30 days following mailing of such confirmation. See discussion of Fund telephone procedures and liability under "Telephone Transactions." Shareholders may decline telephone redemption privileges after an account is opened by instructing the Transfer Agent in writing. Your request will be processed upon receipt. Shareholders may experience delays in exercising telephone redemption privileges during periods of abnormal market activity. During periods of volatile economic or market conditions, shareholders may wish to consider transmitting redemption orders by telegram (not available for IRAs) or overnight courier. Under a Systematic Withdrawal Plan, a shareholder with an account value of $500 or more in a Fund may receive (or have sent to a third party) periodic payments (by check or wire) of $100 or more from the shareholder's account in that Fund on a monthly or quarterly basis. Depending on the form of payment requested, shares will be redeemed up to five business days before redemption proceeds are scheduled to be received by the shareholder. The redemption may result in the recognition of gain or loss for income tax purposes. Dividends and distributions on shares held in a Systematic Withdrawal Plan account will be reinvested in additional shares of that Fund at net asset value. SMALL ACCOUNTS/ANNUAL ACCOUNT MAINTENANCE FEE Due to the relatively high cost of maintaining smaller accounts, each Fund reserves the right to redeem shares or to impose a $20 annual account maintenance fee for any account if at any time, because of redemptions by the shareholder, the total value of a shareholder's account is less than $500. If a Fund decides to make an involuntary redemption, the shareholder will first be notified that the value of the shareholder's account is less than the minimum level and will be allowed 30 days to make an additional investment to bring the value of that account at least to the minimum investment required to open an account before the Fund takes any action. You may exchange Class P shares from another Fund offered by this prospectus, with the same registration, taxpayer identification number and address. You should note that an exchange may result in recognition of a gain or loss for income tax purposes. See the discussion of Fund telephone procedures and limitations of liability under "Telephone Transactions." PURCHASING AND REDEEMING SHARES BY EXCHANGE o You are automatically eligible to make telephone exchanges with your Montgomery account. o Exchange purchases and redemptions will be processed using the next-determined net asset value (with no sales charge or exchange fee) after your request is received. Your request is subject to the Funds' cut-off times. o Exchange purchases must meet the minimum investment requirements of the Fund you intend to purchase. o You may exchange for shares of a Fund only in states where that Fund's shares are qualified for sale and only for Funds offered by this prospectus. o You may not exchange for shares of a Fund that is not open to new shareholders unless you have an existing account with that Fund. o BECAUSE EXCESSIVE EXCHANGES CAN HARM A FUND'S PERFORMANCE, THE TRUST RESERVES THE RIGHT TO TERMINATE, EITHER TEMPORARILY OR PERMANENTLY, YOUR EXCHANGE PRIVILEGES IF YOU MAKE MORE THAN FOUR EXCHANGES OUT OF ANY ONE FUND DURING A TWELVE-MONTH PERIOD. THE FUND MAY ALSO REFUSE AN EXCHANGE INTO A FUND FROM WHICH YOU HAVE REDEEMED SHARES WITHIN THE PREVIOUS 90 DAYS (ACCOUNTS UNDER COMMON CONTROL AND ACCOUNTS WITH THE SAME TAXPAYER IDENTIFICATION NUMBER WILL BE COUNTED TOGETHER). A SHAREHOLDER'S EXCHANGES MAY BE RESTRICTED OR REFUSED IF A FUND RECEIVES, OR THE MANAGER ANTICIPATES, SIMULTANEOUS ORDERS AFFECTING SIGNIFICANT PORTIONS OF THAT FUND'S ASSETS AND, IN PARTICULAR, A PATTERN OF EXCHANGES COINCIDING WITH A "MARKET TIMING" STRATEGY. THE TRUST RESERVES THE RIGHT TO REFUSE EXCHANGES BY ANY PERSON OR GROUP IF, IN THE MANAGER'S JUDGMENT, A FUND WOULD BE UNABLE TO EFFECTIVELY INVEST THE MONEY IN ACCORDANCE WITH ITS INVESTMENT OBJECTIVE AND POLICIES, OR WOULD OTHERWISE BE POTENTIALLY ADVERSELY AFFECTED. ALTHOUGH THE TRUST ATTEMPTS TO PROVIDE PRIOR NOTICE TO AFFECTED SHAREHOLDERS WHEN IT IS REASONABLE TO DO SO, THEY MAY IMPOSE THESE RESTRICTIONS AT ANY TIME. THE EXCHANGE LIMIT MAY BE MODIFIED FOR ACCOUNTS IN CERTAIN INSTITUTIONAL RETIREMENT PLANS TO CONFORM TO PLAN EXCHANGE LIMITS AND U.S. DEPARTMENT OF LABOR REGULATIONS (FOR THOSE LIMITS, SEE PLAN MATERIALS). THE TRUST RESERVES THE RIGHT TO TERMINATE OR MODIFY THE EXCHANGE PRIVILEGES OF FUND SHAREHOLDERS IN THE FUTURE. You may elect systematic exchanges out of the Funds. The minimum exchange is $100. Periodically investing a set dollar amount into a Fund is also referred to as dollar-cost averaging because the number of shares purchased will vary depending on the price per share. Your account with the recipient Fund must meet the applicable minimum of $500. INVESTING THROUGH SECURITIES BROKERS, DEALERS AND FINANCIAL INTERMEDIARIES Investors may purchase shares of a Fund from other selected securities brokers, dealers or through financial intermediaries such as benefit plan administrators. Investors should contact these agents directly for appropriate instructions, as well as information pertaining to accounts and any service or transaction fees that may be charged by these agents. Purchase orders through securities brokers, dealers and other financial intermediaries are effected at the next-determined net asset value after receipt of the order by such agent, provided the agent transmits such order on a timely basis to the Transfer Agent so that it is received by 4:00 p.m., New York time, on days that the Fund issues shares. Orders received after that time will be purchased at the next-determined net asset value. To the extent that these agents perform shareholder servicing activities for the Fund, they may receive fees from the Fund for such services. REPURCHASE ORDERS THROUGH BROKERAGE ACCOUNTS Shareholders also may sell shares back to the Funds by wire or telephone through Montgomery Securities or selected securities brokers or dealers. Shareholders should contact their securities broker or dealer for appropriate instructions and for information concerning any transaction or service fee that may be imposed by the broker or dealer. Shareholders are entitled to the net asset value next determined after receipt of a repurchase order by such broker-dealer, provided the broker-dealer transmits such order on a timely basis to the Transfer Agent so that it is received by 4:00 p.m., New York time, on a day that the Fund redeems shares. Orders received after that time are entitled to the net asset value next determined after receipt. HOW NET ASSET VALUE IS DETERMINED The net asset value of each Fund is determined once daily as of 4:00 p.m., New York time, on each day that the NYSE is open for trading. Per-share net asset value is calculated by dividing the value of each Fund's total net assets by the total number of that Fund's shares then outstanding. As more fully described in the Statement of Additional Information, portfolio securities are valued using current market valuations: either the last reported sales price or, in the case of securities for which there is no reported last sale and fixed income securities, the mean between the closing bid and asked price. Securities for which market quotations are not readily available or which are illiquid are valued at their fair values as determined in good faith under the supervision of the Trust's officers, and by the manager and the Pricing Committee of the Board, respectively, in accordance with methods that are specifically authorized by the Board. Short-term obligations with maturities of 60 days or less are valued at amortized cost as reflecting fair value. The value of securities denominated in foreign currencies and traded on foreign exchanges or in foreign markets will be translated into U.S. dollars at the last price of their respective currency denomination against U.S. dollars quoted by a major bank or, if no such quotation is available, at the rate of exchange determined in accordance with policies established in good faith by the Board. Because the value of securities denominated in foreign currencies must be translated into U.S. dollars, fluctuations in the value of such currencies in relation to the U.S. dollar may affect the net asset value of Fund shares even if there has not been any change in the foreign-currency denominated values of such securities. Because foreign securities markets may close prior to the time the Funds determine their net asset values, events affecting the value of portfolio securities occurring between the time prices are determined and the time the Funds calculate their net asset value may not be reflected in the Funds' calculation of net asset values unless the Manager, under supervision of the Board, determines that a particular event would materially affect a Fund's net asset value. Each Fund distributes substantially all of its net investment income and net capital gains to shareholders each year. The Equity Income Fund declares and pays dividends on or about the last business day of each quarter. Each Fund currently intends to make one or, if necessary to avoid the imposition of tax on a Fund, more distributions during each calendar year. A distribution may be made between November 1 and December 31 of each year with respect to any undistributed capital gains earned during the one-year period ended October 31 of such calendar year. Another distribution of any undistributed capital gains may also be made following each Fund's fiscal year end (June 30). The amount and frequency of Fund distributions are not guaranteed and are at the discretion of the Board. Unless investors request cash distributions in writing at least seven business days prior to the distribution, or on the Account Application, all dividends and other distributions will be reinvested automatically in additional Class P shares of the applicable Fund and credited to the shareholder's account at the closing net asset value on the reinvestment date. Except for the newer Funds that intend to qualify and elect as soon as possible, each of the Funds has qualified and elected and intends to continue to qualify and elect to be treated as a regulated investment company under Subchapter M of the Code, by distributing substantially all of its net investment income and net capital gains to its shareholders and meeting other requirements of the Code relating to the sources of its income and diversification of assets. Accordingly, the Funds generally will not be liable for federal income tax or excise tax based on net income except to the extent their earnings are not distributed or are distributed in a manner that does not satisfy the requirements of the Code pertaining to the timing of distributions. If a Fund is unable to meet certain Code requirements, it may be subject to taxation as a corporation. The Emerging Markets Fund may also incur tax liability to the extent it invests in "passive foreign investment companies." See "Portfolio Securities" and the Statement of Additional Information. For federal income tax purposes, any dividends derived from net investment income and any excess of net short-term capital gain over net long-term capital loss that investors (other than certain tax-exempt organizations that have not borrowed to purchase Fund shares) receive from the Funds are considered ordinary income. Part of the distributions paid by the Funds may be eligible for the dividends-received deduction allowed to corporate shareholders under the Code. Distributions of the excess of net long-term capital gain over net short-term capital loss from transactions of a Fund are treated by shareholders as long-term capital gains regardless of the length of time the Fund's shares have been owned. Distributions of income and capital gains are taxed in the manner described above, whether they are taken in cash or are reinvested in additional shares of the Funds. Each Fund will inform its investors of the source of their dividends and distributions at the time they are paid, and will promptly after the close of each calendar year advise investors of the tax status of those distributions and dividends. Investors (including tax-exempt and foreign investors) are advised to consult their own tax advisers regarding the particular tax consequences to them of an investment in shares of the Funds. Additional information on tax matters relating to the Funds and their shareholders is included in the Statement of Additional Information. All of the Funds are series of The Montgomery Funds, a Massachusetts business trust organized on May 10, 1990. The Agreement and Declarations of Trust of the Trust permits its Board to issue an unlimited number of full and fractional shares of beneficial interest, $.01 par value, in any number of series. The assets and liabilities of each series of the Trust are separate and distinct from each other series. This Prospectus relates only to the Class P shares of the Funds. The Funds have designated other classes of shares and may in the future designate other classes of shares for specific purposes. Shares issued by the Funds have no preemptive, conversion or subscription rights. Each whole share is entitled to one vote as to any matter on which it is entitled to vote and each fractional share is entitled to a proportionate fractional vote. Shareholders have equal and exclusive rights as to dividends and distributions as declared by each Fund and to the net assets of each Fund upon liquidation or dissolution. Each Fund, as a separate series of the Trust, votes separately on matters affecting only that Fund (e.g., approval of the Investment Management Agreement); all series of the Trust vote as a single class on matters affecting all series of the Trust jointly or the Trust as a whole (e.g., election or removal of Trustees). Voting rights are not cumulative, so that the holders of more than 50% of the shares voting in any election of Trustees can, if they so choose, elect all of the Trustees of the Trust. Except as set forth herein, all classes of shares issued by a Fund shall have identical voting, dividend, liquidation and other rights, preferences, and terms and conditions. The only differences among the various classes of shares relate solely to the following: (a) each class may be subject to different class expenses; (b) each class may bear a different identifying designation; (c) each class may have exclusive voting rights with respect to matters solely affecting such class; (d) each class may have different exchange privileges; and (e) each class may provide for the automatic conversion of that class into another class. While the Trust is not required and does not intend to hold annual meetings of shareholders, such meetings may be called by the Trust's Board at its discretion, or upon demand by the holders of 10% or more of the outstanding shares of the Trust for the purpose of electing or removing Trustees. Shareholders may receive assistance in communicating with other shareholders in connection with the election or removal of Trustees pursuant to the provisions of Section 16(c) of the Investment Company Act. From time to time, the Funds may publish their total return, and, in the case of certain Funds, current yield in advertisements and communications to investors. Performance data may be quoted separately for the Class P shares as for other classes. Total return information generally will include a Fund's average annual compounded rate of return over the most recent four calendar quarters and over the period from the Fund's inception of operations. A Fund may also advertise aggregate and average total return information over different periods of time. Each Fund's average annual compounded rate of return is determined by reference to a hypothetical $1,000 investment that includes capital appreciation and depreciation for the stated period according to a specific formula. Aggregate total return is calculated in a similar manner, except that the results are not annualized. Total return figures will reflect all recurring charges against each Fund's income. Current yield as prescribed by the SEC is an annualized percentage rate that reflects the change in value of a hypothetical account based on the income received from the Fund during a 30-day period. It is computed by determining the net change, excluding capital changes, in the value of a hypothetical pre-existing account having a balance of one share at the beginning of the period. A hypothetical charge reflecting deductions from shareholder accounts for management fees or shareholder services fees, for example, is subtracted from the value of the account at the end of the period and the difference is divided by the value of the account at the beginning of the base period to obtain the base period return. The result is then annualized. See "Performance Information" in the Statement of Additional Information. Investment results of the Funds will fluctuate over time, and any presentation of the Funds' total return or current yield for any prior period should not be considered as a representation of what an investor's total return or current yield may be in any future period. The Funds' Annual Report contains additional performance information and is available upon request and without charge by calling (800) 572-FUND. The validity of shares offered by this Prospectus will be passed on by Heller, Ehrman, White & McAuliffe, 333 Bush Street, San Francisco, California 94104. Unless otherwise requested, only one copy of each shareholder report or other material sent to shareholders will be sent to each household or address regardless of the number of shareholders or accounts at that household or address. A confirmation statement will be mailed to the record address each time you request a transaction except for most money market transactions (monthly) and automatic investment and redemption services (quarterly). All transactions are recorded on quarterly account statements which you will receive at the end of each calendar quarter. Your fourth-quarter account statement will be a year-end statement, listing all transaction activity for the entire year. Retain this statement for your tax records. In general, shareholders who redeem shares from a qualifying Montgomery account should expect to receive an Average Cost Statement in February of the following year. Your statement will calculate your average cost using the average cost singlecategory method. Any questions should be directed to The Montgomery Funds at 800-572-FUND (800-572-3863). Shareholders are required by law to provide the Funds with their correct Social Security or other Taxpayer Identification Number ("TIN"), regardless of whether they file tax returns. Failure to do so may subject a shareholder to penalties. Failure to provide a correct TIN or to check the appropriate boxes in the Account Application and to sign the shareholder's name could result in backup withholding by the Funds of an amount of income tax equal to 31% of distributions, redemptions, exchanges and other payments made to a shareholder's account. Any tax withheld may be credited against taxes owed on a shareholder's federal income tax return. A shareholder who does not have a TIN should apply for one immediately by contacting the local office of the Social Security Administration or the IRS. Backup withholding could apply to payments made to a shareholder's account while awaiting receipt of a TIN. Special rules apply for certain entities. For example, for an account established under the Uniform Gifts to Minors Act, the TIN of the minor should be furnished. If a shareholder has been notified by the IRS that he or she is subject to backup withholding because he or she failed to report all interest and dividend income on his or her tax return and the shareholder has not been notified by the IRS that such withholding will cease, the shareholder should cross out the appropriate item in the Account Application. Dividends paid to a foreign shareholder's account by a Fund may be subject to up to 30% withholding instead of backup withholding. A shareholder that is an exempt recipient should furnish a TIN and check the appropriate box. Exempt recipients include certain corporations, certain tax-exempt entities, tax-exempt pension plans and IRAs, governmental agencies, financial institutions, registered securities and commodities dealers and others. For further information, see Section 3406 of the Code and consult with a tax adviser. This Prospectus is not an offering of the securities herein described in any state in which the offering is unauthorized. No salesman, dealer or other person is authorized to give any information or make any representation other than those contained in this Prospectus, the Statement of Additional Information, or in the Funds' official sales literature. Heller, Ehrman, White & McAuliffe Item 24. Financial Statements and Exhibits (1) Portfolio Investments as of June 30, 1995; Statements of Assets and Liabilities as of June 30, 1995; Statements of Operations For the Year Ended June 30, 1995; Statement of Cash Flows for year ended June 30, 1995; Statements of Changes in Net Assets for the Year Ended June 30, 1995; Financial Highlights for a Fund share outstanding throughout each year, including the year ended June 30, 1995 for Montgomery Growth Fund, Montgomery Micro Cap Fund, Montgomery Small Cap Fund, Montgomery Equity Income Fund, Montgomery Asset Allocation Fund, Montgomery Global Opportunities Fund, Montgomery Global Communications Fund, Montgomery International Small Cap Fund, Montgomery Emerging Markets Fund, Montgomery Short Government Bond Fund, Montgomery Government Reserve Fund, Montgomery California Tax-Free Intermediate Bond Fund and Montgomery California Tax-Free Money Fund; Notes to Financial Statements; Independent Auditors' Report on the foregoing, all incorporated by reference to the Annual Report to Shareholders of the above-named funds. (2) Portfolio Investments as of September 30, 1995; Statement of Assets and Liabilities as of September 30, 1995; Statement of Operations for the period ended September 30, 1995; Statement of Cash Flows for the period ended September 30, 1995; Statement of Changes in Net Assets for the period ended September 30, 1995; Financial Highlights for a Fund share outstanding throughout the period ended September 30, 1995; Notes to Financial Statements, all unaudited and with respect to Montgomery International Growth Fund. (1)(A) Agreement and Declaration of Trust is incorporated by reference to the Registrant's Registration Statement as filed with the Commission on May 16, 1990 ("Registration Statement"). (1)(B) Amendment to Agreement and Declaration of Trust is incorporated by reference to Post-Effective Amendment No. 17 to the Registration Statement as filed with the Commission on December 30, 1993 ("Post- Effective Amendment No. 17"). (1)(C) Amended and Restated Agreement and Declaration of Trust is incorporated by reference to Post-Effective Amendment No. 28 to the Registration Statement as filed with the Commission on September 13, 1995 ("Post- Effective Amendment No. 28"). (2) By-Laws are incorporated by reference to the Registration Statement. (3) Voting Trust Agreement - Not applicable. (4) Specimen Share Certificate - Not applicable. (5)(A) Form of Investment Management Agreement is incorporated by reference to Pre-Effective Amendment No. 1 to the Registration Statement as filed with the Commission on July 5, 1990 ("Pre-Effective Amendment No. 1"). (5)(B) Form of Amendment to Investment Management Agreement is incorporated by reference to Post-Effective Amendment No. 24 to the Registration Statement as filed with the Commission on March 31, 1995 ("Post-Effective Amendment No. 24"). (6)(A) Form of Underwriting Agreement is incorporated by reference to Pre-Effective Amendment No. 1. (6)(B) Form of Selling Group Agreement is incorporated by reference to Pre-Effective Amendment No. 1. (7) Benefit Plan(s) - Not applicable. (8) Custody Agreement is incorporated by reference to Post-Effective Amendment No. 24. (9)(A) Form of Administrative Services Agreement is incorporated by reference to Post-Effective Amendment No. 15. (9)(B) Form of Multiple Class Plan is incorporated by reference to Post-Effective Amendment No. 28. (9)(C) Form of Shareholder Services Plan is incorporated by reference to Post-Effective Amendment No. 28. (10) Consent and Opinion of Counsel as to legality of shares is incorporated by reference to Pre-Effective Amendment No. 1. (11) Consent of Independent Public Accountants. (12) Financial Statements omitted from Item 23 - Not applicable. (13) Letter of Understanding re: Initial Shares is incorporated by reference to Pre-Effective Amendment No. 1. (14) Model Retirement Plan Documents are incorporated by reference to Post-Effective Amendment No. 2 to the Registration Statement as filed with the Commission on March 4, 1991 ("Post-Effective Amendment No. 2"). (15) Form of Share Marketing Plan is incorporated by reference to Post- Effective Amendment No. 28. (16)(A) Performance Computation for Montgomery Short Government Bond Fund is incorporated by reference to Post-Effective Amendment No. 13. (16)(B) Performance Computation for Montgomery Government Reserve Fund is incorporated by reference to Post-Effective Amendment No. 12. (16)(C) Performance Computation for Montgomery California Tax-Free Intermediate Bond Fund is incorporated by reference to Post-Effective Amendment No. 17. (16)(D) Performance Computation for the other series of Registrant is incorporated by reference to Post-Effective Amendment No. 2. Item 25. Persons Controlled by or Under Common Control with Registrant. Montgomery Asset Management, L.P., a California limited partnership, is the manager of each series of the Registrant, of The Montgomery Funds II, a Delaware business trust, and of The Montgomery Funds III, a Delaware business trust. Montgomery Asset Management, Inc., a California corporation is the general partner of Montgomery Asset Management, L.P., and Montgomery Securities is its sole limited partner. The Registrant, The Montgomery Funds II and The Montgomery Funds III are deemed to be under the common control of each of those three entities. Item 26. Number of Holders of Securities Title of Class as of December 31, 1995 Montgomery Small Cap Fund (Class R) 6,357 Montgomery Growth Fund (Class R) 47,768 Montgomery International Small Cap Fund (Class R) 1,871 Montgomery Global Opportunities Fund (Class R) 976 Montgomery Global Communications Fund (Class R) 14,809 Montgomery Equity Income Fund (Class R) 833 Montgomery Short Government Bond Fund (Class R) 546 Intermediate Bond Fund (Class R) 142 Montgomery Government Reserve Fund (Class R) 5,107 Money Fund (Class R) 665 Montgomery Micro Cap Fund (Class R) 11,701 Montgomery International Growth Fund (Class R) 271 Montgomery Advisors Emerging Markets Fund (Class R) 26 Montgomery Select 50 Fund (Class R) 2,454 Montgomery Small Cap II Fund 0 Article VII, Section 3 of the Agreement and Declaration of Trust empowers the Trustees of the Trust, to the full extent permitted by law, to purchase with Trust assets insurance for indemnification from liability and to pay for all expenses reasonably incurred or paid or expected to be paid by a Trustee or officer in connection with any claim, action, suit or proceeding in which he or she becomes involved by virtue of his or her capacity or former capacity with the Trust. Article VI of the By-Laws of the Trust provides that the Trust shall indemnify any person who was or is a party or is threatened to be made a party to any proceeding by reason of the fact that such person is and other amounts or was an agent of the Trust, against expenses, judgments, fines, settlement and other amounts actually and reasonable incurred in connection with such proceeding if that person acted in good faith and reasonably believed his or her conduct to be in the best interests of the Trust. Indemnification will not be provided in certain circumstances, however, including instances of willful misfeasance, bad faith, gross negligence, and reckless disregard of the duties involved in the conduct of the particular office involved. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to the Trustees, officers and controlling persons of the Registrant pursuant to the foregoing provisions or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable in the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a Trustee, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such Trustee, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue. Item 28. Business and Other Connections of Investment Adviser. Montgomery Securities, which is a broker-dealer and the principal underwriter of The Montgomery Funds, is the sole limited partner of the investment manager, Montgomery Asset Management, L.P. ("MAM, L.P."). The general partner of MAM, L.P. is a corporation, Montgomery Asset Management, Inc. ("MAM, Inc."), certain of the officers and directors of which serve in similar capacities for MAM, L.P. One of these officers and directors, Mr. R. Stephen Doyle, also is a capital limited partner of Montgomery Securities, and Mr. Jack G. Levin, Secretary of The Montgomery Funds, is a Managing Director of Montgomery Securities. R. Stephen Doyle is the Chairman and Chief Executive Officer of MAM, L.P.; Mark B. Geist is the President; John T. Story is the Managing Director of Mutual Funds and Executive Vice President; David E. Demarest is Chief Administrative Officer; Mary Jane Fross is Manager of Mutual Fund Administration and Finance; and Josephine Jimenez, Bryan L. Sudweeks, Stuart O. Roberts, John H. Brown, William C. Stevens, Roger Honour, Oscar Castro, John Boich and Rhoda Rossman are Managing Directors of MAM, L.P. Information about the individuals who function as officers of MAM, L.P. (namely, R. Stephen Doyle, Mark B. Geist, John T. Story, David E. Demarest, Mary Jane Fross and the ten Managing Directors) is set forth in Part B. (a) Montgomery Securities is the principal underwriter of The Montgomery Funds, The Montgomery Funds II and The Montgomery Funds III. Montgomery Securities acts as the principal underwriter, depositor and/or investment adviser and/or trustee for The Montgomery Funds, an investment company registered under the Investment Company Act of 1940, as amended, and for the following private investment partnerships or trusts: Montgomery Bridge Fund Liquidating Trust Montgomery Bridge Fund II, Liquidating Trust Pathfinder Montgomery Fund I, L.P. Montgomery Growth Partners, L.P. Montgomery Growth Partners II, L.P. Montgomery Capital Partners, L.P. Montgomery Capital Partners II, L.P. Montgomery Emerging Markets Fund Limited Montgomery Emerging World Partners, L.P. The above list does not include limited partners or special limited partners who are not Managing Directors of Montgomery Securities. Item 30. Location of Accounts and Records. The accounts, books, or other documents required to be maintained by Section 31(a) of the Investment Company Act of 1940 will be kept by the Registrant's Transfer Agent, DST Systems, Inc., 1004 Baltimore, Kansas City, Missouri 64105, except those records relating to portfolio transactions and the basic organizational and Trust documents of the Registrant (see Subsections (2)(iii), (4), (5), (6), (7), (9), (10) and (11) of Rule 31a-1(b)), which will be kept by the Registrant at 600 Montgomery Street, San Francisco, California 94111. There are no management-related service contracts not discussed in Parts A and B. (b) Registrant hereby undertakes to file a post-effective amendment including financial statements of Montgomery Advisors Emerging Markets Fund, Montgomery Select 50 Fund, Montgomery Small Cap II Fund and Montgomery Technology Fund, which need not be certified, within four to six months from the later of the effective date of those series of the Registrant or the commencement of operations of those series. (c) Registrant hereby undertakes to furnish each person to whom a prospectus is delivered with a copy of the Registrant's latest annual report to shareholders, upon request and without charge. (d) Registrant has undertaken to comply with Section 16(a) of the Investment Company Act of 1940, as amended, which requires the prompt convening of a meeting of shareholders to elect trustees to fill existing vacancies in the Registrant's Board of Trustees in the event that less than a majority of the trustees have been elected to such position by shareholders. Registrant has also undertaken promptly to call a meeting of shareholders for the purpose of voting upon the question of removal of any Trustee or Trustees when requested in writing to do so by the record holders of not less than 10 percent of the Registrant's outstanding shares and to assist its shareholders in communicating with other shareholders in accordance with the requirements of Section 16(c) of the Investment Company Act of 1940, as amended. Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant certifies that it meets all the requirements for effectiveness of this Amendment pursuant to Rule 485(b) under the Securities Act of 1933, as amended, and that the Registrant has duly caused this Amendment to the Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Francisco and State of California on this 11th day of January, 1996. Pursuant to the requirements of the Securities Act of 1933, this Amendment to Registrant's Registration Statement has been signed below by the following persons in the capacities and on the dates indicated. R. Stephen Doyle* Principal Executive January 11, 1996 R. Stephen Doyle Financial and Accounting Andrew Cox * Trustee January 11, 1996 Cecilia H. Herbert * Trustee January 11, 1996 John A. Farnsworth * Trustee January 11, 1996 * By: /s/ Julie Allecta pursuant to Power of Attorney previously filed. Exhibit No. Document Page No. (11) Independent Auditors' Consent ____	485B24F	485B24F	1996-01-12T00:00:00	1996-01-12T09:16:38
0000735703-96-000004	0000735703-96-000004_0000.txt	U.S. SECURITIES AND EXCHANGE COMMISSION [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 1995. [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____ TO ____. (Exact name of small business issuer as specified in its charter) (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 658 Mendelssohn Avenue North, Minneapolis, Minnesota 55427 (Address of principal executive offices) (Zip Code) (Former name, former address and former fiscal year, if changed since last report) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practible date. Common Stock, $0.01 par value 1,563,420 (Title of Class) (Shares Outstanding) NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) NOTE A - FINANCIAL INFORMATION The unaudited interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission; accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These interim financial statements should be read in conjunction with the financial statements and notes in the Company's 1995 Annual Report on Form 10-KSB filed with the Securities and Exchange Commission. In the opinion of management, the financial statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of the interim periods. NOTE B - EARNINGS PER SHARE Earnings per share is based upon the number of weighted average common shares outstanding of 1,726,161 for the quarter ended November 30, 1995 and 1,642,598 for the quarter ended November 30, 1994. Item 2: Management's Discussion and Analysis Revenues for the first quarter ended November 30, 1995 increased 9% over the same period the preceding year. The revenue increase for the three months ended November 30, 1995 was due to an increase in sales volume of 13% in the industrial control systems product line over the same period the prior year. Gross profit percentages for the three months ended November 30, 1995 was 60% compared to 65% for the three months ended November 30, 1994. The decrease is primarily due to meeting the demands of a more competitive market and cost increases. Operating expenses as a percentage of sales was 50% for the three months ended November 30, 1995 compared to 45% for the same period the prior year. The increase is primarily due to increasing engineering and marketing staff. Other income increased $19,045 for the quarter ended November 30, 1995 from the same period the preceding year. The increase was primarily due to increased investment income. Net income was $90,602 and $125,433 for the quarter ended November 30, 1995 and November 30, 1994 respectively. This represents a 28% decrease. Registrant's balance sheet shows a strong capital position. Operations used $32,669 in cash. Cash and cash equivalents decreased $226,092 since August 31, 1995. The company used $193,768 to purchase investments since August 31, 1995. Registrant expects that there will be sufficient capital to fund its operations during fiscal year 1996. Registrant has no debt and does not anticipate, at this time, that it will be necessary to seek any debt financing in the near future for ongoing operations, but may consider some type of financing for other purposes. Part II - Other Information Item 2: Changes in Securities Item 3: Defaults Upon Senior Securities Item 4: Submission of Matters to a Vote of Security Holders Item 6: Exhibits and Reports on Form 8-K Exhibit 27. Financial Data Schedule. b. Reports on Form 8-K Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. January 12, 1996 Duane Markus	10QSB	10QSB	1996-01-12T00:00:00	1996-01-12T15:08:48
0000891618-96-000013	0000891618-96-000013_0000.txt	<DESCRIPTION>FORM 10-K FOR APPLIED MATERIALS UNITED STATES SECURITIES AND EXCHANGE COMMISSION /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE For the fiscal year ended OCTOBER 29, 1995 / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES For the transition period from _______________ to ______________ (Exact name of registrant as specified in its charter) (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 3050 BOWERS AVENUE, SANTA CLARA, CALIFORNIA 95054 Address of principal executive offices (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (408) 727-5555 SECTION 12(b) OF THE ACT: Title of class Name of each exchange on which registered SECTION 12(g) OF THE ACT: Common Stock, $.01 par value NASDAQ 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 statements incorporated by reference in Part III of this Form 10-K or any amendment to this Aggregate market value of the voting stock held by nonaffiliates of the registrant as of December 15, 1995: $ 7,533,374,394 Number of shares outstanding of the issuer's Common Stock, $.01 par value, as of Portions of Applied Materials 1995 Annual Report for the year ended October 29, 1995 are incorporated by reference into Parts I, II and IV of this Form 10-K. Portions of the definitive Proxy Statement for the Company's Annual Meeting of Stockholders to be held on March 14, 1996 are incorporated by reference into Part III of this Form 10-K. Index to Exhibits appears on pages 17 through 19. Organized in 1967, Applied Materials, Inc. ("Applied Materials" or the "Company") develops, manufactures, markets and services semiconductor wafer fabrication equipment and related spare parts. The Company's worldwide customers include both companies which manufacture semiconductor devices for use in their own products and companies which manufacture semiconductor devices for sale to others. Applied Materials operates exclusively in the semiconductor wafer fabrication equipment industry. The Company is also a fifty percent stockholder in Applied Komatsu Technology, Inc., which produces thin film transistor manufacturing systems for active-matrix liquid crystal displays. Applied Materials' products are sophisticated systems utilizing state-of-the-art technology in wafer processing chemistry and physics, particulate management, process control, software and automation. Many of these technologies are complementary and can be applied across all of the Company's products. The Company's products, which provide enabling technology, productivity and yield enhancements to semiconductor manufacturers, are used to fabricate semiconductor devices on a substrate of semiconductor material (primarily silicon). A finished device consists of thin film layers which can form anywhere from one to millions of tiny electronic components that combine to perform desired electrical functions. The fabrication process must control film and feature quality to ensure proper device performance while meeting yield and throughput goals. The Company currently manufactures equipment that addresses three major steps in wafer fabrication: deposition, etch and ion implantation. Recently, the Company introduced a rapid thermal processing (RTP) system, which provides versatility and broad application to many areas of semiconductor manufacturing. Recognizing the trend toward more stringent process requirements and larger wafer sizes, Applied Materials developed a single-wafer, multi-chamber system called the Precision 5000. The Company introduced the Precision 5000 with dielectric chemical vapor deposition (CVD) processes in 1987, etch processes in 1988 and CVD tungsten processes (WCVD) in 1989. The Precision 5000's single-wafer, multi-chamber architecture features several processing chambers, each of which is attached to a central handling system, and is designed for both serial and integrated processing. The Precision 5000's integrated processing capability makes it possible to perform multiple process steps on a wafer without it leaving a controlled environment, thus reducing the risk of particulate contamination. The Company leveraged its expertise in single-wafer, multi-chamber architecture to develop an evolutionary platform called the Endura 5500 PVD (Physical Vapor Deposition) in 1990 featuring a staged, ultra-high vacuum (UHV) architecture for the rapid sputtering of aluminum and other metal films used to form the circuit interconnections on advanced devices. In October 1991, the Company announced its second-generation Precision 5000 system, the Precision 5000 Mark II, with numerous enhancements to the platform, process chambers and remote support equipment. The Precision 5000 Mark II is used to manufacture advanced devices, such as 16 megabit DRAMs (Dynamic Random Access Memories), on 200mm (8-inch) wafers. In September 1992, the Company announced its latest generation single-wafer, multi-chamber platform, the Centura, to target the high temperature thin films market as well as future process applications with 0.5-micron and below specifications. The Company has shipped more than 3,000 multi-chamber platforms and 9,000 process chambers. For the fiscal year ended October 29, 1995, sales of the Company's single-wafer, multi-chamber systems represented approximately 92% of systems revenue. A fundamental step in semiconductor fabrication, deposition is a process in which a layer of either electrically insulating (dielectric) or electrically conductive material is deposited on a wafer. Deposition can be divided into several different categories of which Applied Materials currently participates in three: chemical vapor deposition (CVD), physical vapor deposition (PVD), and epitaxial and polysilicon deposition. CVD. Chemical vapor deposition is a process used in semiconductor fabrication in which thin films (insulators, conductors and semiconductors) are deposited from gaseous sources. In 1987, the Company introduced the Precision 5000 CVD which, with its automated multi-chamber architecture, provides the flexibility to perform a broad range of deposition processes utilizing up to four individual chambers on a single system. The Company introduced its newest generation of sub-atmospheric process technologies on the Precision 5000 Mark II CVD platform in April 1994, addressing applications to 0.35-microns. In 1995, the Company announced the MxP+, which provides a significant enhancement to its Precision 5000 CVD system by improving system throughput and reducing ownership costs. In addition, the Company announced in April 1995 its entry into the pre-metal CVD market, using the Company's sub-atmospheric CVD technology to deposit borophosphosilicate glass films. In July 1995, the Company introduced the Dielectric CVD product line on the Centura platform and launched CVD's latest chamber technology called "DxZ" on the Centura platform. The chamber features a new, simplified design and a resistive wafer heater. In September 1989, the Company entered the market for WCVD with the introduction of a system for blanket tungsten deposition, the Precision 5000 WCVD. The Company has continued to add capabilities to this system, including integrated tungsten plug fabrication capability which combines blanket tungsten CVD deposition and etchback capabilities in the same system. The Company has also added tungsten silicide and titanium nitride capabilities to further extend the Precision 5000 platform offerings. Other product developments in WCVD include the introduction of a new multi-platform chamber for blanket tungsten deposition on wafers up to 200mm (8-inch) in diameter and the introduction of a new CVD process for tungsten silicide using dichlorosilane as the silicon source gas. PVD. Physical vapor deposition sputters metals on wafers during semiconductor fabrication to form the circuit interconnects. Unlike CVD, the sources of the deposited materials are solid sources called targets. Applied Materials entered the PVD market in April 1990 with the Endura 5500 PVD system. The system utilizes a modular, single-wafer, multi-chamber platform which accommodates UHV processes like PVD, and conventional high vacuum processes like CVD and etch. In July 1993, the Company introduced the Endura HP (High Productivity) PVD system, an enhanced version of the Endura PVD system. In November 1993, the Centura HP PVD was introduced in order to offer customers a choice of platforms using the Company's PVD technology. In November 1994, the Endura VHP (Very High Productivity) PVD system was launched, further enhancing the wafer transfer system to raise throughput. Epitaxial and polysilicon deposition. Epitaxial (Epi) and polysilicon deposition involve depositing layers of high-quality, silicon-based compounds on the surface of a silicon wafer to change its electrical properties and, in the case of epi, to form the base on which the integrated circuit is built. In 1989, the Company introduced the Precision 7700 Epi system for advanced silicon deposition. The 7700 system extends the capabilities of radiantly-heated "barrel" technology and incorporates fully automated wafer handling as well as many features for particulate control. In September 1992, the Company announced the Centura Poly, a single-wafer, multi-chamber platform targeted at the high temperature thin film deposition of polysilicon on wafers up to 200mm (8 inches) in diameter. The Centura Epi system, which features deposition of epitaxial silicon, was announced in March 1993. In December 1993, the Company launched the Centura Polycide which combines chambers for polysilicon and tungsten silicide deposition on the Centura platform. Prior to etch processing, a wafer is patterned with photoresist during photolithography. Etching then selectively removes material from areas which are not covered by the photoresist pattern. Applied Materials entered the etch market in 1981 with the introduction of the AME 8100 Etch system, which utilized a batch process technology for dry plasma etching. In 1985, the Company introduced the Precision Etch 8300, which featured improved levels of automation and particulate control. The Company continues to sell the Precision Etch 8300 product and has shipped nearly 900 systems. Applied Materials' first single-wafer, multi-chamber system for the dry etch market was the Precision 5000 Etch, introduced in 1988. In 1990, the Company introduced a metal etch system based on the Precision 5000 architecture which provides single-wafer, aluminum etch capabilities. In 1993, the Company introduced its next generation etch platform, the Centura HDP Dielectric Etcher, designed for critical oxide etch applications requiring sub-0.5-micron design rules and the Precision 5000 Mark II Etch MxP, a new model of the Precision 5000-series etch system with several enhancements including process capability for 0.35-micron applications. In July 1994, Applied Materials introduced the Metal Etch MxP Centura, which combines sub-0.5-micron process technology with improved throughput. The Company launched a new dielectric etch system in April 1995 combining its latest Centura platform with an enhanced etch chamber, called MxP+. The Remote Plasma Source (RPS) Centura, introduced in June 1995, extends the Company's range of dielectric dry etch process technologies to several isotropic etch steps. During ion implantation, silicon wafers are bombarded by a high-velocity beam of electrically charged ions. These ions are embedded within a wafer at selected sites and change the electrical properties of the implanted area. Applied Materials entered the high-current portion of the implant market in 1985 with the Precision Implant 9000 and introduced the Precision Implant 9200 in 1988. In 1989, the Company added enhancements to the 9200 series including a new option for automated selection of implant angles, and new hardware/software options that enable customers to perform remote monitoring and diagnostics. In 1991, the Company announced an enhanced version of its high-current ion implanter and designated it the Precision Implant 9200XJ. In November 1992, the Company introduced a new high-current ion implantation system, the Precision Implant 9500, to address the production of high-density semiconductor devices, such as 16 megabit and 64 megabit memory devices and advanced microprocessors. In November 1994, the 9500xR model was introduced, further extending the range of the 9500 system into the traditional medium-current area with enhanced low-dose, low-energy implant performance. In October 1995, Applied Materials introduced its latest implant system, the Precision Implant xR80. This system features low-energy and small square footage requirements while maintaining high throughput. In June 1995, Applied Materials introduced a new system, the Rapid Thermal Processing (RTP) Centura, into the emerging RTP market. RTP uses very rapid heating cycles to perform high-temperature processes traditionally done by slower-heating batch furnace technologies. The new system is designed to solve the limiting technical issues - temperature measurement and control, uniformity and process repeatability - that have historically kept RTP from becoming a production technology. The RTP Centura's metal implant annealing processes offer chipmakers improved device performance, with demonstrated potential for significant yield improvements and faster factory cycle time. The demand for improved production yields of integrated circuits requires that semiconductor wafer processing equipment operate reliably, with maximum uptime and within very precise tolerances. Applied Materials installs its equipment and provides warranty service worldwide through offices located in the North America, Japan, Europe (including Israel), Korea and the Asia-Pacific (Taiwan, China and Singapore) regions. Applied Materials maintains 62 sales/service offices worldwide, with 21 offices in North America, 21 offices in Japan, 10 offices in Europe, 6 offices in Korea, and 4 offices in the Asia-Pacific region. The Company offers a variety of service contracts to customers for maintenance of installed equipment and provides a comprehensive training program for all customers. At October 29, 1995, the Company's backlog totaled $1.5 billion, compared to $715.2 million at October 30, 1994. The Company expects to fill the present backlog of orders during fiscal 1996. MANUFACTURING, RAW MATERIALS AND SUPPLIES The Company's manufacturing activities consist primarily of assembling various commercial and proprietary components into finished systems, principally in the United States, with additional operations in England and Japan. Production requires some raw materials and a wide variety of mechanical and electrical components, which are manufactured to the Company's specifications. Multiple commercial sources are available for most components. The Company has consolidated the number of sources for several key purchased items for purposes of improving its position with suppliers, resulting in improved on-time delivery, lower inventory levels and better pricing to the Company. There have been no significant delays in receiving components from sole source suppliers; however, the unavailability of any of these components could disrupt scheduled deliveries to customers. Because of the highly technical nature of its products, the Company markets its products worldwide through a direct sales force, with sales, service and spare parts offices in the North America, Japan, Europe, Korea and Asia-Pacific regions. For the fiscal year ended October 29, 1995, sales to customers in North America, Japan, Korea, Europe, and Asia-Pacific were approximately 32%, 26%, 17%, 15%, and 10%, respectively, of the Company's net sales. For the fiscal year ended October 30, 1994, sales to customers in North America, Japan, Korea, Europe, and Asia-Pacific were approximately 37%, 27%, 12%, 18%, and 6%, respectively, of the Company's net sales. The Company's business is not seasonal in nature, but it is subject to the capital equipment expenditure patterns of major semiconductor manufacturers which are based on many factors including anticipated market demand for integrated circuits, the development of new technologies and global economic conditions. The market served by the Company is characterized by rapid technological change. The Company's research and development efforts are global in nature. Engineering organizations are located in the United States, England, Israel and Japan, with process support and customer demonstration laboratories in the United States, England and Japan. In 1991, the Company announced the opening of an expanded technology center in Narita, Japan. The Company is currently building, and intends to operate in fiscal 1996, technology centers in South Korea and Taiwan. The Company also operates a technology center in Israel to develop controller configuration and software tools for its semiconductor processing systems. Applied Materials' research and development activities are primarily directed toward the development of new wafer processing systems and new process applications for existing products. The Company is currently investing in the development of new products in conjunction with the semiconductor industry's move to the next-generation 300 mm wafer size. Applied Materials works closely with its global customers to design systems that meet its customers' planned technical and production requirements. The global semiconductor equipment industry is highly competitive and is characterized by rapid technological advancements and demanding worldwide service requirements. Each of the Company's products competes in markets defined by the particular wafer fabrication process it performs. There are several companies that compete with Applied Materials in each of these markets. Competition is based on many factors, primarily technological advancements, productivity and cost-effectiveness, customer support, contamination control, and overall product quality. Management believes that the Company's competitive advantage in each of its served markets is based on the ability of its products and services to address customer requirements as they relate to these competitive factors. Applied Materials is a principal supplier in each of its served markets. The Company faces strong competition throughout the world from other semiconductor equipment manufacturers as well as semiconductor manufacturers who design and produce fabrication equipment for their own internal uses and, in some cases, for resale. Management believes that the Company is a strong competitor with respect to its products, services and resources. However, new products, pricing pressures, and other competitive actions from both new and existing competitors could adversely affect the Company's market position. In September 1991, the Company announced its plans to develop thin film transistor (TFT) manufacturing systems for Active-Matrix Liquid Crystal Displays (AMLCDs). The AMLCD market currently includes screens for laptop, notebook and palmtop computers and instrument displays, and the Company believes that this market in the future may include flat panel monitors for desktop computers, high-resolution workstations and television. In September 1993, a joint venture company was formed with Applied Materials, Inc. and Komatsu Ltd. of Japan sharing a 50-50 ownership of the joint venture. The joint venture, Applied Komatsu Technology, Inc. (AKT), is accounted for using the equity method. The Company's management believes that systems developed by AKT have the potential to lower the manufacturing costs of AMLCDs as well as provide new process technologies to enhance flat panel capabilities. The Company has granted to AKT an exclusive license to use the Company's intellectual property to develop, manufacture, and sell products for the manufacture of flat panel displays, in exchange for royalties in respect thereof. AKT has been, and will continue through 1996, accelerating its investment in product technologies for CVD, PVD and Etch in addition to expanding the substrate size capacity of its products. Management believes that the Company's competitive position is primarily dependent upon skills in engineering, production, and marketing rather than its patent position. However, protection of the Company's technology assets by obtaining and enforcing patents is increasingly important. Consequently, the Company has an active program to file applications in the United States and other countries on inventions which the Company considers significant. The Company has a number of patents in the United States and other countries and additional applications are pending for new developments in its equipment and processes. In addition to patents, the Company also possesses other proprietary intellectual property, including trademarks, know-how, trade secrets and copyrights. The Company enters into patent and technology licensing agreements with others when management determines that it is in the Company's best interest to do so. The Company pays royalties under existing patent license agreements for the use, in several of its products, of certain patents which are licensed to the Company for the life of the patents. The Company has made its technology, including patents, available to AKT through a license arrangement which permits AKT to use the Company's technology to develop, manufacture and sell equipment for the flat panel display industry. In the normal course of business, the Company from time to time receives and makes inquiries with regard to possible patent infringement. In dealing with such inquiries, it may become necessary or useful for the Company to obtain and grant licenses or other rights. However, there can be no assurance that such license rights will be available to the Company on commercially reasonable terms. While there can be no assurance about the outcome of such inquiries, the Company believes that it is unlikely that their resolution will have a material adverse effect on its financial position or results of operations. Although one of the Company's locations has been designated as a Superfund site by the U.S. Environmental Protection Agency, neither compliance with Federal, State and local provisions regulating discharge of materials into the environment, nor remedial agreements or other actions relating to the environment, has had or is expected to have a material effect on the Company's capital expenditures, results of operations or competitive position. At October 29, 1995, the Company employed 10,537 regular full-time employees. In the high technology industry, competition for highly skilled employees is intense. The Company believes that a great part of its future success depends on its continued ability to attract and retain qualified employees. None of the Company's employees are represented by a trade union. Management considers its relations with its employees to be good. The following portions of the Company's 1995 Annual Report are incorporated herein by reference: "Management's Discussion and Analysis of Financial Condition and Results of Operations," pages 27 through 30, and the Consolidated Financial Statements and accompanying notes thereto, pages 31 through 46. Certain information concerning the Company's principal properties at October 29, 1995 is set forth below: The Company also leases office space for 62 sales and service offices throughout the world: 21 offices are located in the United States, 21 offices are in Japan, 10 offices are in Europe, 6 offices in Korea, and 4 offices are located in the Asia-Pacific region. The Company is currently constructing manufacturing and other operating facilities in California, Texas, Korea and Taiwan. Upon completion of these facilities, an additional 833,000 square feet of production and operating capacity will be available. The Company also owns 108 acres in Austin, Texas, and 30 acres in Santa Clara, California, of buildable land. The Austin and Santa Clara land can accommodate approximately 2,400,000 and 800,000 square feet, respectively, of additional building space to help satisfy the Company's current and future needs. Management considers the above facilities suitable and adequate to meet the Company's requirements. * Subject to loans totaling $60 million secured by property and equipment having an approximate net book value of $81 million at October 29, 1995. In the first of two lawsuits filed by the Company, captioned Applied Materials Inc. v. Advanced Semiconductor Materials America, Inc., Epsilon Technology, Inc. (doing business as ASM Epitaxy) and Advanced Semiconductor Materials International N.V. (collectively "ASM") (case no. C-91-20061-RMW), Judge William Ingram of the United States District Court for the Northern District of California on April 26,1994, ruled that ASM's Epsilon I epitaxial reactor infringes certain of the Company's United States patents and issued an injunction against ASM's use and sale of the ASM Epsilon I in the United States. ASM has appealed the decision and the injunction has been stayed pending the appeal only as to ASM products offered for sale as of April 1994. The stay order requires that ASM pay a fee, as security for the Company's interest, for each Epsilon I system sold by ASM in the United States after the date of the injunction. Judge Ronald M. Whyte of the same Court ruled that proceedings to resolve the issues of damages, willful infringement and ASM's counterclaims, which had been bifurcated for separate trial, will also be stayed pending the appeal of Judge Ingram's decision. Oral arguments regarding this appeal were completed on June 5, 1995, before the Court of Appeals for the Federal Circuit. The trial of the Company's second patent infringement lawsuit against ASM, captioned Applied Materials Inc. v. ASM (case no. C-92-20643-RMW), was concluded before Judge Whyte in May 1995. On November 1, 1995, the Court issued its judgment holding that the Company's patents were valid and infringed by ASM's reduced pressure epitaxial reactors and stated that a permanent injunction will be entered. A hearing is scheduled for February, 1996 to determine the scope of the injunction and whether the injunction will be stayed pending ASM's appeal. A separate lawsuit filed by ASM against the Company involving one patent relating to the Company's single wafer epitaxial product line, captioned ASM America Inc. v. Applied Materials Inc. (case no. C-93-20853-RMW), has been delayed by the Court sua sponte. The case is proceeding through final discovery and pretrial preparation, and is the subject of three motions by the Company for summary judgment set for hearing in February 1996. A separate action severed from ASM's case, captioned ASM America Inc. v. Applied Materials Inc. (case no. C-95-20169-RWM), involves one patent which relates to the Company's Precision 5000 product line. No trial date has been set. Discovery and pretrial investigation is proceeding. In these cases, ASM seeks injunctive relief, damages and such other relief as the Court may find appropriate. Further, the Company has filed a Declaratory Judgment action against ASM, captioned Applied Materials, Inc. v. ASM (case no. C-95-20003-RMW), requesting that an ASM patent be held invalid and not infringed by the Company's single wafer epitaxial product line. Discovery and pretrial investigation is proceeding. No trial date has been set. On July 7, 1995, ASM filed a lawsuit, captioned ASM America Inc. v. Applied Materials Inc. (case no. C95-20586-RMW), concerning susceptors in chemical vapor deposition chambers. Investigation has just commenced. No discovery has occurred as yet, and no trial date has been set. In September 1994, General Signal Corporation filed a lawsuit against the Company (case no. 94-461-JJF) in the United States District Court, District of Delaware. General Signal alleges that the Company infringes five of General Signal's United States patents by making, using, selling or offering for sale multi-chamber wafer fabrication equipment, including for example, the Precision 5000 series machines. General Signal seeks an injunction, multiple damages and costs, including reasonable attorneys' fees and interest, and such other relief as the court may deem appropriate. This lawsuit is currently in discovery and no trial date has been set. In January 1995, the Company filed a lawsuit against Novellus Systems, Inc. in the United States District Court, Northern District of California (case no. C-95-0243-MMC). This lawsuit alleges that Novellus' Concept One, Concept Two, and Maxxus FTEOS systems infringe the Company's U.S. patent relating to the TEOS-based, plasma enhanced CVD process for silicon oxide deposition. The lawsuit seeks an injunction, multiple damages and costs, including reasonable attorneys' fees and interest, and such other relief as the court may deem just and proper. Damages and counterclaims have been bifurcated for separate trial. A jury trial has been scheduled for August 1996, before the Honorable Maxine M. Chesney. On September 15, 1995, the Company filed another lawsuit against Novellus alleging Novellus' newly announced blanket tungsten interconnect process infringes the Company's U.S. patent relating to a tungsten CVD process. The Company also sought a declaration that a Novellus U.S. patent for a gas purge mechanism is not infringed by the Company and/or is invalid. Novellus answered by denying the allegations and counterclaimed by alleging that the Company's plasma enhanced TEOS CVD systems infringe a Novellus U.S. patent concerning a gas debubbler mechanism. Novellus also filed a new lawsuit as a plaintiff before the same court which contains the same claims and patents as those stated in the Company's September 15 lawsuit. Discovery and investigation is beginning. No trial date has been set. In the normal course of business, the Company from time to time receives and makes inquiries with regard to possible patent infringement. Management believes that it is unlikely that the outcome of these lawsuits or of the patent infringement inquiries will have a material adverse effect on the Company's financial position or results of operations. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS IN FOURTH QUARTER None. EXECUTIVE OFFICERS OF THE REGISTRANT The following table and notes thereto identify and set forth information about the Company's seven executive officers: (1) Mr. Morgan, age 57, has been Chief Executive Officer since 1977 and Chairman of the Board of Directors since 1987. Mr. Morgan also served as President of the Company from 1976 to 1987. (2) Mr. Bagley, age 56, was appointed Vice Chairman of the Board of Directors in December 1993. Mr. Bagley was Chief Operating Officer of the Company from 1987 through October 1995, and served as President of the Company from December 1987 to December 1993. Prior to that, Mr. Bagley served as Senior Vice President of the Company since 1981. Mr. Bagley is a director of Kulicke and Soffa Industries, Inc. and Tencor Instruments. (3) Dr. Maydan, age 60, was appointed President of the Company in December 1993. Dr. Maydan served as Executive Vice President from 1990 to December 1993. Prior to that, Dr. Maydan had been Group Vice President since February 1989. Dr. Maydan joined Applied Materials in 1980 as a Director of Technology. Dr. Maydan is a director of Opal, Inc. (4) Mr. Taylor, age 55, has been Chief Financial Officer of the Company since 1984. Mr. Taylor has also been a Senior Vice President of the Company since 1991 and was previously Vice President of Finance from 1984 to 1991. (5) Dr. Somekh, age 49, was appointed Senior Vice President of the Company in December 1993. Dr. Somekh served as Group Vice President from 1990 to 1993. Prior to that, Dr. Somekh had been a divisional Vice President. Dr. Somekh joined Applied Materials in 1980 as a Project Manager. (6) Dr. Wang, age 49, was appointed Senior Vice President of the Company in December 1993. Dr. Wang served as Group Vice President from 1990 to 1993. Prior to that, Dr. Wang had been a divisional Vice President. Dr. Wang joined Applied Materials in 1980 as a Manager, Process Engineering and Applications. (7) Mr. Yawata, age 61, was appointed President and Chief Executive Officer of Applied Materials Japan, effective January 1, 1995. From 1985 through 1994, Mr. Yawata was a Vice President, and from 1993 through 1994, he was Executive Advisor to the Chairman, of LSI Logic Corp. From 1985 through 1992, Mr. Yawata was President, and from 1992 through 1993, he was Chairman, of LSI Logic K.K. ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS "Stock Price History" on page 48 of the Applied Materials' 1995 Annual Report is incorporated herein by reference. The Company's common stock is traded on the NASDAQ over-the-counter market. As of December 15, 1995 there were approximately 2,068 holders of record of the common stock. To date, the Company has paid no cash dividends to its stockholders. The Company has no plans to pay cash dividends in the near future. ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA "Selected Consolidated Financial Data" on page 26 of the Applied Materials 1995 Annual Report is incorporated herein by reference. ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND "Management's Discussion and Analysis" on pages 27 through 30 of the Applied Materials 1995 Annual Report is incorporated herein by reference. ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements, together with the report thereon of Price Waterhouse LLP, Independent Accountants, dated November 22, 1995 appearing on pages 31 through 48 of Applied Materials 1995 Annual Report are incorporated by reference in this Form 10-K Annual Report. ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND None. Pursuant to Paragraph G(3) of the General Instructions to Form 10-K, portions of the information required by Part III of Form 10-K are incorporated by reference from the Company's Proxy Statement to be filed with the Commission in connection with the 1995 Annual Meeting of Stockholders ("the Proxy Statement"). ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Information concerning directors of the Company appears in the Company's Proxy Statement, under Item 1 - "Election of Directors." This portion of the Proxy Statement is incorporated herein by reference. (b) For information with respect to Executive Officers, see Part I of this Form 10-K. Information concerning executive compensation appears in the Company's Proxy Statement, under the caption "Executive Compensation," and is incorporated herein by reference. ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information concerning the security ownership of certain beneficial owners and management appears in the Company's Proxy Statement, under Item 1 - "Election of Directors," and is incorporated herein by reference. ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning certain relationships and related transactions appears in the Company's Proxy Statement, under Item 1 - "Election of Directors," and is incorporated herein by reference. ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K The financial statements listed in the accompanying index to financial statements and financial statement schedules are filed or incorporated by reference as part of this annual report on Form 10-K. The financial statement schedule listed in the accompanying index to financial statements and financial statement schedules is filed as part of this annual report on Form 10-K. The exhibits listed in the accompanying index to exhibits are filed or incorporated by reference as part of this annual report on Form 10-K. (b) Report on Form 8-K was filed on August 24, 1995. The Report contains the Company's press release, dated August 15, 1995, with respect to its financial results for the period ended July 30, 1995. (1) Financial Statements Page Number Consolidated Statements of Operations for the Fiscal Years ended October 29, 1995, October 30, 1994 and October 31, 1993 31 Consolidated Balance Sheets at October 29, 1995 and October 30, 1994 32 Consolidated Statements of Cash Flows for the Fiscal Years ended October 29, 1995, October 30, 1994 and October 31, 1993 33 Notes to Consolidated Financial Statements 34 - 46 Report of Independent Accountants 48 (2) Financial Statement Schedule Page Number Report of Independent Accountants on Financial Schedule II - Valuation and Qualifying Accounts 22 Schedules not listed above have been omitted because they are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or Notes to Consolidated Financial Statements. The consolidated financial statements listed in the above index which are included in the Company's Annual Report to Stockholders are hereby incorporated by reference. With the exception of the pages listed in the above index and the portion of such report referred to in items 1, 5, 6, 7 and 8 of this Form 10-K, the 1995 Annual Report to Stockholders is not to be deemed filed as part of this report. These Exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K: 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. Chairman of the Board and Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/James C. Morgan Chairman of the Board and January 12, 1996 /s/Gerald F. Taylor Senior Vice President and January 12, 1996 Gerald F. Taylor (Principal Financial Officer) /s/Michael K. O'Farrell Corporate Controller January 12, 1996 James C. Morgan Director January 12, 1996 Herbert M. Dwight, Jr.* Director *By /s/James C. Morgan January 12, 1996 A majority of the members of the Board of Directors. Report of Independent Accountants on To the Board of Directors of Applied Materials, Inc. Our audits of the consolidated financial statements referred to in our report dated November 22, 1995 appearing on page 48 of the 1995 Annual Report of Applied Materials, Inc., (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.	10-K	10-K	1996-01-12T00:00:00	1996-01-12T16:21:13
0000929958-96-000001	0000929958-96-000001_0000.txt	001 A000000 CORE TRUST (DELAWARE) 002 A000000 61 BROADWAY, SUITE 2770 007 C020100 INTERNATIONAL PORTFOLIO OF CORE TRUST (DE) 007 C020200 INTERNATIONAL PORTFOLIO II OF CORE TRUST (DE) 007 C020300 SMALL COMPANY PORTFOLIO OF CORE TRUST (DE) 007 C020400 INDEX PORTFOLIO OF CORE TRUST (DE) 010 A00AA01 FORUM FINANCIAL SERVICES INC 012 A00AA01 FORUM FINANCIAL CORP 013 A00AA01 COOPERS & LYBRAND 020 A000003 ROBERT FLEMING, LONDON 020 A000006 LEHMAN BROTHERS, INC 020 A000008 PAINE WEBBER GROUPS 022 A000001 BEAR, STEARNS & CO. 022 A000005 FIRST NAT'L BANK CHICAGO 022 A000006 BANK OF AMERICA 022 A000008 LEHMAN GOV'T SECURITIES 022 A000009 DONALDSON, LUFKIN, JENRETTE 022 A000010 FIRST BOSTON CORPORATION 008 A000101 SCHRODER CAPITAL MANAGEMENT INTERNATIONAL INC 014 A000101 SCHRODER CAPITAL DISTRIBUTORS INC 014 A000102 WERTHEIM SCHRODER INC 015 A000101 CHASE MANHATTAN BANK, N.A. 015 D010101 U.K. 025 A000101 NOMURA SECURITIES COMPANY, LTD 080 A000100 VIGILANT INSURANCE COMPANY 008 A000201 SCHRODER CAPITAL MANAGEMENT INTERNATIONAL INC 014 A000201 SCHRODER CAPITAL DISTRIBUTORS INC 014 A000202 WERTHEIM SCHRODER INC 015 A000201 CHASE MANHATTAN BANK, N.A. 015 D010201 U.K. 025 A000201 NOMURA SECURITIES COMPANY, LTD. 080 A000200 VIGILANT INSURANCE COMPANY 008 A000301 NORWEST INVESTMENT MANAGMENT 015 A000301 NORWEST BANK MINNESOTA, N.A. 080 A000300 VIGILANT INSURANCE COMPANY 008 A000401 NORWEST INVESTMENT MANAGEMENT 015 A000401 NORWEST BANK MINNESOTA, N.A. 025 A000401 MERRILL LYNCH & COMPANY, INC. 025 A000402 SALOMON, INC. 080 A000400 VIGILANT INSURANCE COMPANY	NSAR-B	NSAR-B	1996-01-12T00:00:00	1996-01-12T16:27:37
0000950130-96-000108	0000950130-96-000108_0014.txt	<DESCRIPTION>AGREEMENT AND PLAN OF MERGER AGREEMENT AND PLAN OF MERGER DATED AS OF JANUARY 7, 1996 CONDITIONS TO CONSUMMATION OF THE MERGER Exhibit A................................................. Tax Sharing Agreement Exhibit B................................................... Conditions to Offer Exhibit C............................... Form of Employment Protection Agreement Exhibit D............................................ Employment Protection Plan Exhibit E........................................ Supplemental Severance Program AGREEMENT AND PLAN OF MERGER THIS AGREEMENT AND PLAN OF MERGER, dated as of January 7, 1996, is among LOCKHEED MARTIN CORPORATION, a Maryland corporation ("PARENT"), LAC ACQUISITION CORPORATION, a New York corporation and a wholly-owned subsidiary of Parent ("PURCHASER"), and LORAL CORPORATION, a New York corporation (the "COMPANY"). WHEREAS, the Boards of Directors of the Company, Parent and Purchaser deem it advisable and in the best interests of their respective stockholders that Parent acquire the Company (other than certain businesses thereof) pursuant to the terms and conditions set forth in this Agreement; WHEREAS, as provided in the Restructuring, Financing and Distribution Agreement dated as of the date hereof herewith among Parent, the Company, Loral Telecommunications Acquisition, Inc. (to be renamed Loral Space & Communications Corporation), a Delaware corporation and wholly-owned subsidiary of the Company (including any successor in interest, "SPINCO"), Loral Aerospace Holdings, Inc., a Delaware corporation and wholly-owned subsidiary of the Company ("LAH"), and Loral Aerospace Corp., a Delaware corporation and wholly-owned subsidiary of LAH (the "DISTRIBUTION AGREEMENT"), prior to the expiration of the Offer (as defined in Section 1.1 hereof) the Company will cause Spinco to be restructured so that as a result thereof the Company's direct and indirect interests in Space Systems/Loral, Inc., a Delaware corporation, Globalstar L.P., a Delaware limited partnership, K&F Industries, Inc., a Delaware corporation, all rights to receive management and certain (but not all) guarantee fees therefrom, several commercial satellite and telecommunications projects in progress (including related FCC (as defined in Section 6.5 hereof) applications), a certain portion of the Company's leased corporate headquarters office space, the Company's corporate aircraft, certain rights and liabilities with respect to certain litigation in which the Company has an interest, the nonexclusive right to use certain intellectual property of the Company, the exclusive right, subject to a limited license granted to the Company, to the "Loral" name and such other rights and assets as shall be deemed Spinco Assets (as defined in the Distribution Agreement), will be owned directly or indirectly by Spinco and substantially all of the Company's other assets, liabilities and businesses will be owned directly by the Company or by Subsidiaries (as defined in the Distribution Agreement) of the Company other than Spinco and Subsidiaries of Spinco; and WHEREAS, as provided in the Distribution Agreement, the Company will make a distribution to the Company's stockholders and to holders of Stock Options (as defined in Section 2.10 hereof) as of the Record Date (as defined in the Distribution Agreement), on a pro rata basis, of 100% of the shares of common stock, par value $.01 per share, of Spinco issued and outstanding immediately prior to such distribution (the "SPIN-OFF"); and WHEREAS, as set forth in Section 6.10 hereof, as a condition to and in consideration of the transactions contemplated hereby, following the date hereof (a) the Company, Spinco and certain other parties will enter into a Tax Sharing Agreement substantially in the form attached hereto as Exhibit A with such changes as shall have been approved prior to the consummation of the Offer by the Company and Parent (or, following the consummation of the Offer, by a majority of the Continuing Directors (as defined in Section 8.4 hereof), if any, and Parent) (the "TAX SHARING AGREEMENT" and, together with the Distribution Agreement, hereafter are collectively referred to as the NOW, THEREFORE, in consideration of the premises and the representations, warranties, covenants and agreements herein contained, and intending to be legally bound hereby, Parent, Purchaser and the Company hereby agree as follows: (a) Subject to this Agreement not having been terminated in accordance with the provisions of Section 8.1 hereof, Purchaser shall, and Parent shall cause Purchaser to, as promptly as practicable, but in no event later than five Business Days (as defined in the Distribution Agreement) from the date of the public announcement of the terms of this Agreement, commence an offer to purchase for cash (as it may be amended in accordance with the terms of this Agreement, the "OFFER") all of the Company's outstanding shares of common stock, par value $.25 per share, together with all preferred stock purchase rights associated therewith (the "SHARES"), subject to the conditions set forth in Exhibit B attached hereto, at a price of not less than $38.00 per Share, net to the seller in cash. Subject only to the conditions set forth in Exhibit B hereto and the express provisions of the Distribution Agreement, the Purchaser shall, and Parent shall cause Purchaser to, (i) accept for payment and pay for all Shares tendered pursuant to the terms of the Offer as promptly as practicable following the expiration date of the Offer, and (ii) extend the period of time the Offer is open until the first Business Day following the date on which the conditions set forth in clause (i)(A) and clause (i)(B) of Exhibit B hereto are satisfied or waived in accordance with the provisions thereof; provided, that the Purchaser shall be permitted, but shall not be obligated, to extend the period of time the Offer is open beyond June 30, 1996. Subject to the preceding sentence of this Section 1.1, neither Purchaser nor Parent will extend the expiration date of the Offer beyond the twentieth Business Day following commencement thereof unless one or more of the conditions set forth in Exhibit B hereto shall not be satisfied or unless Parent reasonably determines that such extension is necessary to comply with any legal or regulatory requirements relating to the Offer or the Spin-Off. Purchaser expressly reserves the right to amend the terms or conditions of the Offer; provided, that without the consent of the Company, no amendment may be made which (i) decreases the price per Share or changes the form of consideration payable in the Offer, (ii) decreases the number of Shares sought, or (iii) imposes additional conditions to the Offer or amends any other term of the Offer in any manner materially adverse to the holders of Shares. Upon the terms and subject to the conditions of the Offer, the Purchaser will accept for payment and purchase, as soon as permitted under the terms of the Offer, all Shares validly tendered and not withdrawn prior to the expiration of the Offer. (b) Parent will not, nor will it permit any of its affiliates to, tender into the Offer any Shares beneficially owned by it; provided, that Shares held beneficially or of record by any plan, program or arrangement sponsored or maintained for the benefit of employees of Parent or any of its Subsidiaries shall not be deemed to be held by Parent or an affiliate thereof regardless of whether Parent has, directly or indirectly, the power to vote or control the disposition of such Shares. The Company will not, nor will it permit any of its Subsidiaries (other than Retained Subsidiaries (as defined in Section 4.1 hereof)) to, tender into the Offer any Shares beneficially owned by it; provided, that Shares held beneficially or of record by any plan, program or arrangement sponsored or maintained for the benefit of employees of the Company or any of its Subsidiaries shall not be deemed to be held by the Company regardless of whether the Company has, directly or indirectly, the power to vote or control the disposition of such Shares. (c) Notwithstanding anything to the contrary contained in this Agreement, Parent and Purchaser shall not be required to commence the Offer in any foreign country where the commencement of the Offer, in Parent's reasonable opinion, would violate the applicable Law (as defined in the Distribution Agreement) of such jurisdiction. (d) On the date of the commencement of the Offer, Purchaser shall file with the Securities and Exchange Commission (the "SEC") a Tender Offer Statement on Schedule 14D-1 with respect to the Offer which will contain an offer to purchase and form of the related letter of transmittal (together with any supplements or amendments thereto, the "OFFER DOCUMENTS"). The Company and its counsel shall be given a reasonable opportunity to review and comment on the Offer Documents prior to the filing of such Offer Documents with the SEC. Purchaser agrees to provide the Company and its counsel in writing with any comments Purchaser and its counsel may receive from the SEC or its staff with respect to the Offer Documents promptly after the receipt thereof. SECTION 1.2. COMPANY ACTIONS. The Company hereby consents to the Offer and represents that its Board of Directors (at a meeting duly called and held) has unanimously (a) determined as of the date hereof that the Offer, the Merger (as defined in Section 2.1 hereof) and the Spin-Off are fair to the stockholders of the Company and are in the best interests of the stockholders of the Company and (b) resolved to recommend acceptance of the Offer and approval and adoption of this Agreement and the Merger by the stockholders of the Company which approval constitutes approval of each of the transactions contemplated by this Agreement for purposes of Sections 902 and 912 of the New York Business Corporation Law ("NYBCL"). The Company further represents that Lazard Freres & Co. LLC has delivered to the Board of Directors of the Company its opinion that the consideration to be received by the holders of Shares in the Offer, the Merger and the Spin-Off is fair to the holders of the Company's common stock from a financial point of view. The Company hereby agrees to file a Solicitation/Recommendation Statement on Schedule 14D-9 (the "SCHEDULE 14D- 9") containing such recommendation with the SEC (and the information required by Section 14(f) of the Exchange Act if Parent shall have furnished such information to the Company in a timely manner) and to mail such Schedule 14D-9 to the stockholders of the Company; provided, that subject to the provisions of Section 6.2(a) hereof, such recommendation may be withdrawn, modified or amended. Such Schedule 14D-9 shall be, if so requested by Purchaser, filed on the same date as Purchaser's Schedule 14D-1 is filed and mailed together with the Offer Documents; provided, that in any event the Schedule 14D-9 shall be filed and mailed no later than 10 Business Days following the commencement of the Offer. Purchaser and its counsel shall be given a reasonable opportunity to review and comment on such Schedule 14D-9 prior to the Company's filing of the Schedule 14D-9 with the SEC. The Company agrees to provide Parent and its counsel in writing with any comments the Company or its counsel may receive from the SEC or its staff with respect to such Schedule 14D-9 promptly after the receipt thereof. SECTION 1.3. STOCKHOLDER LISTS. In connection with the Offer, at the request of Parent or Purchaser, from time to time after the date hereof, the Company will promptly furnish Purchaser with mailing labels, security position listings and any available listing or computer file containing the names and addresses of the record holders of the Shares as of a recent date and shall furnish Purchaser with such information and assistance as Purchaser or its agents may reasonably request in communicating the Offer to the record and beneficial holders of Shares. SECTION 1.4. COMPOSITION OF THE BOARD OF DIRECTORS; SECTION 14(F). In the event that Purchaser acquires at least a majority of the Shares outstanding pursuant to the Offer, Parent shall be entitled to designate for appointment or election to the Company's Board of Directors, upon written notice to the Company, such number of persons so that the designees of Parent constitute the same percentage (but in no event less than a majority) of the Company's Board of Directors (rounded up to the next whole number) as the percentage of Shares acquired in connection with the Offer. Prior to consummation of the Offer, the Board of Directors of the Company will obtain the resignation of such number of directors as is necessary to enable such number of Parent designees to be so elected. In connection therewith, the Company will mail to the stockholders of the Company the information required by Section 14(f) of the Exchange Act and Rule 14f-1 thereunder unless such information has previously been provided to such stockholders in the Schedule 14D-9. Parent and Purchaser will provide to the Company in writing, and be solely responsible for, any information with respect to such companies and their nominees, officers, directors and affiliates required by such Section and Rule. Notwithstanding the provisions of this Section 1.4, the parties hereto shall use their respective best efforts to ensure that at least three of the members of the Company's Board of Directors shall, at all times prior to the Effective Time (as defined in Section 2.2 hereof) be, Continuing Directors (as defined in Section 8.4 hereof). SECTION 2.1. THE MERGER. Upon the terms and subject to the conditions hereof, and in accordance with the NYBCL, Purchaser shall be merged (the "MERGER") with and into the Company as soon as practicable following the satisfaction or waiver of the conditions set forth in Article VII hereof or on such other date as the parties hereto may agree (such agreement to require the approval of a majority of the Continuing Directors if at the time there shall be any Continuing Directors). Following the Merger the Company shall continue as the surviving corporation (the "SURVIVING CORPORATION") and the separate corporate existence of Purchaser shall cease. SECTION 2.2. EFFECTIVE TIME. The Merger shall be consummated by filing with the New York Secretary of State a certificate of merger or, if applicable, a certificate of ownership and merger, executed in accordance with the relevant provisions of the NYBCL (the time the Merger becomes effective being the "EFFECTIVE TIME"). SECTION 2.3. EFFECTS OF THE MERGER. The Merger shall have the effects set forth in the NYBCL. As of the Effective Time the Company shall be a wholly- owned subsidiary of Parent. SECTION 2.4. CERTIFICATE OF INCORPORATION AND BY-LAWS. The Restated Certificate of Incorporation and By-Laws of the Company as in effect at the Effective Time, shall be the Certificate of Incorporation and By-Laws of the Surviving Corporation until amended in accordance with applicable Law; provided, that promptly following the Effective Time, the Certificate of Incorporation shall be amended to change the name of the Surviving Corporation so that the word "Loral" shall be deleted therefrom. SECTION 2.5. DIRECTORS. The directors of Purchaser at the Effective Time shall be the initial directors of the Surviving Corporation and will hold office from the Effective Time until their respective successors are duly elected or appointed and qualify in the manner provided in the Certificate of Incorporation and By-Laws of the Surviving Corporation, or as otherwise provided by Law. SECTION 2.6. OFFICERS. The officers of Purchaser at the Effective Time shall be the initial officers of the Surviving Corporation and will hold office from the Effective Time until their respective successors are duly elected or appointed and qualify in the manner provided in the Certificate of Incorporation and By-Laws of the Surviving Corporation, or as otherwise provided by Law. SECTION 2.7. CONVERSION OF SHARES. At the Effective Time: (a) Each Share issued and outstanding immediately prior to the Effective Time (other than Shares held in the treasury of the Company or held by any Subsidiary of the Company (other than a Retained Subsidiary), and other than Dissenting Shares (as defined in Section 3.1 hereof)) shall, by virtue of the Merger and without any action on the part of the holder thereof, be converted into the right to receive $38.00 in cash, or any higher price paid per Share in the Offer (the "MERGER PRICE"), payable to the holder thereof, without interest thereon, upon the surrender of the certificate formerly representing such Share (except as provided in Section 2.10(c) hereof). (b) Each Share held in the treasury of the Company or held by any Subsidiary of the Company (other than a Retained Subsidiary) and each Share held by Parent or any Subsidiary of Parent immediately prior to the Effective Time shall, by virtue of the Merger and without any action on the part of the holder thereof, be cancelled and retired and cease to exist; provided, that Shares held beneficially or of record by any plan, program or arrangement sponsored or maintained for the benefit of employees of Parent or the Company or any Subsidiaries thereof shall not be deemed to be held by Parent or the Company regardless of whether Parent or the Company has, directly or indirectly, the power to vote or control the disposition of such Shares. SECTION 2.9. CONVERSION OF PURCHASER'S COMMON STOCK. Each share of common stock, par value $.01 per share, of Purchaser issued and outstanding immediately prior to the Effective Time shall, by virtue of the Merger and without any action on the part of the holder thereof, be converted into and exchangeable for one share of common stock of the Surviving Corporation. SECTION 2.10. STOCK OPTIONS AND STOCK AWARDS. (a) The Company shall take all actions (including, but not limited to, obtaining any and all consents from employees to the matters contemplated by this Section 2.10) necessary to provide that all outstanding options and other rights to acquire Shares ("STOCK OPTIONS") granted under any stock option arrangement of the Company or any Subsidiaries, each as amended (the "OPTION PLANS"), shall become fully exercisable and vested on the date (the "VESTING DATE") which shall be set by the Company and which, in any event, shall be not less than 30 days prior to the consummation of the Offer, whether or not otherwise exercisable and vested. All Stock Options which are outstanding immediately prior to Purchaser's acceptance for payment and payment for Shares tendered pursuant to the Offer shall be cancelled as of the consummation of the Offer and the holders thereof (other than holders who are subject to the reporting requirements of Section 16(a) of the Exchange Act) shall be entitled to receive from the Company, for each Share subject to such Stock Option, (1) an amount in cash equal to the difference between the Merger Price and the exercise price per share of such Stock Option, which amount shall be payable upon consummation of the Offer, plus (2) one share of Spinco Common Stock (as defined in the Distribution Agreement), which shall be held by an escrow agent pending delivery on the Distribution Date. All applicable withholding taxes attributable to the payments made hereunder or to distributions contemplated hereby shall be deducted from the amounts payable under clause (1) above and all such taxes attributable to the exercise of Stock Options on or after the Vesting Date shall be withheld from the proceeds received in the Offer or the Merger, as the case may be, in respect of the Shares issuable on such exercise. (b) The Company shall take all actions (including, but not limited to, obtaining any and all consents from employees to the matters contemplated by this Section 2.10) necessary to provide that all restrictions on transferability with respect to each Share which is granted pursuant to the Company's 1987 Restricted Stock Purchase Plan (the "1987 PLAN") and which is outstanding and not vested on the Vesting Date shall lapse, and each such Share shall become free of restrictions as of the Vesting Date. All applicable withholding taxes attributable to the vesting of restricted Shares shall be withheld from the proceeds received in respect of such Shares in the Offer or the Merger, as the case may be. (c) Except as provided herein or as otherwise agreed to by the parties and to the extent permitted by the Option Plans and the 1987 Plan, (i) the Option Plans and the 1987 Plan shall terminate as of the Effective Time and the provisions in any other plan, program or arrangement, providing for the issuance or grant by the Company or any of its Subsidiaries of any interest in respect of the capital stock of the Company or any of its Subsidiaries shall be deleted as of the Effective Time and (ii) the Company shall use all reasonable efforts to ensure that following the Effective Time no holder of Stock Options or any participant in the Option Plans or any other such plans, programs or arrangements shall have any right thereunder to acquire any equity securities of the Company, the Surviving Corporation or any Subsidiary thereof. SECTION 2.11. STOCKHOLDERS' MEETING. If required by applicable Law in order to consummate the Merger, the Company, acting through its Board of Directors, shall, in accordance with applicable Law, its Restated Certificate of Incorporation and By-Laws and the rules and regulations of the New York Stock Exchange: (a) duly call, give notice of, convene and hold a special meeting of its stockholders as soon as practicable following the consummation of the Offer for the purpose of considering and taking action upon this Agreement (the (b) subject to its fiduciary duties under applicable Laws as advised by counsel, include in the Information Statement prepared by the Company for distribution to stockholders of the Company in advance of the Stockholders' Meeting in accordance with Regulation 14C promulgated under the Exchange Act (the "INFORMATION STATEMENT") the recommendation of its Board of Directors referred to in Section 1.2 hereof; and (c) use its best efforts to (i) obtain and furnish the information required to be included by it in the Information Statement, and, after consultation with Parent, respond promptly to any comments made by the SEC with respect to the Information Statement and any preliminary version thereof and cause the Information Statement to be mailed to its stockholders following the consummation of the Offer and (ii) obtain the necessary approvals of this Agreement by its stockholders. Parent will provide the Company with the information concerning Parent and Purchaser required to be included in the Information Statement and will vote, or cause to be voted, all Shares owned by it or its Subsidiaries in favor of approval and adoption of this Agreement. SECTION 2.12. FILING OF CERTIFICATE OF MERGER. Upon the terms and subject to the conditions hereof, as soon as practicable following the satisfaction or waiver of the conditions set forth in Article VII hereof, the Company shall execute and file a certificate of merger or, if applicable, a certificate of ownership and merger, in the manner required by the NYBCL and the parties hereto shall take all such other and further actions as may be required by Law to make the Merger effective. Prior to the filings referred to in this Section 2.12, a closing will be held at the offices of O'Melveny & Myers, 153 East 53rd Street, New York, New York (or such other place as the parties may agree), for the purpose of confirming all of the foregoing. DISSENTING SHARES; EXCHANGE OF SHARES SECTION 3.1. DISSENTING SHARES. Notwithstanding anything in this Agreement to the contrary, Shares which are issued and outstanding immediately prior to the Effective Time and which are held by stockholders who have not voted such Shares in favor of the Merger and shall have delivered a written demand for appraisal of such Shares in the manner provided in the NYBCL (the "DISSENTING SHARES") shall not be converted into or be exchangeable for the right to receive the consideration provided in Section 2.7 of this Agreement, unless and until such holder shall have failed to perfect or shall have effectively withdrawn or lost such holder's right to appraisal and payment under the NYBCL. If such holder shall have so failed to perfect or shall have effectively withdrawn or lost such right, such holder's Shares shall thereupon be deemed to have been converted into and to have become exchangeable for, at the Effective Time, the right to receive the consideration provided for in Section 2.7(a) of this Agreement, without any interest thereon. SECTION 3.2. EXCHANGE OF SHARES. (a) Prior to the Effective Time, Parent shall designate a bank or trust company to act as exchange agent in the Merger (the "EXCHANGE AGENT"). Immediately prior to the Effective Time, Parent will take all steps necessary to enable and cause the Company to deposit with the Exchange Agent the funds necessary to make the payments contemplated by Section 2.7 on a timely basis. (b) Promptly after the Effective Time, the Exchange Agent shall mail to each record holder, as of the Effective Time, of an outstanding certificate or certificates which immediately prior to the Effective Time represented Shares (the "CERTIFICATES") a form letter of transmittal (which shall specify that delivery shall be effected, and risk of loss and title to the Certificates shall pass, only upon proper delivery of the Certificates to the Exchange Agent) and instructions for use in effecting the surrender of the Certificates for payment therefor. Upon surrender to the Exchange Agent of a Certificate, together with such letter of transmittal duly executed, and any other required documents, the holder of such Certificate shall be entitled to receive in exchange therefor the consideration set forth in Section 2.7(a) hereof, and such Certificate shall forthwith be cancelled. No interest will be paid or accrued on the cash payable upon the surrender of the Certificates. If payment is to be made to a person other than the person in whose name the Certificate surrendered is registered, it shall be a condition of payment that the Certificate so surrendered shall be properly endorsed or otherwise in proper form for transfer and that the person requesting such payment shall pay any transfer or other taxes required by reason of the payment to a person other than the registered holder of the Certificate surrendered or establish to the of the Surviving Corporation that such tax has been paid or is not applicable. Until surrendered in accordance with the provisions of this Section 3.2, each Certificate (other than Certificates representing Shares held by Parent or any subsidiary of Parent, Shares held in the treasury of the Company or held by any subsidiary of the Company and Dissenting Shares) shall represent for all purposes only the right to receive the consideration set forth in Section 2.7(a) hereof, without any interest thereon. (c) After the Effective Time there shall be no transfers on the stock transfer books of the Surviving Corporation of the Shares which were outstanding immediately prior to the Effective Time. If, after the Effective Time, Certificates are presented to the Surviving Corporation, they shall be cancelled and exchanged for the consideration provided in Article II hereof in accordance with the procedures set forth in this Article III. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and warrants to Parent and Purchaser as follows: SECTION 4.1. ORGANIZATION. Each of the Company and its Subsidiaries that will be owned, directly or indirectly, by the Company following the Spin-Off (the "RETAINED SUBSIDIARIES") is a corporation duly organized, validly existing and in good standing under the Laws of the jurisdiction of its incorporation and has all requisite corporate power and authority to own, lease and operate its properties and to carry on its business as now being conducted, except in the case of Retained Subsidiaries where the failure to be so existing and in good standing or to have such power and authority would not in the aggregate have a Material Adverse Effect (as defined below). For purposes of this Agreement (except as provided in Section 5.1 hereof), (a) the term "MATERIAL ADVERSE EFFECT" shall mean any change or effect that is reasonably likely to be materially adverse to (i) the business, properties, operations, prospects, results of operations or condition (financial or otherwise) of the Retained Business (as hereinafter defined) taken as a whole, or (ii) the ability of (A) the Company to perform its obligations under this Agreement or the Distribution Agreement, or (B) Spinco to perform its obligations under the Distribution Agreement; and (b) the term "RETAINED BUSINESS" shall mean all of the businesses (and the Assets and Liabilities thereof (each as defined in the Distribution Agreement)) of the Company and its Subsidiaries, other than the Spinco Business (as defined in the Distribution Agreement). Each of the Company and the Retained Subsidiaries is duly qualified or licensed and in good standing to do business in each jurisdiction in which the property owned, leased or operated by it or the nature of the business conducted by it makes such qualification or licensing necessary, except in such jurisdictions where the failure to be so duly qualified or licensed and in good standing would not in the aggregate have a Material Adverse Effect. The Company has heretofore delivered or made available to Parent accurate and complete copies of the Certificate of Incorporation and By-Laws (or other similar organizational documents in the event of any entity other than a corporation), as currently in effect of the Company and each of the Retained Subsidiaries. (a) As of December 31, 1995, the authorized capital stock of the Company consisted of (i) 300,000,000 Shares, of which 173,068,379 Shares were issued and outstanding (inclusive of Shares subject to restrictions under the Company's 1987 Restricted Stock Purchase Plan), and (ii) 2,000,000 shares of Preferred Stock, par value $1.00 per share ("PREFERRED STOCK"), of which 250,000 shares were designated as Series A Preferred Stock, of which no shares were issued and outstanding. All of the issued and outstanding Shares are validly issued, fully paid and non-assessable and free of preemptive rights. As of December 31, 1995, 11,131,234 Shares were issuable upon the exercise of outstanding vested and non-vested Stock Options. Since December 31, 1995, the Company has not granted any Stock Options or issued any shares of its capital stock except as set forth on Schedule 4.2(a) of the disclosure schedule delivered by the Company to Parent on or prior to the date hereof (the "DISCLOSURE SCHEDULE") or except upon exercise of Stock Options or pursuant to any existing Plan in accordance with the current terms of such Plan. Except as set forth above and as otherwise provided for in this Agreement, there are not now, and at the Effective Time there will not be, any shares of capital stock of the Company issued or outstanding or any subscriptions, options, warrants, calls, rights, convertible securities or other agreements or commitments of any character obligating the Company to issue, transfer or sell any of its securities other than the Rights (as defined in the Rights Agreement). Except as permitted by this Agreement, following the Merger, the Company will have no obligation to issue, transfer or sell any shares of its capital stock pursuant to any employee benefit plan or otherwise. (b) All of the outstanding shares of capital stock of, or ownership interest in, each of the Retained Subsidiaries have been validly issued and are fully paid and non-assessable and are owned by either the Company or another of the Retained Subsidiaries free and clear of all Liens (as defined in the Distribution Agreement). There are not now, and at the Effective Time there will not be, any outstanding subscriptions, options, warrants, calls, rights, convertible securities or other agreements or commitments of any character relating to the issued or unissued capital stock or other securities of any of the Retained Subsidiaries, or otherwise obligating the Company or any such subsidiary to issue, transfer or sell any such securities. (c) There are not now, and at the Effective Time there will not be, any voting trusts or other agreements or understandings to which the Company or any of the Retained Subsidiaries is a party or is bound with respect to the voting of the capital stock of the Company or any of the Retained Subsidiaries. SECTION 4.3. AUTHORITY RELATIVE TO THIS AGREEMENT. Each of the Company and each Company Subsidiary which is a party to any of the Ancillary Agreements (each such subsidiary, a "CONTRACTING SUBSIDIARY") has full corporate power and authority to execute and deliver this Agreement and the Ancillary Agreements and to consummate the transactions contemplated hereby and thereby (but only to the extent it is a party thereto). The execution and delivery of this Agreement by the Company and of the Ancillary Agreements by the Company and each Contracting Subsidiary (to the extent it is a party thereto) and the consummation of the transactions contemplated hereby and thereby have been, or with respect to Contracting Subsidiaries will be prior to the Record Date, duly and validly authorized by the Boards of Directors of the Company and each Contracting Subsidiary (to the extent it is a party thereto) and no other corporate proceedings on the part of the Company or each Contracting Subsidiary (to the extent it is a party thereto), including, without limitation, any approval by the stockholders of the Company, are, or with respect to Contracting Subsidiaries will be prior to the Record Date, necessary to authorize this Agreement or the Ancillary Agreements or to consummate the transactions contemplated hereby or thereby (other than (a) with respect to the Merger, the approval and adoption of this Agreement by the holders of the requisite number of the outstanding Shares and (b) the establishment of the Record Date and the Distribution Date (each as defined in the Distribution Agreement) by the Board of Directors of the Company). This Agreement has been, and each of the Ancillary Agreements have been or will prior to the Record Date be, duly and validly executed and delivered by the Company and each Contracting Subsidiary (to the extent it is a party thereto) and constitute or (to the extent such agreement is not being entered into as of the date hereof) will constitute a valid and binding agreement of the Company and each Contracting Subsidiary (to the extent it is a party thereto), enforceable against the Company and each Contracting Subsidiary (to the extent it is a party thereto) in accordance with its terms except to the extent that enforcement thereof may be limited by (a) bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance or other similar laws, now or hereafter in effect, relating to the creditors' rights generally and (b) general principles of equity (regardless of whether enforceability is considered in a proceeding at law or in equity). The affirmative vote of the holders of two-thirds of the Shares, determined on a fully-diluted basis, is the only vote of the holders of any class or series of Company capital stock necessary to approve the Merger. SECTION 4.4. CONSENTS AND APPROVALS; NO VIOLATIONS. Except for any applicable requirements of the Securities Exchange Act of 1934, as amended, and all rules and regulations thereunder (the "EXCHANGE ACT"), the Securities Act of 1933, as amended, and all rules and regulations thereunder (the "SECURITIES ACT"), the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR ACT"), the EC Merger Regulations (as defined below), and the Communications Act of 1934, as amended, and all rules and regulations promulgated thereunder (the "COMMUNICATIONS ACT"), the filing and recordation of a certificate of merger, or a certificate of ownership and merger, as required by the NYBCL, filing with and approval of the New York Stock Exchange, Inc. and the SEC with respect to the delisting and deregistering of the Shares, such filings and approvals as may be required under the "takeover" or "blue sky" Laws of various states, and as disclosed in Section 4.4 of the Disclosure Schedule or as contemplated by this Agreement and the Ancillary Agreements, neither the execution and delivery of this Agreement or the Ancillary Agreements by the Company or any Contracting Subsidiary (to the extent it is a party thereto) nor the consummation by the Company or any Contracting Subsidiary (to the extent it is a party thereto) of the transactions contemplated hereby or thereby will (i) conflict with or result in any breach of any provision of the Certificate of Incorporation or By-Laws of the Company or any Contracting Subsidiary or Retained Subsidiary (other than those Retained Subsidiaries which, when taken together, would not be a "significant subsidiary" within the meaning of Regulation S-X promulgated under the Securities Act) (any such Retained Subsidiary, other than those described in the preceding parenthetical, herein called a "SIGNIFICANT RETAINED SUBSIDIARY"), (ii) require on the part of the Company or any Contracting Subsidiary or a Significant Retained Subsidiary any filing with, or the obtaining of any permit, authorization, consent or approval of, any governmental or regulatory authority or any third party, (iii) result in a violation or breach of, or constitute (with or without due notice or lapse of time or both) a default (or give rise to any right of termination, amendment, cancellation, acceleration or payment, or to the creation of a lien or encumbrance) under any of the terms, conditions or provisions of any note, mortgage, indenture, other evidence of indebtedness, guarantee, license, agreement or other contract, instrument or obligation to which the Company, any Contracting Subsidiary or Retained Subsidiary or any of their respective Subsidiaries is a party or by which any of them or any of their Assets may be bound or (iv) violate any order, writ, injunction, decree, statute, rule or regulation applicable to the Company or any Contracting Subsidiary or Retained Subsidiary, any of their respective Subsidiaries or any of their Assets, except for such requirements, defaults, rights or violations under clauses (ii), (iii) and (iv) above (x) which relate to jurisdictions outside the United States or which would not in the aggregate have a Material Adverse Effect or materially impair the ability of the Company or any Contracting Subsidiary to consummate the transactions contemplated by this Agreement, or (y) which become applicable as a result of the business or activities in which Parent or Purchaser is or proposes to be engaged (other than the business or activities of the Retained Business to be acquired by Purchaser, considered independently of the ownership thereof by Parent and Purchaser) or as a result of other facts or circumstances specific to Parent or Purchaser. For purposes of this Agreement, "EC MERGER REGULATIONS" mean Council Regulation (EEC) No. 4064/89 of December 21, 1989 on the Control of Concentrations Between Undertakings, OJ (1989) L 395/1 and the regulations and decisions of the Councilor Commission of the European Community (the "COMMISSION") or other organs of the European Union or European Community implementing such regulations. SECTION 4.5. ABSENCE OF CERTAIN CHANGES. Except (a) as set forth in Section 4.5 of the Disclosure Schedule, (b) as set forth in the Company's Annual Report on Form 10-K for the year ended March 31, 1995 (the "FORM 10-K") or any other document filed prior to the date hereof pursuant to Section 13(a) or 15(d) of the Exchange Act, or (c) as contemplated by this Agreement or any of the Ancillary Agreements, from April 1, 1995 until the date hereof, neither the Company nor any of its Subsidiaries has taken any of the prohibited actions set forth in Section 6.1 (other than clause (l) thereof) hereof or suffered any changes that, in each case, either individually or in the aggregate, would result in a Material Adverse Effect or conducted its business or operations in any material respect other than in the ordinary and usual course of business, consistent with past practices. SECTION 4.6. NO UNDISCLOSED LIABILITIES. Except (a) for Liabilities and obligations incurred in the ordinary and usual course of business consistent with past practice since April 1, 1995, (b) for Liabilities incurred in connection with the Offer, the Merger and the Spin-Off and (c) as set forth in Section 4.6 of the Disclosure Schedule, from April 1, 1995 until the date hereof neither the Company nor any of its Subsidiaries has incurred any Liabilities that, individually or in the aggregate, would have a Material Adverse Effect and that would be required to be reflected or reserved against in a consolidated balance sheet of the Company and its Subsidiaries prepared in accordance with generally accepted accounting principles as applied in preparing the consolidated balance sheet of the Company and its Subsidiaries as of March 31, 1995 contained in the Form 10-K. (a) The Company has filed all reports, forms, statements and other documents required to be filed with the SEC pursuant to the Exchange Act since April 1, 1991 (collectively, including, without limitation, any financial statements or schedules included or incorporated by reference therein, the "COMPANY SEC DOCUMENTS"). Each of the Company SEC Documents, as of its filing date and at each time thereafter when the information included therein was required to be updated pursuant to the rules and regulations of the SEC, complied in all material respects with all applicable requirements of the Securities Act and the Exchange Act. None of the Company SEC Documents, as of their respective filing dates or any date thereafter when the information included therein was required to be updated pursuant to the rules and regulations of the SEC, contained or will contain any untrue statement of a material fact or omitted or will omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Each of the consolidated balance sheets (including the related notes) included in the Company SEC Documents filed prior to or after the date of this Agreement (but prior to the date on which the Offer is consummated, and excluding the Company SEC Documents described in Section 4.8 hereof) fairly presents or will fairly present in all material respects the consolidated financial position of the Company and its Subsidiaries as of the respective dates thereof, and the other related statements (including the related notes) included therein fairly present or will fairly present in all material respects the results of operations and the cash flows of the Company and its Subsidiaries for the respective periods or as of the respective dates set forth therein. Each of the financial statements (including the related notes) included in the Company SEC Documents filed prior to or after the date of this Agreement (but prior to the date on which the Offer is consummated, and excluding the Company SEC Documents described in Section 4.8 hereof) has been prepared or will be prepared in all material respects in accordance with generally accepted accounting principles consistently applied during the periods involved, except (i) as otherwise noted therein, (ii) to the extent required by changes in generally accepted accounting principles or (iii) in the case of unaudited financial statements, normal recurring year-end audit adjustments. (b) The Company has heretofore made available or promptly will make available to Purchaser a complete and correct copy of any amendments or modifications, which have not yet been filed with the SEC, to agreements, documents or other instruments which previously had been filed by the Company with the SEC pursuant to the Exchange Act. (c) Except as and to the extent set forth in Section 4.7(c) of the Disclosure Schedule, the pro forma consolidated balance sheet and the pro forma statement of operations (including the related notes) of the Retained Business attached as Annex 1 to Section 4.7(c) of the Disclosure Schedule (the "DEFENSE FINANCIAL STATEMENTS") fairly presents on a pro forma basis in all material respects the consolidated financial position of the Retained Business as of the date thereof, and fairly presents on a pro forma basis in all material respects the consolidated results of operations of the Retained Business for the period set forth therein, respectively. The Defense Financial Statements have been prepared in all material respects in accordance with generally accepted accounting principles consistently applied during the periods involved, except as otherwise disclosed therein or in the notes thereto. SECTION 4.8. SCHEDULE 14D-9; OFFER DOCUMENTS; FORM 10; INFORMATION STATEMENT. None of the information (other than information provided in writing by Parent or Purchaser for inclusion therein) included in the Schedule 14D-9, the Form 10 (as defined in the Distribution Agreement (or any registration statement contemplated pursuant to Section 3.1(a) of the Distribution Agreement) or the Information Statement or supplied by the Company for inclusion in the Offer Documents, including any amendments thereto, will be false or misleading with respect to any material fact or will omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading. Except for information supplied by Parent in writing for inclusion therein, the Schedule 14D-9, the Form 10 (or any registration statement contemplated pursuant to Section 3.1(a) of the Distribution Agreement) and the Information Statement, including any amendments thereto, will comply in all material respects with the Exchange Act and the Securities Act. SECTION 4.9. NO DEFAULT. Except as set forth in Section 4.9 of the Disclosure Schedule, neither the Company nor any of its Subsidiaries is in default or violation (and no event has occurred which with notice or the lapse of time or both would constitute a default or violation) of any term, condition or provision of (i) its charter or its by-laws, (ii) any note, mortgage, indenture (including, without limitation, the Indenture dated January 15, 1992 with respect to the Company's 9 1/8% Senior Debentures due 2022, the Indenture dated September 1, 1993 with respect to the Company's 7 5/8% Senior Notes due 2004, 8 3/8% Senior Debentures due 2024 and 7 5/8% Senior Debentures due 2025, and the Indenture dated November 1, 1992 with respect to the Company's 7% Senior Debentures due 2023 and 8 3/8% Senior Debentures due 2023 (collectively, the "PUBLIC INDENTURES")), other evidence of indebtedness, guarantee, license, agreement or other contract, instrument or contractual obligation to which the Company or any of its Subsidiaries is now a party or by which they or any of their Assets may be bound, or (iii) any order, writ, injunction, decree, statute, rule or regulation applicable to the Company or any of its Subsidiaries, except for defaults or violations under clause (i) (with respect to Company Subsidiaries other than the Retained Subsidiaries), clause (ii) (other than defaults under or violations of any of the Public Indentures or the Amended and Restated Credit Agreement dated as of November 23, 1994 between the Company and the banks party thereto (the "CREDIT AGREEMENT")), and clause (iii) above which, (A) in the aggregate would not have a Material Adverse Effect and would not have a material adverse effect on the ability of the Company or Spinco to consummate the transactions contemplated by this Agreement or the Distribution Agreement, or (B) become applicable as a result of the business or activities in which Parent or Purchaser is or proposes to be engaged (other than the business or activities of the Retained Business to be acquired by Purchaser, considered independently of the ownership thereof by Parent and Purchaser) or as a result of any other facts or circumstances specific to Parent or Purchaser. SECTION 4.10. LITIGATION; COMPLIANCE WITH LAW. (a) Except as set forth in Section 4.10(a) of the Disclosure Schedule, as of the date hereof (except as provided in the following sentence), there are no actions, suits, claims, proceedings or investigations pending or, to the best knowledge of the Company, threatened, involving the Company or any of its Subsidiaries or any of their respective Assets (or any person or entity whose liability therefrom may have been retained or assumed by the Company or any of its Subsidiaries either contractually or by operation of Law), by or before any court, governmental or regulatory authority or by any third party which, either individually or in the aggregate, would have a Material Adverse Effect. None of the Company, any of its Subsidiaries or any of their respective Assets is subject to any outstanding order, writ, injunction or decree which, insofar as can be reasonably foreseen, individually or in the aggregate, in the future would have a Material Adverse Effect. (b) Except as disclosed by the Company in the Company SEC Documents filed since April 1, 1995 (the "RECENT SEC DOCUMENTS") or Section 4.10(b) of the Disclosure Schedule, the Company and its Retained Subsidiaries are now being and in the past have been operated in substantial compliance with all Laws except for violations which individually or in the aggregate do not, and, insofar as reasonably can be foreseen, will not, have a Material Adverse Effect. SECTION 4.11. EMPLOYEE BENEFIT PLANS; ERISA. (a) Except for those matters set forth in Section 4.11(a) of the Disclosure Schedule, (i) each "employee benefit plan" (as defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA")), and all other employee benefit, bonus, incentive, stock option (or other equity- based), severance, change in control, welfare (including post-retirement medical and life insurance) and fringe benefit plans (whether or not subject to ERISA) maintained or sponsored by the Company or its Subsidiaries or any trade or business, whether or not incorporated, that would be deemed a "single employer" within the meaning of Section 4001 of ERISA (an "ERISA AFFILIATE"), for the benefit of any employee or former employee of the Company or any of its ERISA Affiliates (the "PLANS") is, and has been, operated in all material respects in accordance with its terms and in substantial compliance (including the making of governmental filings) with all applicable Laws, including, without limitation, ERISA and the applicable provisions of the Internal Revenue Code of 1986, as amended (the "CODE"), (ii) each of the Plans intended to be "qualified" within the meaning of Section 401(a) of the Code has been determined by the Internal Revenue Service (the "IRS") to be so qualified and is not under audit by the IRS or the Department of Labor and the Company knows of no fact or set of circumstances that is reasonably likely to adversely affect such qualification prior to the Effective Time, (iii) no material withdrawal liability with respect to any "multiemployer pension plan" (as defined in Section 3(37) of ERISA) would be incurred by the Company and its ERISA Affiliates if withdrawal from such plan were to occur on the Effective Time, (iv) no "reportable event", as such term is defined in Section 4043(c) of ERISA (for which the 30-day notice requirement to the PBGC has not been waived), has occurred with respect to any Plan that is subject to Title IV of ERISA, and (v) there are no material pending or, to the best knowledge of Company, threatened claims (other than routine claims for benefits) by, on behalf of or against any of the Plans or any trusts related thereto other than routine benefit claim matters. (b) (i) No Plan has incurred an "Accumulated Funding Deficiency" (as defined in Section 302 of ERISA or Section 412 of the Code), whether or not waived, (ii) neither the Company nor any ERISA Affiliate has incurred any Liability under Title IV of ERISA except for required premium payments to the Pension Benefit Guaranty Corporation ("PBGC"), which payments have been made when due, and no events have occurred which are reasonably likely to give rise to any Liability of the Company or an ERISA Affiliate under Title IV of ERISA or which could reasonably be anticipated to result in any claims being made against Buyer by the PBGC, and (iii) the Company has not incurred any material withdrawal liability (including any contingent or secondary withdrawal liability) within the meaning of Section 4201 and 4204 of ERISA to any multiemployer plan (within the meaning of Section 3(37) of ERISA) which has not been satisfied in full. (c) Except as set forth in Section 4.11(c) of the Disclosure Schedule, with respect to each Plan that is subject to Title IV of ERISA (i) the Company has provided to Purchaser copies of the most recent actuarial valuation report prepared for such Plan, (ii) the assets and liabilities in respect of the accrued benefits as set forth in the most recent actuarial valuation report prepared by the Plan's actuary fairly present the funded status of such Plan in all material respects, and (iii) since the date of such valuation report there has been no material adverse change in the funded status of any such Plan. (d) Neither the Company nor any ERISA Affiliate has failed to make any contribution or payment to any Plan or multiemployer plan which, in either case has resulted or could result in the imposition of a material lien or the posting of a material bond or other material security under ERISA or the Code. (e) Except as otherwise set forth on Section 4.11(e) of the Disclosure Schedule or as expressly provided for in this Agreement, the consummation of the transactions contemplated by this Agreement or the Distribution Agreement will not (i) entitle any current or former employee or officer of the Company or any ERISA Affiliate to severance pay, unemployment compensation or any other payment, or (ii) accelerate the time of payment or vesting, or increase the amount of compensation due any such employee or officer. SECTION 4.12. ASSETS; INTELLECTUAL PROPERTY. (a) Except as set forth in Section 4.12(a) of the Disclosure Schedule, upon consummation of the Spin-Off, the Company and the Retained Subsidiaries will own or have rights to use all Assets necessary to permit the Company and the Retained Subsidiaries to conduct the Retained Business as it is currently being conducted except where the failure to own or have the right to use such Assets would not, individually or in the aggregate, have a Material Adverse Effect. (b) To the knowledge of the Company, based solely upon inquiry of the Company's General Counsel and Chief Patent Counsel, the Company does not now and has not in the past used Intellectual Property in the Retained Business which conflicts with or infringes upon any proprietary rights of others except where such conflict or infringement would not have, individually or in the aggregate, a Material Adverse Effect. "INTELLECTUAL PROPERTY" means trademarks, trade names, service marks, service names, mark registrations, logos, assumed names, copyright registrations, patents and all applications therefor and all other similar proprietary rights. SECTION 4.15. CERTAIN CONTRACTS AND ARRANGEMENTS. During the twelve months immediately prior to the date hereof, no significant contracts of the Retained Business have been cancelled or otherwise terminated and during such time the Company has not been threatened with any such cancellation or termination except, in each case, for cancelled or terminated contracts which, individually or in the aggregate, would not constitute a Material Adverse Effect. SECTION 4.16. TAXES. Except as otherwise disclosed in Section 4.16 of the Disclosure Schedule and except for those matters which, either individually or in the aggregate, would not result in a Material Adverse Effect: (a) The Company and each of its Subsidiaries have filed (or have had filed on their behalf) or will file or cause to be filed, all Tax Returns (as defined in Section 4.16(j)(3) hereof) required by applicable Law to be filed by any of them prior to the consummation of the Offer, and all such Tax Returns and amendments thereto are or will be true, complete and correct. (b) The Company and each of its Subsidiaries have paid (or have had paid on their behalf) all Taxes (as defined in Section 4.16(j)(2) hereof) due with respect to any period ending prior to or as of the expiration of the Offer), or where payment of Taxes is not yet due, have established (or have had established on their behalf and for their sole benefit and recourse), or will establish or cause to be established before the consummation of the Offer, an adequate accrual for the payment of all such Taxes which have accrued prior to expiration of the Offer other than Taxes directly attributable to the transactions contemplated by the Distribution Agreement. (c) There are no Liens for any Taxes upon the Assets of the Company or any of its Subsidiaries used primarily in the Retained Business, other than statutory liens for Taxes not yet due and payable and Liens for real estate Taxes being contested in good faith. (d) No Audit (as defined in Section 4.16(j)(3)) is pending with respect to any Taxes due from the Company or any Subsidiary. There are no outstanding waivers extending the statutory period of limitation relating to the payment of Taxes due from the Company or any Subsidiary for any taxable period ending prior to the expiration of the Offer which are expected to be outstanding as of the expiration of the Offer. (e) Neither the Company nor any subsidiary is a party to, is bound by, or has any obligation under, a tax sharing contract or other agreement or arrangement for the allocation, apportionment, sharing, indemnification, or payment of Taxes, other than the Tax Sharing Agreement. (f) Neither the Company nor any of its Subsidiaries has made an election under Section 341(f) of the Code. (g) The statute of limitations for all Tax Returns of the Company and each of its Subsidiaries for all years through 1987 have expired for all federal, state, local and foreign tax purposes, or such Tax Returns have been subject to a final Audit. (h) Neither the Company nor any of its Subsidiaries has received any written notice of deficiency, assessment or adjustment from the Internal Revenue Service or any other domestic or foreign governmental taxing authority that has not been fully paid or finally settled, and any such deficiency, adjustment or assessment shown on such schedule is being contested in good faith through appropriate proceedings and adequate reserves have been established on the Company's financial statements therefor. To the best of their knowledge, there are no other deficiencies, assessments or adjustments threatened, pending or assessed with respect to the Company or any of its Subsidiaries. (i) Except as contemplated by this Agreement and the Ancillary Documents or as disclosed in the Recent SEC Documents, neither the Company nor any of its Subsidiaries is a party to any agreement, contract or other arrangement that would result, separately or in the aggregate, in the requirement to pay any "excess parachute payments" within the meaning of Section 280G of the Code or any gross-up in connection with such an agreement, contract or arrangement. (j) For purposes of this Section 4.16, capitalized terms have the following meaning: (1) "AUDIT" shall mean any audit, assessment or other examination of Taxes or Tax Returns by the IRS or any other domestic or foreign governmental authority responsible for the administration of any Taxes, proceeding or appeal of such proceeding relating to Taxes. (2) "TAXES" shall mean all Federal, state, local and foreign taxes, and other assessments of a similar nature (whether imposed directly or through withholding) including, but not limited to income, excise, property, sales, use (or any similar taxes), gains, transfer, franchise, payroll, value- added, withholding, Social Security, business license fees, customs, duties and other taxes, assessments, charges, or other fees imposed by a governmental authority, including any interest, additions to tax, or penalties applicable thereto. (3) "TAX RETURNS" shall mean all Federal, state, local and foreign tax returns, declarations, statements, reports, schedules, forms and information returns and any amended Tax Return relating to Taxes. SECTION 4.17. RETAINED BUSINESS FCC LICENSES. The licenses and permits issued to the Company or its Subsidiaries by the Federal Communications Commission and used in connection with the Retained Business are not individually or in the aggregate Important Licenses. "IMPORTANT LICENSES" means licenses or permits which are important to the Retained Business and which, if terminated, forfeited or otherwise not available to the Retained Business after the consummation of any of the transactions contemplated by this Agreement, would adversely affect the Retained Business in a significant manner. SECTION 4.18. LABOR MATTERS. Except as set forth in Section 4.18 of the Disclosure Schedule, neither the Company nor any of the Retained Subsidiaries has, since April 1, 1993, (i) been subject to, or threatened with, any material strike, lockout or other labor dispute or engaged in any unfair labor practice, the result of which could have a Material Adverse Effect, or (ii) received notice of any pending petition for certification before the National Labor Relations Board with respect to any material group of Retained Employees (as defined in the Distribution Agreement) who are not currently organized. SECTION 4.19. RIGHTS AGREEMENT. The Board of Directors of the Company has approved a form of Rights Agreement between the Company and the Rights Agent thereunder (the "RIGHTS AGREEMENT"), and a form of amendment thereto (the "RIGHTS AMENDMENT"); the Rights Agreement, as amended by the Rights Amendment, when each are executed and delivered by the Company and the Rights Agent, shall (a) prevent this Agreement or the consummation of any of the transactions contemplated hereby or by the Distribution Agreement, including without limitation, the publication or other announcement of the Offer and the consummation of the Offer and the Merger, from resulting in the distribution of separate rights certificates or the occurrence of a Distribution Date (as defined in the Rights Agreement) or being deemed to be a Triggering Event (as defined in the Rights Agreement) or a Section 13 Event (as defined in the Rights Agreement) and (b) provide that neither Parent nor Purchaser shall be deemed to be an Acquiring Person (as defined in the Rights Agreement) by reason of the transactions expressly provided for in this Agreement. SECTION 4.20. CERTAIN FEES. Except for Lazard Freres & Co. LLC and Lehman Brothers Inc., neither the Company nor any Subsidiary has employed any financial advisor or finder or incurred any Liability for any financial advisory or finders' fees in connection with this Agreement or the Ancillary Agreements or the transactions contemplated hereby or thereby. SECTION 4.21. NO ADDITIONAL APPROVALS NECESSARY. The Board of Directors of the Company has taken all actions necessary under the Company's Restated Certificate of Incorporation and the NYBCL, including approving the transactions contemplated in this Agreement, to ensure that Section 912 of the NYBCL will not, prior to any termination of this Agreement, apply to this Agreement, the Offer, the Merger, the Spin-Off or the transactions contemplated hereby. SECTION 4.22. MATERIALITY. The representations and warranties set forth in this Article IV would in the aggregate be true and correct even without the materiality exceptions or qualifications contained therein except for such exceptions and qualifications which, in the aggregate for all such representations and warranties, are not and could not reasonably be expected to constitute a Material Adverse Effect. REPRESENTATIONS AND WARRANTIES OF PARENT AND PURCHASER Parent and Purchaser represent and warrant to the Company as follows: SECTION 5.1. ORGANIZATION. Each of Parent and Purchaser is a corporation duly organized, validly existing and in good standing under the Laws of the state of its incorporation and has all requisite corporate power and authority to own, lease and operate its properties and to carry on its business as now being conducted, except where the failure to be so organized, existing and in good standing or to have such power and authority would not, in the aggregate, have a Material Adverse Effect (as defined below) on Parent or Purchaser. When used in connection with Parent or Purchaser, the term "MATERIAL ADVERSE EFFECT" means any change or effect that is materially adverse to the business, properties, operations, prospects results of operations or condition (financial or otherwise) of Parent and its Subsidiaries, taken as a whole. SECTION 5.2. AUTHORITY RELATIVE TO THIS AGREEMENT. Each of Parent and Purchaser has full corporate power and authority to execute and deliver this Agreement and the Ancillary Agreements (to the extent it is a party thereto) and to consummate the transactions contemplated hereby and thereby. The execution and delivery of this Agreement and the Ancillary Agreements (to the extent it is a party thereto) and the consummation of the transactions contemplated hereby and thereby have been duly and validly authorized by the Boards of Directors of Purchaser and Parent and no other corporate or other proceedings on the part of Parent, Purchaser or any of their affiliates are necessary to authorize this Agreement or the Ancillary Agreements (to the extent it is a party thereto) or to consummate the transactions so contemplated. This Agreement has been, and each of the Ancillary Agreements have been, or will prior to the Record Date be, duly and validly executed and delivered by each of Parent and Purchaser (to the extent it is a party thereto) and constitute or (to the extent such agreement is not being entered into as of the date hereof) will constitute valid and binding agreements of each of Parent and Purchaser, enforceable against each of Parent and Purchaser in accordance with their respective terms, except to the extent that enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance or other similar Laws, now or hereafter in effect, relating to creditors' rights generally and general principles of equity (regardless of whether enforceability is considered in a proceeding at law or in equity). SECTION 5.3. CONSENTS AND APPROVALS; NO VIOLATIONS. Except for applicable requirements of the Securities Act, the Exchange Act, Antitrust Laws, the Communications Act, the filing and recordation of a certificate of merger, or a certificate of ownership and merger, as required by the NYBCL, any filings required by the Investment Canada Act, such filings and approvals as may be required under the "takeover" or "blue sky" Laws of various states, and as contemplated by this Agreement and the Ancillary Agreements, neither the execution and delivery of this Agreement or the Ancillary Agreements by Parent or Purchaser (to the extent it is a party thereto) nor the consummation by Parent or Purchaser of the transactions contemplated hereby or thereby will (i) conflict with or result in any breach of any provision of the charter or by-laws of Parent or Purchaser, (ii) require on the part of Parent or Purchaser any filing with, or the obtaining of any permit, authorization, consent or approval of, any governmental or regulatory authority or any third party, (iii) result in a violation or breach of, or constitute (with or without due notice or lapse of time or both) a default (or give rise to any right of termination, amendment, cancellation, acceleration or payment, or to the creation of a lien or encumbrance) under any of the terms, conditions or provisions of any note, mortgage, indenture, other evidence of indebtedness, guarantee, license, agreement or other contract, instrument or contractual obligation to which Parent, Purchaser or any of their respective Subsidiaries is a party or by which any of them or any of their Assets may be bound, or (iv) violate any order, writ, injunction, decree, statute, rule or regulation applicable to Parent, Purchaser, any of their Subsidiaries or any of their Assets, except for such requirements, defaults, rights or violations under clauses (ii), (iii) and (iv) above which would not in the aggregate have a material adverse effect on the ability of Parent or Purchaser to consummate the Offer and the Merger. SECTION 5.4. INFORMATION STATEMENT; SCHEDULE 14D-9. Neither the Offer Documents nor any other document filed or to be filed by or on behalf of Parent or Purchaser with the SEC or any other governmental entity in connection with the transactions contemplated by this Agreement contained when filed or will, at the respective times filed with the SEC or other governmental entity, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading; provided, that the foregoing shall not apply to information supplied by or on behalf of the Company specifically for inclusion or incorporation by reference in any such document. The Offer Documents will comply as to form in all material respects with the provisions of the Exchange Act. None of the information supplied by Parent or Purchaser in writing for inclusion in the Information Statement or the Schedule 14D-9 will, at the respective times that the Information Statement and the Schedule 14D-9 or any amendments or supplements thereto are filed with the SEC and are first published or sent or given to holders of Shares, and in the case of the Information Statement, at the time that it or any amendment or supplement thereto is mailed to the Company's shareholders, at the time of the Shareholders' Meeting or at the Effective Time, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. SECTION 5.5. SUFFICIENT FUNDS. Parent and its lenders are negotiating the terms of a credit facility to provide Purchaser with financing sufficient to permit Purchaser to consummate the Offer. Parent is highly confident that such financing will be available and has no reason to believe that Purchaser will not have sufficient funds available prior to the satisfaction of the conditions to the Offer set forth in Exhibit B hereto to purchase all Shares on a fully diluted basis at the Merger Price. SECTION 5.6. BROKERS. Except for Bear, Stearns & Co. Inc. no broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission in connection with the transactions contemplated by this Agreement based upon arrangements made by and on behalf of Parent or Purchaser. SECTION 6.1. CONDUCT OF BUSINESS OF THE COMPANY. Except as contemplated by this Agreement or the Ancillary Agreements, during the period from the date of this Agreement to the consummation of the Offer and, if Parent has made a prompt request therefor pursuant to Section 1.4 hereof, until its Designated Directors (as defined in Section 8.4 hereof) shall constitute in their entirety a majority of the Company's Board of Directors, the Company and its Subsidiaries (other than Spinco and the Spinco Companies (as defined in the Distribution Agreement)) will each conduct its operations according to its ordinary course of business, consistent with past practice, will use its commercially reasonable efforts to (i) preserve intact its business organization, (ii) maintain its material rights and franchises, (iii) keep available the services of its officers and key employees, and (iv) keep in full force and effect insurance comparable in amount and scope of coverage to that maintained as of the date hereof (collectively, the "ORDINARY COURSE OBLIGATIONS"); provided, that Spinco and the Spinco Companies shall comply with the Ordinary Course Obligations to the extent that non-compliance therewith could adversely affect the Retained Business or adversely affect (or materially delay) the consummation of the Offer, the Merger or the Spin-Off. Without limiting the generality of and in addition to the foregoing, and except as otherwise contemplated by this Agreement or the Ancillary Agreements, prior to the time specified in the preceding sentence, neither the Company nor any of its Subsidiaries (other than Spinco and the Spinco Companies insofar as any action of the type specified below could not adversely affect the Retained Business and could not adversely affect (or materially delay) the Offer, the Spin-Off or the Merger) will, without the prior written consent of Parent: (a) amend its charter or by-laws other than filing a Certificate of Amendment of the Company's Restated Certificate of Incorporation as contemplated by the Rights Agreement; (b) authorize for issuance, issue, sell, deliver or agree or commit to issue, sell or deliver (whether through the issuance or granting of options, warrants, commitments, subscriptions, rights to purchase or otherwise) any stock of any class or any other securities (except by the Company in connection with Stock Options, pursuant to the Rights Agreement as contemplated by the Distribution Agreement or pursuant to the current terms of any existing Plan) or amend any of the terms of any such securities or agreements (other than such securities or agreements of any Subsidiary other than any of the Retained Subsidiaries, or amendments of the Distribution Agreement as permitted thereunder) outstanding on the date hereof; (c) split, combine or reclassify any shares of its capital stock, declare, set aside or pay any dividend or other distribution (whether in cash, stock or property or any combination thereof) in respect of its capital stock (other than pursuant to the Rights Agreement) or redeem or otherwise acquire any of its securities or any securities of its Subsidiaries (other than pursuant to the Rights Agreement); provided, that the Company may declare and pay to holders of Shares regular quarterly dividends of not more than $.08 per Share on the dividend declaration and payment dates normally applicable to the Shares. (d) (i) pledge or otherwise encumber shares of capital stock of the Company or any of its Subsidiaries; or (ii) except in the ordinary course of business consistent with past practices, (A) incur, assume or prepay any long-term debt or incur, assume, or prepay any obligations with respect to letters of credit or any material short-term debt; (B) assume, guarantee, endorse or otherwise become liable or responsible (whether directly, contingently or otherwise) for any material obligations of any other person except wholly owned Subsidiaries of the Company; (C) make any material loans, advances or capital contributions to, or investments in, any other person; (iv) change the practices of the Company and its Retained Subsidiaries with respect to the timing of payments or collections; or (D) mortgage or pledge any Assets of the Retained Business or create or permit to exist any material Lien thereupon; (e) except (i) as disclosed in Section 6.1(e) of the Disclosure Schedule and except for arrangements entered into in the ordinary course of business consistent with past practices, (ii) as required by Law or (iii) as specifically provided for in the Agreement or Distribution Agreement, enter into, adopt or materially amend any bonus, profit sharing, compensation, severance, termination, stock option, stock appreciation right, restricted stock, performance unit, pension, retirement, deferred compensation, employment, severance or other employee benefit agreements, trusts, plans, funds or other arrangements of or for the benefit or welfare of any Retained Employee (or any other person for whom the Retained Business will have Liability), or (except for normal increases in the ordinary course of business that are consistent with past practices) increase in any manner the compensation or fringe benefits of any Retained Employee (or any other person for whom the Retained Business will have Liability) or pay any benefit not required by any existing plan and arrangement (including, without limitation, the granting of stock options, stock appreciation rights, shares of restricted stock or performance units) or enter into any contract, agreement, commitment or arrangement to do any of the foregoing; (f) transfer, sell, lease, license or dispose of any lines of business, Subsidiaries, divisions, operating units or facilities (other than facilities currently closed or currently proposed to be closed) relating to the Retained Business outside the ordinary course of business or enter into any material commitment or transaction with respect to the Retained Business outside the (g) acquire or agree to acquire, by merging or consolidating with, by purchasing an equity interest in or a portion of the Assets of, or by any other manner, any business or any corporation, partnership, association or other business organization or division thereof, or otherwise acquire or agree to acquire any Assets of any other person (other than the purchase of Assets in the ordinary course of business and consistent with past practice), in each case where such action would be material to the Retained Business; (h) except as may be required by Law or as disclosed in Section 6.1(e) of the Disclosure Schedule, take any action to terminate or materially amend any of its pension plans or retiree medical plans with respect to or for the benefit of Retained Employees or any other person for whom the Retained (i) materially modify, amend or terminate (1) any significant contract related to the Retained Business or waive any material rights or claims of the Retained Business except in the ordinary course of business consistent with past practice; or (2) any contract having an aggregate contract value of $100 million or greater, whether or not in the ordinary course of business consistent with past practice, unless such modification, amendment or termination does not materially diminish the projected profit or materially increase the projected loss anticipated from such contract; provided, that nothing contained in this Section 6.1(i) shall limit the Company and its Subsidiaries in connection with programs or contracts with respect to which Parent or a Subsidiary of Parent has submitted, or is reasonably expected to submit, a competing bid; provided further, that the provisions of this Section 6.1(i) shall not apply to any arrangement, agreement or contract proposal previously submitted by the Company or a Subsidiary thereof which proposal, upon acceptance thereof, cannot be revised or withdrawn; (j) effect any material change in any of its methods of accounting in effect as of March 31, 1995, except as may be required by Law or generally accepted (k) except as expressly provided in this Agreement, amend, modify, or terminate the Rights Agreement or redeem any Rights thereunder; provided, that if the Board of Directors of the Company by a majority vote determines in its good faith judgment, based as to legal matters upon the written opinion of legal counsel, that the failure to redeem any Rights would likely constitute a breach of the Board's fiduciary duty, the Rights may be redeemed; (l) enter into any material arrangement, agreement or contract that individually or in the aggregate with other material arrangements, agreements and contracts entered into after the date hereof, the Company reasonably expects will adversely affect in a significant manner the Retained Business after the date hereof; provided, that nothing contained in this Section 6.1(l) shall limit the Company and its Subsidiaries from submitting bids for programs or contracts with respect to which the Company reasonably expects Parent or a Subsidiary of Parent to submit a bid; and (m) enter into a legally binding commitment with respect to, or any agreement to take, any of the foregoing actions. (a) The Company and its officers, directors, employees, representatives and agents shall immediately cease any existing discussions or negotiations with any parties conducted heretofore with respect to any Acquisition Proposal (as defined in Section 6.2(b) hereof). The Company and its Subsidiaries will not, and will use their best efforts to cause their respective officers, directors, employees and investment bankers, attorneys, accountants or other agents retained by the Company or any of its Subsidiaries not to, (i) initiate or solicit, directly or indirectly, any inquiries with respect to, or the making of, any Acquisition Proposal, or (ii) except as permitted below, engage in negotiations or discussions with, or furnish any information or data to any Third Party (as defined in Section 8.3(b) hereof) relating to an Acquisition Proposal (other than the transactions contemplated hereby and by the Ancillary Agreements). Notwithstanding anything to the contrary contained in this Section 6.2, the Company may furnish information to, and participate in discussions or negotiations (including, as a part thereof, making any counter- proposal) with, any Third Party which submits an unsolicited written Acquisition Proposal to the Company if the Company's Board of Directors by a majority vote determines in its good faith judgment, based as to legal matters upon the written opinion of legal counsel, that the failure to furnish such information or participate in such discussions or negotiations would likely constitute a breach of the Board's fiduciary duties under applicable Law; provided, that nothing herein shall prevent the Board from taking, and disclosing to the Company's shareholders, a position contemplated by Rules 14D-9 and 14e-2 promulgated under the Exchange Act with regard to any tender offer; provided further, that the Board shall not recommend that the shareholders of the Company tender their Shares in connection with any such tender offer unless the Board by a majority vote determines in its good faith judgment, based as to legal matters on the written opinion of legal counsel, that failing to take such action would likely constitute a breach of the Board's fiduciary duty; provided further, that the Company shall not enter into any agreement with respect to any Acquisition Proposal except concurrently with or after the termination of this Agreement (except with respect to confidentiality and standstill agreements to the extent expressly provided below). The Company shall promptly provide Parent with a copy of any written Acquisition Proposal received and a written statement with respect to any non-written Acquisition Proposal received, which statement shall include the identity of the parties making the Acquisition Proposal and the terms thereof. The Company shall promptly inform Parent of the status and content of any discussions regarding any Acquisition Proposal with a Third Party. In no event shall the Company provide non-public information regarding the Retained Business to any Third Party making an Acquisition Proposal unless such party enters into a confidentiality agreement containing provisions designed to reasonably protect the confidentiality of such information. In the event that following the date hereof the Company enters into a confidentiality agreement with any Third Party which does not include terms and conditions which are substantially similar to the provisions of Paragraph No. 7 (the "STANDSTILL PROVISIONS") of the letter agreement, dated as of December 4, 1995, between the Company and Parent (the "CONFIDENTIALITY AGREEMENT"), then Parent and its affiliates shall be released from their obligations under such Standstill Provisions to the same extent as such third party. (b) For purposes of this Agreement, the term "ACQUISITION PROPOSAL" shall mean any bona fide proposal, whether in writing or otherwise, made by a Third Party to acquire beneficial ownership (as defined under Rule 13(d) of the Exchange Act) of all or a material portion of the Assets of, or any material equity interest in, any of the Company, a Retained Subsidiary or the Retained Business pursuant to a merger, consolidation or other business combination, sale of shares of capital stock, sale of Assets, tender offer or exchange offer or similar transaction involving either the Company, a Retained Subsidiary or the Retained Business, including, without limitation, any single or multi-step transaction or series of related transactions which is structured to permit such third party to acquire beneficial ownership of any material portion of the Assets of, or any material portion of the equity interest in, either the Company, a Retained Subsidiary or the Retained Business (other than the transactions contemplated by this Agreement and the Ancillary Agreements); provided, that the term "ACQUISITION PROPOSAL" shall not include any transactions which relate solely to the businesses to be owned by Spinco and the Spinco Companies following the Spin-Off and which could not have an adverse effect on the consummation of the Offer, the Merger, the Spin- Off or the transactions contemplated hereby. SECTION 6.3. ACCESS TO INFORMATION. (a) Between the date of this Agreement and the Effective Time, upon reasonable notice and at reasonable times, and subject to any access, disclosure, copying or other limitations imposed by applicable Law or any of the Company's or its Subsidiaries' contracts, the Company will give Parent and its authorized representatives reasonable access to all offices and other facilities and to all books and records of it and its Subsidiaries, and will permit Parent to make such inspections as it may reasonably require, and will cause its officers and those of its Subsidiaries to furnish Parent with (i) such financial and operating data and other information with respect to the Company and its Subsidiaries as Parent may from time to time reasonably request, or (ii) any other financial and operating data which materially impacts the Company and its Subsidiaries. Parent and its authorized representatives will conduct all such inspections in a manner which will minimize any disruptions of the business and operations of the Company and its Subsidiaries. (b) Parent, Purchaser and the Company agree that the provisions of the Confidentiality Agreement shall remain binding and in full force and effect (subject, however, to the provisions of Section 6.2(a) hereof) and that the terms of the Confidentiality Agreement are incorporated herein by reference. SECTION 6.4. REASONABLE EFFORTS. Subject to the terms and conditions of this Agreement and without limitation to the provisions of Section 6.6 hereof, each of the parties hereto agrees to use all reasonable efforts to take, or cause to be taken, all action, and to do, or cause to be done, all things reasonably necessary, proper or advisable under applicable Laws and regulations to consummate and make effective the transactions contemplated by this Agreement and the Ancillary Agreements (including, without limitation, (i) cooperating in the preparation and filing of the Offer Documents, the Schedule 14D-9, the Form 10, the Information Statement and any amendments to any thereof; (ii) cooperating in making available information and personnel in connection with presentations, whether in writing or otherwise, to prospective lenders to Parent and Purchaser that may be asked to provide financing for the transactions contemplated by this Agreement; (iii) taking of all action reasonably necessary, proper or advisable to secure any necessary consents or waivers under existing debt obligations of the Company and its Subsidiaries or amend the notes, indentures or agreements relating thereto to the extent required by such notes, indentures or agreements or redeem or repurchase such debt obligations; (iv) contesting any pending legal proceeding relating to the Offer, the Merger or the Spin-Off; and (v) executing any additional instruments necessary to consummate the transactions contemplated hereby and thereby). In case at any time after the Effective Time any further action is necessary to carry out the purposes of this Agreement, the proper officers and directors of each party hereto shall use all reasonable efforts to take all such necessary action. SECTION 6.5. CONSENTS. Each of the Company, Parent and Purchaser shall cooperate and use their respective reasonable efforts to make all filings and obtain all consents and approvals of governmental authorities (including, without limitation, the Federal Communication Commission ("FCC")) and other third parties necessary to consummate the transactions contemplated by this Agreement and the Ancillary Agreements. Each of the parties hereto will furnish to the other party such necessary information and reasonable assistance as such other persons may reasonably request in connection with the foregoing. (a) In addition to and without limiting the agreements of Parent and Purchaser contained in Section 6.5 hereof, Parent, Purchaser and the Company will (i) take promptly all actions necessary to make the filings required of Parent, Purchaser or any of their affiliates under the applicable Antitrust Laws (as defined in Section 6.6(e) hereof), (ii) comply at the earliest practicable date with any request for additional information or documentary material received by Parent, Purchaser or any of their affiliates from the Federal Trade Commission or the Antitrust Division of the Department of Justice pursuant to the HSR Act and from the Commission or other foreign governmental or regulatory authority pursuant to Antitrust Laws, and (iii) cooperate with the Company in connection with any filing of the Company under applicable Antitrust Laws and in connection with resolving any investigation or other inquiry concerning the transactions contemplated by this Agreement or the Ancillary Agreements commenced by any of the Federal Trade Commission, the Antitrust Division of the Department of Justice, state attorneys general, the Commission, or other foreign governmental or regulatory authorities. (b) In furtherance and not in limitation of the covenants of Parent and Purchaser contained in Section 6.5 and Section 6.6(a) hereof, Parent, Purchaser and the Company shall each use all reasonable efforts to resolve such objections, if any, as may be asserted with respect to the Offer, the Spin-Off, the Merger or any other transactions contemplated by this Agreement or the Ancillary Agreements under any Antitrust Law. If any administrative, judicial or legislative action or proceeding is instituted (or threatened to be instituted) challenging the Offer, the Spin-Off, the Merger or any other transactions contemplated by this Agreement or the Ancillary Agreements as violative of any Antitrust Law, Parent, Purchaser and the Company shall each cooperate to contest and resist any such action or proceeding, and to have vacated, lifted, reversed or overturned any decree, judgment, injunction or other order (whether temporary, preliminary or permanent) (any such decree, judgment, injunction or other order is hereafter referred to as an "ORDER") that is in effect and that restricts, prevents or prohibits consummation of the Offer, the Spin-Off, the Merger or any other transactions contemplated by this Agreement or the Ancillary Agreements, including, without limitation, by pursuing all reasonable avenues of administrative and judicial appeal. Parent and Purchaser shall each also use their respective reasonable efforts to take all reasonable action, including, without limitation, agreeing to hold separate or to divest any of the businesses or Assets of Parent or Purchaser or any of their affiliates, or, following the consummation of the Offer or the Effective Time, of the Company or any of the Retained Subsidiaries, as may be required (i) by the applicable governmental or regulatory authority (including without limitation the Federal Trade Commission, the Antitrust Division of the Department of Justice, any state attorney general or any foreign governmental or regulatory authority) in order to resolve such objections as such governmental or regulatory authority may have to such transactions under any Antitrust Law, or (ii) by any domestic or foreign court or other tribunal, in any action or proceeding brought by a private party or governmental or regulatory authority challenging such transactions as violative of any Antitrust Law, in order to avoid the entry of, or to effect the dissolution, vacating, lifting, altering or reversal of, any Order that has the effect of restricting, preventing or prohibiting the consummation of the Offer, the Spin-Off, the Merger or any other transactions contemplated by this Agreement or the Ancillary Agreements; provided, that Parent shall not be required to take any action, divest any Asset or enter into any consent decree if the taking of such action, disposing of such Asset or entering into such decree would have a Significant Adverse Effect. "SIGNIFICANT ADVERSE EFFECT" shall mean any change or effect that, in Parent's judgment, is reasonably likely to adversely affect in a substantial way the benefits and opportunities which Parent reasonably expects to receive from the acquisition of the Retained Business or from Parent's current business. (c) Each of the Company, Parent and Purchaser shall promptly inform the other party of any material communication received by such party from the Federal Trade Commission, the Antitrust Division of the Department of Justice, the Commission or any other governmental or regulatory authority regarding any of the transactions contemplated hereby. Parent and/or Purchaser will promptly advise the Company with respect to any understanding, undertaking or agreement (whether oral or written) which it proposes to make or enter into with any of the foregoing parties with regard to any of the transactions contemplated hereby. (d) "ANTITRUST LAW" means the Sherman Act, as amended, the Clayton Act, as amended, the HSR Act, the Federal Trade Commission Act, as amended, EC Merger Regulations and all other federal, state and foreign statutes, rules, regulations, orders, decrees, administrative and judicial doctrines, and other Laws that are designed or intended to prohibit, restrict or regulate actions having the purpose or effect of monopolization or restraint of trade. SECTION 6.7. PUBLIC ANNOUNCEMENTS. Parent, Purchaser and the Company will consult with each other before issuing any press release or otherwise making any public statements with respect to the Offer, the Spin-Off or the Merger and shall not issue any such press release or make any such public statement prior to such consultation, except as may be required by Law or by obligations pursuant to any listing agreement with any securities exchange. (a) Prior to the Spin-Off, the Company shall use its best efforts to, and shall use its best efforts to cause its Subsidiaries to, assign to Spinco or Subsidiaries of Spinco or terminate all employment agreements with employees of the Company who are not Retained Employees (the "EMPLOYMENT AGREEMENTS") and all individual severance agreements with employees of the Company who are not Retained Employees (the "SEVERANCE AGREEMENTS"). The parties hereto acknowledge and agree that, whether or not such Employment Agreements and Severance Agreements are so assigned or terminated, all Liabilities under or arising from such Employment Agreements and Severance Agreements other than as expressly contemplated in the Distribution Agreement or by this Section 6.8 shall be deemed to be Spinco Liabilities (as defined in the Distribution Agreement), with respect to which Spinco shall indemnify the Company and Parent as provided therein. (b) Parent acknowledges and agrees that all employment agreements and severance agreements with the Retained Employees will be binding and enforceable obligations of the Surviving Corporation, except as the parties thereto may otherwise agree. The parties hereto acknowledge and agree that all Liabilities under or arising from such agreements with the Retained Employees from and after the consummation of the Offer shall be deemed to be Company Liabilities (as defined in the Distribution Agreement), with respect to which the Company and Parent shall indemnify Spinco as provided therein. (c) (i) Parent agrees to cause the Company to pay in cash to each Company Bonus Employee (as defined below) to the extent not previously paid, all bonus compensation payable with respect to the fiscal year of the Company ending March 31, 1996 under any bonus program of the Company or its Subsidiaries in which such Company Bonus Employee participated prior to the consummation of the Offer or under any employment agreement. Such bonus compensation shall be paid at the time or times that comparable bonus compensation was paid to any similarly situated employee after March 31, 1995 with respect to the fiscal year ended March 31, 1995. Bonus compensation which is based on objective criteria shall be calculated and paid in accordance with such criteria. With respect to bonus compensation which is wholly or partially discretionary, such bonus compensation shall be determined and paid on a basis consistent with past practices of the Company. Subject to Section 6.8(c)(iii), the amount of discretionary bonus compensation to be paid to any Company Bonus Employee shall be determined by the Chief Executive Officer of the Company in office immediately prior to the date of the consummation of the Offer or by his designee. "COMPANY BONUS EMPLOYEE" means a person, other than a Spinco Employee, employed by the Company or any of its Subsidiaries immediately prior to the date the Offer is consummated, who was eligible to receive a bonus under any bonus program of the Company or any of its Subsidiaries in effect at December 31, 1995, or under any employment agreement in effect on such date, with respect to the fiscal year ending March 31, 1996. (ii) Spinco agrees to pay in cash to each Spinco Bonus Employee (as defined in this Section 6.8(c)(ii)) to the extent not previously paid, all bonus compensation payable with respect to the fiscal year of the Company ending March 31, 1996 under any bonus program of the Company or its Subsidiaries in which such Spinco Bonus Employee participated prior to the consummation of the Offer or under any employment agreement. Such bonus compensation shall be paid at the time or times that comparable bonus compensation was paid to any similarly situated employee after March 31, 1995 with respect to the fiscal year ended March 31, 1995. Bonus compensation which is based on objective criteria shall be calculated and paid in accordance with such criteria. With respect to bonus compensation which is wholly or partially discretionary, such bonus compensation shall be determined and paid on a basis consistent with past practices of the Company. Subject to Section 6.8(c)(iii), the amount of discretionary bonus compensation to be paid to any Spinco Bonus Employee shall be determined by Spinco. "SPINCO BONUS EMPLOYEE" means any Spinco Employee employed by the Company or any of its Subsidiaries immediately prior to the date the Offer is consummated, who was eligible to receive a bonus under any bonus program of the Company or any of its Subsidiaries in effect at December 31, 1995, or under any employment agreement in effect on such date, with respect to the fiscal year ending March 31, 1996. Upon payment of such bonuses to Spinco Bonus Employees, Spinco shall submit to Parent a statement showing the individual and aggregate bonus amounts paid to Spinco Bonus Employees, and Parent shall thereupon promptly pay to Spinco (or cause the Company to pay to Spinco) the aggregate amount of bonuses so paid; provided, that if the consummation of the Offer occurs prior to March 31, 1996, the amount of such reimbursement shall be a prorated amount of the aggregate bonus amounts so paid, based on a fraction, the numerator of which is the number of days of the Company's fiscal year ending March 31, 1996 which had elapsed as of the consummation of the Offer, and the denominator of which is 365. (iii) The aggregate amount of discretionary bonuses payable to all Company Bonus Employees and Spinco Bonus Employees as a group for the fiscal year ending March 31, 1996 shall not exceed a dollar amount to be mutually agreed to by the Chief Executive Officer of Parent and the Chief Executive Officer of Spinco; provided, that in the event the Chief Executive Officer of Parent and the Chief Executive Officer of Spinco cannot agree on such dollar amount, the maximum aggregate amount of discretionary bonuses payable to Company Bonus Employees and Spinco Bonus Employees shall be based on the aggregate amount of discretionary bonuses paid to all such employees for the Company's fiscal year ending March 31, 1995, increased by a percentage equal to the average of the percentage increases in discretionary bonuses paid to all such employees over the Company's three fiscal years ending March 31, 1993, 1994 and 1995. (d) Pursuant to the "change of control" provisions of the Restated Employment Agreement between the Company and Bernard L. Schwartz dated April 1, 1990, as amended June 14, 1994, the Company shall, subject to the following sentences of this Section 6.8(d), make a cash payment to Mr. Schwartz upon consummation of the Offer, calculated in accordance with such agreement, less $18 million. The Company also may make a cash payment of a bonus (inclusive of the amount paid to Mr. Schwartz pursuant to the preceding sentence, the "TRANSACTION BONUS") to Transaction Bonus Employees (as defined below) other than Mr. Schwartz; provided, that the aggregate Transaction Bonus paid shall not exceed $40 million; and provided further, that the Transaction Bonus payable to any Transaction Bonus Employee shall not exceed the maximum amount which can be paid at such time without such amounts being treated as "excess parachute payments" within the meaning of Section 280G of the Code, taking into account all payments made on or prior to the time the Transaction Bonus is paid (including the value of accelerated vesting of stock options or restricted shares granted under the 1987 Plan determined in accordance with proposed regulations promulgated under Section 280G of the Code) which constitute parachute payments for purposes of Section 280G of the Code. The Transaction Bonus may be paid by the Company, in its discretion, prior to, on or immediately following, the date the Offer is consummated. "TRANSACTION BONUS EMPLOYEE" means Mr. Schwartz and each person employed by the Company or any of its Subsidiaries on or prior to the date the Offer is consummated who is selected by Mr. Schwartz to receive a Transaction Bonus. (e) The Company may provide for employment protection payments to be made to certain Company employees upon qualifying terminations of employment pursuant to "Employment Protection Agreements" and an "Employment Protection Plan," (each substantially in the forms attached hereto as Exhibits C and D, respectively; together, the "EMPLOYMENT PROTECTION ARRANGEMENTS") occurring after a change in control of the Company; provided, that (i) neither the execution of this Agreement and the Distribution Agreement, nor any transaction contemplated thereby, shall constitute a change in control of the Company for any purpose under the Employment Protection Arrangements or give rise to any rights thereunder and (ii) the Employment Protection Arrangements shall terminate as of the consummation of the Offer and no rights thereunder shall continue after the consummation of the Offer. (a) Prior to the Effective Time, the Company shall adopt a severance plan substantially in the form attached hereto as Exhibit E (the "SUPPLEMENTAL SEVERANCE PLAN") covering up to 150 employees of the Company or its Subsidiaries selected by the Company prior to the Effective Time. (b) Except with respect to accruals under any defined benefit pension plans, Parent will, or will cause the Company to, give Retained Employees full credit for purposes of eligibility, vesting and determination of the level of benefits under any employee benefit plans or arrangements maintained by the Parent, the Company or any Subsidiary of Parent or Company for such Retained Employees' service with the Company or any Subsidiary of the Company to the same extent recognized by the Company immediately prior to the Effective Time. Parent will, or will cause the Company to, (i) waive all limitations as to pre-existing conditions exclusions and waiting periods with respect to participation and coverage requirements applicable to the Retained Employees under any welfare plans that such employees may be eligible to participate in after the Effective Time, other than limitations or waiting periods that are already in effect with respect to such employees and that have not been satisfied as of the Effective Time under any welfare plan maintained for the Retained Employees immediately prior to the Effective Time, and (ii) provide each Retained Employee with credit for any co-payments and deductibles paid prior to the Effective Time in satisfying any applicable deductible or out-of- pocket requirements under any welfare plans that such employees are eligible to participate in after the Effective Time. SECTION 6.10. ANCILLARY AGREEMENTS; SPIN-OFF. (a) Simultaneously with the execution hereof, the Company and certain of its Subsidiaries are entering into the Distribution Agreement. Immediately prior to the Record Date, the Company, Spinco and certain other parties will enter into the Tax Sharing Agreement. From and after the Effective Time, Parent shall cause the Surviving Corporation to perform any and all obligations and agreements of the Company set forth herein or in the Ancillary Agreements or in any other agreements contemplated herein or therein. (b) Parent and Purchaser accept and agree that, subject to the provisions of the Distribution Agreement, the form of certificate of incorporation and by- laws of Spinco adopted in contemplation of the Spin-Off shall be as agreed to by the Company and Spinco in their sole discretion; provided, that nothing in the certificates of incorporation and by-laws shall adversely affect or otherwise limit (i) Spinco's ability to perform its obligations under the Ancillary Agreements or the other agreements contemplated by the Distribution Agreement or (ii) the Company's or its affiliates' rights under the Stockholders Agreement. (c) In no event shall Parent or Purchaser or any of their Subsidiaries be entitled to receive any shares of Spinco Common Stock as a distribution with respect to Shares purchased upon consummation of the Offer. If, for any reason, any shares of Spinco Common Stock distributed in the Spin-Off are received by Parent or Purchaser or any of their Subsidiaries with respect to Shares acquired by Purchaser in the Offer, then Parent or Purchaser shall convey, on behalf of the Company, such shares of Spinco to the stockholders of the Company who would have otherwise received such shares of Spinco pursuant to the Distribution Agreement; provided, that the foregoing provisions shall not apply with respect to Shares held by Parent or any of its Subsidiaries prior to the date hereof. (d) If the Company reasonably determines that the Spin-Off may not be effected without registering the shares of common stock of Spinco to be distributed in the Spin-Off pursuant to the Securities Act, the Company, Parent and Purchaser, as promptly as practicable, shall use their respective best efforts to cause the shares of Spinco to be registered pursuant to the Securities Act and thereafter effect the Spin-Off in accordance with the terms of the Distribution Agreement including, without limitation, by preparing and filing on an appropriate form a registration statement under the Securities Act covering the shares of Spinco and using their respective best efforts to cause such registration statement to be declared effective and preparing and making such other filings as may be required under applicable state securities Laws. (e) Parent shall, and shall cause the Surviving Corporation to, treat the Spin-Off for purposes of all federal and state taxes as an integrated transaction with the Offer and the Merger and thus report the Spin-Off as a constructive redemption of a number of Shares equal in value to the value of the Spinco Common Stock distributed in the Spin-Off. SECTION 6.11. RETAINED BUSINESS FINANCIAL STATEMENTS. The Company will forthwith prepare, and retain Coopers & Lybrand L.L.P. to audit, balance sheets for the Retained Business as at March 31, 1993, March 31, 1994, March 31, 1995 and the Effective Time, together with statements of operations and cash flows for the periods then ended (collectively, the "RETAINED BUSINESS FINANCIAL STATEMENTS"). The Company hereby agrees to use its best efforts to take, or cause to be taken, all action, and to do, or cause to be done, all things necessary, proper or advisable to assist and otherwise cause Coopers & Lybrand L.L.P. to complete the audit of the Retained Business Financial Statements as promptly as reasonably practicable, but in no event later than 45 days after the date of this Agreement; provided, that with respect to the period ended the Effective Time, the information will be provided no later than 15 days prior to the latest date on which Parent may file a Current Report on Form 8-K with respect to the Merger and still be in compliance with the regulations promulgated by the SEC under the Exchange Act. The Company will pay the fees and expenses for auditing the Retained Business Financial Statements. The Company also agrees to provide promptly to Parent such quarterly unaudited financial information relating to the Retained Business and covering the period ending December 31, 1995 and the quarterly and annual periods following the date hereof within five days after the filing by the Company with the SEC of its quarterly reports on Form 10-Q and Annual Report on Form 10-K, as the case may be. SECTION 6.12. REDEMPTION OF RIGHTS. At Parent's request, the Company will take such action as Parent may request to effectuate the redemption, at any time before the purchase by Purchaser pursuant to the Offer of at least a majority of the outstanding Shares, of the Rights (as defined in the Rights Agreement). SECTION 6.13. PRE-CLOSING CONSULTATION. Following the date hereof and prior to the Effective Time, the Company shall designate a senior officer of the Company (the "COMPANY REPRESENTATIVE") to consult with an officer of Parent designated by Parent (the "PARENT REPRESENTATIVE") with respect to major business decisions to be made concerning the operation of the Retained Business. Such consultation shall be made on as frequent a basis as may be reasonably requested by Parent. The parties hereto acknowledge and agree that the agreements set forth in this Section 6.13 shall be subject to any restrictions or limitations required under applicable Law. (a) From and after the Effective Time, Parent shall cause the Surviving Corporation to indemnify, defend and hold harmless the present and former officers, directors, employees and agents of the Company and its Subsidiaries (the "INDEMNIFIED PARTIES") against all losses, claims, damages, expenses or liabilities arising out of or related to actions or omissions or alleged actions or omissions occurring at or prior to the Effective Time to the same extent and on the same terms and conditions (including with respect to advancement of expenses) provided for in the Company's Restated Certificate of Incorporation and By-Laws and agreements in effect as of December 31, 1995 (to the extent consistent with applicable Law), which provisions will survive the Merger and continue in full force and effect after the Effective Time. Without limiting the foregoing, (i) Parent shall, and shall cause the Surviving Corporation to, periodically advance expenses (including attorney's fees) as incurred by an Indemnified Person with respect to the foregoing to the full extent permitted under the Company's Restated Certificate of Incorporation and By-Laws in effect on the date hereof (to the extent consistent with applicable Law) and (ii) any determination required to be made with respect to whether an entitled to indemnification shall, if requested by such Indemnified Party, be made by independent legal counsel selected by the Surviving Corporation and reasonably satisfactory to such Indemnified Party. Parent hereby guarantees the obligation of the Surviving Corporation provided for under this Section 6.14(a); provided, that the guarantee obligation of Parent provided for herein shall, in the aggregate, be limited to an amount equal to the Net Worth of the Company. "NET WORTH OF THE COMPANY" means an amount equal to (i) the aggregate value of the consolidated assets of the Retained Business less (ii) the aggregate value of the consolidated liabilities of the Retained Business, each as reflected on the books and records of the Company as of the most recent quarterly period ended prior to the date of the consummation of the Offer. (b) For a period of six years after the Effective Time, Parent shall use reasonable efforts to cause to be maintained in effect the current policies of directors and officers liability insurance maintained by the Company (provided that Parent may substitute therefor policies with reputable and financially sound carriers of at least the same coverage and amounts containing terms and conditions which are no less advantageous) with respect to claims arising from or related to facts or events which occurred at or before the Effective Time; provided, that Parent shall not be obligated to make annual premium payments for such insurance to the extent such premiums exceed 150% of the annual premiums paid as of the date hereof by the Company for such insurance (the "MAXIMUM AMOUNT"). If the amount of the annual premiums necessary to maintain or procure such insurance coverage exceeds the Maximum Amount, Parent and the Surviving Corporation shall maintain the most advantageous policies of directors, and officers' insurance obtainable for an annual premium equal to the Maximum Amount. (c) The provisions of this Section 6.14 are intended to be for the benefit of, and shall be enforceable by, each Indemnified Party, his or her heirs and his or her representatives. SECTION 6.15 BOARD OF DIRECTORS OF PARENT. Upon the consummation of the Offer or as soon as practicable thereafter, Parent shall use its best efforts and take all reasonable steps to cause (a) Bernard L. Schwartz to be appointed a member and Vice Chairman and Frank C. Lanza to be appointed a member, of the Board of Directors of Parent; and (b) the bylaws of Parent to be amended to modify the eligibility requirements of directors to permit Mr. Schwartz to continue to be eligible to serve as a director through 2001, without prejudice or commitment with respect to any further continuation of eligibility thereafter. SECTION 6.16 STANDSTILL PROVISIONS. The restrictions on Parent and its affiliates contained in the Standstill Provisions (as defined in Section 6.2(a) hereof) (the "RESTRICTIONS") are hereby waived and Parent and Purchaser are hereby released therefrom (a) as of and after the date hereof to the extent necessary to permit Parent and Purchaser to comply with their respective obligations and to enable Parent and Purchaser to exercise any of their respective rights, under or as contemplated by this Agreement; and (b) as of and after the termination of this Agreement (other than by the Company pursuant to Section 8.1(f) hereof) if at such time or thereafter there is proposed a Third Party Acquisition (as defined in Section 8.3(b) hereof); provided, that the Restrictions shall not be waived under this Section 6.16(b) with respect to any proposal by Parent, Purchaser and their affiliates to acquire, directly or indirectly, both the Retained Business and all or substantially all of the Spinco Business, whether by merger, consolidation or otherwise, unless the proposed Third Party Acquisition also contemplates a transaction or series of transactions in which both the Retained Business and all or substantially all of the Spinco Business would be acquired, directly or indirectly, by the Third Party or its affiliates. SECTION 6.17 EFFECTIVENESS OF RIGHTS AGREEMENT. On or before January 10, 1996 the Company shall execute and deliver, and cause a person qualified to be the Rights Agent under the Rights Agreement to execute and deliver, each of the Rights Agreement and the Rights Amendment so that each shall be valid and binding agreements of the Company. CONDITIONS TO CONSUMMATION OF THE MERGER SECTION 7.1. CONDITIONS TO EACH PARTY'S OBLIGATION TO EFFECT THE MERGER. The respective obligation of each party to effect the Merger is subject to the satisfaction at or prior to the Effective Time of the following conditions: (a) This Agreement shall have been adopted by the affirmative vote of the stockholders of the Company by the requisite vote in accordance with applicable Law, if required by applicable Law; (b) No statute, rule, regulation, order, decree, or injunction shall have been enacted, entered, promulgated or enforced by any court or governmental authority which prohibits or restricts the consummation of the Merger; (c) Any waiting period applicable to the Merger under the Antitrust Laws shall have terminated or expired and all approvals required under the Antitrust Laws shall have been received; (d) The Spin-Off shall have been consummated in all material respects; and (e) The Offer shall not have been terminated in accordance with its terms prior to the purchase of any Shares. SECTION 7.2. CONDITIONS TO THE OBLIGATION OF THE COMPANY TO EFFECT THE MERGER. The obligation of the Company to effect the Merger is further subject to the satisfaction at or prior to the Effective Time of the following conditions: (a) The representations and warranties of Parent and Purchaser contained in this Agreement shall be true and correct in all material respects at and as of the Effective Time as if made at and as of such time; and (b) Each of Parent and Purchaser shall have performed in all material respects its obligations under this Agreement required to be performed by it at or prior to the Effective Time pursuant to the terms hereof. Parent and Purchaser will furnish the Company with such certificates and other documents to evidence the fulfillment of the conditions set forth in this Section 7.2 as the Company may reasonably request. SECTION 7.3. CONDITIONS TO OBLIGATIONS OF PARENT AND PURCHASER TO EFFECT THE MERGER. The obligations of Parent and Purchaser to effect the Merger are further subject to the satisfaction at or prior to the Effective Time of the following conditions: (a) The representations and warranties of the Company contained in this Agreement shall be true and correct in all material respects at and as of the Effective Time as if made at and as such time; (b) The Company shall have delivered to Purchaser and (i) Bank of America, Illinois (formerly known as Continental Bank, National Association), one or more opinions of counsel acceptable to Bank of America, Illinois, stating that the Merger complies with (A) Article IV of the Indenture dated as of January 15, 1992 between the Company and Continental Bank, National Association, as trustee; and (B) Article Nine of the Indenture dated as of September 1, 1993 between the Company and Continental Bank, National Association, as trustee, as supplemented by a First Supplemental Indenture dated as of June 1, 1994 between the Company and Continental Bank, National Association, as trustee; and (ii) NationsBank of Georgia, National Association, an opinion of counsel acceptable to NationsBank of Georgia, National Association, stating that the Merger complies with Article Nine of the Indenture dated as of November 1, 1992 between the Company and NationsBank of Georgia, National Association, as trustee (collectively, the "PUBLIC INDENTURE MERGER OPINIONS"); (c) The Company shall have performed in all material respects each of its obligations under this Agreement required to be performed by it at or prior to the Effective Time pursuant to the terms hereof. The Company will furnish Parent and Purchaser with such certificates and other documents to evidence the fulfillment of the conditions set forth in this Section 7.3 as Parent or Purchaser may reasonably request. SECTION 7.4. EXCEPTION. The conditions set forth in Sections 7.2 and 7.3 hereof shall cease to be conditions to the obligations of any of the parties hereto if Purchaser shall have accepted for payment and paid for Shares validly tendered pursuant to the Offer or if Purchaser fails to accept for payment any Shares pursuant to the Offer in violation of the terms thereof. SECTION 8.1. TERMINATION. This Agreement may be terminated and the Offer and the Merger may be abandoned at any time (notwithstanding approval of the Merger by the stockholders of the Company) prior to the Effective Time: (a) by mutual written consent of Parent, Purchaser and the Company; (b) by Parent, Purchaser or the Company if any court of competent jurisdiction in the United States or other United States governmental body shall have issued a final order, decree or ruling or taken any other final action restraining, enjoining or otherwise prohibiting the consummation of the Offer, the Spin-Off or the Merger and such order, decree, ruling or other action is or shall have become nonappealable; (c) by Parent or Purchaser if due to an occurrence or circumstance which would result in a failure to satisfy any of the conditions set forth in Exhibit B hereto, Purchaser shall have (i) failed to commence the Offer within the time required by Regulation 14D under the Exchange Act, (ii) terminated the Offer or (iii) failed to pay for Shares pursuant to the Offer prior to (d) by the Company if (i) there shall not have been a material breach of any representation, warranty, covenant or agreement on the part of the Company and Purchaser shall have (A) failed to commence the Offer within the time required by Regulation 14D under the Exchange Act, (B) terminated the Offer or (C) failed to pay for Shares pursuant to the Offer prior to June 30, 1996 or (ii) prior to the purchase of Shares pursuant to the Offer, a Third Party shall have made a bona fide offer that the Board of Directors of the Company by a majority vote determines in its good faith judgment and in the exercise of its fiduciary duties, based as to legal matters on the written opinion of legal counsel, is a Higher Offer (as defined in Section 8.3(b) hereof); provided, that such termination under this clause (ii) shall not be effective until payment of the fee required by Section 8.3(a) hereof; (e) by Parent or Purchaser prior to the purchase of Shares pursuant to the Offer, if (i) there shall have been a breach of any representation or warranty on the part of the Company or Spinco under either this Agreement or the Distribution Agreement having a Material Adverse Effect or materially adversely affecting (or materially delaying) the consummation of the Offer, (ii) there shall have been a breach of any covenant or agreement on the part of the Company or Spinco under either this Agreement or the Distribution Agreement resulting in a Material Adverse Effect or materially adversely affecting (or materially delaying) the consummation of the Offer, which shall not have been cured prior to the earlier of (A) 10 days following notice of such breach and (B) two Business Days prior to the date on which the Offer expires, (iii) the Company shall engage in Active Negotiations (as defined in Section 8.3(b) hereof) with a Third Party with respect to a Third Party Acquisition (as defined in Section 8.3(b) hereof), (iv) the Board of Directors of the Company shall have withdrawn or modified (including by amendment of Schedule 14D-9) in a manner adverse to Purchaser its approval or recommendation of the Offer, the Spin-Off, the Merger, this Agreement or the Distribution Agreement, shall have recommended to the Company's stockholders another offer, shall have authorized the redemption of any Rights (whether or not in accordance with Section 6.1(k) hereof) after the Company's receipt of an Acquisition Proposal or shall have adopted any resolution to effect any of the foregoing or (v) there shall not have been validly tendered and not withdrawn prior to the expiration of the Offer at least two-thirds of the Shares, determined on a fully diluted basis, and on or prior to such date an entity or group (other than Parent or Purchaser) shall have made and not withdrawn a proposal with respect to a (f) by the Company if (i) there shall have been a breach of any representation or warranty in this Agreement or the Distribution Agreement on the part of Parent or Purchaser which materially adversely affects (or materially delays) the consummation of the Offer or (ii) there shall have been a material breach of any covenant or agreement in this Agreement or the Distribution Agreement on the part of Parent or Purchaser which materially adversely affects (or materially delays) the consummation of the Offer which shall not have been cured prior to the earliest of (A) 10 days following notice of such breach and (B) two Business Days prior to the date on which the Offer expires. SECTION 8.2 EFFECT OF TERMINATION. In the event of the termination and abandonment of this Agreement pursuant to Section 8.1, this Agreement shall forthwith become void and have no effect, without any Liability on the part of any party hereto or its affiliates, directors, officers or shareholders, other than the provisions of this Section 8.2 and Sections 6.3(b), 6.14, 8.3, 9.3 and 9.11 hereof. Nothing contained in this Section 8.2 shall relieve any party from Liability for any breach of this Agreement. SECTION 8.3 FEES AND EXPENSES. (i) Parent or Purchaser terminates this Agreement pursuant to Section 8.1(e)(ii), (iii) or (v) hereof and within 12 months thereafter the Company enters into an agreement with respect to a Third Party Acquisition, or a Third Party Acquisition occurs, involving any party (or any affiliate thereof) (A) with whom the Company (or its agents) had negotiations with a view to a Third Party Acquisition, (B) to whom the Company (or its agents) furnished information with a view to a Third Party Acquisition or (C) who had submitted a proposal or expressed an interest in a Third Party Acquisition, in the case of each of clauses (A), (B) and (C) after the date hereof and prior to such termination; or (ii) Parent or Purchaser terminates this Agreement pursuant to Section 8.1(e)(iii) or (v) hereof and, within 12 months thereafter, a Third Party Acquisition shall occur involving a Higher Offer; or (iii) Parent or Purchaser terminates this Agreement pursuant to Section (iv) the Company terminates this Agreement pursuant to Section 8.1(d)(ii) then, in each case, the Company shall pay to Parent, within one Business Day following the execution and delivery of such agreement or such occurrence, as the case may be, or simultaneously with such determination pursuant to Section 8.1(d)(ii), a fee, in cash, of $175 million; provided, that the Company in no event shall be obligated to pay more than one such $175 million fee with respect to all such agreements and occurrences and such termination. (b) "ACTIVE NEGOTIATIONS" means negotiations with a Third Party that has proposed a Third Party Acquisition or made an Acquisition Proposal, or with such Third Party's agents or representatives with respect to the substance of such Third Party Acquisition or Acquisition Proposal, but will not include (x) communications in connection with, or constituting, the furnishing of information pursuant to a confidentiality agreement as contemplated by Section 6.2(a) hereof or (y) communications that include no more than an explicit bona fide rejection of such proposal and a very brief statement of the reasons therefor. "THIRD PARTY ACQUISITION" means the occurrence of any of the following events: (i) the acquisition of the Company by merger or otherwise by any person (which includes for these purposes a "person" as defined in Section 13(d)(3) of the Exchange Act) or entity other than Parent, Purchaser or any affiliate thereof (a "THIRD PARTY"); (ii) the acquisition by a Third Party of more than 30% of the total Assets of the Company and its Subsidiaries, taken as a whole; (iii) the acquisition by a Third Party of 30% or more of the outstanding Shares; (iv) the adoption by the Company of a plan of liquidation or the declaration or payment of an extraordinary dividend; or (v) the purchase by the Company or any of its Subsidiaries of more than 20% of the outstanding Shares. "HIGHER OFFER" means any Third Party Acquisition which reflects a higher value for the Shares than the aggregate value being provided pursuant to the transactions contemplated by this Agreement and the Ancillary Agreements including, without limitation, the shares of Spinco Common Stock distributed in the Spin-Off. Prior to the termination of this Agreement by the Company pursuant to Section 8.1(d)(ii) hereof, the Board of Directors shall provide a reasonable opportunity to a nationally recognized investment banking firm selected by Parent, Purchaser or their designee (the "IB") to evaluate the proposed Third Party Acquisition, to determine whether it is a Higher Offer and to advise the Board of Directors of the Company of the basis for and results of its determination. The Company agrees to cooperate and cause the Company's financial advisors to cooperate with the IB (including, without limitation, providing the IB with full access to all such information which the IB deems relevant and which the IB agrees to keep confidential) to the extent reasonably requested by the IB. The fees and expenses incurred by the IB shall be paid by Parent. Nothing contained in this Section 8.3(b) shall prevent Parent and Purchaser from challenging, by injunction or otherwise, the termination or attempted termination of this Agreement pursuant to Section 8.3(d)(ii) hereof. (c) If this Agreement is terminated pursuant to Sections 8.1(e)(i) or 8.1(e)(ii) (the "DESIGNATED TERMINATION PROVISIONS") or Parent is entitled to receive the $175 million fee under Section 8.3(a) hereof, then the Company shall reimburse Parent, Purchaser and their affiliates (not later than one Business Day after submission of statements therefore) for actual documented out-of-pocket fees and expenses, not to exceed $45 million, actually incurred by any of them or on their behalf in connection with the Offer, the proposed Merger and the proposed Spin-Off and the transactions contemplated by this Agreement and the Distribution Agreement (including, without limitation, fees payable to financing sources, investment bankers (including to the IB), counsel to any of the foregoing and Accountants), whether incurred prior to or after the date hereof. The Company shall in any event pay the amount requested (not to exceed $45 million) within one Business Day of such request, subject to the Company's right to demand a return of any portion as to which invoices are not received in due course. (d) Except as specifically provided in this Section 8.3 and except as otherwise specifically provided in the Distribution Agreement, each party shall bear its own respective expenses incurred in connection with this Agreement, the Offer and the Merger, including, without limitation, the preparation, execution and performance of this Agreement and the Ancillary Agreements and the transactions contemplated hereby and thereby, and all fees and expenses of investment bankers, finders, brokers, agents, representatives, counsel and accountants. (e) Notwithstanding anything to the contrary contained in this Agreement, upon payment by the Company of the amounts referred to in this Section 8.3(a), the Company shall be released from all Liability hereunder, including any Liability for any claims by Parent, Purchaser or any of their affiliates based upon or arising out of any breach of this Agreement or any Ancillary Agreement. The parties agree that reimbursement of Parent's expenses pursuant to Section 8.3(c) hereof in connection with a termination of this Agreement pursuant to any of the Designated Termination Provisions does not constitute the payment of liquidated damages and, except to the extent of the payment thereunder, shall not limit the Liability of the Company for any claims by Parent, Purchaser or any of their affiliates based upon or arising out of any breach of this Agreement or any Ancillary Agreement. SECTION 8.4. AMENDMENT. This Agreement may be amended by action taken by the Company, Parent and Purchaser at any time before or after adoption of the Merger by the stockholders of the Company, if any; provided that (a) in the event that any persons designated by Parent pursuant to Section 1.4 hereof (such directors are hereinafter referred to as the "DESIGNATED DIRECTORS") constitute in their entirety a majority of the Company's Board of Directors, no amendment shall be made which decreases the cash price per Share or which adversely affects the rights of the Company's stockholders hereunder without the approval of a majority of the Continuing Directors (as hereafter defined) if at the time there shall be any Continuing Directors and (b) after the date of adoption of the Merger by the stockholders of the Company, no amendment shall be made which decreases the cash price per Share or which adversely affects the rights of the Company's stockholders hereunder without the approval of such stockholders. This Agreement may not be amended except by an instrument in writing signed on behalf of the parties. For purposes hereof, the term "CONTINUING DIRECTOR" shall mean (a) any member of the Board of Directors of the Company as of the date hereof, (b) any member of the Board of Directors of the Company who is unaffiliated with, and not a Designated Director or other nominee of, Parent or Purchaser or their respective Subsidiaries, and (c) any successor of a Continuing Director who is (i) unaffiliated with, and not a Designated Director or other nominee of, Parent or Purchaser or their respective Subsidiaries and (ii) recommended to succeed a Continuing Director by a majority of the Continuing Directors then on the Board of Directors. SECTION 8.5. EXTENSION; WAIVER. At any time prior to the Effective Time, the parties may (a) extend the time for the performance of any of the obligations or other acts of the other parties hereto, (b) waive any inaccuracies in the representations and warranties of the other parties contained herein or in any document, certificate or writing delivered pursuant hereto or (c) waive compliance with any of the agreements or conditions of the other parties hereto contained herein; provided that (x) in the event that any Designated Directors constitute in their entirety a majority of the Company's Board of Directors, no extensions or waivers shall be made which adversely affect the rights of the Company's stockholders hereunder without the approval of a majority of the Continuing Directors if at the time there shall be any Continuing Directors and (y) after the date of adoption of the Merger by the stockholders of the Company, no extensions or waivers shall be made which adversely affect the rights of the Company's stockholders hereunder without the approval of such stockholders. Any agreement on the part of any party to any such extension or waiver shall be valid only if set forth in an instrument in writing signed on behalf of such party. SECTION 9.1. SURVIVAL. Except as otherwise expressly set forth in the Distribution Agreement, the representations, warranties, covenants and agreements made herein shall not survive beyond the Effective Time; provided, that the covenants and agreements contained in Sections 2.7, 2.10, 3.1, 3.2, 6.3(b), 6.4, 6.5, 6.6, 6.8, 6.9, 6.10, 6.14, 8.2, 8.3, 8.4, 8.5, 9.3, 9.5 and 9.11 hereof shall survive beyond the Effective Time without limitation. SECTION 9.2. ENTIRE AGREEMENT. Except for the provisions of the Confidentiality Agreement which shall continue in full force and effect, this Agreement (including the schedules and exhibits and the agreements and other documents referred to herein, including, without limitation, the Ancillary Agreements) constitutes the entire agreement among the parties with respect to the subject matter hereof and supersedes all other prior negotiations, commitments, agreements and understandings, both written and oral, between the parties or any of them with respect to the subject matter hereof. SECTION 9.3. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the Laws of the State of New York (regardless of the Laws that might otherwise govern under applicable principles of conflicts Law) as to all matters, including, without limitation, matters of validity, construction, effect, performance and remedies. SECTION 9.4. NOTICES. All notices and other communications hereunder shall be in writing and shall be deemed given upon (a) transmitter's confirmation of a receipt of a facsimile transmission, (b) confirmed delivery by a standard overnight carrier or when delivered by hand or (c) the expiration of five Business Days after the day when mailed by certified or registered mail, postage prepaid, addressed at the following addresses (or at such other address for a party as shall be specified by like notice): (a) If to the Parent or Purchaser, to: New York, New York 10022 Attention: C. Douglas Kranwinkle, Esq. Jeffrey J. Rosen, Esq. Skadden, Arps, Slate, Meagher & Flom New York, New York 10022 Attention: Peter Allan Atkins, Esq. Lou R. Kling, Esq. (b) If to the Company, to: New York, New York 10016 New York, New York 10022 Attention: Robert B. Hodes, Esq. Bruce R. Kraus, Esq. SECTION 9.5. SUCCESSORS AND ASSIGNS; NO THIRD PARTY BENEFICIARIES. This Agreement and all of the provisions hereof shall be binding upon and inure to the benefit of the parties and their respective successors and permitted assigns, but neither this Agreement nor any of the rights, interests or obligations hereunder shall be assigned by either party (whether by operation of law or otherwise) without the prior written consent of the other party; provided, that Parent may assign its rights and obligations hereunder or those of Purchaser to Parent or any subsidiary of Parent, and Spinco may assign its rights and obligations hereunder to any successor to Spinco, but in each case no such assignment shall relieve Parent, Purchaser or Spinco, as the case may be, of its obligations hereunder. This Agreement shall be binding upon and inure solely to the benefit of each party hereto, and except for Sections 2.7, 2.10, 6.8 and 6.10 hereof nothing in this Agreement, express or implied, is intended to or shall confer upon any other person any rights, benefits or remedies of any nature whatsoever under or by reason of this Agreement. SECTION 9.6. COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original, but all of which shall constitute one and the same instrument. SECTION 9.7. INTERPRETATION. The descriptive headings herein are inserted for convenience of reference only and are not intended to be part of or to affect the meaning or interpretation of this Agreement. Except as otherwise expressly provided in this Agreement, as used in this Agreement, the term "person" shall have the meaning assigned to that term in the Distribution Agreement. SECTION 9.8. SCHEDULES. The Disclosure Schedule shall be construed with and as an integral part of this Agreement to the same extent as if the same had been set forth verbatim herein. SECTION 9.9. LEGAL ENFORCEABILITY. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without affecting the validity or enforceability of the remaining provisions hereof. Any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. If any provision of this Agreement is so broad as to be unenforceable, the provision shall be interpreted to be only so broad as is enforceable. SECTION 9.10. SPECIFIC PERFORMANCE. Each of the parties hereto acknowledges and agrees that in the event of any breach of this Agreement, each non- breaching party would be irreparably and immediately harmed and could not be made whole by monetary damages. It is accordingly agreed that the parties hereto (a) will waive, in any action for specific performance, the defense of adequacy of a remedy at law and (b) shall be entitled, in addition to any other remedy to which they may be entitled at law or in equity, to compel specific performance of this Agreement in any action instituted in any state or federal court sitting in New York. The parties hereto consent to personal jurisdiction in any such action brought in any state or federal court sitting in New York and to service of process upon it in the manner set forth in Section 9.4 hereof. SECTION 9.11. BROKERAGE FEES AND COMMISSIONS. Except as set forth in Sections 4.18 and 5.6, the Company hereby represents and warrants to Parent with respect to the Company, and Parent hereby represents and warrants to the Company with respect to Parent and Purchaser, that no person or entity is entitled to receive from the Company or Parent and Purchaser, respectively, any investment banking, brokerage or finder's fee or fees for financial consulting or advisory services in connection with this Agreement and Plan of Merger or any of the transactions contemplated hereby. [The remainder of this page has been left blank intentionally.] IN WITNESS WHEREOF, each of the parties has caused this Agreement and Plan of Merger to be executed on its behalf by its officers thereunto duly authorized, all as of the day and year first above written. By: /s/ Michael B. Targoff By: /s/ Marcus C. Bennett By: /s/ Frank H. Menaker, Jr. Name: Frank H. Menaker, Jr. Form of Tax Sharing Agreement, dated as of , 1996 by and among Loral Corporation, Loral Telecommunications Acquisition, Inc., Lockheed Martin Corporation and LAC Acquisition Corporation--Filed as Exhibit (C)(5) to the Tender Offer Statement on Schedule 14D-1 dated January 12, 1996. Notwithstanding any other provision of the Offer, Purchaser shall not be required to accept for payment or pay for, and may delay the acceptance for payment of (whether or not the Shares have theretofore been accepted for payment), or the payment for, any Shares tendered, and may terminate or extend the Offer and not accept for payment any Shares, if: (i) immediately prior to the expiration of the Offer (as extended in accordance with the terms of the Offer), (A) any applicable waiting period under the Antitrust Laws shall not have expired or been terminated or any approvals required under the EC Merger Regulations shall not have been received, (B) the Record Date for the distribution of shares of Spinco common stock to stockholders of the Company pursuant to the Distribution Agreement shall not have been set by the Company's Board of Directors, (C) the Public Indenture Merger Opinions shall not have been delivered to Purchaser and the applicable Public Indenture trustees, or (D) the number of Shares validly tendered and not withdrawn when added to the Shares then beneficially owned by Parent does not constitute two-thirds of the Shares then outstanding and represent two-thirds of the voting power of the Shares then outstanding on a fully diluted basis on the date of purchase; OR (ii) on or after the date of this Agreement and prior to the acceptance for payment of Shares, any of the following conditions exist: (a) any of the representations or warranties of the Company contained in the Merger Agreement shall not have been true and correct at the date when made or (except for those representations and warranties made as of a particular date which need only be true and correct as of such date) shall cease to be true and correct at any time prior to consummation of the Offer, except where the failure to be so true and correct would not, individually or in the aggregate, have a Material Adverse Effect; provided, that if any such failure to be so true and correct is curable by the Company through the exercise of its reasonable efforts, then Purchaser may not terminate the Offer under this subsection (a) until 10 Business Days after written notice thereof has been given to the Company by Parent or Purchaser and unless at such time the matter has not been cured; or (b) any of the representations or warranties of Spinco contained in the Distribution Agreement shall not have been true and correct at the date when made or (except for those representations and warranties made as of a particular date which need only be true and correct as of such date) shall cease to be true and correct at any time prior to consummation of the Offer, except where the failure to be so true and correct would not individually or in the aggregate, have a Material Adverse Effect; provided that, if any such failure to be so true and correct is curable by Spinco through the exercise of its reasonable efforts, then Purchaser may not terminate the Offer under this subsection (b) until 10 Business Days after written notice thereof has been given to the Company by Parent or Purchaser and unless at such time the matter has not been cured; or (c) the Company shall have breached any of its covenants or agreements contained in the Merger Agreement, except for any such breaches that, individually or in the aggregate, would not have a Material Adverse Effect; provided that, if any such breach is curable by the Company through the exercise of its reasonable efforts, then Purchaser may not terminate the Offer under this subsection (c) until 10 Business Days after written notice thereof has been given to the Company by Parent or Purchaser and unless at such time the breach has (d) Spinco or the Company shall have breached any of its covenants or agreements contained in the Distribution Agreement, except for any such breaches that, individually or in the aggregate, would not have a Material Adverse Effect; provided, that if any such breach is curable by Spinco or the Company through the exercise of its reasonable efforts, then Purchaser may not terminate the Offer under this subsection (d) until 10 Business Days after written notice thereof has been given to the Company or Spinco, as the case may be, by Parent or Purchaser and unless at such time the breach has not been cured; or (e) there shall have been any statute, rule, regulation, judgment, order or injunction promulgated, enacted, entered, enforced or deemed applicable to the Offer, or any other legal action shall have been taken, by any state, federal or foreign government or governmental authority or by any U.S. court, other than the routine application to the Offer, the Merger or the Spin-Off of waiting periods under the HSR Act, that presents a substantial likelihood of (1) making the acceptance for payment of, or the payment for, some or all of the Shares illegal or otherwise prohibiting, restricting or significantly delaying consummation of the Offer, (2) imposing material limitations on the ability of Purchaser or Parent to acquire or hold or to exercise any rights of ownership of the Shares, or effectively to manage or control the Retained Business, the Company, the Retained Subsidiaries, Purchaser or any of their respective affiliates, which individually or in the aggregate could constitute a Significant Adverse Effect; or (f) any fact or circumstance exists or shall have occurred that has a (g) there shall have occurred (1) any general suspension of trading in, or limitation on prices for, securities on the New York Stock Exchange, Inc., (2) the declaration of a banking moratorium or any suspension of payments in respect of banks in the United States (whether or not mandatory), (3) the commencement of a war, armed hostilities or other international or national calamity directly or indirectly involving the United States and having a Material Adverse Effect or materially adversely affecting (or materially delaying) the consummation of the Offer, (4) any limitation or proposed limitation (whether or not mandatory) by any U.S. governmental authority or agency, or any other event, that materially adversely affects generally the extension of credit by banks or other financial institutions, (5) from the date of the Merger Agreement through the date of termination or expiration of the Offer, a decline of at least 25% in the Standard & Poor's 500 Index or (6) in the case of any of the situations described in clauses (1) through (5) inclusive, existing at the date of the commencement of the Offer, a material acceleration, escalation or (h) any person (which includes a "person" as such term is defined in Section 13(d)(3) of the Exchange Act) other than Purchaser, any of its affiliates, or any group of which any of them is a member shall have acquired beneficial ownership of more than 20% of the outstanding Shares or shall have entered into a definitive agreement or an agreement in principle with the Company with respect to a tender offer or exchange offer for any Shares or merger, consolidation or other business combination with or involving the Company or any of its (i) prior to the purchase of Shares pursuant to the Offer, the Board of Directors of the Company shall have withdrawn or modified (including by amendment of the Schedule 14D-9) in a manner adverse to Purchaser its approval or recommendation of the Offer, this Agreement, the Merger or the Spin-Off, shall have recommended to the Company's stockholders another offer, shall have authorized the redemption of the Rights (whether or not in accordance with Section 6.1(k) hereof) after the Company has received an Acquisition Proposal or shall have adopted any resolution to effect any of the foregoing which, in the sole judgment of Purchaser in any such case, and regardless of the circumstances (including any action or omission by Purchaser) giving rise to any such condition, makes it inadvisable to proceed with such acceptance for (j) the Merger Agreement shall have been terminated in accordance (k) the Record Date shall not have occurred; or (l) the conditions to the Spin-Off shall not have been satisfied or (iii) Parent and Purchaser shall not have secured financing on terms reasonably acceptable to Parent to finance the purchase of all of the Shares at the Merger Price and to consummate the transactions contemplated by this Agreement and the Ancillary Agreements; provided, that the condition set forth in this clause (iii) shall be a condition to Purchaser's obligations with respect to the Offer only if (A) the Offer has not been consummated on or before April 30, 1996, (B) Parent has not taken any significant action outside of the ordinary course of business, which prevents Parent from obtaining sufficient financing to purchase all of the Shares at the Merger Price and to consummate the transactions contemplated by this Agreement and the Ancillary Agreements and (C) Parent and Purchaser are in substantial compliance with their respective material obligations under Sections 6.4, 6.5 and 6.6 of the Merger Agreement. The foregoing conditions are for the sole benefit of Purchaser and may be asserted by Purchaser regardless of the circumstances giving rise to such conditions, or may be waived by Purchaser in whole or in part at any time and from time to time in its sole discretion; provided, that the condition set forth in clause (ii)(j) above may be waived or modified only by the mutual consent of Purchaser and the Company. Form of Employment Protection Agreement of the Company--Filed as Exhibit (C) (6) to the Tender Offer Statement on Schedule 14D-1 dated January 12, 1996. Employment Protection Plan of the Company--Filed as Exhibit (C)(7) to the Tender Offer Statement on Schedule 14D-1 dated January 12, 1996. Supplemental Severance Program of the Company--Filed as Exhibit (C)(8) to the Tender Offer Statement on Schedule 14D-1 dated on January 12, 1996.	SC 14D1	EX-99.(C)(2)	1996-01-12T00:00:00	1996-01-12T17:26:30
0000950144-96-000096	0000950144-96-000096_0001.txt	$11,352,168.00 Date: December 31, 1995 FOR VALUE RECEIVED, the undersigned, ATLANTIC AMERICAN CORPORATION, hereby promises to pay to the order of FUQUA ENTERPRISES, INC. (f/k/a Vista Resources, Inc. and hereinafter, together with its successors and assigns, referred to as the "Holder") at the offices of the Holder located at 1201 West Peachtree Street, Suite 5000, Atlanta, Georgia 30309, or at such other place as the Holder may designate in writing to the undersigned, an amount equal to the aggregate amount of all payments of principal (including the Additional Amounts and accrued interest added to principal in accordance with Section 2(c) of the InterRedec Note both before and after the date hereof) and interest paid by the Holder after the date hereof under that certain Nonnegotiable Note dated October 11, 1991 ((the "InterRedec Note"); terms used herein and not defined herein have their respective defined meaning as set forth in the InterRedec Note) executed and delivered by the Holder in favor of InterRedec Southern Company, Inc. (together with its successors and assigns including, but not limited to, the Board of Governors of the Federal Reserve System or any person or entity to whom the InterRedec Note may be pledged, "InterRedec"), a copy of which is attached hereto as Exhibit A. Payments under this Note shall be due and payable in the exact amounts and at the exact times as the amounts owing by the Holder to InterRedec are originally scheduled to become due and payable under the InterRedec Note, it being the intent of the undersigned and, by acceptance hereof, the Holder, that the undersigned shall pay the Holder an amount equal to each amount of principal (including the Additional Amounts and accrued interest added to principal in accordance with Section 2(c) of the InterRedec Note both before and after the date hereof) and interest paid from the date hereof by the Holder to InterRedec (or its successors and assigns) under the InterRedec Note simultaneously with each such payment by the Holder to InterRedec. The undersigned acknowledges that, as of the date hereof, the principal amount (including the Additional Amounts that have now accrued pursuant to paragraphs 2(c), 6, 7 and 8 of the InterRedec Note) due and owing by the Holder under the InterRedec Note equals $11,352,168.00, which amount includes $1,352,168.00 of accrued and unpaid interest added to the principal amount of the InterRedec Note in accordance with Section 2(c) of the InterRedec Note. The undersigned further acknowledges that the originally scheduled amounts payable under the InterRedec Note may be reduced pursuant to paragraphs 10, 11 and 16 thereof. Whether and to what extent the amounts due and owing under the InterRedec Note, and therefore this Note, are reduced pursuant to such paragraphs shall be matters solely between the Holder and InterRedec and any payment, agreement, settlement, arbitration or judicial award, or refund or return of monies with respect to such matters shall, for purposes of this Note and the amounts owing by the undersigned hereunder, be binding upon the undersigned and the undersigned shall not be entitled to withhold or offset any amount owing hereunder in the event the undersigned disputes the amount or time any payment is made by the Holder under the InterRedec Note with respect to such matters. In this connection, if, pursuant to paragraph 16 of the Note, the Holder has a claim for Damages (as such term is used in the InterRedec Note) and the Holder pays an amount of proceeds due under the InterRedec Note into escrow as contemplated therein, the undersigned shall simultaneously pay an amount of proceeds due under this Note into escrow pursuant to such terms and arrangements as the undersigned and the Holder shall mutually and reasonably agree. To the extent any Damages paid into escrow by the Holder are returned or refunded to the Holder (whether pursuant to mutual agreement or arbitration or judicial award), the escrow arranged between the Holder and the undersigned shall provide that the undersigned shall be entitled to receive the same amount of funds so refunded or returned to the Holder. To the extent InterRedec is entitled to receive (whether by mutual agreement or arbitration or judicial award) any Damages paid into escrow by the Holder, the escrow arrangements between the Holder and the undersigned shall provide that the Holder shall be entitled to receive the same amount of funds so received by InterRedec. Notwithstanding any provisions contained herein to the contrary, any payment by InterRedec to the Holder that is in satisfaction of a liability of American Southern that has been paid by American Southern, and not previously reimbursed by the Holder, shall be promptly paid to the undersigned. Pursuant to Sections 5.04(e) and 7.01 of the Stock Purchase Agreement (as defined below), the undersigned may have a separate cause of action against the Holder with respect to any such dispute relating to such matters. The undersigned shall have the right at any time and from time to time to prepay the indebtedness represented by this Note in whole or in part without premium or penalty, but with accrued interest to the date of such prepayment on the principal amount prepaid. By acceptance hereof, during the time this Note is outstanding, the Holder agrees not to exercise its right to prepay all or a portion of the principal of the InterRedec Note prior to its stated maturity pursuant to paragraph 9 of the InterRedec Note. Further, the undersigned shall not be obligated to make any mandatory prepayment of the principal amount of, or accrued interest on, this Note by reason of the making by the Holder of any mandatory prepayment of principal or interest under the InterRedec Note by reason of the occurrence of an Event of Default under the InterRedec Note. In such event, the undersigned shall pay the amount of any such mandatory prepayment at the originally scheduled payment dates under the InterRedec Note and in any event no later than October 11, 1996 (the "Maturity Date"). For purposes of this Note, a drawing under that certain Irrevocable Standby Letter of Credit No. 062173 dated December 8, 1995 issued by First Union National Bank of Georgia in favor of the Holder, a copy of which is attached hereto as Exhibit B (the "Letter of Credit"), shall constitute a payment under the InterRedec Note; provided, however, that in the event any such drawing occurs prior to the Maturity Date, the undersigned shall not be obligated to pay to the Holder the amount of such drawing until the Maturity Date. In any event, interest shall continue to accrue on the unpaid principal amount of this Note under the InterRedec Note or drawing under the Letter of Credit prior to the Maturity Date at the pre-default rates and in the manner set forth in the InterRedec Note. If, pursuant to paragraph 12 of the InterRedec Note, InterRedec pays the Holder any Offset Amount thereby increasing the outstanding amount of the InterRedec Note, the Holder may, at its option, either (i) immediately pay such amount directly to the undersigned whereupon the principal amount outstanding under this Note shall be automatically increased by such amount or (ii) retain such payment by InterRedec whereupon the outstanding amount of this Note shall remain reduced by the amount of such amount retained. In no event shall the amount of interest due or payable under this Note exceed the maximum rate of interest allowed by applicable law and, in the event any such payment is inadvertently paid by the undersigned or inadvertently received by the Holder, then such excess sum shall be credited as a payment of principal, unless the undersigned shall notify the Holder in writing that the undersigned elects to have such excess sum returned to it forthwith. It is the express intent of the parties hereto that the undersigned not pay and the Holder not receive, directly or indirectly, in any manner whatsoever, interest in excess of that which may be lawfully paid by the undersigned under applicable law. Each of the following events shall constitute an "Event of Default" under this Note: (i) failure of the undersigned to pay any amount due hereunder when due and the continuance of such failure for a period of five business days after written demand therefor, or the undersigned shall in any way fail to comply with the other terms, covenants or conditions contained in this Note or in the Stock Purchase Agreement, (ii) any oral or written representation or warranty made at any time by the undersigned to the Holder under the Stock Purchase Agreement or otherwise shall prove to have been incorrect or misleading in any material respect when made; (iii) the undersigned shall (a) commence a voluntary case under the Bankruptcy Code of 1978, as amended or other federal bankruptcy law (as now or hereafter in effect); (b) file a petition seeking to take advantage of any other laws, domestic or foreign, relating to bankruptcy, insolvency, reorganization, winding up or composition for adjustment of debts; (c) consent to or fail to contest in a timely and appropriate manner any petition filed against it in an involuntary case under such bankruptcy laws or other laws; (d) apply for or consent to, or fail to contest in a timely and appropriate manner, the appointment of, or the taking of possession by, a receiver, custodian, trustee, or liquidator of itself or of a substantial part of its property, domestic or foreign; (e) be unable to, or admit in writing its inability to, pay its debts as they become due; (f) make a general assignment for the benefit of creditors, or (g) make a conveyance fraudulent as to creditors under any state or federal law, or (iv) a case or other proceeding shall be commenced against the undersigned in any court of competent jurisdiction seeking (a) relief under the Bankruptcy Code of 1978, as amended or other federal bankruptcy law (as now or hereafter in effect) or under any other laws, domestic or foreign, relating to bankruptcy, insolvency, reorganization, winding up or adjustment of debts or (b) the appointment of a liquidator or the like for the undersigned or all or any substantial part of the assets, domestic or foreign, of the undersigned. Upon the occurrence of an Event of Default (other than an Event of Default described in clause (iii) or (iv) of the definition thereof), at the option of the Holder, and without demand or notice of any kind, all outstanding amounts under this Note (as determined by the then outstanding amounts under the InterRedec Note) may be immediately declared, and thereupon shall immediately become, in default and due and payable and the Holder may exercise any and all rights and remedies available to it at law, in equity or otherwise. Upon the occurrence of an Event of Default described in clause (iii) or (iv) of the definition thereof, all outstanding amounts owing under this Note (as determined by the then outstanding amounts under the InterRedec Note), without demand or notice of any kind, shall immediately become in default and due and payable and the Holder may exercise any and all rights and remedies available to it at law, in equity or otherwise. Upon the occurrence of an Event of Default under this Note, interest shall accrue on the outstanding principal amount of this Note (including all Additional Amounts) at the lower of (i) the Prime Rate (as defined in the InterRedec Note) plus two percentage points (2%) or eighteen percent (18%) per annum, such interest, and such principal, being payable on demand. The Holder shall maintain a ledger or other statement of account regarding the amounts due under the InterRedec Note and therefore this Note; provided, however, that the failure of the Holder to maintain such ledger or statement shall in no way affect its rights or the undersigned's obligations hereunder. The entries in such ledger or statement shall be binding and conclusive upon the undersigned absent manifest error. The undersigned shall pay all expenses incurred by the Holder in the collection of this Note, including, without limitation, the reasonable fees and disbursements of counsel to the Holder if this Note is collected by or through an attorney-at-law. However, the undersigned shall not be liable for any costs of collection, including attorneys' fees and disbursements, paid by the Holder to InterRedec. Time is of the essence of this Note. The undersigned agrees that all of its payment obligations hereunder shall be absolute, unconditional and, for the purposes of making payments hereunder, the undersigned hereby waives any right to assert any setoff, counterclaim or cross-claim including any right to setoff amounts due and owing hereunder by reason of any claim for indemnification under the Stock Purchase Agreement. Any such claim for indemnification shall be made in a separate cause of action and shall not affect, impair, reduce or modify the amounts owing by the undersigned hereunder. No delay or failure on the part of the Holder in the exercise of any right or remedy shall operate as a waiver thereof, and no single or partial exercise by the Holder of any right or remedy shall preclude other or further exercise thereof or the exercise of any other right or remedy. All amendments to this Note, and any waiver or consent of the Holder, must be in writing and signed by the Holder and the undersigned. The undersigned hereby waives presentment, demand, notice of dishonor, protests and all other notices whatever. THIS NOTE SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF GEORGIA. This Note is the Purchaser Note referred to in Section 2.03(a) of that certain Stock Purchase Agreement dated as of October 16, 1995 (the "Stock Purchase Agreement") by and between the initial Holder and the undersigned and is subject to, and is entitled to the benefits of, the terms and provisions of the Stock Purchase Agreement. This Note shall be binding upon the successors and assigns of the undersigned. A Holder of this Note may assign or transfer this Note to any person or entity without notice to, or the consent of, the undersigned. Any notice to be given hereunder shall be in writing, shall be sent to such person's address set forth below its signature hereto and shall be deemed received (i) on the earlier of the date of receipt or the date three business days after deposit of such notice in the United States mail, if sent postage prepaid, certified mail, return receipt requested or (ii) when actually received, if personally delivered or (iii) one business day after deposit of such notice with a recognized overnight courier or (iv) when confirmation of transmission has been received by the sender, if via facsimile transmission. IN WITNESS WHEREOF, the undersigned has duly executed and delivered this Promissory Note under seal as of the date and year first written above. By: /s/ Hilton H. Howell, Jr. Name: Hilton H. Howell, Jr. Title: President and Chief Executive Officer By: /s/ John W. Hancock Title: SR. V.P. & Treas. Attn: Hilton H. Howell, Jr. By: /s/ John J. Huntz, Jr. Name: John J. Huntz, Jr. Title: Executive Vice President and One Atlantic Center, Suite 5000 Attn.: John J. Huntz, Jr. FOR VALUE RECEIVED, the undersigned, Vista Resources, Inc. ("Vista"), promises to pay to InterRedec Southern Company, Inc. ("InterRedec"), at such place as InterRedec may designate in writing, the original principal sum of Eight Million Dollars and no cents ($8,000,000.00), on October 11, 1996; plus accrued and unpaid interest on the unpaid balance of such principal amount, at the rate of interest and at the times described below, until full and final payment. 1. Interest on the unpaid principal balance of this Note shall accrue at an annual rate (computed on the basis of actual days elapsed over a 365-day year) of the Prime Rate (as defined below). Vista shall pay all costs of collection, including reasonable attorney's fees, if this Note is collected by legal action or through an attorney at law. 2. All principal and interest shall be paid in immediately available funds and in lawful money of the United States of America as follows: (a) Principal shall be due and payable in full on October 11, 1996, together with all accrued and unpaid interest. (b) One-half of the interest accruing on the outstanding principal amount of this Note from the date hereof until such principal amount is paid in full shall be payable quarterly on the last day of each calendar quarter (March 31, June 30, September 30, and December 31) during the term of this Note. (c) One-half of the interest accruing on the outstanding principal amount of this Note from the date hereof until such principal amount is paid in full shall be added to the principal amount of this Note and shall be due and payable in full (without interest) on October 11, 1996. (d) Whenever a payment under this Note becomes due on a day which is not a business day, the due date for such payment shall be extended to the next succeeding business day, and interest applicable to such amount shall accrue during any such extension. 3. "Prime Rate" shall mean the rate stated in the Wall Street Journal on the first business day of each calendar month as the prime rate. Any change in the interest rate hereunder resulting from a change in the Prime Rate shall be effective as of the beginning of the first calendar day of each calendar month on which the Prime Rate changes. 4. The annual interest rate accruing on this Note on the date of its execution equals eight percent (8%). 5. This Note is issued pursuant to, and shall be subject to and have the benefits of, that certain Stock Purchase Agreement (the "Stock Purchase Agreement"), dated as of September 17, 1991, by and among Vista; Concorde Finance & Investment, Inc., a Delaware corporation; InterRedec; InterRedec, Inc., a Delaware corporation; and American Southern Insurance Company ("ASICo") and the related Pledge and Security Agreement dated of even date by and between Vista and InterRedec. 6. In addition to any other amounts due and payable under this Note, Vista promises to pay to InterRedec One Million Dollars and no cents ($1,000,000.00) on October 11, 1996 if the Earnings Before Taxes (as defined below) of ASICo and its subsidiaries, on a consolidated basis, equal or exceed Five Million Dollars and no cents ($5,000,000.00) for its fiscal year ending December 31, 1992. Any additional amount due to InterRedec under this Paragraph 6 shall accrue interest under this Note in accordance with Paragraph 1 of this Note from January 1, 1993 through October 11, 1996. (The additional amount, if any, payable under this Paragraph 6 shall be referred to in this Note as the "First Additional Amount.") 7. In addition to any other amounts due under this Note, Vista promises to pay to InterRedec One Million Dollars and no cents ($1,000,000.00) on October 11, 1996 if the Earnings Before Taxes (as defined below) of ASICo and its subsidiaries, on a consolidated basis, equal or exceed Fifteen Million Dollars and no cents ($15,000,000.00) on an aggregate basis for its fiscal years ending December 31, 1992, December 31, 1993, and December 31, 1994. Any additional amount due to InterRedec under this Paragraph 7 shall accrue interest under this Note in accordance with Paragraph 1 of this Note from January 1, 1995 through October 11, 1996. (The additional amount, if any, payable under this Paragraph 7 shall be referred to in this Note as the "Second Additional Amount"; and the First Additional Amount and the Second Additional Amount collectively shall be referred to in this Note as the "Additional 8. "Earnings Before Taxes" shall mean the pre-tax earnings of ASICo and its subsidiaries, on a consolidated basis, as determined in accordance with generally accepted accounting principles, consistently applied, as adjusted, where not otherwise duplicative, (a) to eliminate any adjustments to the value of assets or liabilities or other accounting adjustments resulting from the application of "purchase accounting principles"; (b) to include reasonable finance charges related to injections of capital in any form contributed by Vista or any third party; and (c) to eliminate any payments or expense accruals charged by or on behalf of any corporation or other entity affiliated with American Southern other than its subsidiaries (other than payments made directly to third parties relating to ASICo or its subsidiaries.). (Notwithstanding that management fees and certain other expenses are disregarded in computing the amount of Earnings Before Taxes, nothing in this Paragraph 8 shall be construed as denying Vista the right to assess any such charges.) 9. Vista shall have the right at any time and from time to time to prepay the indebtedness represented by this Note in whole or in part without premium or penalty, but with accrued interest to the date of such prepayment on the principal amount prepaid. 10. Upon the occurrence of any of the following events, the principal amount of this Note shall automatically be reduced by an amount determined under Section 3.03 of the Stock Purchase Agreement (an "Offset Amount") for which InterRedec is determined to be obligated to Vista (and any such Offset Amount shall first reduce the amount of any Additional Amounts before reducing the original principal amount of this Note): (a) Vista and InterRedec shall agree in writing (including an agreement as to the amount owed by InterRedec to Vista) that InterRedec is obligated to Vista for indemnification under the Stock Purchase Agreement and InterRedec shall not have paid Vista such amount within seven (7) days of the date of such agreement; (b) Vista and InterRedec shall agree to arbitration procedures with respect to a dispute concerning the indemnification provisions of the Stock Purchase Agreement, the arbitrator thereunder shall enter an award in Vista's favor, and InterRedec shall not have paid Vista the amount of such award within seven (7) days of the date such award is entered; or (c) A court of competent jurisdiction shall enter a judgment concerning the indemnification provisions of the Stock Purchase Agreement in Vista's favor and InterRedec shall not have paid Vista the amount of such judgment within seven (7) days of the date such judgment is entered. 11. Upon the final assessment of any amount of Taxes (as defined in the Stock Purchase Agreement) against ASICo or any of the Subsidiaries for any taxable period ending on or before the date of the Closing, which final assessment is paid by Purchaser or ASICo and is not reimbursed by any of the Sellers within five (5) business days after receipt by Sellers of notice from Purchaser or ASICo that it has paid such Taxes, the principal amount of this Note shall automatically be reduced by the Offset Amount with respect to such final assessment (and any such reduction shall first reduce the amount of any Additional Amounts before reducing the original principal amount of this Note). 12. Notwithstanding anything in Paragraph 10 or 11 of this Note, if, after the date on which the principal amount of this Note has been reduced by an Offset Amount, InterRedec pays Vista the Offset Amount, then the principal amount of this Note immediately shall be increased for all purposes by the amount which InterRedec pays Vista. 13. Notwithstanding any provision to the contrary in this Note, no party shall be required to pay, and no party shall be permitted to collect, any amount of interest in excess of the maximum amount of interest permitted by law ("Excess Interest"). If any Excess Interest is provided for or determined by a court of competent jurisdiction to have been provided for in this Note, then any Excess Interest shall be refunded to the payor thereof, and the interest rate provided for and this Note shall automatically be reduced to the maximum lawful rate allowed from time to time under applicable law. 14. Upon the occurrence of and during the continuance of one or more Events of Default under and as defined in the Pledge and Security Agreement: (a) the full amount of this Note may, at the option of InterRedec, be declared and immediately become due and payable, and InterRedec, subject to the limitations set forth in the Pledge and Security Agreement, may exercise any rights available to it at law and in equity, or available under any agreement, relating to this Note; and (b) interest accruing under this Note shall accrue at the lower of (1) the Prime Rate plus two percentage points (2%), or (2) eighteen percent (18%) per annum. 15. If the amount of this Note shall become due and payable pursuant to Paragraph 14 of this Note, Vista shall immediately pay the outstanding amount due under this Note into an escrow account (and shall deposit the First Additional Amount and the Second Additional Amount, if any, directly into the escrow account within five (5) business days of the dates such amounts are finally determined to be due pursuant to Section 17 of this Agreement,) with a bank that is reasonably acceptable to the parties and pursuant to an escrow agreement in a form reasonably satisfactory to the parties. The escrow agreement shall provide that (a) Vista shall have the right to receive escrowed funds under the circumstances it would be entitled to exercise its offset rights hereunder, and (b) any remaining escrowed funds shall be released to InterRedec on the stated maturity date of this Note, except that if on such date there are one or more outstanding claims for Damages (as defined in the Stock Purchase Agreement), an amount of the escrowed funds which would otherwise be released to InterRedec, equal to the maximum amount of such claims for Damages, shall remain in escrow until the resolution of such claims. 16. If, at the maturity of this Note, there are one or more outstanding claims for Damages (as that term is defined in the Stock Purchase Agreement), an amount of the proceeds due under this Note equal to maximum amount of such claims for Damages shall be paid into escrow pursuant to such terms and arrangements as the parties shall mutually and reasonably agree. 17. Vista shall deliver to InterRedec a written computation of the Earnings Before Taxes by March 31, 1993, with respect to the First Additional Amount, and March 31, 1995, with respect to the Second Additional Amount. InterRedec shall be deemed to have accepted each such computation provided unless, within forty-five (45) days after receipt of such written computation, InterRedec notifies Vista of its objection in writing and, in that event, Vista shall provide InterRedec with information pertinent to its computation of Earnings Before Taxes for such years, together with such access to the pertinent accounting records of American Southern and its subsidiaries as InterRedec may reasonably request. If the parties are unable to resolve any disputes relating to the computation of Earnings Before Taxes within thirty (30) days of InterRedec's notice of objection to Vista's computation, the parties shall promptly refer the matter for arbitration to a mutually agreed major accounting firm of national standing which, at the time of such submission, does not represent or has not represented any of the parties hereto, and the decision of such major accounting firm shall be rendered within not more than twenty (20) days of submission and shall be final and binding on the parties. The expense of such arbitration shall be borne equally by the parties. 18. If, during the term of this Note, Vista sells all of the outstanding stock or substantially all of the assets of ASICo to a third party (a "Subsequent Purchaser"), Vista may assign all of its rights and obligations under this Note, together with all of its rights and obligations under the Stock Pledge and Security Agreement, to such Subsequent Purchaser; provided, however, that Vista (1) must first obtain the written consent of InterRedec to such assignment which, based upon InterRedec's judgment of the creditworthiness of the Subsequent Purchaser, shall not unreasonably be withheld, or (2) delivers to InterRedec a bank letter of credit in a form and from a bank reasonably acceptable to InterRedec and in an amount which at all times shall be at least equal to the outstanding principal amount of this Note. 19. The failure or forbearance of InterRedec to exercise any right hereunder, or otherwise granted to it by law or another agreement, shall not affect or release the liability of Vista, and shall not constitute a waiver of such right unless so stated by InterRedec in writing. 20. This Note shall be governed by and construed in accordance with the substantive laws of the State of Georgia. This Note is executed under the hand and seal of Vista on the date first-above written. [CORPORATE SEAL] By: /s/ Samuel W. Norwood III By: /s/ Bill W. Batastini By: /s/ Bill W. Batastini CONCORDE FINANCE & INVESTMENTS, INC. By: /s/ Bill W. Batastini IRREVOCABLE STANDBY LETTER OF CREDIT We hereby open our Irrevocable Standby Letter of Credit No. S062173, in your favor, for the account of Fuqua Enterprises, Inc., 1201 West Peachtree Street, Suite 5000, Atlanta, Georgia 30309 up to the aggregate amount of US$11,803,914.56 (Eleven Million Eight Hundred Three Thousand Nine Hundred Fourteen and 56/100 US Dollars) available by your sight drafts, at sight, drawn on First Union National Bank of Georgia, and accompanied by (1) a certificate in the form of Annex A hereto appropriately completed and purportedly signed by the holder of the promissory note referred to in Annex A and (2) the documents required by the express terms of such certificate to be delivered with such certificate. This Irrevocable Standby Letter of Credit sets forth in full terms of our undertaking. This undertaking shall not in any way be modified, amended or amplified by reference to any document or contract referred to herein. This Letter of Credit expires at this office on January 31, 1997. This Letter of Credit is transferable. Partial drawings are not permitted. A drawing presented to us by 12:00 noon, provided that such drawing strictly complies with the terms hereof, will be honored by us no sooner than two business days later. Tested telex demands for payment are not acceptable. Draft(s) under this Letter of Credit must state on their face: "Drawn under First Union National Bank of Georgia Letter of Credit No. S062173 dated December 8, 1995." We hereby engage with you that sight draft(s) drawn under and in strict compliance with the terms of this Letter of Credit shall be duly honored by us if presented to us, at this office, on or before the above stated expiration date as provided for herein. All notices, if any, with respect to this Letter of Credit will be sent by facsimile and overnight mail to the addressee named above and to the Federal Reserve Bank of New York, Legal Department, 33 Liberty Street, New York, New York 10045-0001, Attention: Thomas C. Baxter, Jr., General Counsel and Executive Vice President. Except so far as otherwise expressly stated herein, this Letter of Credit is subject to the "Uniform Customs and Practice for Documentary Credits (1993 Revision), International Chamber of Commerce Publication No. 500." FIRST UNION NATIONAL BANK OF GEORGIA First Union National Bank of Georgia Two First Union Center, T-7 Re: Irrevocable Letter of Credit No. S062173 (the "Letter of Credit") For the Account of Fuqua Enterprises, Inc., formerly known as Vista Resources, Reference is made to that certain Nonnegotiable Note dated October 11, 1991 executed by the Applicant, payable to InterRedec Southern Company, Inc. ("InterRedec") in the original principal amount of $8,000,000 (the "Note"). The undersigned, the Federal Reserve Bank of New York (the "Holder") hereby certifies to First Union National Bank of Georgia and to the Applicant that: 1. The Holder is the legal and rightful holder of the Note and is entitled to make this demand for payment under the Letter of Credit. 2. Attached to this Certificate are (a) the original of the Note and (b) a copy of the written disbursement instructions executed by the Secretary of the Board of Governors of the Federal Reserve System (the "Board") required to be delivered to the Federal Reserve Bank of New York (the "New York Fed") under Section 10(b) of the Escrow and Security Agreement dated October 8, 1991 by and among the Board, InterRedec, Inc., the Applicant, Concord Finance & Investment, Inc., Randy A. Mastro and the Federal Reserve Bank of New York. 3. An Event of Default under and as defined in that certain Stock Pledge and Security Agreement dated as of October 11, 1991 (the "Pledge Agreement") by and between the Applicant and InterRedec ("Event of Default") has occurred and is continuing under Section 3(a) thereof. 4. With respect to paragraphs 5(a), (b) or (c) below, InterRedec has given written notice to the Applicant at least 30 day's prior to the date of this certificate, that InterRedec intends to exercise its default rights and remedies under the Pledge Agreement by drawing on the Letter of Credit. A true copy of such notice is attached to this Certificate. 5. The statement noted below is true [check one of the following as applicable]: [ ] (a) The Applicant and InterRedec have agreed in writing (including an agreement as to the amount owed by the Applicant to the Holder) that InterRedec is entitled to exercise its default rights and remedies under the Pledge Agreement and a true copy of such written agreement is attached to this Certificate; [ ] (b) The Applicant and InterRedec have agreed to arbitration procedures with respect to whether InterRedec is entitled to exercise its default rights and remedies under the Pledge Agreement, and the arbitrator thereunder has entered an award in InterRedec's favor and a true copy of such award is attached to this Certificate; or [ ] (c) A court of competent jurisdiction has entered a judgment in InterRedec's favor that InterRedec is entitled to exercise its default rights and remedies under the Pledge Agreement and a true copy of such judgment is attached to this Certificate. [ ] (d) After exercising reasonable efforts but in any event no sooner than 30 days after an Event of Default has occurred, the Holder has not been able to agree with the Applicant as to the terms and arrangements of an escrow as described in paragraph 16 of the Note and at least 10 days have elapsed since the Holder has notified the Applicant in writing that it intends to draw under the Letter of Credit pursuant to this paragraph 5(d). 6. The Holder is entitled to payment under the Letter of Credit in the amount of $ . The holder acknowledges that in the event it draws under the Letter of Credit based upon the certification set forth in paragraph 5(d) above, the amount the Holder is entitled to draw under the Letter of Credit shall not exceed $8,803,914.56. 7. Please direct payment under the Letter of Credit by wire transfer to: Federal Reserve Bank of New York 59 Maiden Lane, 10th Floor New York, New York 10045 General Counsel and Executive Vice President For further credit to account number 021039898 8. Upon payment by you of the amount demanded hereby in accordance with the payment instructions set forth above, you are hereby instructed (a) to mark the Note "Paid in Full" and (b) to deliver the Note to the Applicant. IN WITNESS WHEREOF, the undersigned has duly executed and delivered this Certificate.	8-K	EX-10.(A)	1996-01-12T00:00:00	1996-01-12T16:10:58
0000812073-96-000002	0000812073-96-000002_0000.txt	The investment objective of the Greater Cincinnati Fund (the "Fund") is to provide long-term capital growth by investing primarily in common stocks and other equity securities of publicly-traded companies headquartered in the Greater Cincinnati Area, and those companies having a significant presence in the Greater Cincinnati Area. While there is no assurance that the Fund will achieve its investment objective, it endeavors to do so by following the investment policies described in this Prospectus. Two classes of shares of the Fund are described in this Prospectus - Class A shares and Class B shares. Class A shares are sold with a front-end sales charge. Class B shares are sold with a contingent deferred sales charge. See "Prospectus Summary - Offering Price." The Fund is a non-diversified series of The Nottingham Investment Trust (the "Trust"), a registered open-end management investment company. This Prospectus sets forth concisely the information about the Fund that a prospective investor should know before investing. Investors should read this Prospectus and retain it for future reference. Additional information about the Fund has been filed with the Securities and Exchange Commission and is available upon request and without charge. You may request the Statement of Additional Information dated September 1, 1995, as supplemented effective December 5, 1995, which is incorporated in this Prospectus by reference, by writing the Fund at Post Office Drawer 69, Rocky Mount, North Carolina 27802- 0069, or by calling 1-800-525-FUND. Investment in the Fund involves risks, including the possible loss of principal. Shares of the Fund are not deposits or obligations of, or guaranteed or endorsed by, any financial institution, and such shares are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED ON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The date of this Prospectus is September 1, 1995, as supplemented effective September 1, 1995, November 9, 1995, and December 5, 1995. PROSPECTUS SUMMARY. . . . . . . . . . . . . . . . . . . . . . . 2 SYNOPSIS OF COSTS AND EXPENSES. . . . . . . . . . . . . . . . . 3 FINANCIAL HIGHLIGHTS. . . . . . . . . . . . . . . . . . . . . . 5 INVESTMENT OBJECTIVE AND POLICIES . . . . . . . . . . . . . . . 6 RISK FACTORS. . . . . . . . . . . . . . . . . . . . . . . . . . 8 INVESTMENT LIMITATIONS. . . . . . . . . . . . . . . . . . . . . 10 FEDERAL INCOME TAXES. . . . . . . . . . . . . . . . . . . . . . 11 DIVIDENDS AND DISTRIBUTIONS . . . . . . . . . . . . . . . . . . 12 HOW SHARES ARE VALUED . . . . . . . . . . . . . . . . . . . . . 13 HOW SHARES MAY BE PURCHASED . . . . . . . . . . . . . . . . . . 13 HOW SHARES MAY BE REDEEMED. . . . . . . . . . . . . . . . . . . 24 MANAGEMENT OF THE FUND. . . . . . . . . . . . . . . . . . . . . 26 OTHER INFORMATION . . . . . . . . . . . . . . . . . . . . . . . 29 This Prospectus is not an offering of the securities herein described in any state in which the offering is unauthorized. No sales representative, dealer or other person is authorized to give any information or make any representations other than those contained in this Prospectus. Class B shares of the Fund will not be available for purchase in your state until further notice from the Fund. Until such time, investors desiring to invest in the Fund should purchase Class A shares. Please contact the Advisor at (601) 929-2106 to determine if Class B shares are available in your state. The Fund The Greater Cincinnati Fund (the "Fund") is a non- diversified series of The Nottingham Investment Trust (the "Trust"), a registered open-end management investment company organized as a Massachusetts business trust. See "Other Information - Description of Shares." Offering Price Two classes of shares of the Fund are offered in this Prospectus - Class A shares and Class B shares. The classification of shares of the Fund permits an investor to choose the method of purchasing shares that the investor believes is most beneficial given the amount of the purchase, the length of time the investor expects to hold the shares, and other relevant circumstances. Class A shares in the Fund are offered at net asset value plus a maximum 3.5% front-end sales charge, which is reduced or eliminated on purchases involving larger amounts. Class B shares in the Fund are offered at net asset value. Class B shares are subject to a maximum 5.0% contingent deferred sales charge, which is reduced or eliminated depending on the length of time the shares are held. The minimum initial investment is $1,000 ($250 for IRAs). The minimum subsequent investment is $100. See "How Shares May be Purchased." Investment The investment objective of the Fund is to provide Objective and shareholders with long-term capital growth by investing Special Risk primarily in common stocks and other equity securities of Considerations publicly-traded companies headquartered in the Greater Cincinnati Area, and those companies having a significant presence in the Greater Cincinnati Area. Realization of current income is not a significant investment consideration, and any income realized will be incidental to the Fund's objective. See "Investment Objective and Policies." The Fund has registered as a non-diversified investment company so that it will be able to invest more than 5% of its assets in securities of each of one or more issuers. Some of the Fund's investments may include illiquid securities and securities purchased subject to a repurchase agreement or on a "when-issued" basis, which involve certain risks. The Fund may borrow only under certain limited conditions (including to meet redemption requests) and not to purchase securities. It is not the intent of the Fund to borrow except for temporary cash requirements. Borrowing, if done, would tend to exaggerate the effects of market and interest rate fluctuations on the Fund's net asset value until repaid. See "Risk Factors." Manager Subject to the general supervision of the Trust's Board of Trustees and in accordance with the Fund's investment policies, CityFund Advisory, Inc. of Cincinnati, Ohio (the "Advisor"), manages the Fund's investments. Affiliates of the Advisor currently manage over $75 million in assets. For its advisory services, the Advisor receives a monthly fee based on the Fund's daily net assets at the annual rate of 1.25%. See "Management of the Fund - The Advisor." Dividends Income dividends, if any, are paid quarterly; capital gains, if any, are paid at least once each year. Dividends and capital gains distributions are automatically reinvested in additional shares at net asset value unless the shareholder elects to receive cash. See "Dividends and Distributions." Distributor and Capital Investment Group, Inc. (the "Distributor") serves Distribution Fee as distributor of shares of the Fund. For its services, which include payments to qualified securities dealers for sales of Fund shares, the Distributor receives commissions consisting of the front-end sales charge (after the discounts it allows to securities dealers) and any contingent deferred sales charge. Under the Fund's Distribution Plan with respect to the Class A shares, expenditures by the Fund for distribution activities and service fees related to Class A shares may not exceed 0.50% of the Class A shares' average net assets annually. Under the Fund's Distribution Plan with respect to Class B shares, expenditures by the Fund for distribution activities and service fees relating to Class B shares may not exceed 1.00% of the Class B shares' average net assets annually, consisting of up to 0.75% for distribution activities and up to 0.25% for service fees, based on the average net assets of the Class B shares. See "How Shares May Be Purchased - Distribution Plans." Redemption of There is no charge for redemptions, except for any Shares contingent deferred sales charge that may be applicable to a redemption of Class B shares. Shares may be redeemed at any time at the net asset value next determined after receipt of a redemption request by the Fund. A shareholder who submits appropriate written authorization may redeem shares by telephone. See "How Shares May Be Redeemed." SYNOPSIS OF COSTS AND EXPENSES The following tables set forth certain information in connection with the expenses of the Class A shares of the Fund for the fiscal period ended February 28, 1995, as restated to reflect the anticipated expenses of the Classes of the Fund for the current fiscal year. The information is intended to assist the investor in understanding the various costs and expenses borne by the Classes of the Fund, and therefore indirectly by its investors, the payment of which will reduce an investor's return on an annual basis. Maximum sales load imposed on purchases (as a percentage of offering price) . . . . . . . . . . . . . . 3.50%1 NONE Sales load imposed on reinvested dividends . . . . . . . . . . . . .NONE NONE Maximum deferred sales load (as a percentage of original purchase price or redemption proceeds, whichever is lower). . . . . . . . . .NONE 5.00%3 Redemption fee . . . . . . . . . . . . . . . . . . . . . . . . . . .NONE NONE Exchange fee . . . . . . . . . . . . . . . . . . . . . . . . . . . .NONE NONE Annual Fund Operating Expenses - (as a percentage of average net assets) Investment advisory fees . . . . . . . . . . . . . . . . . . 0.00%2 0.00%2 12b-1 fees . . . . . . . . . . . . . . . . . . . . . . . . . 0.50%4 1.00%4,5 Other expenses . . . . . . . . . . . . . . . . . . . . . . . 1.75%2 1.75%2 Total operating expenses. . . . . . . . . . . . . . . . . 2.25%2 2.75%2 You would pay the following expenses (including the maximum initial sales charge for Class A shares) on a $1,000 investment in the Fund, assuming a 5% annual return and redemption at the end of the period: 1 Year 3 Years 5 Years 10 Years Class A $57 $103 $151 $284 Class B $78 $117 $157 $296* You would pay the following expenses on the same $1,000 investment, assuming no redemption at the end of the period: 1 Year 3 Years 5 Years 10 Years Class A $57 $103 $151 $284 Class B $28 $85 $145 $296* * Based on the conversion of the Class B shares to Class A shares after approximately eight years. THE FOREGOING SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESSER THAN THOSE SHOWN. 1 Reduced for larger purchases, and eliminated for purchases of $500,000 or more. See "How Shares May Be Purchased - Front-End Sales Charges." 2 The "Total operating expenses" shown above are based upon actual operating expenses incurred by the Class A shares of the Fund for the fiscal period ended February 28, 1995, which, after fee waivers and expense reimbursements, were 2.05% of average net assets, but restated to reflect the anticipated expenses of the Classes of the Fund for the current fiscal year (assuming payment of the full distribution and service fees described under footnote 4 below). Absent such waivers and reimbursements, for the Class A shares the "Investment advisory fees" would have been 1.25% and "Total operating expenses" would have been 80.88% (annualized) for the fiscal period ended February 28, 1995. The investment advisory fee is higher than that paid by most other investment companies. The Class A and Class B shares bear potential distribution and service fees at different levels as described under footnote 4 below. Since the Class B shares were not offered during the fiscal period ended February 28, 1995, the actual operating expenses incurred by the Class A shares for the fiscal period ended February 28, 1995 have been used for illustration purposes, subject to restatement as provided above. The Advisor has agreed for the current fiscal year to a reduction in the fees payable to it and to reimburse the Fund, if necessary, in an amount that operates to limit "Total operating expenses" (exclusive of interest, taxes, brokerage commissions, sales charges, distribution fees, and extraordinary expenses) to not more than 2.25% of the average daily net assets of the Class A shares of the Fund and not more than 2.75% of the average daily net assets of the Class B shares of the Fund. There can be no assurance that the foregoing fee waivers and expense reimbursements will continue. 3 This amount applies to redemptions during the first year. The contingent deferred sales charge decreases 1.00% annually thereafter to 0.00% after the fifth year. See "How Shares May Be Purchased - Contingent Deferred Sales Charges." 4 The Fund has adopted a Plan of Distribution for the Class A shares pursuant to Rule 12b-1 under the Investment Company Act of 1940, as amended (the "1940 Act"), which provides that the Fund may pay certain distribution expenses and service fees up to 0.50% of the Class A shares' average net assets annually. The Fund has also adopted a separate Plan of Distribution for the Class B shares pursuant to Rule 12b-1 under the 1940 Act, which provides that the Fund may pay certain distribution expenses and service fees up to an aggregate 1.00% of the Class B shares' average net assets annually, consisting of up to 0.75% for distribution activities and up to 0.25% for service fees, based on the average net assets of the Class B shares. See "How Shares May Be Purchased - Distribution Plans." Long-term shareholders may pay more than the economic equivalent of the maximum front-end sales charge permitted by the National Association of Securities Dealers, Inc. (the "NASD"). 5 Class B shares convert to Class A shares automatically approximately eight years after initial purchase, at which time they will be subject to the lower distribution and service fees of the Class A shares, as described in footnote 4 above. See "How Shares May Be Purchased - Conversion of Class B Shares to Class A Shares." See "How Shares May Be Purchased" and "Management of the Fund" below for more information about the fees and costs of operating the Fund. The assumed 5% annual return in the example is required by the Securities and Exchange Commission. The hypothetical rate of return is not intended to be representative of past or future performance of the Fund; the actual rate of return for the Fund may be greater or less than 5%. The Fund has two classes of shares - Class A shares and Class B shares. See "Other Information - Description of Shares." The financial data included in the table below has been derived from audited financial statements of the Class A shares of the Fund. The financial data for the fiscal period ended February 28, 1995 has been derived from financial statements audited by KPMG Peat Marwick LLP, independent accountants, whose report covering such period is included in the Statement of Additional Information. The information in the table below should be read in conjunction with the Fund's latest audited financial statements and notes thereto, which are also included in the Statement of Additional Information, a copy of which may be obtained at no charge by calling the Fund. Since the public offering of Class B shares of the Fund had not commenced during the fiscal period covered by the Fund's financial statements and related Financial Highlights pertaining to Class A shares of the Fund, no financial statements or related Financial Highlights are available pertaining to the Class B shares of the Fund. Further information about the performance of the Fund is contained in the Annual Report of the Fund, a copy of which may be obtained at no charge by calling the Fund. (For a Share Outstanding Throughout the Fiscal Period) Net asset value, beginning of period $10.00 Income from investment operations: Net realized and unrealized gains on securities (0.01) Total from investment operations 0.00 Net asset value, end of period $10.00 Net assets, end of period $232,998 Ratio of expenses to average net assets: Ratio of net investment loss to average net assets: (a) For the period from January 3, 1995 (commencement of operations) to February 28, 1995. (b) Does not reflect payment of the maximum 3.5% sales charge. (c) Annualized. Investment Objective. The investment objective of the Fund is to provide long-term capital growth by investing primarily (i.e., at least 75% of its total assets under normal conditions) in the common stocks and other equity securities of publicly-traded companies headquartered in the Greater Cincinnati Area, and those companies having a significant presence in the Greater Cincinnati Area. Realization of current income will not be a significant investment consideration, and any such income realized should be considered incidental to the Fund's objective. The Fund's investment objective and fundamental investment limitations described herein may not be altered without the prior approval of a majority of the Fund's shareholders. The Advisor believes that the demographic and economic characteristics of the Greater Cincinnati Area, including population, employment, retail sales, personal income, bank loans, bank deposits and residential construction, are such that many companies headquartered in the Greater Cincinnati Area, or having a significant presence in the area by virtue of having a significant portion of their corporate earnings generated from operations in the area, have a greater than average potential for capital appreciation. For these purposes, the Advisor defines the "Greater Cincinnati Area" to be the City of Cincinnati, Ohio, and an area within one hundred miles of the City. If a company is not headquartered in the Greater Cincinnati Area, the Advisor will consider such company as having a "significant presence" in the Greater Cincinnati Area if 50% or more of its profits are generated from operations (including plants, offices, or a sales force) based in the Greater Cincinnati Area, and/or if the company employs 500 or more local citizens in company operations. Investment Selection. Through fundamental analysis the Advisor will attempt to identify securities and groups of securities with potential for capital appreciation. Under normal market conditions, not less than 75% of the Fund's total assets will be invested in common stocks and other equity securities of those companies headquartered in the Greater Cincinnati Area and those companies headquartered in other areas but of which 50% or more of their profits are generated from operations based in the Greater Cincinnati Area. Under normal market conditions, no more than 25% of the Fund's total assets will be invested in companies not headquartered or having a significant presence in the Greater Cincinnati Area or in other securities. The Advisor will generally focus on common stocks and other equity securities of large companies headquartered or having a significant presence in the Greater Cincinnati Area that have exhibited a history of ten years or more of increased earnings and/or dividend distribution per share. The Fund will generally remain fully invested at all times. The Advisor intends to limit turnover in the Fund, believing that a long term rather than short term selection of investments is preferable. The equity securities in which the Fund may invest include common stock, convertible preferred stock, straight preferred stock, and investment grade convertible bonds. The Fund may also invest up to 5% of its net assets in warrants or rights to acquire equity securities (other than those acquired in units or attached to other securities). See "Investment Limitations." Under normal conditions, at least 90% of the Fund's assets will be invested in equity securities. Warrants and rights will be excluded for purposes of this calculation. As a temporary defensive measure, however, the Fund may invest up to 100% of the Fund's total assets in investment grade bonds, U.S. Government Securities, repurchase agreements, or money market instruments. When the Fund invests its assets in investment grade bonds, U.S. Government Securities or money market instruments as a temporary defensive measure, it is not pursuing its stated investment objective. Under normal circumstances, however, the Fund will also hold money market or repurchase agreement instruments for funds awaiting investment, to accumulate cash for anticipated purchases of portfolio securities, to allow for shareholder redemptions, and to provide for Fund operating expenses. U.S. Government Securities. The Fund may invest a portion of the portfolio in U.S. Government Securities, defined to be U.S. Government obligations such as U.S. Treasury notes, U.S. Treasury bonds, and U.S. Treasury bills, obligations guaranteed by the U.S. Government such as Government National Mortgage Association ("GNMA") as well as obligations of U.S. Government authorities, agencies and instrumentalities such as Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), Federal Home Administration ("FHA"), Federal Farm Credit Bank ("FFCB"), Federal Home Loan Bank ("FHLB"), Student Loan Marketing Association ("SLMA"), Resolution Trust Corporation, and The Tennessee Valley Authority. U.S. Government Securities may be acquired subject to repurchase agreements. While obligations of some U.S. Government sponsored entities are supported by the full faith and credit of the U.S. Government (e.g. GNMA), several are supported by the right of the issuer to borrow from the U.S. Government (e.g. FNMA, FHLMC), and still others are supported only by the credit of the issuer itself (e.g. SLMA, FFCB). No assurances can be given that the U.S. Government will provide financial support to U.S. Government agencies or instrumentalities in the future, other than as set forth above, since it is not obligated to do so by law. The guarantee of the U.S. Government does not extend to the yield or value of the Fund's shares. Money Market Instruments. Money market instruments may be purchased for temporary defensive purposes, to accumulate cash for anticipated purchases of portfolio securities and to provide for shareholder redemptions and operating expenses of the Fund. Money market instruments mature in thirteen months or less from the date of purchase and may include U.S. Government Securities, corporate debt securities (including those subject to repurchase agreements), bankers acceptances and certificates of deposit of domestic branches of U.S. banks, and commercial paper (including variable amount demand master notes) rated in one of the two highest rating categories by any of the nationally recognized statistical rating organizations or if not rated, of equivalent quality in the Advisor's opinion. The Advisor may, when it believes that unusually volatile or unstable economic and market conditions exist, depart from the Fund's investment approach and assume temporarily a defensive portfolio posture, increasing the Fund's percentage investment in money market instruments, even to the extent that 100% of the Fund's total assets may be so invested. Repurchase Agreements. The Fund may acquire U.S. Government Securities or corporate debt securities subject to repurchase agreements. A repurchase agreement transaction occurs when a Fund acquires a security and simultaneously resells it to the vendor (normally a member bank of the Federal Reserve or a registered Government Securities dealer) for delivery on an agreed upon future date. The repurchase price exceeds the purchase price by an amount which reflects an agreed upon market interest rate earned by the Fund effective for the period of time during which the repurchase agreement is in effect. Delivery pursuant to the resale typically will occur within one to five days of the purchase. The Fund will not enter into any repurchase agreement which will cause more than 10% of its net assets to be invested in repurchase agreements which extend beyond seven days or other illiquid securities. In the event of the bankruptcy of the other party to a repurchase agreement, the Fund could experience delays in recovering its cash or the securities lent. To the extent that in the interim the value of the securities purchased may have declined, the Fund could experience a loss. In all cases, the creditworthiness of the other party to a transaction is reviewed and found satisfactory by the Advisor. Repurchase agreements are, in effect, loans of Fund assets. The Fund will not engage in reverse repurchase transactions, which are considered to be borrowings under the 1940 Act. Investment Companies. In order to achieve its investment objective, the Fund may invest up to 10% of the value of its total assets in securities of other investment companies. The Fund will not acquire securities of any one investment company if, immediately thereafter, the Fund would own more than 3% of such company's total outstanding voting securities, securities issued by such company would have an aggregate value in excess of 5% of the Fund's total assets, or securities issued by such company and securities held by the Fund issued by other investment companies would have an aggregate value in excess of 10% of the Fund's total assets. The Fund will only invest in other investment companies by purchase of such securities on the open market where no commission or profit to a sponsor or dealer results from the purchase other than the customary broker's commissions or when the purchase is part of a plan of merger, consolidation, reorganization, or acquisition. To the extent the Fund invests in other investment companies, the shareholders of the Fund would indirectly pay a portion of the operating costs of the underlying investment companies. These costs include management, brokerage, shareholder servicing and other operational expenses. Shareholders of the Fund would then indirectly pay higher operational costs than if they owned shares of the underlying investment companies directly. The Advisor will waive its advisory fee for that portion of the Fund's assets invested in other investment companies, except when such purchase is part of a plan of merger, consolidation, reorganization, or acquisition. Real Estate Securities. The Fund will not invest in real estate (including limited partnership interests), but may invest in readily marketable securities secured by real estate or interests therein or issued by companies that invest in real estate or interests therein. The Fund may also invest in readily marketable interests in real estate investment trusts ("REITs"). REITs are generally publicly traded on the national stock exchanges and in the over-the-counter market and have varying degrees of liquidity. Although the Fund is not limited in the amount of these types of real estate securities it may acquire, it is not presently expected that within the next 12 months the Fund will have in excess of 5% of its net assets in real estate securities. Investment Policies and Techniques. Reference should be made to "Investment Objective and Policies" above for a description of special risks presented by the investment policies of the Fund and the specific securities and investment techniques that may be employed by the Fund, including the risks associated with repurchase agreements. A more complete discussion of certain of these securities and investment techniques and their associated risks is contained in the Statement of Additional Information. Fluctuations in Value. To the extent that the major portion of the Fund's portfolio consists of common stocks and other equity securities, it may be expected that its net asset value will be subject to greater fluctuation than a portfolio containing mostly fixed income securities. Although certain of the U.S. Government Securities in which the Fund may invest are guaranteed as to timely payment of principal and interest, the market value of the securities will fluctuate due to interest rate risks. Additionally, not all U.S. Government Securities are backed by the full faith and credit of the U.S. Government. Because there is risk in any investment, there can be no assurance that the Fund will achieve its investment objective. Concentration. The Fund's concentration in companies headquartered or having a significant presence in the Greater Cincinnati Area generally will tie the performance of the Fund to the economic environment of the Greater Cincinnati Area and the surrounding area. There is no assurance that the demographic and economic characteristics and other factors that the Advisor believes favors companies in the Greater Cincinnati Area will continue in the future. Moreover, the Fund's portfolio may include some securities of smaller companies and companies that are not nationally recognized. The prices of stocks of such companies generally are more volatile than those of larger or more mature companies, their securities are generally less liquid, and they are more likely to be negatively affected by adverse economic or market conditions. Moreover, because of its concentration, the Fund's portfolio may be invested in a smaller number of companies than a general equity mutual fund. This may result in imbalances relative to diversification by industry sector. These limitations may also restrict the Advisor from using certain traditional analytical measures employed to select investments and also exclude some strategies that could offer superior performance or reduce fluctuations in the values of such assets. Non-Diversified Status. The Fund has registered as a non-diversified management investment company so that more than 5% of the total assets of the Fund may be invested in the securities of each of one or more issuers. Because a relatively high percentage of the assets of the Fund may be invested in the securities of a limited number of issuers, the value of shares of the Fund may be more sensitive to any single economic, business, political or regulatory occurrence than the shares of a diversified investment company would be. Portfolio Turnover. The Fund sells portfolio securities without regard to the length of time they have been held in order to take advantage of new investment opportunities. Nevertheless, the Fund's portfolio turnover generally will not exceed 50% in any one year. The degree of portfolio activity affects the brokerage costs of the Fund and other transaction costs on the sale of securities and the reinvestment in other securities. Portfolio turnover may also have capital gain tax consequences. The Fund's portfolio turnover rate for its prior fiscal period is set forth under "Financial Highlights" above. Borrowing. The Fund may borrow, temporarily, up to 5% of its total assets for extraordinary purposes and 15% of its total assets to meet redemption requests which might otherwise require untimely disposition of portfolio holdings. To the extent the Fund borrows for these purposes, the effects of market price fluctuations on portfolio net asset value will be exaggerated. If, while such borrowing is in effect, the value of the Fund's assets declines, the Fund could be forced to liquidate portfolio securities when it is disadvantageous to do so. The Fund would incur interest and other transaction costs in connection with borrowing. The Fund will borrow only from a bank. The Fund will not make any investments if the borrowing exceeds 5% of its assets until such time as repayment has been made to bring the total borrowing below 5% of its assets. Illiquid Investments. The Fund may invest up to 10% of its net assets in illiquid securities. Illiquid securities are those that may not be sold or disposed of in the ordinary course of business within seven days at approximately the price at which they are valued. Under the supervision of the Board of Trustees, the Advisor determines the liquidity of the Fund's investments. The absence of a trading market can make it difficult to ascertain a market value for illiquid investments. Disposing of illiquid securities before maturity may be time consuming and expensive, and it may be difficult or impossible for the Fund to sell illiquid investments promptly at an acceptable price. Included within the category of illiquid securities will also be restricted securities, which cannot be sold to the public without registration under the federal securities laws. Unless registered for sale, these securities can only be sold in privately negotiated transactions or pursuant to an exemption from registration. Forward Commitments and When-Issued Securities. The Fund may purchase when- issued securities and commit to purchase securities for a fixed price at a future date beyond customary settlement time. The Fund is required to hold and maintain in a segregated account until the settlement date, cash, U.S. Government Securities or high-grade debt obligations in an amount sufficient to meet the purchase price. Purchasing securities on a when-issued or forward commitment basis involves a risk of loss if the value of the security to be purchased declines prior to the settlement date, which risk is in addition to the risk of decline in value of the Fund's other assets. In addition, no income accrues to the purchaser of when-issued securities during the period prior to issuance. Although the Fund would generally purchase securities on a when-issued or forward commitment basis with the intention of acquiring securities for its portfolio, the Fund may dispose of a when-issued security or forward commitment prior to settlement if the Advisor deems it appropriate to do so. The Fund may realize short-term gains or losses upon such sales. To limit the Fund's exposure to risk, the Fund has adopted certain investment limitations. Some of these restrictions are that the Fund will not: (1) issue senior securities, borrow money or pledge its assets, except that it may borrow from banks as a temporary measure (a) for extraordinary or emergency purposes, in amounts not exceeding 5% of the Fund's total assets or, (b) in order to meet redemption requests which might otherwise require untimely disposition of portfolio securities in amounts not exceeding 15% of its total assets. The Fund will not make any investments if borrowing exceeds 5% of its total assets; (2) make loans of money or securities, except that the Fund may invest in repurchase agreements (but repurchase agreements having a maturity of longer than seven days are subject to the limitation on investing in illiquid securities); (3) invest more than 10% of its net assets in illiquid securities; (4) invest in securities of issuers which have a record of less than three years' continuous operation (including predecessors and, in the case of bonds, guarantors), if more than 5% of its total assets would be invested in such securities; (5) purchase foreign securities; (6) purchase or sell commodities, commodities contracts, real estate (including limited partnership interests, but excluding readily marketable securities secured by real estate or interests therein, readily marketable interests in real estate investment trusts, or readily marketable securities issued by companies that invest in real estate or interests therein) or interests in oil, gas, or other mineral exploration or development programs or leases (although it may invest in readily marketable securities of issuers that invest in or sponsor such programs or leases); (7) invest more than 10% of its total assets in the securities of other investment companies; (8) write, purchase, or sell puts, calls, straddles, spreads, or combinations thereof, or futures contracts or related options; and (9) invest more that 5% of its net assets in warrants. Investment restrictions (1), (2), (5), (6), (7), and (9) are deemed fundamental, that is, they may not be changed without shareholder approval. See "Investment Limitations" in the Fund's Statement of Additional Information for a complete list of investment limitations. If the Board of Trustees of the Trust determines that the Fund's investment objective can best be achieved by a substantive change in a non-fundamental investment limitation, the Board can make such change without shareholder approval and will disclose any such material changes in the then current Prospectus. Any limitation that is not specified in the Fund's Prospectus, or in the Statement of Additional Information, as being fundamental, is non- fundamental. If a percentage limitation is satisfied at the time of investment, a later increase or decrease in such percentage resulting from a change in the value of the Fund's portfolio securities will not constitute a violation of such limitation. In order to permit the sale of the Fund's shares in certain states, the Fund may make commitments that are more restrictive than the investment policies and limitations described above and in the Statement of Additional Information. Such commitments may have an effect on the investment performance of the Fund. Should the Fund determine that any such commitment is no longer in the best interests of the Fund, it may revoke the commitment and terminate sales of its shares in the state involved. The Fund is classified as non-diversified within the meaning of the 1940 Act, which means that the Fund is not limited by the 1940 Act in the proportion of its assets that it may invest in securities of a single issuer. However, the Fund's investments will be limited so as to qualify as a "regulated investment company" for purposes of the Internal Revenue Code of 1986, as amended (the "Code"). See "Federal Income Taxes." To qualify, among other requirements, the Trust will limit the Fund's investments so that, at the close of each quarter of the taxable year, (i) not more than 25% of the market value of the Fund's total assets will be invested in the securities of a single issuer, and (ii) with respect to 50% of the market value of its total assets not more than 5% of the market value of its total assets will be invested in the securities of a single issuer, and the Fund will not own more than 10% of the outstanding voting securities of a single issuer. These tax-related limitations may be changed by the Trustees of the Trust to the extent necessary to comply with changes to the federal tax requirements. A fund that elects to be classified as "diversified" under the 1940 Act must satisfy the foregoing 5% and 10% requirements with respect to 75% of its total assets. To the extent that the Fund assumes large positions in the securities of a small number of issuers, the Fund's total return may fluctuate to a greater extent than that of a diversified company as a result of changes in the financial condition or in the market's assessment of the issuers. Taxation of the Fund. The Internal Revenue Code of 1986, as amended (the "Code"), treats each series in the Trust, including the Fund, as a separate regulated investment company. Each series of the Trust, including the Fund, intends to qualify or remain qualified as a regulated investment company under the Code by distributing substantially all of its "net investment income" to shareholders and meeting other requirements of the Code. For the purpose of calculating dividends, net investment income consists of income accrued on portfolio assets, less accrued expenses. Upon qualification, the Fund will not be liable for federal income taxes to the extent earnings are distributed. The Board of Trustees retains the right for any series of the Trust, including the Fund, to determine for any particular year if it is advantageous not to qualify as a regulated investment company. Regulated investment companies, such as each series of the Trust, are subject to a non-deductible 4% excise tax to the extent they do not distribute the statutorily required amount of investment income, determined on a calendar year basis, and capital gain net income, using an October 31 year end measuring period. The Fund intends to declare or distribute dividends during the calendar year in an amount sufficient to prevent imposition of the 4% excise tax. Taxation of Shareholders. For federal income tax purposes, any dividends and distributions from short-term capital gains that a shareholder receives in cash from the Fund or which are re-invested in additional shares will be taxable ordinary income. If a shareholder is not required to pay a tax on income, he will not be required to pay federal income taxes on the amounts distributed to him. A dividend declared in October, November or December of a year and paid in January of the following year will be considered to be paid on December 31 of the year of declaration. Distributions paid by the Fund from long-term capital gains, whether received in cash or reinvested in additional shares, are taxable as long-term capital gains, regardless of the length of time an investor has owned shares in the Fund. Capital gain distributions are made when the Fund realizes net capital gains on sales of portfolio securities during the year. Dividends and capital gain distributions paid by the Fund shortly after shares have been purchased, although in effect a return of investment, are subject to federal income taxation. The sale of shares of the Fund is a taxable event and may result in a capital gain or loss. Capital gain or loss may be realized from an ordinary redemption of shares or an exchange of shares between two mutual funds (or two series of a mutual fund). No gain or loss will be recognized by Class B shareholders on the conversion of their Class B shares into Class A shares. A shareholder's basis in the Class A shares acquired will be the same as such shareholder's basis in the Class B shares converted, and the holding period of the acquired Class A shares will include the holding period of the converted Class B shares. The Trust will inform shareholders of the Fund of the source of their dividends and capital gains distributions at the time they are paid and, promptly after the close of each calendar year, will issue an information return to advise shareholders of the federal tax status of such distributions and dividends. Dividends and distributions may also be subject to state and local taxes. Shareholders should consult their tax advisors regarding specific questions as to federal, state or local taxes. Federal income tax law requires investors to certify that the social security number or taxpayer identification number provided to the Fund is correct and that the investor is not subject to 31% withholding for previous under-reporting to the Internal Revenue Service (the "IRS"). Investors will be asked to make the appropriate certification on their application to purchase shares. If a shareholder of the Fund has not complied with the applicable statutory and IRS requirements, the Fund is generally required by federal law to withhold and remit to the IRS 31% of reportable payments (which may include dividends and redemption amounts). The Fund distributes substantially all of its net investment income, if any, in the form of dividends. The Fund will pay income dividends, if any, quarterly, and will distribute net realized capital gains, if any, at least annually. Unless a shareholder elects to receive cash, dividends and capital gains will be automatically reinvested in additional full and fractional shares of the Fund at the net asset value per share next determined. Reinvested dividends and capital gains are exempt from any sales load. Shareholders wishing to receive their dividends or capital gains in cash may make their request in writing to the Fund at 105 North Washington Street, Post Office Drawer 69, Rocky Mount, North Carolina 27802-0069. That request must be received by the Fund prior to the record date to be effective as to the next dividend. If cash payment is requested, checks will be mailed within five business days after the last day of each quarter or the Fund's fiscal year end, as applicable. Each shareholder of the Fund will receive a quarterly summary of his or her account, including information as to reinvested dividends from the Fund. Tax consequences to shareholders of dividends and distributions are the same if received in cash or in additional shares of the Fund. In order to satisfy certain requirements of the Code, the Fund may declare special year-end dividend and capital gains distribution during December. Such distributions, if received by shareholders by January 31, are deemed to have been paid by the Fund and received by shareholders on December 31 of the prior year. There is no fixed dividend rate, and there can be no assurance of the payment of any dividends or the realization of any gains. The Fund's net investment income available for distribution to holders of a particular Class of shares will be reduced by the amount of any expenses allocated to that Class, including the distribution and service fees under the Fund's Distribution Plans. Net asset value for each Class of Shares of the Fund is determined at 4:00 p.m., New York time, Monday through Friday, except on business holidays when the New York Stock Exchange is closed. The net asset value of the shares of the Fund for purposes of pricing sales and redemptions is equal to the total market value of its investments, less all of its liabilities, divided by the number of its outstanding shares. Net asset value is determined separately for each Class of Shares of the Fund and reflects any liabilities allocated to a particular Class as well as the general liabilities of the Fund. Securities that are listed on a securities exchange are valued at the last quoted sales price at the time the valuation is made. Price information on listed securities is taken from the exchange where the security is primarily traded by the Fund. Securities that are listed on an exchange and which are not traded on the valuation date are valued at the mean of the bid and asked prices. Unlisted securities for which market quotations are readily available are valued at the latest quoted sales price, if available, at the time of valuation, otherwise, at the latest quoted bid price. Temporary cash investments with maturities of 60 days or less will be valued at amortized cost, which approximates market value. Securities for which no current quotations are readily available are valued at fair value as determined in good faith using methods approved by the Board of Trustees of the Trust. Securities may be valued on the basis of prices provided by a pricing service when such prices are believed to reflect the fair market value of such securities. HOW SHARES MAY BE PURCHASED Assistance in opening accounts and a purchase application may be obtained from the Fund by calling 1-800-525-FUND, or by writing to the Fund at the address shown below for purchases by mail. Assistance is also available through any broker-dealer authorized to sell shares in the Fund. Payment for shares purchased may also be made through your account at the broker-dealer processing your application and order to purchase. Your investment will purchase shares at the Fund's public offering price next determined after your order is received by the Fund in proper form as indicated herein. The minimum initial investment is $1,000 ($250 for IRAs). The minimum subsequent investment is $100. The Fund may, in the Advisor's sole discretion, accept certain accounts with less than the stated minimum initial investment. You may invest in the following ways: Purchases by Mail. Shares may be purchased initially by completing the application accompanying this Prospectus and mailing it, together with a check payable to the Fund, to the Greater Cincinnati Fund, 105 North Washington Street, Post Office Drawer 69, Rocky Mount, North Carolina 27802-0069. Subsequent investments in an existing account in the Fund may be made at any time in minimum amounts of $250 by sending a check payable to the Fund, to the Greater Cincinnati Fund, 105 North Washington Street, Post Office Drawer 69, Rocky Mount, North Carolina 27802-0069. Please enclose the stub of your account statement and include the amount of the investment, the name of the account for which the investment is to be made and the account number. Please remember to add a reference to the appropriate Class (either "Class A" or "Class B") to your check to ensure proper credit to your account. Purchases by Wire. To purchase shares by wiring federal funds, the Fund must first be notified by calling 1-800-525-FUND to request an account number and furnish the Fund with your tax identification number. Following notification to the Fund, federal funds and registration instructions should be wired through the Federal Reserve System to: Wachovia Bank of North Carolina, N.A. For credit to the Rocky Mount Office For the Greater Cincinnati Fund For further credit to (shareholder's name and SS# or EIN#) Please remember to add a reference to the appropriate Class (either "Class A" or "Class B") to your wiring instructions to ensure proper credit to your account. It is important that the wire contain all the information and that the Fund receive prior telephone notification to ensure proper credit. A completed application with signature(s) of registrant(s) must be mailed to the Fund immediately after the initial wire as described under "Purchases by Mail" above. Investors should be aware that some banks may impose a wire service fee. General. All purchases of shares are subject to acceptance and are not binding until accepted. The Fund reserves the right to reject any application or investment. Orders become effective, and shares are purchased at, the next determined public offering price per share after an investment has been received by the Fund, which is as of 4:00 p.m., New York time, Monday through Friday, exclusive of business holidays. Orders received by the Fund and effective prior to such 4:00 p.m. time will purchase shares at the public offering price determined at that time. Otherwise, your order will purchase shares as of such 4:00 p.m. time on the next business day. For orders placed through a qualified broker-dealer, such firm is responsible for promptly transmitting purchase orders to the Fund. If checks are returned unpaid due to nonsufficient funds, stop payment or other reasons, the Trust will charge $20. To recover any such loss or charge, the Trust reserves the right, without further notice, to redeem shares of any Fund of the Trust already owned by any purchaser whose order is cancelled, and such a purchaser may be prohibited from placing further orders unless investments are accompanied by full payment by wire or cashier's check. Payment must be made by check or money order drawn on a U.S. bank and payable in U.S. dollars. Under certain circumstances the Fund, at its sole discretion, may allow payment in kind for Fund shares purchased by accepting securities in lieu of cash. Any securities so accepted would be valued on the date received and included in the calculation of the net asset value of the Fund. See the Statement of Additional Information for additional information on purchases in kind. The Fund is required by federal law to withhold and remit to the IRS 31% of the dividends, capital gains distributions and, in certain cases, proceeds of redemptions paid to any shareholder who fails to furnish the Fund with a correct taxpayer identification number, who under-reports dividend or interest income or who fails to provide certification of tax identification number. Instructions to exchange or transfer shares held in established accounts will be refused until the certification has been provided. In order to avoid this withholding requirement, you must certify on your application, or on a separate W-9 Form supplied by the Administrator, that your taxpayer identification number is correct and that you are not currently subject to backup withholding or you are exempt from backup withholding. For individuals, your taxpayer identification number is your social security number. Alternative Purchase Options. Purchases of shares of the Fund are subject to a sales charge. Purchases of Class A shares are subject to a "front-end" sales charge deducted at the time of purchase. Class B shares are subject to a deferred or "back-end" sales charge deducted upon their redemption. The deferred sales charge applicable to purchases of Class B shares declines over time and is known as a "contingent deferred sales charge." Investors may elect to have the sales charge applicable to their purchase of shares deducted at the time of purchase by purchasing Class A shares. Alternatively, investors may elect to have the sales charge applicable to their purchase of shares deducted upon their redemption by purchasing Class B shares. Investors who purchase shares of the Fund must specify at the time of purchase whether they are purchasing Class A shares or Class B shares. Classification of the shares of the Fund is intended to permit each investor to choose the method of purchasing shares that the investor believes is most beneficial given the amount of the purchase, the length of time the investor expects to hold the shares, and other relevant circumstances. The sales charge is imposed either at the time of purchase or on a deferred basis, depends upon the Class of shares selected by the investor. Investors should determine whether under their particular circumstances it is more advantageous to incur an initial sales charge or to have the entire purchase price invested in the Fund with the investment thereafter being subject to a contingent deferred sales charge and higher ongoing distribution and service fees. See "Choosing Between Classes of Shares" below. Investors should understand that the purpose and function of the initial sales charge with respect to Class A shares are the same as those of the deferred sales charge with respect to Class B shares in that the sales charge applicable to each Class provides for the financing of distribution of the shares of the Fund. The distribution - related fees paid with respect to one Class will not be used to finance the distribution expenses of the other Class. Choosing Between Classes of Shares. Investors should understand the differences between Class A shares and Class B shares before purchasing shares of the Fund. Class A Shares. Class A shares are sold at the net asset value for Class A shares of the Fund plus the applicable front-end sales charge. This front- end sales charge may be reduced, eliminated, or waived in some cases. See "Purchases of Class A Shares" below. Class A shares bear the expense of payments under the Fund's Distribution Plan with respect to Class A shares at an annual rate not to exceed 0.50% of the average daily net assets of the Fund's outstanding Class A shares. See "Distribution Plans" below. Class B Shares. Class B shares are sold at the net asset value for Class B shares of the Fund. A deferred sales charge is deducted if Class B shares are redeemed within five years of purchase. The deferred sales charge deducted upon the redemption of Class B shares decreases over time. See "Purchases of Class B Shares" below. Class B shares bear the expense of payments under the Fund's Distribution Plan with respect to Class B shares at an annual rate not to exceed 1.00% of the average daily net assets of the Fund's outstanding Class B shares. See "Distribution Plans" below. If payments under the Distribution Plan for Class A shares and payments under the Distribution Plan for Class B shares are made at maximum rates, then Class B shares of the Fund will have higher operating expenses and will pay lower dividends that Class A shares of the Fund. Approximately eight years after the date of purchase, Class B shares will automatically convert to Class A shares. The purpose of the conversion is to relieve the holders of Class B shares of the higher operating expenses charged to Class B shares. The conversion from Class B shares to Class A shares will take place at the net asset value of each Class of shares at the time of the conversion. Upon such conversion, an investor would hold Class A shares subject to the operating expenses for Class A shares discussed above. Upon each conversion of Class B shares that were not acquired through reinvestment of dividends or distributions, a proportionate amount of Class B shares that were acquired through reinvestment of dividends or distributions will likewise automatically convert to Class A shares. See "Conversion of Class B Shares to Class A Shares" below. Factors to Consider in Choosing Between Class A Shares and Class B Shares. Before deciding between Class A shares and Class B shares of the Fund, an investor should carefully consider the amount and intended length of his investment. Specifically, an investor should consider whether the accumulated distribution and service fees and the deferred sales charge applicable to Class B shares would be less that the front-end sales charge and accumulated distribution and service fees applicable to Class A shares purchased at the same time and held for the same period, and the extent to which the difference between those amounts would be offset by the higher returns associated with Class A shares. Because the operating expenses of Class B shares are greater than those of Class A shares, the dividends on Class A shares will be higher that the dividends on Class B shares. However, since a front-end sales charge is deducted at the time of purchase of Class A shares, not all of the purchase amount will purchase Class A shares. Consequently, the same initial investment will purchase more Class B shares than Class A shares. Because of reductions in the front-end sales charge for purchases of Class A shares aggregating $100,000 or more, it may be advantageous for investors purchasing large quantities of shares to purchase Class A shares. Similar sales charge reductions are not available with respect to the deferred sales charge imposed in connection with Class B shares. In any event, the Fund will not accept any purchase order for $500,000 or more of Class B shares. In addition, because the accumulated higher operating expenses of Class B shares may eventually exceed the amount of the front-end sales charge and distribution and service fees associated with Class A shares, investors who intend to hold their shares for an extended period of time should consider purchasing Class A shares. Investors who would qualify for a reduction in the front-end sales charge for purchases of Class A shares may decide that it is more advantageous to have the entire purchase amount invested immediately in Class B shares notwithstanding the higher operating expenses associated with Class B shares. These higher operating expenses may be offset by any return an investor receives from the additional shares received as a result of not having to pay a front-end sales charge. However, investors should understand that the Fund's future return cannot be predicted, and that there is no assurance that such return, if any, would compensate for the higher operating expenses associated with Class B shares. Class B shares will convert into Class A shares automatically after a conversion period of approximately eight years, and thereafter investors will be subject to lower ongoing distribution and service fees. Investors in Class B shares should take into account whether they intend to redeem their shares within the five year period during which the deferred sales charge will be imposed. Purchases of Class A Shares Front-End Sales Charges. The public offering price of Class A shares of the Fund equals net asset value plus a front-end sales charge. Capital Investment Group, Inc. (the "Distributor"), Post Office Box 32249, Raleigh, North Carolina, receives this sales charge as Distributor and may reallow it in the form of dealer discounts and brokerage commissions as follows: At times the Distributor may reallow the entire sales charge to dealers. From time to time dealers who receive dealer discounts and brokerage commissions from the Distributor may reallow all or a portion of such dealer discounts and brokerage commissions to other dealers or brokers. Pursuant to the terms of the Distribution Agreement, the sales charge payable to the Distributor and the dealer discounts may be suspended, terminated or amended. Dealers who receive 90% or more of the sales charge may be deemed to be "underwriters" under the Securities Act of 1933, as amended. The dealer discounts and brokerage commissions schedule above applies to all dealers who have agreements with the Distributor. The Distributor, at its expense, may also provide additional compensation to dealers in connection with sales of shares of the Fund. Compensation may include financial assistance to dealers in connection with conferences, sales or training programs for their employees, seminars for the public, advertising campaigns regarding the Fund, and/or other dealer-sponsored special events. In some instances, this compensation may be made available only to certain dealers whose representatives have sold or are expected to sell a significant amount of such shares. Compensation may include payment for travel expenses, including lodging, incurred in connection with trips taken by invited registered representatives and members of their families to locations within or outside of the United States for meetings or seminars of a business nature. Dealers may not use sales of the Fund shares to qualify for this compensation to the extent such may be prohibited by the laws of any state or any self-regulatory agency, such as the NASD. None of the aforementioned compensation is paid for by the Fund or its shareholders. Concurrent Purchases. For purposes of qualifying for a lower sales charge for Class A shares, investors have the privilege of combining concurrent purchases of the Fund and one or more future series of the Trust affiliated with the Advisor and sold with a front-end sales charge. For example, if a shareholder concurrently purchases shares in future series of the Trust affiliated with the Advisor and sold with a front-end sales charge at the total public offering price of $50,000, and Class A shares in the Fund at the total public offering price of $50,000, the sales charge would be that applicable to a $100,000 purchase as shown in the appropriate table above. This privilege may be modified or eliminated at any time or from time to time by the Trust without notice thereof. Rights of Accumulation. Pursuant to the right of accumulation, investors are permitted to purchase shares at the public offering price applicable to the total of (a) the total public offering price of the Class A shares of the Fund then being purchased plus (b) an amount equal to the then current net asset value of the purchaser's combined holdings of the shares of all of the series of the Trust affiliated with the Advisor and sold with a front-end sales charge. To receive the applicable public offering price pursuant to the right of accumulation, investors must, at the time of purchase, provide sufficient information to permit confirmation of qualification, and confirmation of the purchase is subject to such verification. This right of accumulation may be modified or eliminated at any time or from time to time by the Trust without notice. Letters of Intent. Investors may qualify for a lower sales charge for Class A shares by executing a letter of intent. A letter of intent allows an investor to purchase Class A shares of the Fund over a 13-month period at reduced sales charges based on the total amount intended to be purchased plus an amount equal to the then current net asset value of the purchaser's combined holdings of the shares of all of the series of the Trust affiliated with the Advisor and sold with a front-end sales charge. Thus, a letter of intent permits an investor to establish a total investment goal to be achieved by any number of purchases over a 13-month period. Each investment made during the period receives the reduced sales charge applicable to the total amount of the intended investment. The letter of intent does not obligate the investor to purchase, or the Fund to sell, the indicated amount. If such amount is not invested within the period, the investor must pay the difference between the front-end sales charge applicable to the purchases made and the charges previously paid. If such difference is not paid by the investor, the Distributor is authorized by the investor to liquidate a sufficient number of shares held by the investor to pay the amount due. On the initial purchase of shares, if required (or subsequent purchases, if necessary) shares equal to at least five percent of the amount indicated in the letter of intent will be held in escrow during the 13-month period (while remaining registered in the name of the investor) for this purpose. The value of any shares redeemed or otherwise disposed of by the investor prior to termination or completion of the letter of intent will be deducted from the total purchases made under such letter of intent. A 90-day back-dating period can be used to include earlier purchases at the investor's cost (without a retroactive downward adjustment of the sales charge); the 13-month period would then begin on the date of the first purchase during the 90-day period. No retroactive adjustment will be made if purchases exceed the amount indicated in the letter of intent. Investors must notify the Administrator or the Distributor whenever a purchase is being made pursuant to a letter of intent. Investors electing to purchase shares pursuant to a letter of intent should carefully read the letter of intent, which is included in the Fund Shares Application accompanying this Prospectus or is otherwise available from the Administrator or the Distributor. This letter of intent option may be modified or eliminated at any time or from time to time by the Trust without notice. Reinvestments. Investors may reinvest, without a sales charge, proceeds from a redemption of Class A shares of the Fund either in Class A shares of the Fund or in shares of another series of the Trust affiliated with the Advisor and sold with a front-end sales charge, within 90 days after the redemption. If the other series charges a sales charge higher than the sales charge the investor paid in connection with the shares redeemed, the investor must pay the difference. In addition, the shares of the series to be acquired must be registered for sale in the investor's state of residence. The amount that may be so reinvested may not exceed the amount of the redemption proceeds, and a written order for the purchase of such shares must be received by the Fund or the Distributor within 90 days after the effective date of the redemption. If an investor realizes a gain on the redemption, the reinvestment will not affect the amount of any federal capital gains tax payable on the gain. If an investor realizes a loss on the redemption, the reinvestment may cause some or all of the loss to be disallowed as a tax deduction, depending on the number of shares purchased by reinvestment and the period of time that has elapsed after the redemption, although for tax purposes, the amount disallowed is added to the cost of the shares acquired upon the reinvestment. Purchases by Related Parties and Groups. Reductions in front-end sales charges apply to purchases by a single "person," including an individual, members of a family unit, consisting of a husband, wife and children under the age of 21 purchasing securities for their own account, or a trustee or other fiduciary purchasing for a single fiduciary account or single trust estate. Reductions in front-end sales charges also apply to purchases by individual members of a "qualified group." The reductions are based on the aggregate dollar value of shares purchased by all members of the qualified group and still owned by the group plus the shares currently being purchased. For purposes of this paragraph, a qualified group consists of a "company," as defined in the 1940 Act, which has been in existence for more than six months and which has a primary purpose other than acquiring shares of the Fund at a reduced sales charge, and the "related parties" of such company. For purposes of this paragraph, a "related party" of a company is: (i) any individual or other company who directly or indirectly owns, controls, or has the power to vote five percent or more of the outstanding voting securities of such company; (ii) any other company of which such company directly or indirectly owns, controls, or has the power to vote five percent of more of its outstanding voting securities; (iii) any other company under common control with such company; (iv) any executive officer, director or partner of such company or of a related party; and (v) any partnership of which such company is a partner. Sales at Net Asset Value. The Fund may sell Class A shares at a purchase price equal to the net asset value of such shares, without a sales charge, to Trustees, officers, and employees of the Trust, the Fund, and the Advisor, and to employees and principals of related organizations and their families, and certain parties related thereto, including clients and related accounts of the Advisor and other investment advisors and financial planners. The public offering price of Class A shares of the Fund may also be reduced to net asset value per share in connection with the acquisition of the assets of or merger or consolidation with a personal holding company or a public or private investment company. Purchases of Class B Shares Class B shares are sold at their net asset value. Although investors pay no front-end sales charge on purchases of Class B shares, Class B shares are subject to a deferred sales charge at the rates set forth in the chart below if they are redeemed within five years of purchase. Class B shares are sold without an initial sales charge so that the Fund will receive the full amount of the investor's purchase payment. Dealers, however, will receive commissions from the Distributor in connection with sales of Class B shares. These commissions, which will be paid from the Distributor's own funds, may be different than the reallowances paid to dealers in connection with sales of Class A shares. Proceeds from the deferred sales charge and the distribution fees payable under the Fund's Distribution Plan with respect to the Class B shares (up to 0.75% of the Class B shares' average net assets) will be paid to the Distributor and are used in whole or in part by the Distributor to defray the expenses of dealers and sales personnel related to providing distribution- related expenses to the Fund in connection with the sale of Class B shares, such as the payment from the Distributor's or the dealers' own funds of commissions to dealers and sales personnel for selling Class B shares. The combination of the contingent deferred sales charge and the ongoing distribution fees facilitates the ability of the Fund to sell the Class B shares without a sales charge being deducted at the time of purchase. Approximately eight years after issuance, Class B shares will convert automatically into Class A shares of the Fund, which are subject to lower distribution and service fees. Contingent Deferred Sales Charges. A contingent deferred sales charge ("CDSC") applies to a redemption of Class B shares within five years of the investment. The charge declines from 5.00% to zero over a five year period. The CDSC will be deducted from the redemption proceeds and will reduce the amount paid to the redeeming shareholder. A CDSC will be applied to the lesser of the original purchase price or the current value of the shares being redeemed. Accordingly, no CDSC will be imposed on increases in net asset value above the initial purchase price. In addition, no CDSC will be assessed on shares derived from the reinvestment of dividends or capital gains distributions. The amount of the CDSC, if any, will vary depending on the number of years from the time of payment for the purchase of Class B shares until the time the shares are redeemed. Solely for purposes of determining the number of years from the time of any payment for the purchase of Class B shares, all payments during a month will be aggregated and deemed to have been made on the last day of the month preceding the purchase. Years Since Purchase of Dollar Amount Payment Made Subject to Change In determining whether a CDSC is applicable to a redemption, the calculation will be determined in the manner that results in the lowest applicable rate being charged. Therefore, it will be assumed that the redemption is first of shares held for over five years or shares acquired pursuant to reinvestment of dividends or distributions and then of shares held longest during the five- year period. The charge will not be applied to dollar amounts representing an increase in the net asset value since the time of purchase. To provide an example, assume an investor purchased 100 shares at $10 per share (at a cost of $1,000) and in the third year after purchase, the net asset value per share is $12 and, during such time, the investor has acquired 10 additional shares upon dividend reinvestment. If at such time the investor makes his first redemption of 50 shares (proceeds of $600), 10 shares will not be subject to charge because of dividend reinvestment. With respect to the remaining 40 shares, the charge is applied only to the original cost of $10 per share and not to the increase in net asset value of $2 per share. Therefore, $400 of the $600 redemption proceeds will be charged at a rate of 3.00% (the applicable rate in the third year after purchase). Contingent Deferred Sales Charge Waivers. The Fund offers the following waiver policies, which are designed to eliminate the CDSC when an investor's state of affairs unexpectedly changes or under the other limited circumstances described below. For the waiver to become effective, the investor or investor's estate must meet all the conditions of the waiver policy. Please note that additional documentation may be required depending on the policy requirements. 1. Death. The CDSC is waived when death occurs on an individual account if the beneficiary redeems all or part of the investment within one year of death. A letter of instruction to redeem from the estate administrator must accompany a certified certificate of death and a copy of the instrument appointing the administrator. Class B shares transferred to a beneficiary's account retain the same CDSC status as the original account. Death of fewer that all shareholders in a joint account will not qualify a Class B share redemption for the waiver at any time during the period in which the CDSC applies. The remaining shareholder(s) retain the same CDSC status had the death not occurred. 2. Disability. The CDSC is waived when an individual becomes disabled at any age. Disability is defined using the definition contained in the Internal Revenue Code. A person is generally considered disabled if he cannot do any substantial gainful activity (comparable to what he engaged in prior his disability) because of any physical or mental impairment. A physician must determine that the impairment is expected to continue for a long and indefinite period or to result in death. Qualifying Class B shares must be redeemed within one year of the initial disability. Subsequent disabling events may extend the one year redemption period if the disability is separate and distinct from the initial qualifying disability. The following documentation is required: A letter of instruction to redeem must accompany a copy of Social Security Administration Schedule R or a notarized letter from the shareholder's physician describing the nature of the disability, the date of onset, and a statement that the disability is semi-permanent or expected to result in death. 3. Systematic Withdrawal. The CDSC is waived when a shareholder chooses to systematically redeem Class B shares. See "Systematic Withdrawal Plan" below. The waiver will apply only to accounts valued at greater that $10,000, and the total annual redemption amount may not exceed 15% of the initial value of the Class B shares when the Plan is established. Future distributions must be reinvested. A letter of instruction or Systematic Withdrawal Plan must be sent to the Fund's Administrator. 4. Minimum Required Distributions. The CDSC is waived in connection with minimum required distributions from IRA, 403(b)(7), and qualified employee benefit plan accounts due to the shareholders reaching age 70 1/2. 5. Involuntary Redemptions. The CDSC is waived in connection with involuntary redemptions of Class B shares in accounts with low balances as described in "How Shares May Be Redeemed" below. 6. Exchanges of Shares. The CDSC is waived in connection with the permitted exchanges of shares of the Fund as described under "Exchange Feature" below. Conversion of Class B Shares to Class A Shares. After approximately eight years (the "Conversion Period"), Class B shares will be converted automatically into Class A shares of the Fund. Class A shares are subject to lower distribution and service fees. Automatic conversion of Class B shares into Class A shares will occur at least once each month (on the "Conversion Date") on the basis of the relative net asset values of the shares of the two classes on the Conversion Date, without the imposition of any sales load, fee, or other charge. Conversion of Class B shares to Class A shares will not be deemed a purchase or sale of the shares for Federal income tax purposes. In addition, shares purchased through reinvestment of dividends on Class B shares also will convert automatically to Class A shares. The Conversion Date for dividend reinvestment shares will be calculated taking into account the length of time the shares underlying such dividend reinvestment shares were outstanding. If at a Conversion Date the conversion of Class B shares to Class A shares of the Fund in a single account will result in less that $50 worth of Class B shares being left in the account, all of the Class B shares of the Fund held in the account on the Conversion Date will be converted to Class A shares of the Fund. Distribution Plans. The Distributor is the national distributor for the Fund under a Distribution Agreement with the Trust. The Distributor may sell Fund shares to or through qualified securities dealers or others. The Distributor's address is Post Office Box 32249, Raleigh, North Carolina 27622. The Trust has adopted a separate Plan of Distribution (each a "Plan" or the "Plans") for each Class of the Fund pursuant to Rule 12b-1 under the 1940 Act. Under each Plan the Fund may reimburse any expenditures to finance any activity primarily intended to result in sale of the shares of the applicable Class of the Fund or the servicing of shareholder accounts, including, but not limited to, the following: (i) payments to the Distributor, securities dealers, and others for the sale of shares of the applicable Class of the Fund; (ii) payment of compensation to and expenses of personnel who engage in or support distribution of shares of the applicable Class of the Fund or who render shareholder support services not otherwise provided by the Administrator or Custodian; and (iii) formulation and implementation of marketing and promotional activities. In addition, payments under the Plan applicable to the Class B shares may be used to pay for or finance sales commissions and other fees payable to dealers and other service organizations who may sell Class B shares or service accounts of Class B shareholders. Payments of service fees may be made to such service organizations (which may include the Distributor, the Advisor, and their affiliates) who render support services to their customers who are beneficial owners of shares of the Fund. Such services are intended to supplement the services provided by the Fund's Administrator or Custodian. The categories of expenses for which reimbursement is made are approved by the Board of Trustees of the Trust. Expenditures by the Fund pursuant to each Plan are accrued based on the average daily net assets of the Fund and may not exceed 0.50% of the Class A shares' average net assets and 1.00% of the Class B shares' average net assets for each year elapsed subsequent to adoption of each Plan. Such expenditure paid as service fees to any person who sells Class A or Class B shares of the Fund may not exceed 0.25% of the average annual net asset value of such shares. With respect to the aggregate 1.00% payable under the Plan applicable to the Class B shares, no more than 0.75% of the Class B shares' average net assets can be paid as distribution fees for distribution-related activities in connection with the sale of Class B shares, with the remaining amount of up to 0.25% of the Class B shares' average net assets being payable for service fees for the servicing of accounts of Class B shareholders. In addition to the payments by the Fund pursuant to each Plan for distribution and service fees relating to the Classes of the Fund, dealers and other service organizations may charge their clients additional fees for account services. Customers who are beneficial owners of shares of the Fund should read this Prospectus in light of the terms and fees governing their accounts with dealers or other service organizations. The NASD has adopted rules that generally limit the aggregate sales charges and asset-based payments under each Plan with respect to each Class of shares of the Fund to 6.25% of the total new gross sales of shares (excluding shares issued pursuant to dividend reinvestments and exchanges), plus interest on the unpaid balances at the prime rate plus 1% (the unpaid balance being the maximum amount payable minus amounts received from the payment of distribution fees and sales charges). Shareholder servicing fees of up to 0.25% of average net assets are not included in the limit. The Fund would retain any deferred sales charges collected and stop accruing payments under the applicable Plan if, to the extent, and for as long as, such limit would otherwise be exceeded with respect to a Class of the Fund. The maximum sales charge rules of the NASD are applied separately to each Class of shares. See "How Shares May Be Purchased - Front-End Sales Charges" and "- Contingent Deferred Sales Charges" above for a description of the Fund's sales charges. If in any month the Distributor expends more monies than are immediately payable under the Plans because of the percentage limitations described above (or, due to any expense limitation imposed on the Fund, monies otherwise payable by the Fund to the Distributor under the Plans are rendered uncollectible), the unpaid expenditures may be "carried forward" from month to month until such time, if ever, as they may be paid. In addition, payments to service organizations (which may include the Distributor, the Advisor, and their affiliates) are not tied directly to the organizations' own out-of- pocket expenses and therefore may be used as they elect (including, for example, to defray their overhead expenses). The distribution fees payable under the Plan for the Class B shares ( up to 0.75% of the Class B shares' average net assets) are designed to permit an investor to purchase Class B shares through dealers without the assessment of a front-end sales charge and at the same time to permit the dealer to compensate its personnel in connection with the sale of the Class B shares. In this regard, the purpose and function of the ongoing distribution fees and the deferred sales charge are the same as those of the initial sales charge with respect to the Class A shares in that the distribution fees and the deferred sales charges provide for the financing of the distribution of the Fund's Class B shares. Each Plan may not be amended to increase materially the amount to be spent under the Plan without shareholder approval by the applicable Class of the Fund. The continuation of each Plan must be approved by the Board of Trustees annually. At least quarterly the Board of Trustees must review a written report of amounts expended pursuant to each Plan and the purposes for which such expenditures were made. There is no assurance that the Board of Trustees will approve the continuance of the Plans from year to year. However, the Distributor intends to seek annual continuation of each Plan. In their review of the Plans, the Trustees will be asked to take into consideration expenses incurred by the Distributor in connection with the distribution of each Class of shares separately. The front-end sales charges, distribution and service fees, and/or deferred sales charges with respect to one Class of shares will not be used to subsidize the sale of shares of the other Class. The Fund incurred no costs under the Plan with respect to the Class A shares for the fiscal year ended February 28, 1995. The Class B shares were not offered during such period. Exchange Feature. Investors will have the privilege of exchanging shares of the Fund for shares of any other series of the Trust to be established by the Advisor, if any. An exchange involves the simultaneous redemption of shares of one series and purchase of shares of another series at the respective closing net asset value next determined after a request for redemption has been received plus any applicable sales charge, and is a taxable transaction. Each series of the Trust will have a different investment objective, which may be of interest to investors in each series. Class A shares of the Fund may be exchanged for Class A shares of any other series of the Trust affiliated with the Advisor at the net asset value plus the percentage difference between that series' sales charge and any sales charge previously paid in connection with the shares being exchanged. For example, if a 2% sales charge was paid on shares that are exchanged into a series with a 3% sales charge, there would be an additional sales charge of 1% on the exchange. Similarly, Class B shares of the Fund may be exchanged for Class B shares of any other series of the Trust affiliated with the Advisor at the net asset value without the payment of any contingent deferred sales charge that might otherwise be due upon redemption of the Class B shares. For purposes of computing the CDSC that may be payable upon a disposition of the shares acquired in the exchange, the holding period of the previously owned Class B shares is "tacked" to the holding period of the newly acquired shares. Class B shareholders exercising the exchange privilege will still be subject to the Fund's CDSC schedule if such schedule is higher than the CDSC schedule relating to the new Class B shares. Exchanges may only be made by investors in states where shares of the other series are qualified for sale. An investor may direct the Fund to exchange his shares by writing to the Fund at its principal office. The request must be signed exactly as the investor's name appears on the account, and it must also provide the account number, number of shares to be exchanged, the name of the series to which the exchange will take place and a statement as to whether the exchange is a full or partial redemption of existing shares. A pattern of frequent exchange transactions may be deemed by the Advisor to be an abusive practice that is not in the best interests of the shareholders of the Fund. Such a pattern may, at the discretion of the Advisor, be limited by the Fund's refusal to accept further purchase and/or exchange orders from an investor, after providing the investor with 60 days prior notice. The Advisor will consider all factors it deems relevant in determining whether a pattern of frequent purchases, redemptions and/or exchanges by a particular investor is abusive and not in the best interests of the Fund or its other shareholders. A shareholder should consider the investment objectives and policies of any series into which the shareholder will be making an exchange, as described in the prospectus for that other series. The Board of Trustees of the Trust reserve the right to suspend or terminate, or amend the terms of, the exchange privilege upon 60 days written notice to the shareholders. Automatic Investment Plan. The automatic investment plan enables shareholders to make regular monthly or quarterly investments in shares through automatic charges to their checking account. With shareholder authorization and bank approval, the Administrator will automatically charge the checking account for the amount specified ($100 minimum), which will be automatically invested in shares at the public offering price on or about the 21st day of the month. The shareholder may change the amount of the investment or discontinue the plan at any time by writing to the Administrator. Stock Certificates. Stock certificates will not be issued for your shares. Evidence of ownership will be given by issuance of periodic account statements that will show the number of shares owned. HOW SHARES MAY BE REDEEMED Shares of the Fund may be redeemed (the Fund will repurchase them from shareholders) by mail or telephone. Any redemption may be more or less than the purchase price of your shares depending on the market value of the Fund's portfolio securities. All redemption orders received in proper form, as indicated herein, by the Fund, whether by mail or telephone, prior to 4:00 p.m. New York time, Monday through Friday, except for business holidays, will redeem shares at the net asset value determined at that time, minus any applicable contingent deferred sales charge for the Class B shares. Otherwise, your order will redeem shares as of such 4:00 p.m. time on the next business day. There is no charge for redemptions from the Fund other than such deferred sales charge. You may also redeem your shares through a broker- dealer or other institution, who may charge you a fee for its services. The Board of Trustees reserves the right to involuntarily redeem any account having a net asset value of less than $1,000 (due to redemptions, exchanges or transfers, and not due to market action) upon 30 days written notice. If the shareholder brings his account net asset value up to $1,000 or more during the notice period, the account will not be redeemed. Redemptions from retirement plans may be subject to tax withholding. When redeeming shares of the Fund, shareholders should indicate whether they are redeeming Class A shares or Class B shares. If a redeeming shareholder owns both Class A shares and Class B shares, the Class A shares will be redeemed first unless the shareholder indicates otherwise. If you are uncertain of the requirements for redemption, please contact the Fund, at 1-800-525-FUND, or write to the address shown below. Regular Mail Redemptions. Your request should be addressed to the Greater Cincinnati Fund, 105 North Washington Street, Post Office Drawer 69, Rocky Mount, North Carolina 27802-0069. Your request for redemption must include: 1) Designation of Class ("Class A" or "Class B"); 2) Your letter of instruction specifying the account number, and the number of shares or dollar amount to be redeemed. This request must be signed by all registered shareholders in the exact names in which they are 3) Any required signature guarantees (see "Signature Guarantees" below); and 4) Other supporting legal documents, if required in the case of estates, trusts, guardianships, custodianships, corporations, partnerships, pension or profit sharing plans, and other organizations. Your redemption proceeds (less any applicable contingent deferred sales charge for the Class B shares) will be sent to you within seven days after receipt of your redemption request. However, the Fund may delay forwarding a redemption check for recently purchased shares while it determines whether the purchase payment will be honored. Such delay (which may take up to 15 days from the date of purchase) may be reduced or avoided if the purchase is made by certified check or wire transfer. In all cases the net asset value next determined after the receipt of the request for redemption will be used in processing the redemption. The Fund may suspend redemption privileges or postpone the date of payment (i) during any period that the New York Stock Exchange is closed, or trading on the New York Stock Exchange is restricted as determined by the Securities and Exchange Commission (the "Commission"), (ii) during any period when an emergency exists as defined by the rules of the Commission as a result of which it is not reasonably practicable for the Fund to dispose of securities owned by it, or to fairly determine the value of its assets, and (iii) for such other periods as the Commission may permit. Telephone and Bank Wire Redemptions. The Fund offers shareholders the option of redeeming shares by telephone under certain limited conditions. The Fund will redeem shares when requested by the shareholder if, and only if, the shareholder confirms redemption instructions in writing. The Fund may rely upon confirmation of redemption requests transmitted via facsimile (FAX# 919-442-4226). The confirmation instructions must include: 1) Shareholder name and account number; 2) Designation of Class ("Class A" or "Class B") 3) Number of shares or dollar amount to be redeemed; 4) Instructions for transmittal of redemption funds to the shareholder; and 5) Shareholder signature as it appears on the application then on file with the Fund. The net asset value used in processing the redemption will be the net asset value next determined after the telephone request is received. Proceeds from the redemption of Class B shares will be reduced by the amount of any applicable contingent deferred sales charge. Redemption proceeds will not be distributed until written confirmation of the redemption request is received, per the instructions above. You can choose to have redemption proceeds mailed to you at your address of record, your bank, or to any other authorized person, or you can have the proceeds sent by bank wire to your bank ($5,000 minimum). Shares of the Fund may not be redeemed by wire on days in which your bank is not open for business. You can change your redemption instructions anytime you wish by filing a letter including your new redemption instructions with the Fund. (See "Signature Guarantees" below.) The Fund reserves the right to restrict or cancel telephone and bank wire redemption privileges for shareholders, without notice, if the Fund believes it to be in the best interest of the shareholders to do so. There is currently no charge by the Administrator for wire redemptions. However, the Administrator reserves the right, upon thirty days' written notice, to make reasonable charges for wire redemptions. All charges will be deducted from your account by redemption of shares in your account. Your bank or brokerage firm may also impose a charge for processing the wire. If wire transfer of funds is impossible or impractical, the redemption proceeds will be sent by mail to the designated account. You may redeem shares, subject to the procedures outlined above, by calling the Fund at 1-800-525-FUND. Redemption proceeds will only be sent to the bank account or person named in your Fund Shares Application currently on file with the Fund. Telephone redemption privileges authorize the Fund to act on telephone instructions from any person representing himself or herself to be the investor and reasonably believed by the Fund to be genuine. The Fund will employ reasonable procedures, such as requiring a form of personal identification, to confirm that instructions are genuine, and if it does not follow such procedures, the Fund will be liable for any losses due to fraudulent or unauthorized instructions. The Fund will not be liable for following telephone instructions reasonably believed to be genuine. Systematic Withdrawal Plan. A shareholder who owns shares of the Fund valued at $10,000 or more at current net asset value may establish a Systematic Withdrawal Plan to receive a monthly or quarterly check in a stated amount not less than $100. Each month or quarter as specified, the Fund will automatically redeem sufficient shares from your account to meet the specified withdrawal amount. Call or write the Fund for an application form. See the Statement of Additional Information for further details. The amount of regular periodic payments specified by holders of Class B shares pursuant to a Systematic Withdrawal Plan will be reduced by any applicable contingent deferred sales charge, unless the shareholder qualifies for a waiver of such charge under the circumstances described in "How Shares May Be Purchased - Contingent Deferred Sales Charge Waivers" above. Because of the effects of this deferred sales charge, the maintenance of a Systematic Withdrawal Plan may be disadvantageous for holders of Class B shares unless the shareholder qualifies for such waiver. Signature Guarantees. To protect your account and the Fund from fraud, signature guarantees are required to be sure that you are the person who has authorized a change in registration, or standing instructions, for your account. Signature guarantees are required for (1) change of registration requests, (2) requests to establish or change exchange privileges or telephone redemption service other than through your initial account application, and (3) requests for redemptions in excess of $50,000. Signature guarantees are acceptable from a member bank of the Federal Reserve System, a savings and loan institution, credit union (if authorized under state law), registered broker-dealer, securities exchange or association clearing agency, and must appear on the written request for redemption, establishment or change in exchange privileges, or change of registration. Trustees and Officers. The Fund is a series of The Nottingham Investment Trust (the "Trust"), an investment company organized as a Massachusetts business trust in 1992. The Board of Trustees of the Trust is responsible for the management of the business and affairs of the Trust. The Trustees and executive officers of the Trust and their principal occupations for the last five years are set forth in the Statement of Additional Information under "Management of the Fund - Trustees and Officers." The Board of Trustees of the Trust is primarily responsible for overseeing the conduct of the Trust's business. The Board of Trustees elects the officers of the Trust who are responsible for its and the Fund's day-to-day operations. The Advisor. Subject to the authority of the Board of Trustees, CityFund Advisory, Inc. (the "Advisor") provides the Fund with a continuous program of supervision of the Fund's assets, including the composition of its portfolio, and furnishes advice and recommendations with respect to investments, investment policies and the purchase and sale of securities, pursuant to an Investment Advisory Agreement (the "Advisory Agreement") with the Trust. The Advisor is registered under the Investment Advisors Act of 1940. Registration of the Advisor does not involve any supervision of management or investment practices or policies by the Securities and Exchange Commission. The Advisor was established as an Ohio corporation in 1994. Affiliates of the Advisor currently serve as investment advisor to over $75 million in assets. While it has no prior experience advising an investment company, affiliates of the Advisor have been rendering investment counsel, utilizing investment strategies substantially similar to that of the Fund, to individuals, banks and thrift institutions, pension and profit sharing plans, trusts, estates, charitable organizations and corporations since 1992. The Advisor's address is 525 Vine Street #1800, Cincinnati, Ohio 45202. Under the Advisory Agreement with the Fund, the Advisor receives a monthly management fee equal to an annual rate of 1.25% of the average daily net asset value of the Fund. Although the investment advisory fee is higher than that paid by most other investment companies, the Board of Trustees believes the fee to be comparable to advisory fees paid by many funds having similar objectives and policies. The Advisor may periodically voluntarily waive or reduce its advisory fee to increase the net income of the Fund. The Advisor has voluntarily waived its fee and reimbursed a portion of the Fund's operating expenses for the fiscal period ended February 28, 1995. The total fees waived amounted to $214 and expenses reimbursed amounted to $10,815. The Advisor supervises and implements the investment activities of the Fund, including the making of specific decisions as to the purchase and sale of portfolio investments. Among the responsibilities of the Advisor under the Advisory Agreement is the selection of brokers and dealers through whom transactions in the Fund's portfolio investments will be effected. The Advisor attempts to obtain the best execution for all such transactions. If it is believed that more than one broker is able to provide the best execution, the Advisor will consider the receipt of quotations and other market services and of research, statistical and other data and the sale of shares of the Fund in selecting a broker. The Advisor may also utilize a brokerage firm affiliated with the Trust or the Advisor if it believes it can obtain the best execution of transactions from such broker. For further information, see "Investment Objective and Policies - Investment Transactions" in the Statement of Additional Information. Jill H. Travis, a representative of the Advisor, has been primarily responsible for day-to-day management of the Fund's portfolio since November 9, 1995. From 1993 to the present, Ms. Travis has been a director, President, and Chief Executive Officer of Amelia Earhart Capital Management, Inc., an investment advisory firm located in Southfield, Michigan, which serves as investment advisor to the Amelia Earhart: Eagle Equity Fund, another series of the Trust. Ms. Travis currently serves as portfolio manager of the Amelia Earhart: Eagle Equity Fund, a position she has held since that Fund's inception in 1993. From 1977 to 1990, Ms. Travis served as Vice President of Liberty State Bank and Trust. In 1991 she was Senior Vice President of Huntington Banks. Since 1991 to the present, Ms. Travis has been a self- employed certified financial planner and business consultant and, since 1993, a registered representative with Capital Investment Group, Inc., which serves as Distributor of the Fund. As such, Ms. Travis may actively participate in the sale of shares of the Fund and/or the execution of portfolio transactions for the Fund. Accordingly, Ms. Travis may receive remuneration through the sales charge and/or distribution fee received by the Distributor for sales of shares of the Fund or through brokerage commissions received by the Distributor for execution of portfolio transactions on behalf of the Fund. The Administrator. The Trust has entered into an Administration Agreement with The Nottingham Company, Inc. (the "Administrator"), 105 North Washington Street, Post Office Drawer 69, Rocky Mount, North Carolina 27802-0069, pursuant to which the Administrator receives a fee at the annual rate of 0.20% of the average daily net assets of the Fund on the first $50 million; 0.175% of the next $50 million and 0.15% of its average daily net assets in excess of $100 million. In addition, the Administrator currently receives a base monthly fee of $2,000 for the first class of the Fund and $750 for each additional class of the Fund for accounting and recordkeeping services for the Fund. The Administrator also charges the Fund for certain costs involved with the daily valuation of investment securities and is reimbursed for out-of-pocket expenses. The Administrator charges a minimum fee of $3,000 per month for all of its fees taken in the aggregate, analyzed monthly. Subject to the authority of the Board of Trustees, the services the Administrator provides to the Fund include coordinating and monitoring any third parties furnishing services to the Fund; providing the necessary office space, equipment and personnel to perform administrative and clerical functions for the Fund; preparing, filing and distributing proxy materials, periodic reports to shareholders, registration statements and other documents; and responding to shareholder inquiries. The Administrator was incorporated as a North Carolina corporation in 1988 and converted to a North Carolina limited liability company in 1995. With its predecessors and affiliates, the Administrator has been operating as a financial services firm since 1985. Frank P. Meadows III, Trustee, Vice Chairman, and Treasurer of the Trust, is the firm's Managing Director and controlling member. The Custodian, Transfer Agent and Fund Accounting/Pricing Agent. Wachovia Bank of North Carolina, N.A. (the "Custodian"), 301 North Main Street, Winston-Salem, North Carolina 27102, serves as Custodian of the Fund's assets. The Custodian acts as the depository for the Fund, safekeeps its portfolio securities, collects all income and other payments with respect to portfolio securities, disburses monies at the Fund's request and maintains records in connection with its duties. The Administrator also serves as the Fund's transfer agent. As transfer agent, it maintains the records of each shareholder's account, answers shareholder inquiries concerning accounts, processes purchases and redemptions of the Fund's shares, acts as dividend and distribution disbursing agent and performs other shareholder services functions. The Administrator also performs certain accounting and pricing services for the Fund as pricing agent, including the daily calculation of the Fund's net asset value for each Class of shares. Other Expenses. The Fund is responsible for the payment of its expenses. These include, for example, the fees payable to the Advisor, or expenses otherwise incurred in connection with the management of the investment of the Fund's assets, the fees and expenses of the Custodian, the fees and expenses of the Administrator, the fees and expenses of Trustees, outside auditing and legal expenses, all taxes and corporate fees payable by the Fund, Securities and Exchange Commission fees, state securities qualification fees, costs of preparing and printing prospectuses for regulatory purposes and for distribution to shareholders, costs of shareholder reports and shareholder meetings, and any extraordinary expenses. The Fund also pays for brokerage commissions and transfer taxes (if any) in connection with the purchase and sale of portfolio securities. Expenses attributable to a particular series of the Trust, including the Fund, will be charged to that series, and expenses not readily identifiable as belonging to a particular series will be allocated by or under procedures approved by the Board of Trustees among one or more series in such a manner as it deems fair and equitable. Any expenses relating only to a particular Class of Shares of the Fund will be borne solely by such Class. Description of Shares. The Trust was organized as a Massachusetts business trust on August 12, 1992 under a Declaration of Trust. The Declaration of Trust permits the Board of Trustees to issue an unlimited number of full and fractional shares and to create an unlimited number of series of shares. The Board of Trustees may also classify and reclassify any unissued shares into one or more classes of shares. The Trust currently has the number of authorized series of shares, including the Fund, and classes of shares, described in the Statement of Additional Information under "Description of the Trust." Pursuant to its authority under the Declaration of Trust, the Board of Trustees has authorized the issuance of an unlimited number of shares in each of two Classes ("Class A" and "Class B") representing equal pro rata interests in the Fund, except that the Classes bear different sales charges and expenses that reflect the differences in services provided to them. In connection with the establishment of the Class B shares, the Board of Trustees renamed the existing class of Investor Shares of the Fund as the "Class A" shares and renamed and reestablished the existing class of Institutional Shares of the Fund as the "Class B" shares. Class A shares are sold with a front-end sales charge. Class B shares are sold with a contingent deferred sales charge. The two Classes bear shareholder servicing and distribution fees at different levels as described under "How Shares May Be Purchased - Distribution Plans" above. As a result of different charges, fees, and expenses between the Classes, the total return on the Fund's Class B shares will generally be lower than the total return on the Class A shares. Standardized total return quotations will be computed separately for each Class of shares of the Fund. When issued, the shares of each series of the Trust, including the Fund, will be fully paid, nonassessable and redeemable. The Trust does not intend to hold annual shareholder meetings; it may, however, hold special shareholder meetings for purposes such as changing fundamental policies or electing Trustees. The Board of Trustees shall promptly call a meeting for the purpose of electing or removing Trustees when requested in writing to do so by the record holders of a least 10% of the outstanding shares of the Trust. The term of office of each Trustee is of unlimited duration. The holders of at least two-thirds of the outstanding shares of the Trust may remove a Trustee from that position either by declaration in writing filed with the Custodian or by votes cast in person or by proxy at a meeting called for that purpose. Shareholders of the Trust will vote in the aggregate and not by series (fund) or class except as otherwise required by the 1940 Act or when the Board of Trustees determines that the matter to be voted on affects only the interests of the shareholders of a particular series or class. Matters affecting an individual series, such as the Fund, include, but are not limited to, the investment objectives, policies and restrictions of that series. Shares have no subscription, preemptive or conversion rights. Share certificates will not be issued. Each share is entitled to one vote (and fractional shares are entitled to proportionate fractional votes) on all matters submitted for a vote, and shares have equal voting rights except that only shares of a particular series are entitled to vote on matters affecting only that series. Shares do not have cumulative voting rights. Therefore, the holders of more than 50% of the aggregate number of shares of all series of the Trust may elect all the Trustees. As of December 4, 1995, the Advisor owned of record and beneficially 100% of the Class B shares. Accordingly, the Advisor is deemed to be a "controlling person" of the Class B shares of the Fund within the meaning of the 1940 Act. Under Massachusetts law, shareholders of a business trust may, under certain circumstances, be held personally liable as partners for the obligations of the trust. The Declaration of Trust, therefore, contains provisions which are intended to mitigate such liability. See "Description of the Trust" in the Statement of Additional Information for further information about the Trust and its shares. Reporting to Shareholders. The Fund will send to its shareholders Annual and Semi-Annual Reports; the financial statements appearing in Annual Reports for the Fund will be audited by independent accountants. In addition, the Administrator, as transfer agent, will send to each shareholder having an account directly with the Fund a quarterly statement showing transactions in the account, the total number of shares owned and any dividends or distributions paid. Inquiries regarding the Fund may be directed in writing to 105 North Washington Street, Post Office Drawer 69, Rocky Mount, North Carolina 27802-0069 or by calling 1-800-525-FUND. Calculation of Performance Data. From time to time the Fund may advertise its average annual total return for each Class of Shares. The "average annual total return" refers to the average annual compounded rates of return over 1, 5 and 10 year periods that would equate an initial amount invested at the beginning of a stated period to the ending redeemable value of the investment. The calculation assumes the reinvestment of all dividends and distributions, includes all recurring fees that are charged to all shareholder accounts and deducts all nonrecurring charges at the end of each period including any contingent deferred sales charge that would be applicable to a complete redemption of the investment at the end of the specified period. The calculation further assumes the maximum sales load is deducted from the initial payment. If the Fund has been operating less than 1, 5 or 10 years, the time period during which the Fund has been operating is substituted. In addition, the Fund may advertise other total return performance data other than average annual total return for each Class of Shares. This data shows as a percentage rate of return encompassing all elements of return (i.e. income and capital appreciation or depreciation); it assumes reinvestment of all dividends and capital gain distributions. Such other total return data may be quoted for the same or different periods as those for which average annual total return is quoted. This data may consist of a cumulative percentage rate of return, actual year-by-year rates or any combination thereof. Cumulative total return represents the cumulative change in value of an investment in the Fund for various periods. The total return of the Fund could be increased to the extent the Advisor may waive all or a portion of its fees or may reimburse all or a portion of the Fund's expenses. Total return figures are based on the historical performance of the Fund, show the performance of a hypothetical investment, and are not intended to indicate future performance. The Fund's quotations may from time to time be used in advertisements, sales literature, shareholder reports, or other communications. For further information, see "Additional Information on Performance" in the Statement of Additional Information. No dealer, salesman, or other person has been authorized to give any information or to make any representations, other than those contained in this Prospectus, and, if given or made, such other information or representations must not be relied upon as having been authorized by the Fund or the Advisor. This Prospectus does not constitute an offering in any state in which an offering may not lawfully be made. The Fund reserves the right in its sole discretion to withdraw all or any part of the offering made by this Prospectus or to reject purchase orders. All orders to purchase shares are subject to acceptance by the Fund and are not binding until confirmed or accepted in writing. Rocky Mount, North Carolina 27802-0069 DIVIDEND DISBURSING & TRANSFER AGENT Rocky Mount, North Carolina 27802-0069 Wachovia Bank of North Carolina, N.A. 1021 East Cary Street, Suite 1900 September 1, 1995, as Supplemented November 9, 1995, and December 5, 1995 September 1, 1995, as Supplemented 105 North Washington Street, Post Office Drawer 69 Rocky Mount, North Carolina 27802-0069 INVESTMENT OBJECTIVE AND POLICIES . . . . . . . . . . . . . . . . . . . 2 INVESTMENT LIMITATIONS. . . . . . . . . . . . . . . . . . . . . . . . . 4 NET ASSET VALUE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 ADDITIONAL PURCHASE AND REDEMPTION INFORMATION. . . . . . . . . . . . . 6 DESCRIPTION OF THE TRUST. . . . . . . . . . . . . . . . . . . . . . . . 8 ADDITIONAL INFORMATION CONCERNING TAXES . . . . . . . . . . . . . . . . 8 MANAGEMENT OF THE FUND. . . . . . . . . . . . . . . . . . . . . . . . . 10 SPECIAL SHAREHOLDER SERVICES. . . . . . . . . . . . . . . . . . . . . . 15 ADDITIONAL INFORMATION ON PERFORMANCE . . . . . . . . . . . . . . . . . 16 APPENDIX A - DESCRIPTION OF RATINGS . . . . . . . . . . . . . . . . . . 18 ANNUAL REPORT OF THE FUND FOR THE FISCAL PERIOD ENDED FEBRUARY 28, 1995 . . . . . . . . . . . . . . . . . . . . .ATTACHED This Statement of Additional Information (the "Additional Statement") is meant to be read in conjunction with the Prospectus dated September 1, 1995, as supplemented effective September 1, 1995, November 9, 1995, and December 5, 1995, for the Greater Cincinnati Fund (the "Fund"), and is incorporated by reference in its entirety into the Prospectus. Because this Additional Statement is not itself a prospectus, no investment in shares of the Fund should be made solely upon the information contained herein. Copies of the Fund's Prospectus may be obtained at no charge by writing or calling the Fund at the address and phone number shown above. This Additional Statement is not a prospectus but is incorporated by reference in the Prospectus in its entirety. Capitalized terms used but not defined herein have the same meanings as in the Prospectus. The following policies supplement the Fund's investment objective and policies as set forth in the Prospectus. The Fund, organized in 1994, has no prior operating history. Additional Information on Fund Instruments. Attached to this Additional Statement is Appendix A, which contains descriptions of the rating symbols used by Rating Agencies for securities in which the Fund may invest. Investment Transactions. Subject to the general supervision of the Trust's Board of Trustees, the Advisor is responsible for, makes decisions with respect to, and places orders for all purchases and sales of portfolio securities for the Fund. The annualized portfolio turnover rate for the Fund is calculated by dividing the lesser of purchases or sales of portfolio securities for the reporting period by the monthly average value of the portfolio securities owned during the reporting period. The calculation excludes all securities whose maturities or expiration dates at the time of acquisition are one year or less. Portfolio turnover of the Fund may vary greatly from year to year as well as within a particular year, and may be affected by cash requirements for redemption of shares and by requirements that enable the Fund to receive favorable tax treatment. Portfolio turnover will not be a limiting factor in making Fund decisions, and the Fund may engage in short term trading to achieve its investment objectives. Purchases of money market instruments by the Fund are made from dealers, underwriters and issuers. The Fund currently does not expect to incur any brokerage commission expense on such transactions because money market instruments are generally traded on a "net" basis by a dealer acting as principal for its own account without a stated commission. The price of the security, however, usually includes a profit to the dealer. Securities purchased in underwritten offerings include a fixed amount of compensation to the underwriter, generally referred to as the underwriter's concession or discount. When securities are purchased directly from or sold directly to an issuer, no commissions or discounts are paid. Transactions on U.S. stock exchanges involve the payment of negotiated brokerage commissions. On exchanges on which commissions are negotiated, the cost of transactions may vary among different brokers. Transactions in the over-the-counter market are generally on a net basis (i.e., without commission) through dealers, or otherwise involve transactions directly with the issuer of an instrument. The Fund's fixed income portfolio transactions will normally be principal transactions executed in over-the-counter markets and will be executed on a "net" basis, which may include a dealer markup. With respect to securities traded only in the over-the-counter market, orders will be executed on a principal basis with primary market makers in such securities except where better prices or executions may be obtained on an agency basis or by dealing with other than a primary market maker. The Fund may participate, if and when practicable, in bidding for the purchase of Fund securities directly from an issuer in order to take advantage of the lower purchase price available to members of a bidding group. The Fund will engage in this practice, however, only when the Advisor, in its sole discretion, believes such practice to be otherwise in the Fund's interest. In executing Fund transactions and selecting brokers or dealers, the Advisor will seek to obtain the best overall terms available for the Fund. In assessing the best overall terms available for any transaction, the Advisor shall consider factors it deems relevant, including the breadth of the market in the security, the price of the security, the financial condition and execution capability of the broker or dealer, and the reasonableness of the commission, if any, both for the specific transaction and on a continuing basis. The sale of Fund shares may be considered when determining firms that are to execute brokerage transactions for the Fund. In addition, the Advisor is authorized to cause the Fund to pay a broker-dealer which furnishes brokerage and research services a higher commission than that which might be charged by another broker-dealer for effecting the same transaction, provided that the Advisor determines in good faith that such commission is reasonable in relation to the value of the brokerage and research services provided by such broker-dealer, viewed in terms of either the particular transaction or the overall responsibilities of the Advisor to the Fund. Such brokerage and research services might consist of reports and statistics relating to specific companies or industries, general summaries of groups of stocks or bonds and their comparative earnings and yields, or broad overviews of the stock, bond and government securities markets and the economy. Supplementary research information so received is in addition to, and not in lieu of, services required to be performed by the Advisor and does not reduce the advisory fees payable by the Fund. The Trustees will periodically review any commissions paid by the Fund to consider whether the commissions paid over representative periods of time appear to be reasonable in relation to the benefits inuring to the Fund. It is possible that certain of the supplementary research or other services received will primarily benefit one or more other investment companies or other accounts for which investment discretion is exercised by the Advisor. Conversely, the Fund may be the primary beneficiary of the research or services received as a result of securities transactions effected for such other account or investment company. The Advisor may also utilize a brokerage firm affiliated with the Trust or the Advisor if it believes it can obtain the best execution of transactions from such broker. The Fund will not execute portfolio transactions through, acquire securities issued by, make savings deposits in or enter into repurchase agreements with the Advisor or an affiliated person of the Advisor (as such term is defined in the 1940 Act) acting as principal, except to the extent permitted by the Securities and Exchange Commission ("SEC"). In addition, the Fund will not purchase securities during the existence of any underwriting or selling group relating thereto of which the Advisor, or an affiliated person of the Advisor, is a member, except to the extent permitted by the SEC. Under certain circumstances, the Fund may be at a disadvantage because of these limitations in comparison with other investment companies that have similar investment objectives but are not subject to such limitations. Investment decisions for the Fund will be made independently from those for any other series of the Trust, if any, and for any other investment companies and accounts advised or managed by the Advisor. Such other investment companies and accounts may also invest in the same securities as the Fund. To the extent permitted by law, the Advisor may aggregate the securities to be sold or purchased for the Fund with those to be sold or purchased for other investment companies or accounts in executing transactions. When a purchase or sale of the same security is made at substantially the same time on behalf of the Fund and another investment company or account, the transaction will be averaged as to price and available investments allocated as to amount, in a manner which the Advisor believes to be equitable to the Fund and such other investment company or account. In some instances, this investment procedure may adversely affect the price paid or received by the Fund or the size of the position obtained or sold by the Fund. For the fiscal period ended February 28, 1995, the Fund paid brokerage commissions of $109. Repurchase Agreements. The Fund may acquire U.S. Government Securities or corporate debt securities subject to repurchase agreements. A repurchase transaction occurs when, at the time the Fund purchases a security (normally a U.S. Treasury obligation), it also resell it to the vendor (normally a member bank of the Federal Reserve or a registered Government Securities dealer) and must deliver the security (and/or securities substituted for them under the repurchase agreement) to the vendor on an agreed upon date in the future. The repurchase price exceeds the purchase price by an amount which reflects an agreed upon market interest rate effective for the period of time during which the repurchase agreement is in effect. Delivery pursuant to the resale will occur within one to five days of the purchase. Repurchase agreements are considered "loans" under the Investment Company Act of 1940, as amended (the "1940 Act"), collateralized by the underlying security. The Trust will implement procedures to monitor on a continuous basis the value of the collateral serving as security for repurchase obligations. Additionally, the Advisor to the Fund will consider the creditworthiness of the vendor. If the vendor fails to pay the agreed upon resale price on the delivery date, the Fund will retain or attempt to dispose of the collateral. The Fund's risk is that such default may include any decline in value of the collateral to an amount which is less than 100% of the repurchase price, any costs of disposing of such collateral, and any loss resulting from any delay in foreclosing on the collateral. The Fund will not enter into any repurchase agreement which will cause more than 10% of its net assets to be invested in repurchase agreements which extend beyond seven days and other illiquid securities. Description of Money Market Instruments. Money market instruments may include U.S. Government Securities or corporate debt securities (including those subject to repurchase agreements), provided that they mature in thirteen months or less from the date of acquisition and are otherwise eligible for purchase by the Fund. Money market instruments also may include Banker's Acceptances and Certificates of Deposit of domestic branches of U.S. banks, Commercial Paper and Variable Amount Demand Master Notes ("Master Notes"). Banker's Acceptances are time drafts drawn on and "accepted" by a bank. When a bank "accepts" such a time draft, it assumes liability for its payment. When the Fund acquires a Banker's Acceptance the bank which "accepted" the time draft is liable for payment of interest and principal when due. The Banker's Acceptance carries the full faith and credit of such bank. A Certificate of Deposit ("CD") is an unsecured interest bearing debt obligation of a bank. Commercial Paper is an unsecured, short term debt obligation of a bank, corporation or other borrower. Commercial Paper maturity generally ranges from two to 270 days and is usually sold on a discounted basis rather than as an interest bearing instrument. The Fund will invest in Commercial Paper only if it is rated one of the top two rating categories by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's Corporation ("S&P"), Fitch Investors Service, Inc. ("Fitch") or Duff & Phelps ("D&P") or, if not rated, of equivalent quality in the Advisor's opinion. Commercial Paper may include Master Notes of the same quality. Master Notes are unsecured obligations which are redeemable upon demand of the holder and which permit the investment of fluctuating amounts at varying rates of interest. Master Notes are acquired by the Fund only through the Master Note program of the Fund's custodian bank, acting as administrator thereof. The Advisor will monitor, on a continuous basis, the earnings power, cash flow and other liquidity ratios of the issuer of a Master Note held by the Fund. Illiquid Investments. The Fund may invest up to 10% of its net assets in illiquid securities, which are investments that cannot be sold or disposed of in the ordinary course of business within seven days at approximately the prices at which they are valued. Under the supervision of the Board of Trustees, the Advisor determines the liquidity of the Fund's investments and, through reports from the Advisor, the Board monitors investments in illiquid instruments. In determining the liquidity of the Fund's investments, the Advisor may consider various factors including (1) the frequency of trades and quotations, (2) the number of dealers and prospective purchasers in the marketplace, (3) dealer undertakings to make a market, (4) the nature of the security (including any demand or tender features) and (5) the nature of the marketplace for trades (including the ability to assign or offset the Fund's rights and obligations relating to the investment). Investments currently considered by the Fund to be illiquid include repurchase agreements not entitling the holder to payment of principal and interest within seven days and restricted securities. If through a change in values, net assets or other circumstances, the Fund were in a position where more than 10% of its net assets were invested in illiquid securities, it would seek to take appropriate steps to protect liquidity. Restricted Securities. Within its limitation on investment in illiquid securities, the Fund may purchase restricted securities that generally can be sold in privately negotiated transactions, pursuant to an exemption from registration under the federal securities laws, or in a registered public offering. Where registration is required, the Fund may be obligated to pay all or part of the registration expense and a considerable period may elapse between the time it decides to seek registration and the time the Fund may be permitted to sell a security under an effective registration statement. If during such a period, adverse market conditions were to develop, the Fund might obtain a less favorable price than prevailed when it decided to seek registration of the security. During any time that shares of the Fund may be registered in the State of Ohio, the Fund will include within the category of restricted securities, subject to its limitation on investment in illiquid securities, securities issued pursuant to exemption under federal Rule 144A despite any determinations made by the Board of Trustees that such securities are liquid. The Fund has adopted the following fundamental investment limitations, which cannot be changed without approval by holders of a majority of the outstanding voting shares of the Fund. A "majority" for this purpose, means the lesser of (i) 67% of the Fund's outstanding shares represented in person or by proxy at a meeting at which more than 50% of its outstanding shares are represented, or (ii) more than 50% of its outstanding shares. Unless otherwise indicated, percentage limitations apply at the time of purchase. As a matter of fundamental policy, the Fund may not: (1) Issue senior securities, borrow money, or pledge its assets, except that it may borrow from banks as a temporary measure (a) for extraordinary or emergency purposes, in amounts not exceeding 5% of its total assets or (b) in order to meet redemption requests in amounts not exceeding 15% of its total assets. The Fund will not make any further investments if borrowing exceeds 5% of its total assets until such time as total borrowing represents less than 5% of Fund assets. (2) Invest for the purpose of exercising control or management of another (3) Purchase or sell commodities or commodities contracts, real estate (including limited partnership interests, but excluding readily marketable securities secured by real estate or interests therein, readily marketable interests in real estate investment trusts, or readily marketable securities issued by companies that invest in real estate or interests therein) or interests in oil, gas, or other mineral exploration or development programs or leases (although it may invest in readily marketable securities of issuers that invest in or sponsor such programs or leases). (4) Underwrite securities issued by others except to the extent that the disposition of portfolio securities, either directly from an issuer or from an underwriter for an issuer may be deemed to be an underwriter under the federal securities laws. (5) Invest in warrants, valued at the lower of cost or market, exceeding more than 5% of the value of the Fund's net assets. Included within this amount, but not to exceed 2% of the value of the Fund's net assets, may be warrants which are not listed on the New York or American Stock Exchange; warrants acquired by the Fund in units or attached to securities may be deemed to be without value; (6) Participate on a joint or joint and several basis in any trading (8) Invest more than 10% of its assets in the securities of one or (9) Make loans of money or securities, except that the Fund may (i) invest in repurchase agreements and commercial paper; (ii) purchase a portion of an issue of publicity distributed bonds, debentures or other debt securities; and (iii) acquire private issues of debt securities subject to the limitations on investments in illiquid securities. The following investment limitations are not fundamental, and may be changed without shareholder approval. As a matter of non-fundamental policy, the Fund may not: (1) Invest in securities of issuers which have a record of less than three years' continuous operation (including predecessors and, in the case of bonds, guarantors) if more than 5% of its total assets would be (2) Invest more than 10% of its net assets in illiquid securities. For this purpose, illiquid securities include, among others (a) securities for which no readily available market exists or which have legal or contractual restrictions on resale, (b) fixed time deposits that are subject to withdrawal penalties and have maturities of more than seven days, and (c) repurchase agreements not terminable within seven days; (3) Invest in the securities of any issuer if those officers or Trustees of the Trust and those officers and directors of the Advisor who individually own more than 1/2 of 1% of the outstanding securities of such issuer together own more than 5% of such issuer's securities; (4) Write, purchase, or sells puts, calls, straddles, spreads, or combinations thereof or futures contracts or related options; (5) Make short sales of securities or maintain a short position, except short sales "against the box;" (A short sale is made by selling a security the Fund do not own. A short sale is "against the box" to the extent that the Fund contemporaneously owns or has the right to obtain at no additional cost securities identical to those sold short) (while the Fund has reserved the right to make short sales "against the box," the Advisor has no present intention of engaging in such transactions at this time or during the coming year); (6) Purchase any securities on margin except in connection with such short-term credits as may be necessary for the clearance of transactions. Whenever any fundamental investment policy or investment restriction states a maximum percentage of assets, it is intended that if the percentage limitation is met at the time the investment is made, a later change in percentage resulting from changing total or net asset values will not be considered a violation of such policy. The net asset value per share of each Class of the Fund is calculated separately by adding the value of the Fund's securities and other assets belonging to the Fund and attributable to that Class, subtracting the liabilities charged to the Fund and to that Class, and dividing the result by the number of outstanding shares of such Class. "Assets belonging to" the Fund consist of the consideration received upon the issuance of shares of the Fund together with all net investment income, realized gains/losses and proceeds derived from the investment thereof, including any proceeds from the sale of such investments, any funds or payments derived from any reinvestment of such proceeds, and a portion of any general assets of the Trust not belonging to a particular investment Fund. Income, realized and unrealized capital gains and losses, and any expenses of the Fund not allocated to a particular Class of the Fund will be allocated to each Class of the Fund on the basis of the net asset value of that Class in relation to the net asset value of the Fund. Assets belonging to the Fund are charged with the direct liabilities of the Fund and with a share of the general liabilities of the Trust, which are normally allocated in proportion to the number of or the relative net asset values of all of the Trust's series at the time of allocation or in accordance with other allocation methods approved by the Board of Trustees. Certain expenses attributable to a particular Class of shares (such as the distribution and service fees) will be charged against that Class of shares. Certain other expenses attributable to a particular Class of shares (such as registration fees, professional fees, and certain printing and postage expenses) may be charged against that Class of shares if such expenses are actually incurred in a different amount by that Class or if the Class receives services of a different kind or to a different degree than other Classes, and the Board of Trustees approves such allocation. Subject to the provisions of the Declaration of Trust, determinations by the Board of Trustees as to the direct and allocable liabilities, and the allocable portion of any general assets, with respect to the Fund and the Classes of the Fund are conclusive. The net asset value per share of each Class of the Fund is determined at 4:00 p.m., New York time, Monday through Friday, except on business holidays when the New York Stock Exchange is closed. The New York Stock Exchange recognizes the following holidays: New Year's Day, President's Day, Good Friday, Memorial Day, Fourth of July, Labor Day, Thanksgiving Day, and Christmas Day. Any other holiday recognized by the New York Stock Exchange will be deemed a business holiday on which the net asset value of the Classes of the Fund will not be determined. For the fiscal period ended February 28, 1995, the total expenses of the Fund, after fee waivers and expense reimbursements, were $335 (2.05% of the average daily net assets of the Class A shares). Class B shares of the Fund were not authorized for issuance during such period. ADDITIONAL PURCHASE AND REDEMPTION INFORMATION Purchases. Shares of the Fund are offered and sold on a continuous basis and may be purchased through authorized investment dealers or directly by contacting the Distributor or the Fund. Selling dealers have the responsibility of transmitting orders promptly to the Fund. The public offering price of shares of the Fund equals net asset value, plus a front-end sales charge for Class A shares. Class B shares may be subject to a contingent deferred sales charge upon redemption. Capital Investment Group, Inc. (the "Distributor") receives these sales charges as Distributor, and may reallow all or a part of the front-end sales charges in the form of dealer discounts and brokerage commissions. The Distributor may compensate dealers up-front from its own funds for distribution-related activities in connection with the sale of Class B shares, for which the Distributor will receive the contingent deferred sales charge and a distribution fee under the Fund's Distribution Plan for the Class B shares as described below. The current schedule of sales charges (both front-end and deferred) and related dealer discounts and brokerage commissions is set forth in the Prospectus, along with the information on current purchases, rights of accumulation, and letters of intent. See " How Shares May Be Purchased" in the Prospectus. Distribution Plans. The Trust has adopted a separate Plan of Distribution (each a "Plan" or the "Plans") for each Class of the Fund pursuant to Rule 12b-1 under the 1940 Act (see "How Shares May Be Purchased - Distribution Plans" in the Prospectus). Under the Plans the Fund may expend up to 0.50% of the Class A shares' average net assets annually and up to 1.00% of the Class B shares' average net assets annually to finance any activity which is primarily intended to result in the sale of shares of the applicable Class of the Fund and the servicing of shareholder accounts, provided the Trust's Board of Trustees has approved the category of expenses for which payment is being made. Such expenditures paid as service fees to any person who sells Class A or Class B shares of the Fund may not exceed 0.25% of the average annual net asset value of such shares. Potential benefits of the Plans to the Fund include improved shareholder servicing, savings to the Fund in transfer agency costs, benefits to the investment process from growth and stability of assets and maintenance of a financially healthy management organization. The front-end sales charge and amounts payable to the Distributor under the Distribution Plan for the Class A shares are used by the Distributor to pay commissions and other fees payable to dealers and other service organizations who sell Class A shares. Dealers and other service organizations receive commissions from the Distributor for selling Class B shares, which are paid at the time of the sale. These commissions approximate the commissions payable with respect to sales of Class A shares. The distribution fees payable under the Distribution Plan for the Class B shares (at an annual rate of 0.75% of the average daily net assets of the Class B shares) are intended to cover the expense to the Distributor of paying such up-front commissions, and the contingent deferred sales charge is calculated to charge the investor with any shortfall that would occur if Class B shares are redeemed prior to the expiration of the five year CDSC period. After approximately eight years the Class B shares automatically convert to Class A shares. To provide funds for the payment of up-front sales commissions, the Distributor has arranged a line of credit with an unaffiliated third party lender, which provides funds for the payment of commissions and other fees payable to dealers and other service organizations who sell Class B shares. Under the terms of that financing the Distributor will assign to the lender the distribution fees that may be payable from time to time to the Distributor under the Distribution Plan for the Class B shares and the contingent deferred sales charges payable to the Distributor with respect to Class B shares. All of the distribution expenses incurred by the Distributor and others, such as broker-dealers, in excess of the amount paid by the Fund will be borne by such persons without any reimbursement from the Fund. Subject to seeking best price and execution, the Fund may, from time to time, buy or sell portfolio securities from or to firms which receive payments under the Plan. From time to time the Distributor may pay additional amounts from its own resources to dealers for aid in distribution or for aid in providing administrative services to shareholders. The Plans, the Distribution Agreement with the Distributor, and the form of Dealer Agreement have all been approved by the Board of Trustees of the Trust, including a majority of the trustees who are not "interested persons" (as defined in the 1940 Act) of the Trust and who have no direct or indirect financial interest in the Plans or any related agreements, by vote cast in person or at a meeting duly called for the purpose of voting on the Plans and such Agreements. Continuation of the Plan, the Distribution Agreement and the form of Dealer Agreement must be approved annually by the Board of Trustees in the same manner as specified above. Each year the Trustees must determine whether continuation of each Plan is in the best interest of shareholders of the applicable Class of the Fund and that there is a reasonable likelihood of its providing a benefit to the Fund, and the Board of Trustees has made such a determination for the current year of operations under the Plans. The Plans, the Distribution Agreement and the Dealer Agreement with any broker/dealers may be terminated at any time without penalty by a majority of those trustees who are not "interested persons" or by a majority vote of the Fund's outstanding voting stock of the applicable Class. Any amendment materially increasing the maximum percentage payable under a Plan must likewise be approved by a majority vote of the Fund's outstanding voting stock of the applicable Class, as well as by a majority vote of those trustees who are not "interested persons." Also, any other material amendment to a Plan must be approved by a majority vote of the trustees including a majority of the noninterested Trustees of the Trust having no interest in the Plan. In addition, in order for each Plan to remain effective, the selection and nomination of Trustees who are not "interested persons" of the Trust must be effected by the Trustees who themselves are not "interested persons" and who have no direct or indirect financial interest in the Plans. Persons authorized to make payments under the Plans must provide written reports at least quarterly to the Board of Trustees for their review. The Fund incurred no costs under the Plan for the Class A shares fiscal year ended February 28, 1995. The Class B shares were not offered during such fiscal period. Redemptions. Under the 1940 Act, the Fund may suspend the right of redemption or postpone the date of payment for shares during any period when (a) trading on the New York Stock Exchange is restricted by applicable rules and regulations of the SEC; (b) the Exchange is closed for other than customary weekend and holiday closings; (c) the SEC has by order permitted such suspension; or (d) an emergency exists as determined by the SEC. The Fund may also suspend or postpone the recordation of the transfer of shares upon the occurrence of any of the foregoing conditions. In addition to the situations described in the Prospectus under "How Shares may be Redeemed," the Fund may redeem shares involuntarily to reimburse the Fund for any loss sustained by reason of the failure of a shareholder to make full payment for shares purchased by the shareholder or to collect any charge relating to a transaction effected for the benefit of a shareholder which is applicable to Fund shares as provided in the Prospectus from time to time. The Trust is an unincorporated business trust organized under Massachusetts law on August 12, 1992. The Trust's Declaration of Trust authorizes the Board of Trustees to divide shares into series, each series relating to a separate portfolio of investments. The Declaration of Trust currently provides for the shares of six series, the Greater Cincinnati Fund (the subject of this Additional Statement); Amelia Earhart: Eagle Equity Fund managed by Amelia Earhart Capital Management, Inc. of Southfield, Michigan; Legacy Equity Fund managed by Legacy Advisors, Inc. of Dallas Texas; Nottingham Short Term Income Fund managed by Nottingham Asset Management, LLC of Rocky Mount, North Carolina; The CarolinasFund managed by Morehead Capital Advisors LLC of Charlotte, North Carolina; and the Mississippi Opportunity Fund managed by Vector Money Management Inc. of Jackson, Mississippi. The Board of Trustees has authorized the classification of shares of Amelia Earhart: Eagle Equity Fund, The CarolinasFund, the Greater Cincinnati Fund, and the Mississippi Opportunity Fund. The number of shares of each series shall be unlimited. The Trust does not intend to issue share certificates. In the event of a liquidation or dissolution of the Trust or an individual series, such as the Fund, shareholders of a particular series would be entitled to receive the assets available for distribution belonging to such series. Shareholders of a series are entitled to participate equally in the net distributable assets of the particular series involved on liquidation, based on the number of shares of the series that are held by each shareholder. If there are any assets, income, earnings, proceeds, funds or payments, that are not readily identifiable as belonging to any particular series, the Trustees shall allocate them among any one or more of the series as they, in their sole discretion, deem fair and equitable. Shareholders of all of the series of the Trust, including the Fund, will vote together and not separately on a series-by-series basis or class-by-class basis, except as otherwise required by law or when the Board of Trustees determines that the matter to be voted upon affects only the interests of the shareholders of a particular series or class. Rule 18f-2 under the 1940 Act provides that any matter required to be submitted to the holders of the outstanding voting securities of an investment company such as the Trust shall not be deemed to have been effectively acted upon unless approved by the holders of a majority of the outstanding shares of each series affected by the matter. A series or class is affected by a matter unless it is clear that the interests of each series or class in the matter are substantially identical or that the matter does not affect any interest of the series or class. Under Rule 18f-2, the approval of an investment advisory agreement or any change in a fundamental investment policy would be effectively acted upon with respect to a series only if approved by a majority of the outstanding shares of such series. However, the Rule also provides that the ratification of the appointment of independent accountants, the approval of principal underwriting contracts and the election of Trustees may be effectively acted upon by shareholders of the Trust voting together, without regard to a particular series. When used in the Prospectus or this Additional Statement, a "majority" of shareholders means the vote of the lesser of (1) 67% of the shares of the Trust or the applicable series present at a meeting if the holders of more than 50% of the outstanding shares are present in person or by proxy, or (2) more than 50% of the outstanding shares of the Trust or the applicable series. When issued for payment as described in the Prospectus and this Additional Statement, shares of the Fund will be fully paid and non-assessable. The Declaration of Trust provides that the Trustees of the Trust will not be liable in any event in connection with the affairs of the Trust, except as such liability may arise from his or her own bad faith, willful misfeasance, gross negligence, or reckless disregard of duties. It also provides that all third parties shall look solely to the Trust property for satisfaction of claims arising in connection with the affairs of the Trust. With the exceptions stated, the Declaration of Trust provides that a Trustee or officer is entitled to be indemnified against all liability in connection with the affairs of the Trust. The following summarizes certain additional tax considerations generally affecting the Fund and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the Fund or its shareholders, and the discussion here and in the Prospectus is not intended as a substitute for careful tax planning and is based on tax laws and regulations that are in effect on the date hereof; such laws and regulations may be changed by legislative, judicial, or administrative action. Investors are advised to consult their tax advisors with specific reference to their own tax situations. Each series of the Trust, including the Fund, will be treated as a separate corporate entity under the Code and intends to qualify or remain qualified as a regulated investment company. In order to so qualify, each series must elect to be a regulated investment company or have made such an election for a previous year and must satisfy, in addition to the distribution requirement described in the Prospectus, certain requirements with respect to the source of its income for a taxable year. At least 90% of the gross income of each series must be derived from dividends, interest, payments with respect to securities loans, gains from the sale or other disposition of stocks, securities or foreign currencies, and other income derived with respect to the series' business of investing in such stock, securities or currencies. Any income derived by a series from a partnership or trust is treated as derived with respect to the series' business of investing in stock, securities or currencies only to the extent that such income is attributable to items of income that would have been qualifying income if realized by the series in the same manner as by the partnership or trust. Another requirement for qualification as a regulated investment company under the Code is that less than 30% of a series' gross income for a taxable year must be derived from gains realized on the sale or other disposition of the following investments held for less than three months: (l) stock and securities (as defined in Section 2(a) (36) of the 1940 Act); (2) options, futures and forward contracts other than those on foreign currencies; or (3) foreign currencies (or options, futures or forward contracts on foreign currencies) that are not directly related to a series' principal business of investing in stocks or securities (or options and futures with respect to stocks or securities). Interest (including original issue discount and, with respect to certain debt securities, accrued market discount) received by a series upon maturity or disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of this requirement. However, any other income which is attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. An investment company may not qualify as a regulated investment company for any taxable year unless it satisfies certain requirements with respect to the diversification of its investments at the close of each quarter of the taxable year. In general, at least 50% of the value of its total assets must be represented by cash, cash items, government securities, securities of other regulated investment companies and other securities which, with respect to any one issuer, do not represent more than 5% of the total assets of the investment company nor more than 10% of the outstanding voting securities of such issuer. In addition, not more than 25% of the value of the investment company's total assets may be invested in the securities (other than government securities or the securities of other regulated investment companies) of any one issuer. The Fund intends to satisfy all requirements on an ongoing basis for continued qualification as a regulated investment company. Each series of the Trust, including the Fund, will designate any distribution of long term capital gains as a capital gain dividend in a written notice mailed to shareholders within 60 days after the close of the series' taxable year. Shareholders should note that, upon the sale or exchange of series shares, if the shareholder has not held such shares for at least six months, any loss on the sale or exchange of those shares will be treated as long term capital loss to the extent of the capital gain dividends received with respect to the shares. A 4% nondeductible excise tax is imposed on regulated investment companies that fail to currently distribute an amount equal to specified percentages of their ordinary taxable income and capital gain net income (excess of capital gains over capital losses). Each series of the Trust, including the Fund, intends to make sufficient distributions or deemed distributions of its ordinary taxable income and any capital gain net income prior to the end of each calendar year to avoid liability for this excise tax. If for any taxable year a series does not qualify for the special federal income tax treatment afforded regulated investment companies, all of its taxable income will be subject to federal income tax at regular corporate rates (without any deduction for distributions to its shareholders). In such event, dividend distributions (whether or not derived from interest on tax- exempt securities) would be taxable as ordinary income to shareholders to the extent of the series' current and accumulated earnings and profits, and would be eligible for the dividends received deduction for corporations. Each series of the Trust, including the Fund, will be required in certain cases to withhold and remit to the U.S. Treasury 31% of taxable dividends or 31% of gross proceeds realized upon sale paid to shareholders who have failed to provide a correct tax identification number in the manner required, or who are subject to withholding by the Internal Revenue Service for failure properly to include on their return payments of taxable interest or dividends, or who have failed to certify to the Fund that they are not subject to backup withholding when required to do so or that they are "exempt recipients." Depending upon the extent of the Fund's activities in states and localities in which its offices are maintained, in which its agents or independent contractors are located or in which it is otherwise deemed to be conducting business, the Fund may be subject to the tax laws of such states or localities. In addition, in those states and localities that have income tax laws, the treatment of the Fund and its shareholders under such laws may differ from their treatment under federal income tax laws. Trustees and Officers. The Trustees and executive officers of the Trust, their ages and their principal occupations for the last five years are as follows: and Address During Past 5 Years Robert A. Blackmon III, 35 Investment Executive, 400 East Capitol Street Jackson, Mississippi, Jackson, Mississippi 39201 since July 1994; previously John P. Boone, 63 President, Legacy Equity Fund Executive Vice President, 2911 Turtle Creek Boulevard Forum Securities, Inc. Jack E. Brinson, 63 President, Brinson Investment Co., Trustee President, Brinson Chevrolet, Inc., 1105 Panola Street Tarboro, North Carolina Dodie M. Duffy, 32 Compliance Administrator, 105 North Washington Street Rocky Mount, North Carolina, Rocky Mount, North Carolina 27802 Administrator to the Trust, Jeffrey A. Egan, 35 Vice President, One Towne Square, Suite 1913 Southfield, Michigan, Southfield, Michigan 48076 a division of Cambridge Financial Services, a consulting and securities Ashby M. Foote, III, 44 President, Vice President Vector Money Management, Inc., Mississippi Opportunity Fund Jackson, Mississippi One Jackson Place, Suite 1070 H. Kel Landis, III, 39 Executive Vice President, 304 Stonybrook Road Rocky Mount, North Carolina Rocky Mount, North Carolina 27803 J. Finley Lee, Jr., 56 Julian Price Professor of Business Trustee University of North Carolina, 614 Croom Court Chapel Hill, North Carolina Chapel Hill, North Carolina 27514 John E. Lynch, 35 Investment Executive, Vice President Robert Thomas Securities, Mississippi Opportunity Fund Jackson, Mississippi, 400 East Capitol Street since July 1994; previously Jackson, Mississippi 39201 Vice President Paine Webber, Inc. Frank P. Meadows III, 34 Managing Director, Nottingham Short Term Income Fund Rocky Mount, North Carolina, Trustee, Vice Chairman and Treasurer* Administrator to the Trust; 105 North Washington Street Registered Representative and Limited Rocky Mount, North Carolina 27802 Capital Investment Group, Inc., O. James Peterson, III, 60 Financial/Management Consultant, Five Bellona Arsenal since March 1994; previously Midlothian, Virginia Senior Vice President, Vice Chairman of Board of Directors, Christopher J. Smith, 28 Director, Trustee and Chairman* Amelia Earhart Capital Management, Inc., Amelia Earhart: Eagle Equity Fund Advisor to the Fund; One Towne Square, Suite 1913 Corporate Counsel, Southfield, Michigan 48076 Seligman & Associates, a real estate management and Jasen M. Snelling, 32 President Greater Cincinnati Fund since September 1994; 525 Vine Street #1800 Broker, Cincinnati, Ohio 45202 PNC Bank, Broker, Provident Bank, Cincinnati, Ohio, from September 1991 to March 1992; Agent, The Equitable, Cincinnati, Ohio, from August 1989 to August 1991 Robert B. Thompson, 48 Chief Executive Officer, Trustee* Morehead Capital Advisors LLC; President until 1995, Chief Executive Officer, The CarolinasFund Morehead Investment Advisors, Inc. 1944 Brunswick Avenue Charlotte, North Carolina Charlotte, North Carolina 28207 Registered Representative C. Frank Watson III, 25 Compliance Administrator, Assistant Secretary The Nottingham Company, LLC, Assistant Treasurer Rocky Mount, North Carolina, 105 North Washington Street since 1992; previously, Rocky Mount, North Carolina 27802 Student, University of Timothy C. Wheeler, 36 Senior Vice President, Vice President Legacy Advisors, Inc., Legacy Equity Fund Dallas, Texas; 2911 Turtle Creek Boulevard Vice President, Suite 400 Forum Securities, Inc. Dallas, Texas 75219 Dallas, Texas * Indicates that the Trustee is an "interested person" of the Trust for purposes of the 1940 Act because of his affiliation with the Trust or one of the investment advisors to the Trust. The officers of the Trust will not receive compensation from the Trust for performing the duties of their offices. Each non-affiliated Trustee receives a fee of $2,000 each year plus $250 per series of the Trust per meeting attended in person and $100 per series of the Trust per meeting attended by telephone. All Trustees are reimbursed for any out-of-pocket expenses incurred in connection with attendance at meetings. Principal Holders of Voting Securities. As of December 4, 1995, the Trustees and Officers of the Trust as a group owned beneficially (i.e., had voting and/or investment power) less than 1% of the then outstanding shares of the Fund. On the same date the following shareholders owned of record more than 5% of the outstanding shares of beneficial interest of the Fund. Except as provided below, no person is known by the Trust to be the beneficial owner of more than 5% of the outstanding shares of the Fund as of December 4, 1995. Name and Address of Amount and Nature of Beneficial Owner Beneficial Ownership* Percent BHC Securities, Inc. 9,328.025 shares 17.325% 2005 Market Street Suite 1200 Donaldson, Lufkin & Jenerette 9,996.002 shares 17.392% Securities Corporation, Inc. Jersey City, New Jersey 07303 Donaldson, Lufkin & Jenerette 6,606.559 shares 11.494% Jersey City, New Jersey 07303 Name and Address of Amount and Nature of Beneficial Owner Beneficial Ownership* Percent CityFund Advisory, Inc. 9.924 shares 100.00%** * The shares indicated are believed by the Trust to be owned both of record and beneficially, except shares owned by BHC Securities, Inc. and Donaldson, Lufkin & Jenerette Securities Corporation, Inc. (owned of record for the benefit of their customers). ** Pursuant to applicable SEC regulations, this shareholder is deemed to control the Class B shares of the Fund. Investment Advisor. Information about CityFund Advisory, Inc., 525 Vine Street #1800, Cincinnati, Ohio 45202 (the "Advisor") and its duties and compensation as Advisor is contained in the Prospectus. The Advisor will receive a monthly management fee equal to an annual rate of 1.25% of the average daily net asset value of the Fund. Restrictive limitations may be imposed on the Fund as a result of changes in current state laws and regulations in those states where the Fund has qualified its shares, or by a decision of the Trustees to qualify the shares in other states having restrictive expense limitations. Under the Advisory Agreement, the Advisor is not liable for any error of judgment or mistake of law or for any loss suffered by the Fund in connection with the performance of such Agreement, except a loss resulting from a breach of fiduciary duty with respect to the receipt of compensation for services or a loss resulting from willful misfeasance, bad faith or gross negligence on the part of the Advisor in the performance of its duties or from its reckless disregard of its duties and obligations under the Agreement. The Advisor voluntarily waived its fee in the amount of $214 and reimbursed a portion of the Fund's expenses in the amount of $10,815 for the fiscal period ended February 28, 1995. The Administrator and Transfer Agent. The Trust has entered into a Fund Accounting, Dividend Disbursing & Transfer Agent and Administration Agreement with The Nottingham Company, LLC (the "Administrator"), 105 North Washington Street, Post Office Drawer 69, Rocky Mount, North Carolina 27802-0069, pursuant to which the Administrator receives a fee at the annual rate of 0.20% of the average daily net assets of the Fund on the first $50 million; 0.175% of the next $50 million; and 0.15% of its average daily net assets in excess of $100 million. In addition, the Administrator currently receives a base monthly fee of $2,000 for the first class of the Fund and $750 for each additional class of the Fund for accounting and recordkeeping services for the Fund. The Administrator also charges the Fund for certain costs involved with the daily valuation of investment securities and is reimbursed for out-of- pocket expenses. The Administrator charges a minimum fee of $3,000 per month for all of its fees taken in the aggregate, analyzed monthly. For services to the Fund for the fiscal period ended February 28, 1995, the Administrator waived its administration fees in the amount of $1,939. For such period, the Administrator received $4,000 for accounting and recordkeeping services. The Administrator will perform the following services for the Fund: (1) coordinate with the Custodian and monitor the services it provides to the Fund; (2) coordinate with and monitor any other third parties furnishing services to the Fund; (3) provide the Fund with necessary office space, telephones and other communications facilities and personnel competent to perform administrative and clerical functions for the Fund; (4) supervise the maintenance by third parties of such books and records of the Fund as may be required by applicable federal or state law; (5) prepare or supervise the preparation by third parties of all federal, state and local tax returns and reports of the Fund required by applicable law; (6) prepare and, after approval by the Trust, file and arrange for the distribution of proxy materials and periodic reports to shareholders of the Fund as required by applicable law; (7) prepare and, after approval by the Trust, arrange for the filing of such registration statements and other documents with the Securities and Exchange Commission and other federal and state regulatory authorities as may be required by applicable law; (8) review and submit to the officers of the Trust for their approval invoices or other requests for payment of Fund expenses and instruct the Custodian to issue checks in payment thereof; and (9) take such other action with respect to the Fund as may be necessary in the opinion of the Administrator to perform its duties under the agreement. The Administrator will also serve as the Fund's transfer agent and dividend disbursing agent and will provide certain accounting and pricing services for the Fund. Distributor. Capital Investment Group, Inc. (the "Distributor"), Post Office Box 32249, Raleigh, North Carolina, acts as an underwriter and distributor of the Fund's shares for the purpose of facilitating the registration of shares of the Fund under state securities laws and to assist in sales of Fund shares pursuant to a Distribution Agreement (the "Distribution Agreement") approved by the Board of Trustees of the Trust. In this regard, the Distributor has agreed at its own expense to qualify as a broker-dealer under all applicable federal or state laws in those states which the Fund shall from time to time identify to the Distributor as states in which it wishes to offer its shares for sale, in order that state registrations may be maintained for the Fund. The Distributor is a broker-dealer registered with the Securities and Exchange Commission and a member in good standing of the National Association of Securities Dealers, Inc. The Distribution Agreement may be terminated by either party upon 60 days prior written notice to the other party. For the fiscal period ended February 28, 1995, the Distributor retained sales charges in the amount of $205. Custodian. Wachovia Bank of North Carolina, N.A. (the "Custodian"), 301 North Main Street, Winston-Salem, North Carolina 27102 serves as custodian for the Fund's assets. The Custodian acts as the depository for the Fund, safekeeps its portfolio securities, collects all income and other payments with respect to portfolio securities, disburses monies at the Fund's request and maintains records in connection with its duties as Custodian. For its services as Custodian, the Custodian is entitled to receive from the Fund an annual fee based on the average net assets of the Fund held by the Custodian. Independent Auditors. The firm of KPMG Peat Marwick LLP, 1021 East Cary Street, Richmond, Virginia 23219-4023, serves as independent accountants for the Fund, and will audit the annual financial statements of the Fund, prepare the Fund's federal and state tax returns, and consult with the Fund on matters of accounting and federal and state income taxation. The Fund offers the following shareholder services: Regular Account. The regular account allows for voluntary investments to be made at any time. Available to individuals, custodians, corporations, trusts, estates, corporate retirement plans and others, investors are free to make additions and withdrawals to or from their account as often as they wish. When an investor makes an initial investment in the Fund, a shareholder account is opened in accordance with the investor's registration instructions. Each time there is a transaction in a shareholder account, such as an additional investment or the reinvestment of a dividend or distribution, the shareholder will receive a confirmation statement showing the current transaction and all prior transactions in the shareholder account during the calendar year to date, along with a summary of the status of the account as of the transaction date. As stated in the Prospectus, share certificates are not issued. Automatic Investment Plan. The automatic investment plan enables shareholders to make regular monthly or quarterly investment in shares through automatic charges to their checking account. With shareholder authorization and bank approval, the Administrator will automatically charge the checking account for the amount specified ($100 minimum) which will be automatically invested in shares at the public offering price on or about the 21st day of the month. The shareholder may change the amount of the investment or discontinue the plan at any time by writing to the Administrator. Systematic Withdrawal Plan. Shareholders owning shares with a value of $10,000 or more may establish a Systematic Withdrawal Plan. A shareholder may receive monthly or quarterly payments, in amounts of not less than $100 per payment, by authorizing the Fund to redeem the necessary number of shares periodically (each month, or quarterly in the months of March, June, September and December) in order to make the payments requested. The Fund has the capacity of electronically depositing the proceeds of the systematic withdrawal directly to the shareholder's personal bank account ($5,000 minimum per bank wire). Instructions for establishing this service are included in the Fund Shares Application, enclosed in the Prospectus, or available by calling the Fund. If the shareholder prefers to receive his systematic withdrawal proceeds in cash, or if such proceeds are less than the $5,000 minimum for a bank wire, checks will be made payable to the designated recipient and mailed within 7 days of the valuation date. If the designated recipient is other than the registered shareholder, the signature of each shareholder must be guaranteed on the application (see "Signature Guarantees" in the Prospectus). A corporation (or partnership) must also submit a "Corporate Resolution" (or "Certification of Partnership") indicating the names, titles and required number of signatures authorized to act on its behalf. The application must be signed by a duly authorized officer(s) and the corporate seal affixed. No redemption fees are charged to shareholders under this plan except for potential deferred sales charges with respect to Class B shares. The Prospectus contains additional information and limitations relating to the use of a Systematic Withdrawal Plan by a holder of Class B shares. Costs in conjunction with the administration of the plan are borne by the Fund. Shareholders should be aware that such systematic withdrawals may deplete or use up entirely their initial investment and may result in realized long-term or short-term capital gains or losses. The Systematic Withdrawal Plan may be terminated at any time by the Fund upon sixty days written notice or by a shareholder upon written notice to the Fund. Applications and further details may be obtained by calling the Fund at 1-800- 525-FUND, or by writing to: Rocky Mount, North Carolina 27802-0069 Purchases in Kind. The Fund may accept securities in lieu of cash in payment for the purchase of shares in the Fund. The acceptance of such securities is at the sole discretion of the Advisor based upon the suitability of the securities accepted for inclusion as a long term investment of the Fund, the marketability of such securities, and other factors which the Advisor may deem appropriate. If accepted, the securities will be valued using the same criteria and methods as described in "How Shares are Valued" in the Prospectus. Transactions involving the issuance of shares in the Fund for securities in lieu of cash will be limited to acquisitions of securities (except for municipal debt securities issued by state political subdivisions or their agencies or instrumentalities) which: (a) meet the investment objectives and policies of the Fund; (b) are acquired for investment and not for resale; (c) are liquid securities which are not restricted as to transfer either by law or liquidity of market; and (d) have a value which is readily ascertainable (and not established only by evaluation procedures) as evidenced by a listing on the American Stock Exchange, the New York Stock Exchange, or NASDAQ. Redemptions in Kind. The Fund does not intend, under normal circumstances, to redeem its securities by payment in kind. It is possible, however, that conditions may arise in the future which would, in the opinion of the Trustees, make it undesirable for the Fund to pay for all redemptions in cash. In such case, the Board of Trustees may authorize payment to be made in readily marketable portfolio securities of the Fund. Securities delivered in payment of redemptions would be valued at the same value assigned to them in computing the net asset value per share. Shareholders receiving them would incur brokerage costs when these securities are sold. An irrevocable election has been filed under Rule 18f-1 of the 1940 Act, wherein the Fund committed itself to pay redemptions in cash, rather than in kind, to any shareholder of record of the Fund who redeems during any ninety-day period, the lesser of (a) $250,000 or (b) one percent (1%) of the Fund's net asset value at the beginning of such period. Transfer of Registration. To transfer shares to another owner, send a written request to the Fund at the address shown herein. Your request should include the following: (1) the Fund name and existing account registration; (2) signature(s) of the registered owner(s) exactly as the signature(s) appear(s) on the account registration; (3) the new account registration, address, social security or taxpayer identification number and how dividends and capital gains are to be distributed; (4) signature guarantees (See the Prospectus under the heading "Signature Guarantees"); and (5) any additional documents which are required for transfer by corporations, administrators, executors, trustees, guardians, etc. If you have any questions about transferring shares, call or write the Fund. From time to time, the total return of the each Class of the Fund may be quoted in advertisements, sales literature, shareholder reports or other communications to shareholders. The Fund computes the "average annual total return" of each Class of the Fund by determining the average annual compounded rates of return during specified periods that equate the initial amount invested to the ending redeemable value of such investment. This is done by determining the ending redeemable value of a hypothetical $1,000 initial payment. This calculation is as follows: Where: T = average annual total return. ERV = ending redeemable value at the end of the period covered by the computation of a hypothetical $1,000 payment made at the beginning of the period. P = hypothetical initial payment of $1,000 from which the maximum sales load is deducted. n = period covered by the computation, expressed in terms of years. The Fund may also compute the aggregate total return of each Class of the Fund, which is calculated in a similar manner, except that the results are not annualized. The calculation of average annual total return and aggregate total return assume that the maximum sales load is deducted from the initial $1,000 investment at the time it is made and that there is a reinvestment of all dividends and capital gain distributions on the reinvestment dates during the period. The ending redeemable value is determined by assuming complete redemption of the hypothetical investment and the deduction of all nonrecurring charges at the end of the period covered by the computations, including any contingent deferred sales charge that would be applicable to a complete redemption of the investment at the end of the specified period. The Fund may also quote other total return information that does not reflect the effects of the sales load. The aggregate total return for the Class A shares of the Fund for the fiscal period from the inception of the Fund (January 3, 1995) through February 28, 1995 was -3.27%. Without reflecting the effects of the maximum 3.5% sales load, the aggregate total return for the Class A shares for such fiscal period was 0.00%. These performance quotations should not be considered as representative of the Fund's performance for any specified period in the future. The Class A shares of the Fund were not offered during such period. Aggregate total return is calculated similarly to annual total return, except that the return is aggregated, rather that annualized. The Fund's performance may be compared in advertisements, sales literature, shareholder reports, and other communications to the performance of other mutual funds having similar objectives or to standardized indices or other measures of investment performance. In particular, the Fund may compare its performance to the S&P 500 Index, which is generally considered to be representative of the performance of unmanaged common stocks that are publicly traded in the United States securities markets. Comparative performance may also be expressed by reference to a ranking prepared by a mutual fund monitoring service or by one or more newspapers, newsletters or financial periodicals. The Fund may also occasionally cite statistics to reflect its volatility and risk. The Fund may also compare its performance to published reports of the performance of unmanaged portfolios of companies located in the Greater Cincinnati Area. The performance of such unmanaged portfolios generally does not reflect the effects of dividends or dividend reinvestment. Of course, there can be no assurance that the Fund will experience the same results. Performance comparisons may be useful to investors who wish to compare the Fund's past performance to that of other mutual funds and investment products. Of course, past performance is not a guarantee of future results. The Fund's performance fluctuates on a daily basis largely because net earnings and net asset value per share fluctuate daily. Both net earnings and net asset value per share are factors in the computation of total return as described above. As indicated, from time to time, the Fund may advertise its performance compared to similar funds or portfolios using certain indices, reporting services, and financial publications. These may include the following: - Lipper Analytical Services, Inc. ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specific period of time. - Morningstar, Inc., an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. Investors may use such indices in addition to the Fund's Prospectus to obtain a more complete view of the Fund's performance before investing. Of course, when comparing the Fund's performance to any index, factors such as composition of the index and prevailing market conditions should be considered in assessing the significance of such comparisons. When comparing funds using reporting services, or total return, investors should take into consideration any relevant differences in funds such as permitted portfolio compositions and methods used to value portfolio securities and compute offering price. Advertisements and other sales literature for the Fund may quote total returns that are calculated on non-standardized base periods. The total returns represent the historic change in the value of an investment in the Fund based on monthly reinvestment of dividends over a specified period of time. From time to time the Fund may include in advertisements and other communications information, charts, and illustrations relating to inflation and the reflects of inflation on the dollar, including the purchasing power of the dollar at various rates of inflation. The Fund may also disclose from time to time information about its portfolio allocation and holdings at a particular date (including ratings of securities assigned by independent rating services such as S&P and Moody's). The Fund may also depict the historical performance of the securities in which the Fund may invest over periods reflecting a variety of market or economic conditions either alone or in comparison with alternative investments, performance indices of those investments, or economic indicators. The Fund may also include in advertisements and in materials furnished to present and prospective shareholders statements or illustrations relating to the appropriateness of types of securities and/or mutual funds that may be employed to meet specific financial goals, such as saving for retirement, children's education, or other future needs. The Fund will normally be at least 90% invested in equities. As a temporary defensive position, however, the Fund may invest up to 100% of its assets in investment grade bonds, U.S. Government Securities, repurchase agreements, or money market instruments ("Investment-Grade Debt Securities"). When the Fund invests in Investment Grade-Debt Securities as a temporary defensive measure, it is not pursuing its investment objective. Under normal circumstances, however, the fund may invest in money market or repurchase agreement instruments as described in the Prospectus. The various ratings used by the nationally recognized securities rating services are described below. A rating by a rating service represents the service's opinion as to the credit quality of the security being rated. However, the ratings are general and are not absolute standards of quality or guarantees as to the creditworthiness of an issuer. Consequently, the Advisor believes that the quality of fixed income securities in which the Fund may invest should be continuously reviewed and that individual analysts give different weightings to the various factors involved in credit analysis. A rating is not a recommendation to purchase, sell or hold a security, because it does not take into account market value or suitability for a particular investor. When a security has received a rating from more than one service, each rating is evaluated independently. Ratings are based on current information furnished by the issuer or obtained by the rating services from other sources that they consider reliable. Ratings may be changed, suspended or withdrawn as a result of changes in or unavailability of such information, or for other reasons. Standard & Poor's Ratings Group. The following summarizes the highest four ratings used by Standard & Poor's Ratings Group ("S&P") for bonds which are deemed to be "Investment-Grade Debt Securities" by the Advisor: AAA - This is the highest rating assigned by S&P to a debt obligation and indicates an extremely strong capacity to pay interest and repay principal. AA - Debt rated AA is considered to have a very strong capacity to pay interest and repay principal and differs from AAA issues only in a small degree. A - Debt rated A has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. BBB - Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for bonds in this category than for debt in higher rated categories. To provide more detailed indications of credit quality, the AA, A and BBB ratings may be modified by the addition of a plus or minus sign to show relative standing within these major rating categories. Bonds rated BB, B, CCC, CC and C are not considered by the Advisor to be "Investment-Grade Debt Securities" and are regarded, on balance, as predominantly speculative with respect to the issuer's capacity to pay interest and principal in accordance with the terms of the obligation. BB indicates the lowest degree of speculation and C the highest degree of speculation. While such bonds may have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. Commercial paper rated A-1 by S&P indicates that the degree of safety regarding timely payment is strong. Those issues determined to possess extremely strong safety characteristics are denoted A-1+. Capacity for timely payment on commercial paper rated A-2 is satisfactory, but the relative degree of safety is not as high as for issues designated A-1. The rating SP-1 is the highest rating assigned by S&P to municipal notes and indicates very strong or strong capacity to pay principal and interest. Those issues determined to possess overwhelming safety characteristics are given a plus (+) designation. Moody's Investors Service, Inc. The following summarizes the highest four ratings used by Moody's Investors Service, Inc. ("Moody's") for bonds which are deemed to be "Investment-Grade Debt Securities" by the Advisor: Aaa - Bonds that are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa - Bonds that are rated Aa are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in Aaa securities. A - Debt which is rated A possesses many favorable investment attributes and is to be considered as an upper medium grade obligation. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future. Baa - Debt which is rated Baa is considered as a medium grade obligation, i.e., it is neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such debt lacks outstanding investment characteristics and in fact has speculative characteristics as well. Moody's applies numerical modifiers (l, 2 and 3) with respect to bonds rated Aa, A and Baa. The modifier 1 indicates that the bond being rated ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the bond ranks in the lower end of its generic rating category. Bonds which are rated Ba, B, Caa, Ca or C by Moody's are not considered "Investment-Grade Debt Securities" by the Advisor. Bonds rated Ba are judged to have speculative elements because their future cannot be considered as well assured. Uncertainty of position characterizes bonds in this class, because the protection of interest and principal payments often may be very moderate and not well safeguarded. Bonds which are rated B generally lack characteristics of a desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the security over any long period for time may be small. Bonds which are rated Caa are of poor standing. Such securities may be in default or there may be present elements of danger with respect to principal or interest. Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings. Bonds which are rated C are the lowest rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. The rating Prime-1 is the highest commercial paper rating assigned by Moody's. Issuers rated Prime-1 (or related supporting institutions) are considered to have a superior capacity for repayment of short-term promissory obligations. Issuers rated Prime-2 (or related supporting institutions) are considered to have a strong capacity for repayment of short-term promissory obligations. This will normally be evidenced by many of the characteristics of issuers rated Prime-1 but to a lesser degree. Earnings trends and coverage ratios, while sound, will be more subject to variation. Capitalization characteristics, while still appropriated may be more affected by external conditions. Ample alternate liquidity is maintained. The following summarizes the highest rating used by Moody's for short-term notes and variable rate demand obligations: MIG-l; VMIG-l - Obligations bearing these designations are of the best quality, enjoying strong protection by established cash flows, superior liquidity support or demonstrated broad-based access to the market for refinancing. Duff & Phelps Credit Rating Co. The following summarizes the highest four ratings used by Duff & Phelps Credit Rating Co. ("D&P") for bonds which are deemed to be "Investment-Grade Debt Securities" by the Advisor: AAA - Bonds that are rated AAA are of the highest credit quality. The risk factors are considered to be negligible, being only slightly more than for risk-free U.S. Treasury debt. AA - Bonds that are rated AA are of high credit quality. Protection factors are strong. Risk is modest but may vary slightly from time to time because of economic conditions. A - Bonds rated A have average but adequate protection factors. The risk factors are more variable and greater in periods of economic stress. BBB - Bonds rated BBB have below average protection factors but are still considered sufficient for prudent investment. There is considerable variability in risk during economic cycles. Bonds rated BB, B and CCC by D&P are not considered "Investment-Grade Debt Securities" and are regarded, on balance, as predominantly speculative with respect to the issuer's ability to pay interest and make principal payments in accordance with the terms of the obligations. BB indicates the lowest degree of speculation and CCC the highest degree of speculation. The rating Duff l is the highest rating assigned by D&P for short-term debt, including commercial paper. D&P employs three designations, Duff l+, Duff 1 and Duff 1- within the highest rating category. Duff l+ indicates highest certainty of timely payment. Short-term liquidity, including internal operating factors and/or access to alternative sources of funds, is judged to be "outstanding, and safety is just below risk-free U.S. Treasury short-term obligations." Duff 1 indicates very high certainty of timely payment. Liquidity factors are excellent and supported by good fundamental protection factors. Risk factors are considered to be minor. Duff 1- indicates high certainty of timely payment. Liquidity factors are strong and supported by good fundamental protection factors. Risk factors are very small. Fitch Investors Service, Inc. The following summarizes the highest four ratings used by Fitch Investors Service, Inc. ("Fitch") for bonds which are deemed to be "Investment-Grade Debt Securities" by the Advisor: AAA - Bonds are considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal, which is unlikely to be affected by reasonably foreseeable events. AA - Bonds are considered to be investment grade and of very high credit quality. The obligor's ability to pay interest and repay principal is very strong, although not quite as strong as bonds rated AAA. Because bonds rated in the AAA and AA categories are not significantly vulnerable to foreseeable future developments, short-term debt of these issuers is generally rated F-1+. A - Bonds that are rated A are considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. BBB - Bonds rated BBB are considered to be investment grade and of satisfactory credit quality. The obligor's ability to pay interest and repay principal is considered to be adequate. Adverse changes in economic conditions and circumstances, however, are more likely to have adverse impact on these bonds, and therefore impair timely payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than for bonds with higher ratings. To provide more detailed indications of credit quality, the AA, A and BBB ratings may be modified by the addition of a plus or minus sign to show relative standing within a rating category. Bonds rated BB, B and CCC by Fitch are not considered "Investment-Grade Debt Securities" and are regarded, on balance, as predominantly speculative with respect to the issuer's ability to pay interest and make principal payments in accordance with the terms of the obligations. BB indicates the lowest degree of speculation and CCC the highest degree of speculation. The following summarizes the three highest ratings used by Fitch for short-term notes, municipal notes, variable rate demand instruments and commercial paper: F-1+ - Instruments assigned this rating are regarded as having the strongest degree of assurance for timely payment. F-1 - Instruments assigned this rating reflect an assurance of timely payment only slightly less in degree than issues rated F-1+ F-2 - Instruments assigned this rating have satisfactory degree of assurance for timely payment, but the margin of safety is not as great as for issues assigned F-1+ and F-1 ratings.	497	497	1996-01-12T00:00:00	1996-01-12T17:22:35
0000916764-96-000001	0000916764-96-000001_0000.txt	Lexington Emerging Markets Fund, Inc. P.O. Box 1515 / Park 80 West Plaza Two, Saddle Brook, New Jersey 07663 A NO-LOAD MUTUAL FUND WHOSE INVESTMENT OBJECTIVE IS TO SEEK LONG-TERM GROWTH OF CAPITAL PRIMARILY THROUGH INVESTMENT IN EQUITY SECURITIES OF COMPANIES DOMICILED IN, OR DOING BUSINESS IN EMERGING COUNTRIES AND EMERGING MARKETS. Lexington Emerging Markets Fund, Inc. is a no-load open-end diversified management investment company. The Fund's investment objective is to seek long-term growth of capital primarily through investment in equity securities of companies domiciled in, or doing business in emerging countries and emerging markets. Shares of the Fund may be purchased only by insurance companies for the purpose of funding variable annuity contracts and variable life insurance policies. Lexington Management Corporation ("LMC") is the Fund's investment adviser. Lexington Funds Distributor, Inc. ("LFD") is the distributor of Fund shares. This Prospectus sets forth information about the Fund you should know before investing. It should be read and retained for future reference. A Statement of Additional Information dated May 1, 1995 which provides a further discussion of certain matters in this Prospectus and other matters that may be of interest to some investors, has been filed with the Securities and Exchange Commission and is incorporated herein by reference. For a free copy, call the telephone number above or write to the address listed above. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. Investors Should Read and Retain this Prospectus for Future Reference The following Per Share Income and Capital Changes Information for the period March 30, 1994 (commencement of operations) to December 31, 1994 has been audited by KPMG Peat Marwick LLP, Independent Auditors, whose report thereon appears in the Statement of Additional Information. This information should be read in conjunction with the Financial Statements and related notes thereto included in the Statement of Additional Information. The Fund's annual report, which contains additional performance information, is available upon request and without charge. Lexington Emerging Markets Fund is an open-end management investment company organized as a corporation under the laws of Maryland. The Fund is intended to be the funding vehicle for variable annuity contracts and variable life insurance policies to be offered by the separate accounts of certain life insurance companies ("participating insurance companies"). The Fund currently does not foresee any disadvantages to the holders of variable annuity contracts and variable life insurance policies arising from the fact that the interests of the holders of such contracts and policies may differ. Nevertheless, the Fund's Directors intend to monitor events in order to identify any material irreconcilable conflicts which may possibly arise and to determine what action, if any, should be taken in response thereto. If a conflict were to occur, an insurance company separate account might be required to withdraw its investments in the Fund and the Fund might be forced to sell securities at disadvantageous prices. The variable annuity contracts and variable life insurance policies are described in the separate prospectuses issued by the Participating Insurance Companies. The Fund assumes no responsibility for such prospectuses. Individual variable annuity contract holders and variable life insurance policy holders are not "shareholders" of the Fund. The Participating Insurance Companies and their separate accounts are the shareholders or investors, although such companies may pass through voting rights to their variable annuity contract or variable life insurance policy. Shares of the Fund are not offered directly to the general public. The Fund's investment objective is to seek long-term growth of capital primarily through investment in equity securities and equivalents of companies domiciled in, or doing business in, emerging countries and emerging markets, as defined below. Due to the risks inherent in international investments generally, the Fund should be considered as a vehicle for investing a portion of an investor's assets in foreign securities markets and not as a complete investment program. The investment objective of the Fund is long-term growth of capital. The Fund seeks to achieve this objective by investing primarily in emerging country and emerging market equity securities. Equity securities will consist of all of common stocks and equivalents (the following constitute equivalents: convertible debt securities and warrants.) The Fund may also invest in preferred stocks, bonds, money market instruments of foreign and domestic companies, U.S. government, and governmental agencies. There can be no assurance that the Fund will be able to achieve its investment objective. The Fund's investment objective is a fundamental policy that may not be changed without the approval of a "majority of the Fund's outstanding voting securities" which means the lesser of (i) 67% of the shares represented at a meeting at which more than 50% of the outstanding shares are represented, or (ii) more than 50% of the outstanding shares. Under normal conditions, at least 65% of the Fund's total assets will be invested in emerging country and emerging market equity securities in at least three countries outside of the United States. For purposes of its investment objective, the Fund considers emerging country equity securities to be any country whose economy and market the World Bank or United Nations considers to be emerging or developing. The Fund may also invest in equity securities and equivalents traded in any market, of companies that derive 50% or more of their total revenue from either goods or services produced in such emerging countries and emerging markets or sales made in such countries. Determinations as to eligibility will be made by LMC based on publicly available information and inquiries made to the companies. It is possible in the future that sufficient numbers of emerging country or emerging market equity securities would be traded on securities markets in industrialized countries so that a major portion, if not all, of the Fund's assets would be invested in securities traded on such markets, although such a situation is unlikely at present. The Fund will maintain investments at all times in a minimum of three countries outside of the United States. Currently, investing in many of the emerging countries and emerging markets is not feasible or may involve political risks. Accordingly, LMC currently intends to consider investments only in those countries in which it believes investing is feasible and does not involve such risks. The list of acceptable countries will be reviewed by LMC and approved by the Board of Directors on a periodic basis and any additions or deletions with respect to such list will be made in accordance with changing economic and political circumstances involving such countries. (See Appendix). The Fund's investments in emerging country equity securities are not subject to any maximum limit, and it is the intention of LMC to invest substantially all of the Fund's assets in emerging country and emerging market equity securities. However, to the extent that the Fund's assets are not invested in emerging country and emerging market equity securities, the remaining 35% of the assets may be invested in (i) other equity securities without regard to whether they qualify as emerging country or emerging market equity securities, (ii) debt securities denominated in the currency of an emerging market or issued or guaranteed by an emerging market company or the government of an emerging country, and (iii) short-term and medium-term debt securities of the type described below under "Temporary Investments." The Fund's assets may be so invested in debt securities when LMC believes that, based upon factors such as relative interest rate levels and foreign exchange rates, such debt securities offer opportunities for long-term growth of capital. It is likely that many of the debt securities in which the Fund will invest will be unrated, and whether or not rated, such securities may have speculative characteristics. All unrated debt securities purchased by the Fund will be comparable to, or the issuers of such unrated securities will have the capacity to meet its debt obligations comparable to those issuers of rated securities. In addition, for temporary defensive purposes, the Fund may invest less than 65% of its assets in emerging country and emerging market equity securities, in which case the Fund may invest in other equity securities or may invest in debt securities of the sort described under "Temporary Investments" below. The Fund intends to purchase and hold securities for long-term growth of capital and does not expect to trade for short-term gain. Accordingly, it is anticipated that the annual portfolio turnover rate normally will not exceed 75%. A 100% turnover rate would occur if all of the Fund's portfolio investments were sold and either repurchased or replaced in a year. A higher turnover rate results in correspondingly greater brokerage commissions and other transactional expenses which are borne by the Fund. The Fund's portfolio turnover rate for the year ended December 31, 1994 was 71.21%. High portfolio turnover may result in the realization of net short-term capital gains by the Fund which, when distributed to shareholders, will be taxable as ordinary income. See "Tax Matters." The operating expenses of the Fund can be expected to be greater than that of an investment company investing exclusively in United States securities. For temporary defensive purposes, the Fund may invest up to 100% of its total assets in money market securities, denominated in dollars in the currency of any emerging country, issued by entities organized in the U.S. or any emerging country, such as: short-term (less than twelve months to maturity) and medium-term (not greater than five years to maturity) obligations issued or guaranteed by the U.S. Government or the government of an emerging country, their agencies or instrumentalities; finance company and corporate commercial paper, and other short-term corporate obligations, in each case rated Prime-1 by Moody's Investors Services, Inc. or A or better by Standard & Poor's Corporation or, if unrated, of comparable quality as determined by LMC, obligations (including certificates of deposit, time deposits and banker's acceptances) of banks; and repurchase agreements with banks and broker-dealers with respect to such securities. Repurchase agreements with respect to the securities described in the preceding paragraph are contracts under which the Fund would acquire a security for a relatively short period (usually not more than 7 days) subject to the obligations of the seller to repurchase and the Fund to resell such security at a fixed time and price (representing the Fund's cost plus interest). Although the Fund may enter into repurchase agreements with respect to any portfolio securities which it may acquire consistent with its investment policies and restrictions, it is the Fund's present intention to enter into repurchase agreements only with respect to obligations of the United States Government or its agencies or instrumentalities to meet anticipated redemptions or pending investments or reinvestments of Fund assets in portfolio securities. The Fund will enter into repurchase agreements only with member banks of the Federal Reserve System and with "primary dealers" in United States Government securities. Repurchase agreements are considered loans which must be fully collateralized including interest earned thereon during the entire term of the agreement. If the institution defaults on the repurchase agreement, the Fund will retain possession of the underlying securities. In addition if bankruptcy proceedings are commenced with respect to the seller, realization on the collateral by the Fund may be delayed or limited and the Fund may incur additional costs. In such case the Fund will be subject to risks associated with changes in market value of the collateral securities. The Fund intends to limit repurchase agreements to institutions believed by LMC to present minimal credit risk. The Fund will not enter into repurchase agreements maturing in more than seven days if the aggregate of such repurchase agreements and all other illiquid securities when taken together would exceed 10% of the total assets of the Fund. Certain Investment Methods-The Fund may from time to time engage in the following investment practices: Settlement Transactions-The Fund may, for a fixed amount of United States dollars, enter into a foreign exchange contract for the purchase or sale of the amount of foreign currency involved in the underlying securities transaction. In so doing, the Fund will attempt to insulate itself against possible losses and gains resulting from a change in the relationship between the United States dollar and the foreign currency during the period between the date a security is purchased or sold and the date on which payment is made or received. This process is known as "transaction hedging". To effect the translation of the amount of foreign currencies involved in the purchase and sale of foreign securities and to effect the "transaction hedging" described above, the Fund may purchase or sell foreign currencies on a "spot" (i.e. cash) basis or on a forward basis whereby the Fund purchases or sells a specific amount of foreign currency, at a price set at the time of the contract, for receipt or delivery at a specified date which may be any fixed number of days in the future. Such spot and forward foreign exchange transactions may also be utilized to reduce the risk inherent in fluctuations in the exchange rate between the United States dollar and the relevant foreign currency when foreign securities are purchased or sold for settlement beyond customary settlement time (as described below). Neither type of foreign currency transaction will eliminate fluctuations in the prices of the Fund's portfolio or securities or prevent loss if the price of such securities should decline. Portfolio Hedging-When, in the opinion of LMC, it is desirable to limit or reduce exposure in a foreign currency in order to moderate potential changes in the United States dollar value of the portfolio, the Fund may enter into a forward foreign currency exchange contract by which the United States dollar value of the underlying foreign portfolio securities can be approximately matched by an equivalent United States dollar liability. The Fund, for hedging purposes only, may also enter into forward currency exchange contracts to increase its exposure to a foreign currency that LMC expects to increase in value relative to the United States dollar. The Fund will not attempt to hedge all of its portfolio positions and will enter into such transactions only to the extent, if any, deemed appropriate by LMC. Hedging against a decline in the value of currency does not eliminate fluctuations in the prices of portfolio securities or prevent losses if the prices of such securities decline. The Fund will not enter into forward foreign currency exchange transactions for speculative purposes. The Fund intends to limit such transactions to not more than 70% of total Fund assets. Forward Commitments-The Fund may make contracts to purchase securities for a fixed price at a future date beyond customary settlement time ("forward commitments") because new issues of securities are typically offered to investors, such as the Fund, on that basis. Forward commitments involve a risk of loss if the value of the security to be purchased declines prior to the settlement date. This risk is in addition to the risk of decline in value of the Fund's other assets. Although the Fund will enter into such contracts with the intention of acquiring the securities, the Fund may dispose of a commitment prior to settlement if LMC deems it appropriate to do so. The Fund may realize short-term profits or losses upon the sale of forward commitments. When the Fund engages in a forward commitment transaction, the custodian will set aside cash, U.S. Government securities or other high quality debt obligations equal to the amount of the commitment in a separate account. Except as otherwise specifically noted, the Fund's investment objective and its investment restrictions are fundamental and may not be changed without the approval of a majority of the outstanding voting securities of the Fund. The Statement of Additional Information contains a complete description of the Fund's restrictions and additional information on policies relating to the investment of its assets and its activities. Investments in emerging market and emerging country equity securities may involve risks and considerations not present in domestic investments. Since foreign securities generally are denominated and pay interest or dividends in foreign currencies, the value of the assets of the Fund as measured in United States dollars will be affected favorably or unfavorably by changes in the relationship of the United States dollar and other currency rates. The Fund may incur costs in connection with the conversion or transfer of foreign currencies. In addition, there may be less publicly available information about foreign companies than United States companies. Foreign companies may not be subject to accounting, auditing, and financial reporting standards, practices and requirements comparable to those applicable to United States companies. Foreign securities markets, while growing in volume, have for the most part substantially less volume than United States securities markets and securities of foreign companies are generally less liquid and at times their prices may be more volatile than securities of comparable United States companies. Foreign stock exchanges, brokers and listed companies are generally subject to less government supervision and regulation than in the United States. The customary settlement time for foreign securities may be longer than the 5 day customary settlement time for United States securities. Although the Fund will try to invest in companies and governments of countries having stable political environments, there is the possibility of expropriation or confiscatory taxation, seizure or nationalization or foreign government restrictions or other adverse political, social or diplomatic developments that could affect investment in these nations. (See "Risk Considerations" in the Statement of Additional Information for further information.) Income from foreign securities held by the Fund may, and in some cases will be reduced by a withholding tax at the source or other foreign taxes. A shareholder of the Fund will, subject to certain restrictions, be entitled to claim a credit or deduction for United States Federal income tax purposes for the shareholder's pro rata share of such foreign taxes paid by the Fund. (See The Fund's investment program is subject to a number of investment restrictions which reflect self imposed standards as well as federal and state regulatory limitations. These restrictions are designed to minimize certain risks associated with investing in certain types of securities or engaging in certain transactions. The most significant of these restrictions provide that: (1) The Fund will not borrow money, except that (a) the Fund may enter into certain futures contracts and options related thereto; (b) the Fund may enter into commitments to purchase securities in accordance with the Fund's investment program, including delayed delivery and when-issued securities and reverse repurchase agreements; (c) for temporary emergency purposes, the Fund may borrow money in amounts not exceeding 5% of the value of its total assets at the time when the loan is made; (d) The Fund may pledge its portfolio securities or receivables or transfer or assign or otherwise encumber them in an amount not exceeding one-third of the value of its total assets; and (e) for purposes of leveraging, the Fund may borrow money from banks (including its custodian bank), only if, immediately after such borrowing, the value of the Fund's assets, including the amount borrowed, less its liabilities, is equal to at least 300% of the amount borrowed, plus all outstanding borrowings. If at any time, the value of the Fund's assets fails to meet the 300% asset coverage requirement relative only to leveraging, the Fund will, within three days (not including Sundays and holidays), reduce its borrowings to the extent necessary to meet the 300% test. The Fund will only invest up to 5% of its total assets in reverse repurchase agreements. (2) The Fund will not make loans, except that, to the extent appropriate under its investment program, the Fund may (a) purchase bonds, debentures or other debt securities, including short-term obligations, (b) enter into repurchase transactions and (c) lend portfolio securities provided that the value of such loaned securities does not exceed one-third of the Fund's total assets. (3) The Fund will not concentrate its investments in any one industry, except that the Fund may invest up to 25% of its total assets in securities issued by companies principally engaged in any one industry. The Fund considers foreign government securities and supranational organizations to be industries. This limitation, however, will not apply to securities issued or guaranteed by the U.S. Government, its agencies and instrumentalities. (4) The Fund will not purchase securities of an issuer, if (a) more than 5% of the Fund's total assets taken at market value would at the time be invested in the securities of such issuer, except that such restriction shall not apply to securities issued or guaranteed by the United States govemment or its agencies or instrumentalities or, with respect to 25% of the Fund's total assets, to securities issued or guaranteed by the government of any country other than the United States which is a member of the Organization for Economic Cooperation and Development ("OECD"). The member countries of OECD are at present: Australia, Austria, Belgium, Canada, Denmark, Germany, Finland, France, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States; or (b) such purchases would at the time result in more than 10% of the outstanding voting securities of such issuer being held by the Fund. The forgoing investment restrictions (as well as certain others set forth in the Statement of Additional Information) are matters of fundamental policy which may not be changed without the affirmative vote of the majority of the shareholders of the Fund. The investment policies described below are non-fundamental, therefore, changes to such policies may be made in the future by the Board of Directors without the approval of the shareholders of the Fund: (1) The Fund may purchase and sell futures contracts and related options under the following conditions: (a) the then-current aggregate futures market prices of financial instruments required to be delivered and purchased under open futures contracts shall not exceed 30% of the Fund's total assets, at market value; and (b) no more than 5% of the assets, at market value at the time of entering into a contract, shall be committed to margin deposits in relation to futures contracts. (2) The Fund will not invest more than 15% of its total assets in illiquid securities. Illiquid securities are securities that are not readily marketable or cannot be disposed of promptly within seven days and in the usual course of business without taking a materially reduced price. Such securities include, but are not limited to, time deposits and repurchase agreements with maturities longer than seven days. Securities that may be resold under Rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended, shall not be deemed illiquid solely by reason of being unregistered. The Investment Adviser shall determine whether a particular security is deemed to be liquid based on the trading markets for the specific security and other factors. The Fund has a Board of Directors which establishes the Fund's policies and supervises and reviews the operations and management of the Fund. Lexington Management Corporation ("LMC"), P.O. Box 1515, Park 80 West Plaza Two, Saddle Brook, New Jersey 07663, is the investment adviser of the Fund. For its investment management services to the Fund, under its investment advisory agreement, LMC will receive a monthly fee at the annual rate of 0.85% of the Fund's average daily net assets. LMC has agreed to voluntarily limit the total expenses of the Fund (excluding interest, taxes, brokerage, and extraordinary expenses but including management fee and operating expenses) to an annual rate of 1.30% of the Fund's average net assets. Lexington Funds Distributor, Inc. ("LFD"), a registered broker-dealer, is the Fund's distributor. LMC also acts as administrator to the Fund and performs certain administrative and accounting services, including but not limited to, maintaining general ledger accounts, regulatory compliance, preparation of financial information for semiannual and annual reports, preparing registration statements, calculating net asset values, shareholder communications and supervision of the custodian, transfer agent and provides facilities for such services. The Fund shall reimburse the Administrator for its actual cost in providing such services, facilities and expenses. From time to time, LMC may pay amounts from its past profits to participating insurance companies or insurance companies or other financial institutions that provide administrative services for the Fund or that provide to contract holders other services relating to the Fund. These services may include, among other things, sub-accounting services, answering inquiries of contract holders regarding the Fund, transmitting, on behalf of the Fund, proxy statements, annual reports, updated prospectus and other communications to contract holders regarding the Fund, and such other related services as the Fund or a contract holder may request. LMC will not pay more than 0.25% of the average daily net assets of the Fund represented by shares of the Fund held in the separate account of any participating insurance company. Payment of such amounts by LMC will not increase the fees paid by the Fund or its shareholders. LMC was established in 1938 and currently manages and administers over $3.8 billion in assets. LMC serves as investment adviser to other investment companies and private and institutional investment accounts. Included among these clients are persons and organizations that own significant amounts of capital stock of LMC's parent, Piedmont Management Company Inc. The clients pay fees that LMC considers comparable to the fees paid by similarly served clients. LMC and LFD are wholly-owned subsidiaries of Piedmont Management Company Inc., a Delaware corporation with offices at 80 Maiden Lane, New York, New York 10038. Descendants of Lunsford Richardson, Sr., their spouses, trusts and other related entities are the beneficial owners of a majority of the shares of Piedmont Management Company Inc. common stock. See "Investment Adviser and Distributor" in the Statement of Additional Information. The Fund is managed by an investment management team. Richard T. Saler is lead manager. Richard T. Saler is Senior Vice President, Director of International Investment Strategy of LMC. Mr. Saler is responsible for international investment analysis and portfolio management at LMC. He has nine years of investment experience. Mr. Saler has focused on international markets since first joining Lexington in 1986. In 1991 he was an investment strategist with Nomura Securities and rejoined Lexington in 1992. Mr. Saler is a graduate of New York University with a B.S. Degree in Marketing and an M.B.A. in Finance from New York University's Graduate School of Business Administration. HOW TO PURCHASE AND REDEEM SHARES With the exception of shares held in connection with initial capital of the Fund, shares of the Fund are currently available for purchase solely by insurance companies for the purpose of funding variable annuity contracts. Shares of the Fund are purchased and redeemed at net asset value next calculated after a purchase or redemption order is received by the Fund in good order. There are no minimum investment requirements. Payment for shares redeemed will be made as soon as possible, but in any event within seven days after the order for redemption is received by the Fund. However, payment may be postponed under unusual circumstances, such as when normal trading is not taking place on the New York Stock Exchange. DETERMINATION OF NET ASSET VALUE The net asset value of the shares of the Fund is computed as of the close of trading on each day the New York Stock Exchange is open, by dividing the value of the Fund's securities plus any cash and other assets (including accrued dividends and interest) less all liabilities (including accrued expenses) by the number of shares outstanding, the result being adjusted to the nearest whole cent. A security listed or traded on a recognized stock exchange is valued at its last sale price prior to the time when assets are valued on the principal exchange on which the security is traded. If no sale is reported at that time, the mean between the current bid and asked price will be used. All other securities for which the over-the-counter market quotations are readily available are valued at the mean between the last current bid and asked price. Short-term securities having maturity of 60 days or less are valued at amortized cost when it is determined by the Fund's Board of Directors that amortized cost reflects the fair value of such securities. Securities for which market quotations are not readily available and other assets are valued at fair value as determined by the management and approved in good faith by the Board of Directors. Generally, trading in foreign securities markets is substantially completed each day at various times prior to the close of the New York Stock Exchange. The values of foreign securities used in computing the net asset value of the shares of the Fund are determined as of the earlier of such market close or the closing time of the New York Stock Exchange (the "Exchange"). Foreign currency exchange rates are also generally determined prior to the close of the Exchange. Occasionally, events affecting the value of such securities and such exchange rates may occur between the times at which they are determined and the close of the Exchange, which will not be reflected in the computation of net asset value. If, during such periods, events occur which materially affect the value of such securities, the securities will be valued at their fair market value as determined by the investment adviser and approved in good faith by the Directors. In order to determine net asset value per share, the aggregate value of portfolio securities is added to the value of the Fund's other assets, such as cash and receivables; the total of the assets thus obtained, less liabilities, is then divided by the number of shares outstanding. The Fund will calculate performance on a total return basis for various periods. The total return basis combines changes in principal and dividends for the periods shown. Principal changes are based on the difference between the beginning and closing net asset value for the period and assumes reinvestment of dividends paid by the Fund. Dividends are comprised of net investment income and net realized capital gains, respectively. Performance will vary from time to time and past results are not necessarily representative of future results. A shareholder should remember that performance is a function of portfolio management in selecting the type and quality of portfolio securities and is affected by operating expenses. Comparative performance information may be used from time to time in advertising or marketing of the Fund's shares, including data from Lipper Analytical Services, Inc. or major market indices such as the Dow Jones Industrial Average Index, Standard & Poor's 500 Composite Stock Price Index and Morgan Stanley Capital International World Index. Such comparative performance information will be stated in the same terms in which the comparative data and indices are stated. Further information about the Fund's performance is contained in the annual report, which may be obtained without charge. DIVIDEND, DISTRIBUTION AND REINVESTMENT POLICY The Fund intends to declare or distribute a dividend from its net investment income and/or net capital gain income to shareholders annually or more frequently if necessary in order to comply with distribution requirements of the Code to avoid the imposition of regular Federal income tax, and if applicable, a 4% excise tax. Any dividends and distribution payments will be reinvested at net asset value, without sales charge, in additional full and fractional shares of the Fund. Dividend and capital gain distributions are generally not currently taxable to owners of variable contracts. The Fund. The Fund intends to qualify as a regulated investment company by satisfying the requirements under Subchapter M of the Internal Revenue Code, as amended (the "Code"), concerning the diversification of assets, distribution of income, and sources of income. When a Fund qualifies as a regulated investment company and all of its taxable income is distributed in accordance with the timing requirements imposed by the Code, the Fund will not be subject to Federal income tax. If, however, for any taxable year a Fund does not qualify as a regulated investment company, then all of its taxable income will be subject to tax at regular corporate rates (without any deduction for distributions to the separate accounts of the Participating Insurance Companies), and the receipt of such distributions will be taxable to the extent that the distributing Fund has current and accumulated earnings and profits. Fund distributions. Distributions by the Fund are taxable, if at all, to the separate accounts of the Participating Insurance Companies, and not to variable annuity contract holders and variable life insurance policy holders. Distributions will be included in the taxable income of the separate accounts of the Participating Insurance Companies in the year in which they are received (whether paid in cash or reinvested). Share redemptions. Redemptions of the shares held by the separate accounts of the Participating Insurance Companies generally will not result in gain or loss for the separate accounts of the Participating Insurance Companies and will not result in gain or loss for the variable annuity contract holders and variable life insurance policy holders. Summary. The foregoing discussion of Federal income tax consequences is based on tax laws and regulations in effect on the date of this Prospectus, and is subject to change by legislative or administrative action. The foregoing discussion also assumes that the separate accounts of the Participating Insurance Companies are the owners of the shares and that policies or contracts qualify as life insurance policies or annuities, respectively, under the Code. If the foregoing requirements are not met then the variable annuity contract holders and variable life insurance policy holders will be treated as recognizing income (from distributions or otherwise) related to the ownership of Fund shares. The foregoing discussion is for general information only; a more detailed discussion of Federal income tax considerations is contained in the Statement of Additional Information. Variable annuity contract holders and variable life insurance policy holders must consult the prospectuses of their respective contracts or policies for information concerning the Federal income tax consequences of owning such contracts or policies. ORGANIZATION AND DESCRIPTION OF COMMON STOCK The Company is an open-end, diversified management investment company organized as a corporation under the laws of the State of Maryland on December 27, 1993, and has authorized capital of 1,000,000,000 shares of common stock, par value $.001 of which 500,000,000 have been designated Lexington Emerging Markets Fund Series. Each share of common stock has one vote and shares equally in dividends and distributions when and if declared by the Company and in the Company's net assets upon liquidation. All shares, when issued, are fully paid and non-assessable. There are no preemptive, conversion or exchange rights. Fund shares do not have cumulative voting rights and, as such, holders of at least 50% of the shares voting for Directors can elect all Directors and the remaining shareholders would not be able to elect any Directors. Shareholders of the Fund are given certain voting rights. Each share of the Fund will be given one vote. Participating insurance companies provide variable annuity contracts holders and variable life insurance policy holders the right to direct the voting of Fund shares at shareholder meetings to the extent required by law. See the Separate Account Prospectus for the Variable Annuity Contract or Variable Life Insurance Policy Section for more information regarding the pass through of these voting rights. The Fund will not normally hold annual shareholder meetings except as required by Maryland General Corporation Law or the Investment Company Act of 1940. However, meetings of shareholders may be called at any time by the Secretary upon the written request of shareholders holding in the aggregate not less than 10% of the outstanding shares, such request specifying the purposes for which such meeting is to be called. In addition, the Directors will promptly call a meeting of shareholders for the purpose of voting upon the question of removal of any Director when requested to do so in writing by the recordholders of not less than 10% of the Fund's outstanding shares. The Fund will assist shareholders in any such communication between shareholders and Directors. CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT Chase Manhattan Bank, N.A., 1211 Avenue of the Americas, New York, New York 10036 has been retained to act as custodian for the Fund's portfolio securities including those to be held by foreign banks and foreign securities depositories that qualify as eligible foreign custodians under the rules adopted by the SEC and for the Fund's domestic securities and other assets. State Street Bank and Trust Company, c/o National Financial Data Services, 1004 Baltimore, Kansas City, Missouri 64105, has been retained to act as the transfer agent and dividend disbursing agent for the Fund. Neither Chase Manhattan Bank, N.A. nor State Street Bank and Trust Company have any part in determining the investment policies of the Fund or in determining which portfolio securities are to be purchased or sold by the Fund or in the declaration of dividends and distributions. Kramer, Levin, Naftalis, Nessen, Kamin & Frankel, 919 Third Avenue, New York, New York 10022 will pass upon legal matters for the Fund in connection with the shares offered by this Prospectus. KPMG Peat Marwick LLP, 345 Park Avenue, New York, New York 10154, has been selected as independent auditors for the Fund for the fiscal year ending December 31, 1995. This prospectus omits certain information contained in the registration statement filed with the SEC. Copies of the registration statement, including items omitted herein, may be obtained from the SEC by paying the charges prescribed under its rules and regulations. The Statement of Additional Information included in such registration statement may be obtained without charge from the Fund. No person has been authorized to give any information or to make any representation other than those contained in this Prospectus, and information or representations not herein contained, if given or made, must not be relied upon as having been authorized by the Fund. This Prospectus does not constitute an offer or solicitation in any jurisdiction in which such offering may not lawfully be made. L E X I N G T O N P R O S P E C T U S P.O. Box 1515/Park 80 West Plaza Two P.O. Box 1515/Park 80 West Plaza Two STATE STREET BANK AND TRUST COMPANY c/o National Financial Data Services Description of the Fund ....................... 2 Investment Objective and Policies ............. 2 Management of the Fund ........................ 6 How to Purchase and Redeem Shares ............. 7 Determination of Net Asset Value .............. 7 Dividend, Distribution and Reinvestment Policy 8 Organization and Description of Common Stock .. 8 Dividend Disbursing Agent ................... 9 Counsel and Independent Auditors .............. 9 LEXINGTON EMERGING MARKETS FUND, INC. This Statement of Additional Information which is not a prospectus, should be read in conjunction with the current prospectus of Lexington Emerging Markets Fund, Inc. (the "Fund"), dated May 1, 1995, and as it may be revised from time to time. To obtain a copy of the Fund's prospectus at no charge, please write to the Fund at P.O. Box 1515/Park 80 West - Plaza Two, Saddle Brook, New Jersey 07663 or call the following number: 201-845- 7300. Lexington Management Corporation is the Fund's investment adviser. Lexington Funds Distributor, Inc. is the Fund's distributor. Investment Objective and Policies . . . . . . . . . . . . . . . . . 2 Risk Considerations. . . . . . . . . . . . . . . . . . . . . . . . . 3 Investment Restrictions. . . . . . . . . . . . . . . . . . . . . . . 5 Management of the Fund . . . . . . . . . . . . . . . . . . . . . . . 7 Investment Adviser, Distributor and Administrator . . . . . . . . . 9 Portfolio Transactions and Brokerage Commissions . . . . . . . . . .10 Determination of Net Asset Value . . . . . . . . . . . . . . . . . .11 Tax Matters. . . . . . . . . . . . . . . . . . . . . . . . . . . . .11 Performance Calculation. . . . . . . . . . . . . . . . . . . . . . .19 Other Information. . . . . . . . . . . . . . . . . . . . . . . . . .19 Financial Statements . . . . . . . . . . . . . . . . . . . . . . . .20 For a full description of the Fund's investment objective and policies, see the Prospectus under "Investment Objective and Policies". Settlement Transactions - When the Fund enters into contracts for purchase or sale of a portfolio security denominated in a foreign currency, it may be required to settle a purchase transaction in the relevant foreign currency or receive the proceeds of a sale in that currency. In either event, the Fund will be obligated to acquire or dispose of such foreign currency as is represented by the transaction by selling or buying an equivalent amount of United States dollars. Furthermore, the Fund may wish to "lock in" the United States dollar value of the transaction at or near the time of a purchase or sale of portfolio securities at the exchange rate or rates then prevailing between the United States dollar and the currency in which the foreign security is denominated. Therefore, the Fund may, for a fixed amount of United States dollars, enter into a forward foreign exchange contract for the purchase or sale of the amount of foreign currency involved in the underlying securities transaction. In so doing, the Fund will attempt to insulate itself against possible losses and gains resulting from a change in the relationship between the United States dollar and the foreign currency during the period between the date a security is purchased or sold and the date on which payment is made or received. This process is known as "transaction hedging". To effect the translation of the amount of foreign currencies involved in the purchase and sale of foreign securities and to effect the "transaction hedging" described above, the Fund may purchase or sell foreign currencies on a "spot" (i.e. cash) basis or on a forward basis whereby the Fund purchases or sells a specific amount of foreign currency, at a price set at the time of the contract, for receipt of delivery at a specified date which may be any fixed number of days in the future. Such spot and forward foreign exchange transactions may also be utilized to reduce the risk inherent in fluctuations in the exchange rate between the United States dollar and the relevant foreign dollar and the relevant foreign currency when foreign securities are purchased or sold for settlement beyond customary settlement time (as described below). Neither type of foreign currency transaction will eliminate fluctuations in the prices of the Fund's portfolio or securities or prevent loss if the price of such securities should decline. Portfolio Hedging - Some or all of the Fund's portfolio will be denominated in foreign currencies. As a result, in addition to the risk of change in the market value of portfolio securities, the value of the portfolio in United States dollars is subject to fluctuations in the exchange rate between such foreign currencies and the United States dollar. When, in the opinion of LMC, it is desirable to limit or reduce exposure in a foreign currency in order to moderate potential changes in the United States dollar value of the portfolio, the Fund may enter into a forward foreign currency exchange contract by which the United States dollar value of the underlying foreign portfolio securities can be approximately matched by an equivalent United States dollar liability. This technique is known as "portfolio hedging" and moderates or reduces the risk of change in the United States dollar value of the Fund's portfolio only during the period before the maturity of the forward contract (which will not be in excess of one year). The Fund, for hedging purposes only, may also enter into forward foreign currency exchange contracts to increase its exposure to a foreign currency that the Fund's investment adviser expects to increase in value relative to the United States dollar. The Fund will not attempt to hedge all of its foreign portfolio positions and will enter into such transactions only to the extent, if any, deemed appropriate by the investment adviser. Hedging against a decline in the value of currency does not eliminate fluctuations in the prices of portfolio securities or prevent losses if the prices of such securities decline. The Fund will not enter into forward foreign currency exchange transactions for speculative purposes. The Fund intends to limit transactions as described in this paragraph to not more than 70% of the total Fund assets. Forward Commitments - The Fund may make contracts to purchase securities for a fixed price at a future date beyond customary settlement time ("forward commitments") because new issues of securities are typically offered to investors, such as the Fund, on that basis. Forward commitments involve a risk of loss if the value of the security to be purchased declines prior to the settlement date. This risk is in addition to the risk of decline in value of the Fund's other assets. Although the Fund will enter into such contracts with the intention of acquiring the securities, the Fund may dispose of a commitment prior to settlement if the investment adviser deems it appropriate to do so. The Fund may realize short-term profits or losses upon the sale of forward commitments. Covered Call Options - Call options may also be used as a means of participating in an anticipated price increase of a security on a more limited basis than would be possible if the security itself were purchased. The Fund may write only covered call options. Since it can be expected that a call option will be exercised if the market value of the underlying security increases to a level greater than the exercise price, this strategy will generally be used when the investment adviser believes that the call premium received by the Fund plus anticipated appreciation in the price of the underlying security, up to the exercise price of the call, will be greater than the appreciation in the price of the security. The Fund intends to limit transactions as described in this paragraph to less than 5% of total Fund assets. The Fund will not purchase put and call options written by others. Also, the Fund will not write any put options. Investors should recognize that investing in securities of companies in emerging markets and emerging countries involves certain risk considerations, including those set forth below, which are not typically associated with investing in securities of U.S. companies. The Fund's assets will be invested in securities of companies in emerging markets and emerging countries and substantially all income will be received by the Fund in foreign currencies. However, the Fund will compute and distribute its income in dollars, and the computation of income will be made on the date of its receipt by the Fund at the foreign exchange rate in effect on that date. Therefore, if the value of the foreign currencies in which the Fund receives its income falls relative to the dollar between receipt of the income and the making of Fund distributions, the Fund will be required to liquidate securities in order to make distributions if the Fund has insufficient cash in dollars to meet distribution requirements. The value of the assets of the Fund as measured in dollars also may be affected favorably or unfavorably by fluctuations in currency rates and exchange control regulations. Further, the Fund may incur costs in connection with conversions between various currencies. Foreign exchange dealers realize a profit based on the difference between the prices at which they are buying and selling various currencies. Thus, a dealer normally will offer to sell a foreign currency to the Fund at one rate, while offering a lesser rate of exchange should the Fund desire immediately to resell that currency to the dealer. The Fund will conduct its foreign currency exchange transactions either on a spot (i.e., cash) basis at the spot rate prevailing in the foreign currency exchange market, or through entering into forward or futures contracts to purchase or sell foreign currencies. Some emerging countries have laws and regulations which currently preclude direct foreign investment in the securities of their companies. However, indirect foreign investment in the securities of companies listed and traded on the stock exchanges in these countries is permitted by certain emerging countries through investment funds which have been specifically authorized. The Fund may invest in these investment funds subject to the provisions of the 1940 Act as discussed below under "Investment Restrictions". If the Fund invests in such investment funds, the Fund's shareholders will bear not only their proportionate share of the expenses of the Fund (including operating expenses and the fees of the Investment Manager), but also will bear indirectly similar expenses of the underlying investment funds. In addition to the foregoing investment restrictions, prior governmental approval for foreign investments may be required under certain circumstances in some emerging countries, while the extent of foreign investment in domestic companies may be subject to limitation in other emerging countries. Foreign ownership limitations also may be imposed by the charters of individual companies in emerging countries to prevent, among other concerns, violation of foreign investment limitations. Repatriation of investment income, capital and the proceeds of sales by foreign investors may require governmental registration and/or approval in some emerging countries. The Fund could be adversely affected by delays in or a refusal to grant any required governmental approval for such repatriation. Emerging Country and Emerging Market Securities Markets Trading volume on emerging country stock exchanges is substantially less than that on the New York Stock Exchange. Further, securities of some emerging country or emerging market companies are less liquid and more volatile than securities of comparable U.S. companies. Similarly, volume and liquidity in most emerging country bond markets is substantially less than in the U.S. and, consequently, volatility of price can be greater than in the U.S. Fixed commissions on emerging country stock or emerging market exchanges are generally higher than negotiated commissions on U.S. exchanges, although the Fund endeavors to achieve the most favorable net results on its portfolio transactions and may be able to purchase the securities in which the Fund may invest on other stock exchanges where commissions are negotiable. Companies in emerging countries are not generally subject to uniform accounting, auditing and financial reporting standards, practices and disclosure requirements comparable to those applicable to U.S. companies. Consequently, there may be less publicly available information about an emerging country company than about a U.S. company. Further, there is generally less governmental supervision and regulation of foreign stock exchanges, brokers and listed companies than in the U.S. The economies of individual emerging countries may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross domestic product, rate of inflation, capital reinvestment, resource self- sufficiency and balance of payments position. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. These economies also have been and may continue to be adversely affected by economic conditions in the countries with which they trade. With respect to any emerging country, there is the possibility of nationalization, expropriation or confiscatory taxation, political changes, government regulation, social instability or diplomatic developments (including war) which could affect adversely the economies of such countries or the Fund's investments in those countries. In addition, it may be more difficult to obtain a judgement in a court outside of the United States. The Fund's investment objective, as described under "investment policy" and the following investment restrictions are matters or fundamental policy which may not be changed without the affirmative vote of the lesser of (a) 67% or more of the shares of the Fund present at a shareholders' meeting at which more than 50% of the outstanding shares are present or represented by proxy or (b) more than 50% of the outstanding shares. Under these investment restrictions: (1) the Fund will not issue any senior security (as defined in the 1940 Act), except that (a) the Fund may enter into commitments to purchase securities in accordance with the Fund's investment program, including reverse repurchase agreements, foreign exchange contracts, delayed delivery and when-issued securities, which may be considered the issuance of senior securities; (b) the Fund may engage in transactions that may result in the issuance of a senior security to the extent permitted under applicable regulations, interpretation of the 1940 Act or an exemptive order; (c) the Fund may engage in short sales of securities to the extent permitted in its investment program and other restrictions; (d) the purchase or sale of futures contracts and related options shall not be considered to involve the issuance of senior securities; and (e) subject to fundamental restrictions, the Fund may borrow money as authorized by the 1940 Act. (2) The Fund will not borrow money, except that (a) the Fund may enter into certain futures contracts and options related thereto; (b) the Fund may enter into commitments to purchase securities in accordance with the Fund's investment program, including delayed delivery and when-issued securities and reverse repurchase agreements; (c) for temporary emergency purposes, the Fund may borrow money in amounts not exceeding 5% of the value of its total assets at the time when the loan is made; (d) The Fund may pledge its portfolio securities or receivables or transfer or assign or otherwise encumber them in an amount not exceeding one-third of the value of its total assets; and (e) for purposes of leveraging, the Fund may borrow money from banks (including its custodian bank), only if, immediately after such borrowing, the value of the Fund's assets, including the amount borrowed, less its liabilities, is equal to at least 300% of the amount borrowed, plus all outstanding borrowings. If at any time, the value of the Fund's assets fails to meet the 300% asset coverage requirement relative only to leveraging, the Fund will, within three days (not including Sundays and holidays), reduce its borrowings to the extent necessary to meet the 300% test. The Fund will only invest up to 5% of its total assets in reverse repurchase agreements. (3) The Fund will not act as an underwriter of securities except to the extent that, in connection with the disposition of portfolio securities by the Fund, the Fund may be deemed to be an underwriter under the provisions of the 1933 Act. (4) The Fund will not purchase real estate, interests in real estate or real estate limited partnership interests except that, to the extent appropriate under its investment program, the Fund may invest in securities secured by real estate or interests therein or issued by companies, including real estate investment trusts, which deal in real estate or interests therein. (5) The Fund will not make loans, except that, to the extent appropriate under its investment program, the Fund may (a) purchase bonds, debentures or other debt securities, including short-term obligations, (b) enter into repurchase transactions and (c) lend portfolio securities provided that the value of such loaned securities does not exceed one-third of the Fund's total assets. (6) The Fund will not invest in commodity contracts, except that the Fund may, to the extent appropriate under its investment program, purchase securities of companies engaged in such activities, may enter into transactions in financial and index futures contracts and related options, may engage in transactions on a when-issued or forward commitment basis, and may enter into forward currency contracts. (7) The Fund will not concentrate its investments in any one industry, except that the Fund may invest up to 25% of its total assets in securities issued by companies principally engaged in any one industry. The Fund considers foreign government securities and supranational organizations to be industries. This limitation, however, will not apply to securities issued or guaranteed by the U.S. Government, its agencies and instrumentalities. (8) The Fund will not purchase securities of an issuer, if (a) more than 5% of the Fund's total assets taken at market value would at the time be invested in the securities of such issuer, except that such restriction shall not apply to securities issued or guaranteed by the United States government or its agencies or instrumentalities or, with respect to 25% of the Fund's total assets, to securities issued or guaranteed by the government of any country other than the United States which is a member of the Organization for Economic Cooperation and Development ("OECD"). The member countries of OECD are at present: Australia, Austria, Belgium, Canada, Denmark, Germany, Finland, France, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States; or (b) such purchases would at the time result in more than 10% of the outstanding voting securities of such issuer being held by the Fund. In additional to the above fundamental restrictions, the Fund has undertaken the following non fundamental restrictions, which may be changed in the future by the Board of Directors, without a vote of the shareholders of the Fund: (1) The Fund will not participate on a joint or joint-and-several basis in any securities trading account. The "bunching" of orders for the sale or purchase of marketable portfolio securities with other accounts under the management of the investment adviser to save commissions or to average prices among them is not deemed to result in a securities trading account. (2) The Fund may purchase and sell futures contracts and related options under the following conditions: (a) the then-current aggregate futures market prices of financial instruments required to be delivered and purchased under open futures contracts shall not exceed 30% of the Fund's total assets, at market value; and (b) no more than 5% of the assets, at market value at the time of entering into a contract, shall be committed to margin deposits in relation to futures contracts. (3) The Fund will not make short sales of securities, other than short sales "against the box," or purchase securities on margin except for short-term credits necessary for clearance of portfolio transactions, provided that this restriction will not be applied to limit the use of options, futures contracts and related options, in the manner otherwise permitted by the investment restrictions, policies and investment programs of the Fund. (4) The Fund will not purchase securities of an issuer if to the Fund's knowledge, one or more of the Directors or officers of the Fund or LMC individually owns beneficially more than 0.5% and together own beneficially more than 5% of the securities of such issuer nor will the Fund hold the securities of such issuer. (5) The Fund will not purchase the securities of any other investment company, except as permitted under the 1940 Act. (6) The Fund will not, except for investments which, in the aggregate, do not exceed 5% of the Fund's total assets taken at market value, purchase securities unless the issuer thereof or any company on whose credit the purchase was based has a record of at least three years continuous operations prior to the purchase. (7) The Fund will not invest for the purpose of exercising control over or management of any company. (8) The Fund will not purchase warrants except in units with other securities in original issuance thereof or attached to other securities, if at the time of the purchase, the Fund's investment in warrants, valued at the lower of cost or market, would exceed 5% of the Fund's total assets. Warrants which are not listed on a United States securities exchange shall not exceed 2% of the Fund's net assets. For these purposes, warrants attached to units or other securities shall be deemed to be without value. (9) The Fund will not invest more than 15% of its total assets in illiquid securities. Illiquid securities are securities that are not readily marketable or cannot be disposed of promptly within seven days and in the usual course of business without taking a materially reduced price. Such securities include, but are not limited to, time deposits and repurchase agreements with maturities longer than seven days. Securities that may be resold under Rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended, shall not be deemed illiquid solely by reason of being unregistered. The Investment Adviser shall determine whether a particular security is deemed to be liquid based on the trading markets for the specific security and other factors. (10) The Fund will not purchase interests in oil, gas, mineral leases or other exploration programs; however, this policy will not prohibit the acquisition of securities of companies engaged in the production or transmission of oil, gas or other materials. The percentage restrictions referred to above are to be adhered to at the time of investment and are not applicable to a later increase or decrease in percentage beyond the specified limit resulting from change in values or net assets. The Directors and executive officers of the Fund and their principal occupations are set forth below: +ROBERT M. DEMICHELE, President and Director. P.O. Box 1515, Saddle Brook, N.J. 07663. Chairman and Chief Executive Officer, Lexington Management Corporation; Chairman and Chief Executive Officer, Lexington Funds Distributor, Inc.; President and Director, Piedmont Management Company, Inc.; Director, Reinsurance Corporation of New York; Director, Unione Italiana Reinsurance; Vice Chairman of the Board of Trustees, Union College; Director, Continental National Corporation; Director, The Navigator's Group, Inc.; Chairman, Lexington Capital Management, Inc.; Chairman, LCM Financial Services, Inc.; Director, Vanguard Cellular Systems, Inc.; Chairman of the Board, Market System Research, Inc. and Market Systems Research Advisors, Inc. (registered investment advisers); Trustee, Smith Richardson Foundation. +BEVERLEY C. DUER, Director, 340 East 72nd Street, New York, N.Y. 10021. Private Investor. Formerly, Manager of Opertaions Research Department - CPC International, Inc. +BARBARA R. EVANS, Director. 5 Fernwood Road, Summit, N.J. 07901. Private Investor. Prior to May, 1989, Assistant Vice President and Securities Analyst, Lexington Management Corporation; prior to March 1987, Vice President - Institutional Equity Sales, L.F. Rothschild, Unterberg, Towbin. +LAWRENCE KANTOR, Vice President and Director. P.O. Box 1515, Saddle Brook, N.J. 07663. Managing Director, General Manager and Director, Lexington Management Corporation; Executive Vice President and Director, Lexington Funds Distributor, Inc. +DONALD B. MILLER, Director. 10725 Quail Covey Road, Boynton Beach, FL 33436. Chairman, Horizon Media, Inc.; Trustee, Galaxy Funds; Director, Maguire Group of Connecticut; prior to January 1989, President, Director and C.E.O., Media General Broadcast Services (advertising firm). +FRANCIS OLMSTED, Director. 50 Van Hooten Court, San Anselmo, CA 94960. Private Investor. Formerly, Manager - Commercial Development (West Coast) Essex Chemical Corporation, Clifton, New Jersey (chemical manufacturers). +JOHN G. PRESTON, Director. 3 Woodfield Road, Wellesley, Massachusetts 02181. Associate Professor of Finance, Boston College, Boston, Massachusetts. +MARGARET RUSSELL. Director. 55 North Mountain Avenue, Montclair, N.J. 07042. Private Investor. Formerly, Community Affairs Director, Union Camp Corporation. +PHILIP C. SMITH, Director. 87 Lord's Highway, Weston, Connecticut 06883. Private Investor; Director, Southwest Investors Income Fund, Inc., Government Income Fund, Inc., U.S. Trend Fund, Inc., Investors Cash Reserve and Plimony Fund, Inc. (registered investment companies). +FRANCIS A. SUNDERLAND, Director. 309 Quito Place, Castle Pines, Castle Rock, Colorado 80104. Private Investor. +LISA CURCIO, Vice President and Secretary. P.O. Box 1515, Saddle Brook, N.J. 07663. Senior Vice President and Secretary, Lexington Management Corporation; Vice President and Secretary, Lexington Funds Distributor, Inc. +RICHARD T. SALER, Vice President and Portfolio Manager. P.O. Box 1515, Saddle Brook, N.J. 07663. Senior Vice President, Director International Investment Investment Strategy, Lexington Management Corporation. Prior to July, 1992, Securities Analyst, Nomura Securities, Inc. Prior to November, 1991, Vice President, Lexington Management Corporation. +RICHARD HISEY, Vice President and Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663. Managing Director, Director and Chief Financial Officer, Lexington Management Corporation; Chief Financial Officer, Vice President and Director, Lexington Funds Distributor, Inc.; Chief Financial Officer, Market Systems Research Advisors, Inc. +RICHARD LAVERY, CLU ChFC, Vice President. P.O. Box 1515, Saddle Brook, N.J. 07663. Senior Vice President, Lexington Management Corporation; Vice President, Lexington Funds Distributor, Inc. +JANICE CARNICELLI, Vice President. P.O. Box 1515, Saddle Brook, N.J. 07663. +CHRISTIE CARR, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663. Prior to October 1992, Senior Accountant, KPMG Peat Marwick LLP. +SIOBHAN GILFILLAN, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663. +THOMAS LUEHS, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663. Prior to November 1993, Supervisor of Investment Accounting, Alliance Capital Management. +ANDREW PETRUSKI, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663. Prior to May 1994, Supervising Senior Accountant, NY Life Securities. Prior to December 1990, Senior Accountant, Dreyfus Corporation. +SHERI MOSCA, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663. Prior to September 1990, Fund Accounting Manager, Lexington Group of Investment Companies. +PETER CORNIOTES, Assistant Secretary. P.O. Box 1515, Saddle Brook, N.J. 07663. Assistant Secretary, Lexington Management Corporation. Assistant Secretary, Lexington Funds Distributor, Inc. +ENRIQUE J. FAUST, Assistant Secretary. P.O. Box 1515, Saddle Brook, N.J. 07663. Prior to March 1994, Blue Sky Compliance Coordinator, Lexington Group of Investment Companies. "Interested person" and/or "Affiliated person" of LMC as defined in the Investment Company Act of 1940, as amended. + Messrs. Corniotes, DeMichele, Duer, Hisey, Kantor, Lavery, Luehs, Miller, Olmsted, Petruski, Preston, Saler, Smith and Sunderland and Mmes. Carnicelli, Carr, Curcio, Evans, Gilfillan, Mosca, and Russell hold similar officers with some or all of the other investment companies advised and/or distributed by LMC and LFD. Directors not employed by the Fund or its affiliates receive an annual fee of $600 and a fee of $150 for each meeting attended plus reimbursement of expenses for attendance at regular meetings. The Board does not have any audit, nominating or compensation committees. For the year ended December 31, 1994, the aggregate remuneration paid by the Fund to seven such directors was $7,540. Aggregate Total Compensation Number of Name of Director Compensation From From Fund Directorships Fund and Fund Complex In Fund Complex Robert M. DeMichele 0 0 15 Beverley C. Duer $1350 $20,250 15 Barbara R. Evans 0 0 14 Lawrence Kantor 0 0 15 Donald B. Miller $1350 $20,250 14 Francis Olmsted $1350 $18,900 13 John G. Preston $1350 $20,250 14 Margaret Russell $1350 $18,900 13 Philip C. Smith $1350 $20,250 14 Francis A. Sunderland $1200 $16,800 13 INVESTMENT ADVISER, DISTRIBUTOR AND ADMINISTRATOR Lexington Management Corporation ("LMC"), P.O. Box 1515, Saddle Brook, New Jersey 07663 is the investment adviser to the Fund pursuant to an Investment Advisory Agreement dated January 25, 1994, (the "Advisory Agreement"). Lexington Funds Distributor, Inc. ("LFD") is the distributor of Fund shares pursuant to a Distribution Agreement dated December 5, 1994 (the "Distribution Agreement"). Both of these agreements were approved by the Fund's Board of Directors (including a majority of the Directors who were not parties to either the Advisory Agreement or the Distribution Agreement or "interested persons" of any such party) on December 6, 1994. LMC makes recommendations to the Fund with respect to its investments and investment policies. LMC also acts as administrator to the Fund and performs certain administrative and accounting services, including but not limited to, maintaining general ledger accounts, regulatory compliance, preparation of financial information for semiannual and annual reports, preparing registration statements, calculating net asset values, shareholder communications and supervision of the custodian, transfer agent and provides facilities for such services. The Fund shall reimburse LMC for its actual cost in providing such services, facilities and expenses. For its investment management services to the Fund, under its Advisory Agreement, LMC will receive a monthly fee at the annual rate of 0.85% of the Fund's average daily net assets. LMC has voluntarily agreed to limit the total expenses of the Fund (excluding interest, taxes, brokerage, and extraordinary expenses but including management fee and operating expenses) to an annual rate of 1.30% of the Fund's average net assets. Currently, the most restrictive of expense limitations imposed by the securities laws or regulations of those states or other jurisdictions in which the Fund's shares are registered or qualified for sale would require LMC to reduce its fee so that ordinary expenses (excluding interest, taxes, brokerage commissions and extraordinary expenses) for any fiscal year do not exceed 2.5% of the first $30 million of the Fund's average daily net assets, plus 2.0% of the next $70 million, plus 1.5% of the Fund's average daily net assets in excess of $100 million. LFD pays the advertising and sales expenses of the continuous offering of Fund shares, including the cost of printing prospectuses, proxies and shareholder reports for persons other than existing shareholders. The Fund furnishes LFD, at printer's overrun cost paid by LFD, such copies of its prospectus and annual, semi-annual and other reports and shareholder communications as may reasonably be required for sales purposes. For the year ended December 31, 1994, the Fund paid LMC $17,532 in investment advisory fees and LMC reimbursed the Fund $102,954. The Advisory Agreement, the Distribution Agreement and the Administrative Services Agreement are subject to annual approval by the Fund's Board of Directors and by the affirmative vote, cast in person at a meeting called for such purpose, of a majority of the Directors who are not parties either to the Advisory Agreement or the Distribution Agreement, as the case may be, or "interested persons" of any such party. Either the Fund or LMC may terminate the Advisory Agreement and the Fund or LFD may terminate the Distribution Agreement on 60 days' written notice without penalty. The Advisory Agreement terminates automatically in the event of assignment, as defined in the Investment Company Act of 1940. LMC shall not be liable to the Fund or its shareholders for any act or omission by LMC, its officers, directors or employees or any loss sustained by the Fund or its shareholders except in the case of willful misfeasance, bad faith, gross negligence or reckless disregard of duty. LMC and LFD are wholly owned subsidiaries of Piedmont Management Company Inc., a publicly traded corporation. Descendants of Lunsford Richardson, Sr., their spouses, trusts and other related entities have a majority voting control of outstanding shares of Piedmont Management Company Inc. Of the directors, officers or employees ("affiliated persons") of the Fund, Messrs. Corniotes, DeMichele, Faust, Hisey, Kantor, Lavery, Luehs, Petruski and Saler and Mmes. Carnicelli, Carr, Curcio, Gilfillan and Mosca (see "Management of the Fund"), may also be deemed affiliates of LMC and LFD by virtue of being officers, directors or employees thereof. PORTFOLIO TRANSACTIONS AND BROKERAGE COMMISSIONS The Fund's primary policy is to execute all purchases and sales of portfolio instruments at the most favorable prices consistent with best execution, considering all of the costs of the transaction including brokerage commissions. This policy governs the selection of brokers and dealers and the market in which a transaction is executed. Consistent with this policy, the Rules of Fair Practice of the National Association of Securities Dealers, Inc., and such other policies as the Directors may determine, LMC may consider sales of shares of the Fund and of the other Lexington Funds as a factor in the selection of broker-dealers to execute the Fund's portfolio transactions. However, pursuant to the Fund's investment management agreement, management consideration may be given in the selection of broker-dealers to research provided and payment may be made of a commission higher than that charged by another broker-dealer which does not furnish research services or which furnishes research services deemed to be a lesser value, so long as the criteria of Section 28(e) of the Securities Exchange Act of 1934 are met. Section 28 (e) of the Securities Exchange Act of 1934 was adopted in 1975 and specifies that a person with investment discretion shall not be "deemed to have acted unlawfully or to have breached a fiduciary duty" solely because such person has caused the account to pay higher commission than the lowest available under certain circumstances, provided that the person so exercising investment discretion makes a good faith determination that the commissions paid are "reasonable in the relation to the value of the brokerage and research services provided...viewed in terms of either that particular transaction or his overall responsibilities with respect to the accounts as to which he exercises investment discretion." Currently, it is not possible to determine the extent to which commissions that reflect an element of value for research services might exceed commissions that would be payable for executions services alone, nor generally can the value of research services to the Fund be measured. Research services furnished might be useful and of value to LMC and its affiliates, in serving other clients as well as the Fund. On the other hand, any research services obtained by LMC or its affiliates from the placement of portfolio brokerage of other clients might be useful and of value to LMC in carrying out its obligations to the Fund. The Fund anticipates that its brokerage transactions involving securities of companies domiciled in countries other than the United States will normally be conducted on the principal stock exchanges of those countries. Fixed commissions of foreign stock exchange transactions are generally higher than the negotiated commission rates available in the United States. There is generally less government supervision and regulation of foreign stock exchanges and broker-dealers than in the United States. For the year ended December 31, 1994, the Fund paid $34,699 in brokerage commissions. For the year ended December 31, 1994, the Fund s portfolio turnover rate was 71.21%. DETERMINATION OF NET ASSET VALUE The Fund calculates net asset value as of the close of normal trading on the New York Stock Exchange (currently 4:00 p.m. Eastern time, unless weather equipment failure or other factors contribute to an earlier closing time) on each business day. It is expected that the New York Stock Exchange will be closed on Saturdays and Sundays and on New Year's day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. See the Prospectus for the further discussion of net asset value. The following is only a summary of certain additional tax considerations generally affecting the Fund and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the Fund or its shareholders, and the discussions here and in the Prospectus are not intended as substitutes for careful tax planning. Qualification as a Regulated Investment Company The Fund has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the Fund is not subject to federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the Fund made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. In addition to satisfying the Distribution Requirement, a regulated investment company must: (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock or securities) and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or futures thereon). Because of the Short-Short Gain Test, the Fund may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the Fund from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the Fund at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income that is attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. In general, gain or loss recognized by the Fund on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased by the Fund at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued during the period of time the Fund held the debt obligation. In addition, under the rules of Code Section 988, gain or loss recognized on the disposition of a debt obligation denominated in a foreign currency or an option with respect thereto (but only to the extent attributable to changes in foreign currency exchange rates), and gain or loss recognized on the disposition of a foreign currency forward contract, futures contract, option or similar financial instrument, or of foreign currency itself, except for regulated futures contracts or non-equity options subject to Code Section 1256 (unless the Fund elects otherwise), will generally be treated as ordinary income or loss. Further, the Code also treats as ordinary income, a portion of the capital gain attributable to a transaction where substantially all of the return realized is attributable to the time value of the Fund's net investment in the transaction and: (1) the transaction consists of the acquisition of property by the Fund and a contemporaneous contract to sell substantially identical property in the future; (2) the transaction is a straddle within the meaning of Section 1092 of the Code; (3) the transaction is one that was marketed or sold to the Fund on the basis that it would have the economic characteristics of a loan but the interest-like return would be taxed as capital gain; or (4) the transaction is described as a conversion transaction in the Treasury Regulations. The amount of the gain recharacterized generally will not exceed the amount of the interest that would have accrued on the net investment for the relevant period at a yield equal to 120% of the federal long-term, mid-term, or short-term rate, depending upon the type of instrument at issue, reduced by an amount equal to: (1) prior inclusions of ordinary income items from the conversion transaction; and (2) the capitalized interest on acquisition indebtedness under Code Section 263(g). Built-in losses will be preserved where the Fund has a built-in loss with respect to property that becomes a part of a conversion transaction. No authority exists that indicates that the converted character of the income will not be passed to the Fund's shareholders. In general, for purposes of determining whether capital gain or loss recognized by the Fund on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (1) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used, (2) the asset is otherwise held by the Fund as part of a "straddle" (which term generally excludes a situation where the asset is stock and the Fund grants a qualified covered call option (which, among other things, must not be deep-in-the-money) with respect thereto) or (3) the asset is stock and the Fund grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (1) above. In addition, the Fund may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain recognized by the Fund on the lapse of, or any gain or loss recognized by the Fund from a closing transaction with respect to, an option written by the Fund will be treated as a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of an option written by the Fund will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the Fund may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Transactions that may be engaged in by the Fund (such as regulated futures contracts, certain foreign currency contracts, and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contracts have not terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. Any capital gain or loss for the taxable year with respect to Section 1256 contracts (including any capital gain or loss arising as a consequence of the year-end deemed sale of such contracts) is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss. The Fund, however, may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the Fund that are not Section 1256 contracts. The IRS has held in several private rulings (and Treasury Regulations now provide) that gains arising from Section 1256 contracts will be treated for purposes of the Short-Short Gain Test as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. The Fund may purchase securities of certain foreign investment funds or trusts which constitute passive foreign investment companies ("PFICs") for federal income tax purposes. If the Fund invests in a PFIC, it may elect to treat the PFIC as a qualifying electing fund (a "QEF") in which event the Fund will each year have ordinary income equal to its pro rata share of the PFIC's ordinary earnings for the year and long-term capital gain equal to its pro rata share of the PFIC's net capital gain for the year, regardless of whether the Fund receives distributions of any such ordinary earning or capital gain from the PFIC. If the Fund does not (because it is unable to, chooses not to or otherwise) elect to treat the PFIC as a QEF, then in general (1) any gain recognized by the Fund upon sale or other disposition of its interest in the PFIC or any excess distribution received by the Fund from the PFIC will be allocated ratably over the Fund's holding period of its interest in the PFIC, (2) the portion of such gain or excess distribution so allocated to the year in which the gain is recognized or the excess distribution is received shall be included in the Fund's gross income for such year as ordinary income (and the distribution of such portion by the Fund to shareholders will be taxable as an ordinary income dividend, but such portion will not be subject to tax at the Fund level), (3) the Fund shall be liable for tax on the portions of such gain or excess distribution so allocated to prior years in an amount equal to, for each such prior year, (i) the amount of gain or excess distribution allocated to such prior year multiplied by the highest tax rate (individual or corporate) in effect for such prior year plus (ii) interest on the amount determined under clause (i) for the period from the due date for filing a return for such prior year until the date for filing a return for the year in which the gain is recognized or the excess distribution is received at the rates and methods applicable to underpayments of tax for such period, and (4) the distribution by the Fund to shareholders of the portions of such gain or excess distribution so allocated to prior years (net of the tax payable by the Fund thereon) will again be taxable to the shareholders as an ordinary income dividend. Under recently proposed Treasury Regulations the Fund can elect to recognize as gain the excess, as of the last day of its taxable year, of the fair market value of each share of PFIC stock over the Fund's adjusted tax basis in that share ("marked to market gain"). Such marked to market gain will be included by the Fund as ordinary income, such gain will not be subject to the Short-Short Gain Test, and the Fund's holding period with respect to such PFIC stock commences on the first day of the next taxable year. If the Fund makes such election in the first taxable year it holds PFIC stock, the Fund will include ordinary income from any marked to market gain, if any, and will not incur the tax described in the previous paragraph. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it had been incurred in the succeeding year. In addition to satisfying the requirements described above, the Fund must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of the Fund's taxable year, at least 50% of the value of the Fund's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of other issuers (as to which the Fund has not invested more than 5% of the value of the Fund's total assets in securities of such issuer and as to which the Fund does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the Fund controls and which are engaged in the same or similar trades or businesses. Generally, an option (call or put) with respect to a security is treated as issued by the issuer of the security not the issuer of the option. If for any taxable year the Fund does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable to the shareholders as ordinary dividends to the extent of the Fund's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Qualification of Segregated Asset Accounts Under Code section 817(h), a segregated asset account upon which a variable annuity contract or variable life insurance policy is based must be "adequately diversified." A segregated asset account will be adequately diversified if it satisfies one of two alternative tests set forth in the Treasury Regulations. Specifically, the Treasury Regulations provide, that except as permitted by the "safe harbor" discussed below, as of the end of each calendar quarter (or within 30 days thereafter) no more than 55% of a series' total assets may be represented by any one investment, no more than 70% by any two investments, no more than 80% by any three investments and no more than 90% by any four investments. For this purpose, all securities of the same issuer are considered a single investment, and while each U.S. Government agency and instrumentality is considered a separate issuer, a particular foreign government and its agencies, instrumentalities and political subdivisions are considered the same issuer. As a safe harbor, a separate account will be treated as being adequately diversified if the diversification requirements under Subchapter M are satisfied and no more than 55% of the value of the account's total assets are cash and cash items, government securities and securities of other regulated investment companies. For purposes of these alternative diversifications tests, a segregated asset account investing in shares of a regulated investment company will be entitled to "look-through" the regulated investment company to its pro rata portion of the regulated investment company's assets, provided the regulated investment company satisfies certain conditions relating to the ownership of the shares. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall: (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year; and (2) exclude foreign currency gains and losses incurred after October 31 of any year (or after the end of its taxable year if it has made a taxable year election) in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The Fund intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that the Fund may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. The Fund anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for federal income tax purposes, but they generally should not qualify for the 70% dividends-received deduction for corporate shareholders. The Fund may either retain or distribute to shareholders its net capital gain for each taxable year. The Fund currently intends to distribute any such amounts. If net capital gain is distributed and designated as a capital gain dividend, it will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the Fund prior to the date on which the shareholder acquired his shares. Conversely, if the Fund elects to retain its net capital gain, the Fund will be taxed thereon (except to the extent of any available capital loss carryovers) at the 35% corporate tax rate. If the Fund elects to retain its net capital gain, it is expected that the Fund also will elect to have shareholders of record on the last day of its taxable year treated as if each received a distribution of his pro rata share of such gain, with the result that each shareholder will be required to report his pro rata share of such gain on his tax return as long-term capital gain, will receive a refundable tax credit for his pro rata share of tax paid by the Fund on the gain, and will increase the tax basis for his shares by an amount equal to the deemed distribution less the tax credit. Ordinary income dividends paid by the Fund with respect to a taxable year will qualify for the 70% dividends-received deduction generally available to corporations (other than corporations, such as S corporations, which are not eligible for the deduction because of their special characteristics and other than for purposes of special taxes such as the accumulated earnings tax and the personal holding company tax) to the extent of the amount of qualifying dividends received by the Fund from domestic corporations for the taxable year. A dividend received by the Fund will not be treated as a qualifying dividend (1) if it has been received with respect to any share of stock that the Fund has held for less than 46 days (91 days in the case of certain preferred stock), excluding for this purpose under the rules of Code Section 246(c)(3) and (4): (i) any day more than 45 days (or 90 days in the case of certain preferred stock) after the date on which the stock becomes ex-dividend and (ii) any period during which the Fund has an option to sell, is under a contractual obligation to sell, has made and not closed a short sale of, is the grantor of a deep-in-the-money or otherwise nonqualified option to buy, or has otherwise diminished its risk of loss by holding other positions with respect to, such (or substantially identical) stock; (2) to the extent that the Fund is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property; or (3) to the extent the stock on which the dividend is paid is treated as debt-financed under the rules of Code Section 246A. Moreover, the dividends-received deduction for a corporate shareholder may be disallowed or reduced (1) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of the Fund or (2) by application of Code Section 246(b) which in general limits the dividends-received deduction to 70% of the shareholder's taxable income (determined without regard to the dividends-received deduction and certain other items). Since an insignificant portion of the Fund will be invested in stock of domestic corporations, the ordinary dividends distributed by the Fund will not qualify for the dividends-received deduction for corporate shareholders. Alternative minimum tax ("AMT") is imposed in addition to, but only to the extent it exceeds, the regular tax and is computed at a maximum marginal rate of 28% for noncorporate taxpayers and 20% for corporate taxpayers on the excess of the taxpayer's alternative minimum taxable income ("AMTI") over an exemption amount. In addition, under the Superfund Amendments and Reauthorization Act of 1986, a tax is imposed for taxable years beginning after 1986 and before 1996 at the rate of 0.12% on the excess of a corporate taxpayer's AMTI (determined without regard to the deduction for this tax and the AMT net operating loss deduction) over $2 million. For purposes of the corporate AMT and the environmental superfund tax (which are discussed above), the corporate dividends-received deduction is not itself an item of tax preference that must be added back to taxable income or is otherwise disallowed in determining a corporation's AMTI. However, corporate shareholders will generally be required to take the full amount of any dividend received from the Fund into account (without a dividends-received deduction) in determining its adjusted current earnings, which are used in computing an additional corporate preference item (i.e., 75% of the excess of a corporate taxpayer's adjusted current earnings over its AMTI (determined without regard to this item and the AMT net operating loss deduction)) includable in AMTI. Investment income that may be received by the Fund from sources within foreign countries may be subject to foreign taxes withheld at the source. The United States has entered into tax treaties with many foreign countries which entitle the Fund to a reduced rate of, or exemption from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the amount of the Fund's assets to be invested in various countries is not known. If more than 50% of the value of the Fund's total assets at the close of its taxable year consist of the stock or securities of foreign corporations, the Fund may elect to "pass through" to the Fund's shareholders the amount of foreign taxes paid by the Fund. If the Fund so elects, each shareholder would be required to include in gross income, even though not actually received, his pro rata share of the foreign taxes paid by the Fund, but would be treated as having paid his pro rata share of such foreign taxes and would therefore be allowed to either deduct such amount in computing taxable income or use such amount (subject to various Code limitations) as a foreign tax credit against federal income tax (but not both). For purposes of the foreign tax credit limitation rules of the Code, each shareholder would treat as foreign source income his pro rata share of such foreign taxes plus the portion of dividends received from the Fund representing income derived from foreign sources. No deduction for foreign taxes could be claimed by an individual shareholder who does not itemize deductions. Each shareholder should consult his own tax adviser regarding the potential application of foreign tax credits. Distributions by the Fund that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the Fund will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the Fund (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the Fund reflects undistributed net investment income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the Fund, distributions of such amounts will be taxable to the shareholder in the manner described above, although such distributions economically constitute a return of capital to the shareholder. Ordinarily, shareholders are required to take distributions by the Fund into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the Fund) on December 31 of such calendar year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The Fund will be required in certain cases to withhold and remit to the U.S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the IRS for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the Fund that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the Fund in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the Fund within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the Fund will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the Fund is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the Fund is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends paid to a foreign shareholder will be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate) upon the gross amount of the dividend. Furthermore, such a foreign shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate) on the gross income resulting from the Fund's election to treat any foreign taxes paid by it as paid by its shareholders, but may not be allowed a deduction against this gross income or a credit against this U.S. withholding tax for the foreign shareholder's pro rata share of such foreign taxes which it is treated as having paid. Such a foreign shareholder would generally be exempt from U.S. federal income tax on gains realized on the sale of shares of the Fund, capital gain dividends and amounts retained by the Fund that are designated as undistributed capital gains. If the income from the Fund is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends, and any gains realized upon the sale of shares of the Fund will be subject to U.S. federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the Fund may be required to withhold U.S. federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the Fund with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the Fund, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting investment in the Fund. For the purpose of quoting and comparing the performance of the Fund to that of other mutual funds and to other relevant market indices in advertisements or in reports to shareholders, performance may be stated in terms of total return. Under the rules of the Securities and Exchange Commission ("SEC rules"), funds advertising performance must include total return quotes calculated according to the following formula: Where: P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV= ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof). Under the foregoing formula, the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five and ten year periods or a shorter period dating from the effectiveness of the Fund's Registration Statement. In calculating the ending redeemable value, all dividends and distributions by the Fund are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. Any recurring account charges that might in the future be imposed by the Fund would be included at that time. The Fund may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the performance of the Fund with other measures of investment return. For example, in comparing the Fund's total return with data published by Lipper Analytical Services, Inc., or with the performance of the Standard and Poor's 500 Stock Index or the Dow Jones Industrial Average, the Fund calculates its aggregate total return for the specified periods of time assuming the investment of $10,000 in Fund shares and assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial value of the investment from the ending value and by dividing the remainder by the beginning value. The Fund s total return for the period March 30, 1994 (commencement of operations) to December 31, 1994 was 1.01%. As of February 23, 1995, Reinsurance Corporation of New York, (an affiliate of Lexington Management Corporation, the Fund s investment adviser), 80 Maiden Lane, New York, N.Y., 10038 owned beneficially 204,372 shares of the Fund (38% of the Fund s outstanding shares). The balance of the outstanding shares of the Fund are owned by Transamerica Occidental Life Insurance Company and Aetna Life Insurance and Annuity Company and are allocated to separate accounts which are used for funding variable annuity contracts. The Board of Directors and Shareholders Lexington Emerging Markets Fund, Inc.: We have audited the accompanying statements of net assets (including the portfolio of investments) and assets and liabilities of Lexington Emerging Markets Fund, Inc. as of December 31, 1994, the related statement of operations, changes in net assets and the financial highlights for the period March 30, 1994(commencement of operations) to December 31, 1994. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of December 31, 1994, by correspondence with the custodian and brokers. 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 and financial highlights referred to above present fairly, in all material respects, the financial position of Lexington Emerging Markets Fund, Inc. as of December 31, 1994, the results of its operations for the year then ended, changes in its net assets for each of the years in the two-year period then ended, and financial highlights for each of the years in the four-year period then ended, in conformity with generally accepted accounting principles. LEXINGTON EMERGING MARKETS FUND, INC. STATEMENT OF NET ASSETS (Including the Portfolio of Investments) (In U.S. Dollars)-December 31, 1994 2,500 Banco Comercial S.A. GRD * $35,000 5,000 Commercial Del Plata 12,750 2,500 YPF Sociedad Anonima (ADR) 53,438 200 Bank Austria Staemme 16,323 175,000 Acesita (Preferred shares) 14,893 2,200 Aracruz Celulose (ADR) 28,050 1,200 Companhia Vale (ADR) (Preferred shares) 57,150 503,000 Compania Energetica de Minas Gerais 45,781 552,000 Compania Siderurgica Nacional 18,824 60,000 Coteminas (Preferred shares) 20,567 23,000 Electrobras (Preferred shares) 8,128 18,500 Iochpe Maxion SA (Preferred shares) 12,902 59,000 Petrol Brazileiros (Preferred shares) 7,461 175,914 Telebras (Preferred shares) 7,881 300,000 Telesp (Preferred shares) 42,730 6,171,000 Usiminas (Preferred shares) 8,388 1,400 Banco O'Higgins (ADR) 23,975 700 Compania Cervecerias Unidas (ADR) 17,500 200 Compania de Telefonos de Chile (ADR) 15,750 950 Madeco S.A. (ADR) 25,175 1,600 Maderas y Sinteticos (ADR) 40,800 1,600 Vina Concha y Toro (ADR) 26,400 310 ETVA Leasing S.A. 6,267 1,000 Fotex Rt (ADR) * 15,750 15,500 Argha Karya Prima Industries 16,227 4,000 Bank International Indonesia 12,745 26,600 Indah Kiat Paper & Pulp 30,269 1,000 Perusahaan Indosat (ADR) 35,750 3,100 *First Israel Fund, Inc. 31,000 1,400 Teva Pharmaceutical Industries (ADR) 33,950 1,400 Aokam Perdana Bhd 8,667 9,000 Berjaya Singer Bhd 9,875 6,000 Commerce Assets Holdings 24,216 3,000 Cycle & Carriage Bhd 10,874 11,000 Resorts World Bhd 64,655 25,200 Sime Darby Bhd 57,766 10,000 Sungei Way Holdings 39,969 1,200 Consorcio G Grupo Dina (ADR) 11,400 6,000 Desc Sociedad de Fomento Industrial, S.A. de C.V. "B" 29,702 490 Empresas ICA Sociedad Company (ADR) 7,595 8,600 Grupo Finanaciero Banamex "C" 24,352 37,500 Grupo Financiero Bancomer "C" 21,683 1,100 Grupo Mexicano "B" (ADR) 8,388 6,500 Grupo Sidek S.A. de C.V. "B2" 14,029 500 Grupo Simec S.A. de C.V. (ADR) 7,563 2,200 Hylsamex, S.A. de C.V. (ADR) 36,025 1,600 Telefonos de Mexico S.A. de C.V. (ADR) 65,600 4,300 Tolmex, S.A. de C.V. "B2" 35,762 2,800 Transportacion Maritima S.A. "L" (ADR) 21,350 1,100 Tubos de Acero de Mexico S.A. (ADR) 5,156 3,400 Vitro Sociedad Anonima (ADR) 47,600 21,000 Ayala Land Inc. "B" 32,975 40,000 J.G. Summit "B" 14,711 2,000 Manila Electric Company "B" 27,686 5,000 San Miguel Corporation "B" 26,445 26,000 Universal Robina Corporation 18,802 800 Banco Portugues Do Atlantico 10,123 200 Radio Marconi (P Shares) 6,843 2,000 Cerebos Pacific Ltd. 10,980 7,000 Hitachi Zosen Ltd. 6,198 18,000 Jurong Cement Ltd. 57,075 2,000 Jurong Engineering Ltd. 13,727 5,000 Keppel Corporation Ltd. 42,553 18,000 Neptune Orient Lines Ltd. 24,708 2,000 Overseas Union Bank 11,668 10,000 Pacific Carriers Ltd. 9,677 5,000 Sembawang Corporation Ltd. 37,405 2,000 Singapore Airlines Ltd. 18,394 600 Anglo American Corporation (ADR) 34,538 2,400 Barlow Rand (ADR) 21,450 2,300 Johannesburg Consolidated Investments Ltd., (ADR) 58,980 1,600 Liberty Life (ADR) 38,800 2,000 Rustenburg Platinum Ltd. (ADR) 54,969 2,800 Samancor Ltd. (ADR) 39,165 1,400 South African Breweries (ADR) 33,250 950 Taiwan Fund Inc. 27,430 600 Advanced Info Service Company, Ltd. $8,320 900 Nation Publishing Group Company, Ltd. 1,614 900 Saha Pathanapibul Company 2,366 1,200 Siam Cement Company, Ltd. 71,919 2,600 Siam City Cement Company, Ltd. 44,342 7,400 Antofagasta Holdings Plc 36,503 300 Freeport McMoran Copper & Gold 5,888 2,700 Cermanic Carobobo (ADR) 3,375 1,800 *Mavesa (ADR) 7,650 TOTAL COMMON STOCKS (cost $2,897,032) 2,670,331 10,000 Formosa Chemicals, 1.75%, due 07/19/01 * 9,625 10,000 Nan Ya Plastics, 1.75%, due 07/19/01 * 9,250 TOTAL CONVERTIBLE DEBENTURES (cost $20,000) 18,875 TOTAL SHORT-TERM INVESTMENTS (cost $1,686,833) 1,686,833 TOTAL INVESTMENTS: 94.6% (cost $4,603,865+) $4,376,039 Other Assets in Excess of Liabilities: 5.4% 247,777 (equivalent to $9.86 per share on 469,015 shares outstanding) $4,623,816 At December 31, 1994, the composition of the Fund's net assets by industry concentration was as follows: + Aggregate cost for Federal income tax purposes is identical. The Notes to Financial Statements are an integral part of this statement. Lexington Emerging Markets Fund, Inc. Statement of Assets and Liabilities Investments, at value (cost $4,603,865)(Note 1) ...... $4,376,039 Receivable for shares sold ........................... 45,729 Receivable for securities sold ....................... 148,152 Dividends and interest receivable .................... 4,146 Deferred organization expenses, net (Note 1).......... 18,942 Due from Lexington Management Corporation (Note 2).... 21,817 Payable for shares redeemed .......................... 4,974 Payable for investment securities purchased .......... 5,027 NET ASSETS (equivalent to $9.86 per share on 469,015 shares outstanding) (Note 3) ................. $4,623,816 NET ASSETS consist of: Capital stock- Authorized 500,000,000 shares, $.001 par value per share ........................... $469 Additional paid-in capital ........................... 4,937,120 Undistributed net investment income (Note 1) ......... 346 Distributions in excess of net realized gains on investments and foreign currency (Note 1)............ (86,264) Net unrealized depreciation of investments and foreign currency ................................ (227,855) The Notes to Financial Statements are an integral part of this statement	497	497	1996-01-12T00:00:00	1996-01-12T15:22:43
0000950152-96-000083	0000950152-96-000083_0001.txt	<DESCRIPTION>COOKER RESTAURANT CORP 8-K EXHIBIT 99.1 This Purchase and Sale Agreement ("Agreement") is entered into this 20th day of October, 1995, ("FINAL EXECUTION DATE") by and between GMRI, Inc., a Florida corporation (formerly known as General Mills Restaurants, Inc., prior to name change and hereinafter referred to as "Seller"), having its principal place of business at 1751 Directors Row, Orlando, Florida 32809; and Cooker Restaurant Corporation, an Ohio corporation ("Buyer"), having its principal office at 5500 Village Boulevard, West Palm Beach, Florida 33407 A. Seller is the owner of the parcels described in Exhibits A-1 through A-6 referred to individually and collectively as the "Premises" and commonly known as: CC#6039 1590 Pleasant Hill Rd. CC#6023 790 Cobb Place Blvd. CC#6015 1247 Boardman Poland Rd. B. Seller desires to sell the Premises and other hereinafter defined "Property", to Buyer, and Buyer desires to acquire the Premises and said other "Property", from Seller under the terms and conditions hereinafter set forth. NOW, THEREFORE, in consideration of the foregoing BACKGROUND (which is hereby incorporated), and the mutual covenants hereinafter contained, the parties intending to be legally bound, agree as follows: Seller agrees to sell to Buyer and Buyer agrees to acquire from Seller, the following "Property" (collectively the Premises "FF&E" and "Licenses" respectively described and identified in subparagraphs a., b., and c. of this Paragraph 1.) on the terms and conditions hereinafter set forth: The fee simple interests in all of the Premises described on Exhibits A-1 through A-6, including all building and site improvements located thereon (together with appurtenant rights and easements thereto). b. FURNITURE, FIXTURES AND EQUIPMENT The furniture, fixtures and equipment to the extent located at each of the Premises ("FF&E"), which FF&E includes furniture, booths, non-food inventory, smallwares, kitchen equipment, appliances, wallcoverings and decorations, lighting and lighting fixtures, telephone systems, PC based point-of-sale systems, office equipment, walk-in coolers, hoods and exhaust fans and systems, sound systems where owned by Seller, panic and emergency lighting, HVAC systems, wiring, pipes, flues, cables and related connections to utility services, water systems (water tanks and heaters) including sprinkler systems, pylon standards and sign monuments, and all other personal property, fixtures and improvements located on the Premises except for trade dress items of China Coast. The on-premises alcoholic beverage licenses identified below ("Licenses"). Buyer will pursue applications with the applicable alcoholic beverage commissions for transfer of the Licenses; Seller will cooperate with Buyer in effectuating the transfer of Licenses to Buyer. The Licenses will not be subject to suspension or revocation for any violations which may have occurred prior to Seller's cessation of business at the relevant Premises. Buyer will bear any applicable transfer costs. In the event any License cannot be transferred to Buyer, Buyer will use reasonable, good faith efforts to obtain an alternate, alcoholic beverage license permitting on-premises consumption, seven (7) days a week, at the applicable Premises. The purchase price for the Property is Eleven Million Two Hundred Fifty Thousand Dollars ($11,250,000.00) ("Purchase Price") allocated between each Property as follows: The Purchase Price is to be paid as follows: a. $600,000.00 in cash, certified check or wire transfer of funds on the FINAL EXECUTION DATE as earnest money, to be deposited with and held in escrow by the title company used pursuant to Paragraph 6 hereof (the "Escrow Agent") in an interest bearing account for the benefit of the parties, in accordance with Paragraph 10 of this Agreement. b. The balance in cash, certified check made payable to Seller or wire transfer of funds at "Closing" which will take place on the "CLOSING DATE" (defined in Paragraph 7). a. This Agreement is conditional upon the approval of this transaction by the officers of Seller ("Corporate Approval") within five (5) days after the FINAL EXECUTION DATE. In the event the approval is not obtained within that time period, this Agreement will be null and void and of no further force and effect. The date on which such approval is communicated to Buyer in writing is the "EFFECTIVE DATE" of this Agreement. b. This Agreement is conditional upon the approval of this transaction by the appropriate Board of Directors of Buyer ("Board Approval") within five (5) days after the FINAL EXECUTION DATE. In the event the approval is not obtained within that time period, this Agreement will be null and void and of no further force and effect. c. Each party will provide the other with a certificate of good standing from its respective State of incorporation and a certified resolution of its Board of Directors reflecting approval for that corporation to enter into the transaction contemplated by this Agreement. 4. SELLER'S REPRESENTATIONS AND WARRANTIES Seller represents to Buyer as follows, which representations will be deemed reaffirmed by Seller to Buyer as of the CLOSING DATE, and will survive the Closing: a. There are no parties in possession of any portion of the Premises or b. There are no pending or, to the best of Seller's knowledge and belief, threatened condemnation or similar proceedings affecting the Premises, or any c. With the exception of Seller's need to secure Corporate Approval of this transaction as provided above, Seller has the present full authority and power to execute this Agreement and to close the sale of the Premises; d. Seller will provide good faith cooperation to Buyer in determining the matters set forth in Paragraph 6 of this Agreement; e. Based solely upon title insurance policies previously obtained by Seller, Seller owns the Premises in fee simple and Seller's title to the f. Seller owns title to the FF&E which is unencumbered as reflected in the "Unconditional Bill of Sale" marked Exhibit "C" and attached hereto. 5. BUYER'S REPRESENTATIONS, WARRANTIES AND ACKNOWLEDGMENT Buyer represents and warrants to Seller as follows, which representations and warranties will be deemed reaffirmed by Buyer to Seller as of the CLOSING DATE and will survive the Closing: a. With the exception of Buyer's need to secure Board Approval of this transaction as provided above, Buyer has the present full authority and power to execute this Agreement and to close the purchase of the Premises; b. Buyer will in good faith diligently proceed to obtain all required reports, licenses, permits and approvals to construct, remodel and operate the c. Buyer warrants and represents that its use of the Premises will not d. Buyer acknowledges and agrees that the Property will be conveyed and transferred to Buyer "as is, where is, and with all faults", if any, and, except as expressly set forth in this Agreement (including exhibits annexed hereto and identified herein), Seller does not warrant as to the merchantability, quantity, quality, condition, suitability or fitness of the Property for any purpose whatsoever and will be under no obligation whatsoever to undertake any repairs, alterations or other work of any kind with respect to any portion of the Property. Buyer also acknowledges and agrees that the provisions in this Agreement for inspection and investigation of the Property are adequate to enable Buyer to make Buyer's own determination with respect to the merchantability, quantity, quality, condition and suitability or fitness of the Premises for any purpose. At the closing, Seller will be deemed released by Buyer of and from all liabilities, obligations and claims, known or unknown, that Buyer may have against Seller including those that arise in the future based in whole or in part upon the presence of toxic or hazardous substances or other environmental contamination on or within the Premises as such terms or conditions may now or hereafter be defined or regulated by any federal, state or local law, ordinance, order, rule, regulation, code or other governmental restriction or requirement including, but not limited to the Comprehensive Environmental Response, Compensation and Liability Act, as amended, 42 U.S.C. Sec. 9601 et seq. ("CERCLA") and the Resource Conservation Act, as amended, 42 U.S.C. Sec. 690 et seq. ("RCRA"), or otherwise. a. Buyer, using good faith, diligent efforts, will have thirty (30) days from the FINAL EXECUTION DATE to determine whether the Premises and Licenses are suitable for its use as follows: i. Buyer may, at its sole risk, cost and expense conduct or cause to be conducted soil engineering tests and/or environmental assessments of the Premises and in this connection, it or its designated agents may enter upon the Premises for purposes of inspection, soil analysis, core drilling or other tests that may be deemed necessary by Buyer or its engineer. Buyer will restore or repair any damage caused, related to or arising out of Buyer's conducting of these tests. Buyer will indemnify, hold harmless and, at Seller's option, defend Seller against any and all claims, actions, causes of action, expenses, costs, penalties and liabilities arising out of its work or that of its employees, agents or contractors on the Premises, which indemnity will also include the payment of attorneys' fees and other costs; ii. Buyer will obtain (or be reasonably satisfied that it can obtain) all necessary governmental or quasi-governmental permits, licenses and approvals for the construction or renovation of all intended improvements; iii. Buyer will determine whether the improvements and the use as a Cooker Bar and Grille Restaurants contemplated by Buyer for each of the Premises are prohibited by any governmental or quasi-governmental authority; iv. Buyer will determine whether the utility services required for Buyer's development will be available in capacities and at costs reasonably acceptable to Buyer. If Buyer using good faith, reasonable business judgment determines that it is not possible to develop any of the Premises or acquire Licenses in accordance with Buyer's intended use for reasons gathered in its investigation, Buyer may, by giving written notice to Seller ("TERMINATION NOTICE"), terminate this Agreement with respect to that Property. Such TERMINATION NOTICE will describe the nature of the conditions preventing the development of the Premises or acquisition of the Licenses in reasonable specificity. Said TERMINATION NOTICE must be received prior to 5:01 p.m. (Florida time) on or before the next business day following the expiration of the thirty (30) day period provided for in this Paragraph or Buyer will be conclusively presumed to have irrevocably waived the right to terminate under this Paragraph. Upon receipt of such proper and timely TERMINATION NOTICE by Seller, the Deposit will be returned to Buyer and neither party will have any obligation to the other except in accordance with Paragraphs 6(a) and 14 herein. b. Buyer, within the time periods specified below, may review surveys and title as follows: i. At least twenty (20) days prior to Closing, Seller, at its sole cost and expense, will obtain and provide to Buyer and the Escrow Agent an as-built survey of each of the Premises ("Survey") prepared by a licensed surveyor in accordance with the specifications outlined in Exhibit B, which identifies the Premises by legal description (metes and bounds or plat reference, as the case may be)and reflects whether there are any improvements, easements, encroachments or overlappings affecting the Premises. The surveyor will certify to Buyer, Seller and the title company, that the Survey was made on the ground under his/her supervision. If the Survey reflects defects which would prevent the use of any Premises as a Cooker Bar and Grille Restaurant, Buyer may terminate this Agreement as to that Property by written notice to Seller, specifying the defect, within fifteen (15) days after Buyer's receipt of the Survey. Silence will be deemed to mean that Buyer has irrevocably waived the right to terminate under this subparagraph b(i). ii. At least fifteen (15) days prior to Closing, Seller, at its sole cost and expense, will obtain and provide to Buyer a title insurance commitment for each of the Premises issued by Lawyers Title Insurance Corporation, a Virginia corporation, which commitments shall include a complete UCC, judgment lien and tax lien search for Seller. Within ten (10) days after receipt of the commitments, Buyer will notify Seller in writing of any defects in the title which would render the Premises unmarketable, uninsurable or prevent the use of a Cooker Bar and Grille Restaurant; standard exceptions will not be considered objectionable. Silence will be deemed to mean that Buyer has irrevocably waived the right to terminate under this subparagraph b(ii), subject to Buyer's right to object to any new matters appearing of record after the date(s) of the title commitments. If Seller, after using good faith efforts, is unable to cure the title objections in a reasonable period of time (which will, as necessary, postpone the Closing and CLOSING DATE), Buyer, at its election, may either (i) accept title as it is, or (ii) terminate this Agreement with respect to the particular Property. Upon termination, Buyer will receive its Deposit and both parties will be released from all liability and obligation under this Agreement, except for the specific indemnification provisions in Paragraphs 6(a) and 14. Buyer's failure to notify Seller within the 15 day period will be deemed approval by Buyer of the condition of title. Seller is required to remove all monetary liens and encumbrances at, or prior to, Closing. c. In the event that Buyer determines that any Premises or License (or more than one) is not suitable in accordance with Paragraph 6., of this Agreement, upon written notice to Seller that Property found unsuitable by Buyer shall be deleted from this Agreement (with appropriate adjustment in the Purchase Price pursuant to Paragraph 2.) to the same extent and as fully as though that Property(ies) was not subject to this Agreement. a. The "Closing" hereunder will be through an escrow with the Escrow Agent, in accordance with this Agreement, and will take place within thirty (30) days after Buyer either provides Seller with written notice that the conditions set forth in Paragraph 6 above have been satisfied or waived or is presumed to have satisfied or waived such conditions pursuant to Paragraph 6 above (the "CLOSING DATE"). On or before the CLOSING DATE, Seller will deposit a limited warranty deed for each of the Premises with the Escrow Agent using the legal description by which Seller obtained title and a Bill of Sale for the FF&E at each Premises, in form as shown on Exhibit "C". The FF&E will be transferred free and clear of all liens and encumbrances. The Premises will be transferred free and clear of all liens and encumbrances except for those permitted or accepted pursuant to Paragraph 6(f). Transfer forms for the Licenses submitted by Buyer to Seller shall be executed and delivered by Seller to Buyer at Closing. b. All costs and expenses of Closing the purchase and sale of the Premises will be borne and paid at Closing unless otherwise stated herein, as follows: By Seller: Seller's Attorneys' Fees Title insurance premiums in the aggregate amount of the Purchase Price State's Transfer Taxes, if any By Buyer: Buyer's Attorneys' Fees Recording Fees for Covenants, if any Title Insurance Premiums for any extended c. Seller and Buyer each represents to the other that it has not hired or engaged any broker, finder or other agent to whom a commission is owed as a consequence of this Agreement. Each party will indemnify and hold and save the other party harmless from any and all claims for brokerage arising out of this Agreement as a result of a breach of that party's representation. d. Real Estate Taxes. Seller will pay all special assessments which exist as of the CLOSING DATE (or if not payable, the amount thereof shall be credited against the Purchase Price), and any due or delinquent real estate taxes (plus applicable penalties, if any). Real estate taxes on the Premises which accrue in the current year will be prorated to the CLOSING DATE, so that Seller bears that portion of the accrued real estate taxes applicable for the period up to and including the CLOSING DATE and Buyer bears that portion of the accrued real estate taxes applicable for all periods subsequent to the CLOSING DATE. Buyer will be responsible for all special assessments imposed after the CLOSING DATE. At Closing, Seller will pay to Buyer Seller's share of real estate taxes and special assessments for the year in which Closing occurs and Buyer will pay such real estate taxes and installments of special assessments when due and payable for such tax year. If on the CLOSING DATE the tax rate for such year has not been finally determined, proration will be made upon the basis of the tax rate for the preceding tax year applied to the last officially certified rate of valuation. The parties agree that such proration will be readjusted between the parties, if necessary, based upon the final tax bill for the year in which Closing occurs. e. In the event Buyer terminates this Agreement with respect to any individual Premises, the Agreement will remain in effect as to the remaining Premises, and the Purchase Price will be adjusted in accordance with the allocation schedule set forth in Paragraph 2. 8. RISK OF LOSS AND CONDEMNATION Seller will bear the risk of loss due to fire or other casualty until Closing. In the event of any condemnation of any of the Premises or any part thereof prior to Closing which, in the reasonable opinion of Buyer, would prevent Buyer's intended use of the Premises, Buyer may elect to terminate this Agreement with respect to that individual Property upon written notice to Seller, and upon Seller's receipt of such notice Buyer will have no further duties or obligations hereunder with respect to that Property (except for the indemnification provisions of Paragraph 6(a) and 14). a. In the event Buyer fails to comply with any or all of the obligations, covenants, warranties or agreements under this Agreement and such default is not cured within ten (10) days after notice thereof (other than Buyer's failure to tender the Purchase Price on the date of Closing, a default for which no notice is required), then Seller may terminate this Agreement, whereupon the Deposit will be paid over to Seller by Escrow Agent and the parties will be released from any further liability hereunder except for the indemnification provisions of Paragraph 6(a) and 14 herein. b. In the event Seller fails to comply with any or all of the obligations, covenants, warranties or agreements under this Agreement, and such default is not cured within ten (10) days after notice thereof, then Buyer may terminate this Agreement, in which event the Deposit will be refunded to Buyer as its sole and exclusive remedy and both parties will be released from any further liability hereunder except for the indemnification provisions of Paragraph 6(a) and 14 herein. c. The failure of either party to act upon a default of the other in any of the terms, conditions or obligations under this Agreement will not be deemed a waiver of any subsequent breach or default under the terms, conditions or obligations hereof by such defaulting party. As required in Paragraph 2.a., of this Agreement, on the FINAL EXECUTION DATE, Buyer shall deposit with Lawyers Title Insurance Corporation, a Virginia corporation (heretofore and hereafter called "Escrow Agent") a good faith deposit (heretofore and hereinafter referred to as the "Deposit") in the amount of Six Hundred Thousand and No/100 Dollars ($600,000.00). By its acceptance of the Deposit as indicated by its joinder in this Agreement, Escrow Agent hereby agrees to hold the Deposit in accordance with the following instructions, to wit: a. If the sale and purchase contemplated in this Agreement is closed in accordance with the terms hereof, the Deposit shall be transmitted to Seller to be applied by Seller as a credit against the total Purchase Price due from Buyer to Seller at closing pursuant to Paragraph 2., of this Agreement; b. If Buyer fails or refuses to close the purchase and sale in accordance with this Agreement, or otherwise fails to comply with any of the obligations, covenants, warranties or agreements and such failure is not cured within ten (10) days after notice as provided in Paragraph 9, the Deposit shall be immediately transmitted by Escrow Agent to Seller to be Seller's absolutely in accordance with Paragraph 9.a., above; c. In the event of either (i) Seller's inability to deliver good and marketable title to the Property (or any of them) in accordance with this Agreement (unless expressly waived in writing by Buyer), or (ii) issuance and receipt of the Termination Notice as described in Paragraph 6., Escrow Agent shall immediately return that portion of the Deposit relating to that Property(ies) to Buyer upon Buyer's written request therefor and the Agreement shall thereupon be deemed null, void and of no further force and effect (except for indemnification provision of Paragraph 6.a., and 14). For the purposes of allocating the Deposit, the sum of $100,000.00 shall be allocated toward each of the six (6) Properties. d. If Seller fails or refuses to close the purchase and sale in accordance with this Agreement, or otherwise fails to comply with any of the obligations, covenants, warranties or agreements and such failure is not cured within ten (10)days after notice as provided in Paragraph 9, the Deposit shall be immediately transmitted by Escrow Agent to Buyer in accordance with Paragraph 9.b., above. Upon receipt of the Deposit, Escrow Agent shall use its best and most diligent efforts to cause the funds received by it to be invested in a federally insured financial institution in Atlanta, Georgia to earn a rate of interest currently being paid in Atlanta, Georgia on Money Market Demand Accounts or in such other form of investment specifically authorized and approved in writing by both Buyer and Seller delivered to Escrow Agent. Upon the occurrence of any of the foregoing events entitling either party to the Deposit and written request to the Escrow Agent, the Deposit shall be submitted to the party entitled thereto together with any and all interest earned thereon (less reasonable escrow charges and/or fees imposed by the Escrow Agent, if any) which shall belong solely to the recipient except in the instance that the Deposit is transmitted to Seller in accordance with subparagraph a., above, in which case the interest on the Deposit shall also be credited against the Purchase Price. All notices, demands and communications as provided herein will be served by registered or certified United States mail, return receipt requested, available express mail carrier (such as Federal Express, Emery, Airborne, etc.), or facsimile capable of confirming receipt, to the following address or to such other address(es) as Seller and Buyer may advise each other in writing pursuant to this Paragraph 13. Attn: Ellen F. Parker, Law Department West Palm Beach, Florida 33407 Attn: G. A. Seelbinder, Chairman & CEO cc: James F. Hadley, Esquire James F. Hadley Co., L.P.A. 150 East Wilson Bridge Road Escrow Agent: Lawyers Title Insurance Corporation 950 E. Paces Ferry Road, N. E. Buyer will not sell, convey, lien, or otherwise transfer any of Buyer's interest in this Agreement without obtaining, in each and every instance, the prior written consent of Seller. Seller will have a right of approval of any such transferee and a right to receive 100% of the profit from any such transfer. Buyer represents and warrants to Seller that the Property will not be used for the operation of any restaurant using a name the same as, or similar to, "China Coast", which name is a registered trademark owned by Seller. This covenant may be recorded in the deeds. In the event that this Agreement is terminated by either Buyer or Seller prior to Closing, and notwithstanding the fact that such termination will release Buyer from its obligation to buy the Property, nothing herein will be deemed to release Buyer from any liability arising out of or connected with Buyer's activities (or those of its employees, agents, or contractors) on the Premises including, but not limited to, its actions on the Premises while exercising its rights pursuant to Paragraph 6 hereof. This provision will survive Closing of the transaction herein contemplated and the delivery of the deeds. a. All of the representations, warranties, covenants and agreements of the parties will survive the Closing and will not be merged therein. b. This Agreement will be construed under and in accordance with the laws of the State where the Premises is located and according to its fair meaning and not in favor of or against any party. c. This Agreement will be binding upon and inure to the benefit of the parties hereto and their respective legal representatives, successors and assigns. d. If any term, provision or condition contained in this Agreement will, to any extent, be held to be invalid, illegal or unenforceable in any respect, the remainder of this Agreement (or the application of such term, provision or condition to persons or circumstances other than those in respect of which it is invalid, illegal or unenforceable) will not be affected thereby, and each and every other term, provision and condition of this Agreement will be deemed valid, legal and enforceable. e. This Agreement constitutes the sole and only agreement of the parties hereto and supersedes any prior understandings or written or oral agreements between the parties respecting the within subject matter. This Agreement cannot be amended or modified except by written agreement signed by Buyer and Seller. f. All parties hereto pledge their good faith efforts to act in a timely and reasonable manner to consummate the transaction herein contemplated. g. Words of any gender used in this Agreement will be held and construed to include any other gender, and words in the singular number will be held to include the plural, and vice versa, unless the context requires otherwise. h. The paragraph headings herein are for reference purposes only and are not intended in any way to describe, interpret, define or limit the scope, extent or intent of this Agreement or any part hereof. The failure by either party to enforce against the other any term or provision of this Agreement will not be deemed a waiver of such party's right to enforce against the other party the same or any other such term or provision. i. This Agreement may be executed in multiple originals or counterparts, each of which will be an original and, when all of the parties to this Agreement have signed at least one (1) copy, such copies together will constitute a fully executed and binding Agreement. j. No representation, warranty, or recommendation is made by Seller or its agents, employees or attorneys regarding the legal sufficiency, legal effect, or tax consequences of this Agreement or the transaction, and each signatory is advised to submit this Agreement to his/her attorney before signing it. k. If either party files any action or brings any proceeding against the other arising out of this Agreement, or is made a party to any action or proceeding brought by a third party arising out of this Agreement, then as between Buyer and Seller, the prevailing party will be entitled to recover, as an element of its costs of suit and not as damages, reasonable attorneys' fees to be fixed by the court. The "PREVAILING PARTY" will be the party who is entitled to recover its costs of suit, whether or not the suit proceeds to final judgment. A party not entitled to recover its costs will not recover attorneys' fees. l. If either party hereto will be delayed or hindered in or prevented from the performance of any act required hereunder by reason of strikes, lockouts, labor troubles, fires, acts of God, natural disasters, inability to procure material, failure of power, restrictive governmental laws or regulations, riots, insurrection, war, or other reason of a like nature not the fault of the party delayed in performing work or doing acts required under this agreement, the period for the performance of any such work or act will be extended for a period equivalent to the period of such delay. m. This Agreement will not be recorded in part or in whole by either party hereto. n. Use of the term "business day" or "business days" is hereby defined as a day or days which are neither a Saturday, Sunday or a holiday observed by the United States Postal Service. This Agreement may be executed in multiple counterparts, each of which shall be deemed an original and all of such counterparts together shall constitute but one and the same instrument. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. BY: /s/ Richard D. Halterman /s/ WITNESS TITLE: Senior Vice President /s/ WITNESS DATE: October 20, 1995 BY: /s/ Phillip L. Pritchard /s/ G. Arthur Seelbinder TITLE: President and C.O.O. CEO & Chairman DATE: October 18, 1995 Exhibits: A-1 Legal Description -#CC6039 Duluth/Gwinnett, Georgia A-2 Legal Description -#CC6023 Kennesaw/Town Center, Georgia A-3 Legal Description -#CC6044 Sterling Heights, Michigan A-4 Legal Description -#CC6022 Beavercreek, Ohio A-5 Legal Description -#CC6015 Boardman, Ohio A-6 Legal Description -#CC6014 Vandalia, Ohio C Bill of Sale Form LAWYERS TITLE INSURANCE CORPORATION, a Virginia corporation, referred to in the preceding Agreement as "Escrow Agent", hereby accepts appointment as "Escrow Agent" pursuant to Paragraph 10., of the foregoing agreement and agrees to comply with the terms and conditions imposed upon it in Paragraph 10., of the foregoing Agreement. Provided, however, in no event shall Escrow Agent be liable or obligated to either the Seller or Buyer for any of the following should they occur: (a) A Failure of any financial institution in which the Escrow Agent has deposited funds received pursuant to said paragraph 10.; (b) The collectability of any check or draft submitted by the Buyer to Escrow Agent and comprising a part of the Deposit; or (c) Any loss incurred by either Seller or Buyer for Escrow Agent's failure to perform the duties and responsibilities imposed upon it pursuant to said Paragraph 10., if such error or mistake was made by Escrow Agent in good faith upon and in compliance with advice of Escrow Agent's counsel. Escrow Agent hereby acknowledges receipt from Buyer of the Deposit in the amount of Six Hundred Thousand and No/100 Dollars ($600,000.00) which comprises the entire Deposit required pursuant to in Paragraph 10., of this Agreement. In the event demand for payment of the Deposit is made to Escrow Agent pursuant to Paragraph 10., of the foregoing Agreement, Escrow Agent will immediately advise the other party to the foregoing Agreement in writing delivered in accordance with Paragraph 11., of the foregoing Agreement. If Escrow Agent has not received conflicting instructions from said notified party within five (5) business days of the receipt of said notice by the notified party, Escrow Agent may in good faith pay the Deposit (less Escrow Agent's reasonable charges and fees, if any) in accordance with said original demand. In the event Escrow Agent receives conflicting instructions from the notified party, Escrow Agent shall retain the Deposit until it has received instructions signed by both parties or pursuant to an order or decree of a court competent jurisdiction. So acknowledged and agreed in Atlanta, Georgia, this _____day of ___________________, 1995. Survey shall be made by a Registered Land Surveyor or Engineer who shall promptly prepare and furnish a drawing of the survey. The boundary survey shall close by latitude and departure with an error not to exceed 1:5000. Calculations, closure sheets or other evidence to be provided. The surveyor shall set permanent markers at all property corners which are not marked. Elevation datum shall be U.S.G.S. Mean Sea Level Datum (M.S.L.) or municipal datum. Indicate equation between municipal and M.S.L. if available. Assumed datum shall only be used when specified datum is not available. Bench mark reference shall be made on or adjacent to the site. The drawing of the survey shall be made on a sheet size of 30 x 42 to a scale of 1" = 20', unless specified otherwise. The surveyor shall furnish to _______________ 1 reverse sepia and 6 blue line copies. The drawing shall show all data pertaining to the site and shall include, but shall not necessarily be limited to the following: 1. The scale of the drawing. 2. North arrow. 3. All dimensions, angels, or courses and bearings of boundaries. 4. Boundary of described property shall be clearly labeled and indicated by a bold line. 5. Corner monuments. 6. Name of sub-division, lot number, lot lines, block number, city, county and state. 7. Assessor's Parcel number - APN (where applicable). 8. Streets and alleys, public or private, including dedicated, but unopened streets or alleys. 9. Existing physical boundaries, such as fences, walls, etc., indicating any deviation from true boundary lines. 10. All buildings and other improvements with descriptions, dimensions and location. 11. All encroachments, from or on said property, easements or right-of-ways public or private, recorded, unrecorded, or established by usage. 12. Any deficiencies between deed description and boundary lines. 13. Side walk width and distance to curb and property line and condition of walk. 14. Curb and curb-cut locations and type of curb. 15. Name of streets and width and type of pavement. Indicate any safety islands. 16. If inside lot, give distance and direction to nearest street intersections. 17. Bench mark reference. 18. Show spot elevations on adjacent streets at centerline, edge of pavement (or gutter line) at 50' intervals. Show elevations of all walks, building floors on adjacent properties IF PERMISSIBLE, ditch lines, railroad rails, and adjacent property at least 10' from property lines. Show surface elevation of any body of water within 100' of property. 19. Contours at one-foot intervals of elevation change, including enough adjacent property to show unusual conditions with existing elevations. 20. General direction of surface drainage and disposal of storm drainage. 21. Provide drainage area information indicating existing offsite drainage areas which drain onto or through subject site. 22. Location of any test borings evident. 23. Utility poles. (Company servicing). Name. 24. Underground cables and depth. (Company servicing). Name. 25. Storm and sanitary sewers - locations, size, direction of flow, inverts - fall per ft. and location of stubs. 26. Manholes and catch basins, top and invert elevations. 27. Water main - location, size and depth. (Company servicing). Name. 28. Fire hydrants. 29. Gas main - location, size and depth. (Company servicing). Name. 30. Street lights. (Company servicing). Name. 31. Trees - location, size and type, including decorative landscaping on site. 32. Furnish the following information, if available, to the best of your knowledge. 33. Names of owners of adjacent properties within 20 feet from any property line, and on opposite side of fronting street. 34. Label adjacent property use (or vacant), and zoning classification. 35. Show paved areas adjacent to property. 36. Show flood plain elevation and limits, if applicable. If not applicable, so state. 37. The survey drawing shall be certified as follows: "I hereby certify and represent to______________________________________________ GMRI, INC. that this is a true and correct Plat of a survey made under my supervision in accordance with "Specifications for Land Survey", a copy of which has been delivered to me, of: (Insert legal description of property surveyed) that said Plat correctly shows the locations of all buildings, structures and improvements on said described property; that there are no encroachments from or on said described property, or right-of-ways or easements on said described property, except as shown on said Plat of survey; and that I am a registered land surveyor or engineer in the State of _____________________________________. FOR AND IN CONSIDERATION of the sum of Ten Dollars ($10.00) and other valuable consideration, the receipt and sufficiency of which is hereby acknowledged by GMRI, Inc., a Florida corporation having its principal office at 5900 Lake Ellenor Drive, Orlando, Florida 32859, (hereinafter referred to as "Seller"), Seller does hereby sell and unconditionally transfer, convey and assign to and unto COOKER RESTAURANT CORPORATION, an Ohio corporation having its principal office at 5500 Village Boulevard, West Palm Beach, Florida 33407 (hereinafter referred to as "Buyer"), its successors and assigns, all of Seller's right, title, and interest to and unto the following: 1. All furniture, fixtures, equipment, appliances and other personal property owned by Seller on the date hereof and located on, in, or forming a part of the real estate and/or improvements existing on the real estate described in EXHIBIT A, which is attached hereto and by this reference made a part hereof (herein the "Premises"). 2. This sale, transfer and assignment by and from Seller to and unto Buyer made pursuant to Paragraph 1, next above, specifically includes, but is not limited to: furniture, booths, non-food inventory, smallwares, kitchen equipment, appliances, wallcoverings and decorations, lighting and lighting fixtures, telephone systems, PC based point-of-sale systems, office equipment, walk-in coolers, hoods and exhaust fans and systems, sound systems where owned by Seller, panic and emergency lighting, HVAC systems, wiring, pipes, flues, cables and related connections to utility services, water systems (water tanks and heaters) including sprinkler systems, pylon standards and sign monuments, and all other personal property, fixtures and improvements to the extent located in, on or forming a part of the Premises on the date hereof. The furniture, fixtures, equipment, appliances and other personal property identified in numbered Paragraphs 1., and 2., next above shall hereinafter collectively be referred to as the "Property". Seller hereby represents and warrants to Buyer that: A. Seller is the sole and exclusive owner of all right , title and interest in and to the Property; B. Seller has full right, power and authority to sell, convey, transfer and assign the Property to Buyer; and C. There are no security interests, pledges, liens or encumbrances of any kind or nature upon or affecting the Property; and D. Seller shall warrant and defend the right, title and interest of Buyer and Buyer's successors and assigns in and to the Property against the claims of all persons claiming by, through and under Seller. Except for the warranties expressly set forth in Paragraphs A. through D., inclusive, next above, the Property is sold by Seller and the Buyer accepts the Property "AS IS", "WHERE IS', and "WITH ALL FAULTS" without any additional warranties from Seller whatsoever including, but not limited to any implied warranty of fitness for a particular purpose or of merchantability. TO HAVE AND TO HOLD the Property with all appurtenances thereto, unto Buyer, its successors and assigns forever. IN WITNESS WHEREOF, the Seller, GMRI, INC., has caused this Unconditional Bill of Sale to be executed and delivered by its duly authorized undersigned officer this ____ day of _______________, 1995, in Orlando, Florida. Signed, Acknowledged and GMRI, INC., a Florida corporation Delivered in the Presence of: ("Seller") Print Name:______________________ Richard D. Halterman On _______________, 1995, before me, the undersigned, a Notary Public in and for said State, personally appeared Richard D. Halterman, personally known to me to be the Senior Vice President of GMRI, INC., a Florida corporation , personally known to me to be the person who executed the within instrument for and on behalf of said corporation, and he acknowledged tome that GMRI, INC., executed the within instrument pursuant to its bylaws and duly adopted and effective resolution of its Board of Directors. WITNESS my and Official Seal.	8-K	EX-99.1	1996-01-12T00:00:00	1996-01-12T13:45:28
0000950168-96-000039	0000950168-96-000039_0005.txt	FIRST INVESTORS SERIES FUND II, INC. WHEREAS, FIRST INVESTORS SERIES FUND II, INC. (the "Fund") is a diversified open-end management investment company duly registered with the Securities and Exchange Commission under the Securities Act of 1933, as amended, and the Investment Company Act of 1940, as amended (the "1940 Act"); WHEREAS, the Fund employs one or more broker-dealers as distributors of its shares ("Underwriter") pursuant to a written agreement ("Underwriting WHEREAS, Rule 12b-1 under the 1940 Act permits registered investment companies to bear certain expenses associated with the distribution of their WHEREAS, the Fund offers multiple classes of shares for WHEREAS, the Board of Directors believes that payment of certain expenses associated with the distribution of Class A shares of the Fund and the servicing or maintenance of Class A shareholder accounts would be beneficial to the Fund and its shareholders; and WHEREAS, the Fund, on behalf of each of its separate designated series presently existing or hereafter established (collectively and singularly, "Series"), wishes to adopt a plan under Rule 12b-1 to permit each Series to pay some of the expenses involved in distributing its Class A shares and the servicing or maintenance of its Class A shareholder accounts. NOW, THEREFORE, in consideration of the foregoing, the Fund hereby adopts the following distribution plan in accordance with Rule 12b-1 (the "Class A Plan"): 1. PAYMENT OF THE FEE. Pursuant to one or more Underwriting Agreements which the Fund can enter into from time to time and the Class A Plan, each Series shall pay as compensation for the Underwriter's services a quarterly Rule 12b-1 fee of up to an aggregate of 0.30 of 1% of each Series' average daily net assets attributable to Class A shares on an annual basis (referred to herein as the "Class A 12b-1 fee"). The Class A 12b-1 fee is payable by each Series monthly or at such intervals as shall be determined by the Board of Directors in the manner provided for approval of the Class A Plan in paragraph 5(a). The fee shall consist of a distribution fee and a service fee, in such proportions as shall be determined from time to time by the Board of Directors in the manner provided for approval of the Plan in paragraph 5(a). The distribution and service fees shall be payable regardless of whether that amount exceeds or is less than the actual expenses incurred by the Underwriter in distributing Class A shares of such Series in a particular year. 2. EXPENSES DIFFERENT FROM ANNUAL RATE. To the extent that the Class A 12b-1 fee paid by each Series in a particular year exceeds actual expenses incurred by an Underwriter in that year, the Underwriter would realize a profit in that year. If the expenses incurred by an Underwriter in a particular year are greater than the fee payable under the Class A Plan by the Series, the Underwriter would incur a loss in that year and would not recover from such Series such excess of expenses over the fee paid under the Class A Plan unless actual expenses incurred in a subsequent year in which the Class A Plan remained in effect were less than the fee paid under the Class A Plan in that year. 3. DISTRIBUTION AND SERVICE FEES. "Distribution" fees are fees paid for the distribution of the Series' Class A shares, including continuing payments to registered representatives and dealers for sales of Class A shares, the costs of printing and dissemination of sales material or literature, prospectuses used as sales material and reports or proxy material prepared for the Series' Class A shareholders to the extent that such material is used in connection with the sales of the Series' Class A shares, and general overhead of an Underwriter. "Service" fees are fees paid for services related to the maintenance and servicing of existing Series' Class A shareholder accounts, including shareholder liaison services, whether provided by individual representatives, dealers, an Underwriter or others entitled to receive such fees. 4. REPORTS TO DIRECTORS. Quarterly and annually in each year that the Class A Plan remains in effect, the Treasurer of the Fund shall prepare and furnish to the Board of Directors of the Fund a written report of the amounts so expended and the purposes for which such expenditures were made under the Class A Plan. The Board of Directors will promptly review the Treasurer's report. 5. APPROVAL OF PLAN. The Class A Plan shall become effective with respect to any Series of the Fund immediately upon the approval by the majority vote of (a) the Fund's Board of Directors and of the Directors who are not "interested persons" of the Fund, within the meaning of the 1940 Act, and have no direct or indirect financial interest in the operation of the Class A Plan or in any agreements related to the Class A Plan (the "Independent Directors") cast in person at a meeting called for the purpose of voting on such Class A Plan and (b) the outstanding Class A voting securities of such Series, voting separately from any other class or Series of the Fund, which for this purpose is defined in Section 2(a)(42) of the 1940 Act and means the lesser of (1) more than 50% of the outstanding shares, or (2) 67% or more of the shares present or represented at a shareholders meeting if more than 50% of the outstanding shares are represented at the meeting in person or by proxy, whichever is less. 6. TERMINATION OF PLAN. If the shareholders of any Series approve the Class A Plan, it can be terminated with respect to such Series at any time without the payment of any penalty by vote of a majority of the Independent Directors or by vote of a majority of the outstanding Class A voting securities of such Series, voting separately from any other class or Series of the Fund (as defined in Section 2(a)(42) of the 1940 Act), on not more than 60 days' written notice to any other party to the Class A Plan. 7. AMENDMENTS. Any material amendment to the Class A Plan with respect to any Series must be approved by the outstanding Class A voting securities of such Series, voting separately from any other class or Series of the Fund (as defined in Section 2(a)(42) of the 1940 Act). Any amendment to materially increase the cost to any Series of the Fund under the Class A Plan must also be approved by the outstanding Class B voting securities of such Series, voting separately from any other class or Series of the Fund (as defined in Section 2 (a)(42) of the 1940 Act.) 8. NOMINATION OF DIRECTORS. While the Class A Plan shall be in effect, the selection and nomination of the Independent Directors shall be committed to the discretion of the Independent Directors then in office. 9. TERM. The Class A Plan shall remain in effect with respect to any Series for one year from the date of its approval by the shareholders of such Series and may continue thereafter only if the Class A Plan is approved at least annually by either the Board of Directors or by a vote of a majority of the outstanding Class A voting securities of such Series, voting separately from any other class or Series of the Fund, and in either case by a majority vote of the Independent Directors, cast in person at a meeting called for the purpose of voting on the Class A Plan. 10. PAYMENTS OUTSIDE OF THE PLAN. To the extent any payments made by any Series to its investment advisor, its transfer agent or any company affiliated with an Underwriter, may be deemed to be indirect financing of any monies paid by the Underwriter or investment advisor out of their own assets for distribution expenses, such payments are permissible under the Class A Plan. Permissible payments may include, but are not limited to, the payment by the Series of investment advisory and service fees. 11. TREATMENT OF EXPENSES. The Directors, including all of the Independent Directors, have determined that the Class A 12b-1 fee will not be an operating expense of the Series. However, while it is expected that the payments under the Class A Plan will be excluded from each Series' total expenses for purposes of determining compliance with any state expense limitation, whether any expenditure under the Class A Plan is subject to any such state expense limitation will depend upon the nature of the expenditure and the terms of the state regulation imposing the limitation. In any event, the amounts paid under the Class A Plan will be an expense for accounting purposes. Dated: August 10, 1992, as amended and restated as of September	485BPOS	EX-99.B15.1	1996-01-12T00:00:00	1996-01-12T09:22:27
0000899243-96-000019	0000899243-96-000019_0000.txt	PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of Report (Date of earliest event reported) December 29, 1995 NORTH AMERICAN TECHNOLOGIES GROUP, INC. (Exact name of registrant as specified in its charter) 4710 Bellaire Blvd., Suite 301, Bellaire, Texas 77401 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (713) 662-2699 (Former name or former address, if changed since last report.) ITEM 1. CHANGES IN CONTROL OF REGISTRANT. ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS. On December 29, 1995, Gaia Technologies, Inc., a Texas corporation ("Sub") and wholly-owned subsidiary of the issuer (North American Technologies Group, Inc., which is sometimes referred to herein as "NATK"), acquired substantially all of the assets of GAIA Holdings, Inc., a Delaware corporation formerly known as GAIA Technologies, Inc. ("Gaia Holdings"), and two of its affiliates, Thor Ventures, L.C., a Texas limited liability company ("Thor Ventures"), and Thor Industries, Inc., a Texas corporation ("Thor Industries;" together with Gaia Holdings and Thor Ventures, the "Seller"). The acquired assets (the "Assets") consist of a number of patented and proprietary technologies and other business assets (including among others certain equipment, inventory and raw materials) relating to the use of recycled rubber and plastics for the manufacture and distribution of porous pipe, synthetic construction materials and certain other products with advanced structural properties, together with substantially all other business assets of the Seller relating thereto. NATK currently intends to continue to use the Assets in the same business as did the Seller. The consideration paid for the Assets included (i) the issuance of 1,666,667 shares (the "Shares") of common stock, par value $.001 per share ("NATK Common Stock"), of NATK, (ii) the payment of $305,500 in cash, (iii) the issuance of a 90-day promissory note (the "90-Day Note") by NATK and Sub in the principal amount of $1,050,000.00 and (iv) the forgiveness of certain debt obligations (together with all interest owed thereon) owed by Seller to NATK of approximately $1,881,400. A portion of the cash payment described in (ii) above was applied from the proceeds of a recent sale of shares of NATK's Series D Convertible Preferred Stock. The 90-Day Note bears interest at an annual rate of twelve percent (12%), and is secured by a lien on and security interest in all of the Assets. Interest payments on the 90-Day Note are due and payable monthly, and the entire principal thereof and all accrued and unpaid interest thereon is due and payable in full on March 28, 1996. In connection with the purchase of the Assets, NATK also agreed to pay, during a 15-year period, certain royalty payments and license fees based on the gross margin (defined as the difference between revenues and cost of goods sold, as calculated pursuant to the terms of a written royalty agreement) from sales of certain products manufactured using the technologies included in the Assets and sublicenses of such technologies. Sub also entered into written employment agreements with each of Henry W. Sullivan, formerly of Gaia Holdings, and William Aldrich, formerly of Thor Ventures. Under such agreements, Mr. Sullivan will serve as President of Sub, and Mr. Aldrich will serve as an executive officer of Sub, in exchange for certain salary payments and other benefits, including among others the issuance by NATK of options to each such person to acquire up to 200,000 shares of NATK Common Stock (an aggregate of 400,000 shares of NATK Common Stock) at an exercise price of $2.50 per share, 25% of which options vest each year over a four-year period. NATK also agreed to cause Mr. Aldrich to be appointed to the Board of Directors of NATK in the first half of 1996. In addition, NATK entered into a Crosstie Purchase Option and Loan Agreement pursuant to which it acquired an option (the "Crosstie Purchase Option") to purchase all of the capital stock of TIETEK, INC., a Texas corporation ("TieTek") which is an affiliate of Seller. NATK may exercise the Crosstie Purchase Option during a two-year period (which period may be extended for an additional year under certain circumstances) by forgiving all then- outstanding indebtedness under the Crosstie Loan referred to below, and paying certain royalty payments based on products to be sold by TieTek after the exercise of the Crosstie Purchase Option. In connection with the sale of the Assets, TieTek received the right to use certain of the patented and proprietary technologies included in the Assets to produce railroad crossties and certain other related products. NATK also agreed in the Crosstie Purchase Option and Loan Agreement to lend up to $1,500,000 (the "Crosstie Loan") to TieTek, the proceeds of which loan are to be used in connection with developing TieTek's business. To date, NATK has lent to TieTek an aggregate of approximately $220,000 of such Crosstie Loan amount. The Crosstie Loan is secured by a pledge of, and lien on, all of TieTek's assets and capital stock, and 666,667 of the Shares. ITEM 3. BANKRUPTCY OR RECEIVERSHIP. ITEM 4. CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT. Effective December 31, 1994, NATK and Euro Scotia Funding Limited ("ESF") renegotiated certain outstanding obligations owed by each party to the other, as a result of which, a new note agreement, which included a promissory note (the "ESF Note"), was entered into that provided for repayment (after certain offsets) by ESF in favor of NATK of a net amount of approximately $2,801,000 as of December 31, 1994. In connection therewith, U.S. Treasury Bills were required to have been placed in an account with a brokerage firm, which brokerage firm agreed to hold such collateral for the benefit of NATK until the ESF Note was paid in full. The first cash repayment under such ESF Note was due to be paid in early January 1996, in the principal amount of approximately $178,000, plus accrued and unpaid interest. Principal payments of approximately $328,000, plus accrued interest, are due each six months thereafter until the ESF Note is paid in full. The January 1996 payment on the ESF Note was not paid in whole or in part as required by the terms of the ESF Note. NATK is currently in the process of making demand for payment on the ESF Note in accordance with the terms of such ESF Note and applicable law. In addition, NATK's management is exploring its other options against ESF and the brokerage firm charged with holding the collateral for the ESF Note. NATK recently learned that, in the last quarter of 1995, the brokerage firm that holds the collateral for the ESF Note and an affiliate of ESF were named as defendants in a lawsuit filed by the Florida Department of Insurance in which it is alleged among other things that such brokerage firm issued false account confirmations. NATK has also learned that such brokerage firm has applied for a withdrawal as a registered broker/dealer in a number of states, including the state in which such securities were to have been held. In early 1996, the Company also learned that the United States Securities and Exchange Commission sought and was granted in late December 1995, a temporary restraining order against certain affiliates of ESF in the United States District Court for the District of Colorado that, among other things, froze investor funds of the defendants and certain of their affiliates, and required each such party to prevent the disposition, transfer or other disposal of any of their funds or other assets then held by them, under their control or over which they exercise investment or other authority. After learning of the Florida lawsuit, NATK has unsuccessfully attempted to gain reliable confirmations of the existence and value of the securities that were to have been held for NATK's benefit in connection with the ESF Note. NATK is uncertain at this time what effect, if any, the failure of the January 1996 payment to have been made, the results of the litigation and other matters described above may have upon the ESF Note and such securities. If satisfactory alternative collateral arrangements cannot be obtained, NATK may be required to write off all or a portion of the ESF Note. ITEM 6. RESIGNATIONS OF REGISTRANT'S DIRECTORS. ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS. Note: GAIA Holdings, Inc., a Delaware corporation, was formerly known as GAIA Technologies, Inc. As used in Items 7(a) and 7(b) below, the term, "GAIA Technologies, Inc." refers to GAIA Holdings, Inc., a Delaware corporation. (a) Financial statements of business acquired (Exhibit F) The interim financial information required by Item 7(a) of Form 8-K is not being filed herewith inasmuch as such information is currently being prepared. NATK contemplates that such financial information will be available in a reasonable amount of time following the filing of this Form 8-K and will endeavor to file such information promptly upon its availability. (b) Pro forma financial information The pro forma financial information required by Item 7(b) of Form 8-K is not being filed herewith inasmuch as such information is currently being prepared. NATK contemplates that such financial information will be available in a reasonable amount of time following the filing of this Form 8-K and will endeavor to file such information promptly upon its availability. ITEM 8. CHANGE IN FISCAL YEAR. Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunder duly authorized. NORTH AMERICAN TECHNOLOGIES GROUP, INC. Date: January 12, 1996 /s/ Tim B. Tarrillion President and Chief Executive Officer INDEX TO FINANCIAL STATEMENTS AND EXHIBITS Note: GAIA Holdings, Inc., a Delaware corporation, was formerly known as GAIA Technologies, Inc. As used in (a) and (b) below, the term, "GAIA Technologies, Inc." refers to GAIA Holdings, Inc., a Delaware corporation. (a) Financial statements of business acquired (Exhibit F) The interim financial information required by Item 7(a) of Form 8-K is not being filed herewith inasmuch as such information is currently being prepared. NATK contemplates that such financial information will be available in a reasonable amount of time following the filing of this Form 8-K and will endeavor to file such information promptly upon its availability. (b) Pro forma financial information The pro forma financial information required by Item 7(b) of Form 8-K is not being filed herewith inasmuch as such information is currently being prepared. NATK contemplates that such financial information will be available in a reasonable amount of time following the filing of this Form 8-K and will endeavor to file such information promptly upon its availability. Independent Certified Public Accountants' Report We have audited the accompanying balance sheets of GAIA Technologies, Inc. as of December 31, 1994 and 1993, and the related statements of loss, capital deficit, and cash flows for each of the years in the three year period ending December 31, 1994. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Notes 4 and 5, the company had significant transactions with related parties for each of the years in the three year period ending December 31, 1994. Also, as discussed in Note 11, subsequent to December 31, 1994 the company signed a letter of intent to sell substantially all assets of the company. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of GAIA Technologies, Inc. as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the years in the three year period ending December 31, 1994 in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the company will continue as a going concern. As discussed in Note 1 to the financial statements, the company has incurred operating losses since inception and at December 31, 1994, the company had a negative working capital position and a capital deficit. This situation raises substantial doubt about the company's ability to continue as a going concern. Subsequent to December 31, 1994, the company has entered into a letter of intent to sell substantially all assets of the company. The company's ability to continue as a going concern is dependent upon the successful completion of the sale. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. See accompanying summary of significant accounting policies and notes to financial statements. See accompanying summary of significant accounting policies and notes to financial statements. See accompanying summary of significant accounting policies and notes to financial statements. (1) No stated par, 1,000,000 shares authorized See accompanying summary of significant accounting policies and notes to financial statements. Summary of Significant Accounting Policies Nature of GAIA Technologies, Inc. (the Business company), was incorporated on July 10, 1991, in the State of Delaware. The company is a manufacturer of porous pipe made from recycled rubber and thermoplastic. Also, the company has certain patented and unpatented materials (hard goods) which are to be made from recycled rubber and thermoplastic. As of October 2, 1995, the company has not integrated into its manufacturing process. However, the company is currently building a manufacturing line to produce hard goods and porous pipe with production scheduled to begin in December 1995. Inventories Inventories consist of raw materials and finished goods and are valued at the lower of cost (first-in, first-out) or market. Costs for finished goods include raw materials, direct labor and allocation of manufacturing overhead costs. Property, Property and equipment are stated at Equipment and cost. Depreciation is computed using Depreciation the straight-line method for both financial and tax reporting purposes. Investment in The company's investment in its 50% Joint Venture owned joint venture is accounted for using the equity method of is carried at cost and adjusted for the company's proportionate share of undistributed earnings or losses. Intangible Organization costs are being Assets amortized by the straight-line method over a five year period. Purchased patents and trademarks are being amortized by the straight-line method over their remaining lives of five years. Revenue The company recognizes revenues when Recognition the products are shipped. Income Taxes Deferred income taxes result from the financial statement and income tax basis of assets and liabilities (see Note 6). Summary of Significant Accounting Policies Loss Per Loss per share amounts are based on Share the weighted average number of common shares outstanding for all periods were not included in the loss per share calculation for all years anti-dilutive. Concentration As of October 1994, the company had of Credit cancelled all insurance coverage. 1. Financial Since the inception of the company, Condition the company has incurred operating and Going losses and at December 31, 1994, the Concern company had a negative working capital position of $2,047,650 and a capital deficit of $2,729,691. Also, during 1995 because of the working capital position the company has had limited manufacturing operations. doubt about the company's ability to continue as a going concern. Subsequent to December 31, 1994, the company has entered into a letter of intent to sell substantially all assets of the company (see Note 11). Absent of any additional debt or ability to continue as a going concern is dependent on the successful completion of the sale. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. 2. Inventories At December 31, 1994 and 1993, inventories consisted of the following: Finished goods $ 94,142 $ 210,986 Total $ 99,056 $ 212,057 3. Property and At December 31, 1994 and 1993, property and equipment Equipment consisted of the following: following: machinery 7 $ 377,023 $ 481,356 4. Related Party At December 31, 1994 and 1993, the company had accounts Transactions payable to various stockholders totalling $54,220 and $9,733, respectively, for various administrative expenses incurred on behalf of the company. At December 31, 1994, the company had dividends payable to preferred stockholders totalling $9,328. At December 31, 1994 and 1993, the company had various notes payable primarily with related parties as follows: Note payable to a stockholder due on October 21,1995, interest payable monthly at prime plus 2% (10.5% at by substantially all assets of the company $ 778,000 $ 778,000 Unsecured note payable to a stock- holder, due on demand, interest payable at 8.5% 285,784 161,022 Unsecured note payable to a stock- holder, due on demand, interest at prime plus 1% (10% at December to a stock option holder, due on demand, interest payable at 8.5%, convertible into common stock at approximately $60 per share 50,000 50,000 Note payable to a stockholder due on demand, interest payable at 10%, discussed in Note 11 75,000 - At December 31, 1994 and 1993, the company had long-term debt agreements with a stockholder totalling $500,000 and $480,000, respectively. The notes bear interest at 8.5%, payable quarterly, with principal due September 13, 1998 and December 13, 1998. The notes are collateralized by common stock warrants issued in association with the debt. For the years ended December 31, 1994, 1993 and 1992, the company incurred interest expense on these related party notes totalling approximately $153,000, $102,000 and $64,000, respectively, of which approximately $135,000 and $49,000 remained unpaid at December 31, 1994 and 1993, respectively. 5. Investment in Effective January 1, 1994, the company entered into a Joint Venture joint venture agreement with a company that is a stockholder of the company. The company has a 50% ownership interest in the joint venture which is accounted for using the equity method of accounting. The original purpose of the joint venture was to sublicense the hard goods and porous pipe technology on a national and international basis. However, the primarily activity of the joint venture to date has been the pursuit of a patent infringement case in which the company is the plaintiff (see Note 11). The company contributed the porous pipe licenses as their initial contribution to the joint venture, which had no book value at the time of contribution. The company's share of net loss from the joint venture for the year ended December 31, 1994 was $232,262, however, the company was limited to recording a loss of $132,262 which represents the net amount the company is potentially liable for as of December 31, 1994. The following is a summary of financial position at December 31, 1994 and results of operations of the joint venture for the year ended December 31, 1994: License agreements, net $ 187,614 Note payable to venturer $ 200,000 Accounts payable, legal fees 255,245 Expenses, primarily legal fees 464,524 6. Income and Deferred taxes are determined based on the temporary Payroll differences between the financial statement and income tax Taxes basis of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. The components of deferred income tax assets at December 31, consist of the following: Allowance for doubtful accounts $ 21,000 $ - Net operating loss carryforward 1,619,000 1,265,000 Net deferred tax asset 1,640,000 1,265,000 Total $ - $ - At December 31, 1994 and 1993, the company provided a 100% deferred tax asset valuation allowance because it is unlikely that the company will recognize the deferred tax asset unless the asset sale as described in Note 11 is completed. At December 31, 1994, the company had net operating loss carryfowards of approximately $4,763,000 available to reduce taxable income through the year 2009. The net operating loss carryforwards expire as follows: Year ended December 31, Amount At December 31, 1994 and 1993, the company had past due payroll taxes totalling $386,642 and $222,612, respectively. The internal revenue service has a lien filed on all assets of the company until these liabilities have been satisfied. 7. Capital Stock, The company has 18,680 shares of authorized cumulative Options And convertible redeemable preferred stock of which 18,680 and Warrants 6,538 shares were outstanding at December 31, 1994 and 1993, respectively. The redeemable preferred stock earns dividends at an annual rate of 8% beginning September 1, 1994 payable annually on August 31, of each year. The preferred stockholders have voting rights and are entitled to participate in dividends declared and paid to common stockholders as if their preferred stock had been converted into common stock. The preferred stock has a liquidation preference of $53.53 per share plus all unpaid dividends, and is convertible at the option of the holder into common stock, as determined by dividing $53.53 by the conversion price, as computed in accordance with the agreement. The company is required, in accordance with the mandatory redemption clause, to redeem 20% of the outstanding preferred stock as of August 31, 1995 at a redemption price of $53.53 plus all unpaid dividends, and 25% of the remaining outstanding preferred stock at $53.53 plus all unpaid dividends on August 31, of each year thereafter through August 31, 1999. At any time after August 31, 1996, the company, at its option, may redeem any or all outstanding preferred stock at $53.53 per share plus all unpaid dividends. As of October 2, 1995, the company did not have the funds available to comply with the 20% mandatory redemption as discussed above. During the years ended December 31, 1994 and 1993, the company issued common stock warrants totalling 3,822 and 7,786, respectively, in association with certain debt financing. Each warrant allows the holder to purchase one share of common stock at an exercise price of $19.62 and $64.22, respectively, per share and expire on January 13, 2004 and September 13, 2003, respectively. During 1993, the company issued common stock options totalling 1,019 in association with certain debt financing. Each option allows the holder to purchase one share of common stock at an exercise price ranging from $60.15 to $72.20 per share. The stock options have no expiration date. No common stock options or warrants were exercised during the years ended December 31, 1994, 1993 and 1992. Also, the company did not issue any stock options or warrants during the year ended December 31, 1992. At December 31, common stock was reserved for future issuance as follows: Conversion of preferred stock to Stock options outstanding 1,019 1,019 Stock Warrants outstanding 11,608 7,786 8. Major For the years ended December 31, 1994, 1993 and 1992, the Customers company had sales from four customers representing the following percentage of total sales: Customer A 1% 31% 22% Customer B 1% 16% 12% Customer C 23% 7% 6% Customer D 1% 17% 12% 9. Miscellaneous During the years ended December 31, 1994 and 1993, the Income company sold certain licensing rights for approximately $119,000 and $100,000, respectively, and recorded it as miscellaneous income. 10. Supplemental For the years ended December 31, 1994, 1993 and 1992, the Cash Flow company paid interest totalling $66,350, $73,085 and Information $48,803, respectively. During the year ended December 31, 1994, 12,143 shares of preferred stock were converted into 12,143 shares of common stock at $53.53 per share. At December 31,1 994, the company had dividends payable to preferred stockholders totalling $9,328. 11. Subsequent On June 9, 1995, the company entered into a letter of Events intent to sell substantially all of the assets of the company to a publicly traded company for $2,500,000 in cash and 1,666,667 shares of common stock of the publicly traded company, which was trading at $.94 a share at October 2, 1995. The company plans to use the proceeds to retire existing debts of the company. In association with the letter of intent, the company entered into debt agreements, whereby the purchaser will loan the company up to $1,100,000. The debt bears interest at 10%, is due July 1, 1998 and is collateralized by certain assets of the company. On closing of the sale, the purchaser is expected to forgive the amounts advanced under the loan agreements as part of the cash portion of the purchase price. As of October 2, 1995, the company had borrowed $1,020,000 in accordance with these debt agreements. In addition to the debt agreements discussed above, the letter of intent allowed the company to enter into a third debt agreement with the purchaser, whereby the purchaser will loan the company up to $1,000,000 to be used exclusively for the purchase of equipment and working capital needs for the company's hard goods business. The debt bears interest at 10%, is due July 1, 1998 and is collateralized by assets purchased with the proceeds. On closing of the sale, the purchaser is expected to forgive the balance advanced to the company under this debt agreement in consideration for the assets received by the purchaser that were purchased with the proceeds. As of October 2, 1995, the company had borrowed $318,592 in accordance with this agreement. In accordance with the letter of intent, the company will receive a 10% licensing fee, as defined by the agreement for a period of five years after the closing. Also, the company will receive a 5% royalty on all revenues as defined by the agreement for a period of fifteen years. Additionally, at closing the company will grant the purchaser an exclusive right and option exercisable at any time during a two year period following the closing to acquire the railroad crosstie business assets, as defined by the agreement, with a one year extension at the option of the purchaser. In exchange for the grant of the option, the purchaser agrees to loan up to $1,500,000 to the company to be used exclusively for the development of the railroad crosstie technology. The loan will bear interest at 10% and is due two years after the earlier of (1) the date the purchaser provides notice that they will not exercise their option or (2) the expiration of the option period. The loan will be secured by 666,667 shares of the common stock of the publicly traded company received from the sale. On March 16, 1995, the company won its patent infringement case in which the company was the plaintiff and a final judgment was entered on behalf of the company for approximately $22,000,000. As of October 2, 1995, the case and final judgment were under appeal. Subsequent to March 16, 1995, the main corporate defendant filed for bankruptcy and the amount and timing of any collection is uncertain. Accordingly, any receivable or gain resulting from the judgment had not been recorded in the company's financial statements as of December 31, 1994. The sale of the assets discussed above does not entitle the purchaser to any amounts or assets that the company may recover in the future as a result of this judgment.	8-K	8-K	1996-01-12T00:00:00	1996-01-12T16:52:02
0000950115-96-000012	0000950115-96-000012_0003.txt	<DESCRIPTION>CONSENTS OF EXPERTS AND COUNSEL We consent to the incorporation by reference and inclusion in this Registration Statement of ICC Technologies, Inc. (the Company) on Form S-2 (File No. 33-80223) of our report, which includes an explanatory paragraph which refers to conditions that raise substantial doubt about the Company's ability to continue as a going concern, dated March 24, 1995, on our audits of the consolidated financial statements of ICC Technologies, Inc. as of December 31, 1994 and 1993 and for the years ended December 31, 1994, 1993 and 1992, which report is included in the Company's Annual Report on Form 10-K for the year ended December 31, 1994. We also consent to the incorporation by reference and inclusion in this Registration Statement of the Company of our report, which includes an explanatory paragraph which refers to conditions that raise substantial doubt about Engelhard/ICC's ability to continue as a going concern, dated March 24, 1995, on our audit of the financial statements of Engelhard/ICC as of December 31, 1994 and for the period February 7, 1994 (date of formation) to December 31, 1994, which report is also included in the Company's Annual Report on Form 10-K for the year ended December 31, 1994. We consent to the references to our firm under the captions "Selected Consolidated Financial Data of the Company," "Selected Financial Data of the Partnership" and "Experts."	S-2/A	EX-23.2	1996-01-12T00:00:00	1996-01-11T17:48:48
0000898430-96-000080	0000898430-96-000080_0000.txt	Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Amendment No. ) Filed by the Registrant [X] Filed by a Party other than the Registrant [_] [_] Preliminary Proxy Statement [_] Confidential, for Use of the Commission Only (as permitted by [_] Soliciting Material Pursuant to Section 240.14a-11(c) or Section 240.14a-12 (Name of Registrant as Specified In Its Charter) (Name of Person(s) Filing Proxy Statement, if other than the Registrant) Payment of Filing Fee (Check the appropriate box): [X] $125 per Exchange Act Rules 0-11(c)(1)(ii), 14a-6(i)(1), 14a-6(i)(2) or Item 22(a)(2) of Schedule 14A. [_] $500 per each party to the controversy pursuant to Exchange Act Rule 14a-6(i)(3). [_] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11. (1) Title of each class of securities to which transaction applies: (2) Aggregate number of securities to which transaction applies: (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the filing fee is calculated and state how it was determined): (4) Proposed maximum aggregate value of transaction: [_] Fee paid previously with preliminary materials. [_] Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. (2) Form, Schedule or Registration Statement No.: NOTICE OF ANNUAL MEETING OF SHAREHOLDERS The Annual Meeting of Shareholders of Jacobs Engineering Group Inc. will be held on Tuesday, February 13, 1996 at 3:30 p.m. at 251 South Lake Avenue, First Floor Conference Center, Pasadena, California, for the following purposes: 1. To elect three directors to hold office until the 1999 annual 2. To approve an increase of 1,500,000 shares of common stock in the number of shares reserved for the 1989 Employee Stock Purchase Plan; 3. To approve the appointment of Ernst & Young LLP as independent accountants to audit the accounts of the Company for the fiscal year ending September 30, 1996; and 4. To act upon such other matters as may properly come before the meeting. The shareholders of record at the close of business on January 5, 1996 will be entitled to vote at such meeting and any adjournment thereof. This notice and proxy statement and the accompanying proxy are being mailed to such shareholders on or about January 11, 1996. The stock transfer books will not close. By Order of the Board of Directors YOU ARE URGED TO DATE, SIGN, AND RETURN PROMPTLY THE ENCLOSED PROXY IN THE ENVELOPE PROVIDED. This proxy statement is furnished in connection with the solicitation by the Board of Directors of Jacobs Engineering Group Inc., a Delaware corporation (the "Company"), of proxies to be used at the annual meeting of shareholders of the Company to be held February 13, 1996, and any adjournment thereof. The expense of the solicitation will be paid by the Company. Some officers and regular employees may solicit proxies personally and by telephone if deemed necessary. The proxy is revocable by you by written notice to the Secretary of the Company at any time prior to the exercise of the authority granted thereby or by your being present at the meeting and electing to vote in person. The holders of common stock of record at the close of business on January 5, 1996, the record date fixed by the Board of Directors (the "Record Date"), will be entitled to one vote per share on all business of the meeting. The presence in person or by proxy of the holders of a majority of the outstanding shares of common stock will constitute a quorum for the transaction of business at the meeting. This proxy statement and the accompanying proxy are being mailed on or about January 11, 1996 to the shareholders of record on the Record Date. As of the Record Date the Company had 25,510,721 shares of common stock outstanding. In connection with the solicitation of proxies by the Board of Directors for the Annual Meeting of Shareholders, the Board of Directors has designated Joseph J. Jacobs, Noel G. Watson and Robert M. Barton as proxies. Shares represented by all properly executed proxy cards received in time for the meeting will be voted in accordance with the choice specified on the proxy card. Unless contrary instructions are indicated on the proxy card, the shares of common stock will be voted FOR the election of the nominees listed below under "1. Election of Directors". Where no choice is specified, the shares of common stock will be voted FOR the proposed increase of 1,500,000 shares of common stock in the total number of shares reserved for the 1989 Employee Stock Purchase Plan as described under "2. Approval of an Increase in Number of Shares for the 1989 Employee Stock Purchase Plan", below, and FOR the approval of the appointment of Ernst & Young LLP as the independent auditors for the Company for the year ending September 30, 1996 as described under "3. Approval of Ernst & Young LLP as Auditors", below. The Board of Directors is not aware of any other issue to be brought before the meeting. If other matters are properly brought before the meeting, then the proxies will vote in accordance with their best judgment. Votes cast by proxy or in person at the annual meeting will be tabulated by the inspectors of election appointed for the meeting who will determine whether or not a quorum is present. The inspectors of election will treat abstentions as shares that are present and entitled to vote for purposes of determining the presence of a quorum but as not voted for purposes of determining the approval of any matter submitted to the shareholders for a vote. If a broker indicates on a proxy that it does not have discretionary authority as to certain shares to vote on a particular matter, then those shares will not be considered as present and entitled to vote with respect to that matter. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL The following tables, based in part upon information supplied by officers, directors and principal shareholders, set forth certain information regarding the ownership of the common stock of the Company as of the Record Date by (i) all those persons known by the Company to be beneficial owners of more than five percent of the outstanding common stock of the Company; (ii) each director; (iii) each executive officer named in the compensation tables, below ("Named Executive Officer"); and (iv) all officers and directors of the Company as a group. Unless otherwise indicated, each of these shareholders has sole voting and investment power with respect to the shares beneficially owned, subject to community property laws where applicable. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS (a) (a) Security ownership information for beneficial owners is taken from statements filed with the Securities and Exchange Commission pursuant to Sections 13(d), (f) and (g) and other information made known to the Company. (b) Certain operating subsidiaries of The Capital Group Companies, Inc. exercised investment discretion over various institutional accounts that held, as of December 31, 1994, a total of 2,094,900 shares of common stock of the Company. At that date Capital Guardian Trust Company, a bank, and one of such operating companies, exercised investment discretion over 1,444,500 of said shares. Also, on that date Capital Research and Management Company, a registered investment adviser, and Capital International Limited, another operating subsidiary, had investment discretion with respect to 643,400 and 7,000 shares, respectively, of the above shares. SECURITY OWNERSHIP OF DIRECTORS, NOMINEES AND NAMED EXECUTIVE OFFICERS (b) Includes only those unexercised options that are exercisable within 60 days following the date of this proxy statement. (c) Calculation is based on 25,510,721 shares of common stock outstanding as of January 5, 1996. (d) Mr. Stevenson resigned as an executive officer in July 1995 and is currently serving the Company as a consultant. The bylaws of the Company presently provide for eleven directors. The Certificate of Incorporation and the bylaws of the Company divide the Board of Directors into three classes with the terms of office of the directors of each class ending in different years: The terms of Classes I, II and III end at the annual meetings in 1998, 1997 and 1996, respectively. Classes I and II have four directors, each, and Class III has three directors. The nominees for Class III are to be voted upon at this annual meeting. The directors in Classes I and II will continue in office until expiration of their respective terms. Mr. Robert M. Barton, a director of the Company since its organization and currently a director in Class III, has stated that he does not wish to stand for re-election. Mr. Barton's contributions to the Company were many and are greatly appreciated. The Board of Directors has nominated Joseph J. Jacobs, Dale R. Laurance and Linda Fayne Levinson for election as Class III directors for three year terms expiring at the 1999 annual meeting. The persons named as proxies on the accompanying proxy card intend to vote the shares as to which they are granted authority to vote for the election of the nominees listed above. The proxies may not vote for a greater number of persons than three. In the event that anyone other than these individuals should be nominated for election as a director, the proxies will vote in accordance with their best judgment. Although the Board of Directors does not know of any reason why any nominee will be unavailable for election, in the event any nominee should be unavailable at the time of the meeting, the proxies may be voted for a substitute nominee as selected by the Board of Directors. The following table sets forth information about these nominees and the directors whose terms of office do not expire at the 1996 annual meeting. Board Committees. The Board has two standing committees. The Audit Committee advises the Board on internal control and external audit matters affecting the Company, including recommendations as to the appointment of the independent auditors of the Company; reviews with such auditors the scope and results of their examination of the financial statements of the Company and any investigations by such auditors. During fiscal 1995 the Audit Committee held two meetings. The members of the Audit Committee are Messrs. Petrone (Chairman), Alibrandi, Dailey and Rainey and Dr. Linda K. Jacobs. The Compensation and Benefits Committee approves the salaries and bonuses of the executive officers and approves all grants of stock options under the Jacobs Engineering Group Inc. 1981 Executive Incentive Plan (the "1981 Plan") other than options issued under the Outside Director Stock Option provisions of the 1981 Plan. During fiscal 1995 this committee held nine meetings. The members of the Compensation and Benefits Committee are Messrs. Barton (Chairman) and Gwyn and Drs. Laurance and LaForce. Compensation of Directors. The Company pays directors who are not employed by the Company ("Outside Directors") a retainer at the rate of $25,000 per year plus a fee of $1,000 for each meeting of the board and each committee on which they serve that they attend. Pursuant to the terms of the Outside Director Stock Option Plan, each of the Outside Directors received an option for 2,000 shares of common stock on April 1, 1993. All Outside Directors receive an option for 1,000 shares at an option price equal to the Fair Market Value (as defined in the Plan) of the common stock on the first day of March of each year commencing March 1, 1994. Newly-elected Outside Directors receive an Option for 2,000 shares at a price equal to the Fair Market Value of the Common Stock on the first day of the month following the month in which they are elected. The Board of Directors held nine meetings during the year ended September 30, 1995. All directors attended at least 75% of all meetings of the Board of Directors and of the committees on which they served during fiscal 1995. The following table sets forth information concerning the annual and long- term compensation of the Chief Executive Officer and the other five most highly compensated officers ("Named Executive Officers") of the Company for services in all capacities to the Company and its subsidiaries during its 1993, 1994, and 1995 fiscal years: (1) Represents amounts earned by the named executive during the year indicated, and includes amounts deferred under the Jacobs Engineering Group Inc. 401(k) Plus Savings Plan and Trust (the "(S) 401(k) Plan") and the Company's nonqualified Executive Deferral Plans (the "EDPs"). (2) These amounts represent interest credited to the employees' deferred compensation account balance under the EDPs in excess of 120% of the applicable federal rate in effect at the times the interest crediting rates were set for the EDPs. Under the terms of the EDPs, executives may defer salary and bonus and are credited interest on such deferrals at rates based on the Moody's Corporate Bond Yield Averages and the number of years in the EDPs. The maximum interest rate is credited to deferral amounts only after seven years of plan participation. Although none of the named executives have seven years plan participation, the amounts shown here were computed using the maximum interest rate allowed under the EDPs. Amounts deferred are used by the Company to purchase life insurance contracts on the lives of the participants (including the named executives participating in the plan). Because it is anticipated that over the life of the plan, the insurance contracts will return value to the Company approximating, on an after-tax basis, the amounts credited as interest to the participants' account balances, this plan should have no net cost to the Company over its life. (3) Consists solely of non-qualified stock options pursuant to the 1981 Plan. (4) Consists solely of Company contributions to the (S) 401(k) Plan. (5) Also includes reimbursement of income tax paid on reimbursed moving expenses. OPTION/SAR GRANTS IN LAST FISCAL YEAR The 1981 Plan permits the grant of options and stock appreciation rights and the awards of restricted stock to employees of the Company and its subsidiaries, including officers and directors who are serving in such capacities. The following table contains information concerning options granted during the fiscal year 1995 to the only Named Executive Officers who were granted options that year. During 1995 the Company awarded 61,000 shares of restricted stock under the 1981 Plan; none of the recipients of the restricted stock were Named Executive Officers, however. No stock appreciation rights have been granted to date. (1) All grants were non-qualified options pursuant to the 1981 Plan. Options are exercisable in five cumulative annual installments of 20% of the shares subject to option commencing on the first anniversary of the date of grant. Exercisability will be automatically accelerated if the optionee is terminated within three years following a Change in Control of the Company unless the Board of Directors determines that the event shall not constitute a Change of Control. (2) Calculation based upon grants of options for 324,000 shares and awards of 61,000 shares of restricted stock during fiscal 1995. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR The following table sets forth information regarding option exercises during the fiscal year 1995 by the Named Executive Officers and the value of their unexercised options at September 30, 1995. All options were granted under the 1981 Plan. The Company has not granted any stock appreciation rights. (1) Based on market value of the Company's common stock on the date of exercise less the option exercise price. (2) Based on the closing price of the common stock of the Company as reported in the New York Stock Exchange Composite Transactions Report less the option exercise price. The overall objectives of the Company's executive compensation program are as follows: --To enable the Company to attract, motivate and retain highly-qualified executives by offering competitive base salaries that are consistent with the Company's size. --To reward executives for past performance through a bonus program that places a substantial component of their pay at risk based on Company performance as measured by its return on net equity. --To provide an incentive for continued service and future performance through the use of stock options. --To encourage executives to have an equity ownership in the Company. The Company has no pension plan, but all eligible employees, including executives, may participate in the Company's 401(k) Plus Savings Plan and the 1989 Employee Stock Purchase Plan. The Compensation Committee of the Board of Directors is responsible for reviewing and approving the compensation of all executive officers and all stock option grants to all employees. Base Salary. In setting executive officer base salaries for fiscal 1995 the Committee considered the recommendations of Dr. Jacobs and Mr. Watson, who made salary recommendations as to all executive officers except themselves, the Committee's own subjective evaluations of those executive officers, the salary spread that has normally been maintained by the Company between levels of management, and information compiled by the Company regarding prevailing salaries for professional engineers being offered by companies that the Company regards as its competitors. The Committee also considered a regression analysis of the executive compensation paid by the publicly-traded engineering and construction companies that are comparable to, or greater in size than the Company, that compete with the Company for experienced employees at all levels and for which executive salary information is publicly available (the "Peer Group") made by the Company's financial staff. The Peer Group consists of Guy F. Atkinson, Blount, Inc., Fluor Corporation, Foster Wheeler, International Technology, Michael Baker Corp., Morrison-Knudsen Corp., Stone & Webster, Inc. and the Company. This analysis relates the revenues of the members of the Peer Group to the base salaries paid to their five highest paid executives in the order of their compensation as reported in their annual reports and proxy statements for the prior year. Mr. Watson's initial base salary for fiscal 1995 was established in the same manner as the base salaries of the other executive officers of the Company. The Committee believes that the total salary and bonus paid to Mr. Watson and each of the Named Executive Officers was reasonable in light of the performance of the Company for fiscal 1995. Dr. Jacobs was the Chief Executive Officer of the Company from its organization in 1957 until he resigned that position in November 1992; he continues to serve as Chairman of the Board and as a full-time employee of the Company. The Company has an employment agreement, originally entered into on October 1, 1987, with Dr. Jacobs, described below under "Employment Contracts and Termination of Employment and Change-in-Control Arrangements", that establishes, among other matters, his base salary. The original agreement received the approval of the Board of Directors of the Company in 1987, without dissent and with Dr. Jacobs not voting. The Board subsequently delegated all decisions regarding this agreement to the Committee, which has approved subsequent amendments to it, including extensions of its term, which now expires on September 30, 2000, but there has been no change to Dr. Jacobs' base salary since 1987. The Committee has approved these amendments based on its subjective judgment of Dr. Jacobs' past and continuing contributions to the business strategy, marketing and reputation of the Company. Annual Incentive Bonuses. Pursuant to the Company's Incentive Bonus Plan, each year the Compensation Committee approves a target percentage of pre-tax profits to the net equity of the Company that must be achieved before any bonuses are paid. This target percentage is established on the basis of the Committee's judgment of what constitutes a reasonable minimum return for the shareholders on their investment in the Company. If pre-tax profits exceed the target, then a predetermined percentage of profits in excess of the target is placed in the bonus pool; if pre-tax earnings exceed two times the target, then a larger percentage of the excess is placed into the bonus pool. A major percentage of the bonus pool is allocated to the officers and key managers of the Company. Fifty percent of the allocation to the officers and key employees is then individually allocated to them in proportion to their weighted salaries, with the salaries of the executive officers given the greatest weight. The remainder of the executive officer pool is usually allocated in the same proportions as the initial allocations, but individual allocations are in some cases adjusted on the basis of the Committee's subjective evaluations of individual performance. Generally, bonuses are paid in three annual installments contingent upon continued employment and may be further deferred by participants in the Company's deferred compensation plans. The bonus paid to Mr. Watson for 1995 was determined in the same manner as the bonuses of the other executive officers. Dr. Jacobs does not receive bonuses under the formula in the Incentive Bonus Plan, but he is eligible to receive discretionary bonuses. Stock Options. In determining stock option awards to executive officers for fiscal 1995 the Committee considered Dr. Jacobs' and Mr. Watson's recommendations with respect to all executive officers other than themselves, the Committee's own subjective evaluations of the executive officers and previous option awards to the executive officers. The Committee also considered the stock option awards made by three of the largest competitors of the Company that are public companies (Fluor, Foster Wheeler and Morrison- Knudsen) to their executive officers as a percent of outstanding shares. In general, option grants by the Company as a percentage of outstanding shares have been the second highest in the named group, but the Committee considered the fact that the Company is the only company in the group that has no pension plan in evaluating the significance of its ranking in the group. The number of options granted to Mr. Watson for fiscal 1995 was determined by the committee on the basis of a request that he be granted such options in lieu of a salary increase proposed by the Committee. Dr. Jacobs has never been eligible for stock options by reason of his percentage interest in the outstanding stock of the Company. Tax Deductibility Considerations. In 1993, the Internal Revenue Code was amended to limit the deductibility of certain compensation expenses in excess of $1 million. This amendment will apply to the Company in fiscal year 1995. The Committee believes that the compensation payable for fiscal year 1996 will not result in any loss of tax deductions for the Company. It is the Committee's intent, pending finalization of the tax regulations, to adopt policies to obtain maximum deductibility of executive compensation, consistent with the objectives of the Company's executive compensation program outlined above. The Committee will continue to monitor the regulations as they are finalized to determine whether any program changes are appropriate. ADDITIONAL INFORMATION WITH RESPECT TO COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Robert M. Barton, a director and Secretary of the Company and Chairman of the Compensation Committee, retired as a partner of the law firm of Barton, Klugman & Oetting, which rendered legal services to the Company during the fiscal year, on December 31, 1992. He continues to serve as counsel to the firm. COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN* AMONG JACOBS ENGINEERING GROUP INC., THE S&P 500 INDEX AND THE DOW JONES HEAVY CONSTRUCTION INDEX * $100 invested on September 30, 1990 in stock or index (includes reinvestment of dividends, if any). OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS The Company has an agreement with Dr. Joseph J. Jacobs, originally entered into in 1986 providing for base pay at an annual rate of $432,200 per year for a term that has subsequently been extended to September 30, 2000. He does not receive bonuses under the formula in the Incentive Bonus Plan described above under "Board Compensation Committee Report on Executive Compensation", but he is eligible to receive discretionary bonuses. The agreement will continue in force whether or not Dr. Jacobs continues to be employed by the Company or becomes disabled. If Dr. Jacobs should die during the term of the agreement, then payments under the agreement will be made to a beneficiary named by Dr. Jacobs. If Dr. Jacobs ceases to be an employee of the Company, he will continue as a consultant to the Company in community and public affairs, in the promotion of the business expansion and goodwill of the Company and in undertaking such special assignments as the Company or its Board of Directors may request. During the term of the agreement, the Company will provide Dr. Jacobs with the same medical and life insurance and other benefits as are made available to senior management officials of the Company and will provide him with office and secretarial services. The agreement contains provisions intended to prevent Dr. Jacobs from entering into any form of competition with the Company or disclosing confidential information of the Company. The original agreement, as well as the initial extensions of its term, received the approval of the Board of Directors of the Company without dissent and with Dr. Jacobs not voting. Subsequently, the Board of Directors delegated to the Compensation Committee of the Board the sole power to approve amendments to the agreement extending its term. See "Board Compensation Committee Report on Executive Compensation", above. On January 5, 1996, Mr. Paul A. Miskimin, an executive officer of the Company, owed the Company a total of $83,000; the largest amount owed by Mr. Miskimin during the period September 30, 1994 through January 5, 1996 was $93,000. These amounts were evidenced by promissory notes bearing interest based on the prime rate and represented advances made to facilitate Mr. Miskimin's relocation to the Company's headquarters in Pasadena, California. Also, on January 5, 1996, Mr. Socrates S. Christopher, an executive officer of the Company, owed the Company $150,000 on open account without interest. This was the largest amount owed by Mr. Christopher to the Company at any time between September 30, 1994 and January 5, 1996. Mr. Christopher was an executive officer of CRSS Inc. ("CRSS") in 1994 at the time when the Company acquired the engineering and construction management service businesses of CRSS. The receivable from Mr. Christopher was included in the assets acquired by the Company from CRSS. The Company has been advised that this indebtedness represents an advance made by CRSS to Mr. Christopher to facilitate his relocation to CRSS's office in Greenville, South Carolina. 2. APPROVAL OF AN INCREASE IN NUMBER OF SHARES FOR THE 1989 EMPLOYEE STOCK There will be presented to the meeting a proposal to approve an increase in the number of shares reserved for the Jacobs Engineering Group Inc. 1989 Employee Stock Purchase Plan (the "Stock Purchase Plan") of 1,500,000 shares of common stock. The Stock Purchase Plan was originally adopted by the Board of Directors on December 15, 1988, and by the shareholders on February 14, 1989. The Board of Directors believes that the opportunity for all eligible, full-time employees to acquire shares of common stock of the Company through participation in the Stock Purchase Plan provides an important incentive to the employees of the Company, and that the Stock Purchase Plan assists the Company in attracting new employees. The Stock Purchase is administered by the Compensation and Benefits Committee of the Board of Directors. The members of the Committee must be directors who are not eligible to receive options under the Stock Purchase Plan or awards of stock, stock options or stock appreciation rights under any other plan of the Company other than automatic option grants under the Outside Director Stock Option Plan, and who have not been eligible to receive such options or other awards for at least one year prior to their service on the Committee. The Committee is authorized to construe and interpret the Stock Purchase Plan, to prescribe rules and regulations for its administration and to take any other necessary action in relation to the Plan. All employees of the Company and its domestic subsidiaries and all employees of any foreign subsidiaries designated from time to time by the Board of Directors, except employees who normally work fewer than 20 hours each week or five or fewer months during any fiscal year and employees who have completed less than one year of service with the Company or a participating subsidiary, receive options under the Plan. Any employee who would own five percent or more of the common stock immediately after an option is granted will not be eligible to receive options. At August 31, 1995 approximately 8,500 employees were eligible to receive options under the Stock Purchase Plan. The Stock Purchase Plan permits eligible employees of the Company to purchase shares of common stock from the Company by electing to exercise options to purchase common stock. These options are granted in the form of successive six-month options on March 1 and September 1 of each year. An employee may exercise an option in amounts based upon a percentage of his or her salary or wages ranging from 2% to 15% of basic compensation. An employee may elect to participate or not to participate on each March 1 and September 1 commencement date. The Company will make withholdings from the employee's salary or wages during the six-month term of the option, and the purchases of the shares are effected without any further action on the part of the employee at the completion of the six-month period. If an employee ceases to be an employee during any six-month period, then the option will terminate on the date of termination, and the Company will refund to the employee the full amount of all withholdings without interest. The price at which shares may be purchased is the lesser of 90% of the fair market value of the common stock on the first day of a six-month term of each option that is exercised, or 90% of the fair market value of the common stock on the last day of the six-month term of the option. The fair market value for this purpose is the closing price for the common stock as reported in the New York Stock Exchange Composite Transactions report for the relevant date. The maximum fair market value of common stock that an employee may purchase under the Stock Purchase Plan in any calendar year is $25,000. The Board of Directors may at any time amend or terminate the Stock Purchase Plan, except that no such amendment may be made without the approval of the shareholders if it would increase the number of shares of common stock authorized to be issued under the Stock Purchase Plan, materially increase the benefits accruing to employees under the Stock Purchase Plan, materially modify the requirements as to eligibility for participation or withdraw administration of the Stock Purchase Plan from the Committee. The Stock Purchase Plan will terminate on February 28, 1999, unless the Board of Directors terminates the Stock Purchase Plan at an earlier date or the shares reserved for the Stock Purchase Plan are exhausted, and the shareholders do not vote to reserve additional shares for it. The Stock Purchase Plan is intended to be an "employee stock purchase plan" as defined in Section 423 of the Internal Revenue Code of 1986, which provides that an employee does not have to pay any federal income tax either when he elects to exercise an option under such a stock purchase plan, or when the six-month option period ends and the employee receives shares of common stock of the Company. The employee is, however, required to pay federal income tax on any gain realized on the sale of the shares, as described below. If the employee has owned shares purchased through the Stock Purchase Plan for more than one year and disposes of them at least two years after the commencement date of the six-month option term of the option pursuant to which they were purchased, then the employee will be taxed as follows: If the sale price is greater than the price paid under the Stock Purchase Plan, then the employee will recognize ordinary income in an amount equal to the lesser of (i) the excess of the market price of the shares on the date the offering commenced over the price paid, or (ii) the excess of the sale price over the price paid. Any further gain is treated as a long-term capital gain. If the sale price of the shares is equal to or less than the price paid for them under the Stock Purchase Plan, then the employee will incur a long-term capital loss in the amount equal to the price paid over the sale price. If the employee sells the shares before he has owned them for more than one year or before the expiration of the two-year period commencing on the date the option period commenced, then the employee will recognize ordinary income on the amount of the difference between the actual purchase price and the market price of the shares on the date of purchase, and the Company will receive a deduction for federal income tax purposes for the same amount. The employee will recognize a long-term capital gain or loss on the difference between the sale price and the fair market value on the date of purchase. In the event of a stock split, stock dividend, merger or other like recapitalization or reorganization the Board of Directors is required to make appropriate and proportionate adjustments in the maximum number of shares subject to the Plan and the price per share subject to outstanding options, or, in the event of a merger or reorganization, the substitution of shares in any successor corporation for common stock of the Company. PROPOSED AMENDMENT OF THE STOCK PURCHASE PLAN At the time of its adoption 200,000 shares of common stock were reserved for the Stock Purchase Plan. This was increased to a total of 800,000 shares by subsequent stock splits. At their 1992 annual meeting the shareholders approved an increase of 606,777 in the number of shares reserved for the Stock so adjusted, after reductions for option exercises, there are only 111,038 shares remaining in the reserve for the Stock Purchase Plan, excluding shares that will be purchased with salary withholdings being made during the September 1, 1995 through February 29, 1996 withholding period. The Board of Directors has approved resolutions to increase the number of shares reserved for the Stock Purchase Plan by an additional 1,500,000 shares to increase the total number of shares reserved for the Stock Purchase Plan to 1,611,038. The affirmative vote of the holders of a majority of the shares present at the annual meeting and voting on the proposal is required to approve the increase in the number of shares of common stock of the Company reserved for the Stock Purchase Plan by 1,500,000 shares. THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE YES TO INCREASE THE NUMBER OF SHARES RESERVED FOR THE STOCK PURCHASE PLAN. 3. APPROVAL OF ERNST & YOUNG LLP AS AUDITORS The Board of Directors, with the concurrence of the Audit Committee, has selected Ernst & Young LLP to audit the accounts of the Company for its fiscal year ending September 30, 1996. The Company has been advised by Ernst & Young LLP that the firm has no relationship with the Company or its subsidiaries other than that arising from the firm's engagement as auditors. If the selection of Ernst & Young LLP is not approved by the holders of a majority of the shares represented at the meeting and voting on the proposal, or if prior to the Annual Meeting to be held in February, Ernst & Young LLP should decline to act or otherwise become incapable of acting, or if its employment should be otherwise discontinued by the Board of Directors, then in any such case the Board of Directors will appoint other independent auditors whose employment for any period subsequent to the 1996 Annual Meeting will be subject to ratification by the shareholders at the 1997 Annual Meeting. The Company has been advised that representatives of Ernst & Young LLP will be present at the Annual Meeting where they will have an opportunity to make a statement if they desire to do so and will be available to respond to appropriate questions. THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE FOR THE SELECTION OF ERNST & YOUNG LLP AS AUDITORS FOR THE YEAR ENDING SEPTEMBER 30, 1996. The Board of Directors does not intend to present any other business for action at the meeting and does not know of any business intended to be presented by others. Proposals of shareholders for consideration at the annual meeting of shareholders to be held on Tuesday, February 11, 1997 must be received by the Company no later than August 30, 1996 in order to be included in the Company's proxy statement and proxy relating to that meeting. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers and persons who own more than ten percent of a registered class of the Company's equity securities to file with the Securities and Exchange Commission ("SEC") and the New York Stock Exchange initial reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. Officers, directors and greater than ten-percent shareholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms filed by them. To the Company's knowledge, based solely on review of the copies of such reports furnished to the Company and written representations that no other reports were required all Section 16(a) filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were complied with on a timely basis during the fiscal year ended September 30, 1995. ANNUAL REPORT AND FINANCIAL INFORMATION A copy of the Company's annual report for the year ended September 30, 1995 is being mailed concurrently with this Proxy Statement to each shareholder of record on the Record Date. THE COMPANY WILL FURNISH WITHOUT CHARGE A COPY OF THE COMPANY'S REPORT ON FORM 10-K, INCLUDING THE FINANCIAL STATEMENTS AND SCHEDULES THERETO, TO THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION TO ANY PERSON REQUESTING IN WRITING AND STATING THAT HE WAS THE BENEFICIAL OWNER OF COMMON STOCK OF THE COMPANY ON JANUARY 5, 1996. THE COMPANY WILL ALSO FURNISH COPIES OF ANY EXHIBITS TO THE FORM 10-K TO ELIGIBLE PERSONS REQUESTING EXHIBITS AT $0.50 PER PAGE, PAID IN ADVANCE. THE COMPANY WILL INDICATE THE NUMBER OF PAGES TO BE CHARGED FOR UPON WRITTEN INQUIRY. REQUESTS AND INQUIRIES SHOULD BE ADDRESSED TO: Neither the annual report nor the Form 10-K is to be regarded as proxy soliciting material or as a communication by means of which a solicitation of proxies is to be made. By Order of the Board of Directors SOLICITED BY THE BOARD OF DIRECTORS OF JACOBS ENGINEERING GROUP INC. ANNUAL MEETING OF SHAREHOLDERS--TUESDAY FEBRUARY 13, 1996 THE UNDERSIGNED hereby appoints Joseph J. Jacobs, Noel G. Watson and Robert M. Barton his true and lawful proxies (with full power of substitution) to vote in his name, place and stead all shares in Jacobs Engineering Group Inc. that the undersigned owns or is entitled to vote at the Annual Meeting of Shareholders to be held February 13, 1996, and at any adjournment thereof, upon the matters listed below in accordance with the following instructions: THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS. PLEASE SPECIFY CHOICES, DATE, SIGN AND RETURN THE PROXY IN THE ENCLOSED ENVELOPE. NO POSTAGE IS REQUIRED IF RETURNED IN THE ENCLOSED ENVELOPE AND MAILED IN THE UNITED STATES. (CONTINUED, AND TO BE MARKED, DATED AND SIGNED, ON THE OTHER SIDE) IF ANY OF THE FOLLOWING BOXES ARE CHECKED, THE SHARES COVERED BY THIS PROXY WILL BE VOTED IN ACCORDANCE THEREWITH. IF NO BOX IS CHECKED UNDER ANY OF THE FOLLOWING, THE SHARES WILL BE VOTED FOR THE PERSONS NOMINATED AS DIRECTORS BY THE BOARD OF DIRECTORS AND FOR THE APPROVAL OF ITEMS 2 AND 3. ON OTHER MATTERS PRESENTED, THE SHARES WILL BE VOTED IN ACCORDANCE WITH THE PROXIES' BEST JUDGMENT. Joseph J. Jacobs, Dale R. Laurance and Linda Fayne Levinson as directors. WITHHELD FOR: (Write that nominee's name in the space provided below). 2. To approve an increase in the number of shares reserved for the 1989 Employee Stock Purchase Plan. 3. To approve Ernst & Young LLP as auditors. Receipt of the Jacobs Engineering Group Inc. Proxy Statement dated January 5, 1996 and Annual Report for the year ended September 30, 1995 is hereby acknowledged. Please vote my (our) shares as indicated on the face of this proxy. NOTE: Attorneys, executors, trustees, etc. should show such capacity when signing and unless the certificate(s) is (are) registered in their names, should submit a Proxy from the record owner. Evidence of their authority should accompany the Proxy. Joint owners should each sign individually.	DEF 14A	DEF 14A	1996-01-12T00:00:00	1996-01-11T18:56:50
0000950134-96-000106	0000950134-96-000106_0000.txt	<DESCRIPTION>AMENDMENT TO SC 14D-1 BALCOR REALTY INVESTORS - 83 Tender Offer Statement Pursuant to Section 14(d)(1) of the Securities Exchange Act of 1934 Under the Securities Exchange Act of 1934 BALCOR REALTY INVESTORS - 83 WALTON STREET CAPITAL ACQUISITION CO., L.L.C. FMG ACQUISITION I, L.L.C. INSIGNIA FINANCIAL GROUP, INC. (Title of Class of Securities) (CUSIP Number of Class of Securities) (Name, Address and Telephone Number of Person Authorized to Receive Notices and Communications on Behalf of Bidders) Amendment No. 5 to Schedule 14D-1 This Amendment No. 5 constitutes (i) the final Amendment to the Tender Offer Statement on Schedule 14D-1 filed by Walton Street Capital Acquisition Co., L.L.C., a Delaware limited liability company (the "Purchaser"), with the Commission on November 16, 1995, as amended by Amendment No. 1 filed with the Commission on November 21, 1995, Amendment No. 2 filed with the Commission on December 5, 1995, Amendment No. 3 filed with the Commission on December 19, 1995 and Amendment No. 4 filed with the Commission on December 19, 1995; and (ii) the Statement on Schedule 13D of the Purchaser, WIG 83 Partners, FMG Acquisition I, L.L.C. and Insignia Financial Group, Inc. All capitalized terms used herein but not otherwise defined have the meanings ascribed to such terms in the Offer to Purchase dated November 16, 1995 (the "Offer to Purchase"), the First Supplement to the Offer to Purchase dated December 5, 1995 (the "First Supplement") and the related Letter of Acceptance (the "Letter of Acceptance," which together constitute the "Offer"). ITEM 6. INTEREST IN SECURITIES OF THE SUBJECT COMPANY. Item 6 is hereby amended by the following: (a) - (b) At 5:00 p.m., Eastern Standard Time, on Wednesday, January 3, 1996, the Offer expired pursuant to its terms. Based on information provided by the Depositary, a total of 5,963.0834 Interests, representing approximately 8% of the outstanding Interests, were validly tendered and not withdrawn pursuant to the Offer. The Purchaser has accepted for payment all such Interests at the purchase price of $136 per Interest in cash. ITEM 11. MATERIAL TO BE FILED AS EXHIBITS. 99(g)(1) Agreement of Joint Filing, dated January 12, 1996, among the Purchaser, WIG 83 Partners, FMG Acquisition I, L.L.C. and Insignia Financial Group, Inc. After due inquiry and to the best of my knowledge and belief, I certify that the information set forth in this statement is true, complete and correct.	SC 14D1/A	SC 14D1/A	1996-01-12T00:00:00	1996-01-12T16:58:08
0000950130-96-000094	0000950130-96-000094_0002.txt	<DESCRIPTION>REPORT BY DONALDSON, LUFKIN & JENRETTE Note: All projections and estimates of future events are strictly those of, and the following analyses are based upon financial and other information provided to DLJ by, Wonder, Tom and their respective managements. . Merge Tom with a wholly-owned subsidiary of Wonder . Tom's Class A shareholders receive $30 per share (aggregate consideration of $40.5 million) in Wonder Common Stock or cash, at their option . On account of all of his equity and voting interests in Tom, Trump receives aggregate consideration of $40.5 million in Wonder Common Stock . Tom's Class B shares are redeemed for $0.50 per share in cash (aggregate . Trump receives warrants to purchase 600,000 shares of Wonder Common Stock at a $30.00 strike price (three-year term), 600,000 shares of Wonder Common Stock at a $35.00 strike price (four-year term) and 600,000 shares of Wonder Common Stock at a $40.00 strike price (five-year term) . Purchase land held by Trump Realty and remove First Fidelity contingent liability and receive releases with payment of $50 million in cash and 500,000 shares of Wonder Common Stock . Pay $10 million cash to BT on behalf of Trump for consent and releases by . Refinance Tom Mortgage Bonds with $750 million First Mortgage Note . Raise $100 million in Wonder public equity offering . Trump management fee at Tom eliminated (1) Although Tom will have $55.0 million of excess cash, only $44 million will be used in the Acquisition in order to provide a working capital cushion. (2) Assumes Class A shareholders will receive Wonder stock in the Acquisition. (3) Assumes $20.00 Wonder stock price. . Trump Indiana additional capital expenditures - $25 million required to fund permanent facility /(1)/ - $44.9 million aggregate principal amount . Exercise Trump Plaza East option - Current exercise price of $28 million (1) Assumes $10 million of gaming equipment financing available. (1) Assumes $20.00 Wonder stock price and $100mm primary equity offering. (2) Assumes Tom's Class A shareholders receive Wonder stock. (1) Includes accrued PIK interest through March 31, 1996. (2) Gives effect to loss associated with redemption of First Mortgage Bonds. (3) Currently booked on Tom's balance sheet at $17 million which represents the present value of the obligation. (1) Black-Scholes analysis used to value Trump warrants. Assumed volatility of 35%. (2) Assumes $20.00 Wonder stock price. (3) Includes accrued PIK interest through March 31, 1996. (1) Assumes $18.3 million in synergies expected to be achieved in FY 1997. . Creates one of the largest gaming companies in the United States . Significant presence in growing Atlantic City market - Combined company will have approximately one-quarter of Atlantic City's hotel rooms, gaming space, slots and tables . Alleviates Trump conflict-of-interest concerns . $20.6 million in expected annual cost savings in FY 1998 . Provides critical mass necessary to compete effectively for new gaming . Extends maturity of Tom long-term debt to allow for expansion plan - Comparable M&A transactions analysis - Discounted cash flow analysis (1) Comparable casino hotel companies includes Harrah's Entertainment, Bally Entertainment, Rio Hotels, Showboat, Aztar, Griffin Gaming, Hollywood Casinos, Mirage, MGM Grand and Stratosphere. (2) Tom LTM results represent estimated FY1995, excluding synergies. (3) Assumes $18.3 million in synergies expected to be achieved in FY 1997. COMPARABLE MERGER AND ACQUISITIONS VALUATION ANALYSIS (1) Tom LTM results represent estimated FY 1995, excluding synergies. (2) Assumes $18.3 million in synergies expected to be achieved in FY (3) Average excludes high and low. ENTERPRISE VALUES WITH TOM EXPANSION DISCOUNTED CASH FLOW VALUATION (CONT'D) ENTERPRISE VALUES WITHOUT TOM EXPANSION . Largest casino hotel facility in Atlantic City . Since commencing operations in 1990: - #1 in total gaming revenue - #1 in table revenues - #1 in slot revenues . Top performer in the Atlantic City market in terms of Revenues and . First class hotel and entertainment facilities . Expansion plan provides upside significant potential TOM SUMMARY HISTORICAL FINANCIAL INFORMATION (2) EBITDA figures are after Trump Realty lease payments and Trump management fee. TOM STAND-ALONE PROJECTED FINANCIAL SUMMARY/(1)/ (1) Includes add-back of Trump Realty lease expense and Trump management fee. PROFILE OF THE COMBINED COMPANY PRO FORMA COMBINED FINANCIAL SUMMARY/(1)/ (1) Assumes $20.00 Wonder stock Price. (2) 1995 pro forma for add-back of the Trump management fee and Trump Realty lease payment. (3) 1995 results pro forma for current capital structure, tax rate and G&A expenses. (4) Excludes pre-opening expenses. (5) Reported 1995 EPS will be approximately ($0.20) per share representing the period from June 7 through December 31, 1995. (1) Assumes $20.00 Wonder stock price. Excludes effect of Trump warrants. (2) 1995 results pro forma for current capital structure, tax rate and G&A expenses. (3) Excludes pre-opening expenses. (4) Assumes $9.0 million of synergies for FY 1995 and FY 1996 and $18.3 million for FY 1997. EPS ACCRETION/DILUTION - SENSITIVITY ANALYSIS/(1)/ (1) Assumes $20.00 Wonder stock price. Excludes effect of Trump warrants. (2) Assumes $9.0 million of synergies for FY 1996 and $18.3 million for FY 1997. . Size of equity offering . Class A Option: stock vs. cash . Absence of definitive agreements	SC 13E3	EX-99.17.(B)(4)	1996-01-12T00:00:00	1996-01-11T17:58:48
0000912057-96-000455	0000912057-96-000455_0001.txt	New York, New York 10022 Date: January 8, 1996 Reference is made to the Registration Statement on Form S-3, File No. 33-64449 (the "Registration Statement") filed by United Asset Management Corporation (the "Company") with the Securities and Exchange Commission (the "Commission"), covering the sale of certain shares by you as selling stockholder. In connection with the filing of the Registration Statement pursuant to the Securities Act of 1933, as amended (the "Act"), we hereby agree with you as follows: 1. REPRESENTATIONS, WARRANTIES AND COVENANTS. The Registration Statement has been prepared by the Company in conformity with the requirements of the Act, and the rules and regulations of the Commission under the Act (the "Rules and Regulations"). When the Registration Statement becomes effective and at all times subsequent thereto up to such time as all securities registered thereunder are sold in accordance with the Registration Statement (i) the Registration Statement and the prospectus contained therein (the "Prospectus") and any amendments or supplements thereto will contain as of their respective dates all material statements and information which are required to be included therein in accordance with the Act and Rules and Regulations and will, in all material respects, conform to the requirements of the Act and the Rules and Regulations, and (ii) neither the Registration Statement nor the Prospectus, nor any amendment or supplement thereto, will include as of their respective dates any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; provided, however, that the foregoing representations and warranties shall not apply to information contained in or omitted from the Registration Statement or the Prospectus or any such amendment or supplement in reliance upon, and in conformity with, written information furnished to the Company by you specifically for use in the preparation thereof. 2. EXPENSES. We agree that we will reimburse you for your out-of-pocket expenses, including reasonable attorneys fees and expenses, incurred in connection with your acting as the Selling Stockholder, as contemplated by the Registration Statement. 3. INDEMNIFICATION. We agree that we will indemnify and hold harmless you and your affiliates, any director, officer, agent or employee of you or any of your affiliates and each other person, if any, controlling (within the meaning of the Act) you or any of your affiliates (hereinafter collectively referred to as "you" and "your"), to the full extent lawful, from and against, and that you shall have no liability to us or our affiliates or security holders for, any losses, expenses, claims or proceedings including shareholder actions (hereinafter collectively referred to as "losses"), related to or arising out of or based upon any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, any prospectus forming a part thereof, or any amendment or supplement thereto, or related to or arising out of or based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that we will not be liable in any such case to the extent that any such loss, claim, damage or liability is related to or arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in the Registration Statement, such prospectus or such amendment or such supplement in reliance upon and in conformity with written information furnished to us by you specifically for use therein. In the event that the foregoing indemnity is unavailable to you for any reason other than your bad faith or gross negligence, we agree to contribute to any loss related to or arising out of such Registration Statement or any transaction or conduct in connection therewith. Each of us shall contribute in such proportion as is appropriate to reflect the relative benefits received (or anticipated to be received) by you and by us and the relative fault of each of us in connection with the statements, omissions or other conduct which resulted in such losses, as well as any other relevant equitable considerations. Relative fault shall be determined by reference to, among other things, whether any alleged untrue statement or omission or any other alleged conduct relates to information provided by us or other conduct by us (or our employees or other agents) on the one hand or by you (or your employees or other agents) on the other hand. You and we agree that it would not be just and equitable if contribution were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to above. We agree that we will not, without the prior written consent of Allen & Company Incorporated (which will not be unreasonably withheld) settle any pending or threatened claim or proceeding related to or arising out of such Registration Statement or transactions or conduct in connection therewith are a party to such claim or proceeding) unless such settlement includes a provision unconditionally releasing you from and holding you harmless against all liability in respect of claims by any releasing party related to or arising out of such Registration Statement or any transaction or conduct in connection therewith. We will also promptly reimburse you for all expenses (including counsel fees) as they are incurred by you in connection with investigating, preparing or defending, or providing evidence in, any pending or threatened claim or proceeding in respect of which indemnification or contribution may be sought hereunder (whether or not you are a party to such claim or proceeding) or in enforcing this agreement. We may, at our sole expense and through counsel of our choice acceptable to you, litigate, defend or otherwise attempt to resolve the demand or proceeding underlying any indemnification matter, except that you shall have the right to participate therein, at your sole expense and through counsel of your choice. If we fail to assume and defend diligently in the proceeding or if you shall have defenses which are not available to us or shall be in conflict with us, then you shall have the right to assume such defense at our expense. In any event, we and you shall fully cooperate with each other and our respective counsel in the litigation, defense or other attempt to resolve such demand or proceeding, and shall make available to each other any books, records or other documents necessary or appropriate for such purpose, subject to the right of each party to protect reasonably, from disclosure, confidential business information. The foregoing agreement shall be in addition to any rights that you may have at common law or otherwise. Solely for purposes of enforcing this agreement, we hereby consent to personal jurisdiction, service and venue in any court in which any claim or proceeding which is subject to this agreement is brought against you. Any right to trial by jury with respect to any claim or proceeding related to or arising out of such Registration Statement, or any transaction or conduct in connection therewith or this agreement is waived. This agreement shall remain in full force and effect following the completion or termination of any transaction contemplated by the Registration Statement. By: /s/ William H. Park Title: Executive Vice President and By: /s/ James W. Quinn	S-3/A	EX-1	1996-01-12T00:00:00	1996-01-12T15:54:23
0000950130-96-000108	0000950130-96-000108_0008.txt	This announcement is neither an offer to purchase nor a solicitation of an offer to sell Shares. The Offer is made solely by the Offer to Purchase, dated January 12, 1996, and the related Letter of Transmittal and is not being made to, nor will tenders be accepted from or on behalf of, holders of Shares in any jurisdiction in which the making of the Offer or acceptance thereof would not be in compliance with the laws of such jurisdiction. In those jurisdictions where securities, blue sky or other laws require the Offer to be made by a licensed broker or dealer, the Offer shall be deemed to be made on behalf of the Purchaser by Bear, Stearns & Co. Inc. or one or more registered brokers or dealers licensed under the laws of such jurisdictions. NOTICE OF OFFER TO PURCHASE FOR CASH ALL OUTSTANDING SHARES OF COMMON STOCK a wholly owned subsidiary of LAC Acquisition Corporation, a New York corporation (the "Purchaser") and a wholly owned subsidiary of Lockheed Martin Corporation, a Maryland corporation ("Parent"), is offering to purchase all outstanding shares of common stock, par value $.25 per share (including the associated Rights (as defined in the Offer to Purchase)) (collectively, the "Shares"), of Loral Corporation, a New York corporation (the "Company"), at $38.00 per Share, net to the seller in cash, without interest, upon the terms and subject to the conditions set forth in the Offer to Purchase, dated January 12, 1996 (the "Offer to Purchase") and in the related Letter of Transmittal (which together constitute the "Offer"). THE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 12:00 MIDNIGHT, NEW YORK CITY TIME, ON FRIDAY, FEBRUARY 9, 1996, UNLESS THE OFFER IS EXTENDED. THE PURCHASER HAS AGREED, SUBJECT TO THE TERMS AND CONDITIONS OF THE OFFER, TO EXTEND THE OFFER UNTIL IMMEDIATELY AFTER THE TIME OF THE SPIN-OFF RECORD DATE (AS DEFINED BELOW). THE OFFER IS BEING MADE AS PART OF A SERIES OF TRANSACTIONS THAT ARE EXPECTED TO RESULT IN (I) THE DISTRIBUTION TO THE COMPANY'S STOCKHOLDERS OF SHARES IN LORAL SPACE & COMMUNICATIONS LTD., A NEWLY-FORMED BERMUDA COMPANY ("LORAL SPACE") THAT WILL OWN AND MANAGE SUBSTANTIALLY ALL OF THE COMPANY'S SPACE AND SATELLITE INTERESTS, INCLUDING GLOBALSTAR, L.P. AND SPACE SYSTEMS/LORAL, INC., AND CERTAIN OTHER ASSETS OF THE COMPANY (THE "SPIN-OFF"), AND (II) THE ACQUISITION OF THE COMPANY'S DEFENSE ELECTRONICS AND SYSTEMS INTEGRATION BUSINESSES BY PARENT PURSUANT TO THE OFFER AND MERGER DESCRIBED HEREIN. The Offer is being made pursuant to an Agreement and Plan of Merger, dated as of January 7, 1996 (the "Merger Agreement"), among Parent, the Purchaser and the Company. The Merger Agreement provides that, among other things, the Purchaser will make the Offer and that following the purchase of Shares pursuant to the Offer and the satisfaction of the other conditions set forth in the Merger Agreement and in accordance with relevant provisions of the New York Business Corporation Law, the Purchaser will be merged with and into the Company (the "Merger"). Following consummation of the Merger, the Company will continue as the surviving corporation and will be a wholly owned subsidiary of Parent. At the effective time of the Merger (the "Effective Time"), each Share issued and outstanding immediately prior to the Effective Time (other than Shares held by the Company as treasury stock or by any subsidiary of the Company that will be a subsidiary of Loral Space or by Parent, the Purchaser or any other subsidiary of Parent and other than Shares held by a holder who has not voted in favor of the Merger or consented thereto in writing and who has filed with the Company a written objection to the Merger and demanded fair value for such Shares in accordance with Section 623 of the New York Business Corporation Law) will be converted into the right to receive cash without interest in an amount equal to the price per Share paid in the Offer. THE BOARD OF DIRECTORS OF THE COMPANY HAS UNANIMOUSLY APPROVED THE OFFER, THE MERGER AND THE SPIN-OFF, DETERMINED THAT THE OFFER, THE MERGER AND THE SPIN-OFF ARE FAIR TO THE STOCKHOLDERS OF THE COMPANY AND ARE IN THE BEST INTERESTS OF THE STOCKHOLDERS OF THE COMPANY AND RECOMMENDS ACCEPTANCE OF THE OFFER AND APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AND THE MERGER BY THE STOCKHOLDERS OF THE COMPANY. The Offer is conditioned upon, among other things, there being validly tendered and not withdrawn prior to the Expiration Date (as defined in the Offer to Purchase) a number of Shares which, when added to the number of Shares then beneficially owned by Parent and its affiliates, represents at least two-thirds of the total number of Shares outstanding and two-thirds of the voting power of the Shares outstanding on a fully diluted basis. The Offer is not conditioned upon the Purchaser obtaining financing; provided, that if the Offer remains outstanding after April 30, 1996, the Offer will, subject to certain provisions of the Merger Agreement, be conditioned upon the Purchaser obtaining financing. Promptly following consummation of the Offer, the Company will distribute shares of Loral Space (the "Loral Space Shares") to the record holders of Shares on a date to be determined by the Board of Directors of the Company (the "Spin- Off Record Date") pursuant to a Restructuring, Financing and Distribution Agreement, dated as of January 7, 1996, among Parent, the Company, a predecessor to Loral Space and various other subsidiaries of the Company (the "Distribution Agreement"). Because the parties to the Distribution Agreement have agreed to use their reasonable efforts to cause the time of the Spin-Off Record Date to be established so as to occur immediately prior to the acceptance for payment by the Purchaser of Shares, a record holder of Shares who tenders Shares pursuant to the Offer (and who does not subsequently withdraw and sell such Shares) is expected to be the record holder thereof on the Spin-Off Record Date. Accordingly, in the event that Shares are accepted for payment pursuant to the Offer, such record holders should be entitled to receive, in respect of each Share tendered, $38.00 net in cash from the Purchaser and one Loral Space Share from the Company. As a result of the Spin-Off, Loral Space will own and manage substantially all of the Company's space and satellite interests, including Globalstar, L.P. and Space Systems/Loral, Inc., and certain other assets of the Company. In addition, pursuant to the terms of the Distribution Agreement, approximately $712 million, subject to adjustment under certain circumstances, will be included in the assets of Loral Space after the Spin-Off. After the Spin-Off, the Company will continue to own and operate the defense electronics and systems integration business of the Company and will own shares of preferred stock of Loral Space that are convertible into 20% of Loral Space's common stock. The Offer is subject to certain conditions set forth in the Offer to Purchase. If any such condition is not satisfied, the Purchaser may (i) terminate the Offer and return all tendered Shares to tendering stockholders, (ii) subject to the terms of the Merger Agreement, extend the Offer and, subject to withdrawal rights as set forth below, retain all such Shares until the expiration of the Offer as so extended, (iii) subject to the terms of the Merger Agreement, waive such condition and, subject to any requirement to extend the time during which the Offer is open, purchase all Shares validly tendered and not withdrawn prior to the Expiration Date or (iv) delay acceptance for payment of (whether or not Shares have theretofore been accepted for payment) or payment for Shares, subject to applicable law, until satisfaction or waiver of the conditions to the Offer. The Purchaser reserves the right, at any time or from time to time in accordance with the terms of the Merger Agreement, to extend the period of time during which the Offer is open by giving oral or written notice of such extension to First Chicago Trust Company of New York (the "Depositary"). Any such extension will be followed as promptly as practicable by public announcement thereof no later than 9:00 a.m., New York City time, on the next business day after the previously scheduled date on which the Offer was to expire. During any such extension, all Shares previously tendered and not withdrawn will remain subject to the Offer subject to the right of a tendering stockholder to withdraw such stockholder's Shares. For purposes of the Offer, the Purchaser shall be deemed to have accepted for payment tendered Shares when, as and if the Purchaser gives oral or written notice to the Depositary of its acceptance of the tenders of such Shares. Payment for Shares accepted for payment pursuant to the Offer will be made only after timely receipt by the Depositary of certificates for such Shares (or a confirmation of a book-entry transfer of such Shares into the Depositary's account at one of the Book-Entry Transfer Facilities (as defined in the Offer to Purchase)), a properly completed and duly executed Letter of Transmittal (or facsimile thereof) and any other documents required by the Letter of Transmittal. Tenders of Shares made pursuant to the Offer may be withdrawn at any time prior to the Expiration Date. Thereafter, such tenders are irrevocable, except that they may be withdrawn at any time after March 11, 1996 unless theretofore accepted for payment as provided in the Offer to Purchase. To be effective, a written, telegraphic, telex or facsimile transmission notice of withdrawal must be timely received by the Depositary at one of its addresses set forth in the Offer to Purchase and must specify the name of the person who tendered the Shares to be withdrawn and the number of Shares to be withdrawn. If the Shares to be withdrawn have been delivered to the Depositary, a signed notice of withdrawal with (except in the case of Shares tendered by an Eligible Institution (as defined in the Offer to Purchase)) signatures guaranteed by an Eligible Institution must be submitted prior to the release of such Shares. In addition, such notice must specify, in the case of Shares tendered by delivery of certificates, the name of the registered holder (if different from that of the tendering stockholder) and the serial numbers shown on the particular certificates evidencing the Shares to be withdrawn, or, in the case of Shares tendered by book-entry transfer, the name and number of the account at one of the Book-Entry Transfer Facilities to be credited with the withdrawn Shares. The information required to be disclosed by paragraph (e)(1)(vii) of Rule 14d- 6 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended, is contained in the Offer to Purchase and is incorporated herein by reference. The Company has agreed to provide the Purchaser with the Company's stockholder list and security position listings for the purpose of disseminating the Offer to holders of Shares. The Offer to Purchase and the related Letter of Transmittal will be mailed to record holders of Shares and will be furnished to brokers, banks and similar persons whose names, or the names of whose nominees, appear on the stockholder list or, if applicable, who are listed as participant in a clearing agency's security position listing for subsequent transmittal to beneficial owners of Shares. THE OFFER TO PURCHASE AND THE RELATED LETTER OF TRANSMITTAL CONTAIN IMPORTANT INFORMATION WHICH SHOULD BE READ CAREFULLY BEFORE ANY DECISION IS MADE WITH RESPECT TO THE OFFER. Requests for copies of the Offer to Purchase, the related Letter of Transmittal and other tender offer materials may be directed to the Information Agent or the Dealer Manager as set forth below, and copies will be furnished promptly at the Purchaser's expense. The Purchaser will not pay any fees or commissions to any broker or dealer or any other person (other than the Dealer Manager and the Information Agent) for soliciting tenders of Shares pursuant to the Offer. The Information Agent for the Offer is: 909 Third Avenue, 20th Floor New York, New York 10022 Call Toll Free: (800) 566-9058 Banks and Brokerage Firms, please call: (800) 662-5200 The Dealer Manager for the Offer is: BEAR, STEARNS & CO. INC. New York, New York 10167 Call Toll Free: (800) 726-9849	SC 14D1	EX-99.(A)(8)	1996-01-12T00:00:00	1996-01-12T17:26:30
0000950109-96-000200	0000950109-96-000200_0021.txt	1. HOW TO COMPLETE THE ENCLOSED FORMS: IF YOU ARE OPENING AN IRA WHICH WILL NOT CONTAIN CONTRIBUTIONS THAT HAVE BEEN TRANSFERRED FROM ANOTHER IRA OR QUALIFIED RETIREMENT PLAN: -- To establish an IRA, please complete the "Application, Adoption Agreement and Beneficiary Designation" (Application). Please note that the Applicant's name must be that of an individual not a business. -- If you are opening an IRA for your non-working spouse, a separate Application must be completed by your spouse. Please be sure to check the option for "Spousal IRA" under "Type of Account" in section 1 on page 2 of the Application packet. -- The maximum allowable contribution for an IRA is $2,000 per year (or $2,250 per year combined contribution for an Individual and a Spousal IRA, with neither account receiving more than $2,000). -- The minimum initial investment per Fund is $1000. If you are dividing your contribution between IRAs for yourself and your non-working spouse, the amounts invested per Fund in each account will be combined for the purpose of satisfying the minimum initial investment. Prospectuses for the Funds may be obtained from Weiss Funds, Inc. at 1-800-xxx-xxxx. Please be sure to read the prospectus carefully before investing. -- Please be sure to read carefully the "Terms and Conditions of the IRA Adoption Agreement" in Section 5 of the Application. There is a $10 annual custodial maintenance fee on this account. -- Please make checks payable to Weiss Treasury Funds. If you are dividing your contribution between an Individual and a Spousal IRA, only one check, with instructions how to allocate the contribution between accounts, needs to be included with both Applications. IF YOU ARE OPENING AN IRA WHICH WILL CONTAIN CONTRIBUTIONS WHICH HAVE BEEN TRANSFERRED FROM ANOTHER IRA OR QUALIFIED RETIREMENT PLAN: -- Please read and follow the instructions above for establishing an IRA. Be sure to note on the Application that your contribution is a rollover from another IRA or qualified retirement plan. -- To transfer the distribution from your current IRA or qualified retirement plan directly from the trustee (custodian) of that plan to the custodian for the IRA, please complete the "Transfer Authorization Form." Please note that if an eligible rollover distribution from a qualified plan is not transferred directly to another qualified plan or an IRA, the IRS mandatory 20% withholding amount will be withheld from the distribution. -- To certify that the contribution you are making to the IRA is a rollover from an IRA or a qualified retirement plan, please complete the "Rollover Certification Form." Rollovers must be completed within 60 calendar days of the date you receive the distribution. 2. MAIL THE COMPLETED APPLICATION AND CHECK (IF APPLICABLE) TO: Attn: Weiss Treasury Funds IRA Attn: Retirement Plans P.O. Box 8969 400 Bellevue Parkway Wilmington, DE 19899-8969 Wilmington, DE 19809 APPLICATION, ADOPTION AGREEMENT & BENEFICIARY DESIGNATION Please complete both pages of this form to establish an IRA. 1. TYPE OF ACCOUNT (PLEASE CHECK ONE OF THE OPTIONS BELOW.) __ Regular IRA __ SEP IRA--Name of Employer __ IRA Rollover __ Spousal IRA __ Rollover/Direct Rollover from a __ Direct Transfer Qualified Retirement Plan IRA to IRA First Name Middle Initial Last Name Social Security Number City State Zip Code Telephone 3. INVESTMENT (PLEASE INDICATE THE PERCENTAGE OF YOUR CONTRIBUTION YOU WISH TO Initial investments must be at least $ 1000.00. Enclosed is a check for $___ payable to Weiss Treasury Funds to be invested in each Fund as follows: This contribution applies to the tax year 19__. (Applies only to Regular, Spousal and SEP IRAs. Current year if not marked) Weiss Treasury Only Money Weiss Intermediate Treasury Market Fund $_______ Fund $_______ Complete this section to designate Primary and Contingent Beneficiary(ies) to receive, in the event of your death, any benefits which may be payable under your IRA. A beneficiary must survive you to receive anything. If your Primary Beneficiary(ies) do not survive you, your Contingent Beneficiary(ies) will receive the funds. If more than one person is named and no percentage is indicated, a joint tenancy with the right of survivorship will be deemed to have been created. If the beneficiary is a trust, please indicate the date of the trust and the trustee(s) name. You may change your beneficiaries at any time by giving written notice to the Custodian. Depositor's Designation: In event of my death, I hereby designate the following individuals as the Primary and Contingent Beneficiary(ies) to receive all benefits that may become due and payable under my Weiss Treasury Funds IRA. Consent of Depositor's Spouse: Spousal consent is required in community property and marital property states where an IRA Depositor wishes to name a beneficiary other than, or in addition to, the spouse. Spouses of Depositors who reside in community property or marital property states (AZ, CA, ID, LA, NV, NM, TX, WA, WI) must sign the consent below. I hereby consent to and join in the designation of beneficiary below. I give to the Depositor any interest I have in the funds deposited in this account. Signature of Depositor's Spouse (if applicable) Date PRIMARY BENEFICIARY(IES):___ PLEASE CHECK HERE IF YOU HAVE ATTACHED A SEPARATE SHEET WITH ADDITIONAL PRIMARY BENEFICIARY(IES). SIGN AND DATE THE SHEET. Name % of Distribution Name % of Distribution City State Zip Code City State Zip Code CONTINGENT BENEFICIARIES: PLEASE CHECK HERE IF YOU HAVE ATTACHED A SEPARATE SHEET WITH ADDITIONAL CONTINGENT BENEFICIARY(IES). SIGN AND DATE THE SHEET. Name % of Distribution Name % of Distribution City State Zip Code City State Zip Code 5. TERMS AND CONDITIONS OF THE WEISS IRA ADOPTION AGREEMENT Please sign and date this Application and Adoption Agreement. If you are also establishing a Spousal IRA, be sure to have your spouse sign and date as well. You, the Depositor, acknowledge that you have received and read the current Prospectus for each Fund which you have designated for investment. All subsequent contributions will be invested as indicated by you in the "Investment" section of this form. All dividends and distributions from the Fund shares held in your Account will be reinvested in shares of the Fund from which received. The Custodian, upon written instructions from you, may exchange any Weiss Fund shares for any other Weiss Fund shares in accordance with the then-current prospectus. CUSTODIAL FEES: $10 ANNUAL MAINTENANCE FEE PER ACCOUNT. The annual maintenance fee may be paid by the Depositor in addition to the maximum annual contribution to his or her IRA. If the fee is not included, the Custodian will deduct the fee from the Account at year-end or at the time the Account is closed. The Custodian reserves the right to change the Custodian fee, but will give at least 30 days written notice to the Depositor of any fee changes. The Custodian will keep records, identify and file returns and provide other information concerning your Account as required by the Internal Revenue Code and any Regulations issued or forms adopted by the Treasury Department of the United States. I (THE DEPOSITOR) HEREBY ESTABLISH AN IRA UNDER THE TERMS AND CONDITIONS CONTAINED IN THE ACCOMPANYING CUSTODIAL ACCOUNT AGREEMENT, WHICH IS INCORPORATED HEREIN BY REFERENCE. THE COMBINED INSTRUMENT IS HEREINAFTER REFERRED TO AS THE "AGREEMENT." THIS IRA BECOMES EFFECTIVE UPON WRITTEN ACCEPTANCE OF THIS APPLICATION AND ADOPTION AGREEMENT BY THE CUSTODIAN, PNC BANK, NATIONAL ASSOCIATION, WHICH WRITTEN ACCEPTANCE SHALL CONSIST OF A CONFIRMATION OF TRANSACTION STATEMENT ISSUED BY THE CUSTODIAN. THE DEPOSITOR UNDERSTANDS AND AGREES THAT THE CUSTODIAN IS NOT RESPONSIBLE FOR ANY ASSETS UNTIL RECEIVED. I (THE DEPOSITOR) CERTIFY UNDER THE PENALTIES OF PERJURY THAT MY SOCIAL SECURITY NUMBER IS TRUE, CORRECT AND COMPLETE AND THAT THIS NUMBER IS MY TAXPAYER IDENTIFICATION NUMBER. Accepted: PNC Bank, National Association, C/O PFPC Inc., 400 Bellevue Authorized Representative of Custodian Date Distributor: Weiss Treasury Funds, Inc. Shares of the Funds are offered by the Distributor. The Distributor is not a bank, and shares of the Fund are not deposits or obligations of, or guaranteed or endorsed by, any bank nor are they federally insured or otherwise supported by the FDIC, the Federal Reserve Board or any other agency. Use this form to transfer amounts from your current IRA or qualified retirement plan directly to this IRA. (NOTE: A direct transfer from a qualified plan to your IRA will avoid the IRS mandatory 20% withholding Depositor's Name Spouse's name (if transferring a Depositor's Social Security Number Spouse's Social Security Number 2. PLEASE TELL US ABOUT YOUR PRESENT IRA OR RETIREMENT PLAN Type of account to be transferred: __ Individual IRA __ Spousal IRA __ Qualified Retirement Plan __ 403(b) Plan Arrangement __ SEP--IRA __ Other ______________ Transfer from: (Please complete entirely. For more information or questions about your retirement plan, contact your employer's benefits or personnel Name of Present Trustee/Custodian Name of Employer (if applicable) Street of Present Trustee/Custodian Plan Name (if applicable) City State Zip Code Telephone 3. PLEASE TELL US HOW TO INVEST YOUR IRA OR QUALIFIED RETIREMENT PLAN ASSETS PLEASE NOTE: If you have deductible and nondeductible IRA contributions, you may wish to invest in separate accounts. While these funds may be commingled in a single account, separate accounts may facilitate the keeping of appropriate records. Also please note that if you commingle a qualified plan rollover with annual IRA contributions, you will not be eligible to rollover the amount to another qualified plan in the future. Transfer to: (Please check one of the following.) A. __ I am opening a new account and have attached a completed Application. B. __ Please deposit proceeds in my existing IRA. Complete information below: Existing IRA Account Name Fund Name(s) Account Number 4. IF YOU ARE AGE 70 1/2 OR OLDER, COMPLETE THE FOLLOWING Required Minimum Distribution has been taken for the current tax year: ___ Yes ___ No ___ Joint life non-recalculated (Please fill out beneficiary information below if you checked this item) ___ Joint life recalculated (Please fill out beneficiary information below if you checked this item) Beneficiary name Beneficiary date of birth Beneficiary relationship 5. PLEASE AUTHORIZE YOUR PRESENT TRUSTEE OR CUSTODIAN TO TRANSFER YOUR RETIREMENT PLAN OR YOUR IRA ASSETS TO THE IRA CUSTODIAN--PNC BANK, NATIONAL To Present Trustee or Custodian: Please liquidate ___ all or part ($_______) of the account listed in Section 2 above and transfer the proceeds of liquidation ("cash" only, by check, draft, wire transfer or other form acceptable to the receiving Custodian) to my new Weiss Treasury Funds IRA Custodian--PNC Bank, National Association. I have appointed PNC Bank, National Association as Custodian of my Weiss Treasury Funds IRA and authorize you to transfer amounts as indicated above to the new Custodian. Please send the new Custodian any documents or records needed to complete the transfer. I understand that I am responsible for the transfer of all assets to my successor IRA, and that PNC Bank, National Association, and PFPC Inc. have no duty to enforce the collection of any assets to be transferred to my Weiss Treasury Funds IRA. Signature Guarantee (if required) Date Your present trustee or custodian may require your signature to be guaranteed. Please call them for requirements; the lack of a required signature guarantee could delay your transfer. AUTHORIZED ACCEPTANCE OF PLAN TO BE COMPLETED BY PNC BANK, NATIONAL PNC Bank, National Association, as IRA Custodian, will accept the transfer of assets of the account specified in Item 2 above into an Individual Retirement Account qualified under the Internal Revenue Code and established for the benefit of the Depositor named below. Depositor's Name Account Number Account Number Authorized Representative of PNC Bank, National Association Date Telephone Please indicate Weiss Treasury Funds IRA Account Number(s) on all documents sent to us. Please forward a copy of this form with the transfer proceeds for proper account identification. If any of the funds represent contributions for the current calendar year, please specify said amounts. Make check payable and forward with a copy of this Transfer Authorization Form to: FBO: ______________ Weiss Treasury Funds IRA Account Number: _______________ c/o PFPC INC. Use this form to rollover a distribution from your current IRA or eligible distribution from a qualified retirement plan to your Weiss Treasury Funds IRA. You must complete the rollover within 60 calendar days of your receipt of that distribution. PLEASE NOTE: 20% withholding is required on any eligible rollover distribution from a qualified retirement plan unless the distribution is transferred directly to an IRA or other qualified plan. To transfer your distribution directly, please complete the "Transfer Authorization Form" included with this Application. Name of Depositor (Contributor) Social Security Number Distributing IRA Name Distributing Qualified Plan Name Distributing IRA Account Number Distributing Qualified Plan Account -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- 1. TYPE OF ROLLOVER CONTRIBUTION (PLEASE CHECK ONE.) -- IRA Rollover--Note that 365 days must have passed since you last received a rollover distribution from the distributing IRA. -- Eligible Rollover Distribution--A distribution from a qualified retirement plan of all or part of your plan balance, other than the portion of any distribution which is nontaxable. Your employer's benefits or personnel office should be able to tell you what portion of your distribution is an "eligible distribution". -- Qualified Domestic Relations Order Distribution. 2. 70 1/2 ROLLOVER RESTRICTIONS (PLEASE CHECK ONE.) -- I am not nor will be 70 1/2 or older in this calendar year. -- I am or will be 70 1/2 or older in this calendar year. I understand that I may not rollover any amounts required to be distributed under Internal Revenue Code Sections 408(a)(6) and 401(a)(9). I certify that the contribution described above is an eligible IRA rollover contribution and that I am rolling over this contribution within 60 calendar days of my receipt of that distribution. I understand that this rollover is irrevocable and involves important tax considerations. Specifically, I understand that a rollover contribution from a qualified retirement plan will no longer be eligible for the special averaging, capital gains and separate tax treatment that may be available for distributions from such plans. Other tax considerations may also apply. I agree that I am solely responsible for all tax consequences of this rollover contribution. I also agree that the IRA custodian shall have no responsibility for any tax consequences. I understand that if I commingle a qualified retirement plan rollover with annual IRA contributions, I will not be eligible to rollover the amount to another qualified plan in the future. Other restrictions regarding subsequent rollovers of this contribution may also apply. I HAVE READ AND UNDERSTAND AND AGREE TO BE LEGALLY BOUND BY THE TERMS OF THIS FORM. I ALSO UNDERSTAND THAT THE IRA CUSTODIAN WILL RELY ON THIS FORM WHEN ACCEPTING MY ROLLOVER CONTRIBUTION. I UNDERSTAND THAT THIS ROLLOVER IS IRREVOCABLE AND MAY NOT BE REVERSED IN THE FUTURE. I ALSO UNDERSTAND THAT I AM RESPONSIBLE FOR THE MOVEMENT OF THE ROLLOVER TO MY SUCCESSOR IRA, AND THAT PNC BANK, NATIONAL ASSOCIATION AND PFPC INC. HAVE NO DUTY TO ENFORCE THE COLLECTION OF ANY ASSETS TO BE ROLLED OVER TO MY WEISS TREASURY FUNDS IRA. The following information is the disclosure statement required by Federal Tax regulations. You should read this disclosure statement, the custodial account Agreement, and the prospectuses for the Funds in which your Weiss Treasury Funds Individual Retirement Account (IRA) contributions will be invested. You have the right to revoke your Weiss Treasury Funds IRA and receive the entire amount of your contribution by notifying PNC Bank, National Association, the Custodian of your Weiss Treasury Funds IRA, in writing within seven (7) days of establishment of your IRA. If you revoke your IRA within seven days, you are entitled to a return of the entire amount paid by you, without adjustment for such items as sales commission, administrative expenses, or fluctuations in market value. If you decide to revoke your IRA, notice should be delivered or mailed to: PNC Bank, National Association PNC Bank, National Association c/o PFPC Inc. c/o PFPC Inc. Attn: Weiss Treasury Funds IRA Attn: Weiss Treasury Funds IRA P.O. Box 8969 400 Bellevue Parkway Wilmington, DE 19809-8969 Wilmington, DE 19809 This notice should be signed by you and include the following: 2. A statement that you elect to revoke your Weiss Treasury Funds IRA; 3. Your Weiss Treasury Funds IRA account number; 4. The date your Weiss Treasury Funds IRA was established; 5. Your signature and your printed or typed name. Mailed notice will be deemed given on the date that it is postmarked, if it is deposited in the United States mail, first class postage prepaid and properly addressed. This means that if you mail your notice it must be postmarked on or before the seventh day after your Weiss Treasury Funds IRA was opened. A revoked IRA will be reported to the Internal Revenue Service and the Depositor on Forms 1099-R and 5498. YOUR INDIVIDUAL RETIREMENT ACCOUNT (IRA) You have opened a Weiss Treasury Funds Individual Retirement Account which is an account for the exclusive benefit of you and your beneficiaries, created by a written instrument (the Custodial Account Agreement). The following requirements apply to your Weiss Treasury Funds IRA: 1. Contributions, transfers, and rollovers may be made only in "cash" by check, draft, wire transfer, or other form acceptable to the 2. The Custodian must be a bank; 3. No part may be invested in life insurance; 4. Your interest must be nonforfeitable (not subject to escheat laws); 5. The assets of the custodial account may not be mixed with other property except in a common investment fund; and 6. You must begin receiving distributions from your account no later than April 1 of the year following the year in which you become 70 1/2 years old; and distribution must be completed over a period that is not longer than the joint life expectancy of you and your beneficiary. You may not contribute more than 100% of your compensation or earnings from self-employment, and the maximum contribution is $2,000 per tax year. If your spouse is not employed or elects for IRA purposes to be treated as having no compensation, you may also contribute to a Spousal IRA, but the total contribution for both of you may not exceed $2,250 per tax year. The total ($2,250) may be divided between the accounts for you and your spouse in any manner, except that not more than $2,000 may be contributed to either account. Amounts contributed to your Weiss Treasury Funds IRA in excess of the allowable limit will be subject to a nondeductible excise tax of 6% for each year until the excess is used up as an allowable contribution (in a subsequent year) or returned to you. A distribution of excess contributions must be included in your taxable income when distributed, and may also be subject to the 10% excise tax on early distributions discussed below. The 6% excise tax will not apply if the excess contribution and earnings applicable to it are distributed by the due date for your Federal Income Tax Return, including extensions. If such a distribution is made by the due date of your tax return, only the earnings are taxable (of course, the excess contribution will not be deductible). Your contribution may be deductible on your Federal Income Tax Return. However, there is a phase-out of the IRA deduction if either you or your spouse (if you file a joint return) is an active participant in an employer-sponsored retirement plan. The IRA deduction is reduced proportionately as adjusted gross income increases from $25,000 to $35,000 for a single individual, $40,000 to $50,000 for a married couple filing a joint return, or from $0 to $10,000 for a married individual who is an active participant and files a separate return. The amount of the reduction is equal to 20% of the amount by which your adjusted gross income exceeds the $25,000, $40,000, and $0 amounts, respectively. Your contributions in excess of the permitted deduction will be nondeductible contributions. The income of your Weiss Treasury Funds IRA is not taxed until the money is distributed to you. Distributions are taxable as ordinary income when received except that the amount of any distribution representing non- deductible contributions is not taxed. In general, you may "rollover" a distribution from another IRA, an eligible rollover distribution from your employer's qualified plan, or distributions from certain tax deferred annuities or accounts. If a distribution is rolled over, i.e. deposited to your Weiss Treasury Funds IRA within 60 calendar days of receipt, the amount rolled over is not taxable. The IRS enforces the 60-day time limit strictly. You may rollover a portion of a distribution in which case the remainder will be subject to tax. The IRS requires that distributions from your employer's qualified plan have 20% of the distribution withheld for income tax unless your money is transferred in a direct asset transfer to an eligible retirement plan such as another qualified plan or IRA. The rules regarding rollovers are complex and you should consult your tax adviser prior to rolling over all or part of a distribution. PENALTY TAX ON CERTAIN TRANSACTIONS If you make an excess contribution to your IRA and it is not corrected on a timely basis, an excise tax of 6% is imposed on the excess amount. This tax will apply each year to any part or all of the excess which remains in your account. Your receipt or use of any portion of your account before you attain age 59 1/2 is considered an early distribution unless the distribution is a result of death or disability or is rolled over. The amount of any early taxable distribution (excluding any amount representing a return of nondeductible contributions) is subject to a penalty tax equal to 10% of the distribution. A pre-age 59 1/2 taxable distribution will be exempt from the 10% penalty tax if, for example, it is part of a scheduled series of substantially equal payments over your life, or over the joint life expectancy of you and a beneficiary, or if it was made because you became disabled. If you request a distribution in the form of a series of substantially equal payments, and you modify the payments before 5 years have elapsed and before attaining age 59 1/2, the 10% additional income tax will apply retroactively to the year payments began through the year of such modification. This 10% penalty is in addition to any Federal income tax that is owed at distribution. You are required to begin receiving minimum distributions from your IRA no later than April 1 following the calendar year in which you reach the age of 70 1/2. The distribution may be paid either in installments, or in a lump sum. The installments may be paid over a period not to exceed your life expectancy, or over the joint and last survivor life expectancy of you and your designated beneficiary. If the amount distributed during a taxable year is less than the minimum amount required to be distributed, the recipient is subject to a penalty tax equal to 50% of the difference between the amount distributed and the amount required to be distributed. If you receive more than the greater of $112,500 (subject to annual cost- of-living adjustments) or $150,000 in a calendar year from certain retirement plans, a 15% tax is imposed on the amount in excess of that amount. (Special rules may apply to benefits accumulated prior to August 1, 1986.) All distributions from IRAs, qualified retirement plans, and tax- sheltered annuities must be added together for purposes of this excise tax. There are several possible favorable elections that may reduce or eliminate this tax. The rules are very complicated. You should consult a competent tax adviser. An IRA distribution request form is available from the Custodian, and should be obtained and used to request any distribution from your IRA. If you or your beneficiary engage in any prohibited transaction (such as any sale, exchange, borrowing, or leasing of any property between you and the account; or any other interference with the independent status of the account), the account will lose its exemption from tax and be treated as having been distributed to you. The value of the entire account will be includable in your gross income. If you are under age 59 1/2, you would also be subject to the 10% penalty tax on early distributions. If you or your beneficiary use (pledge) all or any part of your IRA as security for a loan, then the portion so pledged will be treated as if distributed to you, and will be taxable to you as ordinary income, and subject to a 10% penalty tax if you have not attained age 59 1/2 during the year which you make such a pledge. The Custodian is required to withhold income tax from any distribution from your IRA to you at the rate of 10% unless you choose not to have tax withheld. You may elect out of withholding by advising the Custodian in writing, prior to the distribution, that you do not want tax withheld from the distribution. This election may be made on IRS Form W-4P, or any other form acceptable to the Custodian. If you do not elect out of tax withholding, you may direct the Custodian to withhold an additional amount of tax in excess of 10%. For more detailed information, you may obtain Publication 590, Individual Retirement Arrangements (IRAs) from any district office of the Internal Revenue Service or by calling 1-800-TAX-FORM. Any IRA transaction may have tax consequences; consult your tax adviser to obtain information about the tax consequences in connection with your particular circumstances. A mutual fund investment involves investment risks, including possible loss of principal. In addition, growth in the value of your account is neither guaranteed nor projected due to the characteristics of a mutual fund investment. Detailed information about the shares of each mutual fund available for investment by your Weiss Treasury Funds IRA must be furnished to you in the form of a prospectus. The method for computing and allocating annual earnings is set forth in the prospectus. (See prospectus section entitled "Dividends and Distributions.") If you made an initial contribution of $1,000 on the first day of a calendar year and no further investment during that year, your contribution would also be subject to certain costs and expenses which would reduce any yield you might obtain from your investment. (See the prospectus section entitled "Expense Information" and the sections referred to therein.) For further information regarding expenses, earnings, and distributions, see the fund's financial statements, prospectus and/or statement of additional information. The charges in connection with your Weiss Treasury Funds IRA are set forth in the Application. The Custodian may also charge a service fee in connection with any distribution from your IRA. Your Weiss Treasury Funds IRA is the Internal Revenue Service's model custodial account contained in IRS Form 5305-A. Certain additions have been added in Article VIII of the form. By following this form, your Weiss Treasury Funds IRA meets the requirements of the Internal Revenue Code. However, the IRS has not endorsed the merits of the investments allowed under the IRA. Form 5305-A may also be used by qualifying employers in conjunction with Form 5305-SEP to establish a simplified employee pension plan (SEP) on behalf of employees. If your IRA is part of a SEP, details regarding SEPs should also be provided by your employer. (UNDER SECTION 408(A) OF THE INTERNAL REVENUE CODE--FORM 5305-A (REVISED The Depositor (Contributor) whose name appears in the accompanying Application is establishing an Individual Retirement Account (IRA) (under section 408(a) of the Internal Revenue Code of 1986, as amended, the "Code") to provide for his or her retirement and for the support of his or her beneficiary(ies) after death. The Custodian, PNC Bank, National Association, has given the Depositor the disclosure statement required under Treasury Regulations section 1.408-6. The Depositor and the Custodian make the following agreement: The Custodian may accept additional cash contributions on behalf of the Depositor for a tax year of the Depositor. The total cash contributions are limited to $2,000 for the tax year unless the contribution is a rollover contribution described in section 402(c) (but only after December 31, 1992), 403(a)(4), 403(b)(8), 408(d)(3), or an employer contribution to a simplified employee pension plan as described in section 408(k). Rollover contributions before January 1, 1993, include rollovers described in section 402(a)(5), 402(a)(6), 402(a)(7), 403(a)(4), 403(b)(8), 408(d)(3), or an employer contribution to a simplified employee pension plan as described in section 408(k). The Depositor's interest in the balance in the custodial account is nonforfeitable. 1. No part of the custodial funds may be invested in life insurance contracts, nor may the assets of the custodial account be commingled with other property except in a common trust fund or common investment fund (within the meaning of section 408(a)(5)). 2. No part of the custodial funds may be invested in collectibles (within the meaning of section 408(m)) except as otherwise permitted by section 408(m)(3) which provides an exception for certain gold and silver coins and coins issued under the laws of any state. 1. Notwithstanding any provision of this agreement to the contrary, the distribution of the Depositor's interest in the custodial account shall be made in accordance with the following requirements and shall otherwise comply with section 408(a)(6) and Proposed Regulations section 1.408-8, including the incidental death benefit provisions of Proposed Regulations section 1.401(a)(9)-2, the provisions of which are incorporated by reference. 2. Unless otherwise elected by the time distributions are required to begin to the Depositor under paragraph 3, or to the surviving spouse under paragraph 4, other than in the case of a life annuity, life expectancies shall be recalculated annually. Such election shall be irrevocable as to the Depositor and the surviving spouse and shall apply to all subsequent years. The life expectancy of a nonspouse beneficiary may not be recalculated. 3. The Depositor's entire interest in the custodial account must be, or begin to be, distributed by the Depositor's required beginning date (April 1 following the calendar year end in which the Depositor reaches age 70 1/2). By that date, the Depositor may elect, in a manner acceptable to the Custodian, to have the balance in the custodial account distributed in: (a) A single sum payment. (b) An annuity contract that provides equal or substantially equal monthly, quarterly, or annual payments over the life of the Depositor. (c) An annuity contract that provides equal or substantially equal monthly, quarterly, or annual payments over the joint and last survivor lives of the Depositor and his or her designated beneficiary. (d) Equal or substantially equal annual payments over a specified period that may not be longer than the Depositor's life expectancy. (e) Equal or substantially equal annual payments over a specified period that may not be longer than the joint life and last survivor expectancy of the Depositor and his or her designated beneficiary. 4. If the Depositor dies before his or her entire interest is distributed to him or her, the entire remaining interest will be distributed as follows: (a) If the Depositor dies on or after distribution of his or her interest has begun, distribution must continue to be made in accordance with paragraph 3. (b) If the Depositor dies before distribution of his or her interest has begun, the entire remaining interest will, at the election of the Depositor or, if the Depositor has not so elected, at the election of the beneficiary or beneficiaries, either (i) Be distributed by the December 31 of the year containing the fifth anniversary of the Depositor's death, or (ii) Be distributed in equal or substantially equal payments over the life or life expectancy of the designated beneficiary or beneficiaries starting by December 31 of the year following the year of the Depositor's death. If, however, the beneficiary is the Depositor's surviving spouse, then this distribution is not required to begin before December 31 of the year in which the Depositor would have turned age 70 1/2. (c) Except where distribution in the form of an annuity meeting the requirements of section 408(b)(3) and its related regulations has irrevocably commenced, distributions are treated as having begun on the Depositor's required beginning date, even though payments may actually have been made before that date. (d) If the Depositor dies before his or her entire interest has been distributed and if the beneficiary is other than the surviving spouse, no additional cash contributions or rollover contributions may be accepted in the account. 5. In the case of a distribution over life expectancy in equal or substantially equal annual payments, to determine the minimum annual payment for each year, divide the Depositor's entire interest in the Custodial account as of the close of business on December 31 of the preceding year by the life expectancy of the Depositor (or the joint life and last survivor expectancy of the Depositor and the Depositor's designated beneficiary, or the life expectancy of the designated beneficiary, whichever applies). In the case of distributions under paragraph 3, determine the initial life expectancy (or joint life and last survivor expectancy) using the attained ages of the Depositor and designated beneficiary as of their birthdays in the year the Depositor reaches age 70 1/2. In the case of a distribution in accordance with paragraph 4(b)(ii) determine life expectancy using the attained age of the designated beneficiary as of the beneficiary's birthday in the year distributions are required to commence. 6. The owner of two or more individual retirement accounts may use the "alternative method" described in Notice 88-38, 1988-1 C.B. 524, to satisfy the minimum distribution requirements described above. This method permits an individual to satisfy these requirements by taking from one individual retirement account the amount required to satisfy the requirement for another. 1. The Depositor agrees to provide the Custodian with information necessary for the Custodian to prepare any reports required under section 408(i) and Regulations section 1.408-5 and 1.408-6. 2. The Custodian agrees to submit reports to the Internal Revenue Service and the Depositor prescribed by the Internal Revenue Service. Notwithstanding any other articles which may be added or incorporated, the provisions of Article I through III and this sentence will be controlling. Any additional articles that are not consistent with section 408(a) and the related regulations will be invalid. This agreement will be amended from time to time to comply with the provision of the Code and related regulations. Other amendments may be made with the consent of the Depositor and the Custodian. 1. All funds in the custodial account (including earnings) shall be invested in shares of beneficial interest of any one or more of the regulated investment companies managed by the company listed on the Application Form contained in this package or any of its subsidiaries or affiliates, and which have been designated by such company as eligible for investment under this custodial account, which investment companies shall be collectively referred to as "the Funds" and which shares shall be collectively referred to as "Fund Shares". Fund Shares shall be purchased at the public offering value for Fund Shares next to be determined after receipt of the contribution by the Custodian or its agent. 2. The shareholder of record of all Fund Shares shall be the Custodian or its nominee. 3. The Depositor shall, from time to time, direct the Custodian to invest the funds of his/her custodian account in Fund Shares. Any funds which are not directed as to investment will be returned to the Depositor without being deemed to have been contributed to his/her custodial account. The Depositor shall be the beneficial owner of all Fund Shares held in the custodial account, and the Custodian shall not vote any such shares except upon written direction of the Depositor. 4. The Custodian agrees to forward, or to cause to be forwarded, to every Depositor the then-current prospectus(es) of the Funds, as applicable, which have been designated by the Custodian as eligible for investment under the custodial account and selected by the Depositor for such investment, and all notices, proxies and related proxy soliciting materials applicable to said Fund Shares received by it. 5. Each Depositor shall have the right by written notice to the Custodian to designate or to change a beneficiary to receive any benefit to which such Depositor may be entitled in the event of his/her death prior to the complete distribution of such benefit. If no such designation is in effect on the Depositor's death, or if the designated beneficiary has predeceased the Depositor, the beneficiary shall be the Depositor's estate. 6. (a) The Custodian shall have the right to receive rollover contributions as described in Article I of this Agreement. The Custodian reserves the right to refuse to accept any property which is not in the form of cash. (b) The Custodian, upon written direction of the Depositor and after submission to the Custodian of such documents as it may reasonably require, shall transfer the assets held under this Agreement (reduced by (1) any amounts referred to in paragraph 8 of this Article VIII and (2) any amounts required to be distributed during the calendar year of transfer) to a qualified retirement plan, to a successor individual retirement account, to an individual retirement annuity for the Depositor's benefit, or directly to the Depositor. Any amounts received or transferred by the Custodian under this paragraph 6 shall be accompanied by such records and other documents as the Custodian deems necessary to establish the nature, value and extent of the assets and of the various interests therein. 7. Without in any way limiting the foregoing, the Depositor hereby irrevocably delegates to the Custodian the right and power to amend at any time and from time to time the terms and provisions of this Agreement and hereby consents to such amendments, provided they shall comply with all applicable provisions of the Code, the Treasury regulations thereunder and with any other governmental law, regulation or ruling. Any such amendments shall be effective when the notice of such amendments is mailed to the address of the Depositor indicated by the Custodian's records. 8. Any income taxes or other taxes of any kind whatsoever levied or assessed upon or in respect of the assets of the custodial account or the income arising therefrom, any transfer taxes incurred, all other administrative expenses incurred, all other administrative expenses incurred by the Custodian in the performance of its duties including fees for legal services rendered to the Custodian, and the Custodian's compensation may be paid by the Depositor and, unless so paid within such time period as the Custodian may establish, shall be paid from the Depositor's custodial account. The Custodian reserves the right to change or adjust its compensation upon 30 days advance notice to the Depositor. 9. The benefits provided hereunder shall not be subject to alienation, assignment, garnishment, attachment, execution or levy of any kind, and any attempt to cause such benefits to be so subjected shall not be recognized, except to such extent as may be required by law. 10. The Custodian may rely upon any statement by the Depositor when taking any action or determining any fact or question which may arise under this Custodial Agreement. The Depositor hereby agrees that the Custodian will not be liable for any loss or expense resulting from any action taken or determination made in reliance on such statement. The Depositor assumes sole responsibility for assuring that contributions to the custodial account satisfy the limits specified in the appropriate provisions of the Code. 11. The Custodian may resign at any time upon 30 days written notice to the Depositor and may be removed by the Depositor at any time upon 30 days written notice to the Custodian. Upon the resignation or removal of the Custodian, a successor Custodian shall be appointed within 30 days of such resignation notice and in the absence of such appointment, the Custodian shall appoint a successor unless the Agreement be sooner terminated. Any successor Custodian shall be a bank (as defined in section 408(n) of the Code) or such other person found qualified to act as a Custodian under an individual account plan by the Secretary of the Treasury or his delegate. The appointment of a successor Custodian shall be effective upon receipt by the Custodian of such successor's written acceptance which shall be submitted to the Custodian and the Depositor. Within 30 days of the effective date of a successor Custodian's appointment, the Custodian shall transfer and deliver to the successor Custodian applicable account records and assets of the custodial account (reduced by any unpaid amounts referred to in paragraph 8 of this Article VIII). The successor Custodian shall be subject to the provisions of this Agreement (or any successor thereto) on the effective date of its appointment. 12. Notwithstanding any provision hereof to the contrary, for taxable years in which contributions to the custodial account are to qualify as contributions to a Spousal Individual Retirement Account, the following provisions shall apply: a separate custodial account shall be established under this Agreement in the name of the spouse, who shall thereafter be deemed to be the Depositor with respect to such separate custodial account. The sum of the amount contributed to the custodial account of the Depositor and the Depositor's spouse for a given tax year shall not exceed the lesser of: (i) An amount equal to 100% of the compensation (including earned income in the case of a self-employed individual) includable in the employed spouse's gross income for the taxable year or (ii) $2,250, provided, however, that no more than $2,000 may be contributed to either of such custodial accounts. 13. The Custodian shall, from time to time, in accordance with instructions in writing from the Depositor, make distributions out of the custodial account to the Depositor in the manner and amounts as may be specified in such instructions (reduced by any amounts referred to in Article VIII, paragraph 8). An IRA distribution request form is available from the Custodian, and should be obtained and used to request any distribution from your IRA. Notwithstanding the provisions of Article IV above, the Custodian assumes (and shall have) no responsibility to make any distribution to the Depositor (or the Depositor's beneficiary if the Depositor is deceased) unless and until such written instructions specify the occasion for such distribution and the elected manner of distribution, except as set forth in the second part of this paragraph (13) below, with respect to age 70 1/2 distributions. Prior to making any such distribution from the custodial account, the Custodian shall be furnished with any and all applications, certificates, tax waivers, signature guarantees, and other documents (including proof of any legal representative's authority) deemed necessary or advisable by the Custodian, but the Custodian shall not be liable for complying with written instructions which appear on their face to be genuine, or for refusing to comply if not satisfied such instructions are genuine, and assumes no duty of further inquiry. Upon receipt of proper written instructions as required above, the Custodian shall cause the assets of the custodial account to be distributed in cash and/or in kind, as specified in such written order. The Depositor may select as a method of distribution under Article IV, paragraph 3, option (a), (d), or (e); but may not select option (b) or (c), notwithstanding description of such in Article IV. If the Depositor requests age 70 1/2 distribution by timely written instruction but does not choose any of the methods of distribution described above by the April 1st following the calendar year in which he or she reaches age 70 1/2, distribution to the Depositor will be made in accordance with Article IV, paragraph 3, option (d). If the Depositor does not request age 70 1/2 distribution from the custodial account by timely written instruction, or does not specify a method of calculating the amount of the age 70 1/2 distribution which the Depositor will be taking from another IRA(s), calculation of the current year Required Minimum Distribution amount which can not be transferred or rolled over to another IRA will be made in accordance with Article IV, paragraph 3, option (d). 14. Distribution of the assets of the custodial account shall be made in accordance with the provisions of Article IV as the Depositor (or the Depositor's beneficiary if the Depositor is deceased) shall elect by written instructions to the Custodian; subject, however, to the provisions of sections 401(a)(9), 408(a)(6) and 403(b)(10) of the Code, the regulations promulgated thereunder, and the following: (i) The recalculation of life expectancy of the Depositor and/or the Depositor's spouse may be made only at the written election of the Depositor. The recalculation of life expectancy of the surviving spouse shall only be made at the written election of the surviving spouse. (ii) If the Depositor dies before his/her entire interest in the custodial account has been distributed, and if the designated beneficiary of the Depositor is the Depositor's surviving spouse, the spouse may treat the custodial account as his/her own individual retirement arrangement. This election will be deemed to have been made if the surviving spouse makes a regular IRA contribution to the custodial account, makes a rollover to or from such custodial account, or fails to receive a payment from the custodial account within the appropriate time period applicable to the deceased Depositor under section 401(a)(9)(B) of the Code. (iii) With respect to distributions in calendar years beginning in or after 1989, if the Depositor's designated beneficiary is not his/her spouse, then distributions to the Depositor and his/her beneficiary commencing with the Depositor's required beginning date shall comply with the minimum distribution incidental benefit requirement. The provisions of this paragraph (14) of Article VIII shall prevail over the provisions of Article IV to the extent the provisions of this paragraph (14) are permissible under proposed and/or final regulations promulgated by the Internal Revenue Service. 15. In the event any amounts remain in the custodial account after the death of the Depositor, the rights of the Depositor hereunder shall thereafter be exercised by his or her beneficiary. 16. The Custodian is authorized to hire agents (including any transfer agent for Fund Shares) to perform certain duties hereunder. 17. This Agreement shall terminate coincident with the complete distribution of the assets of the Depositor's account. 18. All notices to be given by the Custodian to the Depositor shall be deemed to have been given when mailed to the address of the Depositor indicated by the Custodian's records. 19. The Custodian shall not be responsible for any losses, penalties or other consequences to the Depositor or any other person arising out of the making of, or the failure to make, any contribution or withdrawal. 20. In addition to the reports required by paragraph (2) of Article V, the Custodian shall periodically cause to be mailed to the Depositor in respect of each such period an account of all transactions affecting the custodial account during such period and a statement showing the custodial account as of the end of such period. If, within 60 days after such mailing, the Depositor has not given the Custodian written notice of any exception or objection thereto, the periodic accounting shall be deemed to have been approved and, in such case or upon the written approval of the Depositor, the Custodian shall be released, relieved and discharged with respect to all matters and statements set forth in such accounting as though the account had been settled by judgment or decree of a court of competent jurisdiction. 21. In performing the duties conferred upon the Custodian by the Depositor hereunder, the Custodian shall act as the agent of the Depositor. The parties do not intend to confer any fiduciary duties on the Custodian and none shall be implied. The Custodian shall not be liable (and does not assume any responsibility) for the collection of contributions, the deductibility or the propriety of any contribution under this Agreement, the selection of any Fund Shares for this custodial account, or the purpose or propriety of any distribution made in accordance with Article IV and Paragraph 13, 14 or 15 of Article VIII, which matters are the sole responsibility of the Depositor or the Depositor's beneficiary, as the case may be. 22. The Custodian shall be responsible solely for the performance of those duties expressly assigned to it in this Agreement and by operation of law. The Custodian shall have no duty to account for deductible contributions separately from nondeductible contributions, unless required to do so by applicable law. In determining the taxable amount of a distribution, the Depositor shall rely only on his or her Federal tax records, and the Custodian shall withhold Federal income tax from any distribution from the custodial account as if the total amount of the distribution is includable in the Depositor's income. 23. Except to the extent superseded by Federal law, this Agreement shall be governed by, and construed, administered and enforced according to, the laws of the Commonwealth of Pennsylvania, and all contributions shall be deemed made in Pennsylvania. (Section references are to the Internal Revenue Code unless otherwise Form 5305-A is a model custodial account agreement that meets the requirements of section 408(a) and has been automatically approved by the IRS. An individual retirement account (IRA) is established after the form is fully executed by both the individual (Depositor) and the Custodian and must be completed no later than the due date of the individual's income tax return for the tax year (without regard to extensions). This account must be created in the United States for the exclusive benefit of the Depositor or his or her beneficiaries. Individuals may rely on regulations for the Tax Reform Act of 1986 to the extent specified in those regulations. Do not file Form 5305-A with the IRS. Instead, keep it for your records. For more information on IRAs, including the required disclosure you can get from your custodian, get Pub. 590, Individual Retirement Arrangements (IRAs). CUSTODIAN.--The Custodian must be a bank or savings and loan association, as defined in section 408(n), or any person who has the approval of the IRS to act as custodian. DEPOSITOR.--The Depositor is the person who establishes the custodial account. The depositor's social security number will serve as the identification number of his or her IRA. An employer identification number is required only for an IRA for which a return is to be filed to report unrelated business taxable income. An employer identification number is required for a common fund created for IRAs. Form 5305-A may be used to establish the IRA custodial account for a nonworking spouse. Contributions to an IRA custodial account for a nonworking spouse must be made to a separate IRA custodial account established by the nonworking spouse. ARTICLE IV.--Distributions made under this article may be made in a single sum, periodic payment, or a combination of both. The distribution option should be reviewed in the year the Depositor reaches age 70 1/2 to ensure that the requirements of section 408(a)(6) have been met. ARTICLE VIII.--Article VIII and any that follow it may incorporate additional provisions that are agreed to by the Depositor and Custodian to complete the agreement. They may include, for example, definitions, investment powers, voting rights, exculpatory provisions, amendment and termination, removal of the Custodian, Custodian's fees, state law requirements, beginning date of distributions, accepting only cash, treatment of excess contributions, prohibited transactions with the Depositor, etc. Use additional pages if necessary and attach them to this form. Note. Form 5305-A may be reproduced and reduced in size for adoption to passbook purposes.	N-1/A	EX-99.19	1996-01-12T00:00:00	1996-01-11T17:32:37
0000950153-96-000012	0000950153-96-000012_0000.txt	<DESCRIPTION>AMENDMENT NO. 1 TO AMERCO'S FORM 8-A FOR REGISTRATION OF CERTAIN CLASSES OF SECURITIES PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 (Exact name of registrant as specified in charter) (State of incorporation (I.R.S. Employer 1325 Airmotive Way, Suite 100 (Address of principal executive offices) (Zip Code) Securities to be registered pursuant to Section 12(b) of the Act: Title of each class on which each class to be so registered is to be registered If this Form relates to the registration of a class of debt securities and is effective upon filing pursuant to General Instruction A.(c)(1), please check the If this Form relates to the registration of a class of debt securities and is to become effective simultaneously with the effectiveness of a concurrent registration statement under the Securities Act of 1933 pursuant to General Instruction A.(c)(2), please check the following box. / / Securities to be registered pursuant to Section 12(g) of the Act: Series D Floating Rate Preferred Stock Item 1. Description of Securities to be Registered. The description of securities set forth under the heading "Description of Securities" in the form of prospectus to be filed pursuant to Rule 424(b) under the Securities Act (Registration No. 33-63825), shall be deemed to be incorporated herein by reference. 1 Form of Stock Certificate filed as an exhibit to Pre-Effective Amendment No. 2 to the Company's Registration Statement on Form S-2 filed by the Company with the Commission on January 9, 1996 (Registration No. 33-63825), is hereby incorporated by reference. 2-A Restated Articles of Incorporation, filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1992, is hereby incorporated by reference. 2-B Restated By-Laws of AMERCO, filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, is hereby incorporated by reference. 2-C Certificate of Designation for Series D Floating Rate Preferred Stock, filed as an exhibit to Pre-Effective Amendment No. 2 to the Company's Registration Statement on Form S-2 filed by the Company with the Commission on January 9, 1996 (Registration No. 33-63825), is hereby incorporated by reference. 3 The description of securities set forth under the heading "Description of Securities" in the form of prospectus to be filed pursuant to Rule 424(b) under the Securities Act (Registration No. 33-63825), shall be deemed to be incorporated herein by reference. Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized. By: /s/ Edward J. Shoen Chairman of the Board and President For Registration of Certain Classes of Securities Pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934 (Exact Name of Registrant as Specified in Charter) 1 Form of Stock Certificate filed as an exhibit to Pre-Effective Amendment No. 2 to the Company's Registration Statement on Form S-2 filed by the Company with the Commission on January 9, 1996 (Registration No. 33-63825), is hereby incorporated by reference. 2-A Restated Articles of Incorporation, filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1992, is hereby incorporated by reference. 2-B Restated By-Laws of AMERCO, filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, is hereby incorporated by reference. 2-C Certificate of Designation for Series D Floating Rate Preferred Stock, filed as an exhibit to Pre-Effective Amendment No. 2 to the Company's Registration Statement on Form S-2 filed by the Company with the Commission on January 9, 1996 (Registration No. 33-63825), is hereby incorporated by reference. 3 The description of securities set forth under the heading "Description of Securities" in the form of prospectus to be filed pursuant to Rule 424(b) under the Securities Act (Registration No. 33-63825), shall be deemed to be incorporated herein by reference.	8-A12B/A	8-A12B/A	1996-01-12T00:00:00	1996-01-11T18:26:22
0000950117-96-000031	0000950117-96-000031_0000.txt	<DESCRIPTION>LAZARE KAPLAN INTERNATIONAL INC. FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 1995. [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______________ (Exact name of registrant as specified in its charter) (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 529 Fifth Avenue, New York, NY 10017 (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) 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. As of December 29, 1995, 6,147,808 shares of the registrant's common stock were outstanding. PART 1 - FINANCIAL INFORMATION (in thousands except share and per share data) See Notes to Consolidated Financial Statements. See Notes to Consolidated Financial Statement Consolidated Statements of Cash Flows See Notes to Consolidated Financial Statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS This financial information has been prepared in conformity with the accounting principles and practices reflected in the financial statements included in the annual report filed with the Commission for the preceding fiscal year. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly Lazare Kaplan International Inc.'s operating results for the six months ended November 30, 1995 and 1994 and the financial position as of November 30, 1995. The operating results for the interim periods presented are not necessarily indicative of the operating results for a full year. The Company's subsidiaries do business in foreign countries. The subsidiaries are not subject to federal income taxes and their provisions have been determined based upon the effective tax rates, if any, in the foreign countries. Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and (b) operating loss carryforwards. The Company's net deferred tax asset is comprised primarily of operating loss carryforwards which have a tax effect of approximately $11,400,000 less a valuation allowance of approximately $11,400,000 resulting in no net deferred tax asset. For the six months ended November 30, 1995, the Company has utilized $1,800,000 of net operating loss carryforwards to offset Federal, state and local income taxes. At November 30, 1995, the Company has available U.S. net operating losses of $24.8 million which expire as follows: ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net sales during the six months ended November 30, 1995 of $134.0 million were $45.5 million, or 51%, above the $88.5 million in sales during the comparable period last year. Revenue from the sale of polished diamonds increased 25% to $45.9 million from $36.8 million during the comparable six month period. For the three month period ended November 30, polished diamond sales increased 25% from $20.8 million to $25.9 million. These increases were attributable to higher sales in the U.S. domestic market, Europe and Japan, including increased volume of ideal cut melee produced at the Company's factory in Botswana and sales of large polished stones from its Russian production. Rough sales increased to $88.1 million for the six months ended November 30, 1995 from $51.8 million a year ago. Rough sales increased 59% for the three months ended November 30. The significant increases from the prior year were a result of the Company's continued success in its Angolan rough buying operation as well as an improved supply of rough diamonds from the Company's major supplier in the current year. Gross margin on net polished sales for the six months and three months ended November 30, 1995 was 14.2% and 13.4%, respectively. This was a decrease from the margins of 16.8% and 14.3%, respectively, during the same periods last year The decreases from last year resulted from the Company's inability to pass along increased product costs and from the increased sales volume of stones cut and polished jointly with Roskomdragmet (the Russian Government organization responsible for diamond policy), which material has historically carried lower margins. The overall (both polished and rough diamond) gross margin on net sales for the six month and three month periods ended November 30, 1995 was 7.8% and 8.0%, respectively. This compares to 8.8% and 7.9%, respectively, for the same periods last year. The overall margin decrease for the six months was due primarily to a greater percentage of lower margined rough sales to overall sales as compared with last year. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) On December 1, 1995, in response to an announced price increase by the Company's primary rough supplier, the Company increased its selling prices in many categories of its polished diamond inventory. These price increases should positively impact both the overall gross margin as well as the gross margin on net polished sales. Selling, General and Administrative Expenses Selling, general and administrative expenses for the six months ended November 30, 1995 were $5.8 million, compared to $4.7 million for this period last year. During the three months ended November 30, expenses were $3.0 million as compared to $2.4 million in the prior year. The increases were primarily attributable to higher advertising and marketing costs, higher compensation and benefits and additional rent and office expenses in connection with the opening of a new sales office in Hong Kong. Interest expense for the six month period ended November 30, 1995 was $2,119,000 compared to $1,991,000 last year and $1,080,000 in the three months ended November 30, 1995 compared to $944,000 in the prior year. The increases were a result of the higher interest rate on the Company's Senior Notes in the current year. Income per share is computed based on the weighted average number of shares outstanding, including the assumed exercise of all outstanding stock options, during each period. The Company's working capital at November 30, 1995 was $61.7 million, which was $2.4 million greater than its working capital at May 31, 1995. Stockholders' equity was $40.0 million at November 30, 1995 as compared to $37.7 million at May 31, 1995. No dividends were paid to stockholders during the six months ended November 30, 1995. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (B) Reports on Form 8-K Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. By (s) Sheldon L. Ginsberg	10-Q	10-Q	1996-01-12T00:00:00	1996-01-12T09:16:28
0000905729-96-000010	0000905729-96-000010_0000.txt	REPORT BY ISSUER OF SECURITIES QUOTED ON FILED PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 AND RULE 13A-17 (Exact name of issuer as specified in charter) 620 SOUTH PLATT ROAD, MILAN, MICHIGAN 48160 (Address of principal executive offices) Issuer's telephone number, including area code: (313) 439-4200 I. CHANGE IN NUMBER OF SHARES OUTSTANDING Indicate any change (increase or decrease) of five percent or more in the number of shares outstanding: 1. Title of security: Common Stock 2. Number of shares outstanding before the change: 677,830 3. Number of shares outstanding after the change: 24,177,830 4. Effective date of change: December 31, 1995 5. Method of change: Specify method (such as merger, acquisition, exchange, distribution, stock split, reverse split, acquisition of stock for treasury, etc.): Merger Give brief description of transaction: Effective December 31, 1995, Brainerd International, Inc. merged with and into The Colonel's International, Inc., with The Colonel's International, Inc. as the surviving corporation (the "Brainerd Merger"). The 677,830 shares of Brainerd International, Inc. common stock outstanding before the Brainerd Merger remained outstanding as 677,830 shares of common stock of The Colonel's International, Inc. following the Brainerd Merger. Additionally, effective December 31, 1995, Brainerd Merger Corporation, a wholly owned subsidiary of The Colonel's International, Inc., merged with and into The Colonel's, Inc. ("The Colonel's Merger"). As consideration for The Colonel's Merger, The Colonel's International, Inc. issued 23,500,000 shares of common stock to shareholders of The Colonel's Inc. Following the mergers, The Colonel's International, Inc. had a total of 24,177,830 shares of common stock outstanding. II. CHANGE IN NAME OF ISSUER 1. Name prior to change: Brainerd International, Inc. 2. Name after change: The Colonel's International, Inc. 3. Effective date of charter amendment changing name: The name of the issuer listing securities on the Nasdaq Interdealer Quotation System changed by operation of the Brainerd Merger, effective December 31, 1995 (as described in Part I above). 4. Date of shareholder approval of change, if required: November 21, 1995. Date: January 12, 1996 /S/ JEFFREY A. CHIMOVITZ	10-C	10-C	1996-01-12T00:00:00	1996-01-12T16:01:31
0000820626-96-000007	0000820626-96-000007_0001.txt	1988 Stock Option and Award Plan As Amended and Restated Effective October 19, 1995 The purpose of this plan is to further the growth and success of the Company and its subsidiaries by providing key employees with additional incentive to contribute to such growth and success and by aiding the Company in attracting and retaining such key employees. II. ADMINISTRATION OF THE PLAN The Board of Directors of the Company shall appoint a committee (the "Committee") of not less than three of its members to administer the Plan. A majority of the members of the Committee shall constitute a quorum, and the acts of a majority of the members present at any meeting at which a quorum is present, or acts approved in writing by a majority of the members of the Committee, shall be acts of the Committee. Each member of the Committee shall be (i) a "disinterested person" within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and (ii) "outside director" within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"). The Committee shall have the power to grant options, stock appreciation rights and awards of Restricted Stock ("Restricted Stock Awards") under the Plan, to interpret the Plan and options, stock appreciation rights and Restricted Stock Awards granted under it, to make regulations and to formulate administrative provisions for carrying out the Plan, and to make all other determinations in connection with the granting of options, stock appreciation rights and Restricted Stock Awards and administration of the Plan. The Committee may delegate some or all of its power and authority hereunder to the Chairman and Chief Executive Officer or other executive officer of the Company as the Committee deems appropriate; provided, however, that the Committee may not delegate its power and authority with regard to (i) the grant of an award under this Plan to any person who is a "covered employee" within the meaning of Section 162(m) of the Code and the regulations thereunder who, in the Committee's judgment, is likely to be a covered employee at any time during the period an award hereunder to such employee would be outstanding or (ii) the selection for participation in this Plan of an officer or other person subject to Section 16 of the Exchange Act or decisions concerning the timing, pricing or amount of an award to such an officer or other person. III. STOCK SUBJECT TO THE PLAN (a) The stock to be offered for sale by the Company pursuant to exercise of options or which may be delivered upon the exercise of stock appreciation rights or which may be delivered pursuant to Restricted Stock Awards granted under the Plan shall be shares of the authorized Common Stock, par value $1.00 per share, of the Company (hereafter sometimes call the "Stock") and may consist of either unissued shares or shares reacquired by the Company, or a combination of both as the Board of Directors or the Committee may from time to time determine. Subject to the provisions of subsection (b) of this Section 3, the aggregate number of shares of Stock which may be delivered under the Plan shall not exceed 3,000,000 shares, reduced by the sum of the aggregate number of shares of Common Stock (I) that are issued upon the grant of Restricted Stock Awards and (ii) which become subject to outstanding options. To the extent that shares of Common Stock subject to an outstanding option (except to the extent shares of Common Stock are issued or delivered by the Company in connection with the exercise of a stock appreciation right) or Restricted Stock Award are not issued or delivered by reason of the expiration, termination, cancellation or forfeiture of such award or by reason of the delivery or withholding of shares of Common Stock to pay all or a portion of the exercise price of an award, if any, or to satisfy all or a portion of the tax withholding obligations relating to an award, then such shares of Common Stock shall again be available under this Plan. Except as set forth in this Section 3, any securities resulting from any stock dividend, stock split, stock distribution or other recapitalization or any substituted securities in the event of any substitution referred to in this Section 3, shall be subject to the shares covered by the related option, stock appreciation right or Restricted Stock Award pursuant to the Plan including, in the case of a Restricted Stock Award, escrow of such shares or other securities. (b) (1) In the event of any stock split, stock consolidation, combination, exchange of shares, liquidation, spinoff or other similar change in capitalization or event, or any distribution to holders of Common Stock other than a regular cash dividend, the number and class of securities available under this Plan, the number and class of securities subject to each outstanding option and the purchase price per security, the terms of each outstanding stock appreciation right, and the number and class of securities subject to each outstanding Restricted Stock Award shall be appropriately adjusted by the Committee, such adjustments to be made in the case of outstanding options without an increase in the aggregate purchase price. The decision of the Committee regarding any such adjustment shall be final, binding and conclusive. If any such adjustment would result in a fractional security being (i) available under this Plan, such fractional security shall be disregarded, or (ii) subject to an award under this Plan, the Company shall pay the holder of such award, in connection with the first vesting or exercise of such award, in whole or in part, occurring after such adjustment, an amount in cash determined by multiplying (i) the fraction of such security (rounded to the nearest hundredth) by (ii) the excess, if any, of (A) the fair market value (determined in accordance with Section 6) on the vesting or exercise date over (B) the exercise price, if any, of such award. (2) Notwithstanding any provision in this Plan or any agreement, in the event of a Change in Control in connection with which the holders of Common Stock receive shares of common stock that are registered under Section 12 of the Exchange Act, (i) all outstanding options shall immediately become exercisable in full, (ii) the restrictions applicable to any outstanding Restricted Stock Award shall lapse and (iii) there shall be substituted for each share of Common Stock available under this Plan, whether or not then subject to an outstanding award, the number and class of shares into which each outstanding share of Common Stock shall be converted pursuant to such Change in Control. In the event of any such substitution, the purchase price per share in the case of an option shall be appropriately adjusted by the Committee, such adjustments to be made without an increase in the aggregate purchase price. (3) Notwithstanding any provision in this Plan or any agreement, in the event of a Change in Control (other than a Change in Control in connection with which the holders of Common Stock receive consideration other than shares of common stock that are registered under Section 12 of the Exchange Act), each outstanding award shall be surrendered to the Company by the holder thereof, and each such award shall immediately be canceled by the Company, and the holder shall receive within ten days of the occurrence of such Change in Control, a cash payment from the Company in an amount equal to (i) in the case of an option, the number of shares of Common Stock then subject to such option, multiplied by the excess, if any, of the greater of (A) the highest per share price offered to stockholders of the Company in any transaction whereby the Change in Control takes place or (B) the Fair Market Value of a share of Common Stock on the date of occurrence of the Change in Control, over the purchase price per share of Common Stock subject to the option and (ii) in the case of a Restricted Stock Award, the number of shares of Common Stock then subject to such award, multiplied by the greater of (A) the highest per share price offered to stockholders of the Company in any transaction whereby the Change in Control takes place or (B) the Fair Market Value of a share of Common Stock on the date of occurrence of the Change in Control. In the event of a Change in Control, each stock appreciation right shall be surrendered by the holder thereof and shall be canceled simultaneously with the cancellation of the related option. The Company may, but is not required to, cooperate with any person who is subject to Section 16 of the Exchange Act to assure that any cash payment in accordance with the foregoing to such person is made in compliance with Section 16 and the rules and regulations thereunder. Any regular salaried employee of the Company or any of its subsidiary companies shall be eligible to receive options, stock appreciation rights and Restricted Stock Awards under the Plan. Members of the Board of Directors of the Company who are not employed in any other capacity as regular salaried employees of the Company or of any subsidiary are not eligible to receive options, stock appreciation rights and Restricted Stock Awards under the Plan. V. OFFERING TO DESIGNATED EMPLOYEES Subject to the terms of the Plan, the Committee shall have the authority to select the persons to whom options are to be granted under the Plan (it being understood that more than one option may be granted to the same person), the number of shares to be subject to each such option, the option price of such shares, the time or times when each option may be exercised within the limits stated in this Plan, and other terms of the option. An option, or a portion thereof, may be an "incentive stock option" within the meaning of Section 422 of the Code (an "ISO") or an option that is not an ISO (a "Non- Statutory Stock Option"), provided that no ISO may be granted more than ten years after the date on which the stockholders of the Company approve the amendment and statement of the Plan providing for the grant of ISOs hereunder. The Committee shall also have the authority, subject to the terms of the Plan, to determine (i) whether stock appreciation rights are to be granted in conjunction with an option and (ii) which employees shall receive Restricted Stock Awards, the number of shares to be subject to each such Award and the terms and conditions of such Awards. Each option, stock appreciation right and Restricted Stock Award issued under the Plan may in the discretion of the Committee be covered by an agreement executed on behalf of the Company and the Grantee. Each such Agreement shall be in form approved by the Committee and shall contain such restrictions, terms and conditions as the Committee may require and as are not inconsistent with the provisions of the Plan. Each option and stock appreciation right shall be deemed to have been granted and shall take effect on the date that the Committee approves the granting of the option or stock appreciation right, or the date the Grantee enters the employ of the Company or a subsidiary, whichever is later, regardless of when the agreement or other document evidencing the option or stock appreciation right is executed and delivered. Each such agreement or other document shall be dated as of the date the option, stock appreciation right or Restricted Stock Award evidenced thereby is granted. The option price shall not be less than 100% of the fair market value of the Stock at the time the option is granted; provided; however, that if an ISO shall be granted to any person who, at the time such ISO is granted, who owns capital stock possessing more than ten percent of the total combined voting power of all classes of capital stock of the Company (or of any parent or subsidiary) (a "Ten Percent Holder"), the purchase price per share of Common Stock shall be 110% of Fair Market Value) required by the Code in order to constitute an ISO. The fair market value at the time the option is granted shall, for purposes of the Plan, be the mean between the highest and lowest prices at which the Stock is traded on the day on which the option is granted, as reflected on the consolidated tape of New York Stock Exchange issues, or if such date is not a trading day, on the first trading day preceding such date. If there are no such sales of Stock on the date the option is granted (or on the first trading day preceding such date, if applicable) the mean between the bid and the asked prices as reflected on the consolidated tape of New York Stock Exchange issues at the close of the market on such day shall be deemed to be the fair market value of the Stock. (a) The period during which an option may be exercised shall be determined by the Committee at the time the option is granted, except (but subject to Section 3) that (i) an employee must continue in the employ of the Company and/or one or more of its subsidiaries for a period of not less than one year after the date of grant of the option before he may exercise such (ii) not more than 50% of the total number of shares subject to his option may be purchased by an employee during the one-year period beginning on the first anniversary of the date of grant of (iii) except as otherwise provided in Section 11, no option shall be exercisable after the Grantee ceases to be an employee of the Company; and (iv) no option shall be exercisable more than ten years after its date of grant, provided, that if an ISO shall be granted to a Ten Percent Holder, such ISO shall not be exercisable more than five years after its date of grant. For purposes of the foregoing and Section 11, any Grantee who shall retire from employment with the Company and/or one or more of its subsidiaries prior to the first of the month following his 65th birthday, and who at the time of such retirement shall be committed to render consulting services to the Company and/or one or more of its subsidiaries pursuant to a contract which is approved by the Board of Directors and which in the judgment of the Committee requires that during the period of such contract he be obligated to devote a substantial portion of his time to rendering such services, shall, if the Committee so determines, be deemed for purposes of the Plan to continue in the employment of the Company and/or its subsidiaries so long as his obligation to render consulting services under such contract shall continue in effect, but not beyond three years from the date of his retirement or ten years from the date of grant whichever shall first occur. Subject to the foregoing and Section 11, options may be exercised from time to time in whole or in part. Each exercise of an option shall be accomplished by giving written notice of such exercise to the Treasurer of the Company, number of shares to be purchased and accompanied by payment in full of the purchase price therefor (or arrangement made for such payment to the satisfaction of the Company). An employee to whom an option is granted shall be under no obligation whatsoever to exercise it, and he may exercise the option or not in his discretion. (b) Payment for the options exercised shall be either in (i) cash, or check, bank draft or money order (collectively referred to as "cash") to the order of IMC Global Inc. for an amount in United States dollars equal to the total option price for the number of shares upon which options are being exercised, or (ii) shares of Common Stock of the Company (which shall be valued, for this purpose, at a price per share which is the mean between the highest and lowest prices at which the Stock is traded on the exercise date (or, if such date is not a trading day, on the first trading day preceding the exercise date), as reflected on the consolidated tape of New York Stock Exchange issues, or if there are no such sales of Stock on the exercise date (or on the first trading day preceding such date, if applicable), the mean between the bid and the asked prices as reflected on the consolidated tape of New York Stock Exchange issues at the close of the market on such date) with a value equal to or less than the total option price, plus cash for an amount in United States dollars equal to the amount, if any, by which the total option price exceeds the value (determined as aforesaid) of such shares of Company stock. Payment of the option exercise price in cash may be made by a broker-dealer acceptable to the Company to whom the optionee has submitted an irrevocable notice of exercise. Payment of the option exercise price by shares of Common Stock shall be either (A) by delivery of previously owned whole shares of Common Stock (which the optionee has held for at least six months prior to delivery of such shares and for which the optionee has good title, free and clear of all liens), (B) by authorizing the Company to withhold whole shares of Common Stock which would otherwise be delivered upon exercise of the option of (C) a combination of (A) and (B), in each case to the extent set forth in the agreement relating to the option. The Committee shall have sole discretion to disapprove of an election pursuant to any of clauses (A)-(C) and in the case of an optionee who is subject to Section 16 of the Exchange Act, the Company may require that the method of making such payment be in compliance with Section 16 and the rules and regulations thereunder. The exercise date as used herein shall mean the business day on which an optionee delivers written notice to the Treasurer of the Company specifying the number of shares the optionee then desires to purchase under options held by such optionee. Payment for shares exercised for Stock and/or cash shall be delivered to the Treasurer of the Company not later than the end of the third business day after the exercise date. In the case of payment by delivery of previously owned shares of Stock, such payment shall be made by delivery of the necessary share certificates, with executed stock powers attached, to the Treasurer of the Company or, if such certificates have not yet been delivered to the optionee by written notice to the Treasurer of the Company requesting that the shares represented by such certificates be applied toward payment as hereinabove provided. (C) At the request of a participant, the Company may satisfy any of its tax withholding obligations arising upon the exercise of an option under Federal, State or other tax laws by withholding from the number of shares to be delivered to the Grantee that number of shares equal to the amount of such tax to be withheld. Shares to be withheld under this Section 7 (C) shall be valued in accordance with the provisions of Section 7(b) (ii) above. In the alternative, the Grantee may deliver to the Company in whole or partial satisfaction of the Company's tax withholding requirements, previously owned whole shares of Common Stock (which the optionee has held for at least six months prior to delivery of such shares and for which the optionee has good title, free and clear of all liens), which shares shall be valued for such purpose in accordance with the provisions of Section 7(b) (ii) above. The Committee shall have sole discretion to disapprove of an election or request to withhold or deliver shares of Stock in order to satisfy tax withholding obligations and in the case of an optionee who is subject to Section 16 of the Exchange Act, the Company may require that the method of satisfying such obligations be in compliance with Section 16 and the rules and regulations thereunder. (a) Stock appreciation rights may be granted in conjunction with all or part of any option granted under this Plan, either at the time of the grant of such option or at any subsequent time during the term of the option; provided, however, that any stock appreciation right related to an ISO shall be granted at the same time that such ISO is granted. A "stock appreciation right" is a right to receive, without payment to the Company, a number of shares of Common Stock of the Company and/or cash, as provided in this Section 8, in lieu of the purchase of shares under a related option. A stock appreciation right shall terminate and no longer be exercisable upon the termination of the related option. Stock appreciation rights may be exercised, in accordance with subsection (b) of this Section 8, by a Grantee by surrendering the related option or applicable portion thereof. Upon such exercise and surrender, the Grantee shall be entitled to receive an amount determined in the manner prescribed in subsection (b) of this Section 8. Options which have been so surrendered, in whole or in part, shall no longer be exercisable to the extent the related stock appreciation rights have been exercised. (b) Stock appreciation rights shall be subject to such terms and conditions not inconsistent with other provisions of the Plan as shall be determined from time to time by the Committee, which shall include the following: (1) Stock appreciation rights shall be exercisable at such time or times and only to the extent that the option to which they relate shall be exercisable in accordance with the provisions of Section 7 and this Section 8 of this Plan. (2) Upon the exercise of a stock appreciation right, an optionee shall be entitled to receive an amount equal to the excess of the fair market value of one share of Common Stock over the option price per share specified in the related option multiplied by the number of shares in respect of which the stock appreciation right shall have been exercised. If shares of Common Stock are to be delivered for such excess amount, the number of whole shares shall be determined by dividing such excess amount by the fair market value of one share of Common Stock on the date of exercise of the stock appreciation right. No fractional shares shall be issued upon exercise of the stock appreciation right and no cash shall be paid for such fractional shares. The fair market value of Common Stock on the date of exercise of appreciation rights shall be determined in the same manner as the fair market value of Common Stock on the date of grant of an option is determined pursuant to Section 6 hereof. (3) The Committee shall have the sole discretion to determine the form in which payment of the amount described in paragraph (2) of this subsection (b) will made (i.e., cash, Common Stock, or any combination thereof). (4) The obligation to make payments with respect to stock appreciation rights shall not be funded or secured in any manner. (c) Upon the exercise of a stock appreciation right, the option or part thereof to which such stock appreciation right is related shall be deemed to have been exercised for the purpose of the limitation of the number of shares of Common Stock to be issued under the Plan as set forth in Section 3 hereof. (a) Restricted Stock Awards are awards of restricted shares of Common Stock which are subject to the terms, conditions and restrictions contained in this Plan and in the Award relating to such shares. Upon the grant of any Restricted Stock Award, the awarded shares shall be registered in the name of the Grantee as soon as reasonably practicable after the award is made, but not until the Grantee has executed an award agreement and any other documents which the Committee in its absolute discretion may require. The awarded shares shall be retained by the Treasurer of the Company, an escrow holder, and the Grantee shall not be required to make any payment of cash consideration for such Award. All such Awards shall be contingent and the rights of the Grantee with respect thereto prior to vesting or forfeiture as provided in this Plan shall be only as set forth in this Plan. (b) Unless and until the shares awarded to a Grantee shall have vested as provided in this Section 9, but subject to the provisions of Section 3 where applicable, such shares shall not be sold, transferred or otherwise disposed of or pledged, but the Grantee, after delivery of the shares to the escrow holder, shall have the right to vote the shares and receive all dividends and other distributions paid or made with respect thereto. (c) Each Restricted Stock Award shall be granted by the Committee, in its absolute discretion, subject to the provisions of the Plan, and shall contain such terms and conditions as the Committee shall determine consistent with the Plan, but in no event (except as provided in Section 3 hereto) may any portion of a Restricted Stock Award vest prior to one year after the date of grant. (d) Upon the forfeiture of any share of Restricted Stock in accordance with the provisions of the Plan, or the terms and conditions of the Award, such share shall automatically be transferred to and reacquired by the Company at no cost to the Company. (e) Vested Restricted Stock Awards shall be paid by delivery to the Grantee of certificates for the appropriate number of shares of Common Stock of the Company, registered in his name, free of any restriction or condition other than such restrictions on the resale of such Stock as the Committee, on advice of counsel, may require, which restrictions may be expressed, at the option of the Committee, in a legend on the stock certificate, with appropriate instructions given to the Company's transfer stock agent. Each option and stock appreciation right and restricted Stock Award shall be subject to the requirement that if at any time the Board of Directors shall determine, in its discretion, that the listing, registration or qualification of the shares subject to such option or stock appreciation right or Restricted Stock Award upon any securities exchange or under any state or federal law, or that the consent or approval of any governmental authority, is necessary or desirable as a condition of, or in connection with, the issuance or purchase of shares under such option or upon exercise of such stock appreciation right or the award, vesting or delivery of shares covered by a Restricted Stock Award, such option or stock appreciation right may not be exercised in whole or in part, and such Restricted Stock Award shall not be made or vest, and shares thereunder may not be delivered, as the case may be, unless such listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Board of Directors. Any option or stock appreciation right may be exercised only in accordance with the provisions of all applicable law. (a) If an employee ceases to be employed for any reason, whether by his own volition or otherwise, except where termination is due to death, total disability or retirement (as defined in Section 11(c) of this Plan) of the employee, all options and stock appreciation rights held by the employee under this Plan shall be automatically canceled at the time of termination of employment except that any such option and stock appreciation right may be exercised by him within three months after such termination (but not after the expiration of ten years from the date of grant or after the expiration of any other period for exercise made applicable by the Committee at the time of grant) to the extent exercisable by him at the time of such termination; provided, however, that in the case of an ISO, the period of time after such termination of employment shall not be greater than three months. If such an employee dies within such three month period, any such right of exercise of his option or stock appreciation right, respectively, possessed by him on the date of his death shall be transferred and may be exercised as provided in subsection (b) of this Section, unless the option or stock appreciation right by its terms shall provide otherwise. (b) If an employee dies while in the employ of the Company or any of its subsidiary companies, any option and stock appreciation right held by him at the time of his death shall be transferred as provided in his will or as determined by the laws of descent and distribution, and may be exercised, to the extent exercisable by him at the time or from time to time within twelve months after the date of death (but not after the expiration of ten years from the date of grant or after the expiration of any other period for exercise made applicable by the Committee at the time of grant) unless the option or stock appreciation right by its terms shall provide a shorter period of time during which the option or stock appreciation right may be exercised after death. (c) An employee whose employment terminates because of total disability or retirement (as defined in this subsection) may exercise his option and stock appreciation right, to the extent exercisable by him at the time of such termination, at any time or from time to time within three years after the termination of his employment (but not after the expiration of ten years from the date of grant or after the expiration of any other period for exercise made applicable by the Committee at the time of grant). If such a former employee dies, any such right of exercise of his option or stock appreciation right possessed by him on the date of his death shall be transferred and may be exercised as provided in subsection (b) of this Section unless the option or stock appreciation right by its terms shall provide otherwise. "Retirement", for purposes of this Plan, shall include termination of employment at a time when the Grantee is entitled to a pension under any retirement plan of the Company. (d) If the employment of a Grantee terminates before a Restricted Stock Award is vested in accordance with the Plan, he shall automatically forfeit all shares of Stock then subject to Restricted Stock Awards under the Plan, except to the extent otherwise determined by the Committee in its sole discretion before or after such termination. (a) While an option or stock appreciation right is unexercised, an employee shall have no voting rights or other rights of stockholders with respect to shares which are subject to his option or which he may receive upon exercise of his stock appreciation right. Furthermore, no cash dividends shall accrue or be payable with respect to any such shares. However, an employee shall have full voting and other rights upon the date on which the Committee determines that Stock will be issued to him in connection with the exercise of the stock appreciation right. (b) Stock which is subject to options but has not yet been purchased or which may be issued upon exercise of a stock appreciation right has no subscription rights. (c) No fractional shares of Stock shall be issued upon exercise of an option or a stock appreciation right and in case a fractional share shall become subject to an option or stock appreciation right by reason of a stock dividend or otherwise, the employee holding such option or stock appreciation right shall not be entitled to exercise it with respect to such fractional share. (d) The rights granted to any employee pursuant hereto shall be exercisable, during his lifetime, only by him or by his guardian or legal representative and none of such rights shall be subject to sale, hypothecation, assignment or pledge or be transferable otherwise than by will or intestacy. (e) No Grantee of an option, stock appreciation right or Restricted Stock Award shall have any right to be retained in the employ of the Company or a subsidiary thereof by virtue of his participation in the Plan. (f) This Plan, each option, stock appreciation right and Restricted Stock Award hereunder and the related agreement, and all determination made and actions taken pursuant thereto, to the extent not otherwise governed by the Code or the laws of the United States, shall be governed by the laws of the State of Delaware and construed in accordance therewith without giving effect to principles of conflicts of laws. Subject to any requirement of stockholder approval required by applicable law, rule or regulation including Rule 16b-3 under the Exchange Act and Section 162(m) of the Code, the Board of Directors shall have the power (I) to make such changes in the Plan and in any option, stock appreciation right or Restricted Stock Award previously granted under the Plan as in the opinion of counsel to the Company may be necessary or appropriate from time to time so that options granted under the Plan will continue to be ISOs or Non-Statutory Stock Options, as the case may be, under the Code as in existence from time to time, and (ii) to make such other changes in the Plan and in any option or stock appreciation right previously granted under the Plan as from time to time the Board deems proper and in the best interests of the Company provided, however, that no amendment shall be made without stockholder approval if such amendment would (a) increase the maximum number of shares of Common Stock available under this Plan (subject to Section 3), (b) reduce the minimum purchase price in the case of an option or the base price in the case of a stock appreciation right, (c) effect any change inconsistent with Section 422 of the Code or (d) extend the term of this Plan. No amendment may impair the rights of a holder of an outstanding award without the consent of such holder. XIV. EFFECTIVE DATE AND TERMINATION (a) The Plan or any amendment hereto shall become operative and in effect as of the date the Plan or any such amendment is approved by the affirmative vote of a majority of the shares of Common Stock present in person or represented by proxy at the 1995 annual meeting of stockholders. (b) The Plan shall remain in effect until termination by action of the Board. Termination of this Plan shall not affect the rights of employees under the options theretofore granted to purchase Common Stock under the Plan, or the rights of employees pursuant to stock appreciation rights and Restricted Stock Awards theretofore granted under the Plan, and all such options, stock appreciation rights and Restricted Stock Awards shall continue in force and in operation after termination of the Plan, except as they may be terminated through death or other termination of employment in accordance with the terms of the Plan. XV. DEFINITIONS OF CERTAIN TERMS REFERENCED HERETO (a) Change in Control: The term "Change in Control" of the Company when used in this Plan, shall mean, and be deemed to have occurred as of the first day that any one or more of the following conditions have been satisfied. (1) the acquisition by any individual, entity or group (a "Person"),including any "person" within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act, of beneficial ownership within the meaning of Rule 13d-3 promulgated under the Exchange Act, of 15% or more of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding securities of the Company entitled to vote gnerally in the election of directors (the "Outstanding Company Voting Securities"); excluding, however, the following: (A) any acquisition directly from the Company (excluding any acquisition resulting from the exercise of an exercise, conversion or exchange privilege unless the security being so exercised, converted or exchanged was acquired directly from the Company; (B) any acquisition by the Company, (C) any acquisition by an employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company (D) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (3) of this definition; (2) individuals who, as of the date hereof, constitute the Board of Directors (the "Incumbent Board") cease for any reason to constitute at least a majority of such Board; provided that any individual who becomes a director of the Company subsequent to the date hereof whose election, or nomination for election by the Company's stockholders, was approved by the vote of at least a majority of the directors then comprising the Incumbent Board shall be deemed a member of the Incumbent Board; and provided further, that any individual who was intitially elected as a director of the Company as a result of an actual or threatened election contest, as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act, or any other actual or threatened solicitation of proxies or consents by or on behalf of any Person other than the Board shall not be deemed a member of the Incumbent Board; (3) approval by the stockholders of the Company of a reorganization, merger or consolidation or sale or other disposition of allor substantially all of the assets of the Company (a "Corporate Transaction"); exlcuding, however, a Corporate Transaction pursuant to which (i) all or substantially all of the individuals or entities who are the beneficial owners, respectively, of the Outstanding Company Common Stock and the Outstanding Company Voting Securities immediately prior to such Corporate Transaction will beneficially own, directly or indirectly, more than 60% of, respectively, the outstanding shares of common stock, and the combined voting power of the outstanding securities of such corporation entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Corporate Transaction (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or indirectly) in substantially the same proportions relative to each other as their ownership, immediately prior to such Corporate Transaction, of the Outstanding Company Common Stock and the Outstanding Company Voting Securities, as the case may be, (ii) no Person (other than: the Company: the corporation resulting from such Corporation Transaction; and any Person which beneficially owned, immediately prior to such indirectly, 25% or more of the Outstanding Company Common Stock of the corporation resulting from such Corporate Transaction or the combined voting power of the outstanding securities of such corporation entitled to vote generally in the election of directors and (iii) individuals who were members of the Incumbent Board will constitute at least a majority of the members of the board of directors of the corporation resulting from such Corporate (4) approval by the stockholders of the Company of a plan of complete liquidation or dissolution of the Company. "Non-Statutory Stock Option" shall mean a stock option which is not an ISO. "Permanent and Total Disability" shall have the meaning set forth in Section 22(e)(3) of the Code or any successor thereto. "Termination of Employment" shall mean the termination of employment by IMC Global Inc. or the Company or its successor company of an employee who is a participant in the Plan, that occurs after a Change in Control (as herein defined) has occurred and is not due to cause and is not voluntary. Termination shall not be deemed to be voluntary if the employee elects to resign because his or her position, responsibility, benefits, or compensation have been adversely changed or diminished. This definition is applicable to termination of employment when used in the Plan only when the reference to Section 16 appears along with it. IN WITNESS WHEREOF, IMC Global Inc. has caused this instrument as amended to be executed, effective as of OCTOBER 19, 1995.	S-8	EX-4	1996-01-12T00:00:00	1996-01-12T17:10:55
0000916641-96-000023	0000916641-96-000023_0000.txt	<DESCRIPTION>MENTOR FUNDS POST EFFECTIVE AMENDMENT NO. 10 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 12, 1996 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 (X) PRE-EFFECTIVE AMENDMENT NO. _ ( ) POST-EFFECTIVE AMENDMENT NO. 10 (X) REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 (X) (CHECK APPROPRIATE BOX OR BOXES) (EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (NAME AND ADDRESS OF AGENT FOR SERVICE) IT IS PROPOSED THAT THIS FILING WILL BECOME EFFECTIVE ( ) IMMEDIATELY UPON FILING PURSUANT TO PARAGRAPH (B) (X) ON JAN. 15, 1996 PURSUANT TO PARAGRAPH (B) ( ) 60 DAYS AFTER FILING PURSUANT TO PARAGRAPH (A)(1) ( ) ON (DATE) PURSUANT TO PARAGRAPH (A)(1) ( ) 75 DAYS AFTER FILING PURSUANT TO PARAGRAPH (A)(2) ( ) ON (DATE) PURSUANT TO PARAGRAPH (A)(2) OF RULE 485 IF APPROPRIATE, CHECK THE FOLLOWING BOX: ( ) THIS POST-EFFECTIVE AMENDMENT DESIGNATES A NEW EFFECTIVE DATE FOR A PREVIOUSLY FILED POST-EFFECTIVE AMENDMENT THE REGISTRANT HAS REGISTERED AN INDEFINITE NUMBER OR AMOUNT OF SECURITIES UNDER THE SECURITIES ACT OF 1933 PURSUANT TO RULE 24F-2. A RULE 24F-2 NOTICE FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1995 WAS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 28, 1995. (as required by Rule 404(c)) Part A - The Mentor Funds 1. Cover Page . . . . . . . . . . . . Cover Page 2. Synopsis . . . . . . . . . . . . . Cover Page; Expenses Summary; 3. Condensed Financial Information . . Expenses Summary; Financial 4. General Description of Registrant . Cover Page; Investment 5. Management of the Fund . . . . . . Investment Objectives of Fund Performance . . . . . . . (Contained in the Annual 6. Capital Stock and Other Securities . . . . . . . . . . . How to Buy Shares; How 7. Purchase of Securities Being Offered . . . . . . . . . . . . . Sales Arrangements; How 8. Redemption or Repurchase . . . . . How to Buy Shares; How to Sell Shares; How to 9. Pending Legal Proceedings . . . . . Not Applicable Part A - Mentor Balanced Portfolio 1. Cover Page . . . . . . . . . . . . Cover Page 2. Synopsis . . . . . . . . . . . . . Cover Page; Expense 3. Condensed Financial Information . . Expense summary; 4. General Description of Registrant . Cover Page; Investment 5. Management of the Fund . . . . . . Investment objective and of Fund Performance . . . . . . . (Contained in the Annual 6. Capital Stock and Other Securities . . . . . . . . . . . Management of the 7. Purchase of Securities Being Offered . . . . . . . . . . . . . Management of the 8. Redemption or Repurchase . . . . . How to buy shares; How 9. Pending Legal Proceedings . . . . . Not Applicable 10. Cover Page . . . . . . . . . . . . Cover Page 11. Table of Contents . . . . . . . . Table of Contents 12. General Information and History . Cover Page; Introduction Policies . . . . . . . . . . . . Investment Restrictions (Part I and Part II); 14. Management of the Fund . . . . . . Management of the Trust; 15. Control Persons and Principal Holders of Securities . . . . . Principal Holders of 16. Investment Advisory and Other Services . . . . . . . . . . . . Management of the Trust; 17. Brokerage Allocation . . . . . . . Brokerage Transactions 18. Capital Stock and Other Securities . . . . . . . . . . . How to Buy Shares; 19. Purchase; Redemption and Pricing of Securities Being Offered . . Brokerage Transactions; 20. Tax Status . . . . . . . . . . . . Investment Restrictions; 21. Underwriters . . . . . . . . . . . Distribution 22. Calculations of Performance Data . Performance Information; 23. Financial Statements . . . . . . . Independent Accountants; Information required to be included in Part C is set forth under the appropriate Item, so numbered, in Part C of the Registration Statement. The Mentor Funds, an open-end management investment company, is offering shares of eight different investment portfolios by this Prospectus: Mentor Growth Portfolio, Mentor Capital Growth Portfolio, Mentor Strategy Portfolio (an asset allocation total return fund), Mentor Income and Growth Portfolio, Mentor Perpetual Global Portfolio (a global growth fund), Mentor Quality Income Portfolio, Mentor Municipal Income Portfolio, and Mentor Short-Duration Income Portfolio. CERTAIN OF THE PORTFOLIOS MAY USE "LEVERAGE" -- THAT IS, THEY MAY BORROW MONEY TO PURCHASE ADDITIONAL PORTFOLIO SECURITIES, WHICH INVOLVES SPECIAL RISKS. The Mentor Funds provides investors an opportunity to design their own investment programs by investing in a variety of Portfolios offering a wide array of investment strategies. Each Portfolio pursues its investment objectives through the investment policies described in this Prospectus. This Prospectus sets forth concisely the information about The Mentor Funds that a prospective investor should know before investing. Please read this Prospectus carefully and retain it for future reference. You can find more detailed information in the January 15, 1996 Statement of Additional Information, as amended from time to time. For a free copy of the Statement or for other information, please call 1-800-382-0016. The Statement has been filed with the Securities and Exchange Commission and is incorporated into this Prospectus by reference. The address of The Mentor Funds is P.O. Box 1357, Richmond, Virginia 23286-0109. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. Investment Objectives and Policies................. 11 Valuing the Portfolios' Shares..................... 25 Distribution Plans (Class B Shares)................ 29 How To Sell Shares................................. 30 How To Exchange Shares............................. 31 Expenses are one of several factors to consider when investing in a Portfolio. The following tables summarize your maximum transaction costs from investing in each of the Portfolios and expenses each Portfolio expects to incur in the current fiscal year. The Examples show the cumulative expenses attributable to a hypothetical $1,000 investment in each of the Portfolios over specified periods. (1) Long-term Class B shareholders may pay more than the economic equivalent of the maximum front-end sales charge permitted by the rules of the National Association of Securities Dealers, Inc. (2) A contingent deferred sales charge ("CDSC") of 1.00% is assessed on Class A shares that were purchased without an initial sales charge as part of an investment of over $1 million that are redeemed within one year of purchase. (3) The amount redeemed is computed as the lesser of the current net asset value of the shares redeemed, and the original purchase price of the shares. See "How to Buy Shares -- Class B Shares." (4) A CDSC of 1.00% is assessed on Class B shares that are purchased pursuant to certain asset-allocation plans and that are not otherwise subject to the CDSC shown in the table, if those shares are redeemed within one year of purchase. Contact Mentor Distributors, Inc. for more information. (As a percentage of average net assets) (1) The amounts shown in the tables reflect the expenses each of the Portfolios expects to incur during the current fiscal year. If Total Portfolio Operating Expenses of any Portfolio materially exceed the amounts shown above, Mentor Investment Group, Inc. intends to bear the Portfolio's expenses to that extent. Management Fees for the Global Portfolio were reduced during fiscal 1995 by an expense limitation to 1.05% of the Fund's average net assets. For their last fiscal year, the Portfolios' Total Portfolio Operating Expenses were as follows, without giving effect to any expense limitations in effect during the year: Growth Portfolio, Class A -- 1.36%, Class B -- 2.08%; Capital Growth Portfolio, Class A -- 1.87%, Class B -- 2.56%; Strategy Portfolio, Class A -- 1.65%, Class B -- 2.08%; Income and Growth Portfolio, Class A -- 1.69%, Class B -- 2.43%; Global Portfolio, Class A -- 2.11%, Class B -- 2.79%; Quality Income Portfolio, Class A -- 1.36%, Class B -- 1.79%; Municipal Income Portfolio, Class Class A -- 1.43%, Class B -- 1.92%; Short-Duration Income Portfolio, Class A -- 1.00%, Class B -- 1.70%. For their last fiscal year, the Portfolios' Other Expenses were as follows, without giving effect to any expense limitations in effect during the year: Growth Portfolio, Class A -- 0.41%, Class B -- 0.38%; Capital Growth portfolio, Class A -- 0.82%, Class B -- 0.76%; Strategy Portfolio, Class A -- 0.55%, Class B -- 0.23%; Income and Growth Portfolio, Class A -- 0.69%, Class B -- 0.68%; Global Portfolio, Class A -- 0.81%, Class B -- 0.74%; Quality Income Portfolio, Class A -- 0.55%, Class B -- 0.49%; Municipal Income Portfolio, Class A -- 0.58%, Class B -- 0.57%; Short-Duration Income Portfolio, Class A -- 0.46%, Class B -- 0.65%. Other Expenses for the Short- Duration Income Portfolio reflect the expense limitation described above; in the absence of the limitation, the Portfolio's Other Expenses would be 0.56% for both its Class A and Class B shares, and its Total Portfolio Operating Expenses (without reflecting the waiver of the Management Fees described below) would be 1.31% and 1.61% for its Class A and Class B shares, respectively. (2) In order to limit the Portfolios' operating expenses, the investment advisers of each of the Quality Income and Short-Duration Income Portfolios have agreed to limit their compensation until September 30, 1996; in the absence of such limitations, these Portfolios' Management Fees would be 0.60% and 0.50%, respectively, as would have been the case if no expense limitations had been in effect during the last fiscal year. The tables are provided to help you understand the expenses of investing in each of the Portfolios and your share of the operating expenses of each of the Portfolios. In the case of Class A shares for the Growth, Strategy, and Short-Duration Income Portfolios, "Other expenses" are estimated based on amounts for the 1995 fiscal period. You would pay the following expenses on a $1,000 investment, assuming 5% annual return and no redemption at the end of each period: You would pay the following expenses on a $1,000 investment assuming redemption at the end of each period: THE EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE PERFORMANCE; ACTUAL EXPENSES MAY VARY. (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following tables have been audited by KPMG Peat Marwick LLP, The Mentor Funds' independent auditors. Their report dated November 10, 1995 on the Portfolios' financial statements for the period ended September 30, 1995 is included in the Annual Report dated September 30, 1995, which is incorporated by reference. This table should be read in conjunction with each Portfolio's financial statements and notes thereto, which are included in the Statement of Additional Information and which may be obtained free of charge from The Mentor Funds. The Growth, Strategy, and Short-Duration Income Portfolios are successors to the Mentor Growth, Strategy, and Short-Duration Income Funds, each of which was a series of shares of beneficial interest of Mentor Series Trust, a Massachusetts business trust. Each of those Funds offered only one class of shares until June 1995. Until April 12, 1995, Mentor Quality Income Portfolio was known as "Cambridge Government Income Portfolio"; until that time, the Portfolio was required, among other things, to invest at least 65% of its assets in U.S. Government securities. * For the period from June 5, 1995 to September 30, 1995. Reflects operations for the period from April 29, 1992 (commencement of operations) to September 30, 1992. * Reflects operations for the period from May 24, 1993 (commencement of operations) to September 30, 1993. **** Reflects operations for the period from March 29, 1994 (commencement of operations) to September 30, 1994. * For the period from June 16, 1995 to September 30, 1995. ** Reflects operations for the period from April 29, 1992 (commencement of operations) to September 30, 1992. * For the period from January 1, 1995 to September 30, 1995. ** Reflects operations for the period from April 29, 1992 (commencement of operations) to September 30, 1992. * For the period from January 1, 1995 to September 30, 1995. Reflects operations for the period from April 29, 1992 (commencement of operations) to September 30, 1992. * Reflects operations for the period of October 29, 1993 (commencement of operations) to December 31, 1993. **** Reflects operations for the period from May 24, 1993 (commencement of operations) to September 30, 1993. * For the period from January 1, 1995 to September 30, 1995. Reflects operations for the period from April 29, 1992 (commencement of operations) to September 30, 1992. * Reflects operations for the period of April 29, 1994 (commencement of operations) to December 31, 1993. **** Reflects operations for the period from May 24, 1994 (commencement of operations) to September 30, 1994. The Mentor Funds is offering by this Prospectus shares of eight Portfolios with differing investment objectives and policies. There can, of course, be no assurance that any Portfolio will achieve its investment objective. The differences in objectives and policies among the Portfolios can be expected to affect the investment return of each Portfolio and the degree of market and financial risk of an investment in each Portfolio. For a discussion of certain investment practices in which the Portfolios may engage, and the risks they may entail, see "Other Investment Practices" below. The investment objectives of the Portfolios, other than those of the Strategy Portfolio and the Short-Duration Income Portfolio, are fundamental policies and may not be changed without shareholder approval. Except for the investment policies designated in this Prospectus or the Statement of Additional Information as fundamental, the investment policies described herein are not fundamental and may be changed by approval of the Trustees without shareholder approval. Any percentage limitation on a Portfolio's investments will apply only at the time of investment; a Portfolio would not be considered to have violated any such limitation, unless an excess or deficiency occurs or exists as a result of an investment. In addition, a Portfolio will not necessarily dispose of a security when its rating is reduced below any applicable minimum rating, although the investment adviser or sub-adviser of the Portfolio will monitor the investment to determine whether continued investment in the security will assist in meeting the Portfolio's investment objective. INVESTMENT ADVISER: CHARTER ASSET MANAGEMENT, INC. ("CHARTER") The Growth Portfolio's investment objective is long-term capital growth. Although the Portfolio may receive current income from dividends, interest, and other sources, income is only an incidental consideration. The Portfolio attempts to achieve long-term capital growth by investing in a diversified portfolio of securities. Under normal circumstances at least 75% of the Portfolio's assets will be invested in common stocks of companies domiciled or located in the United States. Although the Portfolio may invest in companies of any size, the Portfolio invests principally in common stocks of small to mid-sized companies. The Portfolio invests in companies that, in the opinion of Charter, have demonstrated earnings, asset values, or growth potential not yet reflected in their market price. A key indication of such undervaluation considered by Charter is earnings growth which is above average compared to the S&P 500 Index. Other important factors in selecting investments include a strong balance sheet and product leadership in niche markets. Charter believes that such investments may offer better than average potential for long-term capital growth. Small and mid-size companies may present greater opportunities for capital growth than do larger companies because of high potential earnings growth, but may also involve greater risk. They may have limited product lines, markets or financial resources, or may depend on a limited management group. Their securities may trade less frequently and in limited volume, and only in the over-the-counter market or on a regional securities exchange. As a result, these securities may change in value more than those of larger, more established companies. INVESTMENT ADVISER: COMMONWEALTH ADVISORS, INC. ("COMMONWEALTH ADVISORS") The investment objective of the Capital Growth Portfolio is to provide long-term appreciation of capital. The Portfolio may invest in a wide variety of securities which Commonwealth Advisors believes offers the potential for capital appreciation over both the intermediate and long term. The Portfolio does not invest for current income. The Portfolio invests primarily in common stocks of companies believed by Commonwealth Advisors to have the potential for capital appreciation. The Portfolio may invest without limit in preferred stocks, investment-grade bonds, convertible preferred stocks, convertible debentures and any other class or type of security Commonwealth Advisors believes offers the potential for capital appreciation. In selecting investments, Commonwealth Advisors will attempt to identify securities it believes will provide capital appreciation over the intermediate or long term due to change in the financial condition of issuers, changes in financial conditions generally, or other factors. The Portfolio also may invest in fixed-income securities, and cash or money market investments, for temporary defensive purposes. INVESTMENT ADVISER: WELLESLEY ADVISORS, INC. ("WELLESLEY") The Strategy Portfolio's investment objective is to seek high total return on its investments. In seeking to achieve this objective, Wellesley actively allocates the Portfolio's assets among the major asset categories of equity securities, fixed-income securities, and money market instruments. The Portfolio will normally invest some portion of its assets in each asset category, but may invest without limit in any asset category. Total return consists of current income (including dividends, interest, and, in the case of discounted instruments, discount accruals) and capital appreciation (including realized and unrealized capital gains and losses). Wellesley believes that the Portfolio has the potential to achieve above-average investment returns at comparatively lower risk by actively allocating its resources among the equity, debt, and money market sectors of the market as opposed to relying solely on just one market sector. For example, Wellesley may at times believe that the equity market holds a higher potential for total return than the debt market and that a relatively large portion of the Portfolio's assets should be allocated to the equity market sector. The reverse would be true at times when Wellesley believes that the potential for total return in the bond market is greater than that in the equity market. Wellesley might also allocate the Portfolio's investments to short-term bonds and money market instruments in order to earn current return and to reduce the potential adverse effect of declines in the bond and equity markets. After determining the portions of the Portfolio's assets to be invested in the various market sectors, Wellesley attempts to select the securities of companies within those sectors offering potential for above-average total return. The achievement of the Portfolio's investment objective depends upon, among other things, the ability of Wellesley to assess correctly the effects of economic and market trends on different sectors of the market. The Portfolio's investments may include both securities of U.S. issuers and securities traded principally in foreign markets. The Portfolio may invest without limit in foreign securities. See "Other Investment Practices -- Foreign Securities" for a description of risks associated with investments in such securities. Within the equity sector, Wellesley actively allocates the Portfolio's assets to those industries and issuers it expects to benefit from major market trends or which it otherwise believes offer the potential for above-average total return. The Portfolio may purchase equity securities (including convertible debt obligations and convertible preferred stock) sold on the New York, American, and other U.S. or foreign stock exchanges and in the over-the- counter market. Within the fixed-income sector, Wellesley seeks to maximize the return on its investments by adjusting maturities and coupon rates as well as by exploiting yield differentials among different types of investment-grade securities. The Portfolio may invest in debt securities of any maturity, preferred stocks, and other fixed-income instruments, including, for example, U.S. Government securities and corporate debt securities (including zero-coupon securities). A substantial portion of the Portfolio's investments in the fixed-income sector may be in mortgage-backed securities, including collateralized mortgage obligations ("CMOs") and certain other stripped mortgage-backed securities, which have certain special risks. See "Other Investment Practices -- Mortgage-backed securities; other asset-backed securities" and " -- Other mortgage-related securities" for a description of these risks. The Portfolio will only invest in debt securities which are rated at the time of purchase Baa or better by Moody's Investors Service, Inc. ("Moody's") or BBB or better by Standard & Poor's ("S&P") or, if unrated, are deemed by Wellesley to be of comparable quality. While bonds rated Baa or BBB are considered to be of investment grade, they have speculative characteristics as well. A description of securities ratings is contained in the Appendix to this Prospectus. The money market portion of the Portfolio will contain short-term fixed-income securities issued by private and governmental institutions. Such securities may include, for example, U.S. Government securities; bank obligations; Eurodollar certificates of deposit issued by foreign branches of domestic banks; obligations of savings institutions; fully insured certificates of deposit; and commercial paper rated within the two highest grades by S&P or the highest grade by Moody's or, if not rated, issued by a company having an outstanding debt issue rated at least Aa by Moody's or AA by S&P. MENTOR INCOME AND GROWTH PORTFOLIO INVESTMENT ADVISER: COMMONWEALTH ADVISORS, INC. SUB-ADVISER: WELLINGTON MANAGEMENT COMPANY ("WELLINGTON") The investment objective of the Income and Growth Portfolio is to provide a conservative combination of income and growth of capital consistent with capital protection. The Portfolio invests in a diversified portfolio of equity securities of companies Wellington believes exhibit sound fundamental characteristics and in investment-grade fixed-income securities and U.S. Government securities, as described below. Wellington will manage the allocation of assets among asset classes based upon its analysis of economic conditions, relative fundamental values and the attractiveness of each asset class, and expected future returns of each asset class. The Portfolio will normally have some portion of its assets invested in each asset class at all times but may invest without limit in any asset class. The Portfolio may invest in a wide variety of equity securities, such as common stocks and preferred stocks, as well as debt securities convertible into equity securities or that are accompanied by warrants or other equity securities. In selecting equity investments, Wellington will attempt to identify securities of out-of-favor companies which Wellington believes are undervalued. Within the equity asset class, the Portfolio seeks to achieve long-term appreciation of capital and a moderate income level by selecting investments in out-of-favor companies with sound fundamentals. These decisions are based primarily on Wellington's fundamental research and security valuations. Within the fixed-income asset class, Wellington seeks to invest in a portfolio that provides as high a level of current income as is consistent with prudent investment risk. The Portfolio may invest in debt securities of any maturity, preferred stocks, and other fixed-income instruments, including, for example, U.S. Government securities and corporate debt securities (including zero-coupon securities). The Portfolio will only invest in debt securities which are rated at the time of purchase Baa or better by Moody's or BBB or better by unrated, are deemed by Wellington to be of comparable quality. While fixed-income securities rated Baa or BBB are considered to be of investment grade, they have speculative characteristics as well. A description of securities ratings is contained in the Appendix to this Prospectus. The Portfolio may invest up to 10% of its assets in securities secured by real estate or interests therein or issued by companies which invest in real estate or interests in real estate. The Portfolio will limit its investment in real estate investment trusts to 10% of its total assets. Such investments may involve many of the risks of direct investment in real estate, such as declines in the value of real estate, risks related to general and local economic conditions, and adverse changes in interest rates. Other risks associated with real estate investment trusts include lack of diversification, borrower default, and voluntary liquidation. INVESTMENT ADVISER: MENTOR PERPETUAL ADVISORS, L.L.C. ("MENTOR PERPETUAL") The investment objective of the Global Portfolio is to seek long-term growth of capital through a diversified portfolio of marketable securities made up primarily of equity securities, including common stocks, preferred stocks, securities convertible into common stocks, and warrants. The Portfolio may also invest in debt securities and other fixed-income securities of private or governmental issuers (including zero-coupon securities) which Mentor Perpetual believes to be consistent with the Portfolio's objective. It is expected that the Portfolio's investments will normally be spread broadly around the world, although (except as described in the next sentence) there is no limit on the amount of the Portfolio's assets that may be invested in any single country. Under normal circumstances, the Portfolio will invest at least 65% of the value of its total assets in securities of at least three countries, one of which may be the United States. The Portfolio may invest all of its assets in securities of issuers outside the United States, and for temporary defensive purposes may at times invest all of its assets in securities of U.S. issuers. To the extent that the Portfolio invests a substantial portion of its assets in securities of issuers located in a single country, it will be more susceptible to adverse economic, business, political, or regulatory conditions in or affecting that country than if it were to invest in a geographically more diverse portfolio. The Portfolio may invest in closed-end investment companies holding foreign securities. The Portfolio also may hold a portion of its assets in cash or cash equivalents, including foreign and domestic money market instruments. It is likely that, at times, a substantial portion of the Portfolio's assets will be invested in securities of issuers in emerging markets, including under-developed and developing nations. Investments in emerging markets are subject to the same risks applicable to foreign investments generally although those risks may be increased due to conditions in such markets. For example, the securities markets and legal systems in emerging markets may only be in a developmental stage and may provide few, or none, of the advantages or protections of markets or legal systems available in more developed countries. Although many of the securities in which the Portfolio may invest are traded on securities exchanges, they may trade in limited volume, and the exchanges may not provide all of the conveniences or protections provided by securities exchanges in more developed markets. The Portfolio may also invest a substantial portion of its assets in securities traded in the over-the-counter markets and not on any exchange, which may affect the liquidity of the investment and expose the Portfolio to the credit risk of its counterparties in trading those investments. See "Other Investment Practices -- Foreign securities." Mentor Perpetual may seek investment opportunities in securities of large, widely traded companies as well as securities of small, less well known companies. Small companies may present greater opportunities for investment return, but may also involve greater risk. They may have limited product lines, markets, or financial resources, or may depend on a limited management group. Their securities may trade less frequently and in limited volume. As a result the prices of these securities may fluctuate more than prices of securities of larger, more established companies. Except as described below, debt and fixed-income securities in which the Portfolio may invest will be investmentgrade securities or those of equivalent quality as determined by Perpetual. The Portfolio may invest up to 5% of its total assets in debt securities rated Baa or below by Moody's, or BBB or below by S&P, or deemed by Mentor Perpetual to be of comparable quality, and may invest in securities rated as low as C by Moody's or D by S&P. Securities rated Baa or BBB lack outstanding investment characteristics and have speculative characteristics and are subject to greater credit and market risks than higher-rated securities. Securities rated below investment grade are commonly referred to as "junk bonds" and are predominately speculative. Securities rated D may be in default with respect to payment of principal or interest. A description of securities ratings is contained in the Appendix to this Prospectus. INVESTMENT ADVISER: COMMONWEALTH ADVISORS, INC. The Quality Income Portfolio's investment objective is to seek high current income consistent with what Commonwealth Advisors believes to be prudent risk. The Portfolio may invest in debt securities, including both U.S. Government and corporate obligations, and in other income-producing securities, including preferred stocks and dividend-paying common stocks. The Portfolio may also hold a portion of its assets in cash or money market instruments. Corporate debt obligations and preferred stocks in which the Portfolio may invest will be of investment grade. A security will be deemed to be of "investment grade" if, at the time of investment by the Portfolio, it is rated at least Baa3 by Moody's or BBB- by S&P or at a comparable rating by another nationally recognized rating organization, or, if unrated, determined by Commonwealth Advisors to be of comparable quality. Securities rated Baa or BBB lack outstanding investment characteristics and have speculative characteristics and are subject to greater credit and market risks than higher-rated securities. The Portfolio will normally invest at least 80% of its assets in U.S. Government securities and in other securities rated at least A by Moody's or S&P, or at a comparable rating by another nationally recognized rating organization, or, if unrated, determined by Commonwealth Advisors to be of comparable quality. A description of securities ratings is contained in the Appendix to this Prospectus. Commonwealth Advisors may take full advantage of the entire range of maturities of the securities in which the Portfolio may invest and may adjust the average maturity of the Portfolio's securities from time to time, depending on its assessment of relative yields on securities of different maturities and expectations of future changes in interest rates. The Portfolio may invest in mortgage-backed certificates and other securities representing ownership interests in mortgage pools, including CMOs and certain stripped mortgage-backed securities (including certain "residual" interests), which involve certain risks. See "Other Investment Practices -- Mortgage-backed securities; other asset-backed securities" and " -- Other mortgage-related securities" below. The Portfolio may also engage in a variety of interest rate transactions, including swaps, caps, floors and collars. See "Other Investment Practices -- Interest rate transactions" below for a description of risks associated with these transactions. INVESTMENT ADVISER: COMMONWEALTH ADVISORS, INC. SUB-ADVISER: VAN KAMPEN/AMERICAN CAPITAL MANAGEMENT, INC. ("VAN KAMPEN") The investment objective of the Municipal Income Portfolio is to provide investors with a high level of current income exempt from federal regular income tax, consistent with preservation of capital. Under normal market conditions, the Portfolio will invest at least 80% of its total assets in tax-exempt municipal securities rated investment grade, or deemed by Van Kampen to be of comparable quality. The Portfolio may invest a substantial portion of its assets in municipal securities that pay interest that is a tax preference item under the federal alternative minimum tax. The Portfolio may not be a suitable investment for investors who are already subject to federal alternative minimum tax or who would become subject to federal alternative minimum tax as a result of an investment in the Portfolio. Tax-exempt municipal securities are debt obligations issued by or on behalf of the governments of states (including the District of Columbia) and United States territories or possessions, and their political subdivisions, agencies, and instrumentalities, and certain interstate agencies, the interest on which, in the opinion of bond counsel, is exempt from federal income tax. The Portfolio may also invest up to 10% of its assets in tax-exempt money market funds, which will be considered tax-exempt municipal securities for this purpose. Up to 20% of the Portfolio's total assets may be invested in tax-exempt municipal securities rated between BB and B-(inclusive) by S&P or between Ba and B3 (inclusive) by Moody's (or equivalently rated short-term obligations) and unrated tax-exempt securities that Van Kampen considers to be of comparable quality. These securities are below investment grade and are considered to be of poor standing and predominantly speculative. Assurance of interest and principal payments or of maintenance of other terms of the securities' contract over any long period of time may be small. The Portfolio will not invest in securities rated below B- by S&P or below B3 by Moody's at the time of purchase. The Portfolio may hold a portion of its assets in cash or money market instruments. The two principal classifications of municipal securities are "general obligation" and "special revenue" bonds. General obligation bonds are secured by the issuer's pledge of its full faith, credit, and taxing power for the payment of principal and interest. Special revenue bonds are usually payable only from the revenues derived from a particular facility or class of facilities or from the proceeds of a special excise tax or other specific revenue source and generally are not payable from the unrestricted revenues of an issuer. Industrial development bonds and private activity bonds are usually special revenue bonds, the credit quality of which is normally directly related to the credit standing of the private user involved. There are, in addition, a variety of hybrid and special types of municipal securities, including variable rate securities, municipal notes, and municipal leases. Variable rate securities bear rates of interest that are adjusted periodically according to formulae intended to minimize fluctuation in values of the instruments. Municipal notes include tax, revenue, and bond anticipation notes of short maturities, generally less than three years, which are issued to obtain temporary funds for various public purposes. Municipal leases are obligations issued by state and local governments or authorities to finance the acquisition of equipment and facilities and may be considered illiquid. They may take the form of a lease, an installment purchase contract, a conditional sales contract, or a participation certificate on any of the above. No more than 5% of the net assets of the Portfolio will be invested in municipal leases. A more detailed description of the types of municipal securities in which the Portfolio may invest is included in the Statement of Additional Information. RISKS OF LOWER-GRADE SECURITIES. Investors should carefully consider the risks of owning shares of a mutual fund which invests in lower-grade securities, commonly known as "junk bonds", before making an investment in the Portfolio. The lower ratings of certain securities held by the Portfolio reflect a greater possibility that the financial condition of the issuer, or adverse changes in general economic conditions, or both, may impair the ability of the issuer to make payments of interest and principal. Lower-grade securities generally involve greater credit risk than higher-grade municipal securities and are more sensitive to adverse economic changes, significant increases in interest rates, and individual issuer developments. The inability (or perceived inability) of issuers to make timely payments of interest and principal would likely make the values of securities held by the Portfolio more volatile and could limit the Portfolio's ability to sell its securities at prices approximating the values the Portfolio had placed on such securities. In the absence of a liquid trading market for securities held by it, the Portfolio may be unable at times to establish the fair value of such securities and may not be able to dispose of such securities in a timely manner at a price which reflects the value of such securities. The rating assigned to a security by Moody's or S&P does not reflect an assessment of the volatility of the security's market value or of the liquidity of an investment in the security. For more information about the rating services' descriptions of lower-rated municipal securities, see the Appendix to this Prospectus. Van Kampen seeks to minimize the risks involved in investing in lower-grade securities through diversification and careful investment analysis. However, the amount of information about the financial condition of an issuer of lower-grade municipal securities may not be as extensive as that which is made available by corporations whose securities are publicly traded. When the Portfolio invests in tax exempt securities in the lower rating categories, the achievement of the Portfolio's goals is more dependent on Van Kampen's ability than would be the case if the Portfolio were investing in securities in the higher rating categories. To the extent that there is no established retail market for some of the lower-grade securities in which the Portfolio may invest, trading in such securities may be relatively inactive. During periods of reduced market liquidity and in the absence of readily available market quotations for lower-grade municipal securities held by the Portfolio, the valuation of the Portfolio's securities becomes more difficult and the use of judgment may play a greater role in the valuation of the Portfolio's securities due to the reduced availability of reliable objective data. The effects of adverse publicity and investor perceptions may be more pronounced for securities for which no established market exists as compared with the effects on securities for which such a market does exist. Further, the Portfolio may have more difficulty selling such securities in a timely manner and at their stated value than would be the case for securities for which an established market does exist. CONCENTRATION. The Portfolio generally will not invest more than 25% of its total assets in any one industry. Governmental issuers of municipal securities are not considered part of any "industry." However, municipal securities backed only by the assets and revenues of nongovernmental users may for this purpose be deemed to be issued by such nongovernmental users, and the 25% limitation would apply to such obligations. It is nonetheless possible that the Portfolio may invest more than 25% of its assets in a broader segment of the municipal securities market, such as revenue obligations of hospitals and other health care facilities, housing agency revenue obligations, or airport revenue obligations, if Van Kampen determines that the yields available from obligations in a particular segment of the market justify the additional risks associated with such concentration. Although such obligations could be supported by the credit of governmental users, or by the credit of nongovernmental users engaged in a number of industries, economic, business, political, and other developments generally affecting the revenues of such users (for example, proposed legislation or pending court decisions affecting the financing of such projects and market factors affecting the demand for their services or products) may have a general adverse effect on all municipal securities in such a market segment. The Portfolio reserves the right to invest more than 25% of its assets in industrial development or private activity bonds or in issuers located in any individual state, although Van Kampen has no present intention to invest more than 25% of the Portfolio's assets in issuers located in the same state. If the Portfolio were to invest more than 25% of its assets in issuers located in one state, it would be more susceptible to adverse economic, business, or regulatory conditions in or affecting that state than if it were to invest in a geographically more diverse portfolio. INVESTMENT ADVISER: COMMONWEALTH INVESTMENT COUNSEL, INC. ("COMMONWEALTH The Short-Duration Income Portfolio's investment objective is to seek current income. As a secondary objective, the Portfolio seeks preservation of capital, to the extent consistent with its objective of current income. The Portfolio will normally invest at least 65% of its assets in debt securities with a "duration" of three years or less. The Portfolio may invest in U.S. Government securities and debt obligations of private issuers and in preferred stocks and dividend-paying common stocks, and may hold a portion of its assets in cash or money market instruments. The Portfolio may at times invest a substantial portion of its assets in mortgage-backed certificates and other securities representing ownership interests in mortgage pools, including CMOs and certain other stripped mortgage-backed securities (including certain "residual" interests). See "Other Investment Practices -- Mortgage-backed securities; other asset-backed securities" and " -- Other mortgage-related securities" below for a description of these securities and risks they may entail. The Portfolio may also invest a substantial portion of its assets in securities representing secured or unsecured interests in other types of assets, such as automobile finance or credit card receivables. Traditionally, a debt security's "term to maturity" has been used to evaluate the sensitivity of the security's price to changes in interest rates (the security's interest-rate "volatility"). However, a security's term to maturity measures only the period of time until the last payment of principal or interest on the security, and does not take into account the timing of the various payments of principal or interest to be made prior to the instrument's maturity. By contrast, "duration" is a measure of the full stream of payments to be received on a debt instrument, including both interest and principal payments, based on their present values. Duration measures the periods of time between the present time and the time when the various interest and principal payments are scheduled or, in the case of a callable bond, expected to be received, and weights them by their present values. There are some situations where even the standard duration calculation does not properly reflect the interest-rate volatility of a security. For example, floating and variable rate securities often have final maturities of ten years or more; however, their interest-rate volatility is determined based principally on the period of time until their interest rates are reset and on the terms on which they may be reset. Another example where a security's interest-rate volatility is not properly measured by its duration is the case of mortgage-related securities. The stated final maturity of such securities may be up to 30 years, but the actual cash flow on the securities will be determined by the anticipated prepayment rates on the underlying mortgage loans. Therefore, the duration of such a security can change if anticipated prepayment rates change. In these and other similar situations, Commonwealth Investment Counsel will estimate a security's duration using sophisticated analytical techniques that take into account such factors as the expected prepayment rate on the security and how the prepayment rate might change under various market conditions, although there can be no assurance that any such estimation will accurately predict actual prepayment rates or their effect on the volatility or value of a security. The Portfolio will invest in investment grade debt securities and preferred stocks and, under normal market conditions, the Portfolio will seek to maintain a portfolio of securities with a dollar-weighted average rating of A or better. A security will be considered to be of "investment grade" if, at the time of investment by the Portfolio, it is rated at least Baa3 by Moody's or BBB- by S&P or the equivalent by another nationally recognized rating organization or, if unrated, determined by Commonwealth Investment Counsel to be of comparable quality. Securities rated Baa or BBB lack outstanding investment characteristics and have speculative characteristics and are subject to greater credit and market risks than higher-rated securities. A description of securities ratings is contained in the Appendix to this Prospectus. The Portfolio may also engage in a variety of interest rate transactions, including swaps, caps, floors, and collars. See "Other Investment Practices -- Interest rate transactions" below for a description of risks associated with these transactions. Each of the Portfolios (except as noted below) may engage in the other investment practices described below. See the Statement of Additional Information for a more detailed description of these practices and certain risks they may involve. MORTGAGE-BACKED SECURITIES; OTHER ASSET-BACKED SECURITIES. Each of the Strategy, Short-Duration Income, Quality Income, and Income and Growth Portfolios may invest in mortgage-backed certificates and other securities representing ownership interests in mortgage pools, including CMOs and, in the case of the Quality Income and Short-Duration Income Portfolios, "residual" interests therein (described more fully below). Interest and principal payments on the mortgages underlying mortgage-backed securities are passed through to the holders of the mortgage-backed securities. Mortgage-backed securities currently offer yields higher than those available from many other types of fixed-income securities but because of their prepayment aspects, their price volatility and yield characteristics will change based on changes in prepayment rates. As a result, mortgage-backed securities are less effective than other securities as a means of "locking in" long-term interest rates. Generally, prepayment rates increase if interest rates fall and decrease if interest rates rise. For many types of mortgage-backed securities, this can result in unfavorable changes in price and yield characteristics in response to changes in interest rates and other market conditions. For example, as a result of their prepayment aspects, mortgage-backed securities have less potential for capital appreciation during periods of declining interest rates than other fixed-income securities of comparable maturities, although such obligations may have a comparable risk of decline in market value during periods of rising interest rates. Mortgage-backed securities have yield and maturity characteristics that are dependent upon the mortgages underlying them. Thus, unlike traditional debt securities, which may pay a fixed rate of interest until maturity when the entire principal amount comes due, payments on these securities may include both interest and a partial payment of principal. In addition to scheduled loan amortization, payments of principal may result from the voluntary prepayment, refinancing, or foreclosure of the underlying mortgage loans. Such prepayments may significantly shorten the effective durations of mortgage-backed securities, especially during periods of declining interest rates. Similarly, during periods of rising interest rates, a reduction in the rate of prepayments may significantly lengthen the effective durations of such securities. Each of the Strategy, Short-Duration Income, and Quality Income Portfolios may invest in stripped mortgage-backed securities. Stripped mortgage-backed securities are usually structured with two classes that receive different portions of the interest and principal distributions on a pool of mortgage assets. A Portfolio may invest in both the interest-only -- or "IO" -- class and the principal-only -- or "PO" -- class. The yield to maturity and price of an IO class is extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on the Portfolio's net asset value. This would typically be the case in an environment of falling interest rates. If the underlying mortgage assets experience greater than anticipated prepayments of principal, a Portfolio may under some circumstances fail to fully recoup its initial investment in these securities. Conversely, POs increase in value if prepayments are greater than anticipated and decline if prepayments are slower than anticipated. The secondary market for stripped mortgage-backed securities may be more volatile and less liquid than that for other mortgage-backed securities, potentially limiting a Portfolio's ability to buy or sell those securities at any particular time. Certain mortgage-backed securities held by the Portfolios may permit the issuer at its option to "call," or redeem, its securities. If an issuer were to redeem securities held by a Portfolio during a time of declining interest rates, the Portfolio may not be able to reinvest the proceeds in securities providing the same investment return as the securities redeemed. Each of the Quality Income, Short-Duration Income, and Strategy Portfolios may invest in securities representing interests in other types of financial assets, such as automobile-finance receivables or credit-card receivables. Such securities may or may not be secured by the receivables themselves or may be unsecured obligations of their issuers. The ability of an issuer of asset-backed securities to enforce its security interest in the underlying assets may be limited. For example, the laws of certain states may prevent or restrict repossession of collateral from a debtor. The Quality Income and Short-Duration Income Portfolios may also invest in other types of mortgage-related securities, including any securities that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans or real property, including collateralized mortgage obligation "residual" interests. "Residual" interests represent the right to any excess cash flow remaining after all other payments are made among the various tranches of interests issued by structured mortgage-backed vehicles. The values of such interests are extremely sensitive to changes in interest rates and in prepayment rates on the underlying mortgages. In the event of a significant change in interest rates or other market conditions, the value of an investment by the Portfolio in such interests could be substantially reduced and the Portfolio may be unable to dispose of the interests at prices approximating the values the Portfolio had previously assigned to them or to recoup its initial investment in the interests. The Portfolios may invest in new types of mortgage-related securities that may be developed and marketed from time to time. If any of the Portfolios were to invest in such newly developed securities, shareholders would, where appropriate, be notified and this Prospectus would be revised accordingly. Mortgage-backed securities and other asset-backed securities are "derivative" securities and present certain special risks. The Portfolios may invest in a wide variety of such securities, including mortgage-backed and other asset-backed securities that will pay principal or interest only under certain circumstances, or in amounts that may increase or decrease substantially depending on changes in interest rates or other market factors. Such securities may experience extreme price volatility in response to changes in interest rates or other market factors; this may be especially true in the case of securities where the amounts of principal or interest paid, or the timing of such payments, varies widely depending on prevailing interest rates. A Portfolio's investment adviser or sub-adviser may not be able to obtain current market quotations for certain mortgage-backed or asset-backed securities at all times, or to obtain market quotations believed by it to reflect the values of such securities accurately. In such cases, a Portfolio's investment adviser may be required to estimate the value of such a security using quotations provided by pricing services or securities dealers making a market in such securities, or based on other comparable securities or other bench-mark securities or interest rates. Mortgage-backed and other asset-backed securities in which a Portfolio may invest may be highly illiquid, and a Portfolio may not be able to sell such a security at a particular time or at the value it has placed on that security. In calculating the value and duration of mortgage-backed or other asset-backed securities, a Portfolio's investment adviser or sub-adviser will be required to estimate the extent to which the values of the securities are likely to change in response to changes in interest rates or other market conditions, and the rate at which prepayments on the underlying mortgages or other assets are likely to occur under different scenarios. There can be no assurance that a Portfolio's investment adviser or sub-adviser will be able to predict the amount of principal or interest to be paid on any security under different interest rate or market conditions or that its predictions will be accurate, nor can there be any assurance that a Portfolio will recover the entire amount of the principal paid by it to purchase any such securities. ZERO-COUPON BONDS. Each of the Global, Income and Growth, Municipal Income, Quality Income, Short-Duration Income, and Strategy Portfolios may at times invest in so-called "zero-coupon" bonds. Zero-coupon bonds are issued at a significant discount from face value and pay interest only at maturity rather than at intervals during the life of the security. Because zero-coupon bonds do not pay current interest, their value is subject to greater fluctuation in response to changes in market interest rates than bonds that pay interest currently. Zero-coupon bonds allow an issuer to avoid the need to generate cash to meet current interest payments. Accordingly, such bonds may involve greater credit risks than bonds that pay interest currently. Even though such bonds do not pay current interest in cash, a Portfolio is nonetheless required for federal income tax purposes to accrue interest income on such investments and to distribute such amounts at least annually to shareholders. Thus, a Portfolio could be required at times to liquidate other investments in order to satisfy this distribution requirement. PREMIUM SECURITIES. The Portfolios may at times invest in securities bearing coupon rates higher than prevailing market rates. Such "premium" securities are typically purchased at prices greater than the principal amount payable on maturity. Although a Portfolio generally amortizes the amount of any such premium into income, the Portfolio may recognize a capital loss if such premium securities are called or sold prior to maturity and the call or sale price is less than the purchase price. Additionally, a Portfolio may recognize a capital loss if it holds such securities to maturity. OPTIONS AND FUTURES. Each of the Portfolios may buy and sell put and call options on securities it owns or plans to purchase to hedge against changes in net asset value or to realize a greater current return. In addition, through the purchase and sale of futures contracts and related options, each of the Portfolios may at times seek to hedge against fluctuations in net asset value. In addition, to the extent consistent with applicable law, the Portfolios may buy and sell futures contracts and related options to increase investment return. The Strategy Portfolio may also buy and sell options and futures contracts (including index options and futures contracts) to implement changes in its asset allocations among various market sectors, pending the sale of its existing investments and reinvestments in new securities. INDEX FUTURES AND OPTIONS. Each of the Portfolios may buy and sell index futures contracts ("index futures") and options on index futures and indices for hedging purposes (or may purchase warrants whose value is based on the value from time to time of one or more foreign securities indices). An "index futures" contract is a contract to buy or sell units of a particular bond or stock index at an agreed price on a specified future date. Depending on the change in value of the index between the time when a Portfolio enters into and terminates an index futures or option transaction, the Portfolio realizes a gain or loss. The Portfolios may also, to the extent consistent with applicable law, buy and sell index futures and options to increase investment return. RISKS RELATED TO OPTIONS AND FUTURES STRATEGIES. OPTIONS AND FUTURES TRANSACTIONS INVOLVE COSTS AND MAY RESULT IN LOSSES. Certain risks arise because of the possibility of imperfect correlations between movements in the prices of futures and options and movements in the prices of the underlying security or index or of the securities held by a Portfolio that are the subject of a hedge. The successful use by a Portfolio of the strategies described above further depends on the ability of its investment adviser or sub-adviser to forecast market movements correctly. Other risks arise from a Portfolio's potential inability to close out futures or options positions. Although a Portfolio will enter into options or futures transactions only if its investment adviser or sub-adviser believes that a liquid secondary market exists for such option or futures contract, there can be no assurance that a Portfolio will be able to effect closing transactions at any particular time or at an acceptable price. Transactions in options and futures contracts involve brokerage costs and may require a Portfolio to segregate assets to cover its outstanding positions. For more information, see the Statement of Additional Information. Federal tax considerations may also limit a Portfolio's ability to engage in options and futures transactions. Each Portfolio's options and futures contract transactions will generally be conducted on recognized exchanges. However, a Portfolio may purchase and sell options in transactions in the over-the-counter markets. A Portfolio's ability to terminate options in the over-the-counter markets may be more limited than for exchange-traded options and may also involve the risk that securities dealers participating in such transactions would be unable to meet their obligations to the Portfolio. A Portfolio will, however, engage in over-the-counter transactions only when appropriate exchange-traded transactions are unavailable and when, in the opinion of its investment adviser or sub-adviser, the pricing mechanism and liquidity of the over-the-counter markets are satisfactory and the participants are responsible parties likely to meet their contractual obligations. LEVERAGE. The Short-Duration Income Portfolio may borrow money to invest in additional securities to seek current income. This technique, known as "leverage," increases the Portfolio's market exposure and risk. When the Portfolio has borrowed money for leverage and its investments increase or decrease in value, its net asset value will normally increase or decrease more than if it had not borrowed money for this purpose. The interest that the Portfolio must pay on borrowed money will reduce its net investment income, and may also either offset any potential capital gains or increase any losses. The Portfolio currently intends to use leverage in order to adjust the dollar-weighted average duration of its portfolio. The Portfolio will not always borrow money for investment and the extent to which the Portfolio will borrow money, and the amount it may borrow, depends on market conditions and interest rates. Successful use of leverage depends on an investment adviser's ability to predict market movements correctly. The amount of leverage (including leverage to the extent employed by the Portfolio through "reverse" repurchase agreements, "dollar-roll" transactions, and forward commitments, described below) that can exist at any one time will not exceed one-third of the value of the Portfolio's total assets. SECURITIES LOANS, REPURCHASE AGREEMENTS, FORWARD COMMITMENTS, AND REVERSE REPURCHASE AGREEMENTS. Each Portfolio, other than the Municipal Income Portfolio, may lend portfolio securities and may enter into repurchase agreements with banks, broker/dealers, and other recognized financial institutions. Each of the Strategy and Short-Duration Income Portfolios may enter into each type of transaction on up to 25% of its assets, and each of the Growth, Capital Growth, Global, Income and Growth, and Quality Income Portfolios may enter into each type of transaction on up to one-third of its assets. These transactions must be fully collateralized at all times, but involve some risk to a Portfolio if the other party should default on its obligations and the Portfolio is delayed or prevented from recovering the collateral. Each Portfolio, other than the Growth and Strategy Portfolios, may enter into "reverse" repurchase agreements. Each of the Capital Growth, Quality Income, Income and Growth, and Global Portfolios may do so with respect to up to one-third of its assets, and the Municipal Income Portfolio may do so with respect to up to 5% of its assets. "Reverse" repurchase agreements generally involve the sale by a Portfolio of securities held by it and an agreement to repurchase the securities at an agreed-upon price, date, and interest payment. Each Portfolio also may enter into forward commitments, in which a Portfolio buys securities for future delivery. Reverse repurchase agreements and forward commitments may increase overall investment exposure and may result in losses. DOLLAR ROLL TRANSACTIONS. In order to enhance portfolio returns and manage prepayment risks, each Portfolio, other than the Growth, Strategy, and Municipal Income Portfolios, may engage in dollar roll transactions with respect to mortgage-related securities issued by GNMA, FNMA, and FHLMC. In a dollar roll transaction, a Portfolio sells a mortgage-related security to a financial institution, such as a bank or broker/dealer, and simultaneously agrees to repurchase a substantially similar (I.E., same type, coupon, and maturity) security from the institution at a later date at an agreed upon price. The mortgage-related securities that are repurchased will bear the same interest rate as those sold, but generally will be collateralized by different pools of mortgages with different prepayment histories. Dollar-roll transactions may increase overall investment exposure and may result in losses. FOREIGN SECURITIES. Each Portfolio other than the Growth and Municipal Income Portfolios may invest in securities principally traded in foreign markets. The Capital Growth and Income and Growth Portfolios will limit such investments to 15% and 10%, respectively, of their total assets. Since foreign securities are normally denominated and traded in foreign currencies, the values of a Portfolio's assets may be affected favorably or unfavorably by changes in currency exchange rates and by exchange control regulations. There may be less information publicly available about a foreign company than about a U.S. company, and foreign companies are not generally subject to accounting, auditing, and financial reporting standards and practices comparable to those in the United States. The securities of some foreign companies are less liquid and at times more volatile than securities of comparable U.S. companies. Foreign brokerage commissions and other fees are also generally higher than in the United States. Foreign settlement procedures and trade regulations may involve certain risks (such as delay in payment or delivery of securities or in the recovery of a Portfolio's assets held abroad) and expenses not present in the settlement of domestic investments. In addition, there may be a possibility of nationalization or expropriation of assets, imposition of currency exchange controls, confiscatory taxation, political or financial instability, and diplomatic developments which could affect the value of a Portfolio's investments in certain foreign countries. Legal remedies available to investors in certain foreign countries may be more limited than those available with respect to investments in the United States or in other foreign countries. The laws of some foreign countries may limit a Portfolio's ability to invest in securities of certain issuers located in those foreign countries. Special tax considerations apply to foreign securities. A Portfolio may buy or sell foreign currencies and options and futures contracts on foreign currencies for hedging purposes in connection with its foreign investments as described more fully below. The risks described above are typically increased to the extent that a Portfolio invests in securities traded in underdeveloped and developing nations, which are sometimes referred to as "emerging markets." FOREIGN CURRENCY EXCHANGE TRANSACTIONS. Each Portfolio that may invest in foreign securities may engage in foreign currency exchange transactions to protect against uncertainty in the level of future currency exchange rates. A Portfolio may engage in foreign currency exchange transactions in connection with the purchase and sale of portfolio securities ("transaction hedging") and to protect against changes in the value of specific portfolio positions ("position hedging"). A Portfolio also may engage in transaction hedging to protect against a change in foreign currency exchange rates between the date on which a Portfolio contracts to purchase or sell a security and the settlement date, or to "lock in" the U.S. dollar equivalent of a dividend or interest payment in a foreign currency. A Portfolio may purchase or sell a foreign currency on a spot (or cash) basis at the prevailing spot rate in connection with transaction hedging. A Portfolio may also enter into contracts to purchase or sell foreign currencies at a future date ("forward contracts") and may purchase and sell foreign currency futures contracts, for hedging and not for speculation. A foreign currency forward contract is a negotiated agreement to exchange currency at a future time at a rate or rates that may be higher or lower than the spot rate. Foreign currency futures contracts are standardized exchange-traded contracts and have margin requirements. For transaction hedging purposes, a Portfolio may also purchase and sell call and put options on foreign currency futures contracts and on foreign currencies. A Portfolio may engage in position hedging to protect against a decline in value relative to the U.S. dollar of the currencies in which its portfolio securities are denominated or quoted (or an increase in value of a currency in which securities the Portfolio intends to buy are denominated). For position hedging purposes, a Portfolio may purchase or sell foreign currency futures contracts and foreign currency forward contracts, and may purchase and sell put and call options on foreign currency futures contracts and on foreign currencies. In connection with position hedging, a Portfolio may also purchase or sell foreign currencies on a spot basis. Although there is no limit to the amount of a Portfolio's assets that may be invested in foreign currency exchange and foreign currency forward contacts, a Portfolio will only enter into such transactions to the extent necessary to effect the hedging transactions described above. INTEREST RATE TRANSACTIONS. In order to attempt to protect the value of its portfolio from interest rate fluctuations and to adjust the interest-rate sensitivity of the portfolio, the Global, Quality Income, and Short-Duration Income Portfolios may enter into interest rate swaps and other interest rate transactions, such as interest rate caps, floors, and collars. Interest rate swaps involve the exchange by a Portfolio with another party of different types of interest-rate streams (E.G., an exchange of floating rate payments for fixed rate payments with respect to a notional amount of principal). The purchase of an interest rate cap entitles the purchaser to receive payments on a notional principal amount from the party selling the cap to the extent that a specified index exceeds a predetermined interest rate or amount. The purchase of a floor entitles the purchaser to receive payments on a notional principal amount from the party selling the floor to the extent that a specified index falls below a predetermined interest rate or amount. A collar is a combination of a cap and a floor that preserves a certain return within a predetermined range of interest rates or values. Each Portfolio intends to use these interest rate transactions as a hedge and not as a speculative investment. A Portfolio's ability to engage in certain interest rate transactions may be limited by tax considerations. The use of interest rate swaps and other interest rate transactions is a highly specialized activity which involves investment techniques and risks different from those associated with ordinary portfolio securities transactions. If a Portfolio's investment adviser or sub-adviser is incorrect in its forecasts of market values, interest rates, or other applicable factors, the investment performance of a Portfolio would be less favorable than it would have been if this investment technique were not used. INDEXED SECURITIES. The Global Portfolio may invest in indexed securities, the values of which are linked to currencies, interest rates, commodities, indices, or other financial indicators. Investment in indexed securities involves certain risks. In addition to the credit risk of the securities issuer and normal risks of price changes in response to changes in interest rates, the principal amount of indexed securities may decrease as a result of changes in the value of the reference instruments. Also, in the case of certain indexed securities where the interest rate is linked to a reference instrument, the interest rate may be reduced to zero and any further declines in the value of the security may then reduce the principal amount payable on maturity. Further, indexed securities may be more volatile than the reference instruments underlying indexed securities. PORTFOLIO TURNOVER. The length of time a Portfolio has held a particular security is not generally a consideration in investment decisions. A change in the securities held by a Portfolio is known as "portfolio turnover." As a result of each Portfolio's investment policies, under certain market conditions its portfolio turnover rate may be higher than that of other mutual funds. Portfolio turnover generally involves some expense to a Portfolio, including brokerage commissions or dealer mark-ups and other transaction costs on the sale of securities and reinvestment in other securities. Such transactions may result in realization of taxable gains. The portfolio turnover rates for the ten most recent fiscal years (or for the life of a Portfolio if shorter) are contained in Highlights." The relatively high portfolio turnover rate for the Quality Income Portfolio during fiscal 1994 was due in substantial part to the implementation of the investment program of Pacific Investment Management Company, which differed from the investment program of the Portfolio's previous sub-adviser. Each Portfolio calculates the net asset value of a share of each class by dividing the total value of its assets, less liabilities, by the number of its shares outstanding. Shares are valued as of the close of regular trading on the New York Stock Exchange each day the Exchange is open. Portfolio securities for which market quotations are readily available are stated at market value. Short-term investments that will mature in 60 days or less are stated at amortized cost, which approximates market value. All other securities and assets are valued at their fair values. The net asset value for Class A shares will generally differ from that of Class B shares due to the variance in daily net income realized by and dividends paid on each class of shares, and any differences in the expenses of the different classes. This Prospectus offers investors two classes of shares which bear sales charges in different forms and amounts and which bear different levels of expenses: CLASS A SHARES. An investor who purchases Class A shares pays a sales charge at the time of purchase. As a result, Class A shares are not subject to any charges when they are redeemed, except that sales at net asset value in excess of $1 million are subject to a contingent deferred sales charge (a "CDSC"). Certain purchases of Class A shares qualify for reduced sales charges. Class A shares currently bear no 12b-1 fees. See "How to Buy Shares -- Class A shares." CLASS B SHARES. Class B shares are sold without an initial sales charge, but are subject to a CDSC of up to 4% if redeemed within five or six years, depending on the Portfolio. Class B shares also bear 12b-1 fees. Class B shares provide an investor the benefit of putting all of the investor's money to work from the time the investment is made, but will have a higher expense ratio and pay lower dividends than Class A shares due to the 12b-1 fees. See "How to Buy Shares -- Class B shares." WHICH ARRANGEMENT IS FOR YOU? The decision as to which class of shares provides a suitable investment for an investor depends on a number of factors, including the amount and intended length of the investment. Investors making investments that qualify for reduced sales charges might consider Class A shares. Investors who prefer not to pay an initial sales charge might consider Class B shares. For more information about these sales arrangements, consult your investment dealer or Mentor Distributors. Sales personnel may receive different compensation depending on which class of shares they sell. Shares may only be exchanged for shares of the same class of another Mentor fund and for shares of Cash Resource U.S. Government Money Market Fund. See "How to Exchange Shares." You can open a Portfolio account with as little as $1,000 and make additional investments at any time with as little at $100. Investments under IRAs and investments under qualified retirement plans are subject to a minimum initial investment of $250. The minimum initial investment may be waived for current and retired Trustees, and current and retired employees of The Mentor Funds or Mentor Distributors. You can buy Portfolio shares BY COMPLETING THE ENCLOSED NEW ACCOUNT FORM and sending it to Mentor Distributors along with a money order made payable to The Mentor Funds, THROUGH YOUR FINANCIAL INSTITUTION, which may be an investment dealer, a bank, or another institution, OR THROUGH AUTOMATIC INVESTING. If you do not have a dealer, Mentor Distributors can refer you to one. AUTOMATIC INVESTMENT PLAN. Once you have made the initial minimum investment in a Portfolio, you can make regular investments of $50 or more on a monthly or quarterly basis through automatic deductions from your bank checking account. Application forms are available from your investment dealer or through Mentor Distributors. Shares are sold at a price based on a Portfolio's net asset value next determined after Mentor Distributors receives your purchase order. In most cases, in order to receive that day's public offering price, Mentor Distributors or your investment dealer must receive your order before the close of regular trading on the New York Stock Exchange. If you buy shares through your investment dealer, the dealer must ensure that Mentor Distributors receives your order before the close of regular trading on the New York Stock Exchange for you to receive that day's public offering price. CLASS A SHARES. The public offering price of Class A shares is the net asset value plus a sales charge. The Portfolio receives the net asset value. The sales charge varies depending on the size of your purchase and is allocated between your investment dealer and Mentor Distributors. The current sales charges for the GROWTH, CAPITAL GROWTH, STRATEGY, INCOME AND GROWTH, and GLOBAL PORTFOLIOS are: The current sales charges for the MUNICIPAL INCOME and QUALITY INCOME PORTFOLIOS are: * At the discretion of Mentor Distributors, the entire sales charge may at times be reallowed to dealers. The Staff of the Securities and Exchange Commission has indicated that dealers who receive more than 90% of the sales charge may be considered underwriters. Shares of the SHORT-DURATION INCOME PORTFOLIO are sold subject to a sales charge of 1%. There is no initial sales charge on purchases of Class A shares of $1 million or more. However, a CDSC of 1.00% is imposed on redemptions of such shares within the first year after purchase, based on the lower of the shares' cost and current net asset value. (A CDSC is also imposed on any shares purchased without a sales charge as part of a purchase of shares of $1 million or more under a purchase accumulation plan. Contact Mentor Distributors for more information.) Any of the shares which were acquired by reinvestment of distributions will be redeemed without a CDSC, and amounts representing capital appreciation will not be subject to a CDSC. In determining whether a CDSC is payable in respect of the shares redeemed, the Portfolio will first redeem shares not subject to any charge. Mentor Distributors receives the entire amount of any CDSC you pay. You may be eligible to buy Class A shares at reduced sales charges. Consult your investment dealer or Mentor Distributors for details about Quantity Discounts and Accumulated Purchases, Letters of Intent, the Reinvestment Privilege, Concurrent Purchases, and the Automatic Investment Plan. Descriptions are also included in the New Account Form and in the Statement of Additional Information. Shares may be sold at net asset value to certain categories of investors, including to shareholders of other mutual funds who invest in The Mentor Funds in response to certain promotional activities, and the CDSC may be waived under certain circumstances. See "How to Buy Shares -- General" below. Mentor Distributors, the investment advisers, or certain sub-advisers, or affiliates thereof, at their own expense and out of their own assets, may also provide other compensation to dealers in connection with sales of shares of the Portfolios. Compensation may also include, but is not limited to, financial assistance to dealers in connection with conferences, sales, or training programs for their employees, seminars for the public, advertising or sales campaigns, or other dealer-sponsored special events. In some instances, this compensation may be made available only to certain dealers whose representatives have sold or are expected to sell significant amounts of shares. Dealers may not use sales of The Mentor Funds' shares to qualify for this compensation to the extent such may be prohibited by the laws of any state or any self-regulatory agency, such as the National Association of Securities Dealers, Inc. CLASS B SHARES. Class B shares are sold without an initial sales charge, although a CDSC will be imposed if you redeem shares within five or six years of purchase, depending on the Portfolio. The following types of shares may be redeemed without charge: (i) shares acquired by reinvestment of distributions and (ii) shares otherwise exempt from the CDSC, as described in "How to Buy Shares -- General" below. For other shares, the amount of the charge is determined as a percentage of the lesser of the current market value or the cost of the shares being redeemed. The amount of the CDSC will depend on the number of years since you invested in the shares being redeemed and the dollar amount being redeemed, according to the following table: No CDSC is imposed upon the redemption of Class B shares purchased pursuant to certain asset-allocation plans and that are not otherwise subject to the CDSC shown above. However, a CDSC of 1.00% is imposed on redemptions of such shares within the first year after purchase, based on the lower of the shares' cost and current net asset value. Consult Mentor Distributors for more information. Any of the shares being redeemed which were acquired by reinvestment of distributions will be redeemed without a CDSC, and amounts representing capital appreciation will not be subject to a CDSC. In determining whether a CDSC is payable in respect of the shares redeemed, the Portfolio will first redeem shares not subject to any charge. For this purpose, the amount of any increase in a share's value above its initial purchase price is exempt from the CDSC. Thus, when a share that has appreciated in value is redeemed during the five- or six-year period, a CDSC is assessed only on its initial purchase price. For information on how sales charges are calculated if you exchange your shares, see "How to Exchange Shares." You have purchased 100 shares at $10 per share. The second year after your purchase, your investment's net asset value per share has increased by $2 to $12, and you have gained 10 additional shares through dividend reinvestment. If you redeem 50 of those shares (including shares purchased through reinvestment of distributions on those 100 shares) at this time, your CDSC will be calculated as follows: Mentor Distributors receives the entire amount of any CDSC you pay. Consult Mentor Distributors for more information. A Portfolio may sell its Class A shares without a sales charge and may waive the CDSC on shares redeemed by The Mentor Funds' current and retired Trustees (and their families), current and retired employees (and their families) of Mentor Distributors, each investment adviser or sub-adviser, and each of their affiliates, registered representatives and other employees (and their families) of broker-dealers having sales agreements with Mentor Distributors, employees (and their families) of financial institutions having sales agreements with Mentor Distributors (or otherwise having an arrangement with a broker-dealer or financial institution with respect to sales of Portfolio shares), financial institution trust departments investing an aggregate of $1 million or more in one or more funds in the Mentor family, clients of certain administrators of tax-qualified plans, employer-sponsored retirement plans, tax-qualified plans when proceeds from repayments of loans to participants are invested (or reinvested) in funds in the Mentor family, shares redeemed under a Portfolio's Systematic Withdrawal Plan (limited to 10% of a shareholder's account in any calendar year), and "wrap accounts" for the benefit of clients of financial planners adhering to certain standards established by Mentor Distributors. A Portfolio may sell shares without a sales charge or a CDSC in connection with the acquisition by the Portfolio of assets of an investment company or personal holding company. In addition, the CDSC may be waived in the case of (i) redemptions of shares held at the time a shareholder dies or becomes disabled, including the shares of a shareholder who owns the shares with his or her spouse as joint tenants with right of survivorship, provided that the requested within one year of the death or initial determination of disability; (ii) redemptions in connection with the following retirement plan distributions: (a) lump-sum or other distributions from a qualified retirement plan following retirement; (b) distributions from an IRA, Keogh Plan, or Custodial Account under Section 403(b)(7) of the Internal Revenue Code following attainment of age 59 1/2; and (c) a tax-free return of an excess contribution to an IRA; (iii) redemptions by pension or profit sharing plans sponsored by Mentor Investment Group, Inc. or an affiliate; and (iv) redemptions by pension or profit sharing plans of which Mentor or any affiliate serves as a plan fiduciary. In addition, certain retirement plans with over 200 employees may purchase Class A shares at net asset value without a sales charge. A Portfolio may sell its Class A shares without a sales charge to shareholders of the mutual funds who invest in The Mentor Funds in response to certain promotional activities (in which case a CDSC of 1% may apply for a period of years after the purchase). Contact Mentor Distributors. Shareholders of other funds in the Mentor family may be entitled to exchange their shares for, or reinvest distributions from their funds in, shares of a Portfolio at net asset value. If you are considering redeeming or exchanging shares of a Portfolio or transferring shares to another person shortly after purchase, you should pay for those shares with a certified check to avoid any delay in redemption, exchange, or transfer. Otherwise the Portfolio may delay payment until the purchase price of those shares has been collected or, if you redeem by telephone, until 15 calendar days after the purchase date. To eliminate the need for safekeeping, The Mentor Funds will not issue certificates for your shares unless you request them. Mentor Distributors may, at its expense, provide additional promotional incentives or payments to dealers that sell shares of the Portfolios. In some instances, these incentives or payments may be offered only to certain dealers who have sold or may sell significant amounts of shares. Certain dealers may not sell all classes of shares. Because of the relatively high cost of maintaining accounts, each Portfolio reserves the right to redeem, upon not less than 60 days' notice, any Portfolio account below $500 as a result of redemptions. A shareholder may, however, avoid such a redemption by a Portfolio by increasing his investment in shares of that Portfolio to a value of $500 or more during such 60-day period. REINVESTMENT PRIVILEGE. If you redeem Class A or B shares of any Portfolio, you have a one-time right, within 60 days, to reinvest the redemption proceeds plus the amount of CDSC you paid, if any, at the next-determined net asset value. Front-end sales charges will not apply to such reinvestment. Mentor Distributors must be notified in writing by you or by your financial institution of the reinvestment for you to recover the CDSC, or to eliminate the front-end sales charge. If you redeem shares in any of the Portfolios, there may be tax consequences. DISTRIBUTION PLANS (CLASS B SHARES) Mentor Distributors, Inc., having its principal offices at 901 East Byrd Street, Richmond, Virginia 23219, is the principal distributor for the Portfolios' shares. Each of the Portfolios has adopted a Distribution Plan under Rule 12b-1 with respect to its Class B shares (each, a "Class B Plan") providing for payments by the Portfolio to Mentor Distributors from the assets attributable to the Portfolio's Class B shares at the annual rate set out under "Summary of Portfolio Expenses -- Annual Portfolio Operating Expenses" above. The Trustees may reduce the amount of payments or suspend the Class B Plan for such periods as they may determine. Mentor Distributors also receives the proceeds of any CDSC imposed on redemptions of shares. Payments under the Plans are intended to compensate Mentor Distributors for services provided and expenses incurred by it as principal underwriter of a Portfolio's Class B shares. Mentor Distributors may select financial institutions (such as a broker/dealer or bank) to provide sales support services as agents for their clients or customers who beneficially own Class B shares of the Portfolios. Financial institutions will receive fees from Mentor Distributors based upon Class B shares owned by their clients or customers. The schedules of such fees and the basis upon which such fees will be paid will be determined from time to time by Mentor Distributors. Mentor Distributors may suspend or modify such payments to dealers. Such payments are also subject to the continuation of the relevant Class B Plan, the terms of any agreements between dealers and Mentor Distributors, and any applicable limits imposed by the National Association of Securities Dealers, Inc. You can sell your shares in any Portfolio to the Portfolio any day the New York Stock Exchange is open, either directly to the Portfolio or through your investment dealer. The Portfolio will only redeem shares for which it has received payment. SELLING SHARES DIRECTLY TO A PORTFOLIO. Send a signed letter of instruction or stock power form, along with any certificates that represent shares you want to sell, to The Mentor Funds, c/o Boston Financial Data Services, Inc. ("BFDS"), 2 Heritage Drive, North Quincy, Massachusetts 02171. The price you will receive is the net asset value next calculated after your request is received in proper form less any applicable CDSC. In order to receive that day's net asset value, your request must be received before the close of regular trading on the New York Stock Exchange. If you sell shares having a net asset value of $50,000 or more or if you want your redemption proceeds payable to you at a different address or to someone else, the signatures of registered owners or their legal representatives must be guaranteed by a bank, broker-dealer, or certain other financial institutions. See the Statement of Additional Information for more information about where to obtain a signature guarantee. Stock power forms are available from your investment dealer, Mentor Distributors, and many commercial banks. Mentor Distributors usually requires additional documentation for the sale of shares by a corporation, partnership, agent, or fiduciary, or surviving joint owner. Contact Mentor Distributors for details. SELLING SHARES BY TELEPHONE. You may use Mentor Distributors' Telephone Redemption Privilege to redeem shares from your account unless you have notified Mentor Distributors of an address change within the preceding 15 days. Unless an investor indicates otherwise on the New Account Form, Mentor Distributors will be authorized to act upon redemption and transfer instructions received by telephone from a shareholder, or any person claiming to act as his or her representative, who can provide Mentor Distributors with his or her account registration and address as it appears on Mentor Distributors' records. Mentor Distributors will employ these and other reasonable procedures to confirm that instructions communicated by telephone are genuine; if it fails to employ reasonable procedures, Mentor Distributors may be liable for any losses due to unauthorized or fraudulent instructions. For information, consult Mentor Distributors. During periods of unusual market changes and shareholder activity, you may experience delays in contacting Mentor Distributors by telephone in which case you may wish to submit a written redemption request, as described above, or contact your investment dealer, as described below. The Telephone Redemption Privilege may be modified or terminated without notice. SELLING SHARES THROUGH YOUR INVESTMENT DEALER. Your dealer must receive your request before the close of regular trading on the New York Stock Exchange to receive that day's net asset value. Your dealer will be responsible for furnishing all necessary documentation to Mentor Distributors, and may charge you for its services. The Portfolio generally sends you payment for your shares the business day after your request is received. Under unusual circumstances, the Portfolio may suspend redemptions, or postpone payment for more than seven days, as permitted by federal securities law. SYSTEMATIC WITHDRAWAL PROGRAM. You may redeem Class A or B shares of a Portfolio through periodic withdrawals for a predetermined amount. Only shareholders with accounts valued at $10,000 or more are eligible to participate. Class B shares redeemed under the Systematic Withdrawal Program are not subject to a CDSC, but the aggregate withdrawals of Class B shares in any year are limited to 10% of the value of the account at the time of enrollment. Contact Mentor Distributors for more information. Except as otherwise described below, you can exchange your shares in a Portfolio worth at least $1,000 for shares of the same class of any other Portfolio at net asset value beginning 15 days after purchase. You may also exchange shares of any Portfolio for shares of Cash Resource U.S. Government Money Market Fund (the "Cash Fund"). If you exchange shares subject to a CDSC, the transaction will not be subject to a CDSC. However, when you redeem the shares acquired through the exchange, the redemption may be subject to the CDSC, depending upon when you originally purchased the shares, using the schedule of the Portfolio from which your first exchange was effected. For purposes of computing the CDSC, the length of time you have owned your shares will be measured from the date of original purchase and will not be affected by any exchange. (If you exchange your shares for shares of the Cash Fund, the period when you hold shares of the Cash Fund will not be included in calculating the length of time you have owned the shares subject to the CDSC, and any CDSC payable on redemption of your shares will be reduced by the amount of any payment collected by the Cash Fund under its distribution plan in respect of those shares. Contact Mentor Distributors for information.) To exchange your shares, simply complete an Exchange Authorization Form and send it to The Mentor Funds, c/o BFDS, 2 Heritage Drive, North Quincy, Massachusetts 02171. Exchange Authorization Forms are available by calling or writing Mentor Distributors. For federal income tax purposes, an exchange is treated as a sale of shares and generally results in a capital gain or loss. A Telephone Exchange Privilege is currently available. Mentor Distributors' procedures for telephonic transactions are described above under "How to Sell Shares." The Telephone Exchange Privilege is not available if you were issued certificates for shares which remain outstanding. Ask your investment dealer or Mentor Distributors for a prospectus relating to the Cash Fund. Shares of certain of the Portfolios may not available to residents of all states. The exchange privilege is not intended as a vehicle for short-term trading. Excessive exchange activity may interfere with portfolio management and have an adverse effect on all shareholders. In order to limit excessive exchange activity and in other circumstances where Mentor Distributors or the Trustees believe doing so would be in the best interests of a Portfolio, the Portfolio reserves the right to revise or terminate the exchange privilege, limit the amount or number of exchanges, or reject any exchange. Shareholders would be notified of any such action to the extent required by law. Consult Mentor Distributors before requesting an exchange by calling 1-800-382-0016. See the Statement of Additional Information to find out more about the exchange privilege. Dividends, if any, are declared daily and paid monthly for the Quality Income, Short-Duration Income, and Municipal Income Portfolios. Any dividends for the other Portfolios are declared and paid as follows: quarterly for the Income and Growth Portfolio; and annually for the Capital Growth, Global, Growth, and Strategy Portfolios. Each Portfolio will distribute its net capital gain, if any, at least annually. All dividends and distributions of net capital gain will be invested in additional shares of the same class of a Portfolio unless a shareholder requests in writing to receive the dividend or distribution in cash. Each Portfolio intends to qualify as a "regulated investment company" for federal income tax purposes and to meet all other requirements that are necessary for it to be relieved of federal taxes on income and gains it distributes to shareholders. All Portfolio distributions, other than exempt-interest dividends, will be taxable to you as ordinary income, except that any distributions of net capital gain will be taxed as long-term capital gain, regardless of how long you have held the shares (although the loss on a sale of shares held for six months or less will be treated as long-term capital loss to the extent of any capital gain distribution received with respect to those shares). Distributions will be taxable as described above whether received in cash or in shares through the reinvestment of distributions. Early in each year The Mentor Funds will notify you of the amount and tax status of distributions paid to you by your Portfolio for the preceding year. The foregoing is a summary of certain federal income tax consequences of investing in a Portfolio. You should consult your tax adviser to determine the precise effect of an investment in a Portfolio on your particular tax situation. To permit the Quality Income, Municipal Income, and Short-Duration Income Portfolios to maintain more stable monthly distributions, each of those Portfolios may from time to time pay out less than the entire amount of net investment income earned in any particular period. Any such amount retained by a Portfolio would be available to stabilize future distributions. As a result, the distributions paid by either Portfolio for any particular period may be more or less than the amount of net investment income actually earned by the Portfolio during that period. MUNICIPAL INCOME PORTFOLIO. Distributions designated by the Portfolio as "exempt-interest dividends" are not generally subject to federal income tax. The Portfolio may engage in investment activities that produce taxable income, the distribution of which will be taxable to shareholders as described above. If you receive Social Security and railroad retirement benefits, you should consult your tax adviser to determine what effect, if any, an investment in the Portfolio may have on the taxation of your benefits. In addition, an investment in the Portfolio may result in liability for federal alternative maximum tax and for state and local taxes, both for individual and corporate shareholders. The Trustees of The Mentor Funds are responsible for generally overseeing the conduct of its business. COMMONWEALTH ADVISORS, INC. acts as investment manager of each of the Portfolios other than the Growth, Short-Duration Income, Global, and Strategy Portfolios. CHARTER ASSET MANAGEMENT, INC. acts as investment manager to the Growth Portfolio; COMMONWEALTH INVESTMENT COUNSEL, INC. acts as investment manager to the Short-Duration Income Portfolio; MENTOR PERPETUAL ADVISORS, L.L.C. acts as investment manager to the Global Portfolio; WELLESLEY ADVISORS, INC. acts as investment manager to the Strategy Portfolio. Each of the investment advisers, except Mentor Perpetual, is a wholly-owned subsidiary of Mentor Investment Group, Inc. ("Mentor"), which is a wholly-owned subsidiary of Wheat First Butcher Singer, Inc. Wheat First Butcher Singer, through other subsidiaries, also engages in securities brokerage, investment banking, and related businesses. Mentor Perpetual is owned equally by Mentor and Perpetual plc, a diversified financial services holding company. Each of the investment advisers is located at 901 East Byrd Street, Richmond, Virginia. Each of the Portfolios pays management fees to its manager at the annual rates described above under "Summary of Portfolio Expenses -- Annual Portfolio Operating Expenses", except that the Global Portfolio pays fees equal to 1.10% of its average daily net assets up to and including $75 million and 1.00% of the average daily net assets of the Portfolio in excess of $75 million. The advisory fees paid by the Growth, Capital Growth, Income and Growth, and Global Portfolios are higher than those paid by many other mutual funds. An investment adviser may from time to time voluntarily waive some or all of its investment advisory fees and may terminate any such voluntary waiver of some or all of its investment advisory fees at any time in its sole discretion. Commonwealth Advisors was incorporated under the laws of Virginia in 1991 and has assets under management in excess of $300 million. All of its directors and officers serve as directors or officers of other investment advisory firms affiliated with Wheat First Butcher Singer. Commonwealth Advisors has served as investment adviser to each of the Portfolios identified above since their inception; however, prior to April 12, 1995, all investment decisions for each of the Portfolios were made by sub-advisers to those Portfolios. For certain of the Portfolios, Commonwealth Advisors now furnishes a continuous investment program. All of the investment advisory personnel of Commonwealth Advisors have substantial experience in the investment advisory field and provide advisory services to other mutual funds in the Mentor family. Charter is a registered investment adviser with total assets under management exceeding $380 million. Charter provides investment management and advisory services to a wide variety of individual and institutional clients. Commonwealth Investment Counsel currently has assets under management in excess of $4 billion, and serves as investment adviser to Cash Resource Trust and Mentor Institutional Trust, both open-end investment companies, and Mentor Income Fund, Inc., a closed-end investment company. Mentor Perpetual is a newly organized investment advisory firm owned equally by Perpetual plc and Mentor. The Perpetual organization currently serves as investment adviser for assets of more than $6 billion. Its clients include 28 unit investment trusts and other public investment pools for over 150 clients, including private individuals, charities, pension plans, and life assurance companies. Wellesley is a newly organized investment advisory firm with assets under management of approximately $240 million. Each of its directors and officers serves as director and officer of other investment advisory firms affiliated with Wheat First Butcher Singer. All investment decisions made for the Portfolios by Commonwealth Advisors, Charter, Commonwealth Investment Counsel, Mentor Perpetual, and Wellesley are made by investment committees at the respective firms, made up of investment professionals at those firms. VAN KAMPEN AMERICAN CAPITAL MANAGEMENT INC. ("Van Kampen") serves as sub-adviser to the Municipal Income Portfolio. Van Kampen, located at One Parkview Plaza, Oakbrook Terrace, Illinois 60181, was incorporated in 1990 and commenced operations in 1992. Van Kampen currently provides investment advice to a wide variety of individual, institutional, and investment company clients. Van Kampen is a wholly-owned subsidiary of Van Kampen American Capital, Inc., which, in turn, is a wholly-owned subsidiary of VK/AC Holding, Inc. VK/AC Holding, Inc. is indirectly controlled by Clayton & Dubilier Associates IV Limited Partnership, the general partners of which are Joseph L. Rice, III, B. Charles Ames, William A. Barby, Alberto Cribiore, Donald J. Gogel, Leon J. Hendrix, Jr., Hubbard C. Howe, and Andrall E. Pearson, each of whom is a principal of Clayton, Dubilier & Rice, Inc., a New York-based private investment firm. As of December 1, 1995, Van Kampen, together with its affiliates, managed or supervised approximately $55.5 billion of assets. David C. Johnson, Senior Vice President of Van Kampen, is manager of the Municipal Income Portfolio. Mr. Johnson joined Van Kampen in 1989 and has served as portfolio manager of the Municipal Income Portfolio since its inception. Mr. Johnson has fourteen years of management experience in the tax-free fixed-income sector. Currently, he is responsible for the management and supervision of 52 Van Kampen municipal funds, including both open and closed-end funds, with total assets exceeding $12 billion. WELLINGTON MANAGEMENT COMPANY ("Wellington") serves as sub-adviser to the Income and Growth Portfolio. Wellington, located at 75 State Street, Boston, Massachusetts 02109, is a professional investment counseling firm which provides investment services to investment companies, employee benefit plans, endowments, foundations, and other institutions and individuals. As of September 30, 1995, Wellington had discretionary investment management authority with respect to approximately $102.4 billion in assets. Wellington and its predecessor organizations have provided investment advisory services to investment companies since 1933 and to investment counseling clients since 1960. For its services as sub-adviser, Commonwealth Advisors pays Wellington a fee at the annual rate expressed as a percentage of the Portfolio's assets as follows: 0.325% on the first $50 million in assets, 0.275% on the next $150 million in assets, 0.225% on the next $300 million in assets, and 0.200% on assets over $500 million. Paul D. Kaplan, Senior Vice President of Wellington, and Arnold C. Schneider III, Senior Vice President of Wellington, have served as portfolio managers to the Portfolio since its inception in May 1993. Mr. Kaplan manages the fixed-income and U.S. Government securities portion of the Portfolio, and Mr. Schneider manages the equity securities portion of the Portfolio. Mr. Kaplan has been a portfolio manager with Wellington since 1982 and Mr. Schneider has been a portfolio manager with Wellington since 1987. GENERAL. Subject to the general oversight of the Trustees, each Portfolio's investment adviser or sub-adviser manages its respective Portfolio in accordance with the stated policies of the Portfolio. Each makes investment decisions for a Portfolio and places the purchase and sale orders for the Portfolio's transactions. In addition, each pays the salaries of all officers and employees who are employed by both it and The Mentor Funds. The Mentor Funds pays all expenses not assumed by the investment advisers and sub-advisers, or Mentor, including, among other things, Trustees' fees, auditing, accounting, legal, custodial, investor servicing, and shareholder reporting expenses, and payments under the Portfolios' Class B Plans. In selecting broker-dealers, the investment adviser or sub-adviser may consider research and brokerage services furnished to it and its affiliates. Subject to seeking the best overall terms available, a Portfolio's investment adviser or sub-adviser may consider sales of shares of The Mentor Funds (and, if permitted by law, of the other funds in the Mentor family) as a factor in the selection of broker-dealers. Until April 12, 1995, Scudder, Stevens & Clark served as sub-adviser to the Perpetual Global Portfolio; Phoenix Investment Counsel, Inc. served as sub-adviser to the Mentor Capital Growth Portfolio; and Pacific Investment Management Company served as sub-adviser to the Mentor Quality Income Portfolio (when that Portfolio was known as the Cambridge Government Income Portfolio). ADMINISTRATIVE SERVICES. Mentor Investment Group, Inc., located at 901 East Byrd Street, Richmond, Virginia 23219, provides each Portfolio with certain administrative personnel and services necessary to operate each Portfolio, such as bookkeeping and accounting services. Mentor provides these services to each of the Portfolios at an annual rate of 0.10% of each Portfolio's average net assets. SHAREHOLDER SERVICING PLAN. The Mentor Funds has adopted a Shareholder Servicing Plan (the "Service Plan") with respect to Class A and Class B shares of each Portfolio. Under the Service Plan, financial institutions will enter into shareholder service agreements with The Mentor Funds to provide to their customers who are Portfolio shareholders. In return for providing these support services, a financial institution may receive payments at a rate not exceeding 0.25% of the average daily net assets of the Class A or Class B shares of a Portfolio. These administrative services may include, but are not limited to, the following functions; providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer personnel, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding the Portfolios; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Portfolios reasonably request. In addition to receiving payments under the Service Plan, financial institutions may be compensated by a Portfolio's investment adviser, a sub-adviser, and/or Mentor, or affiliates thereof, for providing administrative support services to holders of Class A or Class B shares of the Portfolios. These payments will be made directly by a Portfolio's investment adviser, sub-adviser, and/or Mentor and will not be made from the assets of any of the Portfolios. The Mentor Funds is a Massachusetts business trust organized on January 20, 1992. A copy of the Declaration of Trust of The Mentor Funds, which is governed by Massachusetts law, is on file with the Secretary of State of the Commonwealth of Massachusetts. The Mentor Funds is an open-end, diversified, series management investment company with an unlimited number of authorized shares of beneficial interest. Shares of The Mentor Funds may, without shareholder approval, be divided into two or more series of shares representing separate investment portfolios. Any such series of shares may be further divided without shareholder approval into two or more classes of shares having such preferences and special or relative rights and privileges as the Trustees determine. The Mentor Funds' shares are currently divided into nine series, eight of which are being offered by this Prospectus. Each series offered by this prospectus issues shares of two classes, Class A and Class B. Each share has one vote, with fractional shares voting proportionally. Shares of each series will vote together as a single series except when required by law or determined by the Trustees. Shares of each Portfolio are freely transferable, are entitled to dividends as declared by the Trustees, and, if the Portfolio were liquidated, would receive the net assets of that Portfolio. The Mentor Funds may suspend the sale of shares at any time and may refuse any order to purchase shares. Although The Mentor Funds is not required to hold annual meetings of its shareholders, shareholders have the right to call a meeting to elect or remove Trustees, or to take other actions as provided in the Declaration of Trust. In June, 1995, Mentor Growth Fund, Mentor Strategy Fund, and Mentor Short-Duration Income Fund, series of shares of Mentor Series Trust, a Massachusetts business trust, were reorganized as the Mentor Growth Portfolio, Mentor Strategy Portfolio, and Mentor Short-Duration Income Portfolio, respectively. Investors Fiduciary Trust Company, 127 West 10th Street, Kansas City, Missouri 64105, serves as custodian for each Portfolio, except that State Street Bank & Trust Company, P.O. Box 8602, Boston, Massachusetts 02266 serves as custodian for the Global Portfolio. Boston Financial Data Services, Inc. is transfer agent and dividend disbursing agent for the Portfolios. The Trust's independent auditors are KPMG Peat Marwick LLP, 99 High Street, Boston, Massachusetts 02110. Yield and total return data may from time to time be included in advertisements about the Portfolios. A Portfolio's "yield" is calculated by dividing the Portfolio's annualized net investment income per share during a recent 30-day period by the maximum public offering price per share on the last day of that period. "Total return" for the one-, five- and ten-year periods (or for the life of the Portfolio, if shorter) through the most recent calendar quarter represents the average annual compounded rate of return on an investment of $1,000 in the Portfolio at the maximum public offering price (in the case of Class A shares) and reflecting (in the case of Class B shares) the deduction of any applicable CDSC. Total return may also be presented for other periods or based on investment at reduced sales charge levels or at net asset value. Investment performance of different classes of shares of a Portfolio will differ. Any quotation of investment performance not reflecting a CDSC would be reduced if such sales charges were reflected. Quotations of yield or total return for a period when an expense limitation was in effect will be greater than if the limitation had not been in effect. A Portfolio's performance may be compared to various indices. See the Statement of Additional Information for more information. Information may be presented in advertisements about a Portfolio describing the background and professional experience of the Portfolio's investment adviser, sub-adviser, or any of their personnel. ALL DATA ARE BASED ON A PORTFOLIO'S PAST INVESTMENT RESULTS AND DO NOT PREDICT FUTURE PERFORMANCE. Investment performance, which will vary, is based on many factors, including market conditions, the composition of the Portfolio, the Portfolio's operating expenses, and which class of shares you purchase. Investment performance also often reflects the risks associated with a Portfolio's investment objective and policies. These factors should be considered when comparing a Portfolio's investment results to those of other mutual funds and other investment vehicles. As permitted by applicable law, performance information for a Portfolio whose investment adviser or sub-adviser has changed may be presented only for periods after the change was effected. MOODY'S INVESTORS SERVICE, INC., LONG-TERM MUNICIPAL DEBT RATINGS Aaa -- Bonds which are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa -- Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa group, they comprise what are generally known as high-grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in Aaa securities. A -- Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium-grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. Baa -- Bonds which are rated Baa are considered as medium-grade obligations, (I.E., they are neither highly protected nor poorly secured). Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Ba -- Bonds which are Ba are judged to have speculative elements; their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. B -- Bonds which are rated B generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. NOTE: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes possess the strongest investment attributes are designated by the symbols Aa1, A1, Baa1, Ba1 and B1. STANDARD AND POOR'S LONG-TERM MUNICIPAL DEBT RATINGS AAA -- Debt rated AAA has the highest rating assigned by Standard & Poor's. Capacity to pay interest and repay principal is extremely strong. AA -- Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A -- Debt rated A has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. BBB -- Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. BB, B, CCC, CC -- Debt rated BB, B, CCC and CC is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. BB indicates the lowest degree of speculation and CC the highest degree of speculation. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties of major risk exposure to adverse conditions. PLUS (+) OR MINUS (-): The ratings from "A" to "B" may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. MOODY'S INVESTORS SERVICE, INC., SHORT-TERM LOAN RATINGS MIG1/VMIG1 -- This designation denotes best quality. There is present strong protection by established cash flows, superior liquidity support or demonstrated broadbased access to the market for refinancing. MIG2/VMIG2 -- This designation denotes high quality. Margins of protection are ample although not so large as in the preceding group. STANDARD AND POOR'S MUNICIPAL NOTE RATINGS SP-1 -- Strong capacity to pay principal and interest. Issues determined to possess very strong characteristics are given a plus sign (+) designation. SP-2 -- Satisfactory capacity to pay principal and interest with some vulnerability to adverse financial and economic changes over the term of the notes. FITCH INVESTORS SERVICE, INC., SHORT-TERM DEBT RATINGS F-1+ -- Exceptionally Strong Credit Quality. Issues assigned this rating are regarded as having the strongest degree of assurance for timely payment. F-1 -- Very Strong Credit Quality. Issues assigned this rating reflect an assurance of timely payment only slightly less in degree than issues rated F-1+. F-2 -- Good Credit Quality. Issues carrying this rating have a satisfactory degree of assurance for timely payment. MOODY'S INVESTORS SERVICE, INC., COMMERCIAL PAPER RATINGS P-1 -- Issuers rated PRIME-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. PRIME-1 repayment capacity will normally be evidenced by the following characteristics: conservative capitalization structures with moderate reliance on debt and ample asset protection; broad margins in earning coverage of fixed financial charges and high internal cash generation; and well-established access to a range of financial markets and assured sources of alternate liquidity. P-2 -- Issuers rated PRIME-2 (or related supporting institutions) have a strong capacity for repayment of short-term promissory obligations. This will normally be evidenced by many of the characteristics cited above but to a lesser degree. Earnings trends and coverage ratios, while sound, will be more subject to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternate liquidity is maintained. STANDARD AND POOR'S COMMERCIAL PAPER RATINGS A-1 -- This highest category indicates that the degree of safety regarding timely payment is strong. Those issues determined to possess extremely strong safety characteristics are denoted with a plus sign (+) designation. A-2 -- Capacity for timely payment on issues with this designation is satisfactory. However, the relative degree of safety is not as high as for issues designated A-1. (Bullet) Mentor Capital Growth Portfolio (Bullet) Mentor Income and Growth Portfolio (Bullet) Mentor Perpetual Global Portfolio (Bullet) Mentor Quality Income Portfolio (Bullet) Mentor Municipal Income Portfolio (Bullet) Mentor Short-Duration Income Portfolio P R O S P E C T U S January 15, 1996 Mentor Balanced Portfolio seeks capital growth and current income. The Portfolio is a series of shares of beneficial interest of The Mentor Funds, an open-end, diversified management investment company. The Portfolio invests in a diversified portfolio of debt and equity securities which Commonwealth Investment Counsel, Inc., the Portfolio's investment adviser, believes will produce both capital growth and current income. The Portfolio may use "leverage" -- that is, it may borrow money to purchase additional portfolio securities, which involves special risks. See "Other investment practices and risk factors -- Leverage" on page 7. This Prospectus sets forth concisely the information about the Portfolio that a prospective investor should know before investing. Please read this Prospectus and retain it for future reference. You can find more detailed information in the January 15, 1996 Statement of Additional Information, as amended from time to time. For a free copy of the Statement or for other information, call 1-800-382-0016. The Statement has been filed with the Securities and Exchange Commission and is incorporated into this Prospectus by reference. The Portfolio's address is P.O. Box 1357, Richmond, Virginia 23286-0109. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. Expenses are one of several factors to consider when investing in the Portfolio. The following table summarizes your maximum transaction costs from investing in the Portfolio and expenses incurred by the Portfolio based on its most recent fiscal year. The Example shows the cumulative expenses attributable to a hypothetical $1,000 investment in the Portfolio over specified periods. Maximum Sales Load Imposed On Purchases None Maximum Sales Load Imposed on Reinvested Dividends None (as a percentage of the lower of the original purchase price or redemption proceeds of shares redeemed): 5.0% in the (as a percentage of average net assets) Total Portfolio Operating Expenses 2.05%(2) (1) During the Portfolio's last fiscal year, Commonwealth Investment Counsel Inc. ("Commonwealth"), the Portfolio's investment adviser, waived all Management Fees, and Wheat, First Securities, Inc. ("Wheat"), and Mentor Distributors, Inc., the distributors of the Portfolio for fiscal 1995, waived all 12b-1 Fees and Shareholder Service Fees. Commonwealth and/or Mentor Distributors may waive all or a portion of such fees for the current fiscal year. The amounts shown in the table show expenses in the absence of the waivers. (2) Reflects the waiver by Mentor Investment Group, Inc. ("Mentor") of fees pursuant to its Administration Agreement with the Portfolio. In the absence of the waiver, Other Expenses would be 0.40%, and Total Portfolio Operating Expenses would be 2.15%. Your investment of $1,000 in the Portfolio would incur the following expenses, assuming 5% annual return and redemption at the end of each period: 1 year 3 years 5 years 10 years You would pay the following expenses on the same investment, assuming no redemption: 1 year 3 years 5 years 10 years This information is provided to help you understand the expenses of investing in the Portfolio and your share of the estimated operating expenses of the Portfolio. The information concerning the Portfolio is based on the expenses the Portfolio expects to incur during its first full fiscal year. The Example should not be considered a representation of future performance; actual expenses may be more or less than those shown. Long-term shareholders may pay more than the economic equivalent of the maximum front-end sales charge permitted by the rules of the National Association of Securities Dealers, Inc. The financial highlights presented below for the Portfolio have been audited by KPMG Peat Marwick LLP, independent auditors. The report of KPMG Peat Marwick LLP is contained in the Statement of Additional Information, which may be obtained in the manner described on the cover page of this Prospectus. See "Financial Statements" and "Independent Auditor's Report" in the Statement of Additional Information. * For the period January 1, 1995 to September 30, 1995. *For the period from June 21, 1994 (commencement of operations) to December 31, 1994. (a) Annualized. Mentor Balanced Portfolio's investment objective is to seek capital growth and current income. The Portfolio invests in a diversified portfolio of equity and fixed-income securities which Commonwealth believes will produce both capital growth and current income. There can, of course, be no assurance that the Portfolio will achieve its investment objective. The Portfolio is a series of The Mentor Funds (the "Trust"), a diversified, open-end series investment company. The Trustees would not materially change the Portfolio's investment objective without shareholder approval. The Portfolio may invest in almost any type of security. The Portfolio's securities will include some securities selected primarily to provide for growth in value, others selected for current income, and other for stability of principal. Commonwealth will adjust the proportions of the Portfolio's assets invested in the different types of securities in order to adjust to changing market conditions. For example, under certain market conditions, Commonwealth may judge that most of the Portfolio's assets should be invested in equity securities, and that only a relatively small portion of the Portfolio's assets should be invested in fixed-income securities. At other times, Commonwealth may invest most of the Portfolio's assets in fixed-income securities, with a corresponding reduction in the portion of the Portfolio's assets invested in equity securities. Under normal circumstances, the Portfolio will invest at least 25% of its assets in fixed-income securities and 25% of its assets in equity securities. The Portfolio will invest in debt securities and preferred stocks of investment grade, and the Portfolio will seek under normal market conditions to maintain a portfolio of securities with a dollar-weighted average rating of A or better. A security will be considered to be of "investment grade" if, at the time of investment by the Portfolio, it is rated at least Baa3 by Moody's Investors Service, Inc. or BBB- by Standard & Poor's Corporation or the equivalent by another nationally recognized rating organization or, if unrated, determined by Commonwealth to be of comparable quality. Securities rated Baa or BBB lack outstanding investment characteristics and have speculative characteristics and are subject to greater credit and market risks than higher-rated securities. See the Statement of Additional Information for descriptions of securities ratings assigned by Moody's and Standard & Poor's. At times Commonwealth may decide that conditions in the securities markets make pursuing the Portfolio's basic investment strategy inconsistent with the best interests of its shareholders. At such times, Commonwealth may temporarily use alternative investment strategies primarily designed to reduce fluctuations in the value of the Portfolio's assets. In implementing these "defensive" strategies, the Portfolio would be permitted to hold all or any portion of its assets in high quality fixed-income securities, cash, or money market instruments. It is impossible to predict when, or for how long, the Portfolio will use these alternative strategies. Mortgage-backed securities; other asset-backed securities. The Portfolio may invest in mortgage-backed certificates and other securities representing ownership interests in mortgage pools, including collateralized mortgage obligations and certain stripped mortgage-backed securities and "residual" interests therein. Interest and principal payments on the mortgages underlying mortgage-backed securities are passed through to the holders of the mortgage-backed securities. Mortgage-backed securities currently offer yields higher than those available from many other types of fixed-income securities but because of their prepayment aspects, their price volatility and yield characteristics will change based on changes in prepayment rates. As a result, mortgage-backed securities are less effective than other securities as a means of "locking in" long-term interest rates. Generally, prepayment rates increase if interest rates fall and decrease if interest rates rise. For many types of mortgage-backed securities, this can result in unfavorable changes in price and yield characteristics in response to changes in interest rates and other market conditions. For example, as a result of their prepayment aspects, the Portfolio's mortgage-backed securities have less potential for capital appreciation during periods of declining interest rates than other fixed-income securities of comparable maturities, although such obligations may have a comparable risk of decline in market value during periods of rising interest rates. Mortgage-backed securities have yield and maturity characteristics that are dependent upon the mortgages underlying them. Thus, unlike traditional debt securities, which may pay a fixed rate of interest until maturity when the entire principal amount comes due, payments on these securities may include both interest and a partial payment of principal. In addition to scheduled loan amortization, payments of principal may result from the voluntary prepayment, refinancing, or foreclosure of the underlying mortgage loans. Such prepayments may significantly shorten the effective durations of mortgage-backed securities, especially during periods of declining interest rates. Similarly, during periods of rising interest rates, a reduction in the rate of prepayments may significantly lengthen the effective durations of such securities. Stripped mortgage-backed securities are usually structured with two classes that receive different portions of the interest and principal distributions on a pool of mortgage assets. The Portfolio may invest in both the interest-only -- or "IO" -- class and the principal-only -- or "PO" -- class. The yield to maturity and price of an IO class are extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on the Portfolio's average duration and net asset value. This would typically be the case in an environment of falling interest rates. If the underlying mortgage assets experience greater than anticipated prepayments of principal, the Portfolio may under some circumstances fail to recoup fully its initial investment in these securities. Conversely, POs tend to increase in value if prepayments are greater than anticipated and decline if prepayments are slower than anticipated. The secondary market for stripped mortgage-backed securities may be more volatile and less liquid than that for other mortgage-backed securities, potentially limiting the Portfolio's ability to buy or sell those securities at any particular time. Certain securities held by the Portfolio may permit the issuer at its option to "call," or redeem, its securities. If an issuer were to redeem securities held by the Portfolio during a time of declining interest rates, the Portfolio might not be able to reinvest the proceeds in securities providing the same investment return as the securities redeemed. The Portfolio may invest in securities representing interests in other types of financial assets, such as automobile-finance receivables or credit-card receivables. Such securities may or may not be secured by the receivables themselves or may be unsecured obligations of their issuers. The ability of an issuer of asset-backed securities to enforce its security interest in the underlying assets may be limited. For example, the laws of certain states may prevent or restrict repossession of collateral from a debtor. The Portfolio may also invest in other types of mortgage-related securities, including any securities that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans or real property, including collateralized mortgage obligation "residual" interests, as well as new types of mortgage-related securities that may be developed and marketed from time to time. "Residual" interests represent the right to any excess cash flow remaining after all other payments are made among the various tranches of interests issued by structured mortgage-backed vehicles. The values of such interests are extremely sensitive to changes in interest rates and in prepayment rates on the underlying mortgages. In the event of a significant change in interest rates or other market conditions, the value of an investment by the Portfolio in such interests could be substantially reduced and the Portfolio may be unable to dispose of the interests at prices approximating the values the Portfolio had previously assigned to them or to recoup its initial investment in the interests. Mortgage-backed securities and other asset-backed securities are "derivative" securities and present certain special risks. The Portfolio may invest in a wide variety of such securities, including mortgage- and other assetbacked securities that will pay principal or interest only under certain circumstances, or in amounts that may increase or decrease substantially depending on changes in interest rates or other market factors. Such securities may experience extreme price volatility in response to changes in interest rates or other market factors; this may be especially true in the case of securities where the amounts of principal or interest paid, or the timing of such payments, varies widely depending on prevailing interest rates. Commonwealth may not be able to obtain current market quotations for certain mortgage-backed or assetbacked securities at all times, or to obtain market quotations believed by it to reflect the values of such securities accurately. In such cases, Commonwealth may be required to estimate the value of such a security using quotations provided by pricing services or securities dealers making a market in such securities, or based securities or other bench-mark securities or interest rates. Mortgage-backed and other asset-backed securities in which the Portfolio may invest may be highly illiquid, and the Portfolio may not be able to sell such a security at a particular time or at the value it has placed on it. In calculating the value and duration of mortgage-backed or other asset-backed securities, Commonwealth will be required to estimate the extent to which the values of the securities are likely to change in response to changes in interest rate or other market conditions, and the rate at which prepayments on the underlying mortgages or other assets are likely to occur under different scenarios. There can be no assurance that Commonwealth will be able to predict the amount of principal or interest to be paid on any security under different interest rate or market conditions or that its predictions will be accurate, nor can there be any assurance that the Portfolio will recover the entire amount of the principal paid by it to purchase any such securities. Zero-coupon bonds. The Portfolio may at times invest in so-called "zero-coupon" bonds. Zero-coupon bonds are issued at a significant discount from face value and pay interest only at maturity rather than at intervals during the life of the security. Because zero-coupon bonds do not pay current interest, their value is subject to greater fluctuation in response to changes in market interest rates than bonds that pay interest currently. Zerocoupon bonds allow an issuer to avoid the need to generate cash to meet current interest payments. Accordingly, such bonds may involve greater credit risks than bonds that pay interest currently. Even though such bonds do not pay current interest in cash, the Portfolio is nonetheless required for federal income tax purposes to accrue interest income on such investments and to distribute such amounts at least annually to shareholders. Thus, the Portfolio could be required at times to liquidate other investments in order to satisfy this distribution requirement. Premium securities. The Portfolio may at times invest in securities bearing coupon rates higher than prevailing market rates. Such "premium" securities are typically purchased at prices greater than the principal amount payable on maturity. Although the Portfolio generally amortizes the amount of any such premium into income, the Portfolio may recognize a capital loss if such premium securities are called or sold prior to maturity and the call or sale price is less than the purchase price. Additionally, the Portfolio may elect not to amortize the premium, in which case it would likely recognize a capital loss if it holds such securities to maturity and may recognize a larger loss if the security is sold or called prior to its maturity. Other investment practices and risk factors The Portfolio may engage in the other investment practices described below. See the Statement of Additional Information for a more detailed description of these practices and certain risks they may involve. Leverage. The Portfolio may borrow money to invest in additional portfolio securities to see current income. This technique, known as "leverage," increases the Portfolio's market exposure and risk. When the Portfolio has borrowed money for leverage and its investments increase or decrease in value, the Portfolio's net asset value will normally increase or decrease more than if it had not borrowed money for this purpose. The interest that the Portfolio must pay on borrowed money will reduce its net investment income, and may also either offset any potential capital gains or increase any losses. The Portfolio currently intends to use leverage in order to adjust the dollar-weighted average duration of its portfolio, and the Portfolio will not always borrow money for investment. The extent to which the Portfolio will borrow money, and the amount it may borrow, depend on market conditions and interest rates. Successful use of leverage depends on Commonwealth's ability to predict market movements correctly. The amount of leverage that can exist at any one time will not exceed 33-1/3% of the value of the Portfolio's total assets (less all liabilities of the Portfolio other than the leverage). Options and futures. The Portfolio may buy and sell call and put options on securities it owns to hedge against changes in net asset value or to realize a greater current return. In addition, through the purchase and sale of futures contracts and related options, the Portfolio may at times seek to hedge against fluctuations in net asset value and, to the extent consistent with applicable law, to increase its investment return. In addition, the Portfolio may buy and sell options and futures contracts (including index futures contracts, described below) to implement changes in its asset allocations among various market sectors, pending the sale of its existing investments and reinvestment in new securities. The Portfolio's ability to engage in options and futures strategies will depend on the availability of liquid markets in such instruments. It is impossible to predict the amount of trading interest that may exist in various types of options or futures contracts. Therefore, there is no assurance that the Portfolio will be able to utilize these instruments effectively for the purposes stated above. Although the Portfolio will only engage in options and futures transactions for limited purposes, those transactions involve certain risks which are described below and in the Statement of Additional Information. Transactions in options and futures contracts involve brokerage costs and may require the Portfolio to segregate assets to cover its outstanding positions. For more information, see "Options" and "Futures Contracts" in the Statement of Additional Information. Index futures and options. The Portfolio may buy and sell index futures contracts ("index futures") and options on index futures and on indices for hedging purposes (or may purchase warrants whose value is based on the value from time to time of one or more foreign securities indices). An "index future" is a contract to buy or sell units of a particular bond or stock index at an agreed price on a specified future date. Depending on the change in value of the index between the time when the Portfolio enters into and terminates an index futures or option transaction, the Portfolio realizes a gain or loss. The Portfolio may also, to the extent consistent with applicable law, buy and sell index futures and options to increase its investment return. Certain provisions of the Internal Revenue Code may limit the Portfolio's ability to engage in futures and options transactions. Risks related to options and futures strategies. Futures and options transactions involve costs and may result in losses. Certain risks arise because of the possibility of imperfect correlations between movements in the prices of futures and options and movements in the prices of the underlying security or index or of the securities in the Portfolio's portfolio that are the subject of a hedge. The successful use by the Portfolio of the strategies described above further depends on Commonwealth's ability to forecast market movements correctly. Other risks arise from the Portfolio's potential inability to close out futures or options positions. Although the Portfolio will enter into options or futures transactions only if Commonwealth believes that a liquid secondary market exists for such option or futures contract, there can be no assurance that the Portfolio will be able to effect closing transactions at any particular time or at an acceptable price. Transactions in options and futures contracts involve brokerage costs and may require the Portfolio to segregate assets to cover its outstanding positions. For more information, see the Statement of Additional Information. The Portfolio generally expects that its options and futures contract transactions will be conducted on recognized exchanges. In certain instances, however, the Portfolio may purchase and sell options in the over-the-counter markets. The Portfolio's ability to terminate options in the over-the-counter markets may be more limited than for exchange-traded options and may also involve the risk that securities dealers participating in such transactions would be unable to meet their obligations to the Portfolio. The Portfolio will, however, engage in over-the-counter transactions only when appropriate exchange-traded transactions are unavailable and when, in the opinion of Commonwealth, the pricing mechanism and liquidity of the over-the-counter markets are satisfactory and the participants are responsible parties likely to meet their contractual obligations. The Portfolio will not purchase futures or options on futures or sell futures if as a result the sum of the initial margin deposits on the Portfolio's existing futures positions and premiums paid for outstanding options on futures contracts would exceed 5% of the Portfolio's assets. (For options that are "in-the-money" at the time of purchase, the amount by which the option is "in-the-money" is excluded from this calculation.) Securities loans, repurchase agreements, forward commitments, and reverse repurchase agreements. The Portfolio may lend portfolio securities amounting to not more than 25% of its assets to broker-dealers and may enter into repurchase agreements on up to 25% of its assets. These transactions must be fully collateralized at all times, but involve some risk to the Portfolio if the other party should default on its obligations and the Portfolio is delayed or prevented from recovering the collateral. The Portfolio may also purchase securities for future delivery. The Portfolio may also enter into "reverse" repurchase agreements and "dollar-roll" transactions, which generally involve the sale by the Portfolio of securities held by it and an agreement to repurchase the securities (or, in the case of dollar rolls, similar securities), at an agreed-upon price, date and interest payment. Reverse repurchase agreements, dollar-roll transactions, and forward commitments may increase the Portfolio's overall investment exposure and may result in losses. Foreign securities. The Portfolio may invest in securities principally traded in foreign markets. Since foreign securities are normally denominated and traded in foreign currencies, the values of the Portfolio's assets may be affected favorably or unfavorably by currency exchange rates and exchange control regulations. There may be less information publicly available about a foreign company than about a U.S. company, and foreign companies are not generally subject to accounting, auditing, and financial reporting standards and practices comparable to those in the United States. The securities of some foreign companies are less liquid and at times more volatile than securities of comparable U.S. companies. Foreign brokerage commissions and other fees are also generally higher than in the United States. Foreign settlement procedures and trade regulations may involve certain risks (such as delay in payment or delivery of securities or in the recovery of the Portfolio's assets held abroad) and expenses not present in the settlement of domestic investments. In addition, there may be a possibility of nationalization or expropriation of assets, imposition of currency exchange controls, confiscatory taxation, political or financial instability, and diplomatic developments which could affect the value of the Portfolio's investments in certain foreign countries. Legal remedies available to investors in certain foreign countries may be more limited than those available with respect to investments in the United States or in other foreign countries. In the case of securities issued by a foreign governmental entity, the issuer may in certain circumstances be unable or unwilling to meet its obligations on the securities in accordance with their terms, and the Portfolio may have limited recourse available to it in the event of default. The laws of some foreign countries may limit the Portfolio's ability to invest in securities of certain issuers located in those foreign countries. Special tax considerations apply to foreign securities. The Portfolio may buy or sell foreign currencies and options and futures contracts on foreign currencies for hedging purposes in connection with its foreign investments. Interest rate transactions. In order to attempt to protect the value of the Portfolio's portfolio from interest rate fluctuations and to adjust the interest-rate sensitivity of the Portfolio's portfolio, the Portfolio may enter into interest rate swaps and other interest rate transactions, such as interest rate caps, floors, and collars. Interest rate swaps involve the exchange by the Portfolio with another party of different types of interest rate streams (e.g., an exchange of floating rate payments for fixed rate payments with respect to a notional amount of principal). The purchase of an interest rate cap entitles the purchaser to receive payments on a notional principal amount from the party selling the cap to the extent that a specified index exceeds a predetermined interest rate or amount. The purchase of a floor entitles the purchaser to receive payments on a notional principal amount from the party selling the floor to the extent that a specified index falls below a predetermined interest rate or amount. A collar is a combination of a cap and a floor that preserves a certain return within a predetermined range of interest rates or values. The Portfolio intends to use these interest rate transactions as a hedge and not as a speculative investment. The Portfolio's ability to engage in certain interest rate transactions may be limited by tax considerations. The use of interest rate swaps and other interest rate transactions is a highly specialized activity which involves investment techniques and risks different from those associated with ordinary portfolio securities transactions. If Commonwealth is incorrect in its forecasts of market values, interest rates, or other applicable factors, the investment performance of the Portfolio would be less favorable than what it would have been if this investment technique were not used. The Trustees of the Trust are responsible for generally overseeing the conduct of the Trust's and the Portfolio's business. Commonwealth Investment Counsel, Inc., located at 901 East Byrd Street, Richmond, Virginia 23219, acts as investment adviser to the Portfolio. Mentor Investment Group, Inc. serves as administrator to the Portfolio. As compensation for its services as administrator, the Portfolio pays Mentor a fee, accrued daily and paid monthly, at an annual rate of .10% of the average value of the Portfolio's daily assets. In order to limit the Portfolio's expenses, Mentor has agreed to waive its fee for the current fiscal year. Commonwealth is a wholly-owned subsidiary of Mentor, which is a wholly-owned subsidiary of Wheat First Butcher Singer, Inc. ("WFBS"). WFBS, through other subsidiaries, also engages in securities brokerage, investment banking, and related businesses. Commonwealth currently has assets under management in excess of $4 billion, and serves as investment adviser to Cash Resource Trust and certain portfolios of Mentor Institutional Trust, both open-end investment companies, and Mentor Income Fund, Inc., a closed-end investment company, and the Mentor Capital Growth, Mentor Quality Income, and Mentor Short-Duration Income Portfolios of The Mentor Funds. Subject to the general oversight of the Trustees, Commonwealth, as investment adviser, manages the Portfolio's securities in accordance with the stated policies of the Portfolio. Commonwealth makes investment decisions for the Portfolio and places the purchase and sale orders for the Portfolio's portfolio transactions. In addition, Commonwealth pays the salaries of all officers and employees who are employed by both it and the Trust. The Portfolio pays all expenses not assumed by Commonwealth or Mentor, including, among other things, Trustee's fees, auditing, legal, accounting, custodial, investor servicing, and shareholder reporting expenses, and payments under its Plans of Distribution. All investment decisions made for the Portfolio are made by an investment committee at Commonwealth made up of investment professionals at Commonwealth. Commonwealth places all orders for purchases and sales of the Portfolio's securities. In selecting broker-dealers, Commonwealth may consider research and brokerage services furnished to it and its affiliates. Subject to seeking the best overall terms available, Commonwealth may consider sales of shares of the Portfolio (and, if permitted by law, of the other funds in the Mentor family) as a factor in the selection of broker-dealers. The length of time the Portfolio has held a particular security is not generally a consideration in investment decisions. A change in the securities held by the Portfolio is known as "portfolio turnover." As a result of the Portfolio's investment policies, under certain market conditions the Portfolio's portfolio turnover rate may be higher than that of other mutual Portfolios. Portfolio turnover generally involves some expense to the Portfolio, including brokerage commissions or dealer mark-ups and other transaction costs on the sale of securities and reinvestment in other securities. Such transactions may result in realization of taxable capital gains. The Portfolio's portfolio turnover rate for its first fiscal year is shown in the section "Financial Highlights." The Portfolio calculates the net asset value of its shares by dividing the total value of its assets, less liabilities, by the number of its shares outstanding. Shares are valued as of the close of regular trading on the New York Stock Exchange each day the Exchange is open. Portfolio securities for which market quotations are readily available are stated at market value. Short-term investments that will mature in 60 days or less are stated at amortized cost, which approximates market value. All other securities and assets are valued at their fair values. You can open a Portfolio account with as little as $1,000 and make additional investments at any time with as little at $100. Investments under IRAs and investments under qualified retirement plans are subject to a minimum initial investment of $250. The minimum initial investment may be waived for current and retired Trustees, and current and retired employees of The Mentor Funds or Mentor Distributors. You can buy Portfolio shares from Mentor Distributors by check or money order, through your financial institution, which may be an investment dealer, a bank, or another institution, or through automatic investing. If you do not have a dealer, Mentor Distributors can refer you to one. Automatic Investment Plan. Once you have made the initial minimum investment in a Portfolio, you can make regular investments of $50 or on a monthly or quarterly basis through automatic deductions from your bank checking account. Application forms are available from your investment dealer or through Mentor Distributors. Shares are sold at a price based on a Portfolio's net asset value next determined after Mentor Distributors receives your purchase order. In most cases, in order to receive that day's public offering price, Mentor Distributors or your investment dealer must receive your order before the close of regular trading on the New York Stock Exchange. If you buy shares through your investment dealer, the dealer must receive your order before the close of regular trading on the New York Stock Exchange to receive that day's public offering service. Shares of the Portfolio are sold without an initial sales charge, although a contingent deferred sales charge ("CDSC") will be imposed if you redeem shares within five years of purchase. The following types of shares may be redeemed without charge: (i) shares acquired by reinvestment of distributions and (ii) shares otherwise exempt from the CDSC, as described above. For other shares, the amount of the charge is determined as a percentage of the lesser of the current market value or the cost of the shares being redeemed. The amount of the CDSC will depend on the number of years since you invested and the dollar amount being redeemed, according to the following table: Year Since Charge as a Percentage of Purchase Payment Made Applicable Amount Redeemed No CDSC is imposed upon the redemption of shares purchased pursuant to certain asset-allocation plans and that are not otherwise subject to the CDSC shown above. However, a CDSC of 1.00% is imposed on redemptions of such shares within the first year after purchase, based on the lower of the shares' cost and current net asset value. Consult Mentor Distributors for more information. Any of the shares being redeemed which were acquired by reinvestment of distributions will be redeemed without a CDSC, and amounts representing capital appreciation will not be subject to a CDSC. In determining whether a CDSC is payable in respect of the shares redeemed, the Portfolio will first redeem shares not subject to any charge. For this purpose, the amount of any increase in a share's value above its initial purchase price is exempt from the CDSC. Thus, when a share that has appreciated in value is redeemed during the five- or six-year period, a CDSC is assessed only on its initial purchase price. For information on how sales charges are calculated if you exchange your shares, see "How to Exchange Shares." Mentor Distributors receives the entire amount of any CDSC you pay. Consult Mentor Distributors for more information. You have purchased 100 shares at $10 per share. The second year after your purchase, your investment's net asset value per share has increased by $2 to $12, and you have gained 10 additional shares through dividend reinvestment. If you redeem 50 of those shares (including shares purchased through reinvestment of distributions on those 100 shares) at this time, your CDSC will be calculated as follows: The Portfolio may waive the CDSC on shares redeemed by the Trust's current and retired Trustees (and their families), current and retired employees (and their families) of Mentor Distributors, Commonwealth, each their affiliates, registered representatives and other employees (and their families) of broker-dealers having sales agreements with Mentor Distributors, employees (and their families) of financial institutions having sales agreements with Mentor Distributors (or otherwise having an arrangement with a broker-dealer or financial institution with respect to sales of Portfolio shares), financial institution trust departments investing an aggregate of $1 million or more in one or more funds in the Mentor family, clients of certain administrators of tax-qualified plans, employer-sponsored retirement plans, tax-qualified plans when proceeds from repayments of loans to participants are invested (or reinvested) in funds in the Mentor family, shares redeemed under the Portfolio's Systematic Withdrawal Plan (limited to 10% of a shareholder's account in any calendar year), and "wrap accounts" for the benefit of clients of financial planners adhering to certain standards established by Mentor Distributors. In addition, the Portfolio may sell shares without a CDSC in connection with the acquisition by the Portfolio of assets of an investment company or personal holding company. In addition, the CDSC may be waived in the case of (i) redemptions of shares held at the time a shareholder dies or becomes disabled, including the shares of a shareholder who owns the shares with his or her spouse as joint tenants with right of survivorship, provided that the redemption is requested within one year of the death or initial determination of disability; (ii) redemptions in connection with the following retirement plan distributions: (a) lump-sum or other distributions from a qualified retirement plan following retirement; (b) distributions from an IRA, Keogh Plan, or Custodial Account under Section 403(b)(7) of the Internal Revenue Code following attainment of age 59 1/2; and (c) a tax-free return of an excess contribution to an IRA; (iii) redemptions by pension or profit sharing plans sponsored by Mentor or an affiliate; and (iv) redemptions by pension or profit sharing plans of which Mentor or any affiliate serves as a plan fiduciary. If you are considering redeeming or exchanging shares of the Portfolio or transferring shares to another person shortly after purchase, you should pay for those shares with a certified check to avoid any delay in redemption, exchange or transfer. Otherwise the Portfolio may delay payment until the purchase price of those shares has been collected or, if you redeem by telephone, until 15 calendar days after the purchase date. To eliminate the need for safekeeping, the Trust will not issue certificates for your shares unless you request them. Mentor Distributors may, at its expense, provide additional promotional incentives or payments to dealers that sell shares of the Portfolios. In some instances, these incentives or payments may be offered only to certain dealers who have sold or may sell significant amounts of shares. Certain dealers may not sell all classes of shares. Because of the relatively high cost of maintaining accounts, the Portfolio reserves the right to redeem, upon not less than 60 days' notice, any account below $500 as a result of redemptions. A shareholder may, however, avoid such a redemption by the Portfolio by increasing his investment in shares to a value of $500 or more during such 60-day period. Reinvestment Privilege. If you redeem shares of the Portfolio, you have a one-time right, within 60 days, to reinvest the redemption proceeds plus the amount of CDSC you paid, if any, at the next-determined net asset value. Mentor Distributors must be notified in writing by you or by your financial institution of the reinvestment for you to recover the CDSC. If you redeem shares in the Portfolio, there may be tax consequences. You can sell your shares in the Portfolio to the Portfolio any day the New York Stock Exchange is open, either directly to the Portfolio or through your investment dealer. The Portfolio will only redeem shares for which it has received payment. Selling shares directly to the Portfolio. Send a signed letter of instruction or stock power form, along with any certificates that represent shares you want to sell to The Mentor Funds, c/o Boston Financial Data Services, Inc. ("BFDS"), 2 Heritage Drive, North Quincy, Massachusetts 02171. The price you will receive is the next net asset value calculated after your request is received in proper form less any applicable CDSC. In order to receive that day's net asset value, your request must be received before the close of regular trading on the New York Stock Exchange. If you sell shares having a net asset value of $50,000 or more or if you want your redemption proceeds payable to you at a different address or to someone else, the signatures of registered owners or their legal representatives must be guaranteed by a bank, broker-dealer or certain other financial institutions. See the Statement for more information about where to obtain a signature guarantee. Stock power forms are available from your investment dealer, Mentor Distributors and many commercial banks. Mentor Distributors usually requires additional documentation for the sale of shares by a corporation, partnership, agent or fiduciary, or surviving joint owner. Contact Mentor Distributors for details. Selling shares by telephone. You may use Mentor Distributors Telephone Redemption Privilege to redeem shares from your account unless you have notified Mentor Distributors of an address change within the preceding 15 days. Unless an investor indicates otherwise on the New Account Form, Mentor Distributors will be authorized to act upon redemption and transfer instructions received by telephone from a shareholder, or any person claiming to act as his or her representative, who can provide Mentor Distributors with his or her account registration and address as it appears on Mentor Distributors' records. Mentor Distributors will employ these and other reasonable procedures to confirm that instructions communicated by telephone are genuine; if it fails to employ reasonable procedures, Mentor Distributors may be liable for any losses due to unauthorized or fraudulent instructions. For information, consult Mentor Distributors. During periods of unusual market changes and shareholder activity, you may experience delays in contacting Mentor Distributors by telephone in which case you may wish to submit a written redemption request, as described above, or contact your investment dealer, as described below. The Telephone Redemption Privilege may be modified or terminated without notice. Selling share through your investment dealer. Your dealer must receive your request before the close of regular trading on the New York Stock Exchange to receive that day's net asset value. Your dealer will be responsible for furnishing all necessary documentation to Mentor Distributors, and may charge you for its services. The Portfolio generally sends you payment for your shares the business day after your request is received. Under unusual circumstances, the Portfolio may suspend redemptions, or postpone payment for more than seven days, as permitted by federal securities law. Systematic Withdrawal Program. You may redeem shares of a Portfolio through periodic withdrawals for a predetermined amount. Only shareholders with accounts valued at $10,000 or more are eligible to participate. Shares redeemed under the Systematic Withdrawal program are not subject to a CDSC, but the aggregate withdrawals of shares in any year are limited to 10% of the value of the account at the time of enrollment. Contact Mentor Distributors for more information. Except as otherwise described below, you can exchange your shares in the Portfolio worth at least $1,000 for shares of the same class of certain other funds in the Mentor family at net asset value beginning 15 days after purchase. You may also exchange shares of the Portfolio for shares of Cash Resource U.S. Government Money Market Fund the ("Cash Fund"). If you exchange shares subject to a CDSC, the transaction will not be subject to the CDSC. However, when you redeem the shares acquired through the exchange, the redemption may be subject to the CDSC, depending upon when you originally purchased the shares, using the schedule of any Portfolio into or from which you have exchanged your shares that would result in your paying the highest CDSC applicable to your shares. For purposes of computing the CDSC, the length of time you have owned your shares will be measured from the date of original purchase and will not be affected by any exchange. (If you exchange your shares for shares of the Cash Fund, the period when you hold shares of the Cash Fund will be included in calculating the length of time you have owned the shares subject to the CDSC; alternatively, Mentor Distributors may elect not to include the length of time you hold shares of the Cash Fund, in which case any CDSC payable on redemption of your shares will be reduced by the amount of any payment collected by the Cash Fund under its distribution plan in respect of those shares. Contact Mentor Distributors for information.) To exchange your shares, simply complete an Exchange Authorization Form and send it to The Mentor Funds, c/o BFDS, 2 Heritage Drive, North Quincy, Massachusetts 02171. Exchange Authorization Forms are available by calling or writing Mentor Distributors. For federal income tax purposes, an exchange is treated as a sale of shares and generally results in a capital gain or loss. A Telephone Exchange Privilege is currently available. Mentor Distributors' procedures for telephonic transactions are described above under "How to sell shares." The Telephone Exchange Privilege is not available if you were issued certificates for shares which remain outstanding. Ask your investment dealer or Mentor Distributors for a prospectus of the Mentor Family of Funds which relates to the other Portfolios or a prospectus relating to Cash Resource U.S. Government Money Market Fund. Shares of certain of the Portfolios may not available to residents of all states. The exchange privilege is not intended as a vehicle for short-term trading. Excessive exchange activity may interfere with portfolio management and have an adverse effect on all shareholders. In order to limit excessive exchange activity and in other circumstances where Mentor Distributions or the Trustees believe doing so would be in the best interests of the Fund, the Portfolio reserves the right to revise or terminate the exchange privilege, limit the amount or number of exchanges or reject any exchange. Shareholders would be notified of any such action to the extent required by law. Consult Mentor Distributors before requesting an exchange by calling 1-800-382-0016. See the Statement of Additional Information to find out more about the exchange privilege. Exchanges to and from the Portfolio are not available at the date of this Prospectus. Consult Mentor Distributors as to the availability of such exchanges in the future. Dividends, if any, are declared and paid semi-annually. Any next realized capital gain will be distributed at least annually. All dividends and distributions will be invested in additional shares unless a shareholder requests in writing to receive the dividend or distribution in cash. The Portfolio intends to qualify as a "regulated investment company" for federal income tax purposes and to meet all other requirements that are necessary for it to be relieved of federal taxes on income and gains it distributes to shareholders. All Portfolio distributions will be taxable to you as ordinary income, except that any distributions of net long-term capital gains will be taxed as such, regardless of how long you have held the shares (although the loss on a sale of shares held for less than six months will be treated as long-term capital loss to the extent of any capital gain distribution received with respect to those shares). Distributions will be taxable as described above whether received in cash or in shares through the reinvestment of distributions. Early in each year the Mentor Family of Funds will notify you of the amount and tax status of distributions paid to you by the Portfolio for the preceding year. The foregoing is a summary of certain federal income tax consequences of investing in the Portfolio. You should consult your tax adviser to determine the precise effect of an investment in the Portfolio on your particular tax situation. The Portfolio has agreed to indemnify Mentor Distributors against certain liabilities, including liabilities under the Securities Act of 1933, as amended. The Mentor Funds has adopted a Shareholder Servicing Plan (the "Service Plan") with respect to the Portfolio. Under the Service Plan, financial institutions will enter into shareholder service agreements with the Portfolio to provide administrative support services to their customers who are Portfolio shareholders. In return for providing these support services, a financial institution may receive payments from the Portfolios at a rate not exceeding 0.25% of the average daily net assets of the Portfolio. These administrative services may include, but are not limited to, the following functions; providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer personnel, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding the Portfolio; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Portfolio reasonably requests. In addition to receiving payments under the Service Plan, financial institutions may be compensated by Commonwealth and/or The Mentor Funds, or affiliates thereof, for providing administrative support services to holders of the Portfolio's shares. These payments will be made directly by Commonwealth and/or The Mentor Funds and will not be made from the assets of the Portfolio. The Mentor Funds is a Massachusetts business trust organized on January 20, 1992. A copy of the Declaration of Trust, which is governed by Massachusetts law, is on file with the Secretary of State of The Commonwealth of Massachusetts. The Mentor Funds is an open-end, diversified, series management investment company with an unlimited number of authorized shares of beneficial interest. Shares of The Mentor Funds may, without shareholder approval, be divided into two or more series of shares representing separate investment portfolios. Any such series of shares may be further divided without shareholder approval into two or more classes of shares having such preferences and special or relative rights and privileges as the Trustees determine. The Mentor Funds' shares are currently divided into nine series, one representing the Portfolio, the others representing other Portfolios with varying investment objectives and policies. Each share has one vote, with fractional shares voting proportionally. Shares of each class will vote together as a single class except when required by law or determined by the Trustees. Shares of the Portfolio are freely transferable, are entitled to dividends as declared by the Trustees, and, if the Portfolio were liquidated, would receive the net assets of the Portfolio. The Mentor Funds may suspend the sale of shares at any time and may refuse any order to purchase shares. Although The Mentor Funds is not required to hold annual meetings of its shareholders, shareholders have the right to call a meeting to elect or remove Trustees, or to take other actions as provided in the Declaration of Trust. In the interest of economy and convenience, the Portfolio will not issue certificates for its shares except at the shareholder's request. For additional information concerning the Mentor Family of Funds or any of its Portfolios being offered for sale, contact Mentor Distributors, by calling 1-800-382-0016 or writing to Mentor Distributors at 901 East Byrd Street, Richmond, Virginia 23219. Custodian and transfer and dividend agent Investors Fiduciary Trust Company, 127 West 10th Street, Kansas City, Missouri 64105, serves as the Portfolio's custodian. Boston Financial Data Services, Inc. serves as the Portfolio's transfer and dividend agent. Yield and total return data may from time to time be included in advertisements about the Portfolio. The Portfolio's "yield" is calculated by dividing the Portfolio's annualized net investment income per share of the class during a recent 30-day period by the maximum public offering price per share on the last day of that period. A "total return" for the one, five- and ten-year periods (or for the life of the Portfolio, if shorter) through the most recent calendar quarter represents the average annual compounded rate of return on an investment of $1,000 in the Portfolio reflecting the deduction of any applicable contingent deferred sales charge. Total return may also be presented for other periods or based on investment at reduced sales charge levels or at net asset value. Any quotation of investment performance not reflecting the contingent deferred sales charge would be reduced if such sales charges were used. Quotations of yield or total return for any period when an expense limitation was in effect will be greater than if the limitation had not been in effect. The Portfolio's performance may be compared to various indices. See the Statement of Additional Information. Information may be presented in advertisements about the Portfolio describing the background and professional experience of Commonwealth or any of its personnel. All data are based on the Portfolio's past investment results and do not predict future performance. Investment performance, which will vary, is based on many factors, including market conditions, the composition of the Portfolio's securities, and the Portfolio's operating expenses. Investment performance also often reflects the risks associated with the Portfolio's investment objective and policies. These factors should be considered when comparing the Portfolio's investment results to those of other mutual funds and other investment vehicles. No person has been authorized to give any information or to make any representations other than those contained in this Prospectus and in the Portfolio's official sales literature in connection with the offer of the Portfolio's shares, and, if given or made, such other information or representations must not be relied upon as having been authorized by the Portfolio. This Prospectus does not constitute an offer in any State in which, or to any person to whom, such offering may not lawfully be made. This Prospectus omits certain information contained in the Registration Statement, to which reference is made, filed with the Securities and Exchange Commission. Items which are thus omitted, including contracts and other documents referred to or summarized herein, may be obtained from the Commission upon payment of the prescribed fees. Additional information concerning the secu rities offered hereby and the Portfolio is to be found in the Registration Statement, including various exhibits thereto and financial statements included or incorporated therein, which may be inspected at the office of the Commission. The Mentor Funds (the "Trust") is a diversified, open-end series investment company. This Statement of Additional Information is not a prospectus and should be read in conjunction with the prospectus of the Trust dated January 15, 1996 and the prospectus of Mentor Balanced Portfolio dated January 15, 1996. A copy of either prospectus can be obtained upon request by writing to Mentor Distributors, Inc., the Trust's distributor, at P.O. Box 1357, Richmond, Virginia 23286-0109, or by calling Mentor Distributors at 1-800-382-0016. This Statement is in three parts. Part I contains information with respect to Mentor Capital Growth Portfolio, Mentor Quality Income Portfolio, Mentor Municipal Income Portfolio, Mentor Income and Growth Portfolio, and Mentor Perpetual Global Portfolio. Part II contains information with respect to Mentor Growth Portfolio, Mentor Strategy Portfolio, Mentor ShortDuration Income Portfolio, and Mentor Balanced Portfolio, which are the successors to Mentor Growth Fund, Mentor Strategy Fund, Mentor Short-Duration Income Fund, and Mentor Balanced Fund, respectively, each of which was previously a series of shares of Mentor Series Trust, a diversified, open-end series investment company. Part III provides general information with respect to the Trust and all of the Portfolios. CERTAIN INVESTMENT TECHNIQUES ............................................. 10 MANAGEMENT OF THE TRUST.................................................... 31 HOW TO BUY SHARES.......................................................... 42 DETERMINING NET ASSET VALUE................................................ 45 The Mentor Funds is a Massachusetts business trust organized on January 20, 1992. As of the date of this Statement, the Trust consisted of the following nine portfolios (collectively, the "Portfolios" and each individually, the "Portfolio"): Mentor Balanced Portfolio (the "Balanced Portfolio"); Mentor Capital Growth Portfolio (the "Capital Growth Portfolio"); Mentor Perpetual Global Portfolio (the "Global Portfolio"); Mentor Income and Growth Portfolio (the "Income and Growth Portfolio"); Mentor Municipal Income Portfolio (the "Municipal Income Portfolio"); Mentor Short-Duration Income Portfolio (the "Short-Duration Income Portfolio"); and Mentor Strategy Portfolio (the "Strategy Portfolio"). With the exception of the Balanced Portfolio, which has only one class of shares, each Portfolio has two classes of shares of beneficial interest, Class A shares and Class B shares. With respect to the investment restrictions described below, all percentage limitations on investments will apply at the time of investment and shall not be considered violated unless an excess or deficiency occurs or exists immediately after and as a result of such investment. Except for the investment restrictions listed below as fundamental or to the extent designated as such in the Prospectus in respect of a Portfolio, the other investment policies described in this Statement or in the Prospectus are not fundamental and may be changed by approval of the Trustees. As a matter of policy, the Trustees would not materially change a Portfolio's investment objective without shareholder approval. The Investment Company Act of 1940, as amended (the "1940 Act"), provides that a "vote of a majority of the outstanding voting securities" of a Portfolio means the affirmative vote of the lesser of (1) more than 50% of the outstanding shares of the Portfolio, or (2) 67% or more of the shares present at a meeting if more than 50% of the outstanding shares are represented at the meeting in person or by proxy. THE FOLLOWING INFORMATION RELATES TO EACH OF THE CAPITAL GROWTH, QUALITY INCOME, MUNICIPAL INCOME, INCOME AND GROWTH, AND THE GLOBAL PORTFOLIOS, EXCEPT WHERE OTHERWISE NOTED. The following investment restrictions are fundamental and may not be changed without approval by the holders of a majority of the outstanding securities of a Portfolio: 1. The Portfolios will not issue senior securities except that a Portfolio (other than the Municipal Income Portfolio) may borrow money directly or through reverse repurchase agreements in amounts of up to one-third of the value of its net assets, including the amount borrowed; and except to the extent that a Portfolio may enter into futures contracts. The Municipal Income Portfolio may borrow money from banks for temporary purposes in amounts of up to 5% of its total assets. The Portfolios will not borrow money or engage in reverse repurchase agreements for investment leverage, but rather as a temporary, extraordinary, or emergency measure or to facilitate management of the Portfolio by enabling it to meet redemption requests when the liquidation of portfolio securities is deemed to be inconvenient or disadvantageous. The Portfolios will not purchase any securities while any borrowings in excess of 5% of its total assets are outstanding. During the period any reverse repurchase agreements are outstanding, the Quality Income Portfolio will restrict the purchase of portfolio securities to money market instruments maturing on or before the expiration date of the reverse repurchase agreements, but only to the extent necessary to assure completion of the reverse repurchase agreements. Notwithstanding this restriction, the Portfolios may enter into when-issued and delayed delivery transactions. 2. The Portfolios will not sell any securities short or purchase any securities on margin, but may obtain such short-term credits as are necessary for clearance of purchases and sales of securities. The deposit or payment by a Portfolio of initial or variation margin in connection with futures contracts or related options transactions is not considered the purchase of a security on margin. 3. The Portfolios will not mortgage, pledge, or hypothecate any assets, except to secure permitted borrowings. In these cases the Portfolios may pledge assets having a value of 10% of assets taken at cost. For purposes of this restriction, (a) the deposit of assets in escrow in connection with the writing of covered put or call options and the purchase of securities on a when-issued basis; and (b) collateral arrangements with respect to (i) the purchase and sale of stock options (and options on stock indexes) and (ii) initial or variation margin for futures contracts, will not be deemed to be pledges of a Portfolio's assets. Margin deposits for the purchase and sale of futures contracts and related options are not deemed to be a pledge. 4. The Portfolios will not lend any of their respective assets except portfolio securities up to one-third of the value of total assets. (The Municipal Income Portfolio will not lend portfolio securities.) This shall not prevent a Portfolio from purchasing or holding U.S. government obligations, money market instruments, variable amount demand master notes, bonds, debentures, notes, certificates of indebtedness, or other debt securities, entering into repurchase agreements, or engaging in other transactions where permitted by a Portfolio's investment objective, policies and limitations or Declaration of Trust. The Municipal Income Portfolio will not make loans except to the extent the obligations the Portfolio may invest in are considered to be loans. 5. The Portfolios (other than the Quality Income Portfolio) will not invest more than 10% of the value of their net assets in restricted securities; the Quality Income Portfolio will not invest more than 15% of the value of its net assets in restricted securities. 6. None of the Portfolios will invest in commodities, except to the extent that the Portfolios may engage in transactions involving futures contracts or options on futures contracts, and except to the extent the securities the Municipal Income Portfolio invests in are considered interests in commodities or commodities contracts or to the extent the Portfolio exercises its rights under agreements relating to such municipal securities. 7. None of the Portfolios will purchase or sell real estate, including limited partnership interests, except to the extent the securities the Income and Growth Portfolio and Municipal Income Portfolio may invest in are considered to be interests in real estate or to the extent the Municipal Income Portfolio exercises its rights under agreements relating to such municipal securities (in which case the Portfolio may liquidate real estate acquired as a result of a default on a mortgage), although the Portfolios may invest in securities of issuers whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. 8. With respect to 75% of the value of its respective total assets, a Portfolio will not purchase securities issued by any one issuer (other than cash or securities issued or guaranteed by the government of the United States or its agencies or instrumentalities and repurchase agreements collateralized by such securities), if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. A Portfolio will not acquire more than 10% of the outstanding voting securities of any one issuer. 9. A Portfolio will not invest 25% or more of the value of its respective total assets in any one industry (other than securities issued by the U.S. Government, its agencies or instrumentalities). As described in the Trust's Prospectus, the Municipal Income Portfolio may from time to time invest more than 25% of its assets in a particular segment of the municipal bond market; however, that Portfolio will not invest more than 25% of its assets in industrial development bonds in a single industry except as described in the Trust's Prospectus. 10. A Portfolio will not underwrite any issue of securities, except as a Portfolio may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. In addition, the following practices are contrary to the current policy of each of the Portfolios (except as otherwise noted), and may be changed without shareholder approval. Shareholders will be notified before any material change in these limitations becomes effective. 1. The Portfolios will not invest more than 15% of the value of their respective net assets in illiquid securities, including repurchase agreements providing for settlement more than seven days after notice; over-the-counter options; certain restricted securities not determined by the Trustees to be liquid; and non-negotiable fixed income time deposits with maturities over seven days. 2. The Portfolios will limit their respective investments in other investment companies to no more than 3% of the total outstanding voting stock of any investment company, invest no more than 5% of total assets in any one investment company, or invest more than 10% of total assets in investment companies in general. The Portfolios will purchase securities of closed-end investment companies only in open market transactions involving only customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, reorganization, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by a Portfolio in shares of another investment company would be subject to duplicative expenses. 3. Except for the Municipal Income Portfolio, no Portfolio will invest more than 5% of the value of its respective total assets in securities of issuers which have records of less than three years of continuous operations, including the operation of any predecessor. The Municipal Income Portfolio will not invest more than 5% of its total assets in industrial development bonds where the payment of principal and interest is the responsibility of companies with less than three years of operating history. 4. A Portfolio will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust, the investment adviser, or sub-adviser own individually more than 1/2 of 1% of the issuer's securities or together own more than 5% of the issuer's securities. 5. A Portfolio will not purchase interests in oil, gas, or other mineral exploration or development programs or leases, except it may purchase the securities of issuers which invest in or sponsor such programs and except pursuant to the exercise by the Municipal Income Portfolio of its rights under agreements relating to municipal securities 6. A Portfolio will not enter into transactions for the purpose of engaging in arbitrage. 7. A Portfolio will not purchase securities of a company for the purpose of exercising control or management, except to the extent that exercise by the Municipal Income Portfolio of its rights under agreements related to municipal securities would be deemed to constitute such control or management. None of the Portfolios (except for the Quality Income and Short-Duration Income Portfolios) borrowed money (including through use of reverse repurchase agreements) or loaned portfolio securities in excess of 5% of the value of its net assets during the last fiscal year, and no Portfolio (except for the Quality Income and Short-Duration Income Portfolios) has the intention of doing so in the coming fiscal year. The Portfolios (1) will limit the aggregate value of the assets underlying covered call options or put options written by a Portfolio to not more than 25% of its net assets, (2) will limit the premiums paid for options purchased by a Portfolio to 5% of its net assets, (3) will limit the margin deposits on futures contracts entered into by a Portfolio to 5% of its net assets, and (4) will limit investment in warrants to 5% of its net assets to meet certain state registration requirements. No more than 2% will be warrants which are not listed on the New York or American Stock Exchange. Also, the Capital Growth Portfolio and the Income and Growth Portfolio will limit their investment in restricted securities to 5% of total assets. (If state requirements change, these restrictions may be revised without shareholder THE FOLLOWING INFORMATION RELATES TO EACH OF THE BALANCED, GROWTH, SHORT-DURATION INCOME, AND STRATEGY PORTFOLIOS, EXCEPT WHERE OTHERWISE NOTED. As fundamental investment restrictions, which may not be changed with respect to a Portfolio without approval by the holders of a majority of the outstanding shares of that Portfolio, a Portfolio may not: 1. Issue any securities which are senior to the Portfolio's shares as described herein and in the relevant prospectus, except that each of the Portfolios other than the Growth Portfolio and the Strategy Portfolio may borrow money to the extent contemplated by Restriction 4 below. 2. Purchase securities on margin (but a Portfolio may obtain such short-term credits as may be necessary for the clearance of transactions). (Margin payments in connection with transactions in futures contracts, options, and other financial instruments are not considered to constitute the purchase of securities on margin for this 3. Make short sales of securities or maintain a short position, unless at all times when a short position is open, it owns an equal amount of such securities or securities convertible into or exchangeable, without payment of any further consideration, for securities of the same issue as, and equal in amount to, the securities sold short ("short sale against-the-box"), and unless not more than 25% of the Portfolio's net assets (taken at current value) is held as collateral for such sales at any one time. 4. (Growth Portfolio and Strategy Portfolio) Borrow money or pledge its assets except that a Portfolio may borrow from banks for temporary or emergency purposes (including the meeting of redemption requests which might otherwise require the untimely disposition of securities) in amounts not exceeding 10% (taken at the lower of cost or market value) of its total assets (not including the amount borrowed) and pledge its assets to secure such borrowings; provided that a Portfolio will not purchase additional portfolio securities when such borrowings exceed 5% of its total assets. (Collateral or margin arrangements with respect to options, futures contracts, or other financial instruments are not (all other Portfolios) Borrow more than 33 1/3% of the value of its total assets less all liabilities and indebtedness (other than such borrowings) not represented by senior securities. 5. Act as underwriter of securities of other issuers except to the extent that, in connection with the disposition of portfolio securities, it may be deemed to be an underwriter under certain federal securities laws. 6. Purchase any security if as a result the Portfolio would then have more than 5% of its total assets (taken at current value) invested in securities of companies (including predecessors) less than three years old or (in the case of Growth Portfolio) in equity securities for which market quotations are not readily available. 7. (as to the Growth Portfolio only) Purchase any security if as a result the Portfolio would then hold more than 10% of any class of securities of an issuer (taking all common stock issues of an issuer as a single class, all preferred stock issues as a single class, and all debt issues as a single class) or more than 10% of the outstanding voting securities of an issuer. 8. Purchase any security (other than obligations of the U.S. Government, its agencies or instrumentalities) if as a result: (i) more than 5% of the Portfolio's total assets (taken at current value) would then be invested in securities of a single issuer, or (ii) more than 25% of the Portfolio's total assets (taken at current value) would be invested in a single industry; provided that the restriction set out in (i) above shall apply, in the case of each Portfolio other than the Growth Portfolio, only as to 75% of such Portfolio's total assets. 9. Invest in securities of any issuer if, to the knowledge of the Trust, any officer or Trustee of the Trust or of Charter, Commonwealth or Wellesley, as the case may be, owns more than 1/2 of 1% of the outstanding securities of such issuer, and such officers and Trustees who own more than 1/2 of 1% own in the aggregate more than 5% of the outstanding securities of such issuer. 10. Purchase or sell real estate or interests in real estate, including real estate mortgage loans, although it may purchase and sell securities which are secured by real estate and securities of companies that invest or deal in real estate (or, in the case of any Portfolio other than the Growth Portfolio, real estate or limited partnership interests). (For purposes of this restriction, investments by a Portfolio in mortgage-backed securities and other securities representing interests in mortgage pools shall not constitute the purchase or sale of real estate or interests in real estate or real 11. Make investments for the purpose of exercising control or management. 12. (as to the Growth Portfolio only) Participate on a joint or a joint and several basis in any trading account in securities. 13. (as to the Growth Portfolio only) Purchase any security restricted as to disposition under federal securities laws if as a result more than 5% of the Portfolio's total assets (taken at current value) would be invested in restricted securities. 14. (as to the Growth Portfolio only) Invest in securities of other registered investment companies, except by purchases in the open market involving only customary brokerage commissions and as a result of which not more than 5% of its total assets (taken at current value) would be invested in such securities, or except as part of a merger, consolidation or other acquisition. 15. Invest in interests in oil, gas or other mineral exploration or development programs or leases, although it may invest in the common stocks of companies that invest in or sponsor such programs. 16. (as to the Growth Portfolio only) Make loans, except through (i) repurchase agreements (repurchase agreements with a maturity of longer than 7 days together with other illiquid assets being limited to 10% of the Portfolio's assets,) and (ii) loans of portfolio securities (limited to 33% of the Portfolio's total assets). 17. (as to the Growth Portfolio only) Purchase foreign securities or currencies except foreign securities which are American Depository Receipts listed on exchanges or otherwise traded in the United States and certificates of deposit, bankers' acceptances and other obligations of foreign banks and foreign branches of U.S. banks if, giving effect to such purchase, such obligations would constitute less than 10% of the Trust's total assets (at current value). 18. (as to the Growth Portfolio only) Purchase warrants if as a result the Portfolio would then have more than 5% of its total assets (taken at current value) invested in warrants. 19. (as to each Portfolio other than the Growth Portfolio) Acquire more than 10% of the voting securities of any issuer. 20. (as to each Portfolio other than the Growth Portfolio) Make loans, except by purchase of debt obligations in which the Portfolio may invest consistent with its investment policies, by entering into repurchase agreements with respect to not more than 25% of its total assets (taken at current value), or through the lending of its portfolio securities with respect to not more than 25% of its total assets. In addition, it is contrary to the current policy of each of the Portfolios, other than the Growth Portfolio (except as specified below), which policy may be changed without shareholder approval, to: 1. Invest in warrants (other than warrants acquired by the Portfolio as a part of a unit or attached to securities at the time of purchase) if as a result such investment (valued at the lower of cost or market value) would exceed 5% of the value of the Portfolio's net assets, provided that not more than 2% of the Portfolio's net assets may be invested in warrants not listed on the New York or American Stock Exchanges. 2. Purchase or sell commodities or commodity contracts, except that a Portfolio may purchase or sell financial futures contracts, options on financial futures contracts, and futures contracts, forward contracts, and options with respect to foreign currencies, and may enter into swap transactions. (This restriction applies to the Growth Portfolio.) 3. Purchase securities restricted as to resale if as a result (i) more than 10% of the Portfolio's total assets would be invested in such securities or (ii) more than 5% of the Portfolio's total assets (excluding any securities eligible for resale under Rule 144A under the Securities Act of 1933) would be invested in such securities. 4. Invest in (a) securities which at the time of such investment are not readily marketable, (b) securities restricted as to resale, and (c) repurchase agreements maturing in more than seven days, if, as a result, more than 15% of the Portfolio's net assets (taken at current value) would then be invested in the aggregate in securities described in (a), (b), and (c) above. 5. Invest in securities of other registered investment companies, except by purchases in the open market involving only customary brokerage commissions and as a result of which not more than 5% of its total assets (taken at current value) would be invested in such securities, or except as part of a merger, consolidation, or other acquisition. 6. Purchase puts, calls, straddles, spreads, or any combination thereof (other than futures contracts, options on futures contracts or indices, and options on foreign currencies), if, by reason of such purchase, the value of its aggregate investment therein will exceed 5% of its total assets. 7. Invest in real estate limited partnerships. Notwithstanding the provisions of clauses 3 and 16 above, the Growth Portfolio has no intention during the coming year to make short sales of securities or to maintain a short position in any security. Shares of beneficial interest in the Mentor Balanced Portfolio have been registered only in the Commonwealth of Virginia. These shares may not be offered or sold in any other state without being registered or exempt from registration. THE FOLLOWING INFORMATION RELATES TO ALL OF THE PORTFOLIOS OF THE TRUST, EXCEPT WERE OTHERWISE NOTED. All information with respect to fees, expenses and performance (except where otherwise indicated) is based on a Portfolio's fiscal year end. All of the Portfolios have a September 30 fiscal year end. Prior to September 30, 1995, each of the Balanced, Growth, Short-Duration Income, and Strategy Portfolios had a December 31 fiscal year end. Information concerning the expenses of those Portfolios is provided for the fiscal period January 1, 1995 through September 30, 1995. Certain information with respect to certain Portfolios is given for partial fiscal years. See "Financial Highlights" in the Trust's prospectus for information concerning the commencement of operations of the Portfolios. Set forth below is information concerning certain investment techniques in which one or more of the Portfolios may engage, and certain of the risks they may entail. Certain of the investment techniques may not be available to a Portfolio. See the Prospectus relating to a particular Portfolio for a description of the investment techniques generally applicable to that Portfolio. For purposes of this section, a Portfolio's investment adviser or subadviser (if any) is referred to as an "Adviser". A Portfolio may purchase and sell put and call options on its portfolio securities to enhance investment performance or to protect against changes in market prices. COVERED CALL OPTIONS. A Portfolio may write covered call options on its securities to realize a greater current return through the receipt of premiums than it would realize on its securities alone. Such option transactions may also be used as a limited form of hedging against a decline in the price of securities owned by the Portfolio. A call option gives the holder the right to purchase, and obligates the writer to sell, a security at the exercise price at any time before the expiration date. A call option is "covered" if the writer, at all times while obligated as a writer, either owns the underlying securities (or comparable securities satisfying the cover requirements of the securities exchanges), or has the right to acquire such securities through immediate conversion of securities. In return for the premium received when it writes a covered call option, a Portfolio gives up some or all of the opportunity to profit from an increase in the market price of the securities covering the call option during the life of the option. The Portfolio retains the risk of loss should the price of such securities decline. If the option expires unexercised, the Portfolio realizes a gain equal to the premium, which may be offset by a decline in price security. If the option is exercised, the Portfolio realizes a gain or loss equal to the difference between the Portfolio's cost for the underlying security and the proceeds of sale (exercise price minus commissions) plus the amount of the premium. A Portfolio may terminate a call option that it has written before it expires by entering into a closing purchase transaction. A Portfolio may enter into closing purchase transactions in order to free itself to sell the underlying security or to write another call on the security, realize a profit on a previously written call option, or protect a security from being called in an unexpected market rise. Any profits from a closing purchase transaction may be offset by a decline in the value of the underlying security. Conversely, because increases in the market price of a call option will generally reflect increases in the market price of the underlying security, any loss resulting from a closing purchase transaction is likely to be offset in whole or in part by unrealized appreciation of the underlying security owned by the Portfolio. COVERED PUT OPTIONS. A Portfolio may write covered put options in order to enhance its current return. Such options transactions may also be used as a limited form of hedging against an increase in the price of securities that the Portfolio plans to purchase. A put option gives the holder the right to sell, and obligates the writer to buy, a security at the exercise price at any time before the expiration date. A put option is "covered" if the writer segregates cash and high-grade short-term debt obligations or other permissible collateral equal to the price to be paid if the option is exercised. In addition to the receipt of premiums and the potential gains from terminating such options in closing purchase transactions, a Portfolio also receives interest on the cash and debt securities maintained to cover the exercise price of the option. By writing a put option, the Portfolio assumes the risk that it may be required to purchase the underlying security for an exercise price higher than its then current market value, resulting in a potential capital loss unless the security later appreciates in value. A Portfolio may terminate a put option that it has written before it expires by a closing purchase transaction. Any loss from this transaction may be partially or entirely offset by the premium received on the terminated option. PURCHASING PUT AND CALL OPTIONS. A Portfolio may also purchase put options to protect portfolio holdings against a decline in market value. This protection lasts for the life of the put option because the Portfolio, as a holder of the option, may sell the underlying security at the exercise price regardless of any decline in its market price. In order for a put option to be profitable, the market price of the underlying security must decline sufficiently below the exercise price to cover the premium and transaction costs that the Portfolio must pay. These costs will reduce any profit the Portfolio might have realized had it sold the underlying security instead of buying the put option. A Portfolio may purchase call options to hedge against an increase in the price of securities that the Portfolio wants ultimately to buy. Such hedge the life of the call option since the Portfolio, as holder of the call option, is able to buy the underlying security at the exercise price regardless of any increase in the underlying security's market price. In order for a call option to be profitable, the market price of the underlying security must rise sufficiently above the exercise price to cover the premium and transaction costs. These costs will reduce any profit the Portfolio might have realized had it bought the underlying security at the time it purchased the call option. OPTIONS ON FOREIGN SECURITIES. A Portfolio may purchase and sell options on foreign securities if in the opinion of its Adviser the investment characteristics of such options, including the risks of investing in such options, are consistent with the Portfolio's investment objectives. It is expected that risks related to such options will not differ materially from risks related to options on U.S. securities. However, position limits and other rules of foreign exchanges may differ from those in the U.S. In addition, options markets in some countries, many of which are relatively new, may be less liquid than comparable markets in the U.S. RISKS INVOLVED IN THE SALE OF OPTIONS. Options transactions involve certain risks, including the risks that a Portfolio's Adviser will not forecast interest rate or market movements correctly, that a Portfolio may be unable at times to close out such positions, or that hedging transactions may not accomplish their purpose because of imperfect market correlations. The successful use of these strategies depends on the ability of a Portfolio's Adviser to forecast market and interest rate movements correctly. An exchange-listed option may be closed out only on an exchange which provides a secondary market for an option of the same series. There is no assurance that a liquid secondary market on an exchange will exist for any particular option or at any particular time. If no secondary market were to exist, it would be impossible to enter into a closing transaction to close out an option position. As a result, a Portfolio may be forced to continue to hold, or to purchase at a fixed price, a security on which it has sold an option at a time when its Adviser believes it is inadvisable to do so. Higher than anticipated trading activity or order flow or other unforeseen events might cause The Options Clearing Corporation or an exchange to institute special trading procedures or restrictions that might restrict the Portfolio's use of options. The exchanges have established limitations on the maximum number of calls and puts of each class that may be held or written by an investor or group of investors acting in concert. It is possible that the Portfolio and other clients of the Portfolio's Adviser may be considered such a group. These position limits may restrict the Portfolio's ability to purchase or sell options on particular securities. Options which are not traded on national securities exchanges may be closed out only with the other party to the option transaction. For that reason, it may be more difficult to close out unlisted options than listed options. Furthermore, unlisted options are not subject to the protection afforded purchasers of listed options by The Options Clearing Corporation. Government regulations, particularly the requirements for qualification as a "regulated investment company" under the Internal Revenue Code, may also restrict the Portfolio's use of options. In order to hedge against the effects of adverse market changes a Portfolio that may invest in debt securities may buy and sell futures contracts on debt securities of the type in which the Portfolio may invest and on indexes of debt securities. In addition, a Portfolio that may invest in equity securities may purchase and sell stock index futures to hedge against changes in stock market prices. A Portfolio may also, to the extent permitted by applicable law, buy and sell futures contracts and options on futures contracts to increase its current return. All such futures and related options will, as may be required by applicable law, be traded on exchanges that are licensed and regulated by the Commodity Futures Trading Commission (the "CFTC"). FUTURES ON DEBT SECURITIES AND RELATED OPTIONS. A futures contract on a debt security is a binding contractual commitment which, if held to maturity, will result in an obligation to make or accept delivery, during a particular month, of securities having a standardized face value and rate of return. By purchasing futures on debt securities -- assuming a "long" position -- a Portfolio will legally obligate itself to accept the future delivery of the underlying security and pay the agreed price. By selling futures on debt securities -- assuming a "short" position -- it will legally obligate itself to make the future delivery of the security against payment of the agreed price. Open futures positions on debt securities will be valued at the most recent settlement price, unless that price does not, in the judgment of persons acting at the direction of the Trustees as to the valuation of a Portfolio's assets, reflect the fair value of the contract, in which case the positions will be valued by the Trustees or such persons. Positions taken in the futures markets are not normally held to maturity, but are instead liquidated through offsetting transactions that may result in a profit or a loss. While futures positions taken by a Portfolio will usually be liquidated in this manner, a Portfolio may instead make or take delivery of the underlying securities whenever it appears economically advantageous to do so. A clearing corporation associated with the exchange on which futures are traded assumes responsibility for such closing transactions and guarantees that a Portfolio's sale and purchase obligations under closed-out positions will be performed at the termination of the contract. Hedging by use of futures on debt securities seeks to establish with more certainty than would otherwise be possible the effective rate of return on securities. A Portfolio may, for example, take a "short" position in the futures market by selling contracts for the future delivery of debt securities held by the Portfolio (or securities having characteristics similar to those held by the Portfolio) in order to hedge against an anticipated rise in interest rates that would adversely affect the value of the Portfolio's securities. When hedging of this character is successful, any depreciation in the value of securities may substantially be offset by appreciation in the value of the futures position. On other occasions, the Portfolio may take a "long" position by purchasing futures on debt securities. This would be done, for example, when the Portfolio expects to purchase particular securities when it has the necessary cash, but expects the rate of return available in the securities markets at that time to be less favorable than rates currently available in the futures markets. If the anticipated rise in the price of the securities should occur (with its concomitant reduction in yield), the increased cost to the Portfolio of purchasing the securities may be offset, at least to some extent, by the rise in the value of the futures position taken in anticipation of the subsequent purchase. Successful use by a Portfolio of futures contracts on debt securities is subject to its Adviser's ability to predict correctly movements in the direction of interest rates and other factors affecting markets for debt securities. For example, if a Portfolio has hedged against the possibility of an increase in interest rates which would adversely affect the market prices of debt securities held by it and the prices of such securities increase instead the Portfolio will lose part or all of the benefit of the increased value of its securities which it has hedged because it will have offsetting losses in its futures positions. In addition, in such situations, if the Portfolio has insufficient cash, it may have to sell securities to meet daily margin maintenance requirements. The Portfolio may have to sell securities at a time when it may be disadvantageous to do so. A Portfolio may purchase and write put and call options on certain debt futures contracts, as they become available. Such options are similar to options on securities except that options on futures contracts give the purchaser the right, in return for the premium paid, to assume a position in a futures contract (a long position if the option is a call and a short position if the option is a put) at a specified exercise price at any time during the period of the option. As with options on securities, the holder or writer of an option may terminate his position by selling or purchasing an option of the same series. There is no guarantee that such closing transactions can be effected. A Portfolio will be required to deposit initial margin and maintenance margin with respect to put and call options on futures contracts written by it pursuant to brokers' requirements, and, in addition, net option premiums received will be included as initial margin deposits. See "Margin Payments" below. Compared to the purchase or sale of futures contracts, the purchase of call or put options on futures contracts involves less potential risk to a Portfolio because the maximum amount at risk is the premium paid for the options plus transactions costs. However, there may be circumstances when the purchase of call or put options on a futures contract would result in a loss to a Portfolio when the purchase or sale of the futures contracts would not, such as when there is no movement in the prices of debt securities. The writing of a put or call option on a futures contract involves risks similar to those risks relating to the purchase or sale of futures contracts. INDEX FUTURES CONTRACTS AND OPTIONS. A Portfolio may invest in debt index futures contracts and stock index futures contracts, and in related options. A debt index futures contract is a contract to buy or sell units of a specified debt index at a specified future date at a price agreed upon when the contract is made. A unit is the current value of the index. (Debt index futures in which the Portfolios are presently expected to invest are not now available, such futures contracts are expected to become available in the future.) A stock index futures contract is a contract to buy or sell units of a stock index at a specified future date at a price agreed upon when the contract is made. A unit is the current value of the stock index. For example, the Standard & Poor's 100 Stock Index is composed of 100 selected common stocks, most of which are listed on the New York Stock Exchange. The S&P 100 Index assigns relative weightings to the common stocks included in the Index, and the Index fluctuates with changes in the market values of those common stocks. In the case of the S&P 100 Index, contracts are to buy or sell 100 units. Thus, if the value of the S&P 100 Index were $180, one contract would be worth $18,000 (100 units x $180). The stock index futures contract specifies that no delivery of the actual stocks making up the index will take place. Instead, settlement in cash must occur upon the termination of the contract, with the settlement being the difference between the contract price and the actual level of the stock index at the expiration of the contract. For example, if a Portfolio enters into a futures contract to buy 100 units of the S&P 100 Index at a specified future date at a contract price of $180 and the S&P 100 Index is at $184 on that future date, the Portfolio will gain $400 (100 units x gain of $4). If the Portfolio enters into a futures contract to sell 100 units of the stock index at a specified future date at a contract price of $180 and the S&P 100 Index is at $182 on that future date, the Portfolio will lose $200 (100 units x loss of $2). A Portfolio may purchase or sell futures contracts with respect to any securities indexes. Positions in index futures may be closed out only on an exchange or board of trade which provides a secondary market for such futures. In order to hedge a Portfolio's investments successfully using futures contracts and related options, a Portfolio must invest in futures contracts with respect to indexes or subindexes the movements of which will, in its judgment, have a significant correlation with movements in the prices of the Portfolio's securities. OPTIONS ON STOCK INDEX FUTURES. Options on index futures contracts are similar to options on securities except that options on index futures contracts give the purchaser the right, in return for the premium paid, to assume a position in an index futures contract (a long position if the option is a call and a short position if the option is a put) at a specified exercise price at any time during the period of the option. Upon exercise of the option, the holder would assume the underlying futures position and would receive a variation margin payment of cash or securities approximating the increase in the value of the holder's option position. If an option is exercised on the last trading day prior to the expiration date of the option, the settlement will be made entirely in cash based on the difference between the exercise price of the option and the closing level of the index on which the futures contract is based on the expiration date. Purchasers of options who fail to exercise their options prior to the exercise date suffer a loss of the premium paid. OPTIONS ON INDICES. As an alternative to purchasing and selling call and put options on index futures contracts, each of the Portfolios which may purchase and sell index futures contracts may purchase and sell call and put options on the underlying indexes themselves to the extent that such options are traded on national securities exchanges. Index options are similar to options on individual securities in that the purchaser of an index option acquires the right to buy (in the case of a call) or sell (in the case of a put), and the writer undertakes the obligation to sell or buy (as the case may be), units of an index at a stated exercise price during the term of the option. Instead of giving the right to take or make actual delivery of securities, the holder of an index option has the right to receive a cash "exercise settlement amount". This amount is equal to the amount by which the fixed exercise price of the option exceeds (in the case of a put) or is less than (in the case of a call) the closing value of the underlying index on the date of the exercise, multiplied by a fixed "index multiplier". A Portfolio may purchase or sell options on stock indices in order to close out its outstanding positions in options on stock indices which it has purchased. A Portfolio may also allow such options to expire unexercised. Compared to the purchase or sale of futures contracts, the purchase of call or put options on an index involves less potential risk to a Portfolio because the maximum amount at risk is the premium paid for the options plus transactions costs. The writing of a put or call option on an index involves risks similar to those risks relating to the purchase or sale of index futures contracts. MARGIN PAYMENTS. When a Portfolio purchases or sells a futures contract, it is required to deposit with its custodian an amount of cash, U.S. Treasury bills, or other permissible collateral equal to a small percentage of the amount of the futures contract. This amount is known as "initial margin". The nature of initial margin is different from that of margin in security transactions in that it does not involve borrowing money to finance transactions. Rather, initial margin is similar to a performance bond or good faith deposit that is returned to a Portfolio upon termination of the contract, assuming a Portfolio satisfies its contractual obligations. Subsequent payments to and from the broker occur on a daily basis in a process known as "marking to market". These payments are called "variation margin" and are made as the value of the underlying futures contract fluctuates. For example, when a Portfolio sells a futures contract and the price of the underlying security rises above the delivery price, the Portfolio's position declines in value. The Portfolio then pays the broker a variation margin payment equal to the difference between the delivery price of the futures contract and the market price of the securities underlying the futures contract. Conversely, if the price of the underlying security falls below the delivery price of the contract, the Portfolio's futures position increases in value. The broker then must make a variation margin payment equal to the difference between the delivery price of the futures contract and the market price of the securities underlying the futures contract. When a Portfolio terminates a position in a futures contract, a final determination of variation margin is made, additional cash is paid by or to the Portfolio, and the Portfolio realizes a loss or a gain. Such closing transactions involve additional commission costs. SPECIAL RISKS OF TRANSACTIONS IN FUTURES CONTRACTS AND RELATED OPTIONS LIQUIDITY RISKS. Positions in futures contracts may be closed out only on an exchange or board of trade which provides a secondary market for such futures. Although the Portfolio intends to purchase or sell futures only on exchanges or boards of trade where there appears to be an active secondary market, there is no assurance that a liquid secondary market on an exchange or board of trade will exist for any particular contract or at any particular time. If there is not a liquid secondary market at a particular time, it may not be possible to close a futures position at such time and, in the event of adverse price movements, a Portfolio would continue to be required to make daily cash payments of variation margin. However, in the event financial futures are used to hedge portfolio securities, such securities will not generally be sold until the financial futures can be terminated. In such circumstances, an increase in the price of the portfolio securities, if any, may partially or completely offset losses on the financial futures. In addition to the risks that apply to all options transactions, there are several special risks relating to options on futures contracts. The ability to establish and close out positions in such options will be subject to the development and maintenance of a liquid secondary market. It is not certain that such a market will develop. Although a Portfolio generally will purchase only those options for which there appears to be an active secondary market, there is no assurance that a liquid secondary market on an exchange will exist for any particular option or at any particular time. In the event no such market exists for particular options, it might not be possible to effect closing transactions in such options with the result that a Portfolio would have to exercise the options in order to realize any profit. HEDGING RISKS. There are several risks in connection with the use by a Portfolio of futures contracts and related options as a hedging device. One risk arises because of the imperfect correlation between movements in the prices of the futures contracts and options and movements in the underlying securities or index or movements in the prices of a Portfolio's securities which are the subject of a hedge. A Portfolio's Adviser will, however, attempt to reduce this risk by purchasing and selling, to the extent possible, futures contracts and related options on securities and indexes the movements of which will, in its judgment, correlate closely with movements in the prices of the underlying securities or index and the securities sought to be hedged. Successful use of futures contracts and options by a Portfolio for hedging purposes is also subject to its Adviser's ability to predict correctly movements in the direction of the market. It is possible that, where a Portfolio has purchased puts on futures contracts to hedge its portfolio against a decline in the market, the securities or index on which the puts are purchased may increase in value and the value of securities held in the portfolio may decline. If this occurred, the Portfolio would lose money on the puts and also experience a decline in value in its portfolio securities. In addition, the prices of futures, for a number of reasons, may not correlate perfectly with movements in the underlying securities or index due to certain market distortions. First, all participants in the futures market are subject to margin deposit requirements. Such requirements may cause investors to close futures contracts through offsetting transactions which could distort the normal relationship between the underlying security or index and futures markets. Second, the margin requirements in the futures markets are less onerous than margin requirements in the securities markets in general, and as a result the futures markets may attract more speculators than the securities markets do. Increased participation by speculators in the futures markets may also cause temporary price distortions. Due to the possibility of price distortion, even a correct forecast of general market trends by a Portfolio's Adviser may still not result in a successful hedging transaction over a short time period. OTHER RISKS. Portfolios will incur brokerage fees in connection with their futures and options transactions. In addition, while futures contracts and options on futures will be purchased and sold to reduce certain risks, those transactions themselves entail certain other risks. Thus, while a Portfolio may benefit from the use of futures and related options, unanticipated changes in interest rates or stock price movements may result in a poorer overall performance for the Portfolio than if it had not entered into any futures contracts or options transactions. Moreover, in the event of an imperfect correlation between the futures position and the portfolio position which is intended to be protected, the desired protection may not be obtained and the Portfolio may be exposed to risk of loss. A Portfolio may enter into contracts to purchase securities for a fixed price at a future date beyond customary settlement time ("forward commitments") if the Portfolio holds, and maintains until the settlement date in a segregated account, cash or high-grade debt obligations in an amount sufficient to meet the purchase price, or if the Portfolio enters into offsetting contracts for the forward sale of other securities it owns. Forward commitments may be considered securities in themselves, and involve a risk of loss if the value of the security to be purchased declines prior to the settlement date, which risk is in addition to the risk of decline in the value of the Portfolio's other assets. Where such purchases are made through dealers, the Portfolios rely on the dealer to consummate the sale. The dealer's failure to do so may result in the loss to the Portfolio of an advantageous yield or price. Although a Portfolio will generally enter into forward commitments with the intention of acquiring securities for its portfolio or for delivery pursuant to options contracts it has entered into, a Portfolio may dispose of a commitment prior to settlement if its Adviser deems it appropriate to do so. A Portfolio may realize short-term profits or losses upon the sale of forward commitments. A Portfolio may enter into repurchase agreements. A repurchase agreement is a contract under which the Portfolio acquires a security for a not more than one week) subject to the obligation of the seller to repurchase and the Portfolio to resell such security at a fixed time and price (representing the Portfolio's cost plus interest). It is the Trust's present intention to enter into repurchase agreements only with member banks of the Federal Reserve System and securities dealers meeting certain criteria as to creditworthiness and financial condition established by the Trustees of the Trust and only with respect to obligations of the U.S. government or its agencies or instrumentalities or other high quality short term debt obligations. Repurchase agreements may also be viewed as loans made by a Portfolio which are collateralized by the securities subject to repurchase. A Portfolio's Adviser will monitor such transactions to ensure that the value of the underlying securities will be at least equal at all times to the total amount of the repurchase obligation, including the interest factor. If the seller defaults, a Portfolio could realize a loss on the sale of the underlying security to the extent that the proceeds of sale including accrued interest are less than the resale price provided in the agreement including interest. In addition, if the seller should be involved in bankruptcy or insolvency proceedings, a Portfolio may incur delay and costs in selling the underlying security or may suffer a loss of principal and interest if a Portfolio is treated as an unsecured creditor and required to return the underlying collateral to the seller's estate. A Portfolio may lend its portfolio securities, provided: (1) the loan is secured continuously by collateral consisting of U.S. Government securities, cash, or cash equivalents adjusted daily to have market value at least equal to the current market value of the securities loaned; (2) the Portfolio may at any time call the loan and regain the securities loaned; (3) a Portfolio will receive any interest or dividends paid on the loaned securities; and (4) the aggregate market value of securities loaned will not at any time exceed one-third (or such other limit as the Trustee may establish) of the total assets of the Portfolio. In addition, it is anticipated that a Portfolio may share with the borrower some of the income received on the collateral for the loan or that it will be paid a premium for the loan. The risks in lending portfolio securities, as with other extensions of credit, consist of possible delay in recovery of the securities or possible loss of rights in the collateral should the borrower fail financially. Although voting rights or rights to consent with respect to the loaned securities pass to the borrower, a Portfolio retains the right to call the loans at any time on reasonable notice, and it will do so in order that the securities may be voted by a Portfolio if the holders of such securities are asked to vote upon or consent to matters materially affecting the investment. A Portfolio will not lend portfolio securities to borrowers affiliated with the Portfolio. COLLATERALIZED MORTGAGE OBLIGATIONS; OTHER MORTGAGE-RELATED SECURITIES Collateralized mortgage obligations or "CMOs" are debt obligations or pass-through certificates collateralized by mortgage loans or mortgage pass-through securities. Typically, CMOs are collateralized by certificates issued by the Government National Mortgage Association, ("GNMA"), the Federal National Mortgage Association ("FNMA"), or the Federal Home Loan Mortgage Corporation ("FHLMC"), but they also may be collateralized by whole loans or private pass-through certificates (such collateral collectively hereinafter referred to as "Mortgage Assets"). CMOs may be issued by agencies or instrumentalities of the U.S. Government, or by private originators of, or investors in, mortgage loans. In a CMO, a series of bonds or certificates is generally issued in multiple classes. Each class of CMOs is issued at a specific fixed or floating rate coupon and has a stated maturity or final distribution date. Principal prepayments on the mortgage assets may cause the CMOs to be retired substantially earlier than their stated maturities or final distribution dates. Interest is paid or accrues on most classes of the CMOs on a monthly, quarterly, or semi-annual basis. The principal of and interest on the mortgage assets may be allocated among the several classes of a series of a CMO in innumerable ways. In a CMO, payments of principal, including any principal prepayments, on the mortgage assets are applied to the classes of the series in a pre-determined sequence. RESIDUAL INTERESTS. Residual interests are derivative mortgage securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans. The cash flow generated by the mortgage assets underlying a series of mortgage securities is applied first to make required payments of principal of and interest on the mortgage securities and second to pay the related administrative expenses of the issuer. The residual generally represents the right to any excess cash flow remaining after making the foregoing payments. Each payment of such excess cash flow to a holder of the related residual represents income and/or a return of capital. The amount of residual cash flow resulting from a series of mortgage securities will depend on, among other things, the characteristics of the mortgage assets, the coupon rate of each class of the mortgage securities, prevailing interest rates, the amount of administrative expenses, and the prepayment experience on the mortgage assets. In particular, the yield to maturity on residual interests may be extremely sensitive to prepayments on the related underlying mortgage assets in the same manner as an interest-only class of stripped mortgage-backed securities. In addition, if a series of mortgage securities includes a class that bears interest at an adjustable rate, the yield to maturity on the related residual interest may also be extremely sensitive to changes in the level of the index upon which interest rate adjustments are based. In certain circumstances, there may be little or no excess cash flow payable to residual holders. The Portfolio may fail to recoup fully its initial investment in a residual. Residuals are generally purchased and sold by institutional investors through several investment banking firms acting as brokers or dealers. The residual interest market has only recently developed and residuals currently may not have the liquidity of other more established securities trading in other markets. Residuals may be subject to certain restrictions on transferability. A Portfolio may invest in foreign securities and in certificates of deposit issued by United States branches of foreign banks and foreign branches of United States banks. Investments in foreign securities may involve considerations different from investments in domestic securities. There may be less publicly available information about a foreign company than about a U.S. company, and foreign companies may not be subject to accounting, auditing and financial reporting standards and requirements comparable to those applicable to U.S. companies. Securities of some foreign companies are less liquid or more volatile than securities of U.S. companies, and foreign brokerage commissions and custodian fees are generally higher than in the United States. Investments in foreign securities can involve other risks different from those affecting U.S. investments, including local political or economic developments, expropriation or nationalization of assets and imposition of withholding taxes on dividend or interest payments. It may be more difficult to obtain and enforce a judgment against a foreign issuer. In addition, foreign investments may be affected favorably or unfavorably by changes in currency exchange rates or exchange control regulations. A Portfolio may incur costs in connection with conversion between currencies. In determining whether to invest in securities of foreign issuers, the Adviser of a Portfolio seeking current income will consider the likely impact of foreign taxes on the net yield available to the Portfolio and its shareholders. Income received by a Portfolio from sources within foreign countries may be reduced by withholding and other taxes imposed by such countries. Tax conventions between certain countries and the United States may reduce or eliminate such taxes. It is impossible to determine the effective rate of foreign tax in advance since the amount of a Portfolio's assets to be invested in various countries is not known, and tax laws and their interpretations may change from time to time and may change without advance notice. Any such taxes paid by a Portfolio will reduce its net income available for distribution to shareholders. Except as otherwise described in the relevant Prospectus, a Portfolio may engage without limit in currency exchange transactions, including foreign currency forward and futures contracts, to protect against uncertainty in the level of future foreign currency exchange rates. In addition, a Portfolio may purchase and sell call and put options on foreign currency futures contracts and on foreign currencies for hedging purposes. A Portfolio may engage in both "transaction hedging" and "position hedging". When a Portfolio engages in transaction hedging, it enters into foreign currency transactions with respect to specific receivables or payables of the Portfolio generally arising in connection with the purchase or sale of its securities. A Portfolio will engage in transaction hedging when it desires to "lock in" the U.S. dollar price of a security it has agreed to purchase or sell, or the U.S. dollar equivalent of a dividend or interest payment in a foreign currency. By transaction hedging a Portfolio will attempt to protect against a possible loss resulting from an adverse change in the relationship between the U.S. dollar and the applicable foreign currency during the period between the date on which the security is purchased or sold or on which the dividend or interest payment is declared, and the date on which such payments are made or received. A Portfolio may purchase or sell a foreign currency on a spot (or cash) basis at the prevailing spot rate in connection with transaction hedging. A Portfolio may also enter into contracts to purchase or sell foreign currencies at a future date ("forward contracts") and purchase and sell foreign currency futures contracts. For transaction hedging purposes, a Portfolio may purchase exchange-listed and over-the-counter call and put options on foreign currency futures contracts and on foreign currencies. A put option on a futures contract gives a Portfolio the right to assume a short position in the futures contract until expiration of the option. A put option on currency gives a Portfolio the right to sell a currency at an exercise price until the expiration of the option. A call option on a futures contract gives a Portfolio the right to assume a long position in the futures contract until the expiration of the option. A call option on currency gives a Portfolio the right to purchase a currency at the exercise price until the expiration of the option. A Portfolio will engage in over-the-counter transactions only when appropriate exchange-traded transactions are unavailable and when, in the opinion of its Adviser, the pricing mechanism and liquidity are satisfactory and the participants are responsible parties likely to meet their contractual obligations. When a Portfolio engages in position hedging, it enters into foreign currency exchange transactions to protect against a decline in the values of the foreign currencies in which securities held by the Portfolio are denominated or are quoted in their principle trading markets or an increase in the value of currency for securities which a Portfolio expects to purchase. In connection with position hedging, a Portfolio may purchase put or call options on foreign currency and foreign currency futures contracts and buy or sell forward contracts and foreign currency futures contracts. A Portfolio may also purchase or sell foreign currency on a spot basis. The precise matching of the amounts of foreign currency exchange transactions and the value of the portfolio securities involved will not generally be possible since the future value of such securities in foreign currencies will change as a consequence of market movements in the values of those securities between the dates the currency exchange transactions are entered into and the dates they mature. It is impossible to forecast with precision the market value of a Portfolio's securities at the expiration or maturity of a forward or futures contract. Accordingly, it may be necessary for a Portfolio to purchase additional foreign currency on the spot market (and bear the expense of such purchase) if the market value of the security or securities being hedged is less than the amount of foreign currency a Portfolio is obligated to deliver and if a decision is made to sell the security or securities and make delivery of the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received upon the sale of the security or securities of a Portfolio if the market value of such security or securities exceeds the amount of foreign currency the Portfolio is obligated to deliver. To offset some of the costs to a Portfolio of hedging against fluctuations in currency exchange rates, the Portfolio may write covered call options on those currencies. Transaction and position hedging do not eliminate fluctuations in the underlying prices of the securities which a Portfolio owns or intends to purchase or sell. They simply establish a rate of exchange which one can achieve at some future point in time. Additionally, although these techniques tend to minimize the risk of loss due to a decline in the value of the hedged currency, they tend to limit any potential gain which might result from the increase in the value of such currency. CURRENCY FORWARD AND FUTURES CONTRACTS. A forward foreign currency exchange contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract as agreed by the parties, at a price set at the time of the contract. In the case of a cancelable forward contract, the holder has the unilateral right to cancel the contract at maturity by paying a specified fee. The contracts are traded in the interbank market conducted directly between currency traders (usually large commercial banks) and their customers. A forward contract generally has no deposit requirement, and no commissions are charged at any stage for trades. A foreign currency futures contract is a standardized contract for the future delivery of a specified amount of a foreign currency at a future date at a price set at the time of the contract. Foreign currency futures contracts traded in the United States are designed by and traded on exchanges regulated by the CFTC, such as the New York Mercantile Exchange. Forward foreign currency exchange contracts differ from foreign currency futures contracts in certain respects. For example, the maturity date of a forward contract may be any fixed number of days from the date of the contract agreed upon by the parties, rather than a predetermined date in a given month. Forward contracts may be in any amounts agreed upon by the parties rather than predetermined amounts. Also, forward foreign exchange contracts are traded directly between currency traders so that no intermediary is required. A forward contract generally requires no margin or other deposit. At the maturity of a forward or futures contract, a Portfolio may either accept or make delivery of the currency specified in the contract, or at or prior to maturity enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing transactions with respect to forward contracts are usually effected with the currency trader who is a party to the original forward contract. Closing transactions with respect to futures contracts are effected on a commodities exchange; a clearing corporation associated with the exchange assumes responsibility for closing out such contracts. Positions in foreign currency futures contracts and related options may be closed out only on an exchange or board of trade which provides a secondary market in such contracts or options. Although a Portfolio will normally purchase or sell foreign currency futures contracts and related options only on exchanges or boards of trade where there appears to be an active secondary market, there is no assurance that a secondary market on an exchange or board of trade will exist for any particular contract or option or at any particular time. In such event, it may not be possible to close a futures or related option position and, in the event of adverse price movements, a Portfolio would continue to be required to make daily cash payments of variation margin on its futures positions. FOREIGN CURRENCY OPTIONS. Options on foreign currencies operate similarly to options on securities, and are traded primarily in the over-the-counter market, although options on foreign currencies have recently been listed on several exchanges. Such options will be purchased or written only when a Portfolio's Adviser believes that a liquid secondary market exists for such options. There can be no assurance that a liquid secondary market will exist for a particular option at any specific time. Options on foreign currencies are affected by all of those factors which influence exchange rates and investments generally. The value of a foreign currency option is dependent upon the value of the foreign currency and the U.S. dollar, and may have no relationship to the investment merits of a foreign security. Because foreign currency transactions occurring in the interbank market involve substantially larger amounts than those that may be involved in the use of foreign currency options, investors may be disadvantaged by having to deal in an odd lot market (generally consisting of transactions of less than $1 million) for the underlying foreign currencies at prices that are less favorable than for round lots. There is no systematic reporting of last sale information for foreign currencies and there is no regulatory requirement that quotations available through dealers or other market sources be firm or revised on a timely basis. Available quotation information is generally representative of very large transactions in the interbank market and thus may not reflect relatively smaller transactions (less than $1 million) where rates may be less favorable. The interbank market in foreign currencies is a global, around-the-clock market. To the extent that the U.S. options markets are closed while the markets for the underlying currencies remain open, significant price and rate movements may take place in the underlying markets that cannot be reflected in the U.S. options markets. SETTLEMENT PROCEDURES. Settlement procedures relating to investments in foreign securities and to foreign currency exchange transactions may be more complex than settlements with respect to investments in debt or equity securities of U.S. issuers, and may involve certain risks not present in domestic investments. For example, settlement of transactions involving foreign securities or foreign currency may occur within a foreign country, and the Portfolio may be required to accept or make delivery of the underlying securities or currency in conformity with any applicable U.S. or foreign restrictions or regulations, and may be required to pay any fees, taxes or delivery. Such investments may also involve the risk that an entity involved in the settlement may not meet its obligations. FOREIGN CURRENCY CONVERSION. Although foreign exchange dealers do not charge a fee for currency conversion, they do realize a profit based on the difference (the "spread") between prices at which they buy and sell various currencies. Thus, a dealer may offer to sell a foreign currency to a Portfolio at one rate, while offering a lesser rate of exchange should a Portfolio desire to resell that currency to the dealer. Zero-coupon securities in which a Portfolio may invest are debt obligations which are generally issued at a discount and payable in full at maturity, and which do not provide for current payments of interest prior to maturity. Zero-coupon securities usually trade at a deep discount from their face or par value and are subject to greater market value fluctuations from changing interest rates than debt obligations of comparable maturities which make current distributions of interest. As a result, the net asset value of shares of a Portfolio investing in zero-coupon securities may fluctuate over a greater range than shares of other mutual funds investing in securities making current distributions of interest and having similar maturities. Zero-coupon securities may include U.S. Treasury bills issued directly by the U.S. Treasury or other short-term debt obligations, and longer-term bonds or notes and their unmatured interest coupons which have been separated by their holder, typically a custodian bank or investment brokerage firm. A number of securities firms and banks have stripped the interest coupons from the underlying principal (the "corpus") of U.S. Treasury securities and resold them in custodial receipt programs with a number of different names, including Treasury Income Growth Receipts ("TIGRS") and Certificates of Accrual on Treasuries ("CATS"). The underlying U.S. Treasury bonds and notes themselves are held in book-entry form at the Federal Reserve Bank or, in the case of bearer securities (i.e., unregistered securities which are owned ostensibly by the bearer or holder thereof), in trust on behalf of the owners thereof. In addition, the Treasury has facilitated transfers of ownership of zero-coupon securities by accounting separately for the beneficial ownership of particular interest coupons and corpus payments on Treasury securities through the Federal Reserve book-entry record-keeping system. The Federal Reserve program as established by the Treasury Department is known as "STRIPS" or "Separate Trading of Registered Interest and Principal of Securities." Under the STRIPS program, a Portfolio will be able to have its beneficial ownership of U.S. Treasury zero-coupon securities recorded directly in the book-entry record-keeping system in lieu of having to hold certificates or other evidences of ownership of the underlying U.S. Treasury securities. When debt obligations have been stripped of their unmatured interest coupons by the holder, the stripped coupons are sold separately. The principal or corpus is sold at a deep discount because the buyer receives only the right to receive a future fixed payment on the security and does not receive any rights to periodic cash interest payments. Once stripped or separated, the corpus and coupons may be sold separately. Typically, the coupons are sold separately or grouped with other coupons with like maturity dates and sold in such bundled form. Purchasers of stripped obligations acquire, in effect, discount obligations that are economically identical to the zero-coupon securities issued directly by the obligor. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Portfolios may engage in when-issued and delayed delivery transactions. These transactions are arrangements in which a Portfolio purchases securities with payment and delivery scheduled for a future time. A Portfolio engages in when-issued and delayed delivery transactions only for the purpose of acquiring securities consistent with its investment objective and policies, not for investment leverage, but a Portfolio may sell such securities prior to settlement date if such a sale is considered to be advisable. No income accrues to a Portfolio on securities in connection with such transactions prior to the date the Portfolio actually takes delivery of securities. In when-issued and delayed delivery transactions, a Portfolio relies on the seller to complete the transaction. The seller's failure to complete the transaction may cause a Portfolio to miss a price or yield considered to be advantageous. These transactions are made to secure what is considered to be an advantageous price or yield for a Portfolio. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of a Portfolio sufficient to make payment for the securities to be purchased are segregated at the trade date. These securities are marked to market daily and are maintained until the transaction is settled. A Portfolio may invest in the instruments of banks and savings and loans whose deposits are insured by the Bank Insurance Fund or the Savings Association Insurance Fund, both of which are administered by the Federal Deposit Insurance Corporation ("FDIC"), such as certificates of deposit, demand and time deposits, savings shares, and bankers' acceptances. However, the above-mentioned instruments are not necessarily guaranteed by those organizations. In addition to domestic bank obligations, such as certificates of deposit, demand and time deposits, savings shares, and bankers' acceptances, a Portfolio may invest in: Eurodollar Certificates of Deposit ("ECDs") issued by foreign branches of U.S. or foreign banks; Eurodollar Time Deposits ("ETDs"), which are U.S. dollar-denominated deposits in foreign branches of U.S. or foreign banks; Canadian Time Deposits, which are U.S. dollar-denominated deposits issued by branches of major Canadian banks located in the U.S.; and Yankee Certificates of Deposit ("Yankee CDS"), which are U.S. dollar- denominated certificates of deposit issued by U.S. branches of foreign banks and held in the U.S. DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS A Portfolio may enter into dollar rolls, in which the Portfolio sells securities and simultaneously contracts to repurchase substantially similar securities on a specified future date. In the case of dollar rolls involving mortgage-related securities, the mortgage-related securities that are purchased typically will be of the same type and will have the same or similar interest rate and maturity as those sold, but will be supported by different pools of mortgages. The Portfolio forgoes principal and interest paid during the roll period on the securities sold in a dollar roll, but it is compensated by the difference between the current sales price and the price for the future purchase as well as by any interest earned on the proceeds of the securities sold. A Portfolio could also be compensated through the receipt of fee income. A Portfolio may also enter into reverse repurchase agreements in which the Portfolio sells securities and agrees to repurchase them at a mutually agreed date and price. Generally, the effect of such a transaction is that the Portfolio can recover all or most of the cash invested in the portfolio securities involved during the term of the reverse repurchase agreement, while it will be able to keep the interest income associated with those portfolio securities. Such transactions are advantageous if the interest cost to the Portfolio of the reverse repurchase transaction is less than the cost of otherwise obtaining the cash. Dollar rolls and reverse repurchase agreements may be viewed as a borrowing by the Portfolio, secured by the security which is the subject of the agreement. In addition to the general risks involved in leveraging, dollar rolls and reverse repurchase agreements involve the risk that, in the event of the bankruptcy or insolvency of the Portfolio's counterparty, the Portfolio would be unable to recover the security which is the subject of the agreement, the amount of cash or other property transferred by the counterparty to the Portfolio under the agreement prior to such insolvency or bankruptcy is less than the value of the security subject to the agreement, or the Portfolio may be delayed or prevented, due to such insolvency or bankruptcy, from using such cash or property or may be required to return it to the counterparty or its trustee or receiver. A Portfolio may invest in convertible securities. Convertible securities are fixed income securities which may be exchanged or converted into a predetermined number of the issuer's underlying common stock at the option of the holder during a specified time period. Convertible securities may take the form of convertible preferred stock, convertible bonds or debentures, units consisting of "usable" bonds and warrants or a combination of the features of several of these securities. The investment characteristics of each convertible security vary widely, which allows convertible securities to be employed for a variety of investment strategies. A Portfolio will exchange or convert the convertible securities held in its portfolio into shares of the underlying common stock when, in its Adviser's opinion, the investment characteristics of the underlying common shares will assist the Portfolio in achieving its investment objectives. Otherwise, the Portfolio may hold or trade convertible securities. In selecting convertible securities for the Portfolio, the Portfolio's Adviser evaluates the investment characteristics of the convertible security as a fixed income instrument and the investment potential of the underlying equity security for capital appreciation. In evaluating these matters with respect to a particular convertible security, the Portfolio's Adviser considers numerous factors, including the economic and political outlook, the value of the security relative to other investment alternatives, trends in the determinants of the issuer's profits, and the issuer's management capability and practices. A Portfolio may invest in warrants. Warrants are basically options to purchase common stock at a specific price (usually at a premium above the market value of the optioned common stock at issuance) valid for a specific period of time. Warrants may have a life ranging from less than a year to twenty years or may be perpetual. However, most warrants have expiration dates after which they are worthless. In addition, if the market price of the common stock does not exceed the warrant's exercise price during the life of the warrant, the warrant will expire as worthless. Warrants have no voting rights, pay no dividends, and have no rights with respect to the assets of the corporation issuing them. The percentage increase or decrease in the market price of the warrant may tend to be greater than the percentage increase or decrease in the market price of the optioned common stock. Warrants acquired in units or attached to securities may be deemed to be without value for purposes of a Portfolio's policy. SWAPS, CAPS, FLOORS AND COLLARS A Portfolio may enter into interest rate, currency and index swaps and the purchase or sale of related caps, floors and collars. A Portfolio expects to enter into these transactions primarily to preserve a return or spread on a particular investment or portion of its portfolio, to protect against currency fluctuations, as a duration management technique or to protect against any increase in the price of securities the Portfolio anticipates purchasing at a later date. A Portfolio would use these transactions as hedges and not as speculative investments and would not sell interest rate caps or floors where it does not own securities or other instruments providing the income stream the Portfolio may be obligated to pay. Interest rate swaps involve the exchange by a Portfolio with another party of their respective commitments to pay or receive interest, e.g., an exchange of floating rate payments for fixed rate payments with respect to a notional amount of principal. A currency swap is an agreement to exchange cash flows on a notional amount of two or more currencies based on the relative value differential among them and an index swap is an agreement to swap cash flows on a notional amount based on changes in the values of the reference indices. The purchase of a cap entitles the purchaser to receive payments on a notional principal amount from the party selling such cap to the extent that a specified index exceeds a predetermined interest rate or amount. The purchase of a floor entitles the purchaser to receive payments on a notional principal amount from the party selling such floor to the extent that a specified index falls below a predetermined interest rate or amount. A collar is a combination of a cap and a floor that preserves a certain return within a predetermined range of interest rates or values. A Portfolio will usually enter into swaps on a net basis, i.e., the two payment streams are netted out in a cash settlement on the payment date or dates specified in the instrument, with the Portfolio receiving or paying, as the case may be, only the net amount of the two payments. A Portfolio will not enter into any swap, cap, floor or collar transaction unless, at the time of entering into such transaction, the unsecured long-term debt of the counterparty, combined with any credit enhancements, is rated at least A by S&P or Moody's or has an equivalent rating from another nationally recognized securities rating organization or is determined to be of equivalent credit quality by the Portfolio's Adviser. If there is a default by the counterparty, a Portfolio may have contractual remedies pursuant to the agreements related to the transaction. As a result, the swap market has become relatively liquid. Caps, floors and collars are more recent innovations for which standardized documentation has not yet been fully developed and, accordingly, they are less liquid than swaps. A Portfolio may invest in lower-rated fixed-income securities (commonly known as "junk bonds") to the extent described in the relevant Prospectus. The lower ratings of certain securities held by a Portfolio reflect a greater possibility that adverse changes in the financial condition of the issuer or in general economic conditions, or both, or an unanticipated rise in interest rates, may impair the ability of the issuer to make payments of interest and principal. The inability (or perceived inability) of issuers to make timely payment of interest and principal would likely make the values of securities held by a Portfolio more volatile and could limit the Portfolio's ability to sell its securities at prices approximating the values the Portfolio had placed on such securities. In the absence of a liquid trading market for securities held by it, a Portfolio may be unable at times to establish the fair value of such securities. The rating assigned to a security by Moody's Investors Service, Inc. or Standard & Poor's (or by any other nationally recognized securities rating organization) does not reflect an assessment of the volatility of the security's market value or the liquidity of an investment in the security. Like those of other fixed-income securities, the values of lower-rated securities fluctuate in response to changes in interest rates. Thus, a decrease generally result in an increase in the value of the Portfolio's assets. Conversely, during periods of rising interest rates, the value of the Portfolio's assets will generally decline. In addition, the values of such securities are also affected by changes in general economic conditions and business conditions affecting the specific industries of their issuers. Changes by recognized rating services in their ratings of any fixed-income security and in the ability of an issuer to make payments of interest and principal may also affect the value of these investments. Changes in the value of portfolio securities generally will not affect cash income derived from such securities, but will affect the Portfolio's net asset value. A Portfolio will not necessarily dispose of a security when its rating is reduced below its rating at the time of purchase, although its Adviser will monitor the investment to determine whether its retention will assist in meeting the Portfolio's investment objective. The amount of information about the financial condition of an issuer of tax exempt securities may not be as extensive as that which is made available by corporations whose securities are publicly traded. Therefore, to the extent a Portfolio invests in tax exempt securities in the lower rating categories, the achievement of the Portfolio's goals is more dependent on its Adviser's investment analysis than would be the case if the Portfolio were investing in securities in the higher rating categories. A Portfolio may invest in indexed securities, the values of which are linked to currencies, interest rates, commodities, indices or other financial indicators ("reference instruments"). Most indexed securities have maturities of three years or less. Indexed securities differ from other types of debt securities in which a Portfolio may invest in several respects. First, the interest rate or, unlike other debt securities, the principal amount payable at maturity of an indexed security may vary based on changes in one or more specified reference instruments, such as an interest rate compared with a fixed interest rate or the currency exchange rates between two currencies (neither of which need be the currency in which the instrument is denominated). The reference instrument need not be related to the terms of the indexed security. For example, the principal amount of a U.S. dollar denominated indexed security may vary based on the exchange rate of two foreign currencies. An indexed security may be positively or negatively indexed; that is, its value may increase or decrease if the value of the reference instrument increases. Further, the change in the principal amount payable or the interest rate of an indexed security may be a multiple of the percentage change (positive or negative) in the value of the underlying reference instrument(s). Investment in indexed securities involves certain risks. In addition to the credit risk of the security's issuer and the normal risks of price changes in response to changes in interest rates, the principal amount of indexed securities may decrease as a result of changes in the value of reference instruments. Further, in the case of certain indexed securities in which the interest rate is linked to a reference instrument, the interest rate may be zero, and any further declines in the value of the security may then reduce the principal amount payable on maturity. Finally, indexed securities may be more volatile than the reference instruments underlying indexed securities. To reduce the effect of currency fluctuations on the value of existing or anticipated holdings of portfolio securities, a Portfolio may also engage in proxy hedging. Proxy hedging is often used when the currency to which the Portfolio is exposed is difficult to hedge or to hedge against the dollar. Proxy hedging entails entering into a forward contract to sell a currency whose changes in value are generally considered to be linked to a currency or currencies in which some or all of the Portfolio's securities are or are expected to be denominated, and to buy U.S. dollars. The amount of the contract would not exceed the value of the Portfolio's securities denominated in linked currencies. For example, if a Portfolio's Adviser considers that the Austrian schilling is linked to the German deutschmark (the "D-mark"), the Portfolio holds securities denominated in schillings and the Adviser believes that the value of schillings will decline against the U.S. dollar, the Adviser may enter into a contract to sell D-marks and buy dollars. A Portfolio may make investments in Eurodollar instruments. Eurodollar instruments are U.S. dollar-denominated futures contracts or options thereon which are linked to the London Interbank Offered Rate ("LIBOR"), although foreign currency-denominated instruments are available from time to time. Eurodollar futures contracts enable purchasers to obtain a fixed rate for the lending of funds and sellers to obtain a fixed rate for borrowings. A Portfolio might use Eurodollar futures contracts and options thereon to hedge against changes in LIBOR, to which many interest rate swaps and fixed-income instruments are linked. The officers and Trustees of the Trust are listed below, along with their addresses, principal occupations, and present positions, including any positions held with affiliated persons or Mentor Distributors, Inc. NAME AND ADDRESS THE TRUST DURING PAST FIVE YEARS Daniel J. Ludeman(1)(2) Chairman and Trustee Chairman and Chief 901 East Byrd Street Executive Officer since Richmond, Virginia 23219 July 1991, Mentor First Butcher Singer, Inc. Institutional Trust. Peter J. Quinn, Jr.(1)(2) Trustee President, Mentor 901 E. Byrd Street Distributors, Inc.; Richmond, Virginia 23219 Managing Director, Mentor Butcher Singer, Inc. Stanley F. Pauley Trustee Chairman and Chief P. O. Box 27205 Executive Officer, E.R. Richmond, Virginia 23261 Carpenter Company Trust. Louis W. Moelchert, Jr. Trustee Vice President of Business University of Richmond and Finance, University of Richmond, Virginia 23173 Richmond; Trustee, Cash Institutional Trust. Thomas F. Keller Trustee Dean, Fuqua School of Duke University Business, Duke University; Durham, North Carolina 27706 Trustee, Cash Resource Institutional Trust. Arnold H. Dreyfuss Trustee Retired. Formerly, 5100 Cary Street Road Chairman and Chief Richmond, Virginia 23225 Executive Officer, Beach/Proctor-Silex, Inc. Institutional Trust. Troy A. Peery, Jr. Trustee President, Heilig-Meyers 2235 Staples Mill Road Company. Trustee, Cash Richmond, Virginia 23230 Resource Trust and Mentor Institutional Trust. Paul F. Costello President Managing Director, Wheat 901 East Byrd Street First Butcher Singer, Richmond, Virginia 23219 Inc., Mentor Investment Insurance Company. Terry L. Perkins Treasurer Vice President, Mentor 901 East Byrd Street Investment Group, Inc.; Richmond, Virginia 23219 Treasurer, Cash Resource Trust. Michael Wade Assistant Treasurer Associate Vice 901 East Byrd Street President, Mentor Richmond, Virginia 23219 Investment Group, Inc. through March 1993. John M. Ivan Secretary Managing Director since 901 East Byrd Street October 1992, Director of Richmond, Virginia 23219 Compliance since October Mentor Series Trust. (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. (2) Members of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. The table below shows the estimated fees to be paid to each Trustee by the Trust for fiscal 1995 and the fees paid to each Trustee by all funds in the Mentor family (including the Trust) during the 1995 calendar year. TRUSTEES FROM THE TRUST COMPLEX FUNDS Daniel J. Ludeman $ 0 $ 0 Arnold H. Dreyfuss 6,500 17,200 Thomas F. Keller 5,500 14,700 Louis W. Moelchert, Jr. 6,000 16,700 Stanley F. Pauley 6,000 16,675 Troy A. Peery, Jr. 6,000 16,175 Peter J. Quinn, Jr. 0 0 The Trustees do not receive pension or retirement benefits from the Trust. The Trust's Declaration of Trust provides that the Trustees will be liable for their willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of their office. The officers and Trustees of the Trust own as a group less than 1% of the outstanding shares of any class of each Portfolio. To the knowledge of the Trust, no person owned of record or beneficially more than 5% of the outstanding shares of any Portfolio as of December 15, 1995, except as set forth below: Growth Portfolio-Class A Bank of New York TTEE 70.00 Wheat First Butcher Singer 401K Plumbers & Pipe Fitters Local Union 354 Pen FD J D Wright & Richard G. Hall TTEES UA Strategy Portfolio-Class Bank of New York TTEE 41.85 A Wheat First Butcher Singer 401K Plumbers & Pipe Fitters Local Union 354 Pen FD J. D. Wright & Richard G. Hall TTEES UA Global Portfolio-Class A Saxon & Co. 7.76 Quality Portfolio-Class A Wheat First FBO 8.39 Short-Duration Income Wheat First FBO 17.69 Portfolio-Class A John L. Irvin B & B Communications Inc. Robert B. Baine Jr., President Univ. Path Assoc. PSP Fergus O Shiel & D. S. Wilkinson TTES Balanced Portfolio The Wheat Foundation 89.74 Commonwealth Advisors, Inc. (formerly Cambridge Investment Advisors, Inc.) serves as investment adviser to the Capital Growth, Quality Income, Income and Growth, and Municipal Income Portfolios. Commonwealth Advisors has entered into sub-advisory arrangements with respect to certain of the Portfolios. Van Kampen/American Capital Management, Inc. ("Van Kampen") serves as sub-adviser to the Municipal Income Portfolio; Wellington Management Company ("Wellington") as sub-adviser to the Income and Growth Portfolio. Each of these sub-advisers has complete discretion to purchase and sell portfolio securities for its respective Portfolio within the particular Portfolio's investment objective, restrictions, and policies. Charter Asset Management, Inc. ("Charter") serves as investment adviser to the Growth Portfolio. Wellesley Advisors, Inc. ("Wellesley") serves as investment adviser to the Strategy Portfolio. Commonwealth Investment Counsel, Inc. ("Commonwealth") serves as investment adviser to the Balanced and Short-Duration Income Portfolios. Mentor Perpetual Advisors, L.L.C. ("Mentor Perpetual") serves as investment adviser to the Global Portfolio. Mentor Investment Group, Inc. (formerly Investment Management Group, Inc.) ("Mentor") serves as administrator to all of the Portfolios. Each of Commonwealth Advisors, Charter, Commonwealth, and Wellesley is a wholly-owned subsidiary of Mentor, which is a wholly-owned subsidiary of Wheat First Butcher Singer, Inc. ("WFBS"). Mentor Perpetual is owned equally by Mentor and Perpetual plc, a diversified financial services holding company. Subject to the supervision and direction of the Trustees, each investment adviser and/or sub-adviser manages the applicable Portfolio in accordance with the stated policies of that Portfolio and of the Trust. Each makes investment decisions for the Portfolio and places the purchase and sale orders for portfolio transactions. Mentor furnishes each of the Portfolios with certain statistical and research data, clerical help, and certain accounting, data processing, and other services required by the Portfolios, assists in preparation of certain reports to shareholders of the Portfolios, tax returns, and filings with the SEC and state Blue Sky authorities, and generally assists in all aspects of the Portfolios' operations. The investment advisers, sub-advisers, and Mentor, as the case may be, bear all their expenses in connection with the performance of their services (except as may be approved from time to time by the Trustees) and pay the salaries of all officers and employees who are employed by Each Portfolio's investment adviser and/or sub-adviser provides the Trust with investment officers who are authorized to execute purchases and sales of securities. Investment decisions for the Trust and for the other investment advisory clients of the investment advisers and sub-advisers and their affiliates are made with a view to achieving their respective investment objectives. Investment decisions are the product of many factors in addition to basic suitability for the particular client involved. Thus, a particular security may be bought or sold for certain clients even though it could have been bought or sold for other clients at the same time. Likewise, a particular security may be bought for one or more clients when one or more other clients are selling the security. In some instances, one client may sell a particular security to another client. It also sometimes happens that two or more clients simultaneously purchase or sell the same security, in which event each day's transactions in such security are, insofar as possible, averaged as to price and allocated between such clients in a manner which in the investment adviser's or sub-adviser's opinion is equitable to each and in accordance with the amount being purchased or sold by each. There may be circumstances when purchases or sales of securities for one or more clients will have an adverse effect on other clients. In the case of short-term investments, the Treasury area of Mentor handles purchases and sales under guidelines approved by investment officers of the Trust. Each investment adviser and sub-adviser employs professional staffs of portfolio managers who draw upon a variety of resources for research information for the Trust. Expenses incurred in the operation of a Portfolio or otherwise allocated to a Portfolio, including but not limited to taxes, interest, brokerage fees and commissions, compensation paid under a Portfolio's 12b-1 plan and the Shareholder Service Plan, fees to Trustees who are not officers, directors, stockholders, or employees of Wheat and subsidiaries, SEC fees and related expenses, state Blue Sky qualification fees, charges of the custodian and transfer and dividend disbursing agents, outside auditing, accounting, and legal services, charges for the printing of prospectuses and statements of additional information for regulatory purposes or for distribution, and certain costs incurred by Mentor in responding to shareholder inquiries as approved by the Trustees from time to time, to shareholders, certain shareholder report charges and charges relating to corporate matters are borne by the Portfolio. The investment adviser of each Portfolio receives an annual management fee from such Portfolio (which is described in the relevant Prospectus). The investment adviser pays a portion of that fee to any sub-adviser to the Portfolio. The Portfolios paid investment advisory fees in the amounts and for the periods indicated below (amounts shown reflect fee waivers where applicable): The investment advisers of the following Portfolios waived investment advisory fees in the following amounts for the periods indicated below: Commonwealth Advisors paid sub-advisory fees to the Portfolios' sub-advisers in the following amounts for the periods indicated below: (1) Prior to April 13, 1995, Phoenix Investment Counsel, Inc. ("Phoenix") served as sub-adviser to the Capital Growth Portfolio. Commonwealth Advisors paid subadvisory fees of $126,880 to Phoenix for fiscal year 1995. (2) Prior to April 13, 1995, Scudder, Stevens & Clark ("Scudder") served as sub-adviser to the Global Portfolio. Commonwealth Advisors paid subadvisory fees of $49,880 to Scudder for fiscal year 1995. (3) Prior to April 13, 1995, Pacific Investment Management Company ("Pacific") served as sub-adviser to the Quality-Income Portfolio (formerly the Cambridge Government Income Portfolio). Commonwealth Advisors paid $157,161 in subadvisory fees to Pacific for fiscal year 1995. If in any year the aggregate expenses of a Portfolio (including investment advisory fees but excluding interest, taxes, brokerage and distribution fees, and extraordinary expenses) exceed the expense limitation of any state having jurisdiction over that Portfolio, its investment adviser's compensation may be reduced. The most stringent state expense limitation applicable to the Trust presently requires reimbursement of expenses in any year that such expenses exceed the sum of 2.5% of the first $30 million of average daily net assets, 2.0% of the next $70 million of average daily net assets, and 1.5% of average daily net assets over $100 million. If a Portfolio's monthly projected operating expenses exceed this expense limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount of expenses to be borne by an investment adviser or sub-adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. Mentor Investment Group, Inc. serves as administrator to each of the Portfolios pursuant to an Administration Agreement. Prior to June 1, 1994, Cambridge Administrative Services ("CAS") provided administrative services to the Capital Growth, Quality Income, Municipal Income, and Income and Growth Portfolios. Pursuant to the Administration Agreement, Mentor provides continuously business management services to the Portfolios and, subject to the general oversight of the Trustees, manages all of the business and affairs of the Portfolios subject to the provisions of the Trust's Declaration of Trust, By-laws and the 1940 Act, and other policies and instructions the Trustees may from time to time establish. Mentor pays the compensation of all officers and executive employees of the Trust (except those employed by or serving at the request of an investment adviser or sub-adviser) and makes available to the Trust the services of its directors, officers, and employees as elected by the Trustees or officers of the Trust. In addition, Mentor provides all clerical services relating to the Portfolios' business. As compensation for its services, Mentor receives a fee from each Portfolio calculated daily at the annual rate of .10 of 1% of a Portfolio's average daily net assets. The Administration Agreement must be approved (beginning May 30, 1997) at least annually with respect to each Portfolio by a vote of a majority of the Trustees who are not interested persons of Mentor or the Trust. The Agreement may be terminated at any time without penalty on 30 days notice by Mentor, or immediately in respect of any Portfolio upon notice by the Trustees or by vote of a majority of the outstanding voting securities of that Portfolio. The Agreement terminates automatically in the event of any assignment. The Portfolios paid administrative service fees in the following amounts for the periods indicated below (amounts shown reflect fee waivers where applicable): The administrators waived administrative fees in the amounts and for the periods indicated below: During fiscal 1994, the Growth, Strategy, and Balanced Portfolios reimbursed amounts of $24,000, $21,507, and $6,905, respectively, to Mentor for certain accounting and operation related costs not covered by their respective administration arrangements: During Fiscal 1995, the amounts of these reimburse- ments were $6,579, $6,117, and $0, respectively. The Trust has adopted a Shareholder Servicing Plan (the "Service Plan") with Mentor Distributors with respect to each Portfolio. Pursuant to the Service Plan, financial institutions will enter into shareholder service agreements with the Portfolios to provide administrative support services to their customers who from time to time may be record or beneficial owners of shares of one or more Portfolios. In return for providing these support services, a financial institution may receive payments from one or more Portfolios at a rate not exceeding .25% of the average daily net assets of the Class A or Class B shares of the particular Portfolio or Portfolios owned by the financial institution's customers for whom it is the holder of record or with whom it has a servicing relationship. The Service Plan is designed to stimulate financial institutions to render administrative support services to the Portfolios and their shareholders. These administrative support services include, but are not limited to, the following functions: providing office space, equipment, telephone facilities, and various personnel including clerical, supervisory, and computer personnel as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding the Portfolios; assisting clients in changing dividend options, account designations and addresses; and providing such other services as the Portfolios reasonably request. Prior to June 1, 1995, the Balanced, Growth, ShortDuration Income, and Strategy Portfolios were parties to shareholder servicing arrangements with Wheat, First Securities, Inc. ("Wheat") pursuant to which each Portfolio made payments to Wheat at the annual rate of 0.25% of such Portfolio's average net assets. In addition to receiving payments under the Service Plan, financial institutions may be compensated by the investment adviser, a sub-adviser, and/or Mentor, or affiliates thereof, for providing administrative support services to holders of Class A or Class B shares of the Portfolios. These payments will be made directly by the investment adviser, a sub-adviser, and/or Mentor, as applicable, and will not be made from the assets of any of the Portfolios. During fiscal 1995, the Portfolios incurred shareholder service fees under the Service Plan (and, in the case of the Balanced, Growth, Short-Duration Income, and Strategy Portfolios, the shareholder servicing arrangements with Wheat) as follows (amounts shown reflect fee waivers where applicable): Income and Growth Portfolio............................ 153,495 During 1995, Wheat waived $5,965 in shareholder service fees under its agreement in respect of the Balanced Portfolio. Transactions on U.S. stock exchanges, commodities markets, and futures markets and other agency transactions involve the payment by a Portfolio of negotiated brokerage commissions. Such commissions vary among different brokers. A particular broker may charge different commissions according to such factors as the difficulty and size of the transaction. Transactions in foreign investments often involve the payment of fixed brokerage commissions, which may be higher than those in the United States. There is generally no stated commission in the case of securities traded in the over-the-counter markets, but the price paid by the Trust usually includes an undisclosed dealer commission or mark-up. In underwritten offerings, the price paid by the Trust includes a disclosed, fixed commission or discount retained by the underwriter or dealer. It is anticipated that most purchases and sales of securities by funds investing primarily in certain fixed-income securities will be with the issuer or with underwriters of or dealers in those securities, acting as principal. Accordingly, those funds would not ordinarily pay significant brokerage commissions with respect to securities transactions. It has for many years been a common practice in the investment advisory business for advisers of investment companies and other institutional investors to receive brokerage and research services (as defined in the Securities Exchange Act of 1934, as amended (the "1934 Act")) from broker-dealers that execute portfolio transactions for the clients of such advisers and from third parties with which such broker-dealers have arrangements. Consistent with this practice, each of the Portfolios' investment adviser or sub-adviser receives brokerage and research services and other similar services from many broker-dealers with which such investment adviser or sub-adviser places a Portfolio's portfolio transactions and from third parties with which these broker-dealers have arrangements. These services include such matters as general economic and market reviews, industry and company reviews, evaluations of investments, recommendations as to the purchase and sale of investments, newspapers, magazines, pricing services, quotation services, news services and personal computers utilized by the investment adviser's or sub-adviser's managers and analysts. Where the services referred to above are not used exclusively by the investment adviser or sub-adviser for research purposes, the investment adviser or sub-adviser, based upon its own allocations of expected use, bears that portion of the cost of these services which directly relates to its non-research use. Some of these services are of value to the investment adviser or subadviser and its affiliates in advising various of its clients (including the Portfolios), although not all of these services are necessarily useful and of value in managing the Portfolios. The management fee paid by a Portfolio is not reduced because the Portfolio's investment adviser or sub-adviser or any of their affiliates receive these services even though the investment adviser or sub-adviser might otherwise be required to purchase some of these services for cash. A Portfolio's investment adviser or sub-adviser, as the case may be, places all orders for the purchase and sale of portfolio investments for the Portfolio and buys and sells investments for the Portfolio through a substantial number of brokers and dealers investment adviser or sub-adviser. The investment adviser or sub-adviser seeks the best overall terms available for the Portfolio, except to the extent the investment adviser or sub-adviser may be permitted to pay higher brokerage commissions as described below. In doing so, the investment adviser or sub-adviser, having in mind the Portfolio's best interests, considers all factors it deems relevant, including, by way of illustration, price, the size of the transaction, the nature of the market for the security or other investment, the amount of the commission, the timing of the transaction taking into account market prices and trends, the reputation, experience and financial stability of the broker-dealer involved and the quality of service rendered by the broker-dealer in other transactions. As permitted by Section 28(e) of the 1934 Act, and by the Investment Advisory and Management Agreements, a Portfolio's investment adviser or sub-adviser may cause the Portfolio to pay a broker-dealer which provides "brokerage and research services" (as defined in the 1934 Act) to that adviser an amount of disclosed commission for effecting securities transactions on stock exchanges and other transactions for the Portfolio on an agency basis in excess of the commission which another broker-dealer would have charged for effecting that transaction. The investment adviser's or sub-adviser's authority to cause a Portfolio to pay any such greater commissions is also subject to such policies as the Trustees may adopt from time to time. It is the position of the staff of the Securities and Exchange Commission that Section 28(e) does not apply to the payment of such greater commissions in "principal" transactions. Accordingly, the investment adviser and sub-adviser will use its best efforts to obtain the best overall terms available with respect to such transactions, as described above. Consistent with the Rules of Fair Practice of the National Association of Securities Dealers, Inc. and subject to such other policies as the Trustees may determine, an investment adviser or sub-adviser may consider sales of shares of a Portfolio (and, if permitted by law, of the other funds in the Mentor family funds) as a factor in the selection of broker-dealers to execute portfolio transactions for a Portfolio. The Trustees have determined that portfolio transactions for the Trust may be effected through Wheat, First Securities, Inc. ("Wheat"). The Trustees have adopted certain policies incorporating the standards of Rule 17e-l issued by the SEC under the 1940 Act which requires, among other things, that the commissions paid to Wheat must be reasonable and fair compared to the commissions, fees, or other remuneration received by other brokers in connection with comparable transactions involving similar securities during a comparable period of time. Wheat will not participate in brokerage commissions given by the Trust to other brokers or dealers. Over-the-counter purchases and sales are transacted directly with principal market makers except in those cases in which better prices and executions may be obtained elsewhere. The Trust will in no event effect principal transactions with Wheat in over-the-counter securities in which Wheat makes a market. Under rules adopted by the SEC, Wheat may not execute transactions for the Trust on the floor of any national securities exchange, but may effect transactions for the Trust by transmitting orders for execution and arranging for the performance of this function by members of the exchange not associated with Wheat. Wheat will be required to pay fees charged to those persons performing the floor brokerage elements out of the brokerage compensation it receives from the Trust. The Trust has been advised by Wheat that on most transactions, the floor brokerage generally constitutes from 5% and 10% of the total commissions paid. The Portfolios paid brokerage commissions on brokerage transactions in the following aggregate amounts for the periods indicated: The following table shows brokerage commissions paid by each of the Portfolios to Wheat for the periods indicated: The brokerage commissions paid to Wheat for fiscal year 1995 amounted to the following percentages of the aggregate brokerage commissions paid by each Portfolio: Except under certain circumstances described in the Trust's or an individual Portfolio's prospectus, Class A shares of the Portfolios are sold at their net asset value plus an applicable sales charge on days the New York Stock Exchange is open for business. Class B shares of the Portfolios (where applicable) are sold at their net asset value with no sales charge on days the New York Stock Exchange is open for business. The procedure for purchasing Class A and Class B shares of the Portfolios is explained in the relevant Prospectus under the section entitled "How to Buy Shares." Dealers will be compensated on purchases of Class A shares in accordance with the following schedule: Amount of Purchase Dealer Commission Less than $2 million 1.00% $2 million but less than $3 million .80% $3 million but less than $50 million .50% $50 million but less than $100 million .25% $100 million or more .15% The above commission will be paid by Mentor Distributors and not a Portfolio or its shareholders. Each of the Portfolios makes payments to Mentor Distributors, Inc. in accordance with its respective Distribution Plan adopted pursuant to Rule 12b-1 under the Investment Company Act of 1940. Prior to June 1, 1995, each of the Balanced, Growth, Short-Duration Income, and Strategy Portfolios made payments under Rule 12b-1 plan to Wheat. During fiscal year 1995, the Portfolios paid the following 12b-1 fees to Wheat and Mentor Distributors as shown below: Balanced Portfolio.............. -- -- -- Capital Growth Portfolio........ -- $288,262 $ 288,262 Global Portfolio................ -- 68,125 68,125 Growth Portfolio................ $886,494 335,790 1,222,284 Income and Growth Portfolio..... -- 322,260 322,260 Municipal Income Portfolio...... -- 207,611 207,611 Quality Income Portfolio........ -- 334,771 334,771 Short-Duration Income Portfolio 25,133 13,921 39,054 Strategy Portfolio.............. 707,663 397,832 1,105,495 During fiscal year 1994, Mentor Distributors received the following contingent deferred sales charges: Capital Growth Portfolio................. $ 9,588 Income and Growth Portfolio.............. 12,813 During fiscal year 1995, Wheat and Mentor Distributors received the following contingent deferred sales charges: Capital Growth Portfolio............ -- $ 7,52l Income and Growth Portfolio......... -- 10,421 Municipal Income Portfolio.......... -- 2,083 Quality Income Portfolio............ -- 4,460 Short-Duration Income Portfolio -- 320 The following table shows the approximate amount of underwriting commissions retained by the principal underwriter for each Portfolio for the periods indicated: A Portfolio determines its net asset value per share once each day the New York Exchange (the "Exchange") is open as of the close of regular trading on the Exchange. Currently, the Exchange is closed Saturdays, Sundays and the following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial Day, the Fourth of July, Labor Day, Thanksgiving and Christmas. Securities for which market quotations are readily available are valued at prices which, in the opinion of a Portfolio's Adviser most nearly represent the market values of such securities. Currently, such prices are determined using the last reported sale price or, if no sales are reported (as in the case of some securities traded over-the-counter), the last reported bid price, except that certain U.S. Government securities are stated at the mean between the last reported bid and asked prices. Short-term investments having remaining maturities of 60 days or less are stated at amortized cost, which approximates market value. All other securities and assets are valued at their fair value following procedures approved by the Trustees. Liabilities are deducted from the total, and the resulting amount is divided by the number of shares of the class outstanding. Reliable market quotations are not considered to be readily available for long-term corporate bonds and notes, certain preferred stocks, tax-exempt securities, or certain foreign securities. These investments are stated at fair value on the basis of valuations furnished by pricing services approved by the Trustees, which determine valuations for normal, institutional-size trading units of such securities using methods based on market transactions for comparable securities and various relationships between securities which are generally recognized by institutional traders. If any securities held by a Portfolio are restricted as to resale, the Portfolio's Adviser determines their fair values. The fair value of such securities is generally determined as the amount which a Portfolio could reasonably expect to realize from an orderly disposition of such securities over a reasonable period of time. The valuation procedures applied in any specific instance are likely to vary from case to case. However, consideration is generally given to the financial position of the issuer and other fundamental analytical data relating to the investment and to the nature of the restrictions on disposition of the securities (including any registration expenses that might be borne by the Portfolio in connection with such disposition). In addition, specific factors are also generally considered, such as the cost of the investment, the market value of any unrestricted securities of the same class (both at the time of purchase and at the time of valuation), the size of the holding, the prices of any recent transactions or offers with respect to such securities and any available analysts' reports regarding the issuer. In the case of certain fixed-income securities, including certain less common mortgage-backed securities, market quotations are not readily available to the Portfolios on a daily basis, and pricing services may not provide price quotations. In such cases, the Portfolio's Adviser is typically able to obtain dealer quotations for each of the securities on at least a weekly basis. On any day when it is not practicable for the Adviser to obtain an actual dealer quotation for a security, the Adviser reprices the securities based on changes in the value of a U.S. Treasury security of comparable duration. When the next dealer quotation is obtained, the Adviser compares the dealer quote against the price obtained by it using its U.S. Treasury-spread calculation, and makes any necessary adjustments to its calculation methodology. The Adviser attempts to obtain dealer quotes for each security at least weekly, and on any day when there has been an unusual occurrence affecting the securities which, in the Adviser's view, makes pricing the securities on the basis of U.S. Treasuries unlikely to provide a fair value of the securities. Generally, trading in certain securities (such as foreign securities) is substantially completed each day at various times prior to the close of the Exchange. The values of these securities used in determining the net asset value of a Portfolio's shares are computed as of such times. Also, because of the amount of time required to collect and process trading information as to large numbers of securities issues, the values of certain securities (such as convertible bonds, U.S. Government securities, and tax-exempt securities) are determined based on market quotations collected earlier in the day at the latest practicable time prior to the close of the Exchange. Occasionally, events affecting the value of such securities may occur between such times and the close of the Exchange which will not be reflected in the computation of a Portfolio's net asset value. If events materially affecting the value of such securities occur during such period, then these securities will be valued at their fair value following procedures approved by the Trustees. Trading in securities on European and Far Eastern securities exchanges and over-the-counter markets is normally completed well before the close of business on each business day in New York (i.e., a day on which the Exchange is open). In addition, European or Far Eastern securities trading generally or in a particular country or countries may not take place on all business days in New York. Furthermore, trading takes place in Japanese markets on certain Saturdays and in various foreign markets on days which are not business days in New York and on which a Portfolio's net asset value is not calculated. A Portfolio calculates net asset value per share, and therefore effects sales, redemptions and repurchases of its shares, as of the close of the Exchange once on each day on which the Exchange is open. Such calculation does not take place contemporaneously with the determination of the prices of the majority of the portfolio securities used in such calculation. If events materially affecting the value of such securities occur between the time when their price is determined and the time when a Portfolio's net asset value is calculated, such securities will be valued at fair value as determined in good faith by the Trustees. Although the Trust intends to redeem Class A and Class B shares in cash, it reserves the right under certain circumstances to pay the redemption price in whole or in part by a distribution of securities from the respective in kind will be made in conformity with applicable SEC rules, taking such securities at the same value employed in determining net asset value and selecting the securities in a manner that the Trustees determine to be fair and equitable. The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which, with respect to each Portfolio, the Trust is obligated to redeem Class A or Class B shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Each Portfolio intends to qualify each year and elect to be taxed as a regulated investment company under Subchapter M of the United States Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company qualifying to have its tax liability determined under Subchapter M, a Portfolio will not be subject to federal income tax on any of its net investment income or net realized capital gains that are distributed to shareholders. As a series of Massachusetts business trust, a Portfolio will not under present law be subject to any excise or income taxes in Massachusetts. In order to qualify as a "regulated investment company," a Portfolio must, among other things, (a) derive at least 90% of its gross income from dividends, interest, payments with respect to securities loans, gains from the sale or other dispositions of stock, securities, or foreign currencies, and other income (including but not limited to gains from options, futures, or forward contracts) derived with respect to its business of investing in such stock, securities, or currencies; (b) derive less than 30% of its gross income from the sale or other disposition of certain assets (including stock or securities and certain options, futures contracts, forward contracts, and foreign currencies) held less than three months; (c) distribute with respect to each taxable year at least 90% of the sum of its taxable net investment income, its net tax-exempt income, and the excess, if any, of net short-term capital gains over net long-term capital losses for such year; and (d) diversify its holdings so that, at the close of each quarter of its taxable year, (i) at least 50% of the market value of its total assets consists of cash and cash items, U.S. Government Securities, securities of other regulated investment companies, and other securities limited generally with respect to any one issuer to not more than 5% of the value of its total assets and not more than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the value of its assets is invested in the securities (other than those of the U.S. Government or other regulated investment companies) of any issuer or of two or more issuers which the Portfolio controls and which are engaged in the same, similar, or related trades or businesses. In order to receive the favorable tax treatment accorded regulated investment companies and their shareholders, moreover, a Portfolio must in general distribute at least 90% of its interest, dividends, net short-term capital gain, and certain other income each year. If a Portfolio qualifies as a regulated investment company that is accorded special tax treatment, the Portfolio will not be subject to federal income tax paid to its shareholders in the form of dividends (including capital gain dividends). If a Portfolio failed to qualify as a regulated investment company accorded special tax treatment in any taxable year, the Portfolio would be subject to tax on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gains, would be taxable to shareholders as ordinary income. In addition, a Portfolio could be required to recognize unrealized gains, pay substantial taxes and interest and make substantial distributions before requalifying as a regulated investment company that is accorded special tax treatment. If a Portfolio fails to distribute in a calendar year substantially all of its ordinary income for such year and substantially all of its capital gain net income for the one-year period ending October 31 (or later if the Portfolio is permitted so to elect and so elects), plus any retained amount from the prior year, the Portfolio will be subject to a 4% excise tax on the undistributed amounts. A dividend paid to shareholders by a Portfolio in January of a year generally is deemed to have been paid by the Portfolio on December 31 of the preceding year, if the dividend was declared and payable to shareholders of record on a date in October, November or December of that preceding year. A Portfolio intends generally to make distributions sufficient to avoid imposition of the 4% excise tax. EXEMPT-INTEREST DIVIDENDS. A Portfolio will be qualified to pay exempt-interest dividends to its shareholders only if, at the close of each quarter of the Portfolio's taxable year, at least 50% of the total value of the Portfolio's assets consists of obligations the interest on which is exempt form federal income tax. Distributions that the Portfolio properly designates as exempt-interest dividends are treated by shareholders as interest excludable from their gross income for federal income tax purposes but may be taxable for federal alternative minimum tax purposes and for state and local purposes. If the Portfolio intends to be qualified to pay exempt-interest dividends, the Portfolio may be limited in its ability to enter into taxable transactions involving forward commitments, or repurchase agreements, financial futures, and options contracts on financial futures, tax-exempt bond indices, and other assets. Part or all of the interest on indebtedness, if any, incurred or continued by a shareholder to purchase or carry shares of a Portfolio paying exempt-interest dividends is not deductible. The portion of interest that is not deductible is equal to the total interest paid or accrued on the indebtedness, multiplied by the percentage of a Portfolio's total distributions (not including distributions from net long-term capital gains) paid to the shareholder that are exempt-interest dividends. Under rules used by the Internal Revenue Service for determining when borrowed funds are considered used for the purpose of purchasing or carrying particular assets, the purchase of shares may be considered to have been made with borrowed funds even though such funds are not directly traceable to the purchase of shares. In general, exempt-interest dividends, if any, attributable to interest received on certain private activity obligations and certain industrial development bonds will not be tax-exempt to any shareholders who are "substantial users" of the facilities financed by such obligations or bonds or who are "related persons" of such substantial users. A Portfolio which is qualified to pay exempt-interest dividends will inform investors within 60 days of the Portfolio's fiscal year-end of the percentage of its income distributions designated as tax-exempt. The percentage is applied uniformly to all distributions made during the year. The percentage of income designated as tax-exempt for any particular distribution may be substantially different form the percentage of the Portfolio's income that was tax-exempt during the period covered by the distribution. HEDGING TRANSACTIONS. If a Portfolio engages in transactions, including hedging transactions in options, futures contracts, and straddles, or other similar transactions, it will be subject to special tax rules (including mark-to-market, straddle, wash sale, and short sale rules), the effect of which may be to accelerate income to the Portfolio, defer losses to the Portfolio, cause adjustments in the holding periods of the Portfolio's securities, or convert short-term capital losses into long-term capital losses. These rules could therefore affect the amount, timing and character of distributions to shareholders. A Portfolio will endeavor to make any available elections pertaining to such transactions in a manner believed to be in the best interests of the Portfolio. Under the 30% of gross income test described above (see "Taxation of the Portfolio"), the Portfolio will be restricted in selling assets held or considered under Code rules to have been held for less than three months, and in engaging in certain hedging transactions (including hedging transactions in options and futures) that in some circumstances could cause certain Portfolio assets to be treated as held for less than three months. Certain of a Portfolio's hedging activities (including its transactions, if any, in foreign currencies or foreign currency-denominated instruments) are likely to produce a difference between its book income and its taxable income. If a Portfolio's book income exceeds its taxable income, the distribution (if any) of such excess will be treated as a dividend to the extent of the Portfolio's remaining earnings and profits (including earnings and profits arising from tax-exempt income), and thereafter as a return of capital or as gain from the sale or exchange of a capital asset, as the case may be. If a Portfolio's book income is less than its taxable income, the Portfolio could be required to make distributions exceeding book income to qualify as a regulated investment company that is accorded special tax treatment. RETURN OF CAPITAL DISTRIBUTIONS. If a Portfolio makes a distribution to you in excess of its current and accumulated "earnings and profits" in any taxable year, the excess distribution will be treated as a return of capital to the extent of your tax basis in your shares, and thereafter as capital gain. A return of capital is not taxable, but it reduces your tax basis in your shares, thus reducing any loss or increasing any gain on a subsequent taxable disposition by you or your shares. SECURITIES ISSUED OR PURCHASED AT A DISCOUNT. A Portfolio's investment in securities issued at a discount and certain other obligations will (and investments in securities purchased at a discount may) require the Portfolio to accrue and distribute income not yet received. In order to generate sufficient cash to make the requisite distributions, a Portfolio may be required to sell securities in its portfolio that it otherwise would have continued to hold. FOREIGN CURRENCY-DENOMINATED SECURITIES AND RELATED HEDGING TRANSACTIONS. A Portfolio's transactions in foreign currencies, foreign currency-denominated debt securities and certain foreign currency options, futures contracts, and forward contacts (and similar instruments) may give rise to ordinary income or loss to the extent such income or loss results from fluctuations in the value of the foreign currency concerned. If more than 50% of a Portfolio's assets at year end consists of the debt and equity securities of foreign corporations, the Portfolio may elect to permit shareholders to claim a credit or deduction on their income tax returns for their pro rata portion of qualified taxes paid by the Portfolio to foreign countries. In such a case, shareholders will include in gross income from foreign sources their pro rata shares of such taxes. A shareholder's ability to claim a foreign tax credit or deduction in respect of foreign taxes paid by the Portfolio may be subject to certain limitations imposed by the Code, as a result of which a shareholder may not get a full credit or deduction for the amount of such taxes. Shareholders who do not itemize on their federal income tax returns may claim a credit (but no deduction) for such foreign taxes. Investment by a Portfolio in certain "passive foreign investment companies" could subject the Portfolio to a U.S. federal income tax or other charge on the proceeds from the sale of its investment in such a company; however, this tax can be avoided by making an election to mark such investments to market annually or to treat the passive foreign investment company as a "qualified electing fund." SALE OR REDEMPTION OF SHARES. The sale, exchange or redemption of Portfolio shares may give rise to a gain or loss. In general, any gain or loss realized upon a taxable disposition of shares will be treated as long-term capital gain or loss if the shares have been held for more than 12 months, and otherwise as short-term capital gain or loss. However, if a shareholder sells shares at a loss within six months of purchase, any loss will be disallowed for federal income tax purposes to the extent of any exempt-interest dividends received on such shares. In addition, any loss (not already disallowed as provided in the preceding sentence) realized upon a taxable disposition of shares held for six months or less will be treated as long-term, rather than short-term, to the extent of any long-term capital gain distributions received by the shareholder with respect to the shares. All or a portion of any loss realized upon a taxable disposition of Portfolio shares will be disallowed if other Portfolio shares are purchased within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss. SHARES PURCHASED THROUGH TAX-QUALIFIED PLANS. Special tax rules apply to investments though defined contribution plans and other tax-qualified plans. Shareholders should consult their tax adviser to determine the suitability of shares of a Portfolio as an investment through such plans and the precise effect of an investment on their particular tax situation. BACKUP WITHHOLDING. A Portfolio generally is required to withhold and remit to the U.S. Treasury 31% of the taxable dividends and other distributions paid to any individual shareholder who fails to furnish the Portfolio with a correct taxpayer identification number (TIN), who has under reported dividends or interest income, or who fails to certify to the Portfolio that he or she is not subject to such withholding. Shareholders who fail to furnish their current TIN are subject to a penalty of $50 for each such failure unless the failure is due to reasonable cause and not wilful neglect. An individual's taxpayer identification number is his or her social security number. If a Portfolio invests in stock of certain foreign investment companies, the Portfolio may be subject to U.S. federal income taxation on a portion of any "excess distribution" with respect to, or gain from the disposition of, such stock. The tax would be determined by allocating such distribution or gain ratably to each day of a Portfolio's holding period for the stock. The distribution or gain so allocated to any taxable year of a Portfolio, other than the taxable year of the excess distribution or disposition, would be taxed to the Portfolio at the highest ordinary income rate in effect for such year, and the tax would be further increased by an interest charge to reflect the value of the tax deferral deemed to have resulted from the ownership of the foreign company's stock. Any amount of distribution or gain allocated to the taxable year of the distribution or disposition would be included in a Portfolio's investment company taxable income and, accordingly, would not be taxable to the Portfolio to the extent distributed by the Portfolio as a dividend to its shareholders. The foregoing is a general and abbreviated summary of the applicable provisions of the Code and related regulations currently in effect. For the complete provisions, reference should be made to the pertinent Code sections and regulations. The Code and regulations are subject to change by legislative or administrative actions. Dividends and distributions also may be subject to state and federal taxes. Shareholders are urged to consult their tax advisers regarding specific questions as to federal, state or local taxes. The foregoing discussion relates solely to U.S. federal income tax law. Non-U.S. investors should consult their tax advisers concerning the tax consequences of ownership of shares of the Portfolio, including the possibility that distributions may be subject to a 30% United States withholding tax (or a reduced rate of withholding provided by treaty). For a more complete discussion of shareholders' tax status, including a discussion of the individual alternative minimum tax and the corporate alternative minimum tax, see the section of the relevant prospectus in respect of taxes. KPMG Peat Marwick LLP, located at 99 High Street, Boston, Massachusetts 02110, are the Trust's independent auditors, providing audit services, tax return review and other tax consulting services and assistance and consultation in connection with the review of various Securities and Exchange Commission filings. Investors Fiduciary Trust Company, located at 127 West 10th Street, Kansas City, Missouri, is the custodian of each Portfolio, except that State Street Bank & Trust Company, P.O. Box 8602, Boston, Massachusetts serves as custodian to the Global Portfolio and as the foreign custodian to each of the other Portfolios in respect of its foreign assets. A custodian's responsibilities include generally safeguarding and controlling a Portfolio's cash and securities, handling the receipt and delivery of securities, and collecting interest and dividends on a Portfolio's investments. The table below shows the average annual total return for the one- and five-year periods (where applicable) and for the life of the Portfolios: Prior to May 30, 1995, the Balanced, Growth, Short-Duration Income, and Strategy Portfolios only offered one class of shares. Total return information for this period is shown under the Class B share table. THE ANNUAL TOTAL RETURN INFORMATION SHOWN ABOVE FOR THE BALANCED, GROWTH, SHORT-DURATION INCOME, AND STRATEGY PORTFOLIOS REFLECTS VARIOUS SALES CHARGES CURRENTLY NOT APPLICABLE TO THE PORTFOLIOS. The Balanced, Growth, Short-Duration, and Strategy Portfolios are the successors to Mentor Balanced Fund, Mentor Growth Fund, Mentor Short-Duration Income Fund, and Mentor Strategy Fund, respectively, each of which was previously a series of shares of beneficial interest of Mentor Series Trust. For fiscal 1994, none of the Mentor funds bore a front-end sales charge, but each of Mentor Strategy Fund, Mentor Short-Duration Income Fund, and Mentor Balanced Fund was subject to a maximum contingent deferred sales charge of 5%. - - - - - - Total return for one-, five-, and ten-year periods (or for such shorter periods as a Portfolio has been in operation) is determined by calculating the actual dollar amount of investment return on a $1,000 investment in the Portfolio at the beginning of the period, and then calculating the annual compounded rate of return which would produce that amount. Total return for a period of one year is equal to the actual return of the Portfolio during that period. Total return calculations assume deduction of a Portfolio's maximum contingent deferred sales charge, if applicable, and reinvestment of all Portfolio distributions at net asset value on their respective reinvestment dates. At times, a Portfolio's investment adviser or sub-adviser may reduce its compensation or assume expenses of the Portfolio in order to reduce the Portfolio's expenses. The per share amount of any such fee reduction or assumption of expenses during a Portfolio's past ten fiscal years (or for the life of a Portfolio, if shorter) is reflected in the Trust's Prospectus and the Portfolio Prospectuses. Any such fee reduction or assumption of expenses would increase a Portfolio's yield and total return during the period of the fee reduction or assumption of expenses. Total return may be presented for other periods or without giving effect to any contingent deferred sales charge. Any quotation of total return or yield not reflecting the contingent deferred sales charge would be reduced if the sales charges were reflected. ALL DATA ARE BASED ON PAST PERFORMANCE AND DO NOT PREDICT FUTURE RESULTS. The thirty-day yield for both classes of shares of certain of the Portfolios for the period ending September 30, 1995, was as follows: Quality Income Portfolio 6.24% 5.74% Municipal Income Portfolio 5.53% 5.30% Income and Growth Portfolio 1.89% 1.25% A Portfolio's yield is presented for a specified thirty-day period (the "base period"). Yield is based on the amount determined by (i) calculating the aggregate amount of dividends and interest earned by the Portfolio during the base period less expenses accrued for that period, and (ii) dividing that amount by the product of (A) the average daily number of shares of the Portfolio outstanding during the base period and entitled to receive dividends and (B) the net asset value per share on the last day of the base period. The result is annualized on a compounding basis to determine the yield. For this calculation, interest earned on debt obligations held by a Portfolio is generally calculated using the yield to maturity (or first expected call date) of such obligations based on their market values (or, in the case of receivables-backed securities such as GNMA's, based on costs). Dividends on equity securities are accrued daily at their stated dividend rates. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in a Portfolio, the performance will be reduced for those shareholders paying those fees. The tax-equivalent yield for Class A shares of the Municipal Income Portfolio for the thirty-day period ending September 30, 1995, was 9.16%. The tax-equivalent yield for the Class B shares was 8.78% for the same period. The tax-equivalent yield for both classes of the Municipal Income Portfolio is calculated similarly to the yield, but is adjusted to reflect the taxable yield that the Portfolio would have had to earn to equal its actual yield, assuming a 39.6% tax rate (the maximum effective federal rate for individuals) and assuming that income is 100% tax-exempt. The Municipal Income Portfolio may also use a tax-equivalency table in advertising and sales literature. The interest earned by the municipal bonds in the Portfolio's investment portfolio generally remains free from federal regular income tax but may be subject to state and local taxes. (Some portion of the Portfolio's income may be subject to federal alternative minimum tax and state and local taxes.) Capital gains, if any, are subject to federal, state and local tax. As the table below indicates, a "tax-fee" investment is an attractive choice for investors, particularly in times of narrow spreads between tax-free and taxable yields. TAXABLE YIELD EQUIVALENT FOR 1995 Note: The maximum marginal tax rate for each bracket was used in calculating the taxable yield equivalent. The table above is for illustrative purposes only. It is not an indicator of past or future performance of the Portfolio. The following persons are officers of the investment advisers or subadvisers of the Portfolios, as indicated. W. HANCE WEST, JR., CFA MANAGING DIRECTOR, TOTAL RETURN PORTFOLIO Mr. West has eight years of investment management experience. Mr. West serves as co- manager for the Mentor Income Fund (formerly RAC Income Fund), a $130 million closed- end bond fund. He holds his undergraduate degree in accounting from Virginia Polytechnic Institute and his graduate degree in business from University of Rochester. JOHN G. DAVENPORT, CFA MANAGING DIRECTOR, CHIEF EQUITY OFFICER AND Mr. Davenport has eleven years of investment management experience. He joined Commonwealth after heading equity research for Lowe, Brockenbrough, Tierney, & Tattersall. He earned his undergraduate business degree from the University of Richmond and his graduate degree in business from the University of Virginia. Mr. Davenport is also a portfolio manager at Commonwealth Advisors, Inc. P. BARTON PETERS, CFA SENIOR VICE PRESIDENT, DIRECTOR OF EQUITY RESEARCH Mr. Peters has fifteen years of investment management experience and joined Commonwealth after the sale of his company, Parata Analytics Research, to Commonwealth. He has an undergraduate degree from the College of William and Mary and a masters degree in finance and quantitative sciences from Virginia Commonwealth University. RICHARD H. SKEPPSTROM II VICE PRESIDENT, PORTFOLIO MANAGER Mr. Skeppstrom has five years of investment management experience. He has earned both his undergraduate degree and masters of business administration from the University of Virginia. CHRISTOPHER W. RUSBULDT, CFA ASSOCIATE VICE PRESIDENT, PORTFOLIO MANAGER Mr. Rusbuldt has three years of investment experience. He has an undergraduate degree from the University of Virginia. P. MICHAEL JONES, CFA MANAGING DIRECTOR, INCOME PORTFOLIO MANAGER Mr. Jones has ten years of investment management experience. Mr. Jones is responsible for the design and implementation of the fixed-income group's proprietary analytical system. He earned his undergraduate degree from the College of William and Mary. Mr. Jones is also a portfolio manager at Commonwealth Advisors, Inc. STEVEN C. HENDERSON ASSOCIATE VICE PRESIDENT, INCOME PORTFOLIO MANAGER Mr. Henderson has six years of investment management experience. He has an undergraduate degree from the University of Richmond and a masters in business administration from George Washington University. STEPHEN R. MCCLELLAND VICE PRESIDENT, TOTAL RETURN PORTFOLIO MANAGER Mr. McClelland has five years of investment management experience, all of which have been at Commonwealth. He is a Certified Public Accountant and received his undergraduate degree in accounting from Iowa State University and his graduate business degree from Virginia Commonwealth University. KEITH WANTLING ASSOCIATE VICE PRESIDENT, SENIOR RESEARCH ANALYST Mr. Wantling has four years of experience. Mr. Wantling performs analysis and screening for credit sensitive private label mortgage-backed securities and directs the firm's portfolio analysis effort. He holds his undergraduate degree in accounting information systems from Virginia Polytechnic Institute. THEODORE W. PRICE, CFA PRESIDENT, PORTFOLIO MANAGER Mr. Price has thirty years of investment management experience, with over twenty-three years' tenure at Charter. He has managed Mentor Growth Portfolio since its inception. He earned both his undergraduate degree and masters of business administration from the University of Virginia. LINDA A. ZIGLAR, CFA SENIOR VICE PRESIDENT, PORTFOLIO MANAGER Ms. Ziglar has sixteen years of investment management experience. Ms. Ziglar joined Charter from Federated Investors, where she managed $300 million in equity assets. She holds an undergraduate degree from Randolph-Macon Woman's College where she graduated summa cum laude. She also holds a graduate degree in business administration from the University of Pittsburgh. JEFFREY S. DRUMMOND, CFA VICE PRESIDENT, PORTFOLIO MANAGER Mr. Drummond has seven years of investment management experience. Mr. Drummond began his career as a portfolio analyst in the Investment Strategy Department at Wheat First Butcher Singer, where he shared responsibility for directing $100 million in assets following the Strategic Sectors Portfolio. He received his undergraduate degree in finance from the University of Richmond, where he graduated cum laude. EDWARD RICK IV RESEARCH ANALYST Mr. Rick has one year of investment management experience. He received his undergraduate degree in finance from the University of Richmond, where he graduated cum laude. SCOTT MCGLASHAN FAR EAST SPECIALIST, PORTFOLIO MANAGER Mr. McGlashan has eighteen years of investment management experience, twelve years specializing in the Far East, and ten years' tenure in the Perpetual organization. He has earned degrees from Yale University and Cambridge University. ROBERT YERBURY AMERICAN SPECIALIST, PORTFOLIO MANAGER Mr. Yerbury has twenty-three years of investment management experience, with over twenty years experience in North American stock markets, and has been part of the Perpetual team for twelve years. He received his undergraduate degree in mathematics from Cambridge University. STEPHEN WHITTAKER UNITED KINGDOM SPECIALIST, PORTFOLIO MANAGER Mr. Whittaker has fifteen years of investment management experience. Prior to his employment at Perpetual, Mr. Whittaker was responsible for a wide range of UK equity funds for the Save & Prosper Group. He earned a law degree from Manchester University. MARGARET RODDAN EUROPEAN SPECIALIST, PORTFOLIO MANAGER Ms. Roddan has ten years of investment management experience. Ms. Roddan joined the Perpetual organization from Mercury Asset Management, where she shared responsibility for managing more than $750 million in continental European equity holdings. She is a graduate of the Investment Management Programme at the London Business School, studied Finance at City University, and holds an undergraduate degree in economic history from Bristol University. DON R. HAYS PRESIDENT, PORTFOLIO MANAGER Mr. Hays has over twenty-seven years of investment experience and is Director of Investment Strategy for Wheat First Butcher Singer, Inc., a position he has held since 1984. Mr. Hays began his career as an engineer with Von Braun rocket-development team in 1968. He is regarded as one of the country's leading investment strategists and his market outlook is quoted regularly in the WALL STREET JOURNAL, INVESTOR'S BUSINESS DAILY, USA TODAY, and other major media. He has been a guest on the PBS series WALL $TREET WEEK with Louis Rukeyser and is regularly featured by DOW JONES, REUTERS AND BLOOMBERG NEWS SERVICES. ASA W. GRAVES VII, CFA PORTFOLIO ANALYST Mr. Graves has four years of investment management experience and works closely with Mr. Hays to develop the analytical framework used in managing the Strategy Portfolio. He earned his undergraduate degree from the University of Richmond. The performance of Class A and Class B shares, where applicable, of each Portfolio depends upon such variables as: portfolio quality; average portfolio maturity; type of instruments in which the particular Portfolio is invested; changes in the expenses of the Trust or Class A or Class B shares of a particular Portfolio; and various other factors. The performance of each Portfolio's Class A and Class B shares fluctuates on a daily basis largely because net earnings and net asset value per share fluctuate daily. Both net earnings and net asset value per share are factors in the computation of yield and total return for each class of the Portfolios. Independent statistical agencies measure a Portfolio's investment performance and publish comparative information showing how a Portfolio, and other investment companies, performed in specified time periods. Agencies whose reports are commonly used for such comparisons are set forth below. From time to time, a Portfolio may distribute these comparisons to its shareholders or to potential investors. THE AGENCIES LISTED BELOW MEASURE PERFORMANCE BASED ON THEIR OWN CRITERIA RATHER THAN ON THE STANDARDIZED PERFORMANCE MEASURES DESCRIBED IN THE PRECEDING SECTION. LIPPER ANALYTICAL SERVICES, INC., ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specified period of time. From time to time, a Portfolio will quote its Lipper ranking in advertising and sales literature. MORNINGSTAR, INC. distributes mutual fund ratings twice a month. The ratings are divided into five groups: highest, above average, neutral, below average, and lowest. They represent a Portfolio's historical risk/reward ratio relative to other funds with similar objectives. The performance factor is a weighted-average assessment of the Portfolio's 3- year, 5-year, and 10-year total return performance (if available) reflecting deduction of expenses and sales charges. Performance is adjusted using quantitative techniques to reflect the risk profile of the Portfolio. The ratings are derived from a purely quantitative system that does not utilize the subjective criteria customarily employed by rating agencies such as Standard & Poor's Corporation and Moody's Investor Service, Inc. WEISENBERGER'S MANAGEMENT RESULTS publishes mutual fund rankings and is distributed monthly. The rankings are based entirely on total return calculated by Weisenberger for periods such as year-to-date, 1-year, 3-year, 5-year and 10-year performance. Mutual funds are ranked in general categories (e.g., international bond, international equity, municipal bond, and maximum capital gain). Weisenberger rankings do not reflect deduction of sales charges or fees. A Portfolio's shares also may be compared to the following indices: DOW JONES INDUSTRIAL AVERAGE ("DJIA") is an unmanaged index representing share prices of major industrial corporations, public utilities, and transportation companies. Produced by Dow Jones & Company, it is cited as a principal indicator of market conditions. STANDARD & POOR'S DAILY STOCK PRICE INDEX OF 500 COMMON STOCKS, a composite index of common stocks in industry, transportation, and financial and public utility companies, can be used to compare to the total returns of funds whose portfolios are invested primarily in common stocks. In addition, the Standard & Poor's listed on its index. Taxes due on any of these distributions are not included, nor are brokerage or other fees calculated, in the Standard & Poor's figures. CONSUMER PRICE INDEX is generally considered to be a measure of inflation. CDA MUTUAL FUND GROWTH INDEX is a weighted performance average of other mutual funds with growth of capital objectives. LIPPER GROWTH FUND INDEX is an average of the net asset-valuated total returns for the top 30 growth funds tracked by Lipper Analytical Services, Inc., an independent mutual fund rating service. SHEARSON LEHMAN GOVERNMENT/CORPORATE (TOTAL) INDEX is comprised of approximately 5,000 issues, which include non-convertible bonds publicly issued by the U.S. government or its agencies; corporate bonds guaranteed by the U.S. government and quasifederal corporations; and publicly issued, fixed-rate, non-convertible domestic bonds of companies in industry, public utilities and finance. The average maturity of these bonds approximates nine years. Tracked by Shearson Lehman Brothers Inc., the index calculates total returns for one month, three month, twelve month and ten year periods and year-to-date. SHEARSON LEHMAN GOVERNMENT INDEX is an unmanaged index comprised of all publicly issued, non-convertible domestic debt of the U.S. government, or any agency thereof, or any quasi-federal corporation and of corporate debt guaranteed by the U.S. government. Only notes and bonds with a minimum outstanding principal of $1 million and a minimum maturity of one year are included. RUSSELL GROWTH 1000 (RUSSELL 1000 INDEX) is a broadly diversified index consisting of approximately 1,000 common stocks of companies with market values between $20 million and $300 million that can be used to compare the total returns of funds whose portfolios are invested primarily in growth common stocks. SHEARSON LEHMAN AGGREGATE BOND INDEX is a total return index measuring both the capital price changes and income provided by the underlying universe of by market value outstanding. The Aggregate Bond Index is comprised of the Shearson Lehman Government Bond Index, Corporate Bond Index, Mortgage-Backed Securities Index, and Yankee Bond Index. These indices include: U.S. Treasury obligations, including bonds and notes; U.S. agency obligations, including those of the Federal Farm Credit Bank, Federal Land Bank, and the Bank for Cooperatives; foreign obligations; and U.S. investment-grade corporate debt and mortgage-backed obligations. All corporate debt included in the Aggregate Bond Index has a minimum S&P rating of BBB, a minimum Moody's rating of Baa, or a minimum Fitch rating of BBB. SALOMON BROTHERS MORTGAGE-BACKED SECURITIES INDEX-15 YEARS includes the average of all 15-year mortgage securities, which include Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae), and Government National Mortgage Association (Ginnie Mae). SHEARSON LEHMAN MUNICIPAL BOND INDEX is a total return performance benchmark for the long-term, investment-grade tax-exempt bond market. Returns and attributes for the Index are calculated semi-monthly using approximately 21,000 municipal bonds, which are priced by Muller Data Corporation. From time to time, certain of the Portfolios that invest in foreign securities may advertise the performance of both classes of their shares compared to similar funds or portfolios using certain indices, reporting services, and financial publications. These may include the following: Morgan Stanley Capital International World Index, The Morgan Stanley Capital International EAFE (Europe, Australia, Far East) index, J.P. Morgan Global Traded Bond Index, Salomon Brothers World Government Bond Index, and the Standard & Poor's 500 Composite Stock Price Index (S&P 500). A Portfolio also may compare its performance to the performance of unmanaged stock and bond indices, including the total returns of foreign government bond markets in various countries. All index returns are translated into U.S. dollars. The total return calculation for these unmanaged indices may assume the reinvestment of dividends and any distributions, if applicable, may include withholding taxes, and generally do not reflect deductions for administrative and management costs. Investors may use such indices or reporting services in addition to the Trust or an individual Portfolio's prospectus to obtain a more complete view of a particular Portfolio's performance before investing. Of course, when comparing a Portfolio's performance to any index, conditions such as composition of the index and prevailing market conditions should be considered in assessing the significance of such comparisons. When comparing portfolios using reporting services, or total return and yield, investors should take into consideration any relevant differences in portfolios, such as permitted portfolio compositions and methods used to value portfolio securities and compute net asset value. Advertisements and other sales literature for a Portfolio may quote total returns which are calculated on non-standardized base periods. These total returns also represent the historic change in the value of an investment in a Portfolio based on monthly reinvestment of dividends over a specified period of time. From time to time the Portfolios may advertise their performance, using charts, graphs, and descriptions, compared to federally insured bank products, including certificates of deposit and time deposits, and to monthly market funds using the Lipper Analytical Service money market instruments average. Advertisements may quote performance information which does not reflect the effect of the sales load. Independent publications may also evaluate a Portfolio's performance. Certain of those publications are listed below, at the request of Mentor Distributors, which bears full responsibility for their use and the descriptions appearing below. From time to time any or all of the Portfolios may distribute evaluations by or excerpts from these publications to its shareholders or to potential investors. The following illustrates the types of information provided by these publications. BUSINESS WEEK publishes mutual fund rankings in its Investment Figures of the Week column. The rankings are based on 4-week and 52-week total return reflecting changes in net asset value and the reinvestment of all distributions. They do not reflect deduction of any sales charges. Funds are not categorized; they compete in a large universe of over 2,000 funds. The source for rankings is data generated by Morningstar, Inc. INVESTOR'S BUSINESS DAILY publishes mutual fund rankings on a daily basis. The rankings are depicted as the top 25 funds in a given category. The categories are based loosely on the type of fund, e.g., growth funds, balanced funds, U.S. government funds, GNMA funds, growth and income funds, corporate bond funds, etc. Performance periods for sector equity funds can vary from 4 weeks to 39 weeks; performance periods for other fund groups vary from 1 year to 3 years. Total return performance reflects changes in net asset value and reinvestment of dividends and capital gains. The rankings are based strictly on total return. They do not reflect deduction of any sales charges Performance grades are conferred from A+ to E. An A+ rating means that the fund has performed within the top 5% of a general universe of over 2000 funds; an A rating denotes the top 10%; an A- is given to the top 15%, etc. BARRON'S periodically publishes mutual fund rankings. The rankings are based on total return performance provided by Lipper Analytical Services. The Lipper total return data reflects changes in net asset value and reinvestment of distributions, but does not reflect deduction of any sales charges. The performance periods vary from short-term intervals (current quarter or year-to-date, for example) to long-term periods (five-year or ten-year performance, for example). Barron's classifies the funds using the Lipper mutual fund categories, such as Capital Appreciation Funds, Growth Funds, U.S. Government Funds, Equity Income Funds, Global Funds, etc. Occasionally, Barron's modifies the Lipper information by ranking the funds in asset classes. "Large funds" may be those with assets in excess of $25 million; "small funds" may be those with less than $25 million in assets. THE WALL STREET JOURNAL publishes its Mutual Fund Scorecard on a daily basis. Each Scorecard is a ranking of the top-15 funds in a given Lipper Analytical Services category. Lipper provides the rankings based on its total return data reflecting changes in net asset value and reinvestment of distributions and not reflecting any sales charges. The Scorecard portrays 4-week, year-to-date, one-year and 5-year performance; however, the ranking is based on the one-year results. The rankings for any given category appear approximately once per month. FORTUNE magazine periodically publishes mutual fund rankings that have been compiled for the magazine by Morningstar, Inc. Funds are placed in stock or bond fund categories (for example, aggressive growth stock funds, growth stock funds, small company stock funds, junk bond funds, Treasury bond funds etc.), with the top-10 stock funds and the top-5 bond funds appearing in the rankings. The rankings are based on 3-year annualized total return reflecting changes in net asset value and reinvestment of distributions and not reflecting sales charges. Performance is adjusted using quantitative techniques to reflect the risk profile of the fund. MONEY magazine periodically publishes mutual fund rankings on a database of funds tracked for performance by Lipper Analytical Services. The funds are placed in 23 stock or bond fund categories and analyzed for five-year risk adjusted return. Total return reflects changes in net asset value and reinvestment of all dividends and capital gains distributions and does not reflect deduction of any sales charges. Grades are conferred (from A to E): the top 20% in each category receive an A, the next 20% a B, etc. To be ranked, a fund must be at least one year old, accept a minimum investment of $25,000 or less and have had assets of at least $25 million as of a given date. FINANCIAL WORLD publishes its monthly Independent Appraisals of Mutual Funds, a survey of approximately 1000 mutual funds. Funds are categorized as to type, e.g., balanced funds, corporate bond funds, global bond funds, growth and income funds, U.S. government bond funds, etc. To compete, funds must be over one year old, have over $1 million in assets, require a maximum of $10,000 initial investment, and should be available in at least 10 states in the United States. The funds receive a composite past performance rating, which weighs the intermediate - and long-term past performance of each fund versus its category, as well as taking into account its risk, reward to risk, and fees. An A+ rated fund is one of the best, while a D- rated fund is one of the worst. The source for Financial World rating is Schabacker investment management in Rockville, Maryland. FORBES magazine periodically publishes mutual fund ratings based on performance over at least two bull and bear market cycles. The funds are categorized by type, including stock and balanced funds, taxable bond funds, municipal bond funds, etc. Data sources include Lipper Analytical Services and CDA Investment Technologies. The ratings are based strictly on performance at net asset value over the given cycles. Funds performing in the top 5% receive an A+ rating; the top 15% receive an A rating; and so on until the bottom 5% receive an F rating. Each fund exhibits two ratings, one for performance in "up" markets and another for performance in "down" markets. KIPLINGER'S PERSONAL FINANCE MAGAZINE (formerly Changing Times), periodically publishes rankings of mutual funds based on one-, three- and five-year total return performance reflecting changes in net asset value and reinvestment of dividends and capital gains and not reflecting deduction of any sales charges. Funds are ranked by tenths: a rank of 1 means that a fund was among the highest 10% in total return for the period; a rank of 10 denotes the bottom 10%. Funds compete in categories of similar funds -- aggressive growth funds, growth and income funds, sector funds, corporate bond funds, global governmental bond funds, mortgage-backed securities funds, etc. Kiplinger's also provides a risk-adjusted grade in both rising and falling markets. Funds are graded against others with the same objective. The average weekly total return over two years is calculated. Performance is adjusted using quantitative techniques to reflect the risk profile of the fund. U.S. NEWS AND WORLD REPORT periodically publishes mutual fund rankings based on an overall performance index (OPI) devised by Kanon Bloch Carre & Co., a Boston research firm. Over 2000 funds are tracked and divided into 10 equity, taxable bond and tax-free bond categories. Funds compete within the 10 groups and three broad categories. The OPI is a number from 0-100 that measures the relative performance of funds at least three years old over the last 1, 3, 5 and 10 years and the last six bear markets. Total return reflects changes in net asset value and the reinvestment of any dividends and capital gains distributions and does not reflect deduction of any sales charges. Results for the longer periods receive the most weight. THE 100 BEST MUTUAL FUNDS YOU CAN BUY authored by Gordon K. Williamson. The author's list of funds is divided into 12 equity and bond fund categories, and the 100 funds are determined by applying four criteria. First, equity funds whose current management teams have been in place for less than five years are eliminated. (The standard for bond funds is three years.) Second, the author excludes any fund that ranks in the bottom 20 percent of its category's risk level. Risk is determined by analyzing how many months over the past three years the fund has underperformed a bank CD or a U.S. Treasury bill. Third, a fund must have demonstrated strong results for current three-year and five-year performance. Fourth, the fund must either possess, in Mr. Williamson's judgment, "excellent" risk-adjusted return or "superior" return with low levels of risk. Each of the 100 funds is ranked in five categories: total return, risk/volatility, management, current income and expenses. The rankings follow a five-point system: zero designates "poor"; one point means "fair"; two points denote "good"; three points qualify as a "very good"; four points rank as "superior"; and five points mean "excellent." Under Massachusetts law, shareholders could, under certain circumstances, be held personally liable for the obligations of the Trust. However, the Agreement and Declaration of Trust disclaims shareholder liability for acts or obligations of the Trust and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the Trust or the Trustees. The Agreement and Declaration of Trust provides for indemnification out of a Portfolio's property for all loss and expense of any shareholder held personally liable for the obligations of a Portfolio. Thus the risk of a shareholder's incurring financial loss on account of shareholder liability is limited to circumstances in which the Portfolio would be unable to meet its obligations. * Securities not currently producing income. SEE NOTES TO FINANCIAL STATEMENTS. SEE NOTES TO FINANCIAL STATEMENTS. * Securities not currently producing income. SEE NOTES TO FINANCIAL STATEMENTS. MENTOR INCOME & GROWTH PORTFOLIO MENTOR INCOME & GROWTH PORTFOLIO MENTOR INCOME & GROWTH PORTFOLIO MENTOR INCOME & GROWTH PORTFOLIO MENTOR INCOME & GROWTH PORTFOLIO * Securities not currently producing income. American Depository Receipts. REIT -- Real Estate Investment Trust SEE NOTES TO FINANCIAL STATEMENTS. * Securities not currently producing income. (a) All or a portion of these securities are restricted (i.e., securities which may not be publicly sold without registration under the Federal Securities Act of 1933). Dates of acquisition and costs are set forth in parentheses after the title of the restricted securities. (b) These are securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4 (2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. SEE NOTES TO FINANCIAL STATEMENTS. REMIC - Real Estate Mortgage Investment Conduit (a) At September 30, 1995, the cost of securities purchased on a when-issued basis totaled $10,001,875. * $5,250,000 principal amount of these securities have been segregated for a commitment to purchase when-issued securites at September 30, 1995. SEE NOTES TO FINANCIAL STATEMENTS. (a) At September 30, 1995 cost of securities purchased on a when-issued basis totaled $3,182,383. * $3,400,000 principal amount of these securities have been segregated for a commitment to purchase when-issued securities at September 30, 1995. SEE NOTES TO FINANCIAL STATEMENTS. (a) Effective yield is the yield as calculated at time of purchase at which the bond accretes on an annual basis until its maturity date. (b) Interest rates represent annualized yield to date of maturity. For each security, cost (for financial reporting and federal income tax purposes) and carrying value are the same. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENTS OF ASSETS AND LIABILITIES * Investments at cost $185,817,377, $76,760,291, $203,994,840, $60,536,390, $18,085,442, $95,192,126, $20,084,529 and $56,429,527 respectively. (a) Computation of offering price: 100/94.25 of net asset value. (b) Computation of offering price: 100/95.25 of net asset value. (c) Computation of offering price: 100/99 of net asset value. (d) Computation of redemption proceeds: 96/100 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. PERIOD ENDED SEPTEMBER 30, 1995 * For the period from January 1, 1995 to September 30, 1995. Net of interest expense $125,954 for the Mentor Quality Income Portfolio and $170,196 for the Mentor Short-Duration Income Portfolio. * Withholding taxes were $2,161, $8,690, $27,135, $15,273 and $32,044 for the Mentor Growth Portfolio, Mentor Capital Growth Portfolio, Mentor Strategy Portfolio, Mentor Income and Growth Portfolio and Mentor Perpetual Global Portfolio, respectively for the period ended September 30, 1995. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENTS OF CHANGES IN NET ASSETS * For the period from January 1, 1995 to September 30, 1995. ** For the period from March 29, 1994 (commencement of operations) to September 30, 1994. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENTS OF CHANGES IN NET ASSETS * For the period from January 1, 1995 to September 30, 1995. *** For the period from April 29, 1994 (commencement of operations) to December 31, 1994. SEE NOTES TO FINANCIAL STATEMENTS. * For the period from June 5, 1995 to September 30, 1995. ** Reflects operations for the period from April 29, 1992 (commencement of operations), to September 30, 1992. (a) Annualized. SEE NOTES TO FINANCIAL STATEMENTS. * For the period from June 5, 1995 to September 30, 1995. ** Reflects operations for the period from April 29, 1992 (commencement of operations), to September 30, 1992. (a) Annualized. (b) Reflects operations for the period from May 24, 1993 (commencement of operations), to September 30, 1993. (c) Reflects operations for the period from March 29, 1994 (commencement of operations), to September 30, 1994. SEE NOTES TO FINANCIAL STATEMENTS. * For the period from June 16, 1995 to September 30, 1995. ** Reflects operations for the period from April 29, 1992 (commencement of operations), to September 30, 1992. (a) Annualized. SEE NOTES TO FINANCIAL STATEMENTS. * For the period from January 1, 1995 to September 30, 1995. SEE NOTES TO FINANCIAL STATEMENTS. * For the period from January 1, 1995 to September 30, 1995. Reflects operations for the period from April 29, 1992 (commencement of operations), to September 30, 1992. * Reflects operations for the period of October 29, 1993 (commencement of operations), to December 31, 1993. (b) Reflects operations for the period from May 24, 1993 (commencement of operations), to September 30, 1993. SEE NOTES TO FINANCIAL STATEMENTS. * For the period from January 1, 1995 to September 30, 1995. ** Reflects operations for the period from April 29, 1992 (commencement of operations), to September 30, 1992. (c) Reflects operations for the period from March 29, 1994 (commencement of operations), to September 30, 1994. (d) Reflects operations for the period from April 29, 1994 (commencement of operations), to December 31, 1994. SEE NOTES TO FINANCIAL STATEMENTS. Mentor Funds (formerly Cambridge Series Trust) is registered under the Investment Company Act of 1940, as amended, as an open-end management investment company. On April 12, 1995 the name of the Trust was changed to Mentor Funds ("Mentor Funds"). On April 12, 1995 the portfolios of Mentor Series Trust were merged into newly formed portfolios of Mentor Funds. Mentor Funds consists of nine separate Portfolios (hereinafter each individually referred to as a "Portfolio" or collectively as the "Portfolios") at September 30, 1995, as follows: Mentor Income and Growth Portfolio The assets of each Portfolio are segregated and a shareholder's interest is limited to the Portfolio in which shares are held. The Balanced Portfolio is not currently being offered to new investors. These financial statements do not include the Balanced Portfolio. Mentor Funds currently issues two classes of shares. Class A shares are sold subject to a maximum sales charge of 5.75% (4.75% for Quality Income Portfolio and Municipal Income Portfolio and 1% for Short-Duration Income Portfolio) payable at the time of purchase. Class B shares are sold subject to a contingent deferred sales charge payable upon redemption which decreases depending on when shares were purchased and how long they have been held. NOTE 2: SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies consistently followed by the Portfolios: Listed securities held by the Growth Portfolio, Capital Growth Portfolio, Strategy Portfolio, Income and Growth Portfolio and Global Portfolio traded on national stock exchanges and over-the-counter securities quoted on the NASDAQ National Market System are valued at the last reported sales price or, lacking any sales, at the last available bid price. In cases where securities are traded on more than one exchange, the securities are valued on the exchange designated by the Board of Trustees of the Portfolios as the primary market. Securities traded in the over-the-counter market, other than those quoted on the NASDAQ National Market System, are valued at the last available bid price. Short-term investments with remaining maturities of 60 days or less are carried at amortized cost, which approximates market value. Securities for which market quotations are not readily available are valued at fair value as determined in good faith under procedures established by and under the general supervision and responsibility of the Board of Trustees. U.S. Government obligations held by the Quality Income Portfolio, Short-Duration Income Portfolio and Income and Growth Portfolio are valued at the mean between the over-the-counter bid and asked prices as furnished by an independent pricing service. Listed corporate bonds, other fixed income securities, mortgage backed securities, mortgage related, asset-backed and other related securities are valued at the prices provided by an independent pricing service. Security valuations not available from an independent pricing service are provided by dealers approved by the Portfolio's Board of Trustees. In determining value, the pricing services use information with respect to transactions in such securities, market transactions in comparable securities, various relationships between securities, and yield to maturity. Municipal bonds held by the Municipal Income Portfolio are valued at fair value. An independent pricing service values the Portfolio's municipal bonds taking into consideration yield, stability, risk, quality, coupon, maturity, type of issue, trading characteristics, special circumstances of a security or trading market, and any other factors or market data it deems relevant in determining valuations for normal institutional size trading units of debt securities. The pricing service does not rely exclusively on quoted prices. The Board of Trustees has determined that the fair value of debt securities with remaining maturities of 60 days or less shall be their amortized cost value unless the particular circumstances of the security indicate otherwise. Foreign currency amounts are translated into United States dollars as follows: market value of investments, assets and liabilities at the daily rate of exchange, purchases and sales of investment, income and expenses at the rate of exchange prevailing on the respective dates of such transactions. Net unrealized foreign exchange gains/losses are a component of unrealized appreciation/depreciation of investments. It is the policy of Mentor Funds to require the custodian bank to take possession, to have legally segregated in the Federal Reserve Book entry system, or to have segregated within the custodian bank's vault all securities held as collateral in support of repurchase agreement investments. Additionally, procedures have been established by Mentor Funds to monitor, on a daily basis, the market value of each repurchase agreement's underlying securities to ensure the existence of a proper level of collateral. Mentor Funds will only enter into repurchase agreements with banks and other recognized financial institutions such as broker/dealers which are deemed by Mentor Funds' adviser to be creditworthy pursuant to guidelines established by the Mentor Funds' Trustees. Risks may arise from the potential inability of counterparties to honor the terms of the repurchase agreement. Accordingly, Mentor Funds could receive less than the repurchase price on the sale of collateral securities. Each of the Portfolios (except for Municipal Income Portfolio) may, under certain circumstances, borrow money directly or through dollar-roll and reverse repurchase agreements (arrangements in which the Portfolio sells a security for a percentage of its market value with an agreement to buy it back on a set date). Each Portfolio may borrow up to one-third of the value of its net assets. There were no reverse repurchase agreements outstanding at September 30, 1995. The average daily balance of reverse repurchase agreements outstanding for Quality Income Portfolio during the period ended September 30, 1995 was approximately $5,286,560 or $0.77 per share based on average shares outstanding during the year at a weighted average interest rate of 5.23%. The maximum amount of borrowings outstanding at any week-end during the year was $10,574,536 (including accrued interest), at a weighted average interest rate of 5.23%, and was 12.19% of total assets. The average daily balance of reverse repurchase agreements outstanding for short-duration income portfolio during the period ended September 30, 1995 was approximately $4,790,610 or $3.14 per share based on average shares outstanding during the year at an interest rate ranging between 5.80% -- 6.20%. The maximum amount of borrowings outstanding at any week-end during the year was $8,201,367 (including accrued interest), as of April 18, 1995, at a weighted average interest rate of 6.00% and was 33.19% of total assets. (d) Security Transactions and Investment Income Security transactions for the Portfolios are accounted for on the trade date. Realized gain and losses are computed on the identified cost basis. Dividend income is recorded on the ex-dividend date. Interest income (except for Municipal Income Portfolio) is recorded on the accrual basis. Interest income includes interest and discount earned (net of premium) on short-term obligations, and interest earned on all other debt securities including original issue discount as required by the Internal Revenue Code. Dividends to shareholders and capital gain distributions, if any, are recorded on the ex-dividend date. Interest income for the Municipal Income Portfolio includes interest earned net of premium, and original issue discount as required by the Internal Revenue Code. No provision for federal income taxes has been made since it is each Portfolio's policy to comply with the provisions applicable to regulated investment companies under the Internal Revenue Code and to distribute to its shareholders within the allowable time limit substantially all taxable income and realized capital gains. Dividends paid by the Municipal Income Portfolio representing net interest received on tax-exempt municipal securities are not includable by shareholders as gross income for federal income tax purposes because the Portfolio intends to meet certain requirements of the Internal Revenue Code applicable to regulated investment companies which will enable the Portfolio to pay tax-exempt interest dividends. The portion of such interest, if any, earned on private purpose municipal bonds issued after August 7, 1986, may by considered a tax preference item to shareholders. At September 30, 1995, Quality Income Portfolio for federal tax purposes, had a capital loss carryforward of approximately $11,750,000. Pursuant to the Code, such capital loss carryforwards expire as follows: $820,000 in 2001 and $3,680,000 in 2002 and $7,250,000 in 2003. At September 30, 1995, Short-Duration Income Portfolio for federal tax purposes, had a capital loss carryforward of approximately $35,000. Pursuant to the Internal Revenue Code, such capital loss carryforward will expire in 2003. At September 30, 1995, Municipal Income Portfolio for federal tax purposes, had a capital loss carryforward of approximately $895,000. Pursuant to the Internal Revenue Code, such capital loss carryforward will expire in 2003. Such capital loss carryforwards will reduce the Portfolios' taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Internal Revenue Code, and thus will reduce the amount of the distributions to shareholders which would otherwise relieve the Portfolios of any liability for federal tax. (f) When-Issued and Delayed Delivery Transactions The Portfolios may engage in when-issued or delayed delivery transactions. To the extent the Portfolios engage in such transactions, they will do so for the purpose of acquiring portfolio securities consistent with their investment objectives and policies and not for the purpose of investment leverage. The Portfolios will record a when-issued security and the related liability on the trade date. Until the securities are received and paid for, the Portfolios will maintain security positions such that sufficient liquid assets will be available to make payment for the securities purchased. Securities purchased on a when-issued or delayed delivery basis are marked to market daily and begin earning interest on the settlement date. In order to gain exposure to or protect against declines in security values, Quality Income Portfolio, Short-Duration Income Portfolio and Municipal Income Portfolio may buy and sell futures contracts. The Portfolios may also buy or write put or call options on these futures contracts. The Portfolios generally sell futures contracts to hedge against declines in the value of portfolio securities. The Portfolios may also purchase futures contracts to gain exposure to market changes as it may be more efficient or cost effective than actually buying securities. The Portfolios will segregate assets to cover its commitments under such speculative futures contracts. Upon entering into a futures contract, the Portfolios are required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the Portfolios each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The Portfolios recognize a realized gain or loss when the contract is closed. For the period ended September 30, 1995, Quality Income Portfolio had a realized gain of $645,273, Short-Duration Income Portfolio and Municipal Income Portfolio recorded realized losses of $28,629 and $892,033 respectively on closed futures contracts. Risks of entering into futures contracts (and related options) include the possibility that there may be an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. In order to produce incremental earnings or protect against changes in the value of portfolio securities, the Quality Income Portfolio may buy and sell put and call options, write covered call options on portfolio securities and write cash-secured put options. The Portfolio generally purchases put options or writes covered call options to hedge against adverse movements in the value of portfolio holdings. The Portfolio may also use options for speculative purposes, although it does not employ options for this at the present time. The Portfolio will segregate assets to cover its obligations under option contracts. Options contracts are valued daily based upon the last sales price on the principal exchange on which the option is traded and unrealized appreciation or depreciation is recorded. The Portfolio will realize a gain or loss upon the expiration or closing of the option transaction. When an option is exercised, the proceeds on sales for a written call option, the purchase cost for a written put option, or the cost of the security for a purchased put or call option is adjusted by the amount of premium received or paid. For the period ended September 30, 1995 Quality Income Portfolio had a realized gain of $134,642 on closed options contracts. The risk in writing a call option is that the Portfolio gives up the opportunity for profit if the market price of the security increases and the option is exercised. The risk in writing a put option is that the Portfolio may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying an option is that the Portfolio pays a premium whether or not the option is exercised. The Portfolio also has the additional risk of not being able to enter into a closing transaction if a liquid secondary market does not exist. The Portfolio may also write over-the-counter options where the completion of the obligation is dependent upon the credit standing of the counterparty. A derivative security is any investment that derives its value from an underlying security, asset, or market index. The Quality Income Portfolio invests in mortgage security residual interests ("residuals") which are considered derivative securities. The Portfolio's investment in residuals has been primarily in securities issued by proprietary mortgage trusts. While these entities have been highly leveraged, often having indebtedness of up to 95% of their total value, the Portfolio has not incurred any indebtedness in the course of making these residual investments; nor have the Portfolio's assets been pledged to secure the indebtedness of the issuing structure or the Portfolio's investment in the residuals. In consideration of the risk associated with securities, it is the Portfolio's policy to limit its exposure at the time of purchase to no more than 20% of its total assets. The Portfolio will continue to invest in residual securities because, in the opinion of the Investment Manager, these investments can play a key role in fulfilling the Portfolio's objective of achieving high monthly income through providing a means of economic leverage. Costs incurred by the Portfolios in connection with their initial share registration and organization costs were deferred by the Portfolios and are being amortized on a straight-line basis over a five-year period. Income distributions and capital gain distributions are determined in accordance with income tax regulations which may differ from generally accepted accounting principles. These differences are primarily due to differing treatments for net operating losses and deferral of wash sales. Dividends will be declared daily and paid monthly to all shareholders invested in Quality Income Portfolio, Short-Duration Income Portfolio and Municipal Income Portfolio on the record date. Dividends are declared and paid semi-annually to all shareholders invested in Capital Growth Portfolio on the record date, dividends are declared and paid annually to all shareholders invested in the Growth Portfolio, Strategy Portfolio and Global Portfolio on the record date, and dividends are declared and paid quarterly to all shareholders invested in Income and Growth Portfolio on the record date. Dividends will be reinvested in additional shares of the same class and Portfolio on payment dates at the ex-dividend date net asset value without a sales charge unless cash payments are requested by shareholders in writing. Capital gains realized by each Portfolio, if any, are paid annually. NOTE 4: INVESTMENT ADVISORY AND MANAGEMENT AND ADMINISTRATION AGREEMENTS Commonwealth Investment Advisors, Inc., (formerly Cambridge Investment Advisors, Inc.), ("Investment Adviser"), receives for its services an annual investment advisory fee not to exceed the following percentages of the average daily net assets of the particular Portfolio: Capital Growth Portfolio, 0.80%; Quality Income Portfolio, 0.60%; Municipal Income Portfolio, 0.60%; Income and Growth Portfolio, 0.75%; and Global Portfolio, 1.10%. The Investment Adviser may, from time to time, voluntarily waive some or all of its investment advisory fee and may terminate any such voluntary waiver at any time at its sole discretion. The Investment Adviser pays the sub-adviser to Municipal Income Portfolio an 0.30%. The sub-adviser to the Income and Growth Portfolio receives from the Investment Adviser an annual fee expressed as a percentage of that Portfolio's assets as follows: 0.325% on the first $50 million in Portfolio assets, 0.275% on the next $150 million in assets, and 0.200% on assets over $500 million. No performance or incentive fees are paid to the sub-advisers. Under certain Sub-Advisory Agreements, the particular sub-adviser may, from time to time, voluntarily waive some or all of its sub-advisory fee charged to the Investment Adviser and may terminate any such voluntary waiver at any time in its sole discretion. The Growth Portfolio has entered into an Investment Advisory and Management Agreement with Charter Asset Management, Inc. ("Charter"), a wholly-owned subsidiary of Mentor Investment Group, Inc., (formerly Investment Management Group, Inc.) ("Mentor") which is a wholly-owned subsidiary of Wheat First Butcher Singer, Inc. Under this agreement, Charter's management fee is accrued daily and paid monthly at an annual rate of 0.70% applied to the average daily net assets of the Portfolio. The Strategy Portfolio has entered into an Investment Advisory Agreement with Wellesley Advisors, Inc. ("Wellesley"), a wholly-owned subsidiary of Mentor. Under this agreement, Wellesley's management fee is accrued daily and paid monthly at an annual rate of 0.85% applied to the average daily net assets of the Portfolio. The Short-Duration Income Portfolio has entered into an Investment Advisory Agreement with Commonwealth Investment Counsel, Inc. ("Commonwealth"), a wholly-owned subsidiary of Mentor. Under this agreement, Commonwealth's management fee is accrued daily and paid monthly at an annual rate of 0.50% applied to the average daily net assets of the Portfolio. For the period ended September 30, 1995 the Investment Adviser and sub-advisers, Charter, Wellesley and Commonwealth earned and voluntarily waived the following advisory fees: Administrative personnel and services are provided by Mentor, under an Administration Agreement, at an annual rate 0.10% of the average daily net assets of each Portfolio. In order to limit the Portfolio's expenses during its start-up period, Mentor agreed to waive its fee for the first year of each Portfolios' operations. This waiver period elapsed on April 30, 1995 for the Short-Duration Income Portfolio. In addition, the Growth Portfolio and Strategy Portfolio provide direct reimbursement to Mentor for certain accounting and operation related costs not covered under the Administration Agreement. For the period ended September 30, 1995, the Growth Portfolio and Strategy Portfolio paid $6,579 and $6,117 respectively to Mentor for these direct reimbursements. For the period ended September 30, 1995 Mentor earned the following administrative fees: Charter, Wellesley, and Commonwealth have agreed to reimburse the Portfolios for the operating expenses (exclusive of interest, taxes, brokerage and distributions fees, and extraordinary expenses) in excess of the most restrictive expense limitation imposed by state securities commissions with jurisdiction over the Portfolios. The most stringent state expense limitation applicable to the Portfolios requires reimbursement of expenses not including expenses under the Portfolios' Distribution Plan, in any year that such expenses exceed 2.5% of the first $30,000,000 of average daily net assets, 2% of the next $70,000,000 of average daily net assets, and 1.5% of the average daily net assets over $100,000,000. During the period ended September 30, 1995, no reimbursement from Charter, Wellesley or Commonwealth was required as a result of such state expense limitations. NOTE 5: DISTRIBUTION AGREEMENT AND OTHER TRANSACTIONS WITH AFFILIATES The Class B shares of the Portfolios have adopted a Distribution Plan (the Plan) pursuant to Rule 12b-1 under the Investment Company Act of 1940. Under a Distribution Agreement between the Portfolios and Mentor tors, Inc. ("Mentor Distributors") (formerly, Cambridge Distributors, Inc.) a wholly-owned subsidiary of Mentor, Mentor Distributors was appointed distributor of the Portfolios. To compensate Mentor Distributors for the services it provides and for the expenses it incurs under the Distribution Agreement, the Portfolios pay a distribution fee, which is accrued daily and paid monthly at the annual rate of 0.75% of the Portfolios' average daily net assets for the Growth Portfolio, Capital Growth Portfolio, Strategy Portfolio, Income and Growth Portfolio and Global Portfolio, 0.50% of the average daily net assets of the Quality Income Portfolio and Municipal Income Portfolio, and 0.30% of the average daily net assets for the Short-Duration Income Portfolio. Mentor Funds has adopted a Shareholder Servicing Plan (the "Service Plan") with respect to Class A and Class B shares of each Portfolio. Under the Service Plan, financial institutions will enter into shareholder service agreements with the Portfolios to provide administrative support services to their customers who from time to time may be owners of record or beneficial owners of Class A or Class B shares of one or more Portfolios. In return for providing these support services, a financial institution may receive payments from one or more Portfolios at a rate not exceeding .25 of 1% of the average daily net assets of the Class A or Class B shares of the particular Portfolio or Portfolios beneficially owned by the financial institution's customers for whom it is holder of record or with whom it has a servicing relationship. Presently, the Portfolios' class specific expenses are limited to expenses incurred by a class of shares pursuant to its respective Distribution Plan. For the period ended September 30, 1995, distribution fees and shareholder servicing fees were as follows: Distribution fees are only applicable to Class B shares. Purchases and sales of investments (excluding short-term investments), for the period ended September 30, 1995, were as follows: NOTE 7: UNREALIZED APPRECIATION AND DEPRECIATION OF INVESTMENTS The cost of investments for federal income tax purposes amounted to $186,115,335, for the Growth Portfolio, $76,760,291 for the Capital Growth Portfolio, $204,015,264 for the Strategy Portfolio, $60,560,645 for the Income and Growth Portfolio, $18,087,647 for the Global Portfolio, $95,192,126 for the Quality Income Portfolio, $20,084,529 for the Short-Duration Income Portfolio and $56,429,527 for Municipal Income Portfolio at September 30, 1995. Gross unrealized appreciation and depreciation of investments at September 30, 1995 based on such costs were as follows: In connection with portfolio purchases and sales of securities denominated in a foreign currency, Global Portfolio may enter into forward foreign currency exchange contracts ("contracts"). Additionally, from time to time Global Portfolio may enter into contracts to hedge certain foreign currency assets. Contracts are recorded at market value. Realized gains and losses arising from such transactions are included in net gain (loss) on investments and forward foreign currency exchange contracts. The Portfolio is subject to the credit risk that the other party will not complete the obligations of the contract. At September 30, 1995 Global Portfolio had outstanding forward contracts as set forth below. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS NOTE 9: CAPITAL SHARE TRANSACTIONS The Declaration of Trust permits the Trustees to issue an unlimited number of full and fractional shares of beneficial interest. Transactions in Portfolio shares were as follows: * For the period from June 5, 1995 (issuance of Class A shares) to September 30, 1995. For the period from January 1, 1995 to September 30, 1995. * For the period from April 29, 1994 (commencement of operations) to December 31, 1994. + On September 27, 1995, Capital Growth Portfolio acquired the net assets of Mentor/Cambridge Growth Portfolio in exchange for Class A and Class B shares of the Capital Growth Portfolio pursuant to a plan of reorganization approved by the shareholders of Mentor/Cambridge Growth Portfolio on September 21, 1995. The acquisition was accomplished by a tax free exchange of 1,927,004 shares of the Capital Growth Portfolio for the net assets of Mentor/Cambridge Growth Portfolio. The net assets of Mentor/Cambridge Growth Portfolio on that date including $3,953,496 of unrealized appreciation on investments, were combined with Capital Growth Portfolio. The aggregate net assets of Capital Growth Portfolio and Mentor/Cambridge Growth Portfolio immediately before the acquisition were $56,351,987 and $30,350,659, respectively. The net assets of Capital Growth Portfolio immediately after the acquisition were $86,702,646. (a) For the period from March 29, 1994 (commencement of operations) to September 30, 1994. We have audited the accompanying statements of assets and liabilities, including the portfolios of investments, of the Growth Portfolio, Capital Growth Portfolio, Strategy Portfolio, Income and Growth Portfolio, Perpetual Global Portfolio, Quality Income Portfolio, Short-Duration Portfolio and Municipal Income Portfolio, portfolios of Mentor Funds (the Funds) as of September 30, 1995 and the related statements of operations for the year or period then ended (pages 50 to 51), the statements of changes in net assets for each of the years or periods in the two year period then ended (pages 52 to 54) and the financial highlights for Class A and Class B shares for each of the years or periods in the six year period then ended (pages 55 to 63). These financial statements and financial highlights are the responsibility of the Funds' management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of September 30, 1995 by correspondence with the custodian and brokers. 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 and financial highlights referred to above present fairly, in all material respects, the financial position of the Growth Portfolio, Capital Growth Portfolio, Strategy Portfolio, Income and Growth Portfolio, Perpetual Global Portfolio, Quality Income Portfolio, Short-Duration Portfolio and Municipal Income Portfolio, portfolios of Mentor Funds as of September 30, 1995, the results of their operations for the year then ended, the changes in their net assets for each of the aforementioned years or periods in the two year period then ended and the financial highlights for each of the years or periods as indicated on pages 55 to 63, in conformity with generally accepted accounting principles. PERCENT OF NET ASSETS SHARES MARKET VALUE Nalco Chemical Company 1,200 $ 40,950 Sherwin Williams Company 1,200 42,000 Sonoco Products Company 2,698 74,870 CAPITAL GOODS & CONSTRUCTION 7.67% General Electric Company 1,230 78,412 W.W. Grainger, Inc. 850 51,319 York International Company 1,760 74,140 R.R. Donnelley & Sons 1,700 66,300 Interpublic Group Company 1,890 75,128 Johnson & Johnson, Inc. 1,025 75,978 American Express Company 1,700 75,437 Banc One Corporation 1,812 66,138 Federal National Mortgage Association 650 67,275 United Asset Management Company 1,640 65,805 Avon Products Company 890 63,857 May Department Stores 1,600 70,000 General Motors Corporation - Class E 1,200 $ 54,600 Linear Technology Corporation 1,200 49,800 Premier Industrial Corporation 2,770 69,250 Werner Enterprises, Inc. 3,400 70,550 Tyco International, Ltd. 1,170 73,710 TOTAL COMMON STOCKS (COST $1,773,254) 2,095,794 U.S. GOVERNMENT AND AGENCIES SECURITIES 26.67% 7.38% 5/15/96 $ 75,000 75,764 FEDERAL HOME LOAN BANK 1.56% 8.32% 1/30/98 $50,000 $ 50,309 TOTAL U.S. GOVERNMENT AND AGENCIES SECURITIES (COST $816,325] 855,947 Case Equipment Loan, 4.40%, 11/15/98 14,247 14,195 Nationsbank Corporation, 9.38%, 9/15/09 35,000 41,674 Norwest Corporation, 6.80%, 5/15/02 60,000 60,450 Traveler's, Inc., 8.63%, 2/01/07 40,000 44,950 TOTAL CORPORATE BONDS (COST $159,877) 161,269 Dated 9/29/95, 6.40%, due 10/02/95, collateralized by $70,000 U.S. Treasury Note, 11.75%, 11/15/14 (cost $99,557) 99,557 99,557 TOTAL FIXED INCOME SECURITIES (COST $1,075,759) 1,116,773 TOTAL INVESTMENTS (COST $2,849,013) 100.09% 3,212,567 OTHER ASSETS LESS LIABILITIES (0.09%) (2,994) See notes to financial statements. STATEMENT OF ASSETS AND LIABILITIES Investments, at market value * (Note 2) $3,212,567 Payable for investments purchased 82,175 Accrued expenses and other liabilities 381 Undistributed net investment income 77,407 Accumulated net realized gain on Net unrealized appreciation of investments (Note 6) 363,554 NET ASSET VALUE PER SHARE $ 14.85 See notes to financial statements. PERIOD ENDED SEPTEMBER 30, 1995 Distribution fee (Note 4) 17,894 Management fee (Note 3) 14,563 Shareholder servicing fee (Note 4) 5,965 Custodian and accounting fees 5,028 Shareholder reports and postage expenses 674 Legal and audit fees 4,055 Directors' fees and expenses 271 Waiver of distribution fee (Note 4) 17,894 Waiver of management fee (Note 3) 14,563 Waiver of shareholder servicing fee (Note 4) 5,965 REALIZED AND UNREALIZED GAIN ON INVESTMENTS Net realized gain on investments sold 112,161 Net realized and unrealized gain on investments 491,923 Net increase in net assets resulting For the period from January 1, 1995 to September 30, 1995. See notes to financial statements. STATEMENT OF CHANGES IN NET ASSETS For the period from January 1, 1995 to September 30, 1995. *For the period from June 21, 1994 (commencement of operations) to December 31, 1994. See notes to financial statements. NET ASSET VALUE, BEGINNING OF PERIOD $ 12.44 $ 12.50 Net investment income 0.36 0.22 gain (loss) on investments 2.08 (0.09) Total from investment operations 2.44 0.13 Dividends from net investment income (0.03) (0.19) NET ASSET VALUE, END OF PERIOD $ 14.85 $ 12.44 Net assets, end of period (in thousands) $ 3,210 $ 2,911 average net assets 0.50%(a) 0.50%(a) Ratio of expenses to average net assets excluding waiver 2.12%(a) 2.72%(a) Ratio of net investment income to average net assets 3.26%(a) 3.32%(a) Portfolio turnover rate 65% 71% For the period from January 1, 1995 to September 30, 1995. ** For the period from June 21, 1994 (commencement of operations) to December 31, 1994. See notes to financial statements. The Mentor Funds (formerly Cambridge Series Trust) is registered under the Investment Company Act of 1940, as amended, as an open-end management investment company. On April 12, 1995 the name of the Trust was changed to Mentor Funds ("Mentor Funds"). On April 12, 1995 the portfolios of Mentor Series Trust were merged into newly formed portfolios of Mentor Funds. Mentor Funds consists of nine separate Portfolios (hereinafter each individually referred to as a "Portfolio" or collectively as the "Portfolios") at September 30, 1995, as follows: Mentor Growth Portfolio (formerly Mentor Growth Fund) Mentor Capital Growth Portfolio (formerly Cambridge Capital Growth Mentor Strategy Portfolio (formerly Mentor Strategy Fund) Mentor Income and Growth Portfolio (formerly Cambridge Income and Growth Portfolio) ("Income and Growth Portfolio") Mentor Perpetual Global Portfolio (formerly Cambridge Global Portfolio) Mentor Quality Income Portfolio (formerly Cambridge Government Income Mentor Short-Duration Income Portfolio (formerly Mentor Short-Duration Income Fund) ("Short-Duration Income Portfolio") Mentor Municipal Income Portfolio (formerly Cambridge Municipal Income Mentor Balanced Portfolio (formerly Mentor Balanced Fund) The assets of each Portfolio are segregated and a shareholder's interest is limited to the Portfolio in which shares are held. The financial statements included in this report are for the Balanced Portfolio (hereinafter referred to as the "Portfolio"). NOTE 2: SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies consistently followed by the Portfolio: (a) Valuation of Securities - Listed securities held by the Portfolio and traded on national stock exchanges and over-the-counter securities quoted on the NASDAQ National Market System are valued at the last reported sales price or, lacking any sales, at the last available bid price. In cases where securities are traded on more than one exchange, the securities are valued on the exchange designated by the Board of Trustees of the Portfolio as the primary market. Securities traded in the over-the-counter market, other than those quoted on the NASDAQ National Market System, are valued at the last available bid price. Short-term investments with remaining maturities of 60 days or less are carried at amortized cost, which approximates market value. Securities for which market quotations are not readily available are valued at fair value as determined in good faith under procedures established by and under the general supervision of the Board of Trustees. U.S. Government obligations held by the Portfolio are valued at the mean between the over-the-counter bid and asked prices as furnished by an independent pricing service. Listed corporate bonds, other fixed income securities, mortgage backed securities, mortgage related, asset-backed and other related securities are valued at the prices provided by an independent pricing service. Security valuations not available from an independent pricing service are provided by dealers approved by the Portfolio's Board of Trustees. In determining value, the dealers use information with respect to transactions in such securities, market transactions in comparable securities, various relationships between securities, and yield to maturity. (b) Repurchase Agreements- It is the policy of Mentor Funds to require the custodian bank to take possession, to have legally segregated in the Federal Reserve Book entry system, or to have segregated within the custodian bank's vault all securities held as collateral in support of repurchase agreement investments. Additionally, procedures have been established by Mentor Funds to monitor, on a daily basis, the market value of each repurchase agreement's underlying securities to ensure the existence of a proper level of collateral. Mentor Funds will only enter into repurchase agreements with banks and other recognized financial institutions such as broker/dealers which are deemed by Mentor Fund's adviser to be creditworthy pursuant to guidelines established by the Mentor Fund's Trustees. Risks may arise from the potential inability of counterparties to honor the terms of the repurchase agreement. Accordingly, Mentor Funds could receive less than the repurchase price on the sale of collateral securities. (c) Security Transactions and Investment Income - Security transactions for the Portfolio are accounted for on a trade date basis. Dividend income is recorded on the ex-dividend date and interest is recorded on the accrual basis. Interest income includes interest and discount earned (net of premium) on short term obligations, and interest earned on all other debt securities including original issue discounts as required by the Internal Revenue Code. Realized and unrealized gains and losses on investment security transactions are calculated on an identified cost basis. (d) Federal Income Taxes - No provision for federal income taxes has been made since it is the Portfolio's policy to comply with the provisions applicable to regulated investment companies under the Internal Revenue Code and to distribute to its shareholders within the allowable time limit substantially all taxable income and realized capital gains, if any. (e) Distributions to Shareholders- Distributions from net investment income and net realized capital gains, after offsetting capital loss carryovers are distributed annually for the Portfolio. NOTE 3: INVESTMENT ADVISORY AND MANAGEMENT AND ADMINISTRATION AGREEMENTS The Portfolio has entered into an Investment Advisory Agreement with Commonwealth Investment Counsel, Inc. ("Commonwealth"), a wholly-owned subsidiary of Mentor Investment Group, Inc. (formerly Investment Management Group, Inc.) ("Mentor"), which is a wholly-owned subsidiary of Wheat First Butcher Singer, Inc. ("Wheat"). Under this agreement, Commonwealth's management fee is accrued daily and paid monthly at an annual rate of 0.75% applied to the average daily net assets of the Portfolio. In order to limit the Portfolio's expenses, during the period ended September 30, 1995, Commonwealth has agreed to reduce its compensation to the extent that expenses of the Portfolio (exclusive of brokerage, interest, taxes, deferred organization expenses, and payments under the Portfolio's Distributions Plan) exceed an annual rate of 0.50% of the Portfolio's average net assets. For the period ended September 30, 1995, Commonwealth earned and voluntarily waived advisory fees of $14,563 for the Portfolio. Administrative personnel and services are provided by Mentor to the Portfolio, under an Administration Agreement, at an annual rate of .10 of 1% of the average daily net assets of the Portfolio. In order to limit the Portfolio's expenses during its start-up period, Mentor agreed to waive its fee for the first year of the Portfolio's operations. Commonwealth has agreed to reimburse the Portfolio for the operating expenses (exclusive of interest, taxes, brokerage and distributions fees, and extraordinary expenses) in excess of the most restrictive expense limitation imposed by state securities commissions with jurisdiction over the Portfolio. The most stringent state expense limitation applicable to the Portfolio requires reimbursement of expenses in any year that such expenses exceed 2.5% of the first $30,000,000 of average daily net assets, 2% of the next $70,000,000 of average daily net assets, and 1.5% of the average daily net assets over $100,000,000. During the period ended September 30, 1995, no reimbursement from Commonwealth was required as a result of such state expense limitations. NOTE 4: DISTRIBUTION AGREEMENT AND OTHER TRANSACTIONS WITH AFFILIATES Under a Distribution Agreement between the Portfolio and Mentor Distributors, Inc. ("Mentor Distributors") (formerly Cambridge Distributors, Inc.) a wholly-owned subsidiary of Mentor, was appointed distributor of the Portfolio. To compensate Mentor Distributors for the services it provides and for the expenses it incurs under the Distribution Agreement, the Portfolio has adopted a Plan of Distribution pursuant to Rule 12b-1 under the Investment Company Act of 1940, under which the Portfolio pays a distribution fee, which is accrued daily and paid monthly at the annual rate of 0.75% of the Portfolio's average daily net assets. Effective, June 21, 1994 the Portfolio commenced payment of certain compensation to Wheat under a Shareholder Service Agreement for administrative support services at an annual rate of 0.25% of the Portfolio's average daily net assets. The total charges to be borne by the Portfolio, under the Distribution and Shareholder Service Agreements is expected to remain at an annual rate of 1% of the Portfolio's average daily net assets. For the period ended September 30, 1995 Wheat earned and voluntarily waived distribution and shareholder services fees of $17,894 and $5,965 respectively. Purchases and sales of investments, exclusive of short-term securities, aggregated $1,972,063 and $2,102,048 respectively, for the the period ended September 30, 1995. NOTE 6: UNREALIZED APPRECIATION AND DEPRECIATION OF INVESTMENTS At September 30, 1995, the cost of investments for federal income tax purposes amounted to $2,849,013 and net unrealized appreciation aggregated $363,554, of which $375,775 related to appreciated securities and $12,221 related to depreciated securities. NOTE 7: CAPITAL SHARE TRANSACTIONS The Declaration of Trust permits the Trustees to issue an unlimited number of full and fractional shares of beneficial interest. Transactions in Portfolio shares were as follows: * For the period from January 1, 1995 to September 30, 1995. *For the period from June 21, 1994 (commencement of operations) to December 31, 1994. We have audited the accompanying statement of assets and liabilities of the Mentor Balanced Portfolio, a portfolio of Mentor Funds, including the portfolio of investments, as of September 30, 1995, and the related statement of operations for the period from January 1, 1995 to September 30, 1995, and the statements of changes in net assets and financial highlights for the period from January 1, 1995 through September 30, 1995 and the period from June 21, 1994 (commencement of operations) to December 31, 1994. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of September 30, 1995 by correspondence with the custodian and brokers. 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 the Mentor Balanced Portfolio, a portfolio of Mentor Funds, as of September 30, 1995, and the results of its operations for the period from January 1, 1995 through September 30, 1995, and the changes in its net assets and financial highlights for the period from January 1, 1995 through September 30, 1995 and the period from June 21, 1994 to December 31, 1994 in conformity with generally accepted accounting principles. Item 24. Financial Statements and Exhibits: (1) Statement of Assets and Liabilities -- September 30, 1995 Statement of Operations -- period/year ended September 30, 1995* Statement of Changes in Net Assets -- years/periods ended September 30, 1995 and September 30, 1994* * Included in Part B to this Registration Statement. (+) Included in Part A to this Registration Statement. (1) Conformed copy of Declaration of Trust of the Registrant, with Amendments No. 1 and 2 (2); (2) Copy of By-Laws of the Registrant (1); (4) Copy of Specimen Certificates for both Class A and Class B Shares of Beneficial Interest for each New (5)(i) Conformed copy of Management Agreement of the Registrant with Mentor Advisors, Inc.(2); (a)Conformed copy of New Exhibit A to Management Agreement to include the Global Portfolio(4); (ii) Conformed copy of Investment Advisory Agreement for the Cambridge Growth Portfolio (2); (iii) Conformed copy of Investment Advisory Agreement for the Capital Growth Portfolio (2); (iv) Conformed copy of Investment Advisory Agreement for the Government Income Portfolio (4); (v)Conformed copy of Investment Advisory Agreement for the Municipal Income Portfolio (2); (vi) Conformed copy of Investment Advisory Agreement for the Income and Growth Portfolio (3); (vii) Conformed copy of Investment Advisory Agreement for (viii) Form of Investment Advisory and Management Agreement for the Growth Portfolio (6); (ix) Form of Investment Advisory and Management Agreement for the Strategy Portfolio (6); (x) Form of Investment Advisory and Management Agreement for the Short-Duration Income Portfolio (6); (xi) Form of Investment Advisory and Management Agreement for the Balanced Portfolio (6); (6)(i) Conformed copy of Distributor's Contract of the Registrant with Distributors, Inc., through and (ii) Form of New Exhibit J to the Distributor's Contract in respect of the Class A and B shares of the Growth, Strategy, Short-Duration Income Portfolios and the (8)(i) Conformed copy of Custodian Contract of the Registrant with Investors Fiduciary Trust Company (2); (ii) Conformed copy of Custodian Contract of the Registrant with State Street Bank and Trust Company (2); (iii) Form of Administrative Services Agreement of the Registrant in respect of each Portfolio (6); (iv) Form of Custodian Contract with State Street Bank and Trust Company in respect of foreign securities; (9)(i) Conformed copy of Transfer Agency and Registrar Agreement of the Registrant (2); (ii) Conformed copy of Shareholder Services Plan of the Registrant through and including Exhibit B in respect of the Cambridge Growth, Capital Growth, Government Income, Municipal Income, Income and Growth, and (iii) Form of New Exhibit C to the Shareholder Services Plan in respect of the Class A and B shares of the Growth, Strategy, Short-Duration Income Portfolios and the (11)(i) Conformed copy of Independent Auditors Consent; (ii) Conformed copy of KPMG Peat Marwick LLP opinion on Methodology and Procedures for Accounting for Multiple (13) Conformed copy of Initial Capital Understanding (1); (15)(i) Conformed copy of Distribution Plan for each Portfolio of the Trust (other than the New Portfolios); (ii) Copy of 12b-1 Agreement (Sales Agreement) with Mentor (iii) Form of Plan of Distribution pursuant to Rule 12b-1 in respect of the Growth Portfolio (6); (iv) Form of Plan of Distribution pursuant to Rule 12b-1 in respect of the Strategy Portfolio (6); (v) Form of Plan of Distribution pursuant to Rule 12b-1 in respect of the Short-Duration Portfolio (6); (vi) Form of Plan of Distribution pursuant to Rule 12b-1 in respect of the Balanced Portfolio (6); (16)(i) Schedules for Computation of Performance (27)(i) Financial Data Schedules of Class A Shares* (ii) Financial Data Schedules of Class B Shares* (iii) Financial Data Schedules in respect of the Balanced 1. Incorporated by reference to Registrant's Pre-Effective Amendment No. 1 on Form N-1A filed April 14, 1992. 2. Incorporated by reference to Registrant's Post-Effective Amendment No. 3 on Form N-1A filed May 14, 1993. 3. Incorporated by reference to Registrant's Post-Effective Amendment No. 5 on Form N-1A filed November 26, 1993. 4. Incorporated by reference to Registrant's Post-Effective Amendment No. 7 on Form N-1A filed August 3, 1994. 5. Incorporated by reference to Registrant's Post-Effective Amendment No. 8 on Form N-1A filed January 27, 1995. 6. Incorporated by reference to Registrant's Post-Effective Amendment No. 9 on form N-1A filed March 15, 1995. Item 25. Persons Controlled by or Under Common Control with Registrant: References made to "Principal Holders of Securities" in Part B Item 26. Number of Holders of Securities as of November 30, 1995: Multiclass Portfolios Class A Class B Capital Growth Portfolio 2,019 4,976 Income and Growth Portfolios 1,070 3,364 Municipal Income Portfolios 545 1,360 Quality Income Portfolio 1,096 3,348 Short-Duration Income Portfolio 60 1,037 1. Response is incorporated by reference to Registrant's Initial Registration Statement on Form N-1A filed January 31, 1992 (File Nos. 33-45315 and 811-6550). Item 28. Business and Other Connections of Investment Advisers The business and other connections of each director, officer, or partner of the entities below in which such director, officer, or partner is or has been, at any time during the past two fiscal years, engaged for his own account or in the capacity of director, officer, employee, partner, or trustee are set forth in the following tables. (a) The following is additional information with respect to the directors and officers of Commonwealth Advisors, Inc.: Position with the Business, Profession, Name Investment Adviser Vocation or Employment* Peter J. Quinn, Jr. President and Director President, Mentor Securities Inc. John M. Ivan Secretary Managing Director, Singer, Inc. Income Fund, Inc. Thomas L. Souders Treasurer Managing Director and (b) The following is additional information with respect to the directors and officers of Charter Asset Management, Inc. ("Charter"): (d) The following is additional information with respect to the directors and officers of Commonwealth Investment Counsel, Inc. ("CIC"): (e) The following is additional information with respect to the directors and officers of Mentor Perpetual Advisors, L.L.C. ("Mentor Perpetual"): (f) The following is additional information with respect to Wellington Management Company, Inc., located at 75 State Street, Boston Massachusetts 02109: Catherine A. Smith General Partner -- Stephen A. Soderberg General Partner -- Ralph E. Stuart, Jr. General Partner -- Perry M. Traquina General Partner -- Gene R. Tremblay General Partner -- Mary Ann Tynan General Partner -- Ernst H. Von Metzsch General Partner -- James L. Walters General Partner -- Kim Williams General Partner -- Dena G. Willmore General Partner -- Francil V. Wisneski General Partner -- (g) The following is additional information with respect to the directors and officers of Van Kampen/American Capital Management Inc., located at One Parkview Plaza, Oakbrook Terrace, Illinois 60181-4486: Don G. Powell Chairman, Chief Executive -- Dennis J. McDonnell President, Chief Operating -- William R. Rybak Executive Vice President, Chief Financial Officer, Director -- David R. Kowalski Vice President -- Ronald A. Nyberg Executive Vice President, Director -- Edward A. Treichel Senior Vice President -- * The address of Mentor Investment Group, Inc., Wheat, First Securities, Inc., Wheat First Butcher Singer, Inc., The Mentor Funds, Mentor Income Fund, Inc., Commonwealth Advisors, Charter, Wellesley, CIC, and Mentor Perpetual is 901 East Byrd Street, Richmond, VA 23219. The address of Ryland Capital Management, Inc. and RAC Income Fund, Inc. is 11000 Broken Land Parkway, Columbia, MD 21044. The address of Perpetual Portfolio Management Limited is 48 Hart Street, Henley-on-Thames, Oxon, England, RG92AZ. (a) Mentor Distributors, Inc. is the principal distributor for the Registrant's shares and acts as the principal underwriter for the Registrant. Mentor Distributors, Inc. is a Virginia corporation and is an affiliate of Commonwealth Advisors, Charter, Wellesley, and Commonwealth. NAME AND PRINCIPAL POSITIONS AND OFFICES POSITIONS AND OFFICES BUSINESS ADDRESS WITH UNDERWRITERS WITH REGISTRANT Peter J. Quinn, Jr. President and Director Trustee Paul F. Costello Senior Vice President President Thomas L. Souders Treasurer None John M. Harris Secretary None John M. Ivan Assistant Secretary Secretary Item 30. Location of Accounts and Records: Response is incorporated by reference to Registrant's Initial Registration on Form N-1A filed January 31, 1992 (File Nos. 33-45315 and 811-6550). (a) Registrant hereby undertakes to comply with the provisions of Section 16(c) of the 1940 Act with respect to the removal of Trustees and the calling of special shareholder meetings by shareholders. (b) Registrant hereby undertakes to furnish each person to whom a prospectus is delivered with a copy of the Registrant's latest annual report to shareholders, upon request and without charge. Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant, THE MENTOR FUNDS, certifies that it meets all of the requirements for effectiveness of the Registration Statement pursuant to Rule 485(b) under the Securities Act of 1993 and has duly caused this Amendment to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Richmond and the Commonwealth of Virginia, on the 12th day of January, 1996. By: /s/ Paul F. Costello Pursuant to the requirements of the Securities Act of 1933, this Amendment has been signed below by the following persons in the capacity and on the date indicated: Daniel J. Ludeman Chairman and Trustee /s/ Peter J. Quinn, Jr. Trustee January 12, 1996 Peter J. Quinn, Jr. Louis W. Moelchert, Jr. Trustee Troy A. Peery, Jr. Trustee /s/ Paul F. Costello January 12, 1996 /s/ Terry L. Perkins January 12, 1996 Terry L. Perkins Treasurer (Principal Financial */s/ Peter J. Quinn, Jr. Attorney-in-fact January 12, 1996 Peter J. Quinn, Jr. (8)(iv) Form of Custodian Contract (27)(i) Financial Data Schedules - Class A (ii) Financial Data Schedules - Class B (iii) Financial Data Schedule - Balanced Portfolio	485BPOS	485BPOS	1996-01-12T00:00:00	1996-01-12T16:58:28
0000201533-96-000009	0000201533-96-000009_0002.txt	<DESCRIPTION>TERM LOAN AGREEMENT DATED NOV 21, 1995 Dated as of November 21, 1995, SECTION 1.01. Certain Defined Terms. . 5 SECTION 1.02. Computation of Time Periods 14 SECTION 1.03. Accounting Terms . . . . 14 SECTION 2.01. The Commitments. . . . . 14 SECTION 2.02. Fees . . . . . . . . . . 14 SECTION 2.03. Reduction of the Commitments 14 SECTION 2.04. Computations of Outstandings 15 SECTION 3.01. Advances . . . . . . . . 15 SECTION 3.02. Conversion of Advances . 16 SECTION 3.03. Interest Periods . . . . 16 SECTION 3.04.Other Terms Relating to the Making and Conversion of Advances. . . . . . . . . . 16 SECTION 3.05. Repayment of Advances. . 18 SECTION 4.01. Payments and Computations 18 SECTION 4.02. Interest Rate Determination 19 SECTION 4.03. Prepayments. . . . . . . 19 SECTION 4.04. Yield Protection . . . . 20 SECTION 4.05. Sharing of Payments, Etc. 21 SECTION 4.06. Taxes. . . . . . . . . . 21 SECTION 5.01. Conditions Precedent to the Drawdown 22 SECTION 5.02. Conditions Precedent to Each Conversion 23 SECTION 5.03. Reliance on Certificates 24 SECTION 6.01. Representations and Warranties of the Borrower 24 SECTION 7.01. Affirmative Covenants. . 26 SECTION 7.02. Negative Covenants . . . 27 SECTION 7.03. Reporting Obligations. . 30 SECTION 8.01. Events of Default. . . . 32 SECTION 8.02. Remedies . . . . . . . . 33 SECTION 9.01. Authorization and Action 33 SECTION 9.02. Agents' Reliance, Etc. . 34 SECTION 9.03. Citibank, Union Bank and Affiliates 34 SECTION 9.04. Lender Credit Decision . 34 SECTION 9.05. Indemnification. . . . . 34 SECTION 9.06. Successor Agents . . . . 35 SECTION 10.01. Amendments, Etc.. . . . 35 SECTION 10.02. Notices, Etc. . . . . . 35 SECTION 10.03. No Waiver of Remedies . 36 SECTION 10.04. Costs, Expenses and Indemnification 36 SECTION 10.05. Right of Set-off. . . . 37 SECTION 10.06. Binding Effect. . . . . 37 SECTION 10.07. Assignments and Participation 37 SECTION 10.08. Confidentiality . . . . 39 SECTION 10.09. Waiver of Jury Trial. . 40 SECTION 10.10. Governing Law . . . . . 40 SECTION 10.11. Relation of the Parties; No Beneficiary 40 SECTION 10.12. Execution in Counterparts 40 SECTION 10.13. Survival of Agreement . 40 EXHIBIT A - Form of Note EXHIBIT B - Form of Notice of Borrowing EXHIBIT C - Form of Notice of Conversion EXHIBIT D - Form of Opinion of Denise M. Sturdy, Esq., EXHIBIT E - Form of Opinion of King & Spalding, Counsel to the Agents EXHIBIT F - Form of Compliance Schedule EXHIBIT G - Form of Lender Assignment SCHEDULE I Applicable Lending Offices Dated as of November 21, 1995 THIS TERM LOAN AGREEMENT is made by and among: (i)CMS Energy Corporation, a Michigan corporation (the "Borrower"), (ii)the banks (the "Banks") listed on the signature pages hereof and the other Lenders (as hereinafter defined) from time to time (iii)Citibank, N.A. ("Citibank") and Union Bank ("Union Bank"), as co-administrative agents (individually a "Co-Agent" and collectively, the "Co-Agents") for the Lenders hereunder, (iv)Citibank, as documentation agent (the "Documentation Agent) for (v)Union Bank, as operational agent (the "Operational Agent") for (vi)Bank of America Illinois, BZW Division of Barclays Bank PLC, The Chase Manhattan Bank, N.A., The First National Bank of Boston and The First National Bank of Chicago, as co-managers (individually, the "Co-Manager" and, collectively, the "Co- Managers"). The Borrower has requested the Banks to provide the credit facility hereinafter described in the amounts and on the terms and conditions set forth herein. The Banks have so agreed on the terms and conditions set forth herein, and the Agents have agreed to act as agents for the Lenders on such terms and conditions. The parties hereto acknowledge and agree that neither Consumers (as hereinafter defined) nor any of its Subsidiaries (as hereinafter defined) will be a party to, or will in any way be bound by any provision of, this Agreement or any other Loan Document (as hereinafter defined), and that no Loan Document will be enforceable against Consumers or any of its Subsidiaries or their respective assets. Accordingly, the parties hereto agree as follows: SECTION 1.01. Certain Defined Terms. As used in this Agreement, the following terms shall have the following meanings (such meanings to be applicable to the singular and plural forms of the terms defined): "Advance" means an Advance by a Lender to the Borrower pursuant to Section 3.01, and refers to a Base Rate Advance or a Eurodollar Rate Advance (each of which shall be a "Type" of Advance). All Advances by a Lender of the same Type, having the same Interest Period and made or Converted on the same day shall be deemed to be a single Advance by such Lender until repaid or next Converted. "Affiliate" means, with respect to any Person, any other Person directly or indirectly controlling (including but not limited to all directors and officers of such Person), controlled by, or under direct or indirect common control with such Person. A Person shall be deemed to control another entity if such Person possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of such entity, whether through the ownership of voting securities, by contract, or otherwise. "Agent" means, as the context may require, the Co-Agents, the Operational Agent or the Documentation Agent; and "Agents" means any or all of the foregoing. "Alternate Base Rate" means a fluctuating interest rate per annum equal at all times to the highest of: (a) the rate of interest announced publicly by Union Bank in Los Angeles, California, from time to time, as the Union Bank (b) 1/2 of one percent per annum above the latest three-week moving average of secondary market morning offering rates in the United States for three-month certificates of deposit of major United States money market banks, such three-week moving average being determined weekly by the Operational Agent on the basis of such rates reported by certificate of deposit dealers to and published by the Federal Reserve Bank of New York or, if such publication shall be suspended or terminated, on the basis of quotations for such rates received by the Operational Agent from three New York certificate of deposit dealers of recognized standing selected by the Operational Agent, in either case adjusted to the nearest 1/4 of one percent or, if there is no nearest 1/4 of one percent, to the next higher 1/4 of one percent; and (c) 1/2 of one percent per annum above the Federal Funds Rate. Each change in the Alternate Base Rate shall take effect concurrently with any change in such base rate, moving average, or Federal Funds Rate. "Applicable Lending Office" means, with respect to each Lender, (i) such Lender's Domestic Lending Office, in the case of a Base Rate Advance, and (ii) such Lender's Eurodollar Lending Office, in the case of a Eurodollar Rate Advance. "Applicable Margin" means, on any date of determination, (i) for a Base Rate Advance, 0.25% per annum, and (ii) for a Eurodollar Rate Advance, 1.75% per annum. Notwithstanding the foregoing, (i) the foregoing Applicable Margin applicable to Base Rate Advances shall be increased by 0.50% per annum in the event that, and at all times during which, the Senior Notes shall be rated BB- (or its equivalent) or lower by (A) any three of S&P, Fitch, Moody's and D&P, or (B) both S&P and Moody's, (ii) the foregoing Applicable Margin applicable to Eurodollar Rate Advances shall be increased by 0.25% per annum in the event that, and at all times during which, the Senior Notes shall be rated BB- (or its equivalent) or lower by (A) any three of S&P, Fitch, Moody's and D&P, or (B) both S&P and Moody's, and (iii) the foregoing Applicable Margin applicable to Eurodollar Rate Advances shall be decreased by 0.25% per annum in the event that, and at all times during which, the Senior Notes shall be rated BBB- (or its equivalent) or higher by (x) any three of S&P, Fitch, Moody's and D&P, or (y) both S&P and Moody's. The Applicable Margins shall be increased or decreased in accordance with this definition upon any change in the applicable ratings, and such increased or decreased Applicable Margins shall be effective from the date of announcement of any such new ratings. The Borrower agrees to notify the Operational Agent promptly after each change in any rating of the Senior Notes. For purposes of this definition only, if the Senior Notes shall no longer be outstanding or shall no longer be rated by any three of S&P, Fitch, Moody's and D&P or by both Moody's and S&P, "Senior Notes" shall mean such other senior unsecured Debt of the Borrower that is both outstanding and so rated. In the event that no Senior Notes are outstanding and so rated, the Applicable Margins will be such amounts as may be mutually agreed by the Borrower and all the Lenders. (i) in the case of each Base Rate Advance, a rate per annum equal at all times to the sum of the Alternate Base Rate in effect from time to time plus the Applicable Margin in effect from time to time; and (ii) in the case of each Eurodollar Rate Advance comprising part of the same Borrowing, a rate per annum during each Interest Period equal at all times to the sum of the Eurodollar Rate for such Interest Period plus the Applicable Margin in effect from time to time during such Interest Period. "Base Rate Advance" means an Advance that bears interest as provided in Section 3.05(b)(i). "Borrowing" means a borrowing consisting of Advances of the same Type, having the same Interest Period and made or Converted on the same day by the Lenders, ratably in accordance with their respective Percentages. Any Borrowing consisting of Advances of a particular Type may be referred to as being a Borrowing of such "Type". All Advances of the same Type, having the same Interest Period and made or Converted on the same day shall be deemed a single Borrowing hereunder until repaid or next Converted. "Business Day" means a day of the year on which banks are not required or authorized to close in New York City, Los Angeles, California and Detroit, Michigan, and, if the applicable Business Day relates to any Eurodollar Rate Advance, on which dealings are carried on in the London interbank market. "Cash Dividend Income" means, for any period, the amount of all cash dividends received by the Borrower from its Subsidiaries during such period that are paid out of the net income (without giving effect to any extraordinary gains in excess of $5,000,000) of such Subsidiaries during such period; provided, however, that for the fiscal year ending December 31, 1995, "Cash Dividend Income" shall also include an amount equivalent to 80% of Consumers' consolidated net income for such year to the extent that such consolidated net income has not been paid in cash dividends by Consumers to the Borrower. "Closing Date" means the date upon which each of the conditions precedent enumerated in Section 5.01 has been fulfilled to the satisfaction of the Lenders, the Co-Agents and the Borrower. All transactions contemplated by the Closing Date shall take place on or before November 21, 1995, at the offices of King & Spalding, 120 West 45th Street, New York, New York 10036, at 10:00 A.M., or such other time as the parties hereto may mutually agree. "Commitment" means, for each Lender, the obligation of such Lender to make Advances to the Borrower in an aggregate amount no greater than the amount set forth opposite such Lender's name on the signature pages hereof or, if such Lender has entered into one or more Lender Assignments, set forth for such Lender in the Register maintained by the Documentation Agent pursuant to Section 10.07(c), in each such case as such amount may be reduced from time to time pursuant to Section 2.03. "Commitments" means the total of the Lenders' Commitments hereunder. The Commitments shall in no event exceed$125,000,000 million. "Confidential Information" has the meaning assigned to that term in Section 10.08. "Consolidated Capital" means, at any date of determination, the sum of (a) Consolidated Debt, (b) consolidated equity of the common stockholders of the Borrower and the Consolidated Subsidiaries, (c) consolidated equity of the preference stockholders of the Borrower and the Consolidated Subsidiaries, and (d) consolidated equity of the preferred stockholders of the Borrower and the Consolidated Subsidiaries, in the case of clauses (b) through (d) above, determined at such date in accordance with GAAP; provided, however, that Consolidated Capital shall include Project Finance Equity of the Borrower and the Consolidated Subsidiaries in any Consolidated Subsidiary only to the extent of the Borrower's Ownership Interest in such Consolidated Subsidiary. "Consolidated Debt" means, without duplication, at any date of determination, the sum of the aggregate Debt of the Borrower plus the aggregate debt (as such term is construed in accordance with GAAP) of the Consolidated Subsidiaries, provided, however, that Consolidated Debt shall not include any Support Obligation described in clause (iv) or (v) of the definition thereof if such Support Obligation or the primary obligation so supported is not fixed or conclusively determined or is not otherwise reasonably quantifiable as of the date of determination; provided, further, that for purposes of this definition only, Debt of the Borrower shall (a) include only 50% of the aggregate principal amount of Subordinated Debt and Preferred Securities described in clause (b) of the definition thereof, subject to a maximum exclusion of $100,000,000 in the aggregate, and (b) not include Subordinated Debt or Preferred Securities if such Subordinated Debt or Preferred Securities, as the case may be, is mandatorily convertible into common stock of the Borrower upon terms and conditions satisfactory to the Majority Lenders; and provided, further, that for purposes of this definition only, debt of any Consolidated Subsidiary shall include Project Finance Debt of such Consolidated Subsidiary only to the extent of the Borrower's Ownership Interest in such Consolidated Subsidiary. "Consolidated Subsidiary" means any Subsidiary whose accounts are or are required to be consolidated with the accounts of the Borrower in accordance with GAAP. "Consumers" means Consumers Power Company, a Michigan corporation, all of whose common stock is on the date hereof owned by the Borrower. "Consumers Dividend Restriction" means any restriction enacted or imposed after October 1, 1992 upon the ability of Consumers to pay cash dividends to the Borrower in respect of Consumers' capital stock, whether such restriction is imposed by statute, regulation, decisions or rulings by the Michigan Public Service Commission or the Federal Energy Regulatory Commission (or any successor agency or agencies), final judgments of any court of competent jurisdiction, indentures, agreements, contracts or restrictions to which Consumers is a party or by which it is bound or otherwise; provided, that no restriction on such dividends existing on October 1, 1992 shall be a Consumers Dividend Restriction at any time. "Conversion", "Convert" or "Converted" refers to a conversion of Advances of one Type into Advances of another Type, or to the selection of a new, or the renewal of the same, Interest Period for Advances, as the case may be, pursuant to Section 3.02. "D&P" means Duff & Phelps, Inc. or any successor thereto. "Debt" means, for any Person, without duplication, any and all indebtedness, liabilities and other monetary obligations of such Person (whether for principal, interest, fees, costs, expenses or otherwise, and whether contingent or otherwise) (i) for borrowed money or evidenced by bonds, debentures, notes or other similar instruments, (ii) to pay the deferred purchase price of property or services (except trade accounts payable arising in the ordinary course of business which are not overdue), (iii) as lessee under leases which shall have been or should be, in accordance with GAAP, recorded as capital leases, (iv) under reimbursement or similar agreements with respect to letters of credit issued thereunder, (v) under any interest rate swap, "cap", "collar" or other hedging agreements; provided, however, for purposes of the calculation of Debt for this clause (v) only, the actual amount of Debt of such Person shall be determined on a net basis to the extent such agreements permit such amounts to be calculated on a net basis, (vi) to pay rent or other amounts under leases entered into in connection with sale and leaseback transactions involving assets of such Person being sold in connection therewith, (vii) arising from any accumulated funding deficiency (as defined in Section 412(a) of the Internal Revenue Code of 1986, as amended) for a Plan, and (viii) arising from (A) direct or indirect guaranties in respect of, and obligations to purchase or otherwise acquire, or otherwise to warrant or hold harmless, pursuant to a legally binding agreement, a creditor against loss in respect of, Debt of others referred to in clauses (i) through (vii) above and (B) other guaranty or similar financial obligations in respect of the performance of others, including, without limitation, Support Obligations. "Default Rate" means a rate per annum equal at all times to the higher of (i) 2% per annum above the higher, from time to time, of (A) the Applicable Rate for Eurodollar Rate Advances immediately prior to such Default Rate becoming applicable and (B) the Applicable Rate in effect from time to time for Base Rate Advances, and (ii) the highest rate per annum payable pursuant to the Indenture with respect to any principal amount of the Senior Notes that is not paid when due. "Dividend Coverage Ratio" means, at any date, the ratio of (i) Pro Forma Dividend Amounts to (ii) Issuer Interest Expense, as such terms are defined in the Indenture as in effect on the date hereof. "Dollars" and the sign "$" each means lawful money of the United States. "Domestic Lending Office" means, with respect to any Lender, the office or affiliate of such Lender specified as its "Domestic Lending Office" opposite its name on Schedule I hereto or in the Lender Assignment pursuant to which it became a Lender, or such other office or affiliate of such Lender as such Lender may from time to time specify in writing to the Borrower and the Operational Agent. "Drawdown" shall mean the Borrowing made on the Closing Date, in an aggregate amount not to exceed the Commitments on such date. "Eligible Assignee" means (a) a commercial bank or trust company organized under the laws of the United States, or any State thereof; (b) a commercial bank organized under the laws of any other country that is a member of the OECD, or a political subdivision of any such country, provided that such bank is acting through a branch or agency located in the United States; (c) the central bank of any country that is a member of the OECD; and (d) any other commercial bank or other financial institution engaged generally in the business of extending credit or purchasing debt instruments; provided, however, that (A) any such Person shall also (i) have outstanding unsecured indebtedness that is rated A- or better by S&P or A3 or better by Moody's (or an equivalent rating by another nationally-recognized credit rating agency of similar standing if neither of such corporations is then in the business of rating unsecured indebtedness of entities engaged in such businesses) or (ii) have combined capital and surplus (as established in its most recent report of condition to its primary regulator) of not less than $250,000,000 (or its equivalent in foreign currency), (B) any Person described in clause (b), (c), or (d) above, shall, on the date on which it is to become a Lender hereunder, (1) be entitled to receive payments hereunder without deduction or withholding of any United States Federal income taxes (as contemplated by Section 4.06) and (2) not be incurring any losses, costs or expenses of the type for which such Person could demand payment under Section 4.04(a) or (d) (except to the extent that, in the absence of the making of an assignment to such Person, the assigning Lender would have incurred an equal or greater amount of such losses, costs or expenses and such losses, costs or expenses would have been payable by the Borrower to such assigning Lender hereunder) and (C) any Person described in clause (d) above shall, in addition, be acceptable to the Co-Agents. "Enterprises" means CMS Enterprises Company, a Michigan corporation, all of whose common stock is on the date hereof owned by the Borrower. "Enterprises Significant Subsidiary" means Nomeco, CMS Generation Co., CMS Gas Transmission and Storage Company and any other direct subsidiary of Enterprises having a net worth in excess of $50 million. "Equity Distributions" shall mean, for any period, the aggregate amount of cash received by the Borrower from its Subsidiaries during such period that are paid out of proceeds from the sale of common equity of Subsidiaries of the Borrower. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time. "ERISA Affiliate" means, with respect to any Person, any trade or business (whether or not incorporated) that is a "commonly controlled entity" within the meaning of the regulations under Section 414 of the Internal Revenue Code of 1986, as amended. "Eurocurrency Liabilities" has the meaning assigned to that term in Regulation D of the Board of Governors of the Federal Reserve System, as in effect from time to time. "Eurodollar Lending Office" means, with respect to any Lender, the office or affiliate of such Lender specified as its "Eurodollar Lending Office" opposite its name on Schedule I hereto or in the Lender Assignment pursuant to which it became a Lender (or, if no such office or affiliate is specified, its Domestic Lending Office), or such other office or affiliate of such Lender as such Lender may from time to time specify in writing to the Borrower and the Operational Agent. "Eurodollar Rate" means, for each Interest Period for each Eurodollar Rate Advance made as part of the same Borrowing, an interest rate per annum equal to the average (rounded upward to the nearest whole multiple of 1/16 of 1% per annum, if such average is not such a multiple) of the rate per annum at which deposits in U.S. dollars are offered by the principal office of each of the Reference Banks in London, England to prime banks in the London interbank market at 11:00 A.M. (London time) two Business Days before the first day of such Interest Period in an amount substantially equal to such Reference Bank's Eurodollar Rate Advance made as part of such Borrowing and for a period equal to such Interest Period. The Eurodollar Rate for the Interest Period for each Eurodollar Rate Advance made as part of the same Borrowing shall be determined by the Operational Agent on the basis of applicable rates furnished to and received by the Operational Agent from the Reference Banks two Business Days before the first day of such Interest Period, subject, however, to the provisions of Sections 3.04(c) and 4.02. "Eurodollar Rate Advance" means an Advance that bears interest as provided in Section 3.05(b)(ii). "Eurodollar Reserve Percentage" of any Lender for each Interest Period for each Eurodollar Rate Advance means the reserve percentage applicable during such Interest Period (or if more than one such percentage shall be so applicable, the daily average of such percentages for those days in such Interest Period during which any such percentage shall be so applicable) under Regulation D or other regulations issued from time to time by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including, without limitation, any emergency, supplemental or other marginal reserve requirement) for such Lender with respect to liabilities or assets consisting of or including Eurocurrency Liabilities having a term equal to such Interest Period. "Event of Default" has the meaning specified in Section 8.01. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Existing Agreement" means the Credit Agreement, dated as of July 29, 1994, among the Borrower, the lenders named therein, the Co- Agents, the Documentation Agent and the Operational Agent. "Federal Funds Rate" means, for any period, a fluctuating interest rate per annum equal for each day during such period to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations for such day on such transactions received by the Operational Agent from three Federal funds brokers of recognized standing selected by the Operational Agent. "Fee Letter" has the meaning assigned to that term in Section 2.02(b). "Fitch" means Fitch's Investors Services or any successor thereto. "GAAP" has the meaning assigned to that term in Section 1.03. "Governmental Approval" means any authorization, consent, approval, license, permit, certificate, exemption of, or filing or registration with, any governmental authority or other legal or regulatory body, required in connection with the execution, delivery, or performance of any Loan Document by the Borrower. "Hazardous Substance" means any waste, substance, or material identified as hazardous, dangerous or toxic by any office, agency, department, commission, board, bureau, or instrumentality of the United States or of the State or locality in which the same is located having or exercising jurisdiction over such waste, substance or material. "Indemnified Person" has the meaning assigned to that term in Section 10.04(b). "Indenture" means that certain Indenture, dated as of September 15, 1992, between the Borrower and the Trustee, as supplemented by the First Supplemental Indenture, dated as of October 1, 1992, and the Second Supplemental Indenture, dated as of October 1, 1992, as said Indenture may be further amended or otherwise modified from time to time in accordance with its terms. "Interest Period" has the meaning assigned to that term in Section 3.03. "Lender Assignment" means an assignment and agreement entered into by a Lender and an Eligible Assignee, and accepted by the Documentation Agent, in substantially the form of Exhibit G. "Lenders" means the Banks listed on the signature pages hereof, each Eligible Assignee that shall become a party hereto pursuant to Section 10.07. "Lien" has the meaning assigned to that term in Section 7.02(a). "Loan Documents" means this Agreement, the Notes, the Fee Letter and all other agreements, instruments and documents now or hereafter executed and/or delivered pursuant hereto or thereto. "Majority Lenders" means, on any date of determination, Lenders that, collectively, on such date (i) have Percentages in the aggregate of at least 66-2/3% and (ii) if the Commitments have been terminated, hold at least 66-2/3% of the then aggregate unpaid principal amount of the Advances owing to Lenders. Any determination of those Lenders constituting the Majority Lenders shall be made by the Co-Agents and shall be conclusive and binding on all parties absent manifest error. "Measurement Quarter" has the meaning assigned to that term in Section 7.01(j). "Moody's" means Moody's Investors Service, Inc. or any successor thereto. "Net Worth" means, with respect to any Person, the excess of such Person's total assets over its total liabilities, total assets and total liabilities each to be determined in accordance with GAAP consistently applied, excluding, however, from the determination of total assets (i) goodwill, organizational expenses, research and development expenses, trademarks, trade names, copyrights, patents, patent applications, licenses and rights in any thereof, and other similar intangibles, (ii) cash held in a sinking or other analogous fund established for the purpose of redemption, retirement or prepayment of capital stock or Debt, and (iii) any items not included in clauses (i) or (ii) above, that are treated as intangibles in conformity with GAAP. "Nomeco" means NOMECO Oil & Gas Co., a Michigan corporation, all of whose capital stock is on the date hereof owned by Enterprises. "Note" means a promissory note of the Borrower payable to the order of a Lender, in substantially the form of Exhibit A. "Noteholders" means, collectively, the owners of record from time to time of the Senior Notes. "Notice of Borrowing" has the meaning assigned to that term in Section 3.01(a). "OECD" means the Organization for Economic Cooperation and Development. "Ownership Interest" of the Borrower in any Consolidated Subsidiary means, at any date of determination, the percentage determined by dividing (i) the aggregate amount of Project Finance Equity in such Consolidated Subsidiary owned or controlled, directly or indirectly, by the Borrower and any other Consolidated Subsidiary on such date, by (ii) the aggregate amount of Project Finance Equity in such Consolidated Subsidiary owned or controlled, directly or indirectly, by all Persons (including the Borrower and the Consolidated Subsidiaries) on such date. Notwithstanding anything to the contrary set forth above, if the "Ownership Interest," calculated as set forth above, 50% or less, such percentage shall be deemed to equal 0%. "PBGC" means the Pension Benefit Guaranty Corporation (or any successor entity) established under ERISA. "Percentage" means, for any Lender on any date of determination, the percentage obtained by dividing such Lender's Commitment on such day by the total of the Commitments on such date, and multiplying the quotient so obtained by 100%. "Permitted Investments" means each of the following so long as no such Permitted Investment shall have a final maturity later than six months from the date of investment therein: (i)direct obligations of the United States, or of any agency thereof, or obligations guaranteed as to principal and interest by the United States or any agency thereof; (ii)certificates of deposit or bankers' acceptances issued, or time deposits held, or investment contracts guaranteed, by any Lender, any nationally-recognized securities dealer or any other commercial bank, trust company, savings and loan association or savings bank organized under the laws of the United States, or any State thereof, or of any other country which is a member of the OECD, or a political subdivision of any such country, and in each case having outstanding unsecured indebtedness that (on the date of acquisition thereof) is rated AA- or better by S&P or Aa3 or better by Moody's (or an equivalent rating by another nationally-recognized credit rating agency of similar standing if neither of such corporations is then in the business of rating unsecured bank indebtedness); (iii)obligations with any Lender, any other bank or trust company described in clause (ii), above, or any nationally- recognized securities dealer, in respect of the repurchase of obligations of the type described in clause (i), above, provided that such repurchase obligations shall be fully secured by obligations of the type described in said clause (i) and the possession of such obligations shall be transferred to, and segregated from other obligations owned by, such Lender, such other bank or trust company or such securities dealer; (iv)commercial paper rated (on the date of acquisition thereof) A-1 or P-1 or better by S&P or Moody's, respectively (or an equivalent rating by another nationally-recognized credit rating agency of similar standing if neither of such corporations is then in the business of rating commercial (v)any eurodollar certificate of deposit issued by any Lender or any other commercial bank, trust company, savings and loan association or savings bank organized under the laws of the United States, or any State thereof, or of any country which is a member of the OECD, or a political subdivision of any such country, and in each case having outstanding unsecured indebtedness that (on the date of acquisition thereof) is rated AA- or better by S&P or Aa3 or better by Moody's (or an equivalent rating by another nationally-recognized credit rating agency of similar standing if neither of such corporations is then in the business of rating unsecured bank indebtedness). "Person" means an individual, partnership, corporation (including a business trust), joint stock company, trust, unincorporated association, joint venture or other entity, or a government or any political subdivision or agency thereof. "Plan" means, with respect to any Person, an employee benefit plan (other than a Multiemployer Plan) maintained for employees of such Person or any ERISA Affiliate of such Person and covered by Title IV of ERISA. "Plan Termination Event" means, with respect to any Person, (i) a Reportable Event described in Section 4043 of ERISA and the regulations issued thereunder (other than a Reportable Event not subject to the provision for 30-day notice to the PBGC under such regulations), or (ii) the withdrawal of such Person or any of its ERISA Affiliates from a Plan during a plan year in which it was a "substantial employer" as defined in Section 4001(a)(2) of ERISA, or (iii) the filing of a notice of intent to terminate a Plan or the treatment of a Plan under Section 4041 of ERISA, or (iv) the institution of proceedings to terminate a Plan by the PBGC, or (v) any other event or condition which is reasonably likely to constitute grounds under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Plan. "Preferred Securities" means (a) any preferred securities issued by a financing entity (i.e., partnership, trust, limited liability company) used exclusively to raise capital for the Borrower, where such financing transaction and preferred securities have the following characteristics: (i)the financing entity lends substantially all of the proceeds from the issuance of the preferred securities to the Borrower in exchange for Subordinated Debt, which preferred securities contain terms providing for the deferral of interest payments corresponding to provisions providing for the deferral of interest payments on the Subordinated Debt; and (ii)the Borrower makes periodic interest payments on the Subordinated Debt, which interest payments are in turn used by the financing entity to make corresponding payments to the holders of the preferred securities; and (b)any other preferred securities issued by the Borrower, provided that (A) the Borrower requests such preferred securities be treated as "preferred securities" for the purpose of clause (a) of the second proviso of Consolidated Debt and (B) such preferred securities are on terms and conditions satisfactory to the Majority Lenders. "Project Finance Debt" means Debt of any Person that is non- recourse to such Person (unless such Person is a special-purpose entity) and any Affiliate of such Person, other than with respect to the interest of the holder of such Debt in the collateral, if any, securing such Debt. "Project Finance Equity" means, at any date of determination, consolidated equity of the common, preference and preferred stockholders of the Borrower and the Consolidated Subsidiaries relating to any obligor with respect to Project Finance Debt. "Recipient" has the meaning assigned to that term in Section 10.08. "Reference Banks" means Citibank, Union Bank and Bank of America Illinois, or any additional or substitute Lenders as may be selected from time to time to act as Reference Banks hereunder by the Operational Agent, the Majority Lenders and the Borrower. "Register" has the meaning specified in Section 10.07(c). "Required Lenders" means, on any date of determination, Lenders that, collectively, on such date (i) hold at least 51% of the then aggregate unpaid principal amount of the Advances owing to Lenders and (ii) if no Advances are then outstanding, have Percentages in the aggregate of at least 51%. Any determination of those Lenders constituting the Required Lenders shall be made by the Co-Agents and shall be conclusive and binding on all parties absent manifest error. "Restricted Subsidiary" means (i) Enterprises and (ii) any other Subsidiary of the Borrower (other than Consumers and its Subsidiaries) that, on a consolidated basis with any of its Subsidiaries as of any date of determination, accounts for more than 10% of the consolidated assets of the Borrower and its Consolidated Subsidiaries. "S&P" means Standard & Poor's Rating Group or any successor thereto. "Senior Note Debt" means, collectively, all principal indebtedness of the Borrower to the Noteholders now or hereafter existing under the Senior Notes, together with interest and premiums, if any, thereon and other amounts payable in respect thereof or in connection therewith in accordance with the terms of the Senior Notes or the Indenture. "Senior Notes" means the Series A Senior Deferred Coupon Notes Due 1997 and the Series B Senior Deferred Coupon Notes Due 1999 issued by the Borrower pursuant to the Indenture. "Subordinated Debt" means, for any Person, unsecured Debt of such Person (i) issued in exchange for the proceeds of Preferred Securities and (ii) subordinated to the rights of the Lenders hereunder and under the Notes on terms and conditions satisfactory to the Majority Lenders, including, without limitation, (A) terms providing for the deferral of interest payments on such Debt corresponding to provisions providing for the deferral of interest payments on the Preferred Securities and (B) the maturity thereof. "Subsidiary" means, with respect to any Person, any corporation or unincorporated entity of which more than 50% of the outstanding capital stock (or comparable interest) having ordinary voting power (irrespective of whether at the time capital stock (or comparable interest) of any other class or classes of such corporation or entity shall or might have voting power upon the occurrence of any contingency) is at the time directly or indirectly owned by said Person (whether directly or through one or more other Subsidiaries). In the case of an unincorporated entity, a Person shall be deemed to have more than 50% of interests having ordinary voting power only if such Person's vote in respect of such interests comprises more than 50% of the total voting power of all such interests in the unincorporated entity. "Support Obligations" means, for any Person, without duplication, any financial obligation, contingent or otherwise, of such Person guaranteeing or otherwise supporting any Debt or other obligation of any other Person in any manner, whether directly or indirectly, and including, without limitation, any obligation of such Person, direct or indirect, (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Debt or to purchase (or to advance or supply funds for the purchase of) any security for the payment of such Debt, (ii) to purchase property, securities or services for the purpose of assuring the owner of such Debt of the payment of such Debt, (iii) to maintain working capital, equity capital, available cash or other financial statement condition of the primary obligor so as to enable the primary obligor to pay such Debt, (iv) to provide equity capital under or in respect of equity subscription arrangements (to the extent that such obligation to provide equity capital does not otherwise constitute Debt), or (v) to perform, or arrange for the performance of, any non-monetary obligations or non-funded debt payment obligations of the primary obligor. "Tax Sharing Agreement" means the Agreement for the Allocation of Income Tax Liabilities and Benefits, dated as of January 1, 1990, by and among the Borrower, each of the members of the Consolidated Group (as defined therein), and each of the corporations that become members of the Consolidated Group. "Termination Date" means the earlier to occur of (i) November 30, 2002 and (ii) the date of termination or reduction in whole of the Commitments pursuant to Section 2.03 or 8.02. "Trustee" has the meaning assigned to that term in the Indenture. "Type" has the meaning assigned to such term (i) in the definition of "Advance" when used in such context and (ii) in the definition of "Borrowing" when used in such context. "Unmatured Default" means an event that, with the giving of notice or lapse of time or both, would constitute an Event of Default. SECTION 1.02. Computation of Time Periods. Unless otherwise indicated, each reference in this Agreement to a specific time of day is a reference to New York City time. In the computation of periods of time under this Agreement, any period of a specified number of days or months shall be computed by including the first day or month occurring during such period and excluding the last such day or month. In the case of a period of time "from" a specified date "to" or "until" a later specified date, the word "from" means "from and including" and the words "to" and "until" each means "to but excluding". SECTION 1.03. Accounting Terms. All accounting terms not specifically defined herein shall be construed in accordance with generally accepted accounting principles consistent with those applied in the preparation of the financial statements referred to in Section 6.01(e) ("GAAP"). SECTION 2.01. The Commitments. Each Lender severally agrees, on the terms and conditions hereinafter set forth, to make a single Advance to the Borrower on the Closing Date and to Convert Advances during the period from the Closing Date until the Termination Date as provided in Section 3.02, in each case in an aggregate outstanding amount not to exceed on any day such Lender's Commitment. SECTION 2.02. Fees. (a) The Borrower agrees to pay to the Operational Agent for the account of each Bank a participation fee equal to .375% of such Bank's Commitment, such fee to be payable on the Closing Date. (b)In addition to the fees provided for in subsection (a) above, the Borrower shall pay to the Operational Agent, for the account of the Co-Agents, such other fees as are provided for in that certain letter agreement between the Borrower and the Co-Agents (the "Fee Letter") entered into separately herefrom and dated the date hereof. SECTION 2.03. Reduction of the Commitments. (a) The Borrower may, upon at least five Business Days' notice to each Co-Agent, terminate in whole or reduce ratably in part the Commitments; provided that any such partial reduction shall be in the aggregate amount of $10,000,000 or an integral multiple of $1,000,000 in excess thereof. (b)On each date that the Borrower repurchases Senior Notes from any Noteholder as the result of a Change in Control (as defined in the Indenture), the Commitments of the Lenders shall automatically be ratably reduced by an amount equal in the aggregate to the product of (i) the Commitments on such date and (ii) the percentage obtained by dividing (A) the aggregate principal amount of such Senior Notes being repurchased by (B) the aggregate principal amount of the Senior Note Debt then outstanding. (c)On any Business Day following the Closing Date on which the sum of the Commitments shall exceed the aggregate principal amount of Advances outstanding hereunder, the Commitments of the Lenders shall automatically and permanently reduce ratably by an amount equal to such excess. In addition, on the date of any prepayment of the principal amount of the Advances made hereunder, the Commitments of the Lenders shall automatically and permanently reduce ratably by an amount equal to the amount of principal so prepaid. SECTION 2.04. Computations of Outstandings. Whenever reference is made in this Agreement to the principal amount outstanding on any date under this Agreement, such reference shall refer to the aggregate principal amount of all Advances outstanding on such date. At no time shall the principal amount outstanding under this Agreement exceed the aggregate amount of the Commitments. SECTION 3.01. Advances. (a) The Drawdown shall be made by the Borrower by delivering a notice (a "Notice of Borrowing") to the Operational Agent no later than 12:00 noon (New York City time) on the fourth Business Day or, in the case of Base Rate Advances, on the first Business Day, prior to the Closing Date. The Operational Agent shall give each Lender prompt notice of the Notice of Borrowing. The Notice of Borrowing shall be in substantially the form of Exhibit B and shall specify the requested (i) date of such Borrowing, (ii) Type of Advances to be made in connection with such Borrowing and (iii) Interest Period, if any, for such Advances. Each proposed Borrowing shall conform to the requirements of Sections 3.03 and 3.04. Amounts borrowed under this Section 3.01 and repaid or prepaid may not be reborrowed. (b)Each Lender shall, before 12:00 noon (New York City time) on the date of such Borrowing, make available for the account of its Applicable Lending Office to the Operational Agent at the Operational Agent's address referred to in Section 10.02, in same day funds, such Lender's Percentage of such Borrowing. After the Operational Agent's receipt of such funds and upon fulfillment of the applicable conditions set forth in Article V, the Operational Agent will make such funds available to the Borrower at the Operational Agent's aforesaid address; provided, however, that the proceeds of the Drawdown shall be applied first directly by the Operational Agent on the Closing Date to the prepayment in full of all outstanding principal, accrued interest and other amounts then owing under the Existing Agreement (if any), and then, to the extent the proceeds of such Drawdown exceed the amount necessary to prepay in full all outstanding principal, accrued interest and other amounts then owing under the Existing Credit Agreement, to the Borrower at the Operational Agent's aforesaid address for general corporate purposes. Notwithstanding the foregoing, unless the Operational Agent shall have received notice from a Lender prior to the date of any Borrowing that such Lender will not make available to the Operational Agent such Lender's Percentage of such Borrowing, the Operational Agent may assume that such Lender has made such Percentage available to the Operational Agent on the date of such Borrowing in accordance with the first sentence of this subsection (b), and the Operational Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. (c)If and to the extent that any Lender (a "non-performing Lender") shall not have made available to the Operational Agent, in accordance with subsection (b) above, such Lender's Percentage of any Borrowing, the non-performing Lender and the Borrower severally agree to repay to the Operational Agent forthwith on demand corresponding amounts, together with interest thereon for each day from the date such amount is made available to the Borrower until the date such amount is repaid to the Operational Agent, at (i) in the case of the Borrower, the interest rate applicable at the time to Advances made in connection with such Borrowing and (ii) in the case of such Lender, the Federal Funds Rate. If a non-performing Lender shall repay to the Operational Agent such corresponding amount in full (with interest as above provided), (x) the Operational Agent shall apply such corresponding amount and interest to the repayment to the Operational Agent and shall make any remainder available to the Borrower and (y) such amount so repaid shall be deemed to constitute such Lender's Advance, made as part of such Borrowing for purposes of this Agreement as if funded concurrently with the other Advances made as part of such Borrowing, and such Lender shall forthwith cease to be deemed a non-performing Lender; if and so long as such non-performing Lender shall not repay such amount, and unless and until an Eligible Assignee shall have assumed and performed the obligations of such non-performing Lender, all computations by the Operational Agent of Percentages, Commitments and payments hereunder shall be made without regard to the Commitments, or outstanding Advances, of such non-performing Lender, and any amounts paid to the Operational Agent for the account of such non-performing Lender shall be held by the Operational Agent in trust for such non-performing Lender in a non-interest-bearing special purpose account. Nothing herein shall in any way limit, waive or otherwise reduce any claims that any party hereto may have against any non-performing Lender. The failure of any Lender to make the Advance to be made by it as part of any Borrowing shall not relieve any other Lender of its obligation, if any, hereunder to make its Advance on the date of such Borrowing, but no Lender shall be responsible for the failure of any other Lender to make the Advance to be made by such other Lender on the date of any Borrowing. SECTION 3.02. Conversion of Advances. The Borrower may from time to time Convert any Advance (or portion thereof) of any Type to one or more Advances of the same or any other Type by delivering a notice of such Conversion (a "Notice of Conversion") to the Operational Agent no later than 12:00 noon (New York City time) on (x) the fourth Business Day prior to the date of any proposed Conversion into a Eurodollar Rate Advance and (y) the first Business Day prior to the date of any proposed Conversion into a Base Rate Advance. The Operational Agent shall give each Lender prompt notice of each Notice of Conversion. Each Notice of Conversion shall be in substantially the form of Exhibit C and shall specify the requested (i) date of such Conversion, (ii) Type of, and Interest Period, if any, applicable to, the Advances (or portions thereof) proposed to be Converted, (iii) Type of Advances to which such Advances (or portions thereof) are proposed to be Converted, (iv) initial Interest Period, if any, to be applicable to the Advances resulting from such Conversion and (i) aggregate amount of Advances (or portions thereof) proposed to be Converted. Each proposed Conversion shall be subject to the provisions of Sections 3.03 and 3.04. SECTION 3.03. Interest Periods. The period between the date of each Eurodollar Rate Advance and the date of payment in full of such Advance shall be divided into successive periods of months or days ("Interest Periods") for purposes of computing interest applicable thereto. The initial Interest Period for each such Advance shall begin on the day such Advance is made, and each subsequent Interest Period shall begin on the last day of the immediately preceding Interest Period for such Advance. The duration of each Interest Period shall be 1, 2, 3, or 6 months, as the Borrower may, in accordance with Section 3.01 or 3.02, select; provided, however, that: (i)the Borrower may not select any Interest Period that ends after the Termination Date; and (ii)whenever the last day of any Interest Period would otherwise occur on a day other than a Business Day, the last day of such Interest Period shall occur on the next succeeding Business Day, provided that if such extension would cause the last day of such Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the next preceding Business Day. SECTION 3.04. Other Terms Relating to the Making and Conversion of Advances. (a) Notwithstanding anything in Section 3.01 or 3.02 to the contrary: (i) each Borrowing shall be in an aggregate amount not less than $10,000,000, or an integral multiple of $1,000,000 in excess thereof and shall consist of Advances of the same Type, having the same Interest Period and made or Converted on the same day by the Lenders ratably according to their respective Percentages; provided, however, that the Drawdown shall be in an aggregate amount sufficient to repay in full all outstanding principal, accrued interest and other amounts owing under the Existing Agreement (if any) as of the Closing Date; (ii)the Borrower may request that more than one Borrowing be made on the same day; (iii) at no time shall more than five different Borrowings comprising Eurodollar Rate Advances be outstanding hereunder; (iv) no Eurodollar Rate Advance may be Converted on a date other than the last day of the Interest Period applicable to such Advance unless the corresponding amounts, if any, payable to the Lenders pursuant to Section 4.04(c) are paid (v) if the Borrower shall either fail to give a timely Notice of Conversion pursuant to Section 3.02 in respect of any Advances or fail, in any Notice of Conversion that has been timely given, to select the duration of any Interest Period for Advances to be Converted into Eurodollar Rate Advances in accordance with Section 3.03, such Advances shall, on the last day of the then existing Interest Period therefor, automatically Convert into, or remain as, as the case may be, Base Rate (vi) if, on the date of any proposed Conversion, any Event of Default or Unmatured Default shall have occurred and be continuing, all Advances then outstanding shall, on such date, automatically Convert into, or remain as, as the case may be, Base Rate Advances; provided, however, that with respect to any Unmatured Default that occurs and is continuing as a result of the failure of the Borrower to comply with the ratio set forth in Section 7.01(j), any such Advances may be Converted into Eurodollar Rate Advances with an Interest Period not to exceed three months in duration. (b)If any Lender shall notify the Operational Agent that the introduction of or any change in or in the interpretation of any law or regulation makes it unlawful, or that any central bank or other governmental authority asserts that it is unlawful, for such Lender or its Applicable Lending Office to perform its obligations hereunder to make, or to fund or maintain, Eurodollar Rate Advances hereunder, (i) the obligation of such Lender to make, or to Convert Advances into, Eurodollar Rate Advances for such Borrowing or any subsequent Borrowing from such Lender shall be forthwith suspended until the earlier to occur of the date upon which (A) such Lender shall cease to be a party hereto and (B) it is no longer unlawful for such Lender to make, fund or maintain Eurodollar Rate Advances, and (ii) if the maintenance of Eurodollar Rate Advances then outstanding through the last day of the Interest Period therefor would cause such Lender to be in violation of such law, regulation or assertion, the Borrower shall either prepay or Convert all Eurodollar Rate Advances from such Lender within five days after such notice. Promptly upon becoming aware that the circumstances that caused such Lender to deliver such notice no longer exist, such Lender shall deliver notice thereof to the Operational Agent (but the failure to do so shall impose no liability upon such Lender). Promptly upon receipt of such notice from such Lender (or upon such Lender's assigning all of its Commitments, Advances, participation and other rights and obligations hereunder to an Eligible Assignee), the Operational Agent shall deliver notice thereof to the Borrower and the Lenders and such suspension shall terminate. (c)If (i) only one, or none, of the Reference Banks furnishes timely information to the Operational Agent for determining the Eurodollar Rate for Eurodollar Rate Advances to be made in connection with any proposed Borrowing or (ii) the Majority Lenders shall, at least one Business Day before the date of any requested Borrowing, notify the Operational Agent that the Eurodollar Rate for Eurodollar Rate Advances to be made in connection with such Borrowing will not adequately reflect the cost to such Majority Lenders of making, funding or maintaining their respective Eurodollar Rate Advances for such Borrowing, the right of the Borrower to select Eurodollar Rate Advances for such Borrowing and any subsequent Borrowing shall be suspended until the Operational Agent shall notify the Borrower and the Lenders that the circumstances causing such suspension no longer exist, and each Advance to be made or Converted in connection with such Borrowing shall be a Base Rate Advance. (d)If any Lender shall have delivered a notice to the Operational Agent described in Section 3.04(b), or shall become a non-performing Lender under Section 3.01(c), and if and so long as such Lender shall not have withdrawn such notice or corrected such non-performance in accordance with said Section 3.04(b) or Section 3.01(c), the Borrower or the Co- Agents may demand that such Lender assign in accordance with Section 10.07, to one or more Eligible Assignees designated by the Borrower or the Co-Agents, all (but not less than all) of such Lender's Commitment, Advances, participation and other rights and obligations hereunder; provided that any such demand by the Borrower during the continuance of an Event of Default or Unmatured Default shall be ineffective without the consent of the Majority Lenders. If, within 30 days following any such demand by the Co-Agents or the Borrower, any such Eligible Assignee so designated shall fail to consummate such assignment on terms reasonably satisfactory to such Lender, or the Borrower and the Co-Agents shall have failed to designate any such Eligible Assignee, then such demand by the Borrower or the Co-Agents shall become ineffective, it being understood for purposes of this provision that such assignment shall be conclusively deemed to be on terms reasonably satisfactory to such Lender, and such Lender shall be compelled to consummate such assignment forthwith, if such Eligible Assignee (i) shall agree to such assignment in substantially the form of the Lender Assignment attached hereto as Exhibit I and (ii) shall tender payment to such Lender in an amount equal to the full outstanding dollar amount accrued in favor of such Lender hereunder (as computed in accordance with the records of the Operational Agent). (e)The Notice of Borrowing and each Notice of Conversion shall be irrevocable and binding on the Borrower. In the case of any Borrowing which the related Notice of Borrowing or Notice of Conversion specifies is to be comprised of Eurodollar Rate Advances, the Borrower shall indemnify each Lender against any loss, cost or expense incurred by such Lender as a result of any failure to fulfill, on or before the date specified in such Notice of Borrowing or Notice of Conversion for such Borrowing, the applicable conditions (if any) set forth in this Article III (other than failure pursuant to the provisions of Section 3.04(b) or (c) hereof) or in Article V, including, without limitation, any such loss (including loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund the Advance to be made by such Lender when such Advance, as a result of such failure, is not made on such date. SECTION 3.05. Repayment of Advances. (a) Principal. The Borrower shall repay to the Operational Agent for the ratable account of the Lenders the aggregate outstanding principal amount of the Advances in sixteen (16) equal installments each in the amount of $7,812,500, on each March 31, June 30, September 30 and December 31, commencing on March 31, 1999, and ending on the Termination Date. (b) Interest. The Borrower shall pay interest on the unpaid principal amount of each Advance owing to each Lender from the date of such Advance until such principal amount shall be paid in full, at the Applicable Rate for such Advance (except as otherwise provided in this subsection (b)), payable as follows: (i)Base Rate Advances. If such Advance is a Base Rate Advance, interest thereon shall be payable quarterly in arrears on the last day of each January, April, July and October, on the date of any Conversion of such Base Rate Advance and on the date such Base Rate Advance shall become due and payable or shall otherwise be paid in full; provided that any amount of principal that is not paid when due (whether at stated maturity, by acceleration or otherwise) shall bear interest, from the date on which such amount is due until such amount is paid in full, payable on demand, at a rate per annum equal at all times to the Default Rate. (ii)Eurodollar Rate Advances. If such Advance is a Eurodollar Rate Advance, interest thereon shall be payable on the last day of such Interest Period and, if the Interest Period for such Advance has a duration of more than three months, on that day of each third month during such Interest Period that corresponds to the first day of such Interest Period (or, if any such month does not have a corresponding day, then on the last day of such month); provided that any amount of principal that is not paid when due (whether at stated maturity, by acceleration or otherwise) shall bear interest, from the date on which such amount is due until such amount is paid in full, payable on demand, at a rate per annum equal at all times to the Default Rate. SECTION 4.01. Payments and Computations. (a) The Borrower shall make each payment hereunder and under the other Loan Documents not later than 11:00 A.M. (New York City time) on the day when due in U.S. Dollars to the Operational Agent at its address referred to in Section 10.02 in same day funds; any payment received after 2:00 P.M. (New York City time) shall be deemed to have been received at the start of business on the next succeeding Business Day, unless the Operational Agent shall have received from, or on behalf of, the Borrower a Federal Reserve reference number with respect to such payment before 3:00 P.M. (New York City time). The Operational Agent will promptly thereafter cause to be distributed like funds relating to the payment of principal, interest, fees or other amounts payable to the Lenders, to the respective Lenders to which the same are payable, for the account of their respective Applicable Lending Offices, in each case to be applied in accordance with the terms of this Agreement. If and to the extent that any distribution of any payment from the Borrower required to be made to any Lender pursuant to the preceding sentence shall not be made in full by the Operational Agent on the date such payment was received by the Operational Agent, the Operational Agent shall pay to such Lender, upon demand, interest on the unpaid amount of such distribution, at a rate per annum equal to the Federal Funds Rate, from the date of such payment by the Borrower to the Operational Agent to the date of payment in full by the Operational Agent to such Lender of such unpaid amount. Upon the Operational Agent's acceptance of a Lender Assignment and recording of the information contained therein in the Register pursuant to Section 10.07, from and after the effective date specified in such Lender Assignment, the Operational Agent shall make all payments hereunder and under the Notes in respect of the interest assigned thereby to the Lender assignee thereunder, and the parties to such Lender Assignment shall make all appropriate adjustments in such payments for periods prior to such effective date directly between themselves. (b)The Borrower hereby authorizes the Operational Agent and each Lender, if and to the extent payment owed to the Operational Agent or such Lender, as the case may be, is not made when due hereunder (or, in the case of a Lender, under the Note held by such Lender), to charge from time to time against any or all of the Borrower's accounts with the Operational Agent or such Lender, as the case may be, any amount so due. (c)All computations of interest based on the Alternate Base Rate shall be made by the Operational Agent on the basis of a year of 365 or 366 days, as the case may be. All other computations of interest and fees hereunder (including computations of interest based on the Eurodollar Rate and the Federal Funds Rate) shall be made by the Operational Agent on the basis of a year of 360 days. In each such case, such computation shall be made for the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest or fees are payable. Each such determination by the Operational Agent or a Lender shall be conclusive and binding for all purposes, absent manifest error. (d)Whenever any payment hereunder or under any other Loan Document shall be stated to be due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of payment of interest and fees hereunder; provided, however, that if such extension would cause payment of interest on or principal of Eurodollar Rate Advances to be made in the next following calendar month, such payment shall be made on the next preceding Business Day and such reduction of time shall in such case be included in the computation of payment of interest hereunder. (e)Unless the Operational Agent shall have received notice from the Borrower prior to the date on which any payment is due to the Lenders hereunder that the Borrower will not make such payment in full, the Operational Agent may assume that the Borrower has made such payment in full to the Operational Agent on such date, and the Operational Agent may, in reliance upon such assumption, cause to be distributed to each Lender on such due date an amount equal to the amount then due such Lender. If and to the extent the Borrower shall not have so made such payment in full to the Operational Agent, such Lender shall repay to the Operational Agent forthwith on demand such amount distributed to such Lender, together with interest thereon, for each day from the date such amount is distributed to such Lender until the date such Lender repays such amount to the Operational Agent, at the Federal Funds Rate. (f)Any amount payable by the Borrower hereunder or under any of the Notes that is not paid when due (whether at stated maturity, by acceleration or otherwise) shall (to the fullest extent permitted by law) bear interest, from the date when due until paid in full, at a rate per annum equal at all times to the Default Rate payable on demand. SECTION 4.02. Interest Rate Determination. (a) Each Reference Bank agrees to furnish to the Operational Agent timely information for the purpose of determining the Eurodollar Rate for each Interest Period. If any one or more of the Reference Banks shall not furnish such timely information to the Operational Agent for the purpose of determining any such interest rate, the Operational Agent shall determine such interest rate on the basis of timely information furnished by the remaining Reference Banks, subject to Section 3.04(c). (b)The Operational Agent shall give prompt notice to the Borrower and the Lenders of the applicable interest rate determined by the Operational Agent for purposes of Section 3.05(b)(i) or (ii), and the Eurodollar Rate, if any, furnished by each Reference Bank for the purpose of determining the applicable interest rate under Section 3.05(b)(ii). SECTION 4.03. Prepayments. The Borrower shall have no right to prepay any principal amount of any Advances other than as provided in subsections (a), (b) and (c) below. (a)The Borrower may, upon at least five Business Days' notice to the Operational Agent stating the proposed date and aggregate principal amount of the prepayment, and if such notice is given, the Borrower shall, prepay the outstanding principal amounts of Advances made as part of the same Borrowing, in whole or ratably in part, together with (ii) accrued interest to the date of such prepayment on the principal amount prepaid and (iii) in the case of Eurodollar Rate Advances, any amount payable to the Lenders pursuant to Section 4.04(c); provided, however, that each partial prepayment shall be in an aggregate principal amount of not less $10,000,000 or an integral multiple of $1,000,000 in excess thereof. (b)On the date of any termination or optional or mandatory reduction of the Commitments pursuant to Section 2.03, the Borrower shall pay or prepay so much of the principal amount outstanding under this Agreement as shall be necessary in order that such aggregate principal amount outstanding will not exceed the Commitments following such termination or reduction, together with (i) accrued interest to the date of such prepayment on the principal amount repaid and (ii) in the case of prepayments of Eurodollar Rate Advances, any amount payable to the Lenders pursuant to Section 4.04(c). (c)Any prepayments of the principal amount of Advances shall be applied to the Borrower's obligations under Section 4.03(a) in inverse order of maturity. To the extent consistent with the foregoing, any such prepayments shall be applied to outstanding Base Rate Advances up to the full amount thereof before they are applied to outstanding Eurodollar Rate Advances. SECTION 4.04. Yield Protection. (a) Increased Costs. If, due to either (i) the introduction of or any change in or in the interpretation of any law or regulation after the date hereof, or (ii) the compliance with any guideline or request from any central bank or other governmental authority (whether or not having the force of law) issued or made after the date hereof, there shall be reasonably incurred any increase in the cost to any Lender of agreeing to make or making, funding or maintaining Eurodollar Rate Advances, then the Borrower shall from time to time, upon demand by such Lender (with a copy of such demand to the Operational Agent), pay to the Operational Agent for the account of such Lender additional amounts sufficient to compensate such Lender for such increased cost. A certificate as to the amount of such increased cost and giving a reasonable explanation thereof, submitted to the Borrower and the Operational Agent by such Lender shall constitute such demand and shall be conclusive and binding for all purposes, absent manifest error. (b)Eurodollar Reserves. The Borrower shall pay to the Operational Agent for the account of each Lender, so long as such Lender shall be required under regulations of the Board of Governors of the Federal Reserve System to maintain reserves with respect to liabilities or assets consisting of or including Eurocurrency Liabilities, additional interest on the unpaid principal amount of each Eurodollar Rate Advance of such Lender, from the date of such Advance until such principal amount is paid in full, at an interest rate per annum equal at all times to the remainder obtained by subtracting (iv) the Eurodollar Rate for the Interest Period for such Advance from (v) the rate obtained by dividing such Eurodollar Rate by a percentage equal to 100% minus the Eurodollar Reserve Percentage of such Lender for such Interest Period, payable on each date on which interest is payable on such Advance. Such additional interest shall be determined by such Lender and notified to the Borrower and the Operational Agent. A certificate as to the amount of such additional interest, submitted to the Borrower and the Operational Agent by such Lender, shall be conclusive and binding for all purposes, absent manifest error. (c)Breakage. If, due to any prepayment pursuant to Section 4.03, an acceleration of maturity of the Advances pursuant to Section 8.02, or any other reason, any Lender receives payments of principal of any Eurodollar Rate Advance other than on the last day of the Interest Period relating to such Advance, or if the Borrower shall Convert any Eurodollar Rate Advances on any day other than the last day of the Interest Period therefor, the Borrower shall, promptly after demand by such Lender (with a copy of such demand to the Operational Agent), pay to the Operational Agent for the account of such Lender any amounts required to compensate such Lender for additional losses, costs, or expenses (including anticipated lost profits) that such Lender may reasonably incur as a result of such payment or Conversion, including, without limitation, any loss, cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund or maintain such Advance. For purposes of this subsection (c), a certificate setting forth the amount of such additional losses, costs, or expenses and giving a reasonable explanation thereof, submitted to the Borrower and the Operational Agent by such Lender, shall constitute such demand and shall be conclusive and binding for all purposes, absent manifest error. (d)Capital. If any Lender determines that (i) compliance with any law or regulation or any guideline or request from any central bank or other governmental authority (whether or not having the force of law) affects or would affect the amount of capital required or expected to be maintained by such Lender, whether directly, or indirectly as a result of commitments of any corporation controlling such Lender, and (ii) the amount of such capital is increased by or based upon (1) the existence of such Lender's commitment to, or (2) the participation in or issuance or maintenance of any Advance and (3) other similar such commitments, then, upon demand by such Lender, the Borrower shall immediately pay to the Operational Agent for the account of such Lender from time to time as specified by such Lender additional amounts sufficient to compensate such Lender in the light of such circumstances, to the extent that such Lender reasonably determines such increase in capital to be allocable to the transactions contemplated hereby. A certificate as to such amounts and giving a reasonable explanation thereof (to the extent permitted by law), submitted to the Borrower and the Operational Agent by such Lender, shall be conclusive and binding for all purposes, absent manifest error. (e)Notices. Each Lender hereby agrees to use its best efforts to notify the Borrower of the occurrence of any event referred to in subsection (a), (b), (c) or (d) of this Section 4.04 promptly after becoming aware of the occurrence thereof. The failure of any Lender to provide such notice or to make demand for payment under said subsection shall not constitute a waiver of such Lender's rights hereunder; provided that, notwithstanding any provision to the contrary contained in this Section 4.04, the Borrower shall not be required to reimburse any Lender for any amounts or costs incurred under (i) subsection (a), (c) or (d) above, more than 90 days prior to the date that such Lender notifies the Borrower in writing thereof, and (ii) subsection (b) above, more than 180 days prior to the date that such Lender notifies the Borrower in writing thereof, in each case unless, and to the extent that, any such amounts or costs so incurred shall relate to the retroactive application of any event notified to the Borrower which entitles such Lender to such compensation. If any Lender shall subsequently determine that any amount demanded and collected under this Section 4.04 was done so in error, such Lender will promptly return such amount to the Borrower. (f)Survival of Obligations. Subject to subsection (e) above, the Borrower's obligations under this Section 4.04 shall survive the repayment of all other amounts owing to the Lenders, the Agents under the Loan Documents and the termination of the Commitments. If and to the extent that the obligations of the Borrower under this Section 4.04 are unenforceable for any reason, the Borrower agrees to make the maximum contribution to the payment and satisfaction thereof which is permissible under applicable law. SECTION 4.05. Sharing of Payments, Etc. If any Lender shall obtain any payment (whether voluntary, involuntary, through the exercise of any right of set-off, or otherwise) on account of the Advances owing to it (other than pursuant to Section 4.04) in excess of its ratable share of payments obtained by all the Lenders on account of the Advances of such Lenders, such Lender shall forthwith purchase from the other Lenders such participation in the Advances owing to them as shall be necessary to cause such purchasing Lender to share the excess payment ratably with each of them; provided, however, that if all or any portion of such excess payment is thereafter recovered from such purchasing Lender, such purchase from each Lender shall be rescinded and such Lender shall repay to the purchasing Lender the purchase price to the extent of such recovery together with an amount equal to such Lender's ratable share (according to the proportion of (i) the amount of such Lender's required repayment to (ii) the total amount so recovered from the purchasing Lender) of any interest or other amount paid or payable by the purchasing Lender in respect of the total amount so recovered. The Borrower agrees that any Lender so purchasing a participation from another Lender pursuant to this Section 4.05 may, to the fullest extent permitted by law, exercise all its rights of payment (including the right of set-off) with respect to such participation as fully as if such Lender were the direct creditor of the Borrower in the amount of such participation. Notwithstanding the foregoing, if any Lender shall obtain any such excess payment involuntarily, such Lender may, in lieu of purchasing participations from the other Lenders in accordance with this Section 4.05, on the date of receipt of such excess payment, return such excess payment to the Operational Agent for distribution in accordance with Section 4.01(a). SECTION 4.06. Taxes. (a) All payments by the Borrower hereunder and under the other Loan Documents shall be made in accordance with Section 4.01, free and clear of and without deduction for all present or future taxes, levies, imposts, deductions, charges or withholdings, and all liabilities with respect thereto, excluding, in the case of each Lender and each Agent, taxes imposed on its overall net income, and franchise taxes imposed on it by the jurisdiction under the laws of which such Lender or Agent (as the case may be) is organized or any political subdivision thereof and, in the case of each Lender, taxes imposed on its overall net income, and franchise taxes imposed on it by the jurisdiction of such Lender's Applicable Lending Office or any political subdivision thereof (all such non-excluded taxes, levies, imposts, deductions, charges, withholdings and liabilities being hereinafter referred to as "Taxes"). If the Borrower shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder or under any other Loan Document to any Lender or Agent, (i) the sum payable shall be increased as may be necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section 4.06) such Lender or Agent (as the case may be) receives an amount equal to the sum it would have received had no such deductions been made, (ii) the Borrower shall make such deductions and (iii) the Borrower shall pay the full amount deducted to the relevant taxation authority or other authority in accordance with applicable law. (b)In addition, the Borrower agrees to pay any present or future stamp or documentary taxes or any other excise or property taxes, charges or similar levies that arise from any payment made hereunder or under any other Loan Document or from the execution, delivery or registration of, or otherwise with respect to, this Agreement or any other Loan Document (hereinafter referred to as "Other Taxes"). (c)The Borrower will indemnify each Lender and Agent for the full amount of Taxes and Other Taxes (including, without limitation, any Taxes and any Other Taxes imposed by any jurisdiction on amounts payable under this Section 4.06) paid by such Lender or Agent (as the case may be) and any liability (including penalties, interest and expenses) arising therefrom or with respect thereto, whether or not such Taxes or Other Taxes were correctly or legally asserted. This indemnification shall be made within 30 days from the date such Lender or Agent (as the case may be) makes written demand therefor; provided, that such Lender or Agent (as the case may be) shall not be entitled to demand payment under this Section 4.06 for an amount if such demand is not made within one year following the date upon which such Lender or Agent (as the case may be) shall have been required to pay such amount. (d)Within 30 days after the date of any payment of Taxes, the Borrower will furnish to the Documentation Agent, at its address referred to in Section 10.02, the original or a certified copy of a receipt evidencing payment thereof. (e)Each Bank represents and warrants that either (i) it is organized under the laws of a jurisdiction within the United States or (ii) it has delivered to the Borrower or the Operational Agent duly completed copies of such form or forms prescribed by the United States Internal Revenue Service indicating that such Bank is entitled to receive payments without deduction or withholding of any United States federal income taxes, as permitted by the Internal Revenue Code of 1986, as amended. Each other Lender agrees that, on or prior to the date upon which it shall become a party hereto, and upon the reasonable request from time to time of the Borrower or the Operational Agent, such Lender will deliver to the Borrower and the Operational Agent either (A) a statement that it is organized under the laws of a jurisdiction within the United States or (B) duly completed copies of such form or forms as may from time to time be prescribed by the United States Internal Revenue Service, indicating that such Lender is entitled to receive payments without deduction or withholding of any United States federal income taxes, as permitted by the Internal Revenue Code of 1986, as amended. Each Bank that has delivered, and each other Lender that hereafter delivers, to the Borrower and the Operational Agent the form or forms referred to in the two preceding sentences further undertakes to deliver to the Borrower and the Operational Agent further copies of such form or forms, or successor applicable form or forms, as the case may be, as and when any previous form filed by it hereunder shall expire or shall become incomplete or inaccurate in any respect. Each Lender represents and warrants that each such form supplied by it to the Operational Agent and the Borrower pursuant to this subsection (e), and not superseded by another form supplied by it, is or will be, as the case may be, complete and accurate. SECTION 5.01. Conditions Precedent to the Drawdown. The obligation of each Lender to make its Advance in connection with the Drawdown on the Closing Date is subject to the fulfillment of the following conditions precedent: (a)The Documentation Agent shall have received, on or before the Closing Date, the following, each dated such day (except where specified otherwise below), in form and substance satisfactory to each Lender (except where otherwise specified below) and (except for the Notes) in sufficient copies for each Lender: (i)Certified copies of the resolutions of the Board of Directors, or of the Executive Committee of the Board of Directors, of the Borrower authorizing the Borrower to enter into this Agreement, the Notes and the other Loan Documents to which it is, or is to be, a party, and of all documents evidencing other necessary corporate action and governmental approvals, if any, with respect to this Agreement, the Notes and such Loan Documents. (ii)A certificate of the Secretary or an Assistant Secretary of the Borrower certifying the names, true signatures and incumbency of (A) the officers of the Borrower authorized to sign this Agreement, the Notes and the other Loan Documents to which it is, or is to be, a party, and the other documents to be delivered hereunder and thereunder and (B) the representatives of the Borrower authorized to sign notices to be provided under this Agreement and the other Loan Documents to which it is, or is to be, a party, which representatives shall be acceptable to the Co-Agents. (iii) Copies of the Certificate of Incorporation (or comparable charter document) and by-laws of the Borrower, together with all amendments thereto, certified by the Secretary or an Assistant Secretary of the Borrower. (iv) An irrevocable notice from the Borrower requesting termination of the "Commitments" under the Existing Agreement effective automatically on such date upon the satisfaction (or waiver) of the other conditions precedent set forth in this Section 5.01. (v) A Note, payable to the order of each Lender then party hereto, duly executed by the Borrower. (vi) The Fee Letter, duly executed by the Borrower. (vii) A certified copy of Schedule II hereto, in form and substance reasonably satisfactory to the Co-Agents setting forth: (A)all Project Finance Debt of the Consolidated Subsidiaries, together with the Borrower's Ownership Interest in each such Consolidated Subsidiary; and (B) debt (as such term is construed in accordance with GAAP) of Enterprises as of the Closing Date. (A)Denise M. Sturdy, Esq., Assistant General Counsel of the Borrower, in substantially the form of Exhibit D and as to such other matters as the Majority Lenders, through the Documentation Agent, may reasonably request; and (B)King & Spalding, counsel to the Agents, in substantially the form of Exhibit E and as to such other matters as the Majority Lenders, through the Documentation Agent, may reasonably request. (b)The Existing Credit Agreement has been (or will have been, upon the Drawdown and the application of the proceeds thereof) paid in full, the commitments thereunder terminated and all letters of credit issued thereunder either canceled or replaced. (c)The following statements shall be true and the Documentation Agent shall have received a certificate of a duly authorized officer of the Borrower, dated the Closing Date and in sufficient copies for each Lender stating that: (i)the representations and warranties set forth in Section 6.01 of this Agreement are true and correct on and as of the Closing Date as though made on and as of such date, and (ii)no event has occurred and is continuing that constitutes an Unmatured Default or an Event of Default. (d)The Borrower shall have paid all fees under or referenced in Section 2.02 hereof, to the extent then due and payable; and SECTION 5.02. Conditions Precedent to Each Conversion. The obligation of each Lender to make an Advance in connection with a Conversion shall be subject to the further conditions precedent that, on the date of such Conversion and after giving effect thereto: (a)the following statements shall be true (and each of the giving of the applicable notice or request with respect thereto and the making of such Conversion without prior correction by the Borrower shall (to the extent that such correction has been previously consented to by the Lenders) constitute a representation and warranty by the Borrower that, on the date of such Conversion, such statements are true): (i)the representations and warranties contained in Section 6.01 of this Agreement (other than those contained in subsections (e)(ii) and (f) thereof) are correct on and as of the date of such Conversion, before and after giving effect to such Conversion and to the application of the proceeds thereof, as though made on and as of such date; and (ii)no Event of Default has occurred and is continuing, or would result from such Conversion or the application of the (b)the Documentation Agent shall have received such other approvals, opinions and documents as any Lender through the Documentation Agent, may reasonably request as to the legality, validity, binding effect or enforceability of the Loan Documents or the financial condition, results of operations, properties or business of the Borrower and its Consolidated Subsidiaries. SECTION 5.03. Reliance on Certificates. The Lenders and each Agent shall be entitled to rely conclusively upon the certificates delivered from time to time by officers of the Borrower as to the names, incumbency, authority and signatures of the respective persons named therein until such time as the Documentation Agent may receive a replacement certificate, in form acceptable to the Documentation Agent, from an officer of such Person identified to the Documentation Agent as having authority to deliver such certificate, setting forth the names and true signatures of the officers and other representatives of such Person thereafter authorized to act on behalf of such Person. SECTION 6.01. Representations and Warranties of the Borrower. The Borrower represents and warrants as follows: (a)Each of the Borrower, Consumers and each of the Restricted Subsidiaries is a corporation duly organized, validly existing and in good standing under the laws of the state of its incorporation and is duly qualified to do business in, and is in good standing in, all other jurisdictions where the nature of its business or the nature of property owned or used by it makes such qualification necessary. (b)The execution, delivery and performance by the Borrower of each Loan Document to which it is or will be a party (i) are within the Borrower's corporate powers, (ii) have been duly authorized by all necessary corporate action and (iii) do not and will not (A) require any consent or approval of the stockholders of the Borrower, (B) violate any provision of the charter or by-laws of the Borrower or of law, (C) violate any legal restriction binding on or affecting the Borrower, (D) result in a breach of, or constitute a default under, any indenture or loan or credit agreement or any other agreement, lease or instrument to which the Borrower is a party or by which it or its properties may be bound or affected, or (E) result in or require the creation of any Lien (other than pursuant to the Loan Documents) upon or with respect to any of its properties. (c)No Governmental Approval is required. (d)This Agreement is, and each other Loan Document to which the Borrower will be a party when executed and delivered hereunder will be, legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with their respective terms; subject to the qualification, however, that the enforcement of the rights and remedies herein and therein is subject to bankruptcy and other similar laws of general application affecting rights and remedies of creditors and the application of general principles of equity (regardless of whether considered in a proceeding in equity or at law). (e)(i) The consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as at December 31, 1994, and the related consolidated statements of income, retained earnings and cash flows of the Borrower and its Consolidated Subsidiaries for the fiscal year then ended, together with the report thereon of Arthur Andersen & Co. included in the Borrower's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, and the unaudited consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as at September 30, 1995, and the related unaudited consolidated statements of income, retained earnings and cash flows for the nine-month period then ended, copies of each of which have been furnished to each Lender, fairly present (subject, in the case of such balance sheets and statements of income for the nine months ended September 30, 1995, to year-end adjustments) the financial condition of the Borrower and its Consolidated Subsidiaries as at such dates and the results of operations of the Borrower and its Consolidated Subsidiaries for the periods ended on such dates, all in accordance with generally accepted accounting principles consistently applied; (ii) since December 31, 1994, except as disclosed in the Borrower's Quarterly Report on Form 10-Q for the period ended September 30, 1995, there has been no material adverse change in the business, financial condition or results of operations of the Borrower and its Subsidiaries, considered as a whole, or in the Borrower's ability to perform its obligations under this Agreement or any other Loan Document to which it is or will be a party; and (iii) the Borrower has no material liabilities or obligations except as reflected in the foregoing financial statements and in Schedule II hereto, as evidenced by the Loan Documents and as may be incurred, in accordance with the terms of this Agreement, in the ordinary course of business (as presently conducted) following the date of this Agreement. (f)Except as disclosed in the Borrower's Quarterly Report on Form 10-Q for the period ended September 30, 1995, there are no pending or threatened actions, suits or proceedings against or, to the knowledge of the Borrower, affecting the Borrower or any of its Subsidiaries or the properties of the Borrower or any of its Subsidiaries before any court, governmental agency or arbitrator, that would, if adversely determined, reasonably be expected to materially adversely affect the financial condition, properties, business or operations of the Borrower and its Subsidiaries, considered as a whole, or affect the legality, validity or enforceability of this Agreement or any other Loan Document. (g)All insurance required by Section 7.01(b) is in full force and effect. (h)No Plan Termination Event has occurred nor is reasonably expected to occur with respect to any Plan of the Borrower or any of its ERISA Affiliates which would result in a material liability to the Borrower, except as disclosed and consented to by the Majority Lenders in writing from time to time. Since the date of the most recent Schedule B (Actuarial Information) to the annual report of the Borrower (Form 5500 Series), if any, there has been no material adverse change in the funding status of the Plans referred therein and no "prohibited transaction" has occurred with respect thereto which is reasonably expected to result in a material liability to the Borrower. Neither the Borrower nor any of its ERISA Affiliates has incurred nor reasonably expects to incur any material withdrawal liability under ERISA to any Multiemployer Plan, except as disclosed and consented to by the Majority Lenders in writing from time to time. (i)No fire, explosion, accident, strike, lockout or other labor dispute, drought, storm, hail, earthquake, embargo, act of God or of the public enemy or other casualty (except for any such circumstance, if any, which is covered by insurance which coverage has been confirmed and not disputed by the relevant insurer) affecting the properties, business or operations of the Borrower, Consumers or any Restricted Subsidiary has occurred that could reasonably be expected to have a material adverse effect on the business, financial condition or results of operations of (A) the Borrower and its Subsidiaries, considered as a whole, or (B) Consumers and its Subsidiaries, considered as a whole. (j)The Borrower and its Subsidiaries have filed all tax returns (Federal, state and local) required to be filed and paid all taxes shown thereon to be due, including interest and penalties, or, to the extent the Borrower or any of its Subsidiaries is contesting in good faith an assertion of liability based on such returns, has provided adequate reserves for payment thereof in accordance with GAAP. (k)No extraordinary judicial, regulatory or other legal constraints exist which limit or restrict Consumers' ability to declare or pay cash dividends with respect to its capital stock. (l)The Borrower owns 100% of the outstanding shares of common stock of Enterprises. (m)The Borrower owns not less than 80% of the outstanding shares of common stock of Consumers. (n)The CMS Energy Corporation 1995-1999 Financial Forecast, dated August 21, 1995 (the "Projections"), copies of which have been distributed to the Banks, is based upon assumptions that the Borrower believed were reasonable at the time the Projections were delivered, and all other financial information previously delivered by the Borrower to the Co- Agents are true and correct in all material respects as at the dates and for the periods indicated therein. (o)The Borrower is not engaged in the business of extending credit for the purpose of buying or carrying margin stock (within the meaning of Regulation U issued by the Board of Governors of the Federal Reserve System), and no proceeds of any Advance will be used to buy or carry any margin stock or to extend credit to others for the purpose of buying or carrying any margin stock. (p)The Borrower is not an investment company (within the meaning of the Investment Company Act of 1940, as amended). (q)No proceeds of any Advance will be used to acquire any equity security of a class that is registered pursuant to Section 12 of the Exchange Act. (r)Following application of the proceeds of each Advance, not more than 25 percent of the value of the assets of the Borrower and its Subsidiaries on a consolidated basis will be margin stock (within the meaning of Regulation U issued by the Board of Governors of the Federal Reserve System). SECTION 7.01. Affirmative Covenants. So long as any Note shall remain unpaid or any Lender shall have any Commitment: (a)Payment of Taxes, Etc. The Borrower shall pay and discharge, and each of its Subsidiaries shall pay and discharge, before the same shall become delinquent, all taxes, assessments and governmental charges, royalties or levies imposed upon it or upon its property except, in the case of taxes, to the extent the Borrower or any Subsidiary, as the case may be, is contesting the same in good faith and by appropriate proceedings and has set aside adequate reserves for the payment thereof in accordance with GAAP. (b)Maintenance of Insurance. The Borrower shall maintain, and each of its Restricted Subsidiaries and Consumers shall maintain, insurance covering the Borrower, each of its Restricted Subsidiaries, Consumers and their respective properties in effect at all times in such amounts and covering such risks as is usually carried by companies engaged in similar businesses and owning similar properties in the same general geographical area in which the Borrower, its Restricted Subsidiaries and Consumers operates, either with reputable insurance companies or, in whole or in part, by establishing reserves of one or more insurance funds, either alone or with other corporations or associations. (c)Preservation of Existence, Etc. The Borrower shall preserve and maintain, and each of its Restricted Subsidiaries and Consumers shall preserve and maintain, its corporate existence, material rights (statutory and otherwise) and franchises, and take such other action as may be necessary or advisable to preserve and maintain its right to conduct its business in the states where it shall be conducting its business. (d)Compliance with Laws, Etc. The Borrower shall comply, and each of its Restricted Subsidiaries and Consumers shall comply, in all material respects with the requirements of all applicable laws, rules, regulations and orders of any governmental authority, including without limitation any such laws, rules, regulations and orders relating to zoning, environmental protection, use and disposal of Hazardous Substances, land use, construction and building restrictions, and employee safety and health matters relating to business operations. (e)Inspection Rights. Subject to the requirements of laws or regulations applicable to the Borrower or its Subsidiaries, as the case may be, and in effect at the time, at any time and from time to time upon reasonable notice, the Borrower shall permit (i) the Co-Agents and their respective agents and representatives to examine and make copies of and abstracts from the records and books of account of, and the properties of, the Borrower or any of its Subsidiaries and (ii) the Co-Agents, each of the Lenders, and their respective agents and representatives to discuss the affairs, finances and accounts of the Borrower and its Subsidiaries with the Borrower and its Subsidiaries and their respective officers, directors and accountants, in each case, to the extent that any out-of- pocket expenses are incurred in connection therewith at such time as no Event of Default or Unmatured Default shall have occurred and be continuing, at the expense of the Co-Agents, each of the Lenders, or their respective agents and representatives, as the case may be. (f)Keeping of Books. The Borrower shall keep, and each of its Subsidiaries shall keep, proper records and books of account, in which full and correct entries shall be made of all financial transactions of the Borrower and its Subsidiaries and the assets and business of the Borrower and its Subsidiaries, in accordance with GAAP. (g)Maintenance of Properties, Etc. The Borrower shall maintain, and each of its Restricted Subsidiaries shall maintain, in substantial conformity with all laws and material contractual obligations, good and marketable title to all of its properties which are used or useful in the conduct of its business; provided, however, that the foregoing shall not restrict the sale of any asset of the Borrower or any Restricted Subsidiary to the extent not prohibited by Section 7.02(i). In addition, the Borrower shall preserve, maintain, develop, and operate, and each of its Subsidiaries shall preserve, maintain, develop and operate, in substantial conformity with all laws and material contractual obligations, all of its material properties which are used or useful in the conduct of its business in good working order and condition, ordinary wear and tear excepted. (h)Use of Proceeds. The Borrower shall apply the proceeds of the Drawdown, to the extent necessary, to the repayment in full and termination of all outstanding obligations under the Existing Agreement, whether for principal, interest, fees, or otherwise (if any) (and, in furtherance thereof, the Borrower hereby expressly and irrevocably authorizes the Operational Agent to so apply such proceeds to such repayment), and then for general corporate purposes (subject to the terms and conditions of this Agreement). (i)Consolidated Leverage Ratio. The Borrower shall maintain at all times a ratio of Consolidated Debt to Consolidated Capital of not more than the amount set forth below during each corresponding period set forth below: (j)Cash Dividend Coverage Ratio. The Borrower shall maintain, as of the last day of each fiscal quarter (in each case, the "Measurement Quarter"), a ratio of (i) the sum of (A) Cash Dividend Income for the immediately preceding four-fiscal-quarter period ending on the last day of the fiscal quarter immediately preceding such Measurement Quarter, plus (B) 25% of the amount of Equity Distributions received by the Borrower during such period but in no event in excess of $10,000,000, plus (C) all amounts received by the Borrower from its Subsidiaries and Affiliates during such period constituting reimbursement of interest expense (including commitment, guaranty and letter of credit fees) paid by the Borrower on behalf of any such Subsidiary to (ii) interest expense (including commitment, guaranty and letter of credit fees) accrued by the Borrower in respect of all Debt during such period of (1) not less than 2.1 to 1.0 for each such period from the Closing Date until (and including) the fiscal quarter ending December 31, 1998 and (2) not less than 2.0 to 1.0 thereafter; provided, that the Borrower shall be deemed not to be in breach of the foregoing covenant if, during the Measurement Quarter, it has a) permanently reduced the Commitments and the principal amount outstanding under this Agreement and the Notes such that the amount determined pursuant to clause (ii) above, when recalculated on a pro forma basis assuming that the amount of such reduced Commitments and principal amount outstanding under this Agreement and the Notes were in effect at all times during such four-fiscal-quarter period, would result in the Borrower being in compliance with such ratio, and/or b) increased Cash Dividend Income during such Measurement Quarter such that the ratio of (x) Cash Dividend Income for the four-fiscal-quarter period ending on the last day of the Measurement Quarter to (y) the amount determined pursuant to clause (ii) above (as recalculated pursuant to clause a) above), equals or exceeds (1) 2.1 to 1.0 for each such period from the Closing Date until (and including) the fiscal quarter ending December 31, 1998 and (2) 2.0 to 1.0 thereafter. (k)Refinancing of Senior Note Debt. In connection with any refinancings of the Senior Note Debt, the Borrower shall cause the maturity thereof to be no sooner than the earlier to occur of (vi) the third anniversary of the date of any such refinancing and (i) the then- scheduled maturity date of the Senior Notes being refinanced. (l)Further Assurances. The Borrower shall promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary or that any Lender through the Documentation Agent may reasonably request in order to give effect to the transactions contemplated by this Agreement and the other Loan Documents. In addition, the Borrower will use all reasonable efforts to duly obtain or make Governmental Approvals required from time to time on or prior to such date as the same may become legally required. SECTION 7.02. Negative Covenants. So long as any Note shall remain unpaid or any Lender shall have any Commitment, the Borrower shall not, without the written consent of the Majority Lenders: (a)Liens, Etc. Create, incur, assume or suffer to exist, or permit any of its Restricted Subsidiaries to create, incur, assume or suffer to exist, any lien, security interest, or other charge or encumbrance (including the lien or retained security title of a conditional vendor) of any kind, or any other type of arrangement intended or having the effect of conferring upon a creditor a preferential interest upon or with respect to any of its properties of any character (including, without limitation, capital stock of Consumers, Enterprises, Nomeco and any of the Borrower's other directly-owned Subsidiaries and accounts) (any of the foregoing being referred to herein as a "Lien"), whether now owned or hereafter acquired, or sign or file, or permit any of its Restricted Subsidiaries to sign or file, under the Uniform Commercial Code of any jurisdiction a financing statement which names the Borrower or any Restricted Subsidiary as debtor, sign, or permit any of its Restricted Subsidiaries to sign, any security agreement authorizing any secured party thereunder to file such financing statement, or assign, or permit any of its Restricted Subsidiaries to assign, accounts, excluding, however, from the operation of the foregoing restrictions the Liens created under the Loan Documents and the following: (i)Liens for taxes, assessments or governmental charges or levies to the extent not past due; (ii)cash pledges or deposits to secure (A) obligations under workmen's compensation laws or similar legislation, (B) public or statutory obligations of the Borrower or any of its Restricted Subsidiaries, or (C) Support Obligations of the Borrower; provided that the aggregate amount of pledges or deposits securing such Support Obligations shall not exceed $30 million at any one time outstanding; (iii)Liens imposed by law, such as materialmen's, mechanics', carriers', workmen's and repairmen's liens and other similar Liens arising in the ordinary course of business securing obligations which are not overdue or which have been fully bonded and are being contested in good faith; and (iv)purchase money Liens or purchase money security interests upon or in property acquired or held by the Borrower or any of its Restricted Subsidiaries in the ordinary course of business to secure the purchase price of such property or to secure indebtedness incurred solely for the purpose of financing the acquisition of any such property to be subject to such Liens or security interests, or Liens or security interests existing on any such property at the time of acquisition, or extensions, renewals or replacements of any of the foregoing for the same or a lesser amount, provided that no such Lien or security interest shall extend to or cover any property other than the property being acquired and no such extension, renewal or replacement shall extend to or cover property not theretofore subject to the Lien or security interest being extended, renewed or replaced, and provided, further, that the aggregate principal amount of the Debt at any one time outstanding secured by Liens permitted by this clause (iv) shall not exceed $10,000,000. (b)Enterprises Debt. Permit Enterprises to create, incur, assume or suffer to exist any debt (as such term is construed in accordance with GAAP) other than: (i)debt arising by reason of the endorsement of negotiable instruments for deposit or collection or similar transactions in the ordinary course of Enterprises' business; (ii)in the form of indemnities in respect of unfiled mechanics' liens and Liens affecting Enterprises' properties permitted under Section 7.02(a)(iii); and (iii)other debt of Enterprises outstanding on the Closing Date set forth on Schedule II hereto; (c)Lease Obligations. Create, incur, assume or suffer to exist, or permit any of its Restricted Subsidiaries to create, incur, assume or suffer to exist, any obligations as lessee for the rental or hire of real or personal property of any kind under leases or agreements to lease (other than leases which constitute Debt) having an original term of one year or more which would cause the aggregate direct or contingent liabilities of the Borrower and its Restricted Subsidiaries in respect of all such obligations payable in any period of 12 consecutive calendar months to exceed $10,000,000. (d)Investments in Other Persons. Upon the occurrence and during the continuance of an Event of Default or an Unmatured Default (other than an Unmatured Default that occurs and is continuing prior to the last day of any Measurement Quarter resulting from the failure of the Borrower to comply with the ratio set forth in Section 7.01(j)), make, or permit any of its Restricted Subsidiaries to make, any loan or advance to any Person or purchase or otherwise acquire any capital stock, obligations or other securities of, make any capital contribution to, or otherwise invest in, any Person, other than Permitted Investments. (e)Restricted Payments. Declare or pay, or permit any of its Restricted Subsidiaries to declare or pay, directly or indirectly, any dividend, payment or other distribution of assets, properties, cash, rights, obligations or securities on account of any share of any class of capital stock of the Borrower or any of its Restricted Subsidiaries (other than (1) stock splits and dividends payable solely in nonconvertible equity securities of the Borrower and (2) distributions made to the Borrower or a Restricted Subsidiary), or purchase, redeem, retire, or otherwise acquire for value, or permit any of its Restricted Subsidiaries to purchase, redeem, retire, or otherwise acquire for value, any shares of any class of capital stock of the Borrower or any of its Restricted Subsidiaries or any warrants, rights, or options to acquire any such shares, now or hereafter outstanding, or make, or permit any of its Restricted Subsidiaries to make, any distribution of assets to any of its shareholders (other than distributions to the Borrower or a Restricted Subsidiary) (any such dividend, payment, distribution, purchase, redemption, retirement or acquisition being hereinafter referred to as a "Restricted Payment"), unless (i) no Unmatured Default or Event of Default has occurred and is continuing or would occur as a result of such Restricted Payment, and (ii) after giving effect thereto, the aggregate amount of all such Restricted Payments made since September 30, 1993 shall not have exceeded the sum of (A) $120,000,000, (B) 100% of Consolidated Net Income (as defined in the Indenture in effect on the date hereof) accrued during the period (treated as one accounting period) from September 30, 1993 to the end of the most recent fiscal quarter of the Borrower ending at least 45 days prior to the date of such Restricted Payment (or, in case such amount shall be a deficit, minus 100% of such deficit), and (C) the aggregate Net Proceeds (as defined in the Indenture in effect on the date hereof) received by the Borrower from any issuance or sale of, or contribution with respect to, its capital stock subsequent to September 30, 1993; provided, however, that the foregoing shall not prohibit (1) any purchase or redemption of capital stock of the Borrower made by exchange for, or out of the proceeds of the substantially concurrent sale of, capital stock of the Borrower (other than Redeemable Stock or Exchangeable Stock (as such terms are defined in the Indenture in effect on the date hereof)), provided that such purchase or redemption shall be excluded from the calculation of the amount of Restricted Payments permitted by this subsection (e); (2) dividends or other distributions paid in respect of any class of the Borrower's capital stock issued in respect of the acquisition of any business or assets by the Borrower or a Restricted Subsidiary where the dividends or other distributions with respect to such capital stock are payable solely from the net earnings of such business or assets; (3) dividends paid within 60 days after the date of declaration thereof if at such date of declaration such dividend would have complied with this subsection (e), provided that at the time of payment of such dividend, no Unmatured Default or Event of Default shall have occurred and be continuing (or result therefrom), and provided further that such dividends shall be included (without duplication) in the calculation of the amount of Restricted Payments permitted by this subsection (e); or (4) payments made by the Borrower or any Restricted Subsidiary pursuant to the Tax Sharing Agreement. For purposes of this subsection (e), the amount of any Restricted Payment not in the form of cash shall be the fair market value of such Restricted Payment as determined in good faith by the Board of Directors of the Borrower, provided that if the value of the non-cash portion of such Restricted Payment as determined by the Borrower's Board of Directors is in excess of $25 million, such value shall be based on an opinion from a nationally-recognized firm acceptable to the Co-Agents experienced in the appraisal of similar types of property or transactions. (f)Compliance with ERISA. (i) Permit to exist any "accumulated funding deficiency" (as defined in Section 412(a) of the Internal Revenue Code of 1986), (ii) terminate, or permit any ERISA Affiliate to terminate, any Plan so as to result in any material (in the opinion of the Majority Lenders) liability of the Borrower, any Restricted Subsidiary or Consumers to the PBGC, or (iii) permit to exist any occurrence of any Reportable Event (as defined in Title IV of ERISA), or any other event or condition, which presents a material (in the opinion of the Majority Lenders) risk of such a termination by the PBGC of any Plan and such a material liability to the Borrower, any Restricted Subsidiary or Consumers. (g)Transactions with Affiliates. Enter into, or permit any of its Subsidiaries to enter into, any transaction with any of its Affiliates unless such transaction is on terms no less favorable to the Borrower or such Subsidiary than if the transaction had been negotiated in good faith on an arm's-length basis with a non-Affiliate. (h)Mergers, Etc. Merge with or into or consolidate with or into, or permit any of its Restricted Subsidiaries, Consumers or Nomeco to merge with or into or consolidate with or into, any other Person, except that (1) any Restricted Subsidiary (other than Enterprises) may merge into any other Restricted Subsidiary; (2) Nomeco may merge with or into Enterprises or the Borrower; (3) Nomeco may merge with or into any other Person, provided that, in connection with such merger, Enterprises shall have received fair consideration (as determined by the Board of Directors of Enterprises or the Borrower); (4) any Restricted Subsidiary may merge with or into the Borrower, and the Borrower may merge with any other Person, provided that, immediately after giving effect to any such merger, (A) no event shall occur and be continuing which constitutes an Unmatured Default or an Event of Default, (B) the Borrower is the surviving corporation, and (C) the Borrower shall not be liable with respect to any Debt or allow its property to be subject to any Lien which it could not become liable with respect to or allow its property to become subject to under this Agreement or any other Loan Document on the date of such transaction; (5) Consumers may merge with any other Person, provided that, immediately after giving effect thereto, (w) no event shall occur and be continuing which constitutes an Unmatured Default or an Event of Default, (x) Consumers is the surviving corporation, (y) the Borrower shall continue to own not less than 80% of the outstanding shares of common stock of Consumers and (z) Consumers' Net Worth shall be equal to or greater than its Net Worth immediately prior to such merger; and (6) any Person (other than the Borrower and its Affiliates) may merge with or into Enterprises, provided that, immediately after giving effect thereto, (A) no event shall occur and be continuing which constitutes an Unmatured Default or an Event of Default, (B) Enterprises is the surviving corporation, (C) Enterprises' Net Worth shall be equal to or greater than its Net Worth immediately prior to such merger and (D) Enterprises shall not be liable with respect to any Debt or allow its property to be subject to any Lien which it could not become liable with respect to or allow its property to become subject to under this Agreement or any other Loan Document on the date of such transaction; provided, that after giving effect to any merger described in clause (2), (3), or (5) above, the Borrower shall be in compliance with Section 7.01(i). (i)Sales, Etc., of Assets. Sell, lease, transfer, assign, or otherwise dispose of all or any substantial part of its assets, or permit any of its Restricted Subsidiaries to sell, lease, transfer, or otherwise dispose of all or any substantial part of its assets, except to give effect to a transaction permitted by subsection (h) above or subsection (j) below. (j)Maintenance of Ownership of Subsidiaries. Sell, transfer, assign or otherwise dispose of any shares of capital stock of any of its Restricted Subsidiaries or Consumers (other than preferred or preference stock of Consumers) or any warrants, rights or options to acquire such capital stock, or permit any Restricted Subsidiary or Consumers to issue, sell, transfer, assign or otherwise dispose of any shares of its capital stock (other than preferred or preference stock of Consumers) or the capital stock of any other Restricted Subsidiary or any warrants, rights or options to acquire such capital stock, except to give effect to a transaction permitted by subsection (h) above; provided, however, that (i) the Borrower may sell, transfer, assign or otherwise dispose of not more than 20% of the common stock of Consumers, provided that after giving effect to such transaction the Borrower shall be in compliance with Section 7.01(i) and (ii) Enterprises may, and the Borrower may permit Enterprises to, sell, transfer, assign or otherwise dispose of not more than 49% of the common stock of any Enterprises Significant Subsidiary, provided that after giving effect to such transaction the Borrower shall be in compliance with Section 7.01(i). (k)Amendment of Tax Sharing Agreement. Directly or indirectly, amend, modify, supplement, waive compliance with, seek a waiver under, or assent to noncompliance with, any term, provision or condition of the Tax Sharing Agreement if the effect of such amendment, modification, supplement, waiver or assent is to (i) reduce materially any amounts otherwise payable to, or increase materially any amounts otherwise owing or payable by, the Borrower thereunder, or (ii) change materially the timing of any payments made by or to the Borrower thereunder. SECTION 7.03. Reporting Obligations. So long as any Note shall remain unpaid or any Lender shall have any Commitment, the Borrower will, unless the Majority Lenders shall otherwise consent in writing, furnish to each Lender, the following: (a)as soon as possible and in any event within five days after the Borrower knows or should have reason to know of the occurrence of each Unmatured Default or Event of Default continuing on the date of such statement, a statement of the chief financial officer or chief accounting officer of the Borrower setting forth details of such Unmatured Default or Event of Default and the action that the Borrower proposes to take with (b) as soon as available and in any event within 60 days after the end of each of the first three quarters of each fiscal year of the Borrower, a consolidated balance sheet of the Borrower and its Subsidiaries as at the end of such quarter and consolidated statements of income and retained earnings and of cash flows of the Borrower and its Subsidiaries for the period commencing at the end of the previous fiscal year and ending with the end of such quarter (which requirement shall be deemed satisfied by the delivery of the Borrower's quarterly report on Form 10-Q for such quarter), all in reasonable detail and duly certified (subject to year-end audit adjustments) by the chief financial officer or chief accounting officer of the Borrower as having been prepared in accordance with GAAP, together with (A) a schedule (substantially in the form of Exhibit F appropriately completed) of (1) the computations used by the Borrower in determining compliance with the covenants contained in Sections 7.01(i) and 7.01(j) and, after the enactment of any Consumers Dividend Restriction, the ratio set forth in Section 8.01(i), (2) all Project Finance Debt of the Consolidated Subsidiaries, together with the Borrower's Ownership Interest in each such Consolidated Subsidiary and (3) all Support Obligations of the Borrower of the types described in clauses (iv) and (v) of the definition of Support Obligations (whether or not each such Support Obligation or the primary obligation so supported is fixed, conclusively determined or reasonably quantifiable) to the extent such Support Obligations have not been previously disclosed as "Consolidated Debt" pursuant to clause (1) above, and (B) a certificate of said officer stating that no Unmatured Default or Event of Default has occurred and is continuing or, if an Unmatured Default or Event of Default has occurred and is continuing, a statement as to the nature thereof and the action that the Borrower proposes to take with respect thereto; (c)as soon as available and in any event within 120 days after the end of each fiscal year of the Borrower and its Subsidiaries, a copy of the Annual Report on Form 10-K (or any successor form) for the Borrower and its Subsidiaries for such year, including therein a consolidated balance sheet of the Borrower and its Subsidiaries as of the end of such fiscal year and consolidated statements of income and retained earnings and of cash flows of the Borrower and its Subsidiaries for such fiscal year, accompanied by a report thereon of Arthur Andersen & Co. or another nationally-recognized independent public accounting firm, together with a schedule in form satisfactory to the Majority Lenders of (A) the computations used by such accounting firm in determining, as of the end such fiscal year, compliance with the covenants contained in Sections 7.01(i) and 7.01(j) and, after the enactment of any Consumers Dividend Restriction, the ratio set forth in Section 8.01(k), (B) all Project Finance Debt of the Consolidated Subsidiaries, together with the Borrower's Ownership Interest in each such Consolidated Subsidiary and (C) all Support Obligations of the Borrower of the types described in clauses (iv) and (v) of the definition of Support Obligations (whether or not each such Support Obligation or the primary obligation so supported is fixed, conclusively determined or reasonably quantifiable) to the extent such Support Obligations have not been previously disclosed as "Consolidated Debt" pursuant to clause (A) above; (d)as soon as available and in any event within 60 days after the end of each of the first three quarters of each fiscal year of the Borrower, a balance sheet of the Borrower as at the end of such quarter and statements of income and retained earnings and of cash flows of the Borrower for the period commencing at the end of the previous fiscal year and ending with the end of such quarter, all in reasonable detail and duly certified (subject to year-end audit adjustments) by the chief financial officer or chief accounting officer of the Borrower as having been prepared in accordance with GAAP; (e)as soon as available and in any event within 120 days after the end of each fiscal year of the Borrower, a balance sheet of the Borrower as at the end of such fiscal year and statements of income and retained earnings and of cash flows of the Borrower for such fiscal year, all in reasonable detail and duly certified (subject to year-end audit adjustments) by the chief financial officer or chief accounting officer of the Borrower as having been prepared in accordance with GAAP; (f)as soon as possible and in any event (A) within 30 days after the Borrower knows or has reason to know that any Plan Termination Event described in clause (i) of the definition of Plan Termination Event with respect to any Plan of the Borrower or any ERISA Affiliate of the Borrower has occurred and could reasonably be expected to result in a material liability to the Borrower and (B) within 10 days after the Borrower knows or has reason to know that any other Plan Termination Event with respect to any Plan of the Borrower or any ERISA Affiliate of the Borrower has occurred and could reasonably be expected to result in a material liability to the Borrower, a statement of the chief financial officer or chief accounting officer of the Borrower describing such Plan Termination Event and the action, if any, which the Borrower proposes to take with (g)promptly after receipt thereof by the Borrower or any of its ERISA Affiliates from the PBGC copies of each notice received by the Borrower or any such ERISA Affiliate of the PBGC's intention to terminate any Plan or to have a trustee appointed to administer any Plan; (h)promptly and in any event within 30 days after the filing thereof with the Internal Revenue Service, copies of each Schedule B (Actuarial Information) to the annual report (Form 5500 Series) with respect to each Plan (if any) to which the Borrower is a contributing (i)promptly after receipt thereof by the Borrower or any of its ERISA Affiliates from a Multiemployer Plan sponsor, a copy of each notice received by the Borrower or any of its ERISA Affiliates concerning the imposition or amount of withdrawal liability in an aggregate principal amount of at least $250,000 pursuant to Section 4202 of ERISA in respect of which the Borrower is reasonably expected to be liable; (j)promptly after the Borrower becomes aware of the occurrence thereof, notice of all actions, suits, proceedings or other events of the type described in Section 6.01(f); (k)promptly after the sending or filing thereof, copies of all proxy statements, financial statements and reports which the Borrower sends to its public security holders (if any), copies of all regular, periodic and special reports which the Borrower files with the Securities and Exchange Commission or any governmental authority which may be substituted therefor, or with any national securities exchange, pursuant to the Exchange Act, and copies of all final prospectuses with respect to any securities issued or to be issued by the Borrower or any of its (l)as soon as possible and in any event within five days after the occurrence of any material default under any material agreement to which the Borrower or any of its Subsidiaries is a party, which default would materially adversely affect the financial condition, business, results of operations or property of the Borrower and its Subsidiaries, considered as a whole, any of which is continuing on the date of such certificate, a certificate of the chief financial officer of the Borrower setting forth the details of such material default and the action which the Borrower or any such Subsidiary proposes to take with respect thereto; and (m)promptly after requested, such other information respecting the business, properties, condition or operations, financial or otherwise, of the Borrower and its Subsidiaries as any Agent or the Majority Lenders may from time to time reasonably request in writing. SECTION 8.01. Events of Default. If any of the following events (each an "Event of Default") shall occur and be continuing, the Co-Agents and the Lenders shall be entitled to exercise the remedies set forth in Section 8.02: (a)The Borrower shall fail to pay (i) any principal of any Note when due or (ii) any interest thereon within two Business Days after such interest shall have become due; or (b)Any representation or warranty made by or on behalf of the Borrower in any Loan Document or certificate or other writing delivered pursuant thereto shall prove to have been incorrect in any material respect when made or deemed made; or (c)The Borrower or any of its Subsidiaries shall fail to perform or observe any term or covenant on its part to be performed or observed contained in Section 7.01(c), (h), (i) or (j) or in Section 7.02 hereof (and the Borrower, each Lender and each Agent hereby agrees that an Event of Default under this subsection (c) shall be given effect as if the defaulting Subsidiary were a party to this Agreement); or (d)The Borrower or any of its Subsidiaries shall fail to perform or observe any other term or covenant on its part to be performed or observed contained in any Loan Document and any such failure shall remain unremedied, after written notice thereof shall have been given to the Borrower by the Documentation Agent, for a period of 10 Business Days (and the Borrower, each Lender and each Agent hereby agrees that an Event of Default under this subsection (d) shall be given effect as if the defaulting Subsidiary were a party to this Agreement); or (e)The Borrower, any Restricted Subsidiary or Consumers shall fail to pay any of its Debt (including any interest or premium thereon but excluding Debt evidenced by the Notes) (i) aggregating, in the case of the Borrower and each Restricted Subsidiary, $6,000,000 or more or, in the case of Consumers, $25,000,000 or more, or (ii) arising under the Indenture or any Senior Note, when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) and such failure shall continue after the applicable grace period, if any, specified in any agreement or instrument relating to such Debt; or any other default under any agreement or instrument relating to any such Debt, or any other event, shall occur and shall continue after the applicable grace period, if any, specified in such agreement or instrument, if the effect of such default or event is to accelerate, or to permit the acceleration of, the maturity of such Debt; or any such Debt shall be declared to be due and payable, or required to be prepaid (other than by a regularly scheduled required prepayment) prior to the stated maturity thereof; unless in each such case the obligee under or holder of such Debt shall have waived in writing such circumstance so that such circumstance is no longer continuing; or (f)(i) The Borrower, any Restricted Subsidiary or Consumers shall generally not pay its debts as such debts become due, or shall admit in writing its inability to pay its debts generally, or shall make an assignment for the benefit of creditors; or (ii) any proceeding shall be instituted by or against the Borrower, any Restricted Subsidiary or Consumers seeking to adjudicate it a bankrupt or insolvent, or seeking liquidation, winding up, reorganization, arrangement, adjustment, protection, relief, or composition of its debts under any law relating to bankruptcy, insolvency, or reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, or other similar official for it or for any substantial part of its property and, in the case of a proceeding instituted against the Borrower, either such proceeding shall remain undismissed or unstayed for a period of 60 days or any of the actions sought in such proceeding (including without limitation the entry of an order for relief against the Borrower, a Restricted Subsidiary or Consumers or the appointment of a receiver, trustee, custodian or other similar official for the Borrower, such Restricted Subsidiary or Consumers or any of its property) shall occur; or (iii) the Borrower, any Restricted Subsidiary or Consumers shall take any corporate or other action to authorize any of the actions set forth above in this subsection (f); or (g)Any judgment or order for the payment of money in excess of $6,000,000 shall be rendered against the Borrower or its properties and either (i) enforcement proceedings shall have been commenced by any creditor upon such judgment or order or (ii) there shall be any period of 30 consecutive days during which a stay of enforcement of such judgment or order, by reason of a pending appeal or otherwise, shall not be in effect; (h)Any material provision of any Loan Document, after execution hereof or delivery thereof under Article V, shall for any reason other than the express terms hereof or thereof cease to be valid and binding on any party thereto; or the Borrower shall so assert in writing; or (i)There shall be imposed or enacted any Consumers Dividend Restriction, the result of which is that the Dividend Coverage Ratio shall be less than 1.15 to 1.0 at any time after the imposition of such Consumers Dividend Restriction. SECTION 8.02. Remedies. If any Event of Default has occurred and is continuing, then the Co-Agents shall at the request, or may with the consent, of the Required Lenders, upon notice to the Borrower (i) declare the Commitments and the obligation of each Lender to make or Convert Advances to be terminated, whereupon the same shall forthwith terminate, and (ii) declare the Notes, all interest thereon and all other amounts payable under this Agreement and the other Loan Documents to be forthwith due and payable, whereupon the Notes, all such interest and all such amounts shall become and be forthwith due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by the Borrower; provided, however, that in the event of an actual or deemed entry of an order for relief with respect to the Borrower under the Federal Bankruptcy Code, (A) the Commitments and the obligation of each Lender to make Advances shall automatically be terminated and (B) the Notes, all such interest and all such amounts shall automatically become and be due and payable, without presentment, demand, protest or any notice of any kind, all of which are hereby expressly waived by the Borrower. SECTION 9.01. Authorization and Action. Each Lender hereby appoints and authorizes each of the Agents to take such action as agent on its behalf and to exercise such powers under this Agreement as are delegated to such Agents by the terms hereof, together with such powers as are reasonably incidental thereto. The Operational Agent is hereby expressly authorized on behalf of each Lender, without hereby limiting any implied authority, to receive on behalf of each of the Lenders any payment of principal of, or interest on, the Notes and all other amounts accrued thereunder or hereunder paid to the Operational Agent, and promptly to distribute in accordance with Section 4.01(a) to each Lender its proper share of all payments so received. Each Agent is hereby expressly authorized on behalf of each Lender, without hereby limiting any implied authority, to distribute to each Lender copies of all notices, agreements and other materials as provided for in this Agreement and any other Loan Document received by such Agent. As to any matters not expressly provided for by this Agreement (including, without limitation, enforcement or collection of the Notes), the Agents shall not be required to exercise any discretion or take any action, but shall be required to act or to refrain from acting (and shall be fully protected in so acting or refraining from acting) upon the instructions of the Majority Lenders, and such instructions shall be binding upon all Lenders and all holders of Notes; provided, however, that the Agents shall not be required to take any action that exposes any Agent to personal liability or that is contrary to this Agreement or applicable law. Each Agent agrees to give to each Lender prompt notice of each notice given to it by the Borrower pursuant to the terms of this Agreement. SECTION 9.02. Agents' Reliance, Etc. Neither any Agent nor any of its directors, officers, agents or employees shall be liable for any action taken or omitted to be taken by it or them under or in connection with any Loan Document, except for its or their own gross negligence or wilful misconduct. Without limitation of the generality of the foregoing: (i) each Agent may treat the payee of any Note as the holder thereof until the Documentation Agent receives and accepts a Lender Assignment entered into by the Lender which is the payee of such Note, as assignor, and an Eligible Assignee, as assignee, as provided in Section 10.07; (ii) each Agent may consult with legal counsel (including counsel for the Borrower), independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken in good faith by it in accordance with the advice of such counsel, accountants or experts; (iii) the Agents make no warranty or representation to any Lender and shall not be responsible to any Lender for any statements, warranties or representations made in or in connection with any Loan Document; (iv) no Agent shall have any duty to ascertain or to inquire as to the performance or observance of any of the terms, covenants or conditions of any Loan Document on the part of the Borrower or to inspect any property (including the books and records) of the Borrower; (v) no Agent shall be responsible to any Lender for the due execution, legality, validity, enforceability, genuineness, sufficiency or value of any Loan Document; and (vi) no Agent shall incur liability under or in respect of any Loan Document by acting upon any notice, consent, certificate or other instrument or writing (which may be by telegram, cable, telex, telecopy or other teletransmission) believed by it to be genuine and signed or sent by the proper party or parties. SECTION 9.03. Citibank, Union Bank and Affiliates. With respect to its Commitment and the Note issued to it, each of Citibank and Union Bank shall have the same rights and powers under this Agreement as any other Lender and may exercise the same as though it were not an Agent; and the term "Lender" or "Lenders" shall, unless otherwise expressly indicated, include Citibank and Union Bank each in its individual capacity. Citibank and Union Bank and their respective Affiliates may accept deposits from, lend money to, act as trustee under indentures of, and generally engage in any kind of business with, the Borrower, any of its Subsidiaries, its Affiliates and any Person who may do business with or own securities of the Borrower or any such Subsidiary or Affiliate, all as if Citibank and Union Bank were not an Agent and without any duty to account therefor to the Lenders. SECTION 9.04. Lender Credit Decision. Each Lender acknowledges that it has, independently and without reliance upon the Agents or any other Lender and based on the financial information referred to in Section 6.01(e) and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon the Agents or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement. SECTION 9.05. Indemnification. The Lenders agree to indemnify the Agents (to the extent not reimbursed by the Borrower), ratably according to the respective principal amounts of the Notes then held by each of them (or if no Notes are at the time outstanding or if any Notes are held by Persons which are not Lenders, ratably according to the respective Percentages of the Lenders), from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, incurred by, or asserted against the Agents in any way relating to or arising out of this Agreement or any action taken or omitted by the Agents under this Agreement, provided that no Lender shall be liable for any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements resulting from the Agents' gross negligence or willful misconduct. Without limitation of the foregoing, each Lender agrees to reimburse the Agents promptly upon demand for its ratable share of any out-of-pocket expenses (including counsel fees) incurred by the Agents in connection with the preparation, execution, delivery, administration, modification, amendment or enforcement (whether through negotiations, legal proceedings or otherwise) of, or legal advice in respect of rights or responsibilities under, this Agreement to the extent that the Agents are entitled to reimbursement for such expenses pursuant to Section 10.04 but are not reimbursed for such expenses by the Borrower. SECTION 9.06. Successor Agents. Each Agent may resign at any time by giving written notice thereof to the Lenders and the Borrower and may be removed at any time with or without cause by the Majority Lenders, with any such resignation or removal to become effective only upon the appointment of a successor Agent in such capacity, pursuant to this Section 9.06. Upon any such resignation or removal, the Majority Lenders shall have the right to appoint a successor Agent in such capacity which shall be a Lender or another commercial bank or trust company reasonably acceptable to the Borrower organized under the laws of the United States, or of any State thereof. If no successor Agent shall have been so appointed by the Majority Lenders, and shall have accepted such appointment, within 30 days after the retiring Agent's giving of notice of resignation or the Majority Lenders' removal of the retiring Agent, then the retiring Agent may, on behalf of the Lenders, appoint a successor Agent in such capacity, which shall be a Lender or shall be another commercial bank or trust company organized under the laws of the United States or of any State thereof reasonably acceptable to the Borrower. Upon the acceptance of any appointment as an Agent hereunder by a successor Agent and the execution and delivery by the Borrower and the successor Agent of an agreement relating to the fees to be paid to the successor Agent under Section 2.02(b) hereof in connection with its acting as an Agent hereunder, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent and the retiring Agent shall be discharged from its duties and obligations under this Agreement. After any retiring Agent's resignation or removal hereunder as an Agent, the provisions of this Article IX shall inure to its benefit as to any actions taken or omitted to be taken by it while it was an Agent in such capacity under this Agreement. SECTION 10.01. Amendments, Etc. No amendment or waiver of any provision of any Loan Document, nor consent to any departure by the Borrower therefrom, shall in any event be effective unless the same shall be in writing and signed by the Majority Lenders, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given; provided, however, that no amendment, waiver or consent shall, unless in writing and signed by all the Lenders, do any of the following: (i) waive, modify or eliminate any of the conditions specified in Article V, (ii) increase the Commitments of the Lenders that may be maintained hereunder or subject the Lenders to any additional obligations, (iii) reduce the principal of, or interest on, the Notes, any Applicable Margin or any fees or other amounts payable hereunder (other than fees payable to the Operational Agent pursuant to Section 2.02(b)), (iv) postpone any date fixed for any payment of principal of, or interest on, the Notes or any fees or other amounts payable hereunder (other than fees payable to the Operational Agent pursuant to Section 2.02(b)), (v) change the percentage of the Commitments or of the aggregate unpaid principal amount of the Notes, or the number of Lenders which shall be required for the Lenders or any of them to take any action hereunder, (vi) amend any Loan Document in a manner intended to prefer one or more Lenders over any other Lenders, or (vii) amend Section 2.03(b) or this Section 10.01; and provided, further, that no amendment, waiver or consent shall, unless in writing and signed by each Agent in addition to the Lenders required above to take such action, affect the rights or duties of any Agent under this Agreement or any Note. Any request from the Borrower for any amendment, waiver or consent under this Section 10.01 shall be addressed to the Documentation Agent. SECTION 10.02. Notices, Etc. All notices and other communications provided for hereunder and under the other Loan Documents shall be in writing (including telegraphic, facsimile, telex or cable communication) and mailed, telegraphed, telecopied, telexed, cabled or delivered, (vii) if to the Borrower, at its address at Fairlane Plaza South, 330 Town Center Drive, Suite 1100, Dearborn, Michigan 48126, Attention: Denise M. Sturdy, Esq., Assistant General Counsel, with a copy to Doris F. Galvin, Vice President and Treasurer, 212 West Michigan Avenue, Jackson, Michigan 49201; (i) if to any Bank, at its Domestic Lending Office specified opposite its name on Schedule I hereto; (ii) if to any Lender other than a Bank, at its Domestic Lending Office specified in the Lender Assignment pursuant to which it became a Lender; (iii) if to the Operational Agent, at its address at 445 South Figueroa Street, 15th Floor, Los Angeles, California 90071, Attention: Utilities Department Head; and (iv) if to the Documentation Agent, at its address at 399 Park Avenue, New York, New York 10043, Attention: Utilities Department Head; or, as to each party, at such other address as shall be designated by such party in a written notice to the other parties. All such notices and communications shall, when mailed, telegraphed, telecopied, telexed or cabled, be effective five days after when deposited in the mails, or when delivered to the telegraph company, telecopied, confirmed by telex answerback or delivered to the cable company, respectively, except that notices and communications to any Agent pursuant to Article II, III, or IX shall not be effective until received by such Agent. SECTION 10.03. No Waiver of Remedies. No failure on the part of the Borrower, any Lender or any Agent to exercise, and no delay in exercising, any right hereunder or under any Note shall operate as a waiver thereof; nor shall any single or partial exercise of any such right preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law. SECTION 10.04. Costs, Expenses and Indemnification. (a) The Borrower agrees to (i) reimburse on demand all reasonable costs and expenses of each Agent (including, without limitation, reasonable fees and expenses of counsel to the Agents) in connection with (A) the preparation, negotiation, execution and delivery of the Loan Documents and (B) any proposed modification, amendment, or consent relating to any Loan Document, and (ii) to pay on demand all reasonable costs and expenses of each Agent and, on and after the date upon which the Notes become or are declared to be due and payable pursuant to Section 8.02 or an Event of Default specified in Section 8.01(a) shall have occurred and be continuing, each Lender (including, without limitation, reasonable fees and expenses of counsel to the Agents, special Michigan counsel to the Lenders and, from and after such date, counsel for each Lender (including the allocated costs and expenses of in-house counsel)) in connection with the enforcement (whether through negotiations, legal proceedings or otherwise) of this Agreement, the Notes and the other documents to be delivered hereunder. (b)The Borrower hereby agrees to indemnify and hold each Lender, each Agent and their respective officers, directors, employees, professional advisors and affiliates (each, an "Indemnified Person") harmless from and against any and all claims, damages, losses, liabilities, costs or expenses (including reasonable attorney's fees and expenses, whether or not such Indemnified Person is named as a party to any proceeding or is otherwise subjected to judicial or legal process arising from any such proceeding) which any of them may incur or which may be claimed against any of them by any Person: (i)by reason of or in connection with the execution, delivery or performance of any of the Loan Documents or any transaction contemplated thereby, or the use by the Borrower of the proceeds of any Advance; (ii)in connection with any documentary taxes, assessments or charges made by any governmental authority by reason of the execution and delivery of any of the Loan Documents; or (iii)in connection with or resulting from the utilization, storage, disposal, treatment, generation, transportation, release or ownership of any Hazardous Substance (i) at, upon or under any property of the Borrower or any of its Affiliates or (ii) by or on behalf of the Borrower or any of its Affiliates at any time and in any place; provided, however, that nothing contained in this subsection (b) shall constitute a relinquishment or waiver of the Borrower's rights to any independent claim that the Borrower may have against any Indemnified Person for such Indemnified Person's gross negligence or wilful misconduct, but no Lender shall be liable for any such conduct on the part of any Agent or any other Lender, and no Agent shall be liable for any such conduct on the part of any Lender. (c)The Borrower's other obligations under this Section 10.04 shall survive the repayment of all amounts owing to the Lenders and the Agents under the Loan Documents and the termination of the Commitments. If and to the extent that the obligations of the Borrower under this Section 10.04 are unenforceable for any reason, the Borrower agrees to make the maximum contribution to the payment and satisfaction thereof which is permissible under applicable law. SECTION 10.05. Right of Set-off. (a) Upon (i) the occurrence and during the continuance of any Event of Default and (ii) the making of the request or the granting of the consent specified by Section 8.02 to authorize the Co-Agents to declare the Notes due and payable pursuant to the provisions of Section 8.02, each Lender is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by such Lender to or for the credit or the account of the Borrower, against any and all of the obligations of the Borrower now or hereafter existing under this Agreement and the Note held by such Lender, irrespective of whether or not such Lender shall have made any demand under this Agreement or such Note and although such obligations may be unmatured. Each Lender agrees to notify promptly the Borrower after any such set-off and application made by such Lender, provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of each Lender under this Section 10.05 are in addition to other rights and remedies (including, without limitation, other rights of set-off) which such Lender may have. (b)The Borrower agrees that it shall have no right of off-set, deduction or counterclaim in respect of its obligations hereunder, and that the obligations of the Lenders hereunder are several and not joint. Nothing contained herein shall constitute a relinquishment or waiver of the Borrower's rights to any independent claim that the Borrower may have against any Agent or any Lender for such Agent's or such Lender's, as the case may be, gross negligence or wilful misconduct, but no Lender shall be liable for any such conduct on the part of any Agent or any other Lender, and no Agent shall be liable for any such conduct on the part of any Lender. SECTION 10.06. Binding Effect. This Agreement shall become effective when it shall have been executed by the Borrower and the Agents and when the Documentation Agent shall have been notified by each Bank that such Bank has executed it and thereafter shall be binding upon and inure to the benefit of the Borrower, the Agents and each Lender and their respective successors and assigns, except that the Borrower shall not have the right to assign its rights hereunder or any interest herein without the prior written consent of the Lenders. SECTION 10.07. Assignments and Participation. (a) Each Lender may, with the consent of the Borrower (such consent not to be unreasonably withheld or delayed), assign to one or more banks or other entities all or a portion of its rights and obligations under this Agreement and the other Loan Documents (including, without limitation, all or a portion of its Commitment, the Advances owing to it and the Note or Notes held by it); provided, however, that (i) each such assignment shall be of a constant, and not a varying, percentage of all of the assigning Lender's rights and obligations under this Agreement, (ii) the amount of the Commitment of the assigning Lender being assigned pursuant to each such assignment (determined as of the date of the Lender Assignment with respect to such assignment) shall in no event be less than the lesser of the amount of such Lender's Commitment and $10,000,000 and shall be an integral multiple of $5,000,000, (iii) each such assignment shall be to an Eligible Assignee, and (iv) the parties to each such assignment shall execute and deliver to the Documentation Agent (with a copy to the Operational Agent), for its acceptance and recording in the Register, a Lender Assignment, together with any Note or Notes subject to such assignment and a processing and recordation fee of $2,500; and provided further, however, that the consent of the Borrower shall not be required for any assignments by a Lender to any of its Affiliates or to any other Lender or any of its Affiliates. Upon such execution, delivery, acceptance and recording, from and after the effective date specified in each Lender Assignment, which effective date shall be at least five Business Days after the execution thereof, (A) the assignee thereunder shall be a party hereto and, to the extent that rights and obligations hereunder have been assigned to it pursuant to such Lender Assignment, have the rights and obligations of a Lender hereunder and (B) the Lender assignor thereunder shall, to the extent that rights and obligations hereunder have been assigned by it to an Eligible Assignee pursuant to such Lender Assignment, relinquish its rights and be released from its obligations under this Agreement (and, in the case of a Lender Assignment covering all or the remaining portion of an assigning Lender's rights and obligations under this Agreement, such Lender shall cease to be a party hereto); provided, however, that the limitation set forth in clause (iii), above, shall not apply if an Event of Default shall have occurred and be continuing and the Co-Agents shall have declared all Advances to be immediately due and payable hereunder. The Documentation Agent agrees to give prompt notice to the Lenders and the Borrower of any assignment or participation of its rights and obligations as a Bank hereunder. Notwithstanding anything to the contrary contained in this Agreement, any Lender may at any time assign all or any portion of the Advances owing to it to any Affiliate of such Lender. The assigning Lender shall promptly notify the Borrower of any such assignment. No such assignment, other than to an Eligible Assignee, shall release the assigning Lender from its obligations hereunder. (b)By executing and delivering a Lender Assignment, the Lender assignor thereunder and the assignee thereunder confirm to and agree with each other and the other parties hereto as follows: (i) other than as provided in such Lender Assignment, such assigning Lender makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with any Loan Document or the execution, legality, validity, enforceability, genuineness, sufficiency or value of any Loan Document or any other instrument or document furnished pursuant thereto; (ii) such assigning Lender makes no representation or warranty and assumes no responsibility with respect to the financial condition of the Borrower or the performance or observance by the Borrower of any of its obligations under any Loan Document or any other instrument or document furnished pursuant thereto; (iii) such assignee confirms that it has received a copy of each Loan Document, together with copies of the financial statements referred to in Section 6.01(e) and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into such Lender Assignment; (iv) such assignee will, independently and without reliance upon the Agents, such assigning Lender or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Loan Documents; (v) such assignee confirms that it is an Eligible Assignee (unless an Event of Default shall have occurred and be continuing and the Co-Agents shall have declared all Advances to be immediately due and payable hereunder, in which case no such confirmation is necessary); (vi) such assignee appoints and authorizes each Agent to take such action as agent on its behalf and to exercise such powers under the Loan Documents as are delegated to each Agent by the terms thereof, together with such powers as are reasonably incidental thereto; and (vii) such assignee agrees that it will perform in accordance with their terms all of the obligations which by the terms of the Loan Documents are required to be performed by it as a Lender. (c)The Documentation Agent shall maintain at its address referred to in Section 10.02 a copy of each Lender Assignment delivered to and accepted by it and a register for the recordation of the names and addresses of the Lenders and the Commitment of, and principal amount of the Advances owing to, each Lender from time to time (the "Register"). The entries in the Register shall be conclusive and binding for all purposes, absent manifest error, and the Borrower, the Agents and the Lenders may treat each Person whose name is recorded in the Register as a Lender hereunder for all purposes of this Agreement. The Register shall be available for inspection by the Borrower or any Lender at any reasonable time and from time to time upon reasonable prior notice. (d)Upon its receipt of a Lender Assignment executed by an assigning Lender and an assignee representing that it is an Eligible Assignee, together with any Note or Notes subject to such assignment, the Documentation Agent shall, if such Lender Assignment has been completed and is in substantially the form of Exhibit G, (i) accept such Lender Assignment, (ii) record the information contained therein in the Register and (iii) give prompt notice thereof to the Borrower. Within five Business Days after its receipt of such notice, the Borrower, at its own expense, shall execute and deliver to the Documentation Agent in exchange for the surrendered Note or Notes a new Note to the order of such Eligible Assignee in an amount equal to the Commitment assumed by it pursuant to such Lender Assignment and, if the assigning Lender has retained a Commitment hereunder, a new Note to the order of the assigning Lender in an amount equal to the Commitment retained by it hereunder. Such new Note or Notes shall be in an aggregate principal amount equal to the aggregate principal amount of such surrendered Note or Notes, shall be dated the effective date of such Lender Assignment and shall otherwise be in substantially the form of Exhibit A. (e)Each Lender may sell participations to one or more banks or other entities in or to all or a portion of its rights and obligations under the Loan Documents (including, without limitation, all or a portion of its Commitment, the Advances owing to it and the Note or Notes held by it); provided, however, that (i) such Lender's obligations under this Agreement (including, without limitation, its Commitment to the Borrower hereunder) shall remain unchanged, (ii) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, (iii) such Lender shall remain the holder of any such Note for all purposes of this Agreement, and (iv) the Borrower, the Agents and the other Lenders shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under this Agreement. (f)Any Lender may, in connection with any assignment or participation or proposed assignment or participation pursuant to this Section 10.07, disclose to the assignee or participant or proposed assignee or participant, any information relating to the Borrower furnished to such Lender by or on behalf of the Borrower; provided that, prior to any such disclosure, the assignee or participant or proposed assignee or participant shall agree, in accordance with the terms of Section 10.08, to preserve the confidentiality of any Confidential Information received by it from such Lender. (g)If any Lender (or any bank or other entity to which such Lender has sold a participation) shall make any demand for payment under Section 4.04(a) or (d), then within 30 days after any such demand (if, but only if, such demanded payment has been made by the Borrower) or notice, the Borrower may, with the approval of the Agents (which approval shall not be unreasonably withheld) and provided that no Event of Default or Unmatured Default shall then have occurred and be continuing, demand that such Lender assign in accordance with this Section 10.07 to one or more Eligible Assignees designated by the Borrower all (but not less than all) of such Lender's Commitment and the Advances owing to it within the period ending on the later to occur of (x) 30 days after any such demand or notice by such Lender under Section 4.04(a) or (d) as applicable, and (y) the last day of the longest of the then current Interest Periods for such Advances. If any such Eligible Assignee designated by the Borrower shall fail to consummate such assignment on terms acceptable to such Lender, or if the Borrower shall fail to designate any such Eligible Assignees for all or part of such Lender's Commitment or Advances, then such demand by the Borrower shall become ineffective; it being understood for purposes of this subsection (g) that such assignment shall be conclusively deemed to be on terms acceptable to such Lender, and such Lender shall be compelled to consummate such assignment to an Eligible Assignee designated by the Borrower, if such Eligible Assignee (1) shall agree to such assignment by entering into a Lender Assignment with such Lender and (2) shall offer compensation to such Lender in an amount equal to all amounts then owing by the Borrower to such Lender hereunder and under the Note made by the Borrower to such Lender, whether for principal, interest, fees, costs or expenses (other than any amount demanded for payment pursuant to clause 4.04(a) or (d), and payable by the Borrower as a condition to the Borrower's right to demand such assignment) or otherwise. In addition, in the case of any amount demanded for payment by any Lender (or such a participant) pursuant to Section 4.04(a) or (d), the Borrower may, in the case of any such Lender, with the approval of the Agents (which approval shall not be unreasonably withheld) and provided that no Event of Default or Unmatured Default shall then have occurred and be continuing, terminate all (but not less than all) such Lender's Commitment and prepay all (but not less than all) such Lender's Advances not so assigned, together with all interest accrued thereon to the date of such prepayment and all fees, costs and expenses and other amounts then owing by the Borrower to such Lender hereunder and under the Note made by the Borrower to such Lender, at any time from and after such later occurring day in accordance with Sections 2.03 and 4.03(a) hereof (but without the requirement stated therein for ratable treatment of the other Lenders), if and only if, after giving effect to such termination and prepayment, the sum of the aggregate principal amount of the Advances of all Lenders then outstanding does not exceed the then remaining Commitments of the Lenders. Notwithstanding anything set forth above in this subsection (g) to the contrary, the Borrower shall not be entitled to compel the assignment by any Lender demanding payment under Section 4.04(a) of its Commitment and Advances or terminate and prepay the Commitment and Advances of such Lender if, prior to or promptly following any such demand by the Borrower, such Lender shall have changed or shall change, as the case may be, its Applicable Lending Office for its Eurodollar Rate Advances so as to eliminate the further incurrence of such increased cost. In furtherance of the foregoing, any such Lender demanding payment or giving notice as provided above agrees to use reasonable efforts to so change its Applicable Lending Office if, to do so, would not result in the incurrence by such Lender of additional costs or expenses which it deems material or, in the sole judgment of such Lender, be inadvisable for regulatory, competitive or internal management reasons. (h)Anything in this Section 10.07 to the contrary notwithstanding, any Lender may assign and pledge all or any portion of its Commitment and the Advances owing to it to any Federal Reserve Bank (and its transferees) as collateral security pursuant to Regulation A of the Board of Governors of the Federal Reserve System and any Operating Circular issued by such Federal Reserve Bank. No such assignment shall release the assigning Lender from its obligations hereunder. SECTION 10.08. Confidentiality. In connection with the negotiation and administration of this Agreement and the other Loan Documents, the Borrower has furnished and will from time to time furnish to the Agents and the Lenders (each, a "Recipient") written information which is identified to the Recipient when delivered as confidential (such information, other than any such information which (i) was publicly available, or otherwise known to the Recipient, at the time of disclosure, (ii) subsequently becomes publicly available other than through any act or omission by the Recipient or (iii) otherwise subsequently becomes known to the Recipient other than through a Person whom the Recipient knows to be acting in violation of his or its obligations to the Borrower, being hereinafter referred to as "Confidential Information"). The Recipient will not knowingly disclose any such Confidential Information to any third party (other than to those persons who have a confidential relationship with the Recipient), and will take all reasonable steps to restrict access to such information in a manner designed to maintain the confidential nature of such information, in each case until such time as the same ceases to be Confidential Information or as the Borrower may otherwise instruct. It is understood, however, that the foregoing will not restrict the Recipient's ability to freely exchange such Confidential Information with prospective participants in or assignees of the Recipient's position herein, but the Recipient's ability to so exchange Confidential Information shall be conditioned upon any such prospective participant's entering into an agreement as to confidentiality similar to this Section 10.08. It is further understood that the foregoing will not prohibit the disclosure of any or all Confidential Information if and to the extent that such disclosure may be required (i) by a regulatory agency or otherwise in connection with an examination of the Recipient's records by appropriate authorities, (ii) pursuant to court order, subpoena or other legal process or (iii) otherwise, as required by law; in the event of any required disclosure under clause (ii) or (iii), above, the Recipient agrees to use reasonable efforts to inform the Borrower as promptly as practicable to the extent not prohibited by law. SECTION 10.09. Waiver of Jury Trial. THE BORROWER, THE AGENTS, THE CO-MANAGER AND THE LENDERS EACH HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT, OR ANY OTHER INSTRUMENT OR DOCUMENT DELIVERED HEREUNDER OR THEREUNDER. SECTION 10.10. Governing Law. This Agreement and the Notes shall be governed by, and construed in accordance with, the laws of the State of New York. The Borrower, the Lenders, the Co-Manager and the Agents each (i) irrevocably submits to the jurisdiction of any New York State court or Federal court sitting in New York City in any action arising out of any Loan Document, (ii) agrees that all claims in such action may be decided in such court, (iii) waives, to the fullest extent it may effectively do so, the defense of an inconvenient forum and (iv) consents to the service of process by mail. A final judgment in any such action shall be conclusive and may be enforced in other jurisdictions. Nothing herein shall affect the right of any party to serve legal process in any manner permitted by law or affect its right to bring any action in any other court. SECTION 10.11. Relation of the Parties; No Beneficiary. No term, provision or requirement, whether express or implied, of any Loan Document, or actions taken or to be taken by any party thereunder, shall be construed to create a partnership, association, or joint venture between such parties or any of them. No term or provision of the Loan Documents shall be construed to confer a benefit upon, or grant a right or privilege to, any Person other than the parties hereto. SECTION 10.12. Execution in Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same Agreement. SECTION 10.13. Survival of Agreement. All covenants, agreements, representations and warranties made herein and in the certificates pursuant hereto shall be considered to have been relied upon by the Agents and the Lenders and shall survive the making by the Lenders of the Advances and the execution and delivery to the Lenders of the Notes evidencing the Advances and shall continue in full force and effect so long as any Note or any amount due hereunder is outstanding and unpaid or any Commitment of any Lender has not been terminated. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written. as Co-Agent, Documentation Agent and Bank as Co-Agent, Operational Agent and Bank $10,000,000 BANK OF AMERICA ILLINOIS $10,000,000 THE FIRST NATIONAL BANK OF BOSTON, as Co-Manager and Bank $10,000,000 THE FIRST NATIONAL BANK OF CHICAGO, as Co-Manager and Bank $10,000,000 THE CHASE MANHATTAN BANK, N.A., as Co-Manager and Bank $20,000,000 TORONTO DOMINION (TEXAS), INC. U.S.$ Dated: November __, 1995 FOR VALUE RECEIVED, the undersigned, CMS ENERGY CORPORATION, a Michigan corporation (the "Borrower"), HEREBY PROMISES TO PAY to the order of (the "Lender") for the account of its Applicable Lending Office (as defined in the Agreement referred to below) the principal sum of U.S.$[amount of the Lender's Commitment in figures] at such times and in such installments as are specified in the Agreement; provided, however, that the last such installment payable on the Termination Date (as defined in the Agreement) shall be in an amount necessary to repay in full the unpaid principal amount thereof. The Borrower promises to pay interest on the unpaid principal amount hereof from the date hereof until such principal amount is paid in full, at such interest rates, and payable at such times, as are specified in the Agreement. Both principal and interest are payable in lawful money of the United States of America to Union Bank, as Operational Agent, at its offices at 445 South Figueroa Street, 15th Floor, Los Angeles, California 90071, in same day funds. All payments made on account of the principal amount thereof, shall be recorded by the Lender and, prior to any transfer hereof, endorsed on the grid attached hereto which is part of this Promissory Note, provided that the failure to so record any payment on account thereof shall not affect the payment obligations of the Borrower hereunder or under the Agreement. This Promissory Note is one of the Notes referred to in, and is entitled to the benefits of, the Term Loan Agreement, dated as of November 21, 1995 (as amended, modified or supplemented from time to time, the "Agreement", the terms defined therein and not otherwise defined herein being used herein as therein defined), among the Borrower, the Lender and certain other Lenders parties thereto, the Co-Agents, the Documentation Agent and the Operational Agent, and the Loan Documents referred to therein and entered into pursuant thereto. The Agreement, among other things, contains provisions for acceleration of the maturity hereof upon the happening of certain stated events and also for prepayments on account of principal hereof prior to the maturity hereof upon the terms and conditions therein specified. Amount of Principal PrincipalNotation Made Date Paid or Prepaid Balance By FORM OF NOTICE OF BORROWING Agent for the Lenders parties The undersigned, CMS Energy Corporation, refers to the Term Loan Agreement, dated as of November 21, 1995 (as amended, modified or supplemented from time to time, the "Agreement", the terms defined therein and not otherwise defined herein being used herein as therein defined), among the Borrower, the Lenders named therein, the Co-Agents, the Documentation Agent and the Operational Agent, and hereby gives you notice, irrevocably, pursuant to Section 3.01 of the Agreement that the undersigned hereby requests a Borrowing under the Agreement, and in that connection sets forth below the information relating to such Borrowing (the "Proposed Borrowing") as required by Section 3.01(a) of the Agreement: (i) The Business Day of the Proposed Borrowing is , 19 . (ii) The Type of Advances comprising the Proposed Borrowing is [Base Rate Advances] [Eurodollar Rate Advances]. (iii) The aggregate amount of the Proposed Borrowing is $ . 1[(iv) The initial Interest Period for each Advance made as part of the Proposed Borrowing is ____ months.] The undersigned hereby acknowledges that the delivery of this Notice of Borrowing shall constitute a representation and warranty by the Borrower that, on the date of the Proposed Borrowing, the statements contained in Section 5.01(c) of the Agreement are true. 1 To be included for a Proposed Borrowing comprised of Eurodollar Rate Advances. FORM OF NOTICE OF CONVERSION Agent for the Lenders parties The undersigned, CMS Energy Corporation, refers to the Term Loan Agreement, dated as of November 21, 1995 (as amended, modified or supplemented from time to time, the "Agreement", the terms defined therein and not otherwise defined herein being used herein as therein defined), among the Borrower, the Lenders named therein, the Co-Agents, the Documentation Agent and the Operational Agent, and hereby gives you notice, irrevocably, pursuant to Section 3.02 of the Agreement that the undersigned hereby requests a Conversion under the Agreement, and in that connection sets forth below the information relating to such Conversion (the "Proposed Conversion") as required by Section 3.02 of the Agreement: (i) The Business Day of the Proposed Conversion is . (ii)The Type of Advances comprising the Proposed Conversion is [Base Rate Advances] [Eurodollar Rate Advances]. (iii)The aggregate amount of the Proposed Conversion is $ . (iv)The Type of Advances to which such Advances are proposed to be Converted is [Base Rate Advances] [Eurodollar Rate Advances]. (v) The Interest Period for each Advance made as part of the Proposed Conversion is ____ month(s).1 The undersigned hereby certifies that the Borrower's request for the Proposed Conversion is made in compliance with Sections 3.02, 3.03 and 3.04 of the Agreement. The undersigned hereby acknowledges that the delivery of this Notice of Conversion shall constitute a representation and warranty by the Borrower that, on the date of the Proposed Conversion, [(i)] the statements contained in Section 5.02(a) of the Agreement are true and [(ii) no Unmatured Default [(other than an Unmatured Default resulting from the failure of the Borrower to comply with the ratio set forth in Section 7.01(j) of the Agreement)] 2 has occurred and is continuing]3. 1 Delete for Base Rate Advances. 2 Include only if an Unmatured Default has occurred and is continuing as the result of the failure of the Borrower to comply with the ratio set forth in Section 7.01(j) of the Agreement. In such case, a Conversion into Eurodollar Rate Advances with an Interest Period not to exceed three months in duration is permitted pursuant to Section 3.04(a)(vi) of the Agreement. 3 Delete if Conversion is into Base Rate Advances. OF COUNSEL FOR THE BORROWER To each of the Lenders parties to the Term Loan Agreement referred to below, and to Citibank, N.A. and Union Bank, as Agents under the Term This letter is furnished to you pursuant to Section 5.01(a)(viii)(A) of the Term Loan Agreement, dated as of November __, 1995 (the "Agreement"), among CMS Energy Corporation (the "Borrower"), the Banks parties thereto and the other Lenders from time to time parties thereto, Citibank, N.A. and Union Bank, as Co-Agents, Citibank, N.A., as Documentation Agent, and Union Bank, as Operational Agent. Capitalized terms not defined herein have the meanings ascribed thereto in the Agreement and the other Loan Documents (as defined in the Agreement). I am Assistant General Counsel of the Borrower and I, or an attorney or attorneys under my general supervision, have represented the Borrower in connection with the preparation, execution and delivery of, and the Drawdown made under, the Agreement and other Loan Documents. In that capacity, I, or an attorney or attorneys under my general supervision, have examined: (c) The Articles of Incorporation of the Borrower and all amendments thereto (the "Charter"); and (d) The by-laws of the Borrower and all amendments thereto (the "By-laws"). In addition, I, or an attorney or attorneys under my general supervision, have examined the originals, or copies certified to my satisfaction, of such other corporate records of the Borrower, certificates of public officials and of officers of the Borrower, and agreements, instruments and other documents, as I have deemed necessary as a basis for the opinions expressed below. As to various questions of fact material to such opinions, I have, when relevant facts were not independently established by me, relied upon the representations of officers of the Borrower in the Loan Documents, and upon certificates of the Borrower or their respective officers or of public officials. I have assumed (i) the due execution and delivery, pursuant to due authorization, of each document referred to in clauses (a) through (b) above by all parties to such document (other than the Borrower), (ii) the authenticity of all such documents submitted to us as originals, (iii) the genuineness of all signatures (other than those of the Borrower), and (iv) the conformity to the originals of all such documents submitted to us as copies. Based upon the foregoing and upon such investigation as we have deemed necessary, I am of the following opinion: 1. The Borrower is a corporation duly organized, validly existing and in good standing under the laws of the State of Michigan. 2. The execution, delivery and performance by the Borrower of the Agreement, the Notes and the other Loan Documents to which it is, or is to be, a party, are within the corporate power and authority of the Borrower, have been duly authorized by all necessary corporate action, and do not contravene (a) the Charter or the By-laws, (b) any provision of applicable law or (c) any legal or contractual restriction binding on the Borrower or its properties; and such execution, delivery and performance do not result in or require the creation or imposition of any mortgage, deed of trust, pledge, or Lien upon or with respect to any of its properties. The Agreement and the Notes have been duly executed and delivered on behalf of the Borrower. 3. Except as disclosed in the Borrower's Quarterly Report on Form 10-Q for the period ended September 30, 1995, there are no pending or threatened actions or proceedings against the Borrower or its properties before any court, governmental agency or arbitrator, that could, if adversely determined, reasonably be expected to materially adversely affect the financial condition, properties, business or operations of the Borrower, the legality, validity or enforceability of the Agreement or any other Loan Document to which the Borrower is, or is to be, a party. 4. No authorization or approval or other action by, and no notice to or filing with, any Michigan governmental authority or regulatory body (including, without limitation, the Michigan Public Service Commission) is required for the valid execution, delivery and performance by the Borrower of the Agreement and the other Loan Documents to which it is, or is to be, a party. 5. In any action or proceeding arising out of or relating to the Agreement, the Notes or any other Loan Document to which the Borrower is, or is to be, a party in any Michigan state court or any Federal court sitting in the State of Michigan, such court would recognize and give effect to the provisions of the Agreement, the Notes or any other Loan Document, as the case may be, wherein the parties thereto agree that the Agreement, the Notes or such other Loan Document, as the case may be, shall be governed by, and construed in accordance with, the laws of the State of New York, except in the case of those provisions set forth in the Agreement, the Notes and the other Loan Documents the enforcement of which would contravene a fundamental policy of the State of Michigan. In the course of our review of the Agreement, the Notes and the other Loan Documents, nothing has come to my attention to indicate that any of such provisions would do so. The opinions expressed herein are limited to the laws of the State of Michigan and the Federal laws of the United States of America. I consent to the reliance on this opinion by King & Spalding in their opinion to you of even date herewith delivered pursuant to Section 5.01(a)(viii)(B) of the Agreement. Except as otherwise specified herein, this opinion is being delivered solely for the benefit of the parties to whom it is addressed. Accordingly, it may not be quoted, filed with any governmental authority or otherwise circulated or utilized for any other purpose without my prior written consent. FORM OF OPINION OF COUNSEL TO THE AGENTS To the Banks and other Lenders parties to the Agreement herein referred to and to Citibank, N.A. and Union Bank, as Agents We have acted as special New York counsel to Citibank, N.A. and Union Bank, individually and as Agents, in connection with the execution and delivery of, and the making of the Drawdown on this date under, the Term Loan Agreement, dated as of November 21, 1995 (the "Agreement"), among CMS Energy Corporation, the Banks parties thereto and the other Lenders from time to time parties thereto, and Citibank, N.A. and Union Bank, as Co-Agents. Terms defined in the Agreement are used herein as therein defined. In this connection, we have examined the following documents: 1. counterparts of the Agreement, executed by the parties 2. the Notes to the order of each Bank; and 3. the other documents furnished to the Agents pursuant to Section 5.01(a) of the Agreement, including (without limitation) the opinion (the "Opinion") of Denise M. Sturdy, Esq., Assistant General Counsel of the Borrower. In our examination of the documents referred to above, we have assumed the authenticity of all such documents submitted to us as originals, the genuineness of all signatures, the due authority of the parties executing such documents and the conformity to the originals of all such documents submitted to us as copies. We have further assumed that you have evaluated, and are satisfied with, the creditworthiness of the Borrower and the business and financial terms evidenced by the Loan Documents. We have relied, as to factual matters, on the documents we have examined. To the extent that our opinions expressed below involve conclusions as to matters governed by law other than the law of the State of New York, we have relied upon the Opinion and have assumed without independent investigation the correctness of the matters set forth therein, our opinions expressed below being subject to the assumptions, qualifications and limitations set forth in the Opinion. Based upon and subject to the foregoing, and subject to the qualifications set forth below, we are of the opinion that the Agreement and the other Loan Documents are, and upon delivery for value received, the Notes will be, the legal, valid and binding obligations of the Borrower, enforceable against the Borrower in accordance with their respective terms. Our opinion is subject to the following qualifications: (a) The enforceability of the Borrower's obligations under the Agreement, the Notes and the other Loan Documents is subject to the effect of any applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium or similar law affecting creditors' rights generally. (b) The enforceability of the Borrower's obligations under the Agreement, the Notes and the other Loan Documents is subject to the effect of general principles of equity, including (without limitation) concepts of materiality, reasonableness, good faith and fair dealing (regardless of whether considered in a proceeding in equity or at law). Such principles of equity are of general application, and, in applying such principles, a court, among other things, might not allow a contracting party to exercise remedies in respect of a default deemed immaterial, or might decline to order an obligor to perform covenants. (c) We note further that, in addition to the application of equitable principles described above, courts have imposed an obligation on contracting parties to act reasonably and in good faith in the exercise of their contractual rights and remedies, and may also apply public policy considerations in limiting the right of parties seeking to obtain indemnification under circumstances involving securities laws or where the conduct of such parties is determined to have constituted negligence. (d) We express no opinion herein as to (i) Section 9.05 of the Credit Agreement, (ii) the enforceability of provisions purporting to grant to a party conclusive rights of determination, (iii) the availability of specific performance or other equitable remedies, (iv) the enforceability of rights to indemnity under federal or state securities laws or (v) the enforceability of waivers by parties of their respective rights and remedies under law. (e) Our opinions expressed above are limited to the law of the State of New York, and we do not express any opinion herein concerning any other law. The foregoing opinion is solely for your benefit and may not be relied upon by any other person or entity, other than any Person that may become a Lender under the Credit Agreement after the date hereof. IN DETERMINING COMPLIANCE WITH COVENANTS CONTAINED IN SECTIONS 7.01(i) AND 7.01(j) (Capitalized terms used herein and not otherwise defined shall have the meanings ascribed thereto in the Term Loan Agreement dated as of November 21, 1995, among CMS Energy Corporation, the banks named therein, and Citibank, N.A. and Union Bank, as Co-Agents) I. SECTION 7.01(i) (Consolidated Leverage Ratio) (a) Debt of the Borrower (See worksheet set forth on Schedule I hereto)$ (b)1 Aggregate debt (as such term is construed in accordance with GAAP) (a) Total Consolidated Debt (See (i) above)$ (b)2 Consolidated equity of the common stockholders of the Borrower and the (c)2 Consolidated equity of the preference stockholders of the Borrower and the (d)2 Consolidated equity of the preferred stockholders of the Borrower and the Maximum Ratio - Section 7.01(i) ------ II. SECTION 7.01(j) (Cash Dividend Coverage Ratio) (a) Cash Dividend Income $ (b) 25% of Equity Distributions 1 To the extent included, Project Finance Debt of any Consolidated Subsidiary shall be included only to the extent of the Borrower's Ownership Interest in such Consolidated Subsidiary. 2 To the extent included in (b), (c) or (d) above, Project Finance Equity of the Borrower and the Consolidated Subsidiaries in any Consolidated Subsidiary should be included only to the extent of the Borrower's Ownership Interest in each such Consolidated Subsidiary. (c) All amounts received by the and letter of credit fees) paid by the Borrower on behalf of any (ii) Interest expense (including commitment, guaranty and letter of credit fees) accrued by the Borrower in respect of all Debt$ Maximum Ratio - Section 7.01(j) ------ III. SECTION Project Finance Debt3 3 Set forth all Project Finance Debt of any Consolidated Subsidiary and the Borrower's Ownership Interest in such Consolidated Subsidiary. 4 Set forth all Support Obligations of the Borrower of the types described in clauses (iv) and (v) of the definition of Support Obligations (whether or not each such Support Obligation or the primary obligation so supported is fixed, conclusively determined or reasonably quantifiable) unless such Support Obligation is previously disclosed as "Consolidated Debt" pursuant to Section I or II above. Computation of Aggregate Debt of the Borrower Aggregate Debt of the Borrower1 (without duplication) any and all indebtedness, liabilities and other monetary obligations of the Borrower (whether for principal, interest, fees, costs, expenses or otherwise, and contingent or otherwise): (i) for borrowed money or evidenced by bonds, debentures, notes or other (ii) to pay the deferred purchase price of property or services (except trade accounts payable arising in the ordinary course of business which (iii)as lessee under leases which shall have been or should be, in accordance with GAAP, recorded as capital leases$ (iv) under reimbursement or similar agreements with respect to letters of (v) under any interest rate swap, "cap", "collar" or other hedging agreements; provided, however, for purposes of the calculation of Debt for this clause only, the actual amount of Debt of the Borrower shall be determined on a net basis to the extent such agreements permit such amounts to be calculated on (vi) to pay rent or other amounts under leases entered into in connection with sale and leaseback transactions involving assets of the Borrower being sold in connection (vii)arising from any accumulated funding deficiency (as defined in Section 412(a) of the Internal Revenue Code of 1986, as amended) for a Plan $ (viii)direct or indirect guaranties in respect of, and obligations to purchase or otherwise acquire, or otherwise to warrant or hold harmless, pursuant to a legally binding agreement, a creditor against loss in respect of, Debt of others referred to in clauses (i) through (vii) above $ 1 Debt of the Borrower shall (a) include only 50% of the aggregate principal amount of Subordinated Debt and Preferred Securities described in clause (b) of the definition of Preferred Securities, subject to a maximum exclusion of $100,000,000 in the aggregate, and (b) not include Subordinated Debt or Preferred Securities if such Subordinated Debt or Preferred Securities, as the case may be, is mandatorily convertible into common stock of the Borrower upon terms and conditions satisfactory to the Majority Lenders. (ix) other guaranty or similar financial obligations in respect of the performance of others, including, without limitation, any financial obligation, contingent or otherwise, of the Borrower guaranteeing or otherwise supporting any Debt or other obligation of any other Person in any manner, whether directly or indirectly, and including, without limitation, any obligation of such Person, direct or indirect$ (A) to purchase or pay (or advance or supply funds for the purchase or payment of) such Debt or to purchase (or to advance or supply funds for the purchase of) any security for the payment of such (B) to purchase property, securities or services for the purpose of assuring the owner of such Debt of the payment of such Debt $ (C) to maintain working capital, equity capital, available cash or other financial statement condition of the primary obligor so as to enable the primary obligor to pay such Debt$ (D)2 to provide equity capital under or in respect of equity subscription arrangements (to the extent that such obligation to provide equity capital does not otherwise constitute (E)2 to perform, or arrange for the payment obligations of the primary Total of Debt of the Borrower$ 2 For purposes of this clause do not include Support Obligations if such Support Obligation or the primary obligation so supported is not fixed or conclusively determined or is not otherwise reasonably quantifiable as of the date of determination. Reference is made to the Term Loan Agreement, dated as of November 21, 1995 (said Agreement, as it may hereafter be amended or otherwise modified from time to time, being the "Agreement", the terms defined therein and not otherwise defined herein being used herein as therein defined), among the Borrower, the Lenders, the Co-Agents, the Documentation Agent and the Operational Agent. Pursuant to the Agreement, (the "Assignor") has committed to make advances ("Advances") to the Borrower, which Advances are evidenced by a promissory note (the "Note") issued by the Borrower to the Assignor. (the "Assignee") agree as follows: 1. The Assignor hereby sells and assigns to the Assignee, and the Assignee hereby purchases and assumes from the Assignor, that interest in and to all of the Assignor's rights and obligations under the Agreement as of the date hereof which represents the percentage interest specified on Schedule 1 of all outstanding rights and obligations under the Agreement (the "Assigned Interest"), including, without limitation, such interest in the Assignor's Commitment, the Advances owing to the Assignor and the Note held by the Assignor. After giving effect to such sale and assignment, the Assignee's Commitment and the amount of the Advances owing to the Assignee will be as set forth in Section 2 of Schedule 1. The effective date of this sale and assignment shall be the date specified in Section 3 of Schedule 1 hereto (the "Effective Date"). 2. On , 19 , the Assignee will pay to the Assignor, in same day funds, at such address and account as the Assignor shall advise the Assignee, $ , and the sale and assignment contemplated hereby shall thereupon become effective as of the Effective Date. From and after the Effective Date, the Assignor agrees that the Assignee shall be entitled to all rights, powers and privileges of the Assignor under the Agreement and the Note to the extent of the Assigned Interest, including without limitation (i) the right to receive all payments in respect of the Assigned Interest for the period from and after the Effective Date, whether on account of principal, interest, fees, indemnities in respect of claims arising after the Effective Date, increased costs, additional amounts or otherwise, (ii) the right to vote and to instruct the Agents under the Agreement according to its Percentage based on the Assigned Interest, (iii) the right to set-off and to appropriate and apply deposits of the Borrower as set forth in the Agreement and (iv) the right to receive notices, requests, demands and other communications. The Assignor agrees that it will promptly remit to the Assignee any amount received by it in respect of the Assigned Interest (whether from the Borrower, any Agent or otherwise) in the same funds in which such amount is received by the Assignor. 3. The Assignor (v) represents and warrants that it is the legal and beneficial owner of the interest being assigned by it hereunder and that such interest is free and clear of any adverse claim; (vi) makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with the Agreement or the execution, legality, validity, enforceability, genuineness, sufficiency or value of the Agreement or any other instrument or document furnished pursuant thereto; and (vii) makes no representation or warranty and assumes no responsibility with respect to the financial condition of the Borrower or the performance or observance by the Borrower of any of its obligations under the Agreement or any other instrument or document furnished pursuant thereto. Except as specified in this Section 3, the assignment of the Assigned Interest contemplated hereby shall be without recourse to the Assignor. 4. The Assignee (viii) confirms that it has received a copy of the Agreement, together with copies of the financial statements referred to in Section 6.01(e)(i) thereof and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into this Assignment and purchase the Assigned Interest, (ix) agrees that it will, independently and without reliance upon the Assignor and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Agreement, (x) confirms that it satisfies the requirements of an Eligible Assignee, (xi) appoints and authorizes each Agent to take such action as agent on its behalf and to exercise such powers under the Loan Documents as are delegated to each Agent by the terms thereof, together with such powers as are reasonably incidental thereto and (xii) agrees that it will perform in accordance with their terms all of the obligations which by the terms of the Loan Documents are required to be performed by it as a Lender. 5. This Assignment may be executed in any number of counterparts and by different parties in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute but one and the same instrument. 6. This Assignment shall be governed by, and construed in accordance with, the laws of the State of New York. IN WITNESS WHEREOF, the parties hereto have caused this Assignment to be executed by their respective officers thereunto duly authorized, as of the date first above written, such execution being made on Schedule 1 hereto. Advances owing to the Assignee: $ 1 Consent of the Borrower is required for all assignments EXCEPT for any assignment by a Lender to any of its Affiliates or to any other Lender or any of its Affiliates. Term Loan Agreement, dated as of November 21, 1995 among CMS Energy Corporation, the Banks named therein, Citibank, N.A. and Union Bank, as Co-Agents Name of Bank Domestic Lending Office Eurodollar Lending Office Citibank, N.A. 399 Park Avenue, - same - New York, New York 10043 Union Bank 445 South Figueroa Street - same - Bank of America 200 West Jackson Boulevard - same - BZW Division of 222 Broadway, 11th Floor - same - Barclays Bank New York, New York 10038 The First National 100 Federal Street - same - Bank of Boston Mail Stop 01-08-02 The First National One First National Bank Plaza - same - Bank of Chicago Suite 0363 Attention:Mr. Michael K. The Chase 1 Chase Manhattan Plaza, - same - Bank, N.A. New York, New York 10081 Toronto Dominion Houston Agency - same - Comerica Bank One Detroit Center - same - Bank of Montreal 115 South LaSalle Street, - same - Michigan National 124 West Allegan Street - same - TO THE TERM LOAN AGREEMENT As of November 21, 1995 Jackson Pipeline Company Partnership Debt $ 5,378,948 Centrales Termica's Mendoza Debt $23,048,968 Debt (according to GAAP) of Enterprises -0-	POS AM	EX-4	1996-01-12T00:00:00	1996-01-12T15:11:58
0000950109-96-000200	0000950109-96-000200_0017.txt	Establishment and Designation of Series of Beneficial Interest, $.01 Par Value The undersigned, being a majority of the duly elected and qualified Trustees of Weiss Treasury Fund, a Massachusetts business trust (the "Trust") acting pursuant to Section 5.11 of the Trust's Declaration of Trust dated August 10, 1995 (the "Declaration of Trust"), hereby divide the shares of beneficial interest of the Trust into three separate series (each individually a "Fund" or collectively the "Funds"), each Fund to have the following special and relative rights: 1. The Funds shall be designated as follows: Weiss Treasury Only Money Market Fund 2. Each Fund shall be authorized to hold cash and invest in securities and instruments and use investment techniques as described in the Trust's registration statement under the Securities Act of 1933, as amended from time to time. Each share of beneficial interest of each Fund ("share") shall be redeemable as provided in the Declaration of Trust, shall be entitled to one vote (or fraction thereof in respect of a fractional share) on matters on which shares of that Fund shall be entitled to vote and shall represent a pro rata beneficial interest in the assets allocated to that Fund. The proceeds of sales of shares of a Fund, together with any income and gain thereon, less any diminution or expenses thereof, shall irrevocably belong to that Fund, unless otherwise required by law. Each share of a Fund shall be entitled to receive its pro rata share of net assets of that Fund upon liquidation of that Fund. 3. Shareholders of each Fund shall vote separately as a class on any matter to the extent required by, and any matter shall be deemed to have been effectively acted upon with respect to that Fund as provided in Rule 18f-2, as from time to time in effect, under the Investment Company Act of 1940, as amended, or any successor rule. 4. The shares of beneficial interest of the Trust outstanding on the date hereof shall be deemed to be shares of Weiss Treasury Only Money Market Fund, Weiss Intermediate Treasury Fund and Weiss Treasury Bond Fund. 5. The assets and liabilities of the Trust existing on the date hereof shall, except as provided below, be allocated to Weiss Treasury Only Money Market Fund, Weiss Intermediate Treasury Fund and Weiss Treasury Bond Fund and, hereafter, the assets and liabilities of the Trust shall be allocated among the Funds as set forth in Section 5.11 of the Declaration of Trust, except as provided below. (a) Costs incurred in connection with the organization and registration of shares of Weiss Treasury Only Money Market Fund, Weiss Intermediate Treasury Fund and Weiss Treasury Bond Fund shall be amortized by such Funds over the five-year period beginning with the month the Funds commence operations. (b) The liabilities, expenses, costs, charges or reserves of the Trust which are not readily identifiable as belonging to any particular Fund shall be allocated among the Funds on the basis of their relative average daily net assets. (c) The Trustees may from time to time in particular cases make specific allocations of assets or liabilities among the Funds. 6. The Trustees (including any successor Trustees) shall have the right at any time and from time to time to reallocate assets and expenses or to change the designation of any Fund now or hereafter created, or to otherwise change the special and relative rights of any such Fund provided that such change shall not adversely affect the rights of shareholders of a Fund. The foregoing shall be effective upon the date the Trust's Registration Statement under the Securities Act of 1933 offering shares of the Funds as designated becomes effective.	N-1/A	EX-99.15	1996-01-12T00:00:00	1996-01-11T17:32:37
0000950144-96-000092	0000950144-96-000092_0000.txt	<DESCRIPTION>BASSETT FURNITURE INDUSTRIES, INC. 2/21/96 PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES EXCHANGE ACT OF 1934 (AMENDMENT NO. ) Filed by the Registrant /X/ Filed by a Party other than the Registrant / / (Name of Registrant as Specified In Its Charter) (Name of Person(s) Filing Proxy Statement, if other than the Registrant) Payment of Filing Fee (Check the appropriate box): /X/ $125 per Exchange Act Rules 0-11(c)(1)(ii), 14a-6(i)(1), or 14a-6(i)(2) or Item 22(a)(2) of Schedule 14A. / / $500 per each party to the controversy pursuant to Exchange Act Rule 14a-6(i)(3). / / Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11. (1) Title of each class of securities to which transaction applies: (2) Aggregate number of securities to which transaction applies: (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the filing fee is calculated and state how it was determined): (4) Proposed maximum aggregate value of transaction: / / Fee paid previously with preliminary materials. / / Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. (2) Form, Schedule or Registration Statement No.: NOTICE OF ANNUAL MEETING OF STOCKHOLDERS TO BE HELD FEBRUARY 21, 1996 NOTICE IS HEREBY GIVEN that the Annual Meeting of Stockholders of Bassett Furniture Industries, Incorporated (the Company) will be held at the Company's Main Office Building, Bassett, Virginia, on Wednesday, February 21, 1996, at 10:00 a.m., Local Time, for the purpose of considering and acting upon the following: 1. The election of eleven Directors. 2. A proposal to ratify the selection of KPMG Peat Marwick as independent public accountants for the fiscal year ending November 30, 1996. 3. Any and all other matters that may properly come before the meeting or any adjournment thereof. The Board of Directors has fixed the close of business on December 15, 1995 as the record date for determining the stockholders entitled to notice of and to vote at the meeting and any adjournment thereof, and only holders of Common Stock of the Company of record at such date will be entitled to notice of or to vote at the meeting. THE BOARD OF DIRECTORS WILL APPRECIATE THE PROMPT RETURN OF THE ENCLOSED PROXY, DATED AND SIGNED. THE PROXY MAY BE REVOKED BY YOU AT ANY TIME BEFORE IT IS EXERCISED AND WILL NOT BE EXERCISED IF YOU ATTEND THE MEETING AND VOTE IN PERSON. By Order of the Board of Directors Post Office Box 626, Bassett, Virginia 24055 This Proxy Statement is furnished in connection with the solicitation by the Board of Directors of proxies to be used at the Annual Meeting of Stockholders of Bassett Furniture Industries, Incorporated (the Company) to be held at its Main Office Building, Bassett, Virginia, at 10:00 a.m., Local Time, on Wednesday, February 21, 1996. This Proxy Statement and accompanying proxy are being sent to the stockholders of the Company on or about January 12, 1996. Solicitation other than by mail may be made personally and by telephone by regularly employed officers and employees of the Company who will not be additionally compensated therefor. The Company will request brokers, dealers, banks or voting trustees, or their nominees, who hold stock in their names for others or hold stock for others who have the right to give voting instructions, to forward proxy materials to their principals and request authority for the execution of the proxy and will reimburse such institutions for their reasonable expenses in so doing. The total cost of soliciting proxies will be borne by the Company. Any proxy delivered in the accompanying form may be revoked by the person executing the proxy at any time, before the authority thereby granted is exercised, by written request addressed to J. Stanley Payne, Vice President, Secretary and General Counsel, Bassett Furniture Industries, Incorporated, Post Office Box 626, Bassett, Virginia 24055 or by attending the meeting and electing to vote in person. Proxies received in such form will be voted as therein set forth at the meeting or any adjournment thereof. The only matters to be considered at the meeting, so far as known to the Board of Directors, are the matters set forth in the Notice of Annual Meeting of Stockholders, and routine matters incidental to the conduct of the meeting. However, if any other matters should come before the meeting or any adjournment thereof, it is the intention of the persons named in the accompanying form of proxy, or their substitutes, to vote said proxy in accordance with their judgment on such matters. Stockholders present or represented and entitled to vote on a matter at the meeting or any adjournment thereof will be entitled to one vote on such matter for each share of the Common Stock of the Company held by them of record at the close of business on December 15, 1995, which is the record date for determining the stockholders entitled to notice of and to vote at such meeting or any adjournment thereof. Voting on all matters, including the election of Directors, will be by voice vote or by show of hands. The number of shares of Common Stock of the Company outstanding on December 15, 1995 was 13,633,953. PRINCIPAL STOCKHOLDERS AND HOLDINGS OF MANAGEMENT At December 15, 1995, the only person known to the Company to be a beneficial owner of more than 5% of the $5.00 par value Common Stock of the Company (the Common Stock) was as follows: (1) In his capacity as Trustee, B. M. Brammer, Executive Vice President-Finance and Treasurer of the Company, has sole voting and dispositive power over these shares. The following table sets forth, as of December 15, 1995, information as to the beneficial ownership of the Common Stock by all Directors and executive officers of the Company as a group and by the named Executive Officers who are not also nominees as Directors. Information with respect to the beneficial ownership of the Common Stock by Robert H. Spilman, Glenn A. Hunsucker and the other nominees for Directors is contained in the table under "Election of Directors." (1) Based on the number of shares outstanding plus options held by directors and executive officers that are currently exercisable or that are exercisable within 60 days. (2) Includes 166,379 shares subject to options held by directors and executive officers that are currently exercisable or that are exercisable within 60 days. (3) Includes 977,847 shares of Common Stock held by the Company's Employee Savings/Retirement Plan, for which B. M. Brammer, Executive Vice President-Finance and Treasurer of the Company, has sole voting and dispositive power in his capacity as Trustee. Also includes 12,620 shares held in trusts of which Mr. Brammer is trustee and shares held by Mr. Brammer's wife. Mr. Brammer disclaims beneficial ownership of these 12,620 shares. (4) Includes 28,938 shares subject to options that are currently exercisable or that are exercisable within 60 days as follows: J. C. Philpott 9,765; B. M. Brammer 8,694; and Robert H. Spilman, Jr. 10,479. Does not include shares attributable to the named Executive Officers under the Company's Employee Savings/Retirement Plan. (5) Less than 1% of the outstanding Common Stock. (6) Robert H. Spilman, Jr. is the son of Robert H. Spilman, Chairman of the Board and Chief Executive Officer of the Company. The Bylaws of the Company provide for eleven Directors. At the meeting, eleven Directors will be elected to serve, subject to the provisions of the Bylaws, until the 1997 Annual Meeting of Stockholders and until their successors are duly elected and qualified. George W. Lyles, Jr., a dedicated and loyal director, has chosen not to run for reelection to the Board of Directors this year. Thomas W. Moss, Jr. has been nominated to fill Mr. Lyles' position on the Board. Directors are elected by a plurality of the votes cast by the holders of the shares entitled to vote at a meeting at which a quorum is present. Provided a quorum is present, abstentions and shares not voted are not taken into account in determining a plurality. A quorum consists of a majority of votes entitled to be cast. It is the intention of the persons named in the accompanying proxy to vote all proxies solicited by the Board of Directors FOR the eleven nominees listed below unless authority to vote for the nominees or any individual nominee is withheld by a stockholder in such stockholder's proxy. If for any reason any nominee shall not become a candidate for election as a Director at the meeting, an event not now anticipated, the proxies will be voted for the eleven nominees including such substitutes as shall be designated by the Board of Directors. The eleven nominees for election as a Director are listed below. All of the nominees were elected to their current terms, which expire in 1996, at the Annual Meeting of Stockholders held on February 15, 1995, except for Mr. Moss, who is a nominee for election as a director for the first time this year. (1) Does not include shares attributable to officers of the Company as participants in the Company's Employee Savings/Retirement Plan. (2) Based on the number of shares outstanding plus options held by directors and executive officers that are currently exercisable or which are exercisable within 60 days. (3) Includes 1,000 shares subject to an option which is currently exercisable or exercisable within 60 days. (4) Less than 1% of the outstanding Common Stock. (5) Includes 15,265 shares that are subject to options which are presently exercisable or are exercisable within 60 days. (6) Robert H. Spilman is the father of Robert H. Spilman, Jr., Executive Vice President of Marketing and Merchandising of the Company. (7) Includes 29,658 shares that are subject to options which are presently exercisable or are exercisable within 60 days. Also includes a total of 119,126 shares that are held in a trust of which Mr. Spilman is co-trustee, shares held by Mr. Spilman's wife directly and shares held in trusts of which Mr. Spilman's wife is trustee. Mr. Spilman disclaims beneficial ownership of these 119,126 shares. THE BOARD OF DIRECTORS AND ITS COMMITTEES The Board of Directors met four times during the 1995 fiscal year. Each Director attended at least 75% of the meetings of the Board of Directors and Committees on which he served. The Company has an Audit Committee and an Organization and Compensation Committee. The Board of Directors does not have a Nominating Committee. The Audit Committee is composed of Messrs. Brown, Capps, Dickson, Fulton, Lyles and Sloan and is responsible for monitoring the performance of the independent auditors for the Company, recommending their engagement or dismissal to the Board of Directors, approving all audit and related fees and reviewing and evaluating the internal auditor's audit schedule. The Audit Committee met two times during the fiscal year. The Organization and Compensation Committee is composed of Messrs. Dickson, Goodwin, McGlothlin, Sloan and Snow and reviews and makes recommendations to the Board of Directors with respect to executive and officer compensation and establishes, reviews and recommends changes to the organizational structure of the Company so as to utilize the management resources to best respond to the changing demands of the marketplace. The Organization and Compensation Committee met once during the fiscal year. ORGANIZATION AND COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Organization and Compensation Committee is composed of Messrs. Dickson, Goodwin, McGlothlin, Sloan and Snow. Mr. McGlothlin is Chairman of the Board and Chief Executive Officer of The United Company. In 1993, a subsidiary of The United Company, United Central Industrial Supply Company, purchased the assets of Blue Ridge Industrial Supply Company. United Central Industrial Supply Company has operated mining, mill and industrial supply stores for the past 20 years. Blue Ridge Industrial Supply Company conducted business with the Company prior to such acquisition and has continued to do business with the Company. Blue Ridge Industrial Supply Company had sales of approximately $1,725,000 to the Company in the 1995 fiscal year. The prices charged by Blue Ridge Industrial Supply Company were negotiated on an arms-length basis and the Company believes such prices are at or below the prices charged for comparable products by other companies in the area. ORGANIZATION AND COMPENSATION COMMITTEE REPORT The Organization and Compensation Committee of the Board of Directors has assisted the Company in developing and implementing compensation policies and programs which seek to improve the profitability of the Company and to maximize stockholder value over time. To accomplish this, the five outside directors who compose the Organization and Compensation Committee have developed executive compensation policies which are consistent with, and directly linked to, the Company's business objectives. These business objectives represent a composite of factors that are considered important for the future success of the Company. These factors attempt to balance long and short-term performance, including the continued maintenance of a strong balance sheet, growth of pre-tax profitability and earnings per share, control of costs, market growth and diversification and other criteria which may be introduced over time as a result of changes in the household furniture environment. The members of the Organization and Compensation Committee deliberate on matters affecting executive compensation. The decisions are reviewed by the full Board, with the exception of decisions on stock or option awards which are made by the Organization and Compensation Committee to satisfy tax and securities law requirements. The key principles which the Organization and Compensation Committee emphasizes in developing compensation programs affecting senior executives are: - Paying for performance that emphasizes corporate, business unit and individual achievement. - Motivating senior executives to the achievement of strategic and tactical business goals and objectives and rewarding outstanding achievement. - Linking the interests of senior executives with the long-term interests of the stockholders through ownership of the Common Stock. As the level of responsibility increases, an executive's compensation will be proportionately at greater risk, reflecting the rewards earned as a result of goal attainment. As responsibility increases, the compensation mix will rely increasingly on the value of stock awards. The four components of executive compensation are: Base Salary. Base salaries are generally competitive with high-performing, similar-sized companies in the industry. However, in recent years the base salaries have been kept at a relatively fixed rate to reflect the general economic conditions of the industry and to keep fixed costs under control. Significant increases in base salary have been the result of increased responsibilities assumed by an executive officer and the continued profitability of the Company in an increasingly competitive industry. The Organization and Compensation Committee emphasizes rewards in the total compensation context, rather than increasing base salary. Annual Incentive Bonuses. Target annual incentives are established for each executive in the form of a percentage of base salary. Discretionary adjustments to targets are made based on performance criteria, subjectively applied, which include the continued maintenance of a strong balance sheet, growth of pre-tax profitability and earnings per share, control of costs, market growth and diversification and other criteria which may be introduced over time as a result of changes in the household furniture environment. Annual bonuses are considered part of the total compensation package and represent a targeted portion of such total compensation. There were approximately 400 participants in the executive and management incentive plans for the years covered by this report. Annual Stock Option Grants. The Organization and Compensation Committee may grant options to acquire shares of Company Common Stock to those key executives who, in their judgment, have achieved goals and objectives as described in the corporate business plans. The performance criteria used to determine the eligibility to receive a stock option include growth of pre-tax profitability and earnings per share, control of costs, market growth and diversification, continued maintenance of a strong balance sheet and other criteria which may be introduced over time as a result of changes in the household furniture environment. The number of option shares granted to each executive is determined by taking a percentage of the total cash compensation and dividing that amount by the fair market value per share at the date of grant. The percentage is set annually by the Organization and Compensation Committee on a subjective basis, based upon individual performance. The number of option shares granted will be reduced in the event the executive does not own at least that number of shares of Company Common Stock equal to the number of shares subject to the option grant. This encourages executives to hold shares received upon the exercise of the options, further linking their interests to those of the stockholders. Stock option grants are considered part of the total compensation package and represent a targeted portion of such total compensation. Benefits. These programs are designed to provide protection against financial catastrophe that can result from illness, disability or death. Benefits offered to senior executives are those offered to all employees, with certain variations, to promote tax efficiency and replacement of benefits lost due to regulatory limitations. The Organization and Compensation Committee believes that executive compensation programs serve the interest of the stockholders of the Company. Pay delivered to the senior executive is intended to emphasize the achievement of goals and objectives of the Company. At risk, performance-based bonus compensation averaged approximately 30% of total annual cash compensation for the executive group during the fiscal year ended November 30, 1995. The range of bonus compensation can be from zero to a multiple of base salary, depending upon performance against goals and objectives for the year. The use of equity in the form of stock option grants requires executives to invest in the company they manage, and stockholder value creation becomes important, as with other stockholders. Chief Executive Officer's 1995 Compensation. Robert H. Spilman, Chairman of the Board and Chief Executive Officer of the Company, is eligible to participate in the same compensation programs available to other senior executives. The Organization and Compensation Committee seeks to be competitive with high-performing, similar-sized companies in the household furniture industry in the context of total compensation, placing more emphasis on at-risk incentives than on base salary. While this performance-driven compensation may produce variable compensation over the years, it is the belief of the Organization and Compensation Committee that this approach focuses the executive on the achievement of short and long-term goals and objectives which enhance stockholder value. The Organization and Compensation Committee determines, subjectively, the emphasis and importance of the above criteria each year to reflect the economic conditions of the household furniture industry and that of the Company. The base salary component of total compensation for Mr. Spilman for fiscal year 1995 was unchanged, remaining at $450,000. Mr. Spilman's salary is relatively competitive when compared to company size, performance and position within the industry. The annual bonus paid to Mr. Spilman was based upon the subjective application of the objective performance criteria stated above. The annual bonus for fiscal year 1995 was determined using these criteria resulting in a payment of $225,000, which is 50% of his base salary. No stock option grants were awarded to Mr. Spilman in 1995. For fiscal year 1996, the Organization and Compensation Committee will again establish performance criteria designed to enhance stockholder value. These criteria will be consistent with financial objectives of the Company and will be representative of the success needed to insure growth and profitability. Included below is a line graph comparing the yearly percentage change in the cumulative total stockholder return on the Company's Common Stock against the cumulative total return of the Standard & Poor's 500 Index and the Company's Peer Group for the period commencing December 1, 1990 and ending November 30, 1995, covering the Company's five fiscal years ended November 30, 1995. The Company's Peer Group consists of nine publicly-traded companies, the Company, Ameriwood Industries International Corporation, Bush Industries, Inc. Class A Common Stock, DMI Furniture, Inc., La-Z-Boy Chair Company, Ladd Furniture, Inc., Masco Corp., Pulaski Furniture Corp. and Rowe Furniture Corp., each of which is in the household furniture industry. COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN AMONG THE COMPANY, S&P 500 INDEX AND THE PEER GROUP This graph assumes that $100 was invested in the Company's Common Stock on December 1, 1990, in the S&P 500 Index, and the Peer Group, and that dividends were reinvested. The table below shows the compensation paid or accrued by the Company for the three fiscal years ended November 30, 1995, to or for the account of the Chief Executive Officer and the Company's four other most highly compensated officers whose total annual salary and bonus exceeded $100,000 for the 1995 fiscal year (collectively, the named Executive Officers). (1) The salaries shown above include deferred compensation for each named Executive Officer under the Section 401(k) qualified, defined contribution Employee Savings/Retirement Plan. (2) Under the Company's incentive bonus program, executives are paid cash awards which are directly related to their performance and contribution to the attainment of Company objectives and individual goals. Awards are made annually following the completion of the fiscal year. (3) No named Executive Officer has received personal benefits during the listed years in excess of the lesser of $50,000 or 10% of annual salary. (4) Company matching contributions under the Company's Employee Savings/Retirement Plan. The table below shows, on an aggregated basis, each exercise of stock options or SARs during the fiscal year ended November 30, 1995 by the Chief Executive Officer and each named Executive Officer and the 1995 fiscal year-end value of unexercised in-the-money options and SARs. AGGREGATED OPTION/SAR EXERCISES IN THE 1995 FISCAL YEAR (1) No SARs were exercised in 1995 and there were no SARs outstanding at the 1995 fiscal year end. (2) The exercise price for unexercised options is $26.25 per share for 1994 grants, $37.40 per share for 1993 grants and $28 per share for 1992 grants. The Company has a Supplemental Retirement Income Plan (the Supplemental Plan) that covers certain senior executives to promote their long service and dedication and to provide an additional retirement benefit. Upon retirement, the Supplemental Plan provides for lifetime monthly payments in an amount equal to 65% of the Participant's final average compensation under the Supplemental Plan, which amount is reduced by (i) 50% of old age social security benefits, (ii) the benefit that would be payable on a life annuity basis from Company contributions to the Employee Savings/Retirement Supplemental Plan based on a formula using maximum employee contributions, and (iii) the benefit that would be payable on a life annuity basis from funds the Company contributed to a Defined Benefit Plan that was terminated in 1977. There is no provision under the Supplemental Plan for a disability benefit if a participant's employment is terminated prior to age 65 due to disability; however, the participant, notwithstanding the termination of employment, shall continue to be covered by the Supplemental Plan. The death benefit is divided into (a) prior to retirement death, which pays the beneficiary 50% of final average compensation for a period of 120 months, and (b) post retirement death, which pays the beneficiary 200% of final average compensation in a single payment. There are no benefits payable as a result of a termination of employment for any reason other than death or retirement. The Supplemental Plan contains a change of control provision which provides for the immediate vesting and payment of the retirement benefit under the Supplemental Plan in the event of an employment termination resulting from a change of control. The Supplemental Plan is an unfunded liability of the Company which is credited with an interest rate representative of the Company's interest rate used in its major financial transactions and fluctuates with the market. The executives covered under this Supplemental Plan have waived participation in the Company's Group Life Insurance Program. Assuming no change in the rate of compensation after November 30, 1995, the estimated annual net benefit payable on retirement at age 65 (at a later assumed age for Mr. Spilman) for the named Executive Officers was as follows: Robert H. Spilman $283,005, Glenn A. Hunsucker $156,416, J. C. Philpott $67,994 and B. M. Brammer $60,529. Inasmuch as the estimated annual net benefit is based on the assumption of no change in the rate of compensation after November 30, 1995, it is projected that the net benefit payable to Robert H. Spilman, Jr. will be covered by the benefits calculated (using the aforementioned formula) to be payable from Company contributions to the Employee Savings/Retirement Plan. Directors who are also employees of the Company or its subsidiaries receive no additional compensation for serving as directors. Directors who are not employees of the Company or its subsidiaries receive an annual retainer fee of $15,000, plus a fee of $500 for each Board and for each Committee meeting attended. Under the Company's 1993 Stock Plan for Non-Employee Directors (the Director Plan), Directors who are not regular employees of the Company are each automatically granted an option to purchase 500 shares of Common Stock on April 1 of each year, subject to adjustment in the event of stock dividends and splits, recapitalizations and similar transactions. On April 1, 1995, nine Directors were each granted an option to purchase 500 shares of Common Stock at an exercise price of $26.50 per share. An option granted under the Director Plan is not exercisable unless the optionee remains available to serve as a Director of the Company for six months after the date of grant. An optionee's rights under all outstanding options will terminate three months after his termination as a Director, unless the termination is because of death or disability, in which case the options will be exercisable for one year after such termination. Unless earlier terminated, all options granted under the Director Plan expire ten years from the date of grant. In addition, the Director Plan provides that eligible Directors of the Company may make an annual irrevocable election to receive up to 100% of their annual retainer fee in the form of a stock award. The total number of shares subject to a stock award will be determined based on the fair market value of the Common Stock on the date the award is made. The Director may specify the percentage of the Director's annual retainer fee subject to the election, and the percentage of and the dates on which the shares covered by the stock award are to be issued. In the event a Director ceases to be a member of the Board of Directors for any reason, the total number of shares subject to the award which have not yet been issued to the Director will be issued to the Director within one year of his termination as a Director. The Company also has established a planned gift program for directors funded by life insurance policies on directors as part of its overall program to promote charitable giving. Upon the death of a Director, the Company will donate $500,000 to one or more qualifying charitable organizations recommended by the individual director and subsequently be reimbursed by life insurance proceeds. Individual directors derive no financial benefit from this program since all charitable deductions accrue solely to the Company. The program does not result in any material cost to the Company. COMPLIANCE WITH SECTION 16(A) OF SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934 (the Exchange Act) requires the Company's Directors and executive officers and persons who own more than 10% of the Company's Common Stock to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of the Common Stock and other equity securities. Executive officers, Directors and greater than 10% stockholders are required to furnish the Company such reports they file. To the Company's knowledge, based solely on a review of the copies of such reports furnished to the Company and written representations that no other reports were required, during the fiscal year ended November 30, 1995, all Section 16(a) filing requirements applicable to its executive officers, Directors and greater than 10% beneficial stockholders were complied with. RATIFICATION OF SELECTION OF INDEPENDENT PUBLIC ACCOUNTANTS Upon the recommendation of the Audit Committee, the Board of Directors has approved the selection of KPMG Peat Marwick as independent public accountants to audit the financial statements of the Company for the fiscal year ending November 30, 1996. This selection is being presented to the stockholders for their ratification at the Annual Meeting of Stockholders. The firm of KPMG Peat Marwick has audited the Company's financial statements annually since 1990 and is considered well qualified. Representatives of KPMG Peat Marwick are expected to be present at the Annual Meeting of Stockholders with an opportunity to make a statement if they desire to do so, and they are expected to be available to respond to appropriate questions. The Board of Directors recommends a vote FOR the ratification of the selection of KPMG Peat Marwick as independent public accountants to audit the financial statements of the Company for the fiscal year ending November 30, 1996, and proxies solicited by the Board of Directors will be so voted unless stockholders specify a different choice. If the stockholders do not ratify the selection of KPMG Peat Marwick, the selection of independent public accountants will be reconsidered by the Board of Directors. Any proposal that a stockholder intends to present for action at the 1997 Annual Meeting of Stockholders, currently scheduled for February 19, 1997, must be received by the Company no later than September 12, 1996, in order for the proposal to be included in the proxy statement and form of proxy for the 1997 Annual Meeting of Stockholders. The proposal should be sent to J. Stanley Payne, Vice President, Secretary and General Counsel, Bassett Furniture Industries, Incorporated, Post Office Box 626, Bassett, Virginia 24055. PROXY BASSETT FURNITURE INDUSTRIES, INCORPORATED PROXY PROXY SOLICITED BY THE BOARD OF DIRECTORS FOR THE ANNUAL MEETING TO BE HELD FEBRUARY 21, 1996 The undersigned hereby appoints Glenn A. Hunsucker and B. M. Brammer, each or either of them, proxies, with full power of substitution, with the powers the undersigned would possess if personally present, to vote, as designated below, all shares of the $5.00 par value Common Stock of the undersigned in Bassett Furniture Industries, Incorporated at the Annual Meeting of Stockholders to be held on February 21, 1996, and at any adjournment thereof. THIS PROXY WILL BE VOTED AS SPECIFIED HEREIN AND, UNLESS OTHERWISE DIRECTED, WILL BE VOTED FOR THE ELECTION OF ALL NOMINEES AS DIRECTORS AND FOR THE SELECTION OF INDEPENDENT PUBLIC ACCOUNTANTS. The Board of Directors recommends voting FOR on each item. 1. ELECTION OF DIRECTORS: Nominees are Peter W. Brown, M.D., Thomas E. Capps, Alan T. Dickson, Paul Fulton, William H. Goodwin, Jr., Glenn A. Hunsucker, James W. McGlothlin, Thomas W. Moss, Jr., Albert F. Sloan, John W. Snow and Robert H. Spilman. [ ] FOR all listed nominees (except do not vote for the nominee(s) whose name(s) I have written below) [ ] WITHHOLD AUTHORITY to vote for the listed nominees 2. RATIFICATION OF SELECTION OF KPMG PEAT MARWICK AS INDEPENDENT PUBLIC [ ] FOR [ ] AGAINST [ ] ABSTAIN 3. In their discretion, the proxies are authorized to vote upon such other business as may properly come before the meeting. Receipt of Notice of Annual Meeting of Stockholders and accompanying Proxy Statement is hereby acknowledged. PLEASE DATE AND SIGN EXACTLY AS PRINTED BELOW AND RETURN PROMPTLY IN THE ENCLOSED POSTAGE PAID ENVELOPE. give title as such. If joint	DEF 14A	DEF 14A	1996-01-12T00:00:00	1996-01-12T12:12:15
0000820626-96-000007	0000820626-96-000007_0002.txt	At the request of IMC Global Inc. (the "Company"), I have reviewed such documents as I considered necessary for purposes of rendering this opinion, including copies of resolutions of the Board of Directors of the Company, a copy of the 1988 Stock Option and Award Plan, as amended and restated effective October 19, 1995 (the "Plan"), and the Company's Form S-8 Registration Statement related to the registration of 1,000,000 shares of Common Stock, par value $1.00 per share (the "Shares"), of the Company in connection with the Plan. Based upon my examination of the foregoing and such other corporate documents and proceedings as I have deemed relevant, it is my opinion that the shares of Common Stock which are distributed by the Company under the Plan, when distributed in accordance with the terms and provisions of the Plan, are legally issued, fully paid and nonassessable. This opinion is limited to the General Corporation Law of the State of Delaware and the laws of the United States of America. I do not find it necessary for the purposes of this opinion to cover, and accordingly express no opinion as to, the application of the securities or blue sky laws of the various states to the issuance and sale of the Shares. I consent to the filing of this opinion as an exhibit to the Company's Form S-8 Registration Statement.	S-8	EX-5	1996-01-12T00:00:00	1996-01-12T17:10:55
0000950009-96-000029	0000950009-96-000029_0000.txt	Filed Pursuant to Rule 424(b)(3) Registration Nos. 33-55787 and 33-64179 PRICING SUPPLEMENT NO. 22, dated January 11, 1996 (To Prospectus dated December 20, 1995 and Prospectus Supplement dated December 20, 1995) Due 9 Months or More From Date of Issue Original Issue Date: January 17, 1996 Stated Maturity: January 17, 2001 Interest Payment Dates: February 15 and August 15 (If other than U.S. Dollars, see attachment hereto) Option to Receive Payments in Specified Currency: [ ] Yes [ ] No (Applicable only if Specified Currency is other than U.S. Dollars) (Applicable only if Specified Currency is other than U.S. Dollars) Redemption: [X] The Notes cannot be redeemed prior to maturity. [ ] The Notes may be redeemed prior to maturity. The Redemption Price shall initially be % of the principal amount of the Notes to be redeemed and shall decline at each anniversary of the initial Redemption Date by % of the principal amount to be redeemed until the Redemption Price is 100% of such principal amount. Repayment: [X] The Notes cannot be repaid prior to maturity. [ ] The Notes can be repaid prior to maturity at the option of the holder of the Notes. Discount Notes: [ ] Yes [X] No Agent's Discount or Commission: .50% Agent's Capacity: [X] Agent [ ] Principal Net proceeds to Company (if sale to Agent as principal): Agent: [ ] Merrill Lynch & Co. [ ] Salomon Brothers Inc [X] Other: Prudential Securities Incorporated	424B3	424B3	1996-01-12T00:00:00	1996-01-12T15:19:37
0000898430-96-000082	0000898430-96-000082_0000.txt	Pacific Select Fund (the "Fund") is a mutual fund that currently offers eleven separate portfolios (each a "Portfolio"). The Portfolios serve as the investment medium for variable life insurance policies and variable annuity contracts (the "Variable Contracts") issued or administered by Pacific Mutual Life Insurance Company ("Pacific Mutual") or Pacific Corinthian Life Insurance Company ("Pacific Corinthian"). You can instruct Pacific Mutual or Pacific Corinthian to allocate cash value under your Variable Contract to investment options funded by an account known as a "Separate Account," which invests in the Portfolios. Your allocation rights are described in the accompanying Prospectus for the Separate Account. The eleven Portfolios of the Fund are as follows: The Money Market Portfolio* The Multi-Strategy The High Yield Bond Portfolio The Managed Bond Portfolio The Equity Portfolio** Portfolio The Bond and Income The Growth LT Portfolio The Equity Index Portfolio The Equity Income The International This Prospectus contains information about the investment objective and policies of each Portfolio and related information. You should carefully consider a Portfolio's investment objective and policies and potential risks before investing. THE FUND'S SHARES INVOLVE INVESTMENT RISK, INCLUDING LOSS OF PRINCIPAL, AND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK. THE FUND'S SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY. This Prospectus sets forth concisely the information a prospective investor should know before investing in the Fund. A Statement of Additional Information, dated May 1, 1995 containing additional and more detailed information about the Fund has been filed with the Securities and Exchange Commission and is hereby incorporated by reference into this Prospectus. The Statement of Additional Information is available without charge and may be obtained by writing to the Fund at the address printed above or calling the Fund at (800) 800-7681. * Investment in the Money Market Portfolio (or in any other Portfolio) is neither insured nor guaranteed by the U.S. Government. ** The Equity Portfolio and Bond and Income Portfolio are not available for variable life insurance policies. THIS PROSPECTUS SHOULD BE READ IN CONJUNCTION WITH THE PROSPECTUS OF THE SEPARATE ACCOUNT, WHICH ACCOMPANIES THIS PROSPECTUS. BOTH PROSPECTUSES SHOULD BE READ CAREFULLY AND RETAINED FOR FUTURE REFERENCE. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THE DATE OF THIS PROSPECTUS IS MAY 1, 1995. THE FUND'S PORTFOLIOS AT A GLANCE A summary of the highlights of Pacific Select Fund's Portfolios appears below. THIS CHART IS ONLY A SUMMARY. YOU SHOULD ALSO READ THE COMPLETE DESCRIPTIONS OF EACH PORTFOLIO'S INVESTMENT OBJECTIVES AND POLICIES, WHICH BEGINS ON PAGE 4, AND RELATED INFORMATION. The following tables present condensed financial information about each Portfolio of the Fund. The tables present historical information based upon a single share outstanding through each fiscal year. The information in the tables for the years 1990 through 1994 is included and can be read in conjunction with the Fund's financial statements, which are in the Fund's Annual Report dated as of December 31, 1994. These financial statements have been audited by Deloitte & Touche LLP, independent public accountants, except for information with respect to the Equity Portfolio and Bond and Income Portfolio for years prior to 1994, which was audited by other independent public accountants. The Annual Report, which is available without charge, contains more information about the Fund's performance. (1) Information is for the period from January 4, 1988 (commencement of operations) to December 31, 1988. (2) Prior years ratios of expenses to average net assets have been restated for comparative purposes to reflect expenses exclusive of foreign taxes on dividends which are reflected as a component of dividend income. (3) Information is for the period from January 4, 1994 (commencement of operations) to December 31, 1994. (4) Information is for the period from January 30, 1991 (commencement of operations) to December 31, 1991. (5) J.P. Morgan Investment began serving as Portfolio Manager to the Equity Income and Multi-Strategy Portfolios on January 1, 1994. Prior to January 1, 1994, a different firm served as Portfolio Manager. (6) Templeton began serving as Portfolio Manager to the International Portfolio on January 1, 1994. Prior to January 1, 1994, a different firm served as Portfolio Manager. (7) Total return includes reinvestment of dividends and distributions. Total return does not include deductions at the separate account or contract level for fees and charges that may be incurred under a variable contract. THE PORTFOLIOS: INVESTMENT OBJECTIVES AND POLICIES Each Portfolio of the Fund has its own investment objective and investment policies which are described below. There can be no assurance that any Portfolio will achieve its investment objective. You should carefully consider the investment objective, investment policies, and potential risks of any Portfolio before investing. As with any security, a risk of loss is inherent in investment in the Fund's shares. Each Portfolio is subject to varying degrees of financial, market, and credit risks. Each Portfolio is subject to the risk of changing economic conditions. The different types of securities and investment techniques used by the individual Portfolios all have attendant risks of varying degrees. For example, for equity securities, there can be no assurance of capital appreciation and there is a substantial risk of market decline. For debt securities, there is a risk of market decline and there is the risk that the issuer of a security may not be able to meet its obligations on interest or principal payments at the time called for by an instrument. In addition, because the value of debt instruments generally rises and falls inversely with interest rates, the longer the maturity of a debt security, the more volatile it can be in terms of changes in value. Both equity and debt securities can also be subject to general economic conditions, company and industry earnings prospects and investor psychology. Certain types of investments and investment techniques common to one or more Portfolios are described in greater detail, including the risks of each, in this Prospectus under "Securities and Investment Techniques" and in the Statement of Additional Information. INVESTMENT OBJECTIVE. Current income consistent with preservation of capital. INVESTMENT POLICIES. The Portfolio invests at least 95% of its total assets, measured at the time of investment, in a diversified portfolio of money market securities that are in the highest rating category for short term instruments, or, if not rated, are of equivalent quality. The Portfolio may also invest up to 5% of its total assets, measured at the time of investment, in money market securities that are in the second-highest rating category for short-term debt obligations, or, if not rated, are of equivalent quality. Money market securities in which the Portfolio may invest may include: (i) U.S. Government obligations; (ii) bank obligations; (iii) commercial paper; (iv) short-term corporate debt securities; (v) savings and loan obligations; (vi) repurchase agreements involving these securities; and (vii) foreign securities--U.S. dollar denominated money market securities issued by foreign issuers and foreign branches of U.S. banks. The Portfolio may also lend its securities to brokers, dealers and other financial institutions to earn income. ELIGIBLE SECURITIES. The Portfolio may invest only in U.S. dollar denominated money market instruments that present minimal credit risk. The Adviser shall determine whether a security presents minimal credit risk under procedures adopted by the Fund's Board of Trustees that conform to Securities and Exchange Commission ("SEC") rules for money market funds. See "Investment Policies for Money Market Portfolio" in the Statement of Additional Information. The Money Market Portfolio's investments are limited to securities that mature in 13 months or less from the date of purchase (except that securities held subject to repurchase agreements having terms of 13 months or less from the date of delivery may mature in excess of 13 months from such date). It is anticipated that the dollar-weighted average portfolio maturity of the Portfolio will not exceed 90 days. The Portfolio is subject to diversification standards applicable to money market funds under SEC rules. Unlike many money market funds that are offered to the public, the Fund's Money Market Portfolio does not attempt to maintain a stable net asset value of $1.00 per share. INVESTMENT OBJECTIVE. High level of current income. INVESTMENT POLICIES. The Portfolio invests primarily in a diversified portfolio of intermediate and long-term, high-yielding, lower and medium quality ("high risk") fixed-income securities, including corporate bonds and notes, convertible securities and preferred stock. Such securities will be rated Baa or lower by Moody's Investor Service, Inc. ("Moody's"), or BBB or lower by Standard & Poor's Corporation ("S&P"), or, if not rated by Moody's or S&P, be of equivalent investment quality as determined by the Adviser. These debt securities include high yield bonds that are commonly referred to as "junk bonds." The convertible securities in which the Portfolio may invest include debt securities convertible into or exchangeable for equity securities. The Portfolio may also invest in: (i) U.S. Government securities (including securities of U.S. agencies and instrumentalities); (ii) bank obligations; (iii) commercial paper; (iv) repurchase and reverse repurchase agreements involving these securities; (v) foreign securities--U.S. dollar-denominated debt securities issued by foreign issuers and foreign branches of U.S. banks; (vi) dividend-paying common stocks (including up to 10% of the market value of the Portfolio's total assets in warrants to purchase common stocks) that are considered by Pacific Mutual to be consistent with the investment objective of current income; and (vii) higher-quality corporate bonds. The Portfolio will hold short-term cash reserves (money market instruments maturing in 13 months or less) as Pacific Mutual believes is advisable to maintain liquidity or for temporary defensive purposes. During times that Pacific Mutual believes that adoption of a temporary defensive position is desirable due to prevailing market or economic conditions, the Portfolio may invest to a greater degree in U.S. Government securities, higher-quality corporate securities, and money market securities. OTHER TECHNIQUES. In seeking higher income or a reduction in principal volatility, the Portfolio may (1) purchase and sell put and call options on debt securities as described in "Options" below, (2) purchase or sell interest rate futures contracts and options on interest rate futures contracts as described in "Futures Contracts and Futures Options" and (3) purchase, up to 5% of the Portfolio's total assets, covered spread options, which give the Portfolio the right to sell a security that it owns at a fixed dollar spread or yield spread in relationship to another security that the Portfolio does not own, but which is used as a benchmark. The Portfolio may also lend its securities to brokers, dealers, and other financial institutions to earn income. Certain of these techniques may involve a greater degree or different type of risk than those inherent in more conservative investment approaches. For a description of these investment practices and their associated risks, see the "Securities and Investment Techniques" below and in the Statement of Additional Information. HIGH YIELD BONDS. In general, debt securities rated lower than Baa by Moody's or BBB by S&P or of equivalent quality ("high yield bonds") are not considered to be investment grade, and are regarded as predominantly speculative with respect to the issuer's continuing ability to meet principal and interest payments. For more information on the risks of such securities, see "High Yield Bonds" below. See the Appendix for a description of Moody's and S&P ratings applicable to the fixed-income securities. In an effort to reduce credit risk, the Portfolio diversifies its holdings among many issuers. As of December 31, 1994, the Portfolio held securities of 59 corporate issuers, excluding short-term obligations. Based upon an average of the Portfolio's holdings at the end of each month in 1994, an average of approximately 85.5% of the Portfolio's holdings during 1994 were invested in bonds rated Ba or B by Moody's or rated BB or B by S&P or if unrated, determined to be of equivalent rating as determined by the Adviser. The asset composition after this time may or may not be the same as shown in 1994. VOLATILITY. Since shares of the Portfolio normally represent an investment primarily in securities with fluctuating market prices, an investor should understand that the value of the Portfolio's shares will vary as the aggregate value of the Portfolio's securities increases or decreases. Changes in the value of portfolio securities subsequent to their acquisition will normally not affect the Portfolio's income, but will be reflected in the net asset value of the Portfolio's shares. The Portfolio is intended for long-term investors who can accept the risks associated with investment in high yield securities, and should not constitute a complete investment program. INVESTMENT OBJECTIVE. Maximize total return consistent with prudent investment management. INVESTMENT POLICIES. The Portfolio will primarily invest in the following types of securities: obligations issued or guaranteed by the U.S. Government, its agencies, or instrumentalities; U.S. dollar-denominated corporate debt securities of domestic or foreign issuers; mortgage and other asset-backed securities; variable and floating rate debt securities; U.S. dollar-denominated obligations of foreign governments, foreign government agencies, and international agencies (such as the International Bank for Reconstruction and Development); and any of the following: high quality commercial paper, certificates of deposit, fixed time deposits and bankers' acceptances issued by domestic and foreign banks denominated in U.S. dollars, and repurchase and reverse repurchase agreements. The Portfolio, except as provided below, may invest only in securities rated Baa or better by Moody's or BBB or better by S&P or, if not rated by Moody's or S&P, determined by the Portfolio Manager to be of comparable quality. The dollar-weighted average quality of all fixed-income securities held by the Portfolio will be A or higher as rated by Moody's and S&P. The Portfolio may also invest up to 10% of its assets in debt securities that are below investment grade, but rated B or higher by Moody's or S&P or, if not rated by Moody's or S&P, of equivalent quality. A security is generally of investment grade when rated in one of the top four categories of investment ratings as described by Moody's or S&P. In general, debt securities rated lower than Baa by Moody's or BBB by S&P or of equivalent quality ("high yield/high risk bonds") are not considered to be investment grade, and are regarded as predominantly speculative with respect to the issuer's continuing ability to meet principal and interest payments. For more information on the risks of such securities, see "High Yield Bonds." In the event that a security owned by the Portfolio is downgraded to below a rating of B, the Portfolio may nonetheless retain the security. See the Appendix for a description of Moody's and S&P ratings applicable to fixed income securities. For the year ended December 31, 1994, the amount of the Portfolio's average total assets, measured on the basis of month-end values, invested in debt securities rated less than investment grade was approximately 10.39%. SELECTION OF SECURITIES. The Portfolio invests in a diversified portfolio primarily consisting of long, intermediate, and short-term marketable debt securities. The proportion invested in each category of maturity can be expected to vary depending upon the evaluation of market patterns and trends by the Portfolio Manager. In selecting securities for the Portfolio, the Portfolio Manager will use economic forecasting, interest rate anticipation, credit and call risk analysis, and other security selection techniques. The proportion of the Portfolio's assets committed to investment in securities with particular and coupon rate may vary based on the Portfolio Manager's outlook for the economy, the financial markets, and other factors. DURATION. The Portfolio will invest in a portfolio of securities of varying maturities and, under normal circumstances, will maintain an average portfolio duration of 3 to 6 years. Duration is one of the fundamental tools used by the Portfolio Manager in security selection. Historically, the maturity of a bond was used as a proxy for the sensitivity of a bond's price to changes in interest rates, otherwise known as a bond's "interest rate risk" or "volatility." According to this measure, the longer the maturity of a bond, the more its price will change for a given change in market interest rates. However, this method ignores the amount and timing of all cash flows from the bond prior to final maturity. Duration is a measure of average life of a bond on a present value basis, which was developed to incorporate a bond's yield, coupons, final maturity and call features into one measure. For point of reference, the maturity of a current coupon bond with a 3 year duration is approximately 3.5 years, and the maturity of a current coupon bond with a 6 year duration is approximately 9 years. More detailed discussion of "duration" as an investment technique is provided in the Statement of Additional Information. OTHER TECHNIQUES. In pursuing its investment objective, the Portfolio may purchase and sell put and call options on debt securities as described in "Options" below. In addition, the Portfolio may purchase or sell interest rate futures contracts and options on interest rate futures contracts as described in "Futures Contracts and Futures Options" below. The Portfolio may also lend its securities to brokers, dealers, and other financial institutions to earn income, and borrow money for temporary administrative or emergency purposes. In addition, the Portfolio may invest up to 10% of its assets in debt securities of foreign issuers which may be denominated in foreign currencies. Furthermore, the Portfolio may engage in forward currency contracts in anticipation of or to protect itself against fluctuations in currency exchange rates with respect to investments in securities of foreign issuers. These investment techniques may involve a greater degree or different type of risk than those inherent in more conservative investment approaches. See "Securities and Investment Techniques" below and in the Statement of Additional Information for a description of these techniques, their attendant risks, and restrictions generally applicable to the Portfolio's investment in or use of them. INVESTMENT OBJECTIVE. Maximize total return consistent with prudent investment management. INVESTMENT POLICIES. The Portfolio invests primarily in securities that are obligations of or guaranteed by the U.S. Government, its agencies or instrumentalities. Among the securities the Portfolio may purchase are mortgage-backed securities guaranteed by the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Federal National Mortgage Association. More detailed discussion of these and other U.S. Government securities is provided in the Statement of Additional Information. The Portfolio normally maintains at least 65% of its assets invested in U.S. Government securities (including futures contracts and options thereon and options relating to U.S. Government securities). The remainder of the Portfolio's assets may be invested in corporate debt securities of domestic issuers rated Aa or better by Moody's or AA or better by S&P, or, if not rated by Moody's or S&P, of comparable quality as determined by the Portfolio Manager, in mortgage-related securities, including collateralized mortgage obligations and mortgage-backed bonds, and in cash or high quality money market instruments. The Portfolio may increase the amount of its assets invested in money market securities during times that the Portfolio Manager believes that adoption of a temporary defensive position is desirable due to prevailing market or economic conditions. DURATION. The Portfolio invests in a portfolio of securities of varying maturities and, under normal circumstances, intends to maintain an average portfolio duration of 3 to 6 years. A discussion of "duration" is provided above in the description of the Managed Bond Portfolio and in the Statement of Additional Information. OTHER TECHNIQUES. In pursuing its investment objective, the Portfolio may purchase and sell put and call options on U.S. Government securities and on other debt securities, as described in "Options" below. In addition, the Portfolio may purchase or sell interest rate futures contracts and options on interest rate futures contracts as described in "Futures Contracts and Futures Options" below. The Portfolio also may make loans of portfolio securities (up to an aggregate of 25% of its total assets) and enter into reverse repurchase agreements. In addition, the Portfolio may invest up to 10% of its assets in debt securities of foreign issuers, which may be denominated in foreign currencies. Furthermore, the Portfolio may engage in forward currency contracts in anticipation of or to protect itself against fluctuations in currency exchange rates with respect to investments in securities of foreign issuers. These investment techniques may involve a greater degree or different type of risk than those inherent in more conservative investment approaches. See "Securities and Investment Techniques" below and in the Statement of Additional Information for a description of these techniques and their attendant risks. INVESTMENT OBJECTIVE. Long-term growth of capital in a manner consistent with the preservation of capital. INVESTMENT POLICIES. The Portfolio is a diversified portfolio that pursues its investment objective by investing in the common stock of a large number of issuers of any size. The Portfolio may invest in large, well-established companies, as well as smaller emerging growth companies. It may from time to time emphasize investments in companies with market capitalization between $1 billion and $5 billion. Companies with market capitalization of $1 billion to $5 billion, as well as smaller companies, may suffer more significant losses as well as realize more substantial growth than larger, more established issuers. Thus, investments in such companies tend to be more volatile and somewhat speculative. The Portfolio may invest in securities of both domestic and foreign issuers. The Portfolio is not designed as a short-term trading vehicle. STOCK SELECTION. The Portfolio invests substantially all of its assets in common stocks when the Portfolio Manager believes that the relevant market environment favors profitable investing in those securities. Common stock investments are selected in industries and companies that the Portfolio Manager believes are experiencing favorable demand for their products and services, and which operate in a favorable competitive environment and regulatory climate. The Portfolio Manager's analysis and selection process focuses on earnings growth potential. In particular, the Portfolio intends to buy stocks with earnings growth potential that may not be recognized by the market. Securities are selected solely for their capital growth potential; investment income is not a consideration and any income realized on the Portfolio's investments will be incidental to its primary objective. These selection criteria apply equally to stocks of foreign issuers. In selecting foreign stocks, factors such as expected levels of inflation, government policies influencing business conditions, the outlook for currency relationships, and prospects for relative economic growth among countries, regions, or geographic areas may warrant greater consideration. OTHER INVESTMENTS. Although the Portfolio normally invests primarily in equity securities, it may increase its cash position when the Portfolio Manager is unable to locate investment opportunities with desirable risk/reward characteristics. The Portfolio may invest in government securities, corporate bonds and debentures, high-grade commercial paper, warrants, preferred stocks, certificates of deposit, or other debt securities when the Portfolio Manager perceives an opportunity for capital growth from such securities or so that the Portfolio may receive a return on idle cash. The Portfolio may invest up to 10% of its assets, measured at the time of investment, in debt securities that are lower rated bonds, i.e., rated below investment grade by one of the primary rating agencies (or if not rated, deemed to be comparable quality by the Portfolio Manager), but which may offer higher yields. See "High Yield Bonds." When the Portfolio invests in fixed income securities, investment income will increase and may constitute a large portion of the return on the Portfolio, and the Portfolio probably would not participate in market advances or declines to the extent that it would if it remained fully invested in common stocks. The Portfolio may invest up to 25% of its assets in foreign securities denominated in a foreign currency and not publicly traded in the United States. In addition, the Portfolio may purchase American Depositary Receipts ("ADRs"), European Depository Receipts ("EDRs"), Global Depository Receipts ("GDRs"), and other types of receipts of shares evidencing ownership of the underlying foreign securities. In pursuing its investment objective, the Portfolio may engage in the purchase and writing of put and call options on securities, stock indexes and foreign currencies. In addition, the Portfolio may purchase or sell interest rate, stock index, and foreign currency futures contracts and options thereon. The Portfolio may also engage in forward foreign currency contracts. These investment techniques may involve a greater degree or different type of risk than those inherent in more conservative investment approaches. See "Securities and Investment Techniques" below and in the Statement of Additional Information for a description of these techniques and their attendant risks. INVESTMENT OBJECTIVE. Long-term growth of capital and income. INVESTMENT POLICIES. The Portfolio seeks to achieve its objective consistent with reasonable investment risk. Ordinarily, the Portfolio pursues its investment objective by investing primarily in dividend-paying common stock. The Portfolio may also invest in other equity securities, consisting of, among other things, non dividend-paying common stock, preferred stock, and securities convertible into common stock, such as convertible preferred stock and convertible bonds, and warrants. The Portfolio may also invest in ADRs and in various foreign securities if U.S. exchange-listed. STOCK SELECTION. The Portfolio is not subject to any limit on the size of companies in which it may invest, but intends, under normal circumstances, to be fully invested to the extent practicable in the large- and medium-sized companies primarily included in the Standard & Poor's 500 Composite Stock Price Index ("S&P 500"). The Portfolio is designed for investors who want an actively managed equity portfolio of selected equity securities that seeks to outperform the total return of the S&P 500. In managing the Portfolio, the potential for appreciation and dividend growth is given more weight than current dividends. Nonetheless, the Portfolio Manager will normally strive for gross income for the Portfolio at a level not less than 75% of the dividend income generated on the stocks included in the S&P 500, although this income level is merely a guideline and there can be no certainty that this income level will be achieved. The Portfolio does not seek to achieve its objective with any individual portfolio security, but rather it aims to manage the portfolio as a whole in such a way as to achieve its objective. The Portfolio attempts to reduce risk by investing in many different economic sectors, industries and companies. The Portfolio Manager may under- or over-weight selected economic sectors against the S&P 500's sector weightings to seek to enhance the Portfolio's total return or reduce fluctuations in market value relative to the S&P 500. In selecting securities, the Portfolio Manager may emphasize securities that it believes to be undervalued. Securities of a company may be undervalued for a variety of reasons such as an overreaction by investors to unfavorable news about a company, an industry, or the stock markets in general; or as a result of a market decline, poor economic conditions, tax-loss selling, or actual or anticipated unfavorable developments affecting a company. OTHER SECURITIES. During ordinary market conditions, the Portfolio Manager will keep the Portfolio as fully invested as practicable in the equity securities described above. The Portfolio may also invest in money market instruments, including U.S. Government securities, short term bank obligations rated in the highest two rating categories by Moody's or S&P, or, if unrated, determined to be of equal quality by the Portfolio's Manager, certificates of deposit, time deposits and banker's acceptances issued by U.S. and foreign banks and savings and loan institutions with assets of at least $500 million as of the end of their most recent fiscal year; and commercial paper and corporate obligations, including variable rate demand notes, that are issued by U.S. and foreign issuers and that are rated in the highest two rating categories by Moody's or S&P, or if unrated, determined to be of equal quality by the Portfolio Manager. Under normal circumstances, the Portfolio will invest in such money market instruments to invest temporary cash balances or to maintain liquidity to meet redemptions or expenses. The Portfolio may also, however, invest in these instruments, without limitation, as a temporary defensive measure taken during, or in anticipation of, adverse market conditions. Convertible bonds and other fixed income securities (other than money market instruments) in which the Portfolio may invest will, at the time of investment, be rated Baa or better by Moody's or BBB or better by S&P or, if not rated by Moody's or S&P, will be of comparable quality as determined by the Portfolio Manager. In the event that an existing holding is downgraded below these ratings, the Portfolio may nonetheless retain the security. OTHER TECHNIQUES. In pursuing its investment objective, the Portfolio may purchase and sell put and call options on securities and stock indexes. In addition, the Portfolio may purchase or sell stock index futures contracts and options thereon. These investment techniques may involve a greater degree or different type of risk or than those inherent in more conservative investment approaches. See "Securities and Investment Techniques" below and in the Statement of Additional Information for a description of these techniques and their attendant risks. INVESTMENT OBJECTIVE. Provide a high total return from a portfolio of equity and fixed income securities. Total return will consist of income plus realized and unrealized capital gains and losses. INVESTMENT POLICIES. The Portfolio is managed to earn current income on, and to anticipate long-term capital growth of, the portfolio as a whole rather than any individual security in it. The Portfolio's equity investments will be primarily the common stock of large and medium-size U.S. companies, including common stock of any class or series or any similar equity interest. The Portfolio's equity investments may also include preferred stock, warrants, rights, and convertible securities. The Portfolio may also invest in the equity securities of small companies and foreign issuers. The Portfolio's equity securities may or may not pay dividends and may or may not carry voting rights. Fixed income securities may include corporate bonds, debentures, notes, mortgage-related securities, and asset-backed securities, U.S. Government securities, preferred stock, money market instruments, and other securities that may have conversion or purchase rights. It is contemplated that most of the Portfolio's common stock investments will be made in securities listed on a U.S. stock exchange, and the Portfolio may invest in various foreign securities if U.S. exchange-listed. ASSET ALLOCATION. Under normal circumstances, the Portfolio Manager expects that approximately 60% of the Portfolio's assets will be invested in equities and approximately 40% in fixed income securities. However, these amounts may vary in that the Portfolio Manager may allocate the Portfolio's investments between these asset classes in a manner consistent with the Portfolio's investment objective and current market conditions. Using a variety of analytical tools, the Portfolio Manager assesses the relative attractiveness of each asset class and determines an allocation between them believed to be optimal. The Portfolio Manager then selects securities in each asset class based on fundamental research and quantitative analysis. OTHER TECHNIQUES. In pursuing its investment objective, the Portfolio may purchase and sell put and call options on securities and stock indexes. In addition, the Portfolio may purchase or sell interest rate and stock index futures contracts and options thereon. These investment techniques may involve a greater degree or different type of risk than those inherent in more conservative investment approaches. See "Securities and Investment Techniques" below and in the Statement of Additional Information for a description of these techniques and their attendant risks. THE EQUITY PORTFOLIO OFFERS ITS SHARES ONLY TO SEPARATE ACCOUNTS OF PACIFIC MUTUAL AND PACIFIC CORINTHIAN TO SERVE AS AN INVESTMENT MEDIUM FOR VARIABLE ANNUITY CONTRACTS. THE PORTFOLIO IS NOT AVAILABLE FOR VARIABLE LIFE INSURANCE POLICIES. INVESTMENT OBJECTIVE. The primary investment objective of the Equity Portfolio is capital appreciation. Current income is of secondary importance. INVESTMENT POLICIES. The Portfolio seeks to achieve this objective by investing primarily in common stocks, or securities convertible into or exchangeable for common stocks (such as convertible preferred stocks, convertible debentures, or warrants), which are believed by the Portfolio Manager to have above-average market appreciation potential. Except when in a temporary defensive investment position, the Portfolio intends to maintain at least 65% of its assets invested in common stocks or securities convertible or exchangeable for common stocks. The Equity Portfolio also may invest in U.S. Government securities, corporate bonds, money market instruments, enter into repurchase agreements, and for temporary defensive purposes, increase its investment in these securities up to 100% of its assets. The Equity Portfolio may lend its portfolio securities and enter into "short sales against the box." (See "Short Sales Against the Box" in the Statement of Additional Information). Corporate bonds purchased by the Portfolio must be rated at the time of purchase Aa or better by Moody's or AA or better by S&P, and commercial paper must be rated at the time of purchase Prime-1 by Moody's or A-1 by S&P or, if not so rated, must have been issued by a corporation with corporate bonds outstanding which meet the standards set forth above. OTHER TECHNIQUES. The Equity Portfolio may sell exchange-listed call options ("calls") if the calls are "covered" throughout the life of the option and may purchase a call on securities only to effect a "closing purchase transaction". THE BOND AND INCOME PORTFOLIO OFFERS ITS SHARES ONLY TO SEPARATE ACCOUNTS OF PACIFIC MUTUAL AND PACIFIC CORINTHIAN TO SERVE AS AN INVESTMENT MEDIUM FOR VARIABLE ANNUITY CONTRACTS. THE PORTFOLIO IS NOT AVAILABLE FOR VARIABLE LIFE INSURANCE POLICIES. INVESTMENT OBJECTIVE. Provide as high a level of current income as is consistent with prudent investment management and preservation of capital. INVESTMENT POLICIES. The Portfolio may invest in any of the following securities: corporate bonds which are rated Baa or better by Moody's or BBB or better by S&P; U.S. Government securities; commercial paper rated Prime-1 or Prime-2 by Moody's or A-1 or A-2 by S&P or, if not rated by Moody's or S&P, issued by a corporation having an outstanding debt issue rated Aa or better by Moody's or AA or better by S&P; negotiable bank certificates of deposit or banker's acceptances issued by domestic banks (but not their foreign branches) having, together with branches or subsidiaries, total assets in excess of $2 billion; high dividend-paying common stocks; and warrants. Securities rated Baa by Moody's are described by it as having speculative characteristics and, according to S&P, fixed income securities rated BBB normally exhibit adequate protection parameters, although adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal. Except when in a temporary defensive investment position, the Portfolio intends to maintain at least 65% of its assets invested in bonds. The Portfolio may also invest in U.S. Government securities, and money market instruments, and may enter into repurchase agreements, and for temporary defensive purposes, may increase its investment in these securities. OTHER TECHNIQUES. The Bond and Income Portfolio may enter into reverse repurchase agreements, and lend its portfolio securities, in each case in accordance with the description of those techniques (and subject to the same risks) set forth in this Prospectus and in the Statement of Additional Information. INVESTMENT OBJECTIVE. Provide investment results that correspond to the total return performance of common stocks that are publicly traded in the United States. INVESTMENT POLICIES. The Portfolio attempts to achieve its objective by investing in stocks included in the Standard & Poor's 500 Composite Stock Price Index ("S&P 500" or the "Index"). The Portfolio attempts to replicate the investment results of the S&P 500, while minimizing transactional costs and other expenses. The Portfolio will purchase the common stock of those companies included in the S&P 500, which the Portfolio Manager believes, based on statistical data, will represent the industry diversification of the entire S&P 500. The Portfolio will be managed to attempt to minimize the degree to which the investment results of the Portfolio (before taking into account the Portfolio's expenses) differ from the results of the Index ("tracking error"). The Portfolio will incur expenses not reflected in the investment results of the Index, including advisory and administrative fees and transactional and other expenses. The degree to which the Portfolio correlates with the Index will depend upon the size and cash flow of the Portfolio, the liquidity of the securities represented in the Index, and the Portfolio's expenses, among other factors. There is no fixed number of component stocks in which the Portfolio will invest. However, it is anticipated that under normal circumstances the Portfolio will hold between 200 and 450 of the stocks listed in the S&P 500. The composition of the portfolio securities may be rebalanced by the Portfolio Manager at such times as it deems advisable in order to minimize tracking error. No attempt, however, is made to "manage" the Portfolio in the traditional sense, such as by using economic, financial, and market analysis, nor will the adverse financial situation of a company directly result in its elimination from the Portfolio unless, of course, the company is removed from the Index. From time to time, administrative adjustments may be made in the Portfolio because of mergers, changes in the composition of the Index, and similar reasons, but such changes should be infrequent and the attendant costs minimized. Thus, portfolio turnover is expected to be lower than that of most other investment company portfolios investing in common stock. As a consequence, brokerage costs are expected to be relatively low. Due to tracking error, transactional costs, and other expenses, the return on the Portfolio likely will be lower than the return on the S&P 500. OTHER TECHNIQUES. The Portfolio may purchase and sell stock index futures, purchase options on stock indexes, and purchase options on stock index futures that are based on stock indexes which the Portfolio attempts to track or which tend to move together with stocks included in the index. The Portfolio may use these techniques as an adjunct to its securities activities or to hedge against changes in securities prices. See "Options" below and "Futures Contracts and Futures Options" below. The Portfolio may invest in foreign equity securities if U.S. exchange listed to the extent included in the S&P 500. The Portfolio may temporarily invest cash balances, maintained for liquidity purposes or pending investment, in short-term high quality debt instruments, including commercial paper, bank obligations, and U.S. Government securities. Temporary investments will not be made for defensive purposes in the event of or in anticipation of a general decline in the market price of stocks in which the Portfolio invests. A defensive investment posture is precluded by the investment objective to provide investment results that correspond to the total return performance of common stocks that are publicly traded in the United States; accordingly, investors in the Portfolio bear the risk of general declines in stock prices in the stock markets. ABOUT THE S&P 500: The S&P 500 is a capitalization-weighted index, based on the relative market capitalization of 500 different companies selected by S&P, including companies in the industrial, utility, financial, and transportation industry sectors. The weightings of stocks in the Index are based on each component stock's relative total market value, that is, its market price per share multiplied by the number of common shares outstanding for that company. S&P may, from time to time, adjust the composition of common stocks in the Index. Inclusion of a stock in the S&P 500 in no way implies an opinion by S&P as to its attractiveness as an investment; nor is S&P a sponsor or in any way affiliated with the Portfolio, the Fund, the Adviser, or the Portfolio Manager. The Fund reserves the right to change the index whose performance the Portfolio will attempt to replicate or for the Portfolio to seek its investment objective by means other than attempting to replicate an index, such as by operating the Portfolio as a managed fund, and reserves the right to do so without seeking shareholder approval, but only if operating the Portfolio as described above is not permitted under applicable law for an investment company that serves as an investment medium for variable insurance contracts, or otherwise involves substantial legal risk. See "What is the Federal Income Tax Status of the Fund" below. INVESTMENT OBJECTIVE. Seek long-term capital appreciation primarily through investment in equity securities of corporations domiciled in countries other than the United States. Current income from dividends and interest will not be an important consideration. INVESTMENT POLICIES. Other than when in a defensive posture, at least 70% of the Portfolio's assets will consist of corporate securities, primarily common stock and, to a lesser extent, securities convertible into common stock. The Portfolio may, however, for defensive purposes as described below, invest in non-convertible fixed income securities denominated in currencies of foreign countries and in United States dollars. The Portfolio will attempt to maximize opportunity and reduce risk by investing in a diversified portfolio of companies in different stages of development. Portfolio companies will range from large, well established companies to medium-sized companies and smaller, less seasoned companies in an earlier stage of development. The allocation of the Portfolio's assets among the various securities markets in the different countries will be determined by the Portfolio Manager. In making the allocation of assets among the securities markets, the Portfolio Manager may consider such factors as technological developments in the various countries, the condition and growth potential for the various economies and securities markets, currency and taxation considerations, and other pertinent financial, social, national, and political factors. Some of these countries can be considered "emerging market countries," which generally refers to countries whose economies are less developed or mature than economies in other countries or whose markets are undergoing a process of development. Under certain adverse investment conditions, the Portfolio may restrict the securities markets in which its assets will be invested, and may increase the proportion of assets invested in United States Government and money market securities. The Portfolio reserves the right as a defensive measure to invest in nonconvertible fixed income securities denominated in currencies of foreign countries and in United States dollars. (For this purpose, investments made for defensive purposes will be maintained only during periods in which Templeton determines that economic or financial conditions are adverse for holding equity securities of corporate issuers.) Securities held for defensive purposes, which include non-convertible preferred stock, debt securities, government securities issued by United States and foreign countries, and money market securities, may be held in such proportions as, in the opinion of the Portfolio Manager, prevailing market or economic conditions warrant. The Portfolio may invest up to 5% of its assets, measured at the time of investment, in debt securities that are rated below investment grade, or if not rated, of equivalent quality. See "High Yield Bonds." The Portfolio may also hold cash (in United States dollars or foreign currencies) or short-term securities denominated in such currencies to provide for redemptions; it is not expected that such reserve for redemptions will exceed 10% of the Portfolio's assets. Money market securities which may be held defensive purposes, or to provide for redemptions, include short-term corporate or U.S. Government obligations and bank certificates of deposit. The Portfolio is subject to guidelines for diversification of foreign security investments that prescribe the minimum number of countries in which the Portfolio's assets may be invested. These guidelines are discussed under "Foreign Securities." The Portfolio may not invest in securities that are subject to restrictions on resale, or which are not otherwise readily marketable, if, as a result, more than 5% of its total assets would be invested in such securities. OTHER TECHNIQUES. The Portfolio may enter into repurchase agreements and may lend its securities to brokers, dealers, and other financial institutions to earn income. The Portfolio may purchase and sell financial futures contracts, stock index futures contracts, and foreign currency futures contracts and options on such futures contracts. See "Futures Contracts and Futures Options." RISKS OF FOREIGN INVESTMENT. Investing in the securities of foreign issuers involves special risks and considerations not typically associated with investing in U.S. companies. These risks include exposure to foreign currencies and fluctuations in such currencies and political, economic, regulatory, and operational factors associated with exposure to foreign countries. Investment in emerging market countries presents risks in greater degree than, and in addition to, those presented by investment in foreign issuers in general. See "Foreign Securities" below and in the Statement of Additional Information for a discussion of some of the risks associated with foreign investment. The United States Government has, from time to time in the past, imposed restrictions, through taxation and otherwise, on foreign investments by United States investors such as the Portfolio. If such restrictions should be reinstituted, it might become necessary for the Portfolio to invest all, or substantially all, of its assets in United States short-term securities. In such event, the Portfolio would review its investment objective and investment policies to determine whether changes are appropriate. CURRENCY TECHNIQUES. The Portfolio may engage in foreign currency transactions in anticipation of or to protect itself against fluctuations in currency exchange rates. The Portfolio may enter into forward currency contracts. The Portfolio may also purchase and write put and call options on foreign currencies. The use of these techniques is discretionary with the Portfolio Manager, and there is no commitment to use them. See "Securities and Investment Techniques" below and in the Statement of Additional Information for a description of these techniques and their attendant risks. ALL PORTFOLIOS: DIVERSIFICATION AND CHANGES IN POLICIES Each of the Portfolios is diversified, so that with respect to 75% of the assets of each Portfolio, it may not invest more than 5% of its assets (taken at market value at the time of investment) in securities of any one issuer, except that this restriction does not apply to U.S. Government securities. The investment policies for any of the Portfolios may be changed by the Fund's Board of Trustees. The investment objective of each Portfolio, as described in the previous section, is considered "fundamental." In addition, the Portfolios are subject to investment restrictions that are described in the Statement of Additional Information. Some of those investment restrictions, including the diversified status of each Portfolio, are also designated as "fundamental." These fundamental investment objectives and investment restrictions require a vote of a majority of the shareholders of a Portfolio to be changed. This section describes certain securities and investment techniques that may be used by the Portfolios and the potential risks associated with these securities and investment techniques. For more detailed information on these investment techniques, see the Statement of Additional Information. The Statement of Additional Information also contains information on other types of securities in which a Portfolio may invest, including U.S. Government securities, debt securities generally, variable and floating rate securities, repurchase agreements, reverse repurchase agreements, lending portfolio securities, firm commitment agreements and when-issued securities, and warrants. APPLICABLE PORTFOLIOS: High Yield Bond, Managed Bond, Government Securities, Growth LT, Multi-Strategy, Equity, and Bond and Income Portfolios. The Government Securities, Growth LT, and Multi-Strategy Portfolios may invest only in high-quality, mortgage-related (or other asset-backed) securities either (i) issued by United States Government sponsored corporations (currently GNMA, FHLMC, FNMA) or (ii) rated Aa or better by Moody's or AA or better by S&P or, if not rated, determined to be of equivalent investment quality. The Equity Portfolio and Bond and Income Portfolio may only invest in mortgage-related securities that are obligations of, or guaranteed by, the U.S. Government, its agencies, or instrumentalities. Mortgage-related securities include mortgage pass-through securities, which are securities under which payments of both interest and principal from an underlying pool of mortgages are made periodically, in effect "passing through" payments made by the individual borrowers on the mortgage loans. Timely payment of principal and interest on mortgage backed securities known as "GNMAs", which are guaranteed by the Government National Mortgage Association, is guaranteed by the full faith and credit of the U.S. Government. Some mortgage related securities are not backed by the full faith and credit of the U.S. Government, but are guaranteed by agencies or instrumentalities of the U.S. Government such as the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"). Other mortgage-related securities are issued by financial institutions such as commercial banks, savings and loan associations, mortgage banks, and securities broker-dealers (or affiliates) and are called collateralized mortgage obligations ("CMOs"). CMOs are fully collateralized directly or indirectly by a pool of mortgages, and in some instances by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or FNMA. Payments are passed through to the holders, although not necessarily on a pro rata basis, on the same schedule as they are received. CMOs are structured into multiple classes, with each class bearing a different stated maturity. Monthly payments of principal, including prepayments, generally are first returned to investors holding the shortest maturity class; investors holding the longer maturity classes receive principal only after the first class has been retired. The Managed Bond, Government Securities, and Multi-Strategy Portfolios may also invest in stripped mortgage-backed securities and CMO residuals. Stripped mortgage-backed securities are usually structured with two classes. One class will receive all of the interest (the interest-only class, or "IO"), whereas the other class will receive all of the principal (the principal-only class or "PO"). RISKS OF MORTGAGE-RELATED SECURITIES. Although mortgage loans underlying a mortgage-related security may have maturities of up to 30 years, the actual average life of a mortgage-backed security typically will be substantially less because (1) the mortgages will be subject to normal principal amortization, and (2) may be prepaid prior to maturity due to the sale of the underlying property, the refinancing of the loan, or foreclosure. Early repayment may expose a Portfolio to a lower rate of return upon reinvestment of the principal. Prepayment rates vary widely and cannot be accurately predicted. They may be affected by changes in market interest rates. Therefore, prepayments will be reinvested at rates that are available upon receipt, which likely will be higher or lower than the original yield on the certificates. Accordingly, the actual maturity and realized yield on pass-through or modified pass-through mortgage-related securities will vary from the designated maturity and yield on the original security based upon the prepayment experience of the underlying pool of mortgages. Stripped mortgage-backed securities are likely to experience greater price volatility than other types of mortgage securities. The yield to maturity on the IO class is extremely sensitive, both to changes in prevailing interest rates and to the rate of principal payments (including prepayments) on the underlying mortgage assets. Similarly, the yield to maturity on CMO residuals is extremely sensitive to prepayments on the related underlying mortgage assets. In addition, if a series of a CMO includes a class that bears interest at an adjustable rate, the yield to maturity on the related CMO residual will also be extremely sensitive to changes in the level of the index upon which interest rate adjustments are made. A Portfolio could fail to fully recover its initial investment in a CMO residual or a stripped mortgage-backed security. OTHER ASSET-BACKED SECURITIES. The High Yield Bond, Managed Bond, Growth LT and Multi-Strategy Portfolios may purchase other asset-backed securities which are backed by particular assets such as automobile loans, installment sales contracts, home equity loans, computer and other leases, credit card receivables, or other assets. As in the case of mortgage-related securities, those asset-backed securities are subject to prepayment risk, which will alter an instrument's maturity and yield. Other risks relate to the nature of the underlying collateral. For example, credit card debt receivables are generally unsecured and the debtors are entitled to the protection of a number of consumer credit laws, many of which can result in reductions in outstanding balances. Additionally, holders of asset-backed securities may also experience delays in payments or losses if the full amounts due on underlying sales contracts are not realized. Because asset-backed securities are relatively new, the market experience in these securities is limited and the market's ability to sustain liquidity through all phases of the market cycle has not been tested. APPLICABLE PORTFOLIOS. High Yield Bond, Managed Bond (up to 10% of its assets), Growth LT (up to 10% of its assets), and International Portfolios (up to 5% of its assets). Generally, high yield/high risk debt securities are those rated lower than Baa or BBB, or, if not rated by Moody's or S&P, of equivalent quality (although the Managed Bond Portfolio may not invest in securities rated lower than B) and which are commonly referred to as "junk bonds". Investment in such securities generally provides greater income and increased opportunity for capital appreciation than investments in higher quality debt securities, but they also typically entail greater potential price volatility and principal and income risk. In general, high yield bonds are not considered to be investment grade. They are regarded as predominately speculative with respect to the issuing company's continuing ability to meet principal and interest payments. The prices of high yield bonds have been found to be less sensitive to interest-rate changes than higher-rated investments, but more sensitive to adverse economic downturns or individual corporate developments. A projection of an economic downturn or of a period of rising interest rates, for example, could cause a decline in high yield bond prices. In the case of high yield bonds structured as zero-coupon or pay-in-kind securities, their market prices are affected to a greater extent by interest rate changes, and therefore tend to be more volatile than securities which pay interest periodically and in cash. The secondary market in which high yield bonds are traded is generally less liquid than the market for higher grade bonds. Less liquidity in the secondary trading market could adversely affect the price at which a Portfolio could sell a high yield bond, and could adversely affect the daily net asset value of the Portfolio's shares. At times of less liquidity, it may be more difficult to value the high yield bonds because such valuation may require more research, and elements of judgment may play a greater role in the valuation because there is less reliable, objective data available. APPLICABLE PORTFOLIOS. Growth LT, Equity Portfolios, and to a lesser degree, Equity Income and Multi-Strategy Portfolios. Investments in larger companies present certain advantages in that such companies generally have greater financial resources, more extensive research and development, manufacturing, marketing and service capabilities, more stability and greater depth of management and technical personnel. Investments in smaller, less seasoned companies may present greater opportunities for growth but also involve greater risks than customarily are associated with more established companies. The securities of smaller companies may be subject to more abrupt or erratic market movements than larger, more established companies. These companies may have limited product lines, markets or financial resources, or they may be dependent upon a limited management group. Their securities may be traded only in the over-the-counter market or on a regional securities exchange and may not be traded every day or in the volume typical of trading on a major securities exchange. As a result, the disposition by a Portfolio of securities to meet redemptions or otherwise may require the Portfolio to sell these securities at a discount from market prices or during a period when such disposition is not desirable or to make many small sales over a lengthy period of time. Though not an ordinary practice, each Portfolio may borrow money to help meet redemptions or for other purposes. Borrowing may exaggerate the effect on net asset value of any increase or decrease in the market value of a Portfolio, and money borrowed will be subject to interest costs. For information on limits on the ability of any Portfolio to borrow, see the Statement of Additional Information. APPLICABLE PORTFOLIOS: All Portfolios may acquire illiquid securities. The Money Market, High Yield Bond, Growth LT, Equity Income, Multi-Strategy, Equity, and Bond and Income Portfolios may acquire restricted securities and the International Portfolio may invest up to 5% of its assets in restricted securities. A Portfolio may invest in an illiquid or restricted security if the Portfolio Manager believes that it presents an attractive investment opportunity. Generally, a security is considered illiquid if it cannot be disposed of within seven days. Its illiquidity might prevent the sale of such a security at a time when a Portfolio Manager might wish to sell, and these securities could have the effect of decreasing the overall level of a Portfolio's liquidity. Further, the lack of an established secondary market may make it more difficult to value illiquid securities, requiring the Fund to rely on judgments that may be somewhat subjective in determining value, which could vary from the amount that a Portfolio could realize upon disposition. Restricted securities, including private placements, are subject to legal or contractual restrictions on resale. They can be eligible for purchase without SEC registration by certain institutional investors known as "qualified institutional buyers," and under the Fund's procedures, restricted securities could be treated as liquid. However, some restricted securities may be illiquid and restricted securities that are treated as liquid could be less liquid than registered securities traded on established secondary markets. A Portfolio may not invest more than 15%, (10% for the Money Market Portfolio), of its total assets in illiquid securities, measured at the time of investment. APPLICABLE PORTFOLIOS. Equity Portfolio, and possibly other Portfolios that invest in equity securities. Precious-metals-related securities are considered equity securities of U.S. and foreign companies involved in the exploration, mining, development, production, or distribution of gold or other natural resources, including minerals and metals such as copper, aluminum, silver, platinum, uranium, strategic metals, diamonds, coal, oil, and phosphates. The value of these securities may be affected by worldwide financial and political factors, and prices may fluctuate sharply over short time periods. For example, precious metals securities may be affected by changes in inflation expectations in various countries, metal sales by central banks of governments or international agencies, governmental restrictions on the private ownership of certain precious metals or minerals and other factors. For a more extensive discussion of the risks of investing in foreign securities, see the discussion in "Foreign Securities" below. APPLICABLE PORTFOLIOS: International Portfolio--invests primarily in equity securities of foreign issuers and may invest in debt securities of foreign issuers; Growth LT Portfolio--may invest up to 25% of its assets in foreign securities denominated in a foreign currency; Growth LT, Equity Income, Multi- Strategy, and Equity Index Portfolios--may invest in equity securities of foreign issuers if U.S. exchange listed or included in the S&P 500; Managed Bond and Government Securities Portfolios--may invest up to 10% of their assets in foreign debt securities denominated in a foreign currency; Money Market, High Yield Bond, Managed Bond, Government Securities, Growth LT, Multi- Strategy, and International Portfolios--may invest in fixed income securities, including money market instruments and bank obligations of foreign issuers, including corporate, foreign governmental, and international agency issuers, that are denominated in U.S. dollars. All Portfolios may purchase American Depositary Receipts (ADRs), which are dollar-denominated receipts issued generally by domestic banks and representing the deposit with the bank of a security of a foreign issuer. ADRs are publicly traded on exchanges or over- the-counter in the United States. The Growth LT and International Portfolios may invest in European Depositary Receipts (EDRs), which are receipts issued in Europe, typically by banking institutions in London or Brussels, which evidence a similar ownership arrangement, and are designed for use in European securities markets, and Global Depositary Receipts (GDRs), which are similar to ADRs, but are issued and traded in several international financial markets, as well as other types of receipts of shares evidencing ownership of the underlying foreign securities. Most foreign securities are denominated in foreign currencies and investment in foreign securities involves exposure to currency fluctuations. Transactions in most foreign securities are conducted in foreign currencies, so that a Portfolio's assets must be exchanged for another currency each time a security is bought or sold or a dividend is paid. Similarly, share price quotations and total return information reflect conversion into U.S. dollars. Fluctuations in foreign exchange rates can significantly increase or decrease the U.S. dollar value of a foreign investment, which will enhance or diminish the return of a foreign security in its own currency. Investing in the securities of foreign issuers involves other special risks and considerations not typically associated with investing in U.S. companies. These include differences in accounting, auditing and financial reporting standards, generally higher commission rates on foreign portfolio transactions, the possibility of expropriation, nationalization or confiscatory taxation, adverse changes in investment or exchange control regulations, political instability that could affect U.S. investments in foreign countries, and potential restrictions on the flow of international capital. In many countries, there is less publicly available information about issuers than is available in reports about companies in the United States. It may be more difficult to obtain and enforce judgments against foreign entities. Additionally, income (including interest and dividends) derived from foreign securities may be subject to foreign taxes, including foreign withholding taxes, and other foreign taxes may apply with respect to securities transactions. Foreign securities often trade with less frequency and volume than domestic securities and therefore may exhibit greater price volatility and less liquidity. These risks are intensified with respect to investments in emerging market countries. In addition, a number of the currencies of developing countries have experienced significant declines against the U.S. dollar in recent years, and devaluation may occur subsequent to investments in these currencies by a Portfolio. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of certain emerging market countries. Emerging markets have different clearance and settlement procedures and in certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions making it difficult to conduct such transactions. The inability of the Fund to make intended security purchases due to settlement problems could cause the Fund to miss attractive investment opportunities. Inability to dispose of a portfolio security due to settlement problems could result either in losses to the Fund due to subsequent declines in the value of the portfolio security or, if the Fund has entered into a contract to sell a security, could result in possible liability of the Fund to the purchaser. Investment in foreign securities also involves the risk of possible losses through the holding of securities in custodian banks and securities depositories in foreign countries. For a description of the Fund's custody arrangements for foreign securities, see "Foreign Securities" in the Statement of Additional Information. DIVERSIFICATION. Each Portfolio that invests in foreign securities is subject to guidelines for diversification of foreign security investments that are imposed by California insurance authorities. Under these guidelines, foreign investments must be allocated to at least five countries if at least 80% of a Portfolio's net assets is invested in foreign issuers. A Portfolio may not invest more than 20% of its net assets in any one country, except that a Portfolio may invest up to 35% of its net assets in issuers domiciled or primarily traded in any one of the following countries: Australia, Canada, France, Japan, the United Kingdom, or Germany. A Portfolio is not subject to any limit upon investment in issuers domiciled or primarily traded in the United States. The California diversification guidelines are more fully described in the Statement of Additional Information. APPLICABLE PORTFOLIOS: Managed Bond, Government Securities, Growth LT, Multi- Strategy, and International Portfolios. A forward currency contract is an obligation to purchase or sell a currency against another currency at a future date at a price set at the time of the contract. A Portfolio could engage in a forward currency transaction in anticipation of or to protect itself against fluctuations in currency exchange rates. Although forward contracts typically will involve the purchase or sale of a foreign currency against the dollar, a Portfolio also may purchase or sell one foreign currency forward against another foreign currency. There are certain markets where it is not possible to engage in effective foreign currency hedging. This may be true, for example, for the currencies of various Latin American countries in which the foreign exchange markets are not sufficiently developed to permit hedging activity to take place. A Portfolio's dealings in forward foreign exchange will be limited to hedging involving either specific transactions or portfolio positions. Transaction hedging is the purchase or sale of forward foreign currency to "lock in" the U.S. dollar price of a security purchased or sold by a Portfolio. Position hedging is the sale of forward foreign currency with respect to portfolio security positions denominated in a foreign currency. A Portfolio will not speculate in forward foreign exchange. Employing hedging strategies with forward currency contracts does not eliminate fluctuations in the prices of portfolio securities or prevent losses if the prices of such securities decline. Forward contracts involve some transactional expense for a Portfolio. Although forward contracts will be used primarily to protect a Portfolio from adverse currency movements, they also involve the risk that anticipated currency movements will not be accurately predicted and a Portfolio's total return could be adversely affected as a result. For a more extensive description of this investment technique see "Foreign Currency Transactions" in the Statement of Additional Information. APPLICABLE PORTFOLIOS: The High Yield Bond, Managed Bond, Government Securities, Growth LT, Equity Income, and Multi-Strategy Portfolios may purchase put and call options on securities in pursuing their investment objectives. The High Yield Bond, Managed Bond, Government Securities, Growth LT, Equity Income, and Multi-Strategy Portfolios may sell (write) covered call and secured put options. The Growth LT, Equity Income, Multi-Strategy, and Equity Index Portfolios may purchase put and call options on securities indexes that are exchange traded to protect against price movements in the stock market generally (or in particular segments of the market) rather than in individual stocks. The Equity Portfolio may write covered call options that are traded on a national securities exchange with respect to securities comprising 25% of its aggregate net assets, taken at market value at the time the option is written. For a description of these techniques, see the Statement of Additional Information. RISKS OF OPTIONS TRANSACTIONS. The purchase and selling (writing) of options involves certain risks. During the option period, the covered call writer has given up the opportunity to profit from a price increase in the underlying securities above the exercise price. The writer of an option has no control over the time when it may be required to fulfill its obligation as a writer of the option. If a put or call option purchased by a Portfolio is not sold when it has remaining value, and if the market price of the underlying security, in the case of a put, remains equal to or greater than the exercise price or, in the case of a call, remains less than or equal to the exercise price, the Portfolio will lose its entire investment in the option. Also, where a put or call option is purchased to hedge against price movements in a particular security or market, the price of the put or call option may move more or less than the price of the related security or index. In this regard, index options can never be a perfect hedge against the overall risk of a stock position except where the stock position and the index are composed of exactly the same stocks, in the same proportions. There can be no assurance that a liquid market will exist when a Portfolio seeks to close out an option position. Furthermore, if trading restrictions or suspensions are imposed on the options markets, a Portfolio may be unable to close out a position. APPLICABLE PORTFOLIOS: Growth LT and International Portfolios. Options on foreign currencies may be purchased or written as a hedge against changes in the value of the U.S. dollar (or another currency) in relation to a foreign currency in which a Portfolio's securities may be denominated. Currency options traded on U.S. or other exchanges may be subject to position limits which may limit the ability of the Portfolio to reduce foreign currency risk using such options. Over-the-counter options may be negotiated, but they generally do not have as much market liquidity as exchange-traded options. Employing hedging strategies with options on currencies does not eliminate fluctuations in the prices of portfolio securities or prevent losses if the prices of such securities decline. Furthermore, such hedging transactions reduce or preclude the opportunity for gain if the value of the hedged currency should change relative to the U.S. dollar (or other hedged currency). A Portfolio will not speculate in options on foreign currencies. There is no assurance that a liquid secondary market will exist for any particular foreign currency option, or at any particular time. In the event no liquid secondary market exists, it might not be possible to effect closing transactions in particular options. If a Portfolio cannot close out an option which it holds, it would have to exercise its option in order to realize any profit and would incur transactional costs on the sale of the underlying assets. APPLICABLE PORTFOLIOS: High Yield Bond Portfolio. The High Yield Bond Portfolio may purchase and sell covered spread options to securities dealers. Covered spread options are not presently exchange listed or traded. The purchase of a spread option gives the Portfolio the right to put, or sell, a security that it owns at a fixed dollar spread or fixed yield spread in relationship to another security that the Portfolio does not own, but which is used as a benchmark. The purchase of spread options will be used to protect the Portfolio against adverse changes in the yield spread between high quality and lower quality securities. Such protection is only provided during the life of the spread option. The risk of loss on a spread transaction includes the premium and any transaction costs paid by the Portfolio to obtain the option. There is no assurance that closing transactions will be available. For more information see the discussion of Spread Transactions in the "Securities and Investment Techniques" in the Statement of Additional Information. FUTURES CONTRACTS AND FUTURES OPTIONS APPLICABLE PORTFOLIOS: The High Yield Bond, Managed Bond, Government Securities, Growth LT, Multi-Strategy and International Portfolios may invest in interest rate futures contracts and options thereon. The Growth LT, Equity Income, Multi-Strategy, Equity Index and International Portfolios may invest in stock index futures contracts and options thereon. The High Yield Bond, Managed Bond, Government Securities, Growth LT, and Multi-Strategy Portfolios may purchase and write call and put options on interest rate futures contracts, and the Growth LT, Equity Income, Multi-Strategy, and Equity Index Portfolios may purchase call and put options on stock index futures ("futures options"). The Growth LT and International Portfolios may invest in foreign currency futures contracts and may purchase and write options thereon. USE OF FUTURES. These investments may be made for bona fide hedging purposes and as an adjunct to a Portfolio's securities activities. A Portfolio is required to collateralize or cover a futures transaction or futures option so that the position will be unleveraged. For a general description of these futures contracts and options thereon, including information on margin requirements, see the Statement of Additional Information. RISKS OF FUTURES AND FUTURES OPTIONS. There are several risks associated with the use of futures and futures options. While a Portfolio's hedging transactions may protect the Portfolio against adverse movements in the general level of interest rates or stock or currency prices, such transactions could also preclude the opportunity to benefit from favorable movements in the level of interest rates or stock or currency prices. A hedging transaction may not correlate perfectly with price movements in the assets being hedged. An incorrect correlation could result in a loss on both the hedged assets in a Portfolio and/or the hedging vehicle, so that the Portfolio's return might have been better had hedging not been attempted. There can be no assurance that a liquid market will exist at a time when a Portfolio seeks to close out a futures contract or a futures option position. Most futures exchanges and boards of trade limit the amount of fluctuation permitted in futures contract prices during a single day; once the daily limit has been reached on a particular contract, no trades may be made that day at a price beyond that limit. In addition, certain of these instruments are relatively new and lack a deep secondary market. Lack of a liquid market for any reason may prevent a Portfolio from liquidating an unfavorable position and the Portfolio would remain obligated to meet margin requirements until the position is closed. A Portfolio other than the Growth LT and International Portfolios will only enter into futures contracts or futures options which are standardized and traded on a U.S. exchange or board of trade, or, in the case of futures options, for which an established over-the-counter market exists. Each Portfolio is subject to limitations on the amount that may be invested in futures and futures options transactions for purposes other than bona fide hedging, under which initial margin deposits for futures contracts and premiums paid for futures options may not exceed 5% of a Portfolio's total assets (net of amounts that are "in the money"). FOREIGN FUTURES. The Growth LT and International Portfolios may trade futures contracts and options on futures contracts not only on U.S. domestic markets, but also on exchanges located outside of the United States. Foreign markets may offer advantages such as trading in indices that are not currently traded in the United States. Foreign markets, however, may have greater risk potential than domestic markets. Unlike trading on domestic commodity exchanges, trading on foreign commodity exchanges is not regulated by the Commodity Futures Trading Commission ("CFTC"). Foreign exchanges generally are principal markets so that no common clearing facility exists, and a Portfolio might be able to look only to the broker for performance of the contract. Amounts received for foreign futures or foreign options transactions may not be provided the same protection as funds received in respect of transactions on United States futures exchanges. Trading in foreign futures or foreign options contracts may not be afforded certain of the protective measures provided by U.S. law and regulation, including the right to use reparations proceedings before the CFTC and arbitration proceedings provided by the National Futures Association or any domestic futures exchange. In addition, any profits that a Portfolio might realize in trading could be eliminated by adverse changes in the exchange rate of the currency in which the transaction is denominated. Transactions on foreign exchanges may include both commodities that are traded on domestic exchanges or boards of trade and those that are not. The Fund reserves the right to engage in other types of futures transactions in the future. ORGANIZATION AND MANAGEMENT OF THE FUND HOW IS THE FUND ORGANIZED? The Fund was organized as a Massachusetts business trust on May 4, 1987, and currently consists of eleven separate Portfolios. The assets of each Portfolio are segregated, and your interest is limited to the Portfolio to which proceeds from your Variable Contract's Accumulated Value is allocated. WHO OVERSEES THE BUSINESS OF THE FUND? The business and affairs of the Fund are managed under the direction of the Board of Trustees under the Fund's Agreement and Declaration of Trust. The Trustees are Thomas C. Sutton, Richard L. Nelson, Lyman W. Porter, and Alan Richards. Mr. Sutton is also the Chief Executive Officer of Pacific Mutual. Messrs. Nelson, Porter, and Richards are independent trustees. See the Statement of Additional Information under the heading "Management of the Fund." WHO IS THE FUND'S INVESTMENT ADVISER? Pacific Mutual Life Insurance Company. Pacific Mutual's relationship with the Fund is governed by an Investment Advisory Agreement. Under this agreement, Pacific Mutual, subject to the supervision of the Fund's Board of Trustees, administers the affairs of the Fund and supervises the investment program for the Fund's Portfolios. MORE ABOUT PACIFIC MUTUAL. Pacific Mutual is a mutual life insurance company that was organized under the laws of the State of California and was authorized to conduct business as a life insurance company on January 2, 1868. Its address is 700 Newport Center Drive, Post Office Box 9000, Newport Beach, California 92660. Pacific Mutual offers a complete line of life insurance policies and annuity contracts, as well as financial and retirement contracts. As of the end of 1994, Pacific Mutual had over $38.3 billion of individual life insurance in force and total assets of approximately $14.7 billion. Together with its subsidiaries and affiliated enterprises, Pacific Mutual had total assets and funds under management of over $91.1 billion. Pacific Mutual also provides investment advisory services to the Money Market Fund of PIMCO Advisors Institutional Trust, and has had extensive investment advisory experience in managing its general account and pension and other accounts. DOES PACIFIC MUTUAL MANAGE ANY OF THE PORTFOLIOS DIRECTLY? Pacific Mutual directly manages both the High Yield Bond and the Money Market Portfolios. Mr. Larry J. Card, Executive Vice President, Securities, of Pacific Mutual, has primary responsibility for investment management of the Money Market Portfolio, as well as various other accounts of Pacific Mutual. Mr. Card joined Pacific Mutual in 1972 and holds a Bachelor of Science Degree from Northern State College and an MBA Degree from Harvard University. He is a Chartered Financial Analyst. Mr. Raymond J. Lee has portfolio management responsibilities for the High Yield Bond Portfolio, and also is in charge of all publicly traded bonds and has responsibility for portfolio management of pension assets for Pacific Mutual. Mr. Lee is Senior Vice President, Portfolio Manager, of Pacific Mutual, and joined Pacific Mutual in 1976 after completing his MBA in Finance from the Wharton School of the University of Pennsylvania. Mr. Lee received his bachelor's degree in Economics from UCLA. He is a member of the Los Angeles Society of Financial Analysts. Mr. Simon T. Lee, Assistant Vice President, Securities, of Pacific Mutual, shares portfolio management responsibilities for the High Yield Bond Portfolio and has responsibility for portfolio management of Pacific Mutual's high yield and convertible bond assets. Mr. Lee joined Pacific Mutual in 1985. He holds a bachelor's degree in Business Administration and an MBA from Loyola Marymount University. He is a Chartered Financial Analyst. Pacific Mutual and the Fund employ other investment advisory firms as Portfolio Managers for nine of the Fund's eleven Portfolios. WHO IS THE PORTFOLIO MANAGER FOR THE MANAGED BOND AND GOVERNMENT SECURITIES PORTFOLIOS? Pacific Investment Management Company ("PIMCO"). PIMCO is an investment management firm organized as a general partnership. PIMCO is the successor investment adviser to the former Pacific Investment Management Company, which was an indirect wholly-owned subsidiary of Pacific Mutual that commenced operations in 1971. PIMCO has two partners, PIMCO Advisors L.P. as the supervisory partner, and PIMCO Management, Inc. as the managing partner. PIMCO is a subsidiary partnership of PIMCO Advisors L.P. a Delaware limited partnership organized in 1987. PIMCO Advisors L.P. succeeded to the investment advisory and other business of PIMCO and other former investment advisory subsidiaries of Pacific Mutual as a result of a consolidation of PIMCO and other businesses with Thomson Advisory Group L.P., the former name for PIMCO Advisors L.P., which closed in November, 1994. A portion of the units of the limited partner interests in PIMCO Advisors L.P. is traded publicly on the New York Stock Exchange. The general partner of PIMCO Advisors L.P. is PIMCO Partners, G.P. Pacific Mutual and its subsidiaries and affiliates hold a substantial interest in PIMCO Advisors L.P. through direct or indirect ownership of its outstanding units, and indirectly hold a majority interest in PIMCO Partners G.P., with a remainder held indirectly by a group comprised of the Managing Directors of PIMCO. PIMCO Advisors L.P. is governed by an Operating Board and an Equity Board, which exercise substantially all of the governance powers of the general partner and serves as the functional equivalent of a board of directors. PIMCO had approximately $56.9 billion assets under management as of year-end 1994. PIMCO also provides investment advisory services to PIMCO Funds and several other mutual fund portfolios and to private accounts for pension and profit sharing plans. PIMCO's address is 840 Newport Center Drive, Suite 360, Newport Beach, California 92660. WHO AT PIMCO MANAGES THE MANAGED BOND AND GOVERNMENT SECURITIES PORTFOLIOS? Mr. John L. Hague, Managing Director and senior member of PIMCO, has primary responsibility for investment management of the Managed Bond and Government Securities Portfolios as well as various other accounts of PIMCO. Mr. Hague joined Pacific Investment Management Company in 1987. During his 14 years of investment experience, he was associated with Salomon Brothers, Inc. specializing in international fixed income products and mortgage securities and Morgan Guaranty in credit research. Mr. Hague holds a bachelor's degree in Economic Analysis from Bowdoin College and an MBA in Finance from Stanford University. WHO IS THE PORTFOLIO MANAGER FOR THE GROWTH LT PORTFOLIO? Janus Capital Corporation ("Janus"). Kansas City Southern Industries, Inc. owns approximately 83% of the outstanding voting stock of Janus. Janus' address is 100 Fillmore Street, Suite 300, Denver, Colorado 80206-4923. Janus currently serves as investment adviser or subadviser to the Janus Funds, as well as other mutual funds and individual, corporate, charitable, and retirement accounts. WHO AT JANUS MANAGES THE GROWTH LT PORTFOLIO? Warren B. Lammert, III, Vice President of Janus, is primarily responsible for the day-to-day management and implementation of Janus' investment strategy for the Growth LT Portfolio. Mr. Lammert is portfolio manager and Executive Vice President of Janus Mercury Fund and Janus Venture Fund, Executive Vice President of Janus Investment Fund, and has been the portfolio manager of various growth oriented accounts since 1991. He joined Janus as a securities analyst in 1987, taking an educational sabbatical from 1988 to 1989. He received his undergraduate degree in economics from Yale University and received his M.S. in economic history (with distinction) from the London School of Economics, London, England. Mr. Lammert is a Chartered Financial Analyst. WHO IS THE PORTFOLIO MANAGER FOR THE EQUITY INCOME AND MULTI-STRATEGY PORTFOLIOS? J.P. Morgan Investment Management Inc. ("J.P. Morgan Investment"), a wholly-owned subsidiary of J.P. Morgan & Co. J.P. Morgan Investment's address is 522 Fifth Avenue, New York, New York 10036. J.P. Morgan Investment is an investment manager for corporate, public, and union employee benefit funds, foundations, endowments, insurance companies, government agencies and the accounts of other institutional investors. Capital Guardian served as portfolio manager to the Equity Income and Multi-Strategy Portfolios from their commencement of operations in 1988 through December 31, 1993. WHO AT J.P. MORGAN INVESTMENT MANAGES THE EQUITY INCOME AND MULTI-STRATEGY PORTFOLIOS? Lisa J. Waller and William G. Tennille are primarily responsible for the day-to-day management and implementation of J.P. Morgan Investment's process for the Multi-Strategy Portfolio, and Ms. Waller is primarily responsible for the Equity Income Portfolio. Lisa J. Waller, Vice President, is a portfolio manager with responsibility for several pension fund clients. Ms. Waller previously followed the aerospace and multi-industry sectors before becoming head of Small Capitalization Research. She joined Morgan in 1982 upon graduation from the University of Wisconsin where she earned undergraduate and graduate degrees. Ms. Waller is a Chartered Financial Analyst. William G. Tennille, Vice President, is a portfolio manager for separately managed and commingled funds with an emphasis in mortgage securities and derivatives. Prior to joining Morgan in 1992, he managed the investment portfolios of Manufacturers Hanover Trust, Deposit Guaranty Bank, and First Florida Banks. He is a graduate of the University of North Carolina. Mr. Tennille manages 16 accounts at the present time. WHO IS THE PORTFOLIO MANAGER FOR THE EQUITY PORTFOLIO AND BOND AND INCOME PORTFOLIO? Greenwich Street Advisors Division of Smith Barney Mutual Funds Management Inc., ("Greenwich Street Advisors"), a wholly-owned subsidiary of Smith Barney Holdings Inc., which in turn is a wholly-owned subsidiary of The Travelers Inc. The Greenwich Street Advisors Division is located at 388 Greenwich Street, 23rd Floor, New York, New York 10013. The Greenwich Street Advisors Division and its predecessors have been in the investment counseling business since 1934. Smith Barney Mutual Funds Management Inc. ("SBMFM") and its predecessors have been providing investment-advisory services to mutual funds since 1968. As of December 31, 1994, SBMFM managed approximately $54 billion of mutual fund assets. WHO AT GREENWICH STREET ADVISORS MANAGES THE EQUITY PORTFOLIO AND BOND AND INCOME PORTFOLIO? George V. Novello is primarily responsible for the day-to-day management of the Equity Portfolio. Mr. Novello became Managing Director of Smith Barney Inc. in August 1993. He previously held the same position with Shearson or its predecessor firms since 1990. Mr. Novello was a Managing Director and Director of Research for McKinley Allsopp and Gruntal from 1988 through 1990. Mr. Novello received a B.A. from St. John's University. George Mueller is primarily responsible for the day-to-day management of the Bond and Income Portfolio. Mr. Mueller became Director of Smith Barney Inc. in August 1993. He previously held the same position at Shearson or its predecessor firms since 1985. Mr. Mueller holds a B.S. from Duquesne University and a M.B.A. from Pace University. WHO IS THE PORTFOLIO MANAGER OF THE EQUITY INDEX PORTFOLIO? Bankers Trust Company ("BTC"), a wholly-owned subsidiary of Bankers Trust New York Corporation. BTC's address is 130 Liberty Street, New York, New York 10006. BTC is a wholly-owned subsidiary of Bankers Trust New York Corporation, the seventh largest bank holding company in the United States. The Global Investment Management Group of BTC, the department directly responsible for the management of the Equity Index Portfolio, as of December 31, 1994, managed assets approximating $159.1 billion. BTC is the investment adviser to 23 other mutual fund portfolios. WHO IS THE PORTFOLIO MANAGER OF THE INTERNATIONAL PORTFOLIO? Templeton Investment Counsel, Inc. ("Templeton"), an indirect wholly-owned subsidiary of Templeton Worldwide, Inc., which is in turn a wholly-owned subsidiary of Franklin Resources, Inc. Templeton's address is Broward Financial Centre, Suite 2100, Fort Lauderdale, Florida 33394-3091. Templeton and its affiliates serve as advisers for over 150 registered investment companies. The Templeton organization has been investing globally over the past 52 years and provides investment management and advisory services to a worldwide client base, including approximately 850,000 mutual fund shareholders, foundations and endowments, employee benefit plans and individuals. Franklin Resources, Inc. is engaged in various aspects of the financial services industry through its subsidiaries. Nomura Capital Management, Inc. served as portfolio manager to the International Portfolio from its commencement of operations in 1988 through December 31, 1993. WHO AT TEMPLETON MANAGES THE INTERNATIONAL PORTFOLIO? Lauretta A. Reeves, Vice President, Portfolio Management/Research, is primarily responsible for the day-to-day investment management and implementation of Templeton's investment strategy for the International Portfolio. She also is a research analyst covering European and Asian banks, and for other accounts, has research responsibility for the chemical, medical supply and devices sectors, as well as the coverage of the Belgium market. Prior to joining Templeton in 1987, Ms. Reeves was the manager of equity trading for the First Equity Corporation of Florida, a regional investment banking firm. Ms. Reeves holds a bachelor's degree in Business Administration from Florida International University and an MBA in Business Administration from Nova University. Ms. Reeves is a Chartered Financial Analyst. James E. Chaney, Senior Vice President, Portfolio Management/Research, assists in the day-to-day investment management and implementation of Templeton's investment strategy for the International Portfolio. He currently manages several investment company, corporate, and public fund separate accounts. He is also a research analyst whose responsibilities include merchandising, regional banks and environmental companies. Prior to joining Templeton in 1991, Mr. Chaney was a Vice President of International Equities with GE Investments, from 1986 to 1991. Mr. Chaney holds a bachelor's degree in Engineering from the University of Massachusetts- Amherst, an MS in Engineering from Northeastern University and an MBA from Columbia University. Howard J. Leonard, Senior Vice President, Portfolio Management/Research, also assists in the day-to-day investment management and implementation of Templeton's investment strategy for the International Portfolio. He also is a research analyst whose research responsibilities include forest products and money management industries. Prior to joining Templeton in 1989, Mr. Leonard was Director of Investment Research at First Pennsylvania Bank, from 1986 to 1989. Mr. Leonard holds a bachelor's degree in Business Administration from Temple University. Mr. Leonard is a Chartered Financial Analyst. HOW MUCH DOES THE FUND PAY FOR THE SERVICES OF PACIFIC MUTUAL AND THE PORTFOLIO MANAGERS? The Fund pays the Adviser for its services under the Investment Advisory Agreement, a fee based on an annual percentage of the average daily net assets of each Portfolio. For the Money Market Portfolio, the Fund pays to the Adviser a fee at an annual rate of .40% of the first $250 million of the average daily net assets of the Portfolio, .35% of the next $250 million of the average daily net assets of the Portfolio, and .30% of the average daily net assets of the Portfolio in excess of $500 million. For the Equity Index Portfolio, the Fund pays .25% of the first $100 million of the average daily net assets of the Portfolio, .20% of the next $100 million of the average daily net assets of the Portfolio, and .15% of the average daily net assets of the Portfolio in excess of $200 million. For the Managed Bond, High Yield Bond, Government Securities, and Bond and Income Portfolios, the Fund pays .60% of the average daily net assets of each of the Portfolios. For the Equity Income, Equity, and Multi-Strategy Portfolios, the Fund pays .65% of the average daily net assets of each of the Portfolio. For the Growth LT Portfolio, the Fund pays .75% of the average daily net assets of the Portfolio. For the International Portfolio, the Fund pays .85% of the average daily net assets of the Portfolio. These fees are computed and accrued daily and paid monthly. HOW HAS THE FUND SECURED THE SERVICES OF THE INVESTMENT ADVISER AND THE PORTFOLIO MANAGERS? The Fund has entered into an Investment Advisory Agreement with Pacific Mutual under which Pacific Mutual serves as Investment Adviser to the Fund. The Fund and Pacific Mutual have entered into Portfolio Management Agreements with the Portfolio Managers. After initial two year terms, the Investment Advisory Agreement and the Portfolio Management Agreements require renewal by the Fund's Board of Trustees annually. Any of these agreements can be terminated by the Fund's Board of Trustees. The Portfolio Management Agreements can be terminated by Pacific Mutual or by any of the Portfolio Managers. In the event of termination of a Portfolio Management Agreement, the current Portfolio Manager could no longer service the applicable Portfolio. Pacific Mutual could manage the applicable Portfolio directly or could recommend a replacement to the Fund's Board of Trustees. Under the Portfolio Management Agreements, the Portfolio Managers are compensated directly by Pacific Mutual, and not directly from the Fund. Pacific Mutual derives the amounts that it pays the Portfolio Managers from its own fees under the Investment Advisory Agreement. For information on the fees payable to the Portfolio Managers, see the Statement of Additional Information. WHAT OTHER EXPENSES DOES THE FUND BEAR? The Fund bears all costs of its operations. These costs may include expenses for custody, portfolio accounting, printing, legal and audit fees, fees and expenses of the independent trustees, organizational expenses and other expenses of its operations, and may, if applicable, include extraordinary expenses such as expenses for special consultants or legal expenses. Fund expenses directly attributable to a Portfolio are charged to that Portfolio; other expenses are allocated proportionately among all the Portfolios in relation to the net assets of each Portfolio. For the period ended December 31, 1994, the total expenses of each Portfolio that had commenced operations on or before such date were the following percentages of average daily net assets: Money Market Portfolio-- .64%, High Yield Bond Portfolio--.88%, Managed Bond Portfolio--.84%, Government Securities Portfolio--.88%, Growth LT Portfolio--1.08% (annualized), Equity Income Portfolio--.94%, Multi-Strategy Portfolio--.94%, Equity Portfolio--.96%, Bond and Income Portfolio--.93%, Equity Index Portfolio--.51%, and International Portfolio--1.22%. The expenses of each Portfolio, expressed as a percentage of the Portfolio's average daily net assets, is shown under "Ratio of Expenses to Average Net Assets" in the Financial Highlights section at the beginning of this Prospectus for each year of each Portfolio's operation. More information on the expenses of the Portfolios is included in the Portfolios' Statements of Operations, which can be found in the financial statements included in the Fund's annual and semi-annual reports sent to shareholders. WHAT IS PACIFIC MUTUAL DOING TO LIMIT FUND EXPENSES? Pacific Mutual has agreed, until at least December 31, 1995, to reimburse each Portfolio for its operating expenses to the extent that such expenses, exclusive of advisory fees, additional custodial charges associated with holding foreign securities, foreign taxes on dividends, interest, or gains, and extraordinary expenses, exceed 0.25% of the Portfolio's average daily net assets. Pacific Mutual began this expense reimbursement policy in April 1989. There can be no assurance that this policy will be continued beyond December 31, 1995. WHO DISTRIBUTES THE FUND'S SHARES? Shares of the Fund are distributed through Pacific Equities Network (the "Distributor" or "PEN"), an indirect wholly-owned subsidiary of Pacific Mutual. PEN's address is 700 Newport Center Drive, Newport Beach, California 92660. PEN is a broker-dealer registered with the SEC and a member of the National Association of Securities Dealers. PEN acts as Distributor without remuneration from the Fund. WHO IS THE CUSTODIAN OF THE FUND? Investor's Fiduciary Trust Company ("IFTC") provides the Fund with portfolio accounting and custodial services. IFTC's address is 127 West 10th Street, Kansas City, Missouri 64105. MORE ON THE FUND'S SHARES HOW DO YOU PURCHASE SHARES OF THE FUND? Shares of the Fund are not sold directly to the general public. Shares of the Fund are currently offered only for purchase by the Separate Accounts to serve as an investment medium for the Variable Contracts issued or administered by Pacific Mutual and Pacific Corinthian. For information on purchase of a Variable Contract, consult a prospectus for the Separate Account. The shares of the Equity Portfolio and Bond and Income Portfolio are offered to only Separate Accounts of Pacific Mutual and Pacific Corinthian that fund variable annuity contracts; thus, these Portfolios are not available for variable life insurance policies. HOW ARE SHARES REDEEMED? Shares of any Portfolio may be redeemed on any business day upon receipt of a request for redemption from the insurance company whose separate account owns the shares. Redemptions are effected at the per share net asset value next determined after receipt of the redemption request. Redemption proceeds ordinarily will be paid within seven days following receipt of instructions in proper form or, if sooner, other period required by law. The right of redemption may be suspended by the Fund or the payment date postponed beyond seven days when the New York Stock Exchange is closed (other than customary weekend and holiday closings) or for any period during which trading thereon is restricted because an emergency exists, as determined by the SEC, making disposal of portfolio securities or valuation of net assets not reasonably practicable, and whenever the SEC has by order permitted such suspension or postponement for the protection of shareholders. If the Board of Trustees should determine that it would be detrimental to the best interests of the remaining shareholders of a Portfolio to make payment wholly or partly in cash, the Portfolio may pay the redemption price in whole or part by a distribution in kind of securities from the Portfolio, in lieu of cash, in conformity with applicable rules of the SEC. If shares are redeemed in kind, the redeeming shareholder might incur brokerage costs in converting the assets into cash. Under the Investment Company Act of 1940, the Fund is obligated to redeem shares solely in cash up to the lesser of $250,000 or 1 percent of its net assets during any 90-day period for any one shareholder. CAN YOU MAKE EXCHANGES AMONG THE PORTFOLIOS? Variable Contract Owners do not deal directly with the Fund to purchase, redeem, or exchange shares of a Portfolio, and Variable Contract Owners should refer to the Prospectus for the applicable Separate Account for information on the allocation of premiums and on transfers of accumulated value among options available under the contract. HOW IS THE VALUE OF THE PORTFOLIOS' SHARES DETERMINED? Shares of each Portfolio are sold at their respective net asset values (without a sales charge) computed after receipt of a purchase order. Net asset value of a share is determined by dividing the value of a Portfolio's net assets by the number of its shares outstanding. That determination is made once each business day, Monday through Friday, exclusive of federal holidays at or about 4:00 P.M., New York City time, on each day that the New York Stock Exchange is open for trading. To calculate a Portfolio's net asset value, a Portfolio's assets are valued and totalled, liabilities are subtracted, and the balance, called net assets, is divided by the number of shares outstanding. In general, the value of assets is based on actual or estimated market value, with special provisions for assets not having readily available market quotations and short-term debt securities. The value of foreign portfolio securities traded on foreign exchanges is based upon the price of the close of the exchange immediately preceding the time of the Fund's valuation, or, if earlier, at the time of the Fund's valuation. Therefore, the calculation of the net asset value of the International Portfolio or other Portfolios that invest in foreign securities may not take place contemporaneously with the determination of the prices of certain foreign securities used in the calculation. Further, under the Fund's procedures, the prices of foreign securities are determined using information derived from pricing services and other sources. Prices derived under these procedures will be used in determining daily net asset value. Information that becomes known to the Fund or its agents after the time that net asset value is calculated on any business day may be assessed in determining net asset value per share after the time of receipt of the information, but will not be used to retroactively adjust the price of the security so determined earlier or on a prior day. Events affecting the values of portfolio securities that occur between the time their prices are determined and the time the Portfolio's net asset value is determined may not be reflected in the calculation of net asset value. If events materially affecting the value of such securities occur during such period, then these securities may be valued at fair value as determined by the management and approved in good faith by the Board of Trustees. The Money Market Portfolio's securities are valued using the amortized cost method of valuation, which involves valuing a security at cost on the date of acquisition and thereafter assuming a constant accretion of a discount or amortization of a premium to maturity. The net asset values per share of each Portfolio will fluctuate in response to changes in market conditions and other factors. See the Statement of Additional Information. INFORMATION ABOUT PORTFOLIO TRANSACTIONS. The Adviser or the Portfolio Manager for a Portfolio places orders for the purchase and sale of portfolio investments for a Portfolio with brokers or dealers selected by it in its discretion. In effecting purchases and sales of portfolio securities in transactions on United States stock exchanges for the account of the Fund, the Adviser or Portfolio Manager may pay higher commission rates than the lowest available when the Adviser or Portfolio Manager believes it is reasonable to do so in light of the value of the brokerage and research services provided by the broker effecting the transaction. Consistent with a policy of obtaining best net results, a Portfolio Manager's affiliate, including BT Brokerage Corporation and BT Futures Corporation, J.P. Morgan Securities, and Smith Barney Inc. may serve as the Fund's broker in effecting portfolio transactions, including transactions on a national securities exchange, and may retain commissions, in accordance with certain regulations of the SEC. INFORMATION ABOUT PORTFOLIO TURNOVER. The Portfolio turnover rate represents the rate at which securities in a Portfolio other than short-term debt obligations are replaced. This rate for the Portfolios is shown in the tables in Condensed Financial Information. The High Yield Bond, Managed Bond, and Government Securities, Growth LT, Equity Income, Multi-Strategy, Equity, and Bond and Income Portfolios had portfolio turnover rates in excess of 100% in certain years, which could be considered relatively high. Such a Portfolio turnover rate may result in higher brokerage commissions or other transactional expenses for these Portfolios than for other Portfolios, which expenses must be borne, directly or indirectly, by a Portfolio and ultimately by the Portfolio's shareholders. In addition, high portfolio turnover may affect the ability of a Portfolio to qualify as a regulated investment company. See "Taxation" and "Portfolio Turnover" in the Statement of Additional Information. DO ANY ISSUES ARISE FROM THE FUND OFFERING ITS SHARES FOR VARIABLE ANNUITIES AND VARIABLE LIFE INSURANCE POLICIES? The Fund serves as an investment medium for both variable annuity contracts and variable life insurance policies. The Fund currently does not foresee any disadvantages to Variable Contract Owners due to the fact that the Fund serves as an investment medium for both variable life insurance policies and annuity contracts; however, due to differences in tax treatment or other considerations, it is theoretically possible that the interests of owners of annuity contracts and insurance policies for which the Fund serves as investment medium might at some time be in conflict. However, the Fund's Board of Trustees, Pacific Mutual and Pacific Corinthian are required to monitor events to identify any material conflicts between variable annuity contract owners and variable life policy owners, and will determine what action, if any, should be taken in the event of such a conflict. If such a conflict were to occur, Pacific Mutual, Pacific Corinthian, or another insurance company participating in the Fund might be required to redeem the investment of one or more of its separate accounts from the Fund. This might force the Fund to sell securities at disadvantageous prices. OTHER INFORMATION ABOUT THE FUND HOW IS THE FUND CAPITALIZED? The capitalization of the Fund consists solely of an unlimited number of shares of beneficial interest with a par value of $0.001 each. When issued, shares of the Fund are fully paid, freely transferable, and non-assessable by the Fund. Under Massachusetts law, shareholders could under certain circumstances, be held personally liable for the obligations of the Fund. However, the Declaration of Trust disclaims liability of the shareholders, Trustees, or officers of the Fund for acts or obligations of the Fund, which are binding only on the assets and property of the Fund and requires that notice of the disclaimer be given in each contract or obligation entered into or executed by the Fund or the Trustees. The Declaration of Trust provides for indemnification out of Fund property for all loss and expense of any shareholder held personally liable for the obligations of the Fund. The risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the Fund itself would be unable to meet its obligations and thus should be considered remote. WHAT IS THE FEDERAL INCOME TAX STATUS OF THE FUND? Each Portfolio intends to qualify each year as a regulated investment company under Subchapter M of the Internal Revenue Code. A Portfolio so qualifying generally will not be subject to federal income taxes to the extent that it distributes on a timely basis its investment company taxable income and its net capital gains. Such income and capital gains distributions are automatically reinvested in additional shares of the Portfolio, unless the shareholder elects to receive cash. Each Portfolio also intends to comply with diversification regulations under section 817(h) of the Code, that apply to mutual funds underlying variable contracts. Generally, a Portfolio will be required to diversify its investments so that on the last day of each quarter of a calendar year no more than 55% of the value of its total assets is represented by any one investment, no more than 70% is represented by any two investments, no more than 80% is represented by any three investments, and no more than 90% is represented by any four investments. For this purpose, securities of a given issuer generally are treated as one investment, but each U.S. Government agency and instrumentality is treated as a separate issuer. Compliance with the diversification rules under Section 817(h) of the Code generally will limit the ability of any Portfolio, and in particular, the Government Securities Portfolio, to invest greater than 55% of its total assets in direct obligations of the U.S. Treasury (or any other issuer) or to invest primarily in securities issued by a single agency or instrumentality of the U.S. Government. Reference is made to the Prospectus for the applicable Separate Account and Contract for information regarding the Federal income tax treatment of distributions to the Separate Account. See "Taxation" in the Fund's Statement of Additional Information for more information on taxes. WHAT VOTING RIGHTS DO SHAREHOLDERS HAVE? Shareholders of the Fund are given certain voting rights. Each share of each Portfolio will be given one vote, unless a different allocation of voting rights is required under applicable law for a mutual fund that is an investment medium for variable insurance products. Massachusetts business trust law does not require the Fund to hold annual shareholder meetings, although special meetings may be called for a specific Portfolio, or for the Fund as a whole, for purposes such as electing or removing Trustees, changing fundamental policies, or approving a new or amended advisory contract or portfolio management agreement. In accordance with current laws, it is anticipated that an insurance company issuing a Variable Contract that participates in the Fund will request voting instructions from Variable Contract Owners and will vote shares or other voting interests in the Separate Account in proportion to the voting instructions received. MAY THE FUND DISCONTINUE THE OFFERING OF ANY PORTFOLIO? The Fund reserves the right to discontinue offering shares of one or more Portfolio at any time. In the event that a Portfolio ceases offering its shares, any investments allocated by an insurance company investing in the Fund to such Portfolio will, subject to any necessary regulatory approvals, be invested in the Portfolio deemed appropriate by the Trustees. ADVERTISING PERFORMANCE. The Fund may, from time to time, include the yield and effective yield of its Money Market Portfolio, the yield of the remaining Portfolios, and the total return of all Portfolios in advertisements, sales literature, or reports to shareholders or prospective investors. Total return for the Fund will not be advertised or included in sales literature unless accompanied by comparable performance information for a Separate Account to which the Fund offers its shares. Performance information should be considered in light of a Portfolio's investment objectives and policies, characteristics of the Portfolio, and the market conditions during the given time period, and should not be considered as a representation of what may be achieved in the future. For a description of the methods used to determine yield and total return for the Portfolios, see the Statement of Additional Information. The table below presents the total return for each Portfolio. The total return shown in the table tells you how much an investment in a Portfolio has changed in value from year to year. It reflects any net increase or decrease in the share price and assumes that all dividends and distributions were reinvested in additional shares. The total return does not include fees and charges at the Separate Account level under the Variable Contract or other fees and charges under the Variable Contract. (1) Information is for the period from January 4, 1988 (commencement of operations) to December 31, 1988. (2) Information for the Equity Index Portfolio is for the period from January 30, 1991 (commencement of operations) to December 31, 1991. (3) Information for the Growth LT Portfolio is for the period from January 4, 1994 (commencement of operations) to December 31, 1994. (4) The performance results of the Equity Income, Multi-Strategy, and International Portfolios occurred when these Portfolios were advised by different Portfolio Managers. J.P. Morgan Investment began serving as Portfolio Manager to the Equity Income Portfolio and Multi-Strategy Portfolio and Templeton began serving as Portfolio Manager of the International Portfolio on January 1, 1994. (5) The performance results of the Equity Portfolio and the Bond and Income Portfolio are based on the performance of predecessor portfolios (series) of Pacific Corinthian Variable Fund, which began their first full year of operations on January 1, 1984 and were acquired by the Fund on December 31, 1994. Corporate Bonds: Bonds rated Aa by Moody's are judged by Moody's to be of high quality by all standards. Together with bonds rated Aaa (Moody's highest rating) they comprise what are generally known as high-grade bonds. Aa bonds are rated lower than Aaa bonds because margins of protection may not be as large as those of Aaa bonds, or fluctuation of protective elements may be of greater amplitude, or there may be other elements present which make the long- term risks appear somewhat larger than those applicable to Aaa securities. Bonds which are rated A by Moody's possess many favorable investment attributes and are to be considered as upper medium-grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. Moody's Baa rated bonds are considered as medium-grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and, in fact, have speculative characteristics as well. Bonds rated AA by Standard & Poor's are judged by Standard & Poor's to be high-grade obligations and in the majority of instances differ only in small degree from issues rated AAA (Standard & Poor's highest rating). Bonds rated AAA are considered by Standard & Poor's to be the highest grade obligations and possess the ultimate degree of protection as to principal and interest. With AA bonds, as with AAA bonds, prices move with the long-term money market. Bonds rated A by Standard & Poor's, regarded as upper medium grade, have a strong capacity and interest, although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions. Standard & Poor's BBB rated bonds, or medium-grade category bonds, are borderline between definitely sound obligations and those where the speculative element begins to predominate. These bonds have adequate asset coverage and normally are protected by satisfactory earnings. Their susceptibility to changing conditions, particularly to depressions, necessitates constant watching. These bonds generally are more responsive to business and trade conditions than to interest rates. This group is the lowest which qualifies for commercial bank investment. Moody's Ba rated bonds are judged to have speculative elements; their future cannot be considered as well-assured. Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds rated Ba. Bonds which are rated B by Moody's generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Bonds rated Caa by Moody's are considered to be of poor standing. Such issues may be in default or there may be elements of danger with respect to principal or interest. Bonds rated Ca are considered by Moody's to be speculative in a high degree, often in default. Bonds rated C, the lowest class of bonds under Moody's bond ratings, are regarded by Moody's as having extremely poor prospects. Moody's also applies numerical indicators 1, 2 and 3 to rating categories. The modifier 1 indicates that the security is in the higher end of its rating category; 2 indicates a mid-range ranking; and 3 indicates a ranking toward the lower end of the category. A bond rated BB, B, CCC, and CC by Standard & Poor's is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. BB indicates the lowest degree of speculation and CC the highest degree of speculation. While such bonds will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposure to adverse conditions. Commercial Paper: The Prime rating is the highest commercial paper rating assigned by Moody's. Among the factors considered by Moody's in assigning ratings are the following: (1) evaluation of the management of the issuer; (2) economic evaluation of the issuer's industry or industries and an appraisal of speculative-type risks which may be inherent in certain areas; (3) evaluation of the issuer's products in relation to competition and customer acceptance; (4) liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over a period of ten years; (7) financial strength of a parent company and the relationships which exist with the issuer; and (8) recognition by management of obligations which may be present or may arise as a result of public interest questions and preparations to meet such obligations. Issuers with this Prime category may be given ratings 1, 2 or 3, depending on the relative strengths of these factors. Commercial paper rated A by Standard & Poor's has the following characteristics: (i) liquidity ratios are adequate to meet cash requirements; (ii) long-term senior debt rating should be A or better, although in some cases BBB credits may be allowed if other factors outweigh the BBB rating, (iii) the issuer should have access to at least two additional channels of borrowing; (iv) basic earnings and cash flow should have an upward trend with allowances made for unusual circumstances; and (v) typically the issuer's industry should be well established and the issuer should have a strong position within its industry and the reliability and quality of management should be unquestioned. Issuers rated A are further referred to by use of numbers 1, 2 and 3 to denote relative strength with this highest classification. Pacific Mutual Life Insurance Company Pacific Equities Network 700 Newport Center Drive Member: NASD & SIPC Post Office Box 9000 700 Newport Center Drive Newport Beach, California 92660 P.O. Box 9000 130 Liberty Street Investors Fiduciary Trust Company New York, New York 10006 127 West Tenth Street Two World Trade Center ACCOUNTANTS 101st Floor Deloitte & Touche LLP New York, New York 10048 695 Town Center Drive Janus Capital Corporation Costa Mesa, California 92626 Denver, Colorado 80206-4923 Dechert Price & Rhoads 1500 K Street, N.W. J.P. Morgan Investment Management Inc. Suite 500 522 Fifth Avenue Washington, D.C. 20005 New York, New York 10036 Prospectus dated May 1, 1995 Pacific Select Fund (the "Fund") is an open-end diversified management investment company currently offering eleven separate investment Portfolios: the Money Market Portfolio; the High Yield Bond Portfolio; the Managed Bond Portfolio; the Government Securities Portfolio; the Growth LT Portfolio; the Equity Income Portfolio; the Multi-Strategy Portfolio; the Equity Portfolio; the Bond and Income Portfolio; the Equity Index Portfolio; and the International Portfolio. The Fund's Adviser is Pacific Mutual Life Insurance Company. This Statement of Additional Information is intended to supplement the information provided to investors in the Prospectus dated May 1, 1995, of the Fund and has been filed with the Securities and Exchange Commission as part of the Fund's Registration Statement. Investors should note, however, that this Statement of Additional Information is not itself a prospectus and should be read carefully in conjunction with the Fund's Prospectus and retained for future reference. The contents of this Statement of Additional Information are incorporated by reference in the Prospectus in their entirety. A copy of the Prospectus may be obtained free of charge from the Fund at the address and telephone numbers listed below. Pacific Mutual Life Insurance Company This Statement of Additional Information is designed to elaborate upon information contained in the Prospectus, including the discussion of certain securities and investment techniques. The more detailed information contained herein is intended solely for investors who have read the Prospectus and are interested in a more detailed explanation of certain aspects of the Fund's securities and investment techniques. Captions and defined terms in this Statement of Additional Information generally correspond to like captions and terms in the Prospectus. INVESTMENT POLICIES FOR MONEY MARKET PORTFOLIO The investment objective and investment policies of the Money Market Portfolio are described in the Prospectus. The following description presents more detailed information on investment policies that apply to the Portfolio, and is intended to supplement the information provided in the Prospectus. A money market instrument will be considered to be highest quality (1) if the instrument (or other comparable short-term instrument of the same issuer) is rated in the highest rating category, (i.e., Aaa or Prime-1 by Moody's Investors Service, Inc. ("Moody's"), AAA or A-1 by Standard & Poor's Corporation ("S&P")) by (i) any two nationally recognized statistical rating organizations ("NRSROs") or, (ii) if rated by only one NRSRO, by that NRSRO, and whose acquisition is approved or ratified by the Board of Trustees; (2) if, for an instrument with a remaining maturity of 13 months or less that was long term at the time of issuance, it is issued by an issuer that has short-term debt obligations of comparable maturity, priority, and security, and that are rated in the highest rating category by (i) any two NRSROs or, (ii) if rated by only one NRSRO, by that NRSRO, and whose acquisition is approved or ratified by the Board of Trustees; or (3) an unrated security that is of comparable quality to a security in the highest rating category as determined by the Adviser and, unless it is a U.S. Government security, whose acquisition is approved or ratified by the Board of Trustees. With respect to 5% of its total assets, measured at the time of investment, the Portfolio may also invest in money market instruments that are in the second-highest rating category for short- term debt obligations (i.e., rated Aa or Prime-2 by Moody's or AA or A-2 by S&P). A money market instrument will be considered to be in the second-highest rating category under the criteria described above with respect to instruments considered highest quality, as applied to instruments in the second-highest rating category. The Portfolio may not invest more than 5% of its total assets, measured at the time of investment, in securities of any one issuer that are of the highest quality, except that this limitation shall not apply to U.S. Government securities and repurchase agreements thereon. The Portfolio may not invest more than the greater of 1% of its total assets or $1,000,000, measured at the time of investment, in securities of any one issuer that are in the second-highest rating category, except that this limitation shall not apply to U.S. Government securities. In the event that an instrument acquired by the Portfolio is downgraded or otherwise ceases to be of the quality that is eligible for the Portfolio, the Adviser, under procedures approved by the Board of Trustees (or the Board of Trustees itself if the Adviser becomes aware an unrated security is downgraded below high quality and the Adviser does not dispose of the security or it does not mature within five business days) shall promptly reassess whether such security presents minimal credit risk and determine whether or not to retain the instrument. All Portfolios may invest in U.S. Government securities. U.S. Government securities are obligations of, or guaranteed by, the U.S. Government, its agencies, or instrumentalities. Treasury bills, notes, and bonds are direct obligations of the U.S. Treasury, and they differ with respect to certain items such as coupons, maturities, and dates of issue. Treasury bills have a maturity of one year or less. Treasury notes have maturities of one to ten years and Treasury bonds generally have a maturity of greater than ten years. Securities guaranteed by the U.S. Government include federal agency obligations guaranteed as to principal and interest by the U.S. Treasury (such as GNMA certificates (described below) and Federal Housing Administration debentures). In guaranteed securities, the payment of principal and interest is unconditionally guaranteed by the U.S. Government, and thus they are of the highest credit quality. Such direct obligations or guaranteed securities are subject to variations in market value due to fluctuations in interest rates, but, if held to maturity, the U.S. Government is obligated to or guarantees to pay them in full. Securities issued by U.S. Government instrumentalities and certain federal agencies are neither direct obligations of, nor guaranteed by, the U.S. Treasury. However, they involve federal sponsorship in one way or another: some are backed by specific types of collateral; some are supported by the issuer's right to borrow from the U.S. Treasury; some are supported by the discretionary authority of the U.S. Treasury to purchase certain obligations of the issuer; others are supported only by the credit of the issuing government agency or instrumentality. These agencies and instrumentalities include, but are not limited to Federal National Mortgage Association, Federal Home Loan Bank, Federal Land Banks, Farmers Home Administration, Central Bank for Cooperatives, Federal Intermediate Credit Banks, Federal Financing Bank, Farm Credit Banks, and the Tennessee Valley Authority. All the Portfolios may invest in U.S. Government securities. Mortgage-related securities are interests in pools of mortgage loans made to residential home buyers, including mortgage loans made by savings and loan institutions, mortgage banks, commercial banks, and others. Pools of mortgage loans are assembled as securities for sale to investors by various governmental, government-related, and private organizations. The High Yield Bond, Managed Bond, Government Securities, Growth LT, and Multi-Strategy Portfolios may invest in mortgage-related securities as well as debt securities which are secured with collateral consisting of mortgage-related securities, and in other types of mortgage-related securities. The Equity Portfolio and Bond and Income Portfolio may only invest in mortgage-related securities that are obligations of, or guaranteed by, the U.S. Government, its agencies or instrumentalities. Mortgage Pass-Through Securities. These are securities representing interests in "pools" of mortgages in which payments of both interest and principal on the securities are made periodically, in effect "passing through" periodic payments made by the individual borrowers on the residential mortgage loans which underlie the securities (net of fees paid to the issuer or guarantor of the securities). Early repayment of principal on mortgage pass-through securities (arising from prepayments of principal due to sale of the underlying property, refinancing, or foreclosure, net of fees and costs which may be incurred) may expose a Portfolio to a lower rate of return upon reinvestment of principal. Payment of principal and interest on some mortgage pass-through securities may be guaranteed by the full faith and credit of the U.S. Government (in the case of securities guaranteed by the Government National Mortgage Association, or "GNMAs"); or guaranteed by agencies or instrumentalities of the U.S. Government (in the case of securities guaranteed by the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"), which are supported only by the discretionary authority of the U.S. Government to purchase the agency's obligations). Mortgage pass-through securities created by nongovernmental issuers (such as commercial banks, savings and loan institutions, private mortgage insurance companies, mortgage bankers, and other secondary market issuers) which can be purchased by the Managed Bond, High Yield Bond, Growth LT, and Multi-Strategy Portfolios may be supported by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance and letters of credit, which may be issued by governmental entities, private insurers, or the mortgage poolers. GNMA Certificates. GNMA certificates are mortgage-backed securities representing part ownership of a pool of mortgage loans on which timely payment of interest and principal is guaranteed by the full faith and credit of the U.S. Government. GNMA is a wholly-owned U.S. Government corporation within the Department of Housing and Urban Development. GNMA is authorized to guarantee, with the full faith and credit of the U.S. Government, the timely payment of principal and interest on securities issued by institutions approved by GNMA (such as savings and loan institutions, commercial banks, and mortgage bankers) and backed by pools of FHA-insured or VA-guaranteed mortgages. GNMA certificates differ from typical bonds because principal is repaid monthly over the term of the loan rather than returned in a lump sum at maturity. Because both interest and principal payments (including prepayments) on the underlying mortgage loans are passed through to the holder of the certificate, GNMA certificates are called "pass- through" securities. Interests in pools of mortgage-related securities differ from other forms of debt securities, which normally provide for periodic payment of interest in fixed amounts with principal payments at maturity or specified call dates. Instead, these securities provide a periodic payment which consists of both interest and principal payments. In effect, these payments are a "pass-through" of the periodic payments made by the individual borrowers on the residential mortgage loans, net of any fees paid to the issuer or guarantor of such securities. Additional payments are caused by repayments of principal resulting from the sale of the underlying residential property, refinancing or foreclosure, net of fees or costs which may be incurred. Mortgage-related securities issued by GNMA are described as "modified pass-through" securities. These securities entitle the holder to receive all interest and principal payments owed on the mortgage pool, net of certain fees, at the scheduled payment dates regardless of whether or not the mortgagor actually makes the payment. Although GNMA guarantees timely payment even if homeowners delay or default, tracking the "pass-through" payments may, at times, be difficult. Expected payments may be delayed due to the delays in registering the newly traded paper securities. The custodian's policies for crediting missed payments while errant receipts are tracked down may vary. Other mortgage-backed securities such as those of FHLMC and FNMA trade in book-entry form and are not subject to the risk of delays in timely payment of income. Although the mortgage loans in the pool will have maturities of up to 30 years, the actual average life of the GNMA certificates typically will be substantially less because the mortgages will be subject to normal principal amortization and may be prepaid prior to maturity. Early repayments of principal on the underlying mortgages may expose a Portfolio to a lower rate of return upon reinvestment of principal. Prepayment rates vary widely and may be affected by changes in market interest rates. In periods of falling interest rates, the rate of prepayment tends to increase, thereby shortening the actual average life of the GNMA certificates. Conversely, when interest rates are rising, the rate of prepayment tends to decrease, thereby lengthening the actual average life of the GNMA certificates. Accordingly, it is not possible to accurately predict the average life of a particular pool. Reinvestment of prepayments may occur at higher or lower rates than the original yield on the certificates. Due to the prepayment feature and the need to reinvest prepayments of principal at current rates, GNMA certificates can be less effective than typical bonds of similar maturities at "locking in" yields during periods of declining interest rates, although they may have comparable risks of decline in value during periods of rising interest rates. FNMA and FHLMC Mortgage-Backed Obligations. Government-related guarantors (i.e., not backed by the full faith and credit of the U.S. Government) include the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). FNMA, a federally chartered and privately-owned corporation, issues pass-through securities representing interests in a pool of conventional mortgage loans. FNMA guarantees the timely payment of principal and interest but this guarantee is not backed by the full faith and credit of the U.S. Government. FNMA is a government sponsored corporation owned entirely by private stockholders. It is subject to general regulation by the Secretary of Housing and Urban Development. FNMA purchases conventional (i.e., not insured or guaranteed by any government agency) residential mortgages from a list of approved seller/servicers which include state and federally-chartered savings and loan associations, mutual savings banks, commercial banks and credit unions, and mortgage bankers. FHLMC, a corporate instrumentality of the United States, was created by Congress in 1970 for the purpose of increasing the availability of mortgage credit for residential housing. Its stock is owned by the 12 Federal Home Loan Banks. FHLMC issues Participation Certificates ("PCs") which represent interests in conventional mortgages from FHLMC's national portfolio. FHLMC guarantees the timely payment of interest and ultimate collection of principal and maintains reserves to protect holders against losses due to default, but PCs are not backed by the full faith and credit of the U.S. Government. As is the case with GNMA certificates, the actual maturity of and realized yield on particular FNMA and FHLMC pass-through securities will vary based on the prepayment experience of the underlying pool of mortgages. Collateralized Mortgage Obligations (CMOs). A CMO is a hybrid between a mortgage-backed bond and a mortgage pass-through security. Similar to a bond, interest and prepaid principal is paid, in most cases, semiannually. CMOs may be collateralized by whole mortgage loans but are more typically collateralized by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or FNMA, and their income streams. CMOs that are issued or guaranteed by the U.S. Government or by any of its agencies or instrumentalities will be considered U.S. Government securities by the Portfolios, while other CMOs, even if collateralized by U.S. Government securities, will have the same status as other privately issued securities for purposes of applying a Portfolio's diversification tests. CMOs are structured into multiple classes, each bearing a different stated maturity. Actual maturity and average life will depend upon the prepayment experience of the collateral. CMOs provide for a modified form of call protection through a de facto breakdown of the underlying pool of mortgages according to how quickly the loans are repaid. Monthly payment of principal received from the pool of underlying mortgages, including prepayments, generally is first returned to investors holding the shortest maturity class. Investors holding the longer maturity classes receive principal only after the first class has been retired. An investor is partially guarded against a sooner than desired return of principal because of the sequential payments. In a typical CMO transaction, a corporation ("issuer") issues multiple series (e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond offering are used to purchase mortgages or mortgage pass-through certificates ("Collateral"). The Collateral is pledged to a third party trustee as security for the Bonds. Principal and interest payments from the Collateral are used to pay principal on the Bonds in the order A, B, C, Z. The series A, B, and C Bonds all bear current interest. Interest on the series Z Bond is accrued and added to principal and a like amount is paid as principal on the series A, B, or C Bond currently being paid off. When the series A, B, and C Bonds are paid in full, interest and principal on the series Z Bond begins to be paid currently. With some CMOs, the issuer serves as a conduit to allow loan originators (primarily builders or savings and loan associations) to borrow against their loan portfolios. FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations of FHLMC issued in multiple classes having different maturity dates which are secured by the pledge of a pool of conventional mortgage loans purchased by FHLMC. Unlike FHLMC PCs, payments of principal and interest on the CMOs are made semiannually, as opposed to monthly. The amount of principal payable on each semiannual payment date is determined in accordance with FHLMC's mandatory sinking fund schedule, which, in turn, is equal to approximately 100% of FHA prepayment experience applied to the mortgage collateral pool. All sinking fund payments in the CMOs are allocated to the retirement of the individual classes of bonds in the order of their stated maturities. Payment of principal on the mortgage loans in the collateral pool in excess of the amount of FHLMC's minimum sinking fund obligation for any payment date are paid to the holders of the CMOs as additional sinking fund payments. Because of the "pass-through" nature of all principal payments received on the collateral pool in excess of FHLMC's minimum sinking fund requirement, the rate at which principal of the CMOs is actually repaid is likely to be such that each class of bonds will be retired in advance of its scheduled maturity date. If collection of principal (including prepayments) on the mortgage loans during any semiannual payment period is not sufficient to meet FHLMC's minimum sinking fund obligation on the next sinking fund payment date, FHLMC agrees to make up the deficiency from its general funds. Criteria for the mortgage loans in the pool backing the CMOs are identical to those of FHLMC PCs. FHLMC has the right to substitute collateral in the event of delinquencies and/or defaults. Other Mortgage-Related Securities. Commercial banks, savings and loan institutions, private mortgage insurance companies, mortgage bankers, and other secondary market issuers also create pass-through pools of conventional residential mortgage loans. Such issuers may, in addition, be the originators and/or servicers of the underlying mortgage loans as well as the guarantors of the mortgage-related securities. Pools created by such non-governmental issuers generally offer a higher rate of interest than government and government- related pools because there are no direct or indirect government or agency guarantees of payments in the former pools. However, timely payment of interest and principal of these pools may be supported by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance, and letters of credit. The insurance and guarantees are issued by governmental entities, private insurers, and the mortgage poolers. Such insurance and guarantees and the creditworthiness of the issuers thereof will be considered in determining whether a mortgage-related security meets a Portfolio's investment quality standards. There can be no assurance that the private insurers or guarantors can meet their obligations under the insurance policies or guarantee arrangements. A Portfolio may buy mortgage-related securities without insurance or guarantees, if, in an examination of the loan experience and practices of the originator/servicers and poolers, the Adviser or Portfolio Manager determines that the securities meet a Portfolio's quality standards. Although the market for such securities is becoming increasingly liquid, securities issued by certain private organizations may not be readily marketable. A Portfolio will not purchase mortgage-related securities or any other assets which in the opinion of the Adviser or Portfolio Manager are illiquid if, as a result, more than 15% of the value of a Portfolio's total assets will be illiquid. It is expected that governmental, government-related, or private entities may create mortgage loan pools and other mortgage-related securities offering mortgage pass-through and mortgage collateralized investments in addition to those described above. As new types of mortgage- related securities are developed and offered to investors, the Adviser or Portfolio Manager will, consistent with a Portfolio's investment objectives, policies, and quality standards, consider making investments in such new types of mortgage-related securities. CMO Residuals. CMO residuals are derivative mortgage securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings and loan associations, homebuilders, mortgage banks, commercial bank, investment banks and special purpose entities of the foregoing. The cash flow generated by the mortgage assets underlying a series of CMOs is applied first to make required payments of principal and interest on the CMOs and second to pay the related administrative expenses of the issuer. The residual in a CMO structure generally represents the interest in any excess cash flow remaining after making the foregoing payments. Each payment of such excess cash flow to a holder of the related CMO residual represents income and/or a return of capital. The amount of residual cash flow resulting from a CMO will depend on, among other things, the characteristics of the mortgage assets, the coupon rate of each class of CMO, prevailing interest rates, the amount of administrative expenses and the prepayment experience on the mortgage assets. In particular, the yield to maturity on CMO residuals is extremely sensitive to prepayments on the related underlying mortgage assets, in the same manner as an interest-only ("IO") class of stripped mortgage-backed securities. See "Other Mortgage-Related Securities--Stripped Mortgage-Backed Securities." In addition, if a series of a CMO includes a class that bears interest at an adjustable rate, the yield to maturity on the related CMO residual will also be extremely sensitive to changes in the level of the index upon which interest rate adjustments are based. As described below with respect to stripped mortgage-backed securities, in certain circumstances a Portfolio may fail to recoup fully its initial investment in a CMO residual. CMO residuals are generally purchased and sold by institutional investors through several investment banking firms acting as brokers or dealers. The CMO residual market has only very recently developed and CMO residuals currently may not have the liquidity of other more established securities trading in other markets. Transactions in CMO residuals are generally completed only after careful review of the characteristics of the securities in question. In addition, CMO residuals may or, pursuant to an exemption therefrom, may not have been registered under the Securities Act of 1933, as amended. CMO residuals, whether or not registered under such Act, may be subject to certain restrictions on transferability, and may be deemed "illiquid" and subject to a Portfolio's limitations on investment in illiquid securities. Stripped Mortgage-backed Securities. Stripped mortgage-backed securities ("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by agencies or instrumentalities of the U.S. Government, or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing. SMBS are usually structured with two classes that receive different proportions of the interest and principal distributions on a pool of mortgage assets. A common type of SMBS will have one class receiving some of the interest and most of the principal from the mortgage assets, while the other class will receive most of the interest and the remainder of the principal. In the most extreme case, one class will receive all of the interest (the IO class), while the other class will receive all of the principal (the principal- only or "PO" class). The yield to maturity on an IO class is extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on the Portfolio's yield to maturity from these securities. If the underlying mortgage assets experience greater than anticipated prepayments of principal, a Portfolio may fail to fully recoup its initial investment in these securities even if the security is in one of the highest rating categories. Although SMBS are purchased and sold by institutional investors through several investment banking firms acting as brokers or dealers, these securities were only recently developed. As a result, established trading markets have not yet developed and, accordingly, these securities may be deemed "illiquid" and subject to a Portfolio's limitations on investment in illiquid securities. In addition to mortgage-related securities, the High Yield Bond, Managed Bond, Growth LT, and Multi-Strategy Portfolios may invest in other asset-backed securities which are securities that directly or indirectly represent a participation interest in, or are secured by and payable from a stream of payments generated by particular assets such as automobile loans or installment sales contracts, home equity loans, computer and other leases, credit card receivables, or other assets. Generally, the payments from the collateral are passed through to the security holder. Due to the possibility that prepayments (on automobile loans and other collateral) will alter cash flow on asset-backed securities, generally it is not possible to determine in advance the actual final maturity date or average life of many asset-backed securities. Faster prepayment will shorten the average life and slower prepayments will lengthen it. However, it may be possible to determine what the range of that movement could be and to calculate the effect that it will have on the price of the security. Other risks relate to limited interests in applicable collateral. For example, credit card debt receivables are generally unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit laws, many of which give such debtors the right to set off certain amounts on credit card debt thereby reducing the balance due. Additionally, holders of asset-backed securities may also experience delays in payments or losses if the full amounts due on underlying sales contracts are not realized. Because asset- backed securities are relatively new, the market experience in these securities is limited and the market's ability to sustain liquidity through all phases of the market cycle has not been tested. The High Yield Bond Portfolio and, to the extent of 10% of their assets, the Managed Bond Portfolio and Growth LT Portfolio, and, to the extent of 5% of its assets, the International Portfolio, (measured at the time of investment), may invest in high risk debt securities rated lower than Baa or BBB, or, if not rated by Moody's or S&P, of equivalent quality (although the Managed Bond Portfolio may not invest in securities rated lower than B) ("high yield bonds," which are commonly referred to as "junk bonds"). In general, high yield bonds are not considered to be investment grade, and investors should consider the risks associated with high yield bonds before investing in the pertinent Portfolio, and in particular the High Yield Bond Portfolio. Investment in such securities generally provides greater income and increased opportunity for capital appreciation than investments in higher quality securities, but they also typically entail greater price volatility and principal and income risk. Investment in high yield bonds involves special risks in addition to the risks associated with investments in higher rated debt securities. High yield bonds are regarded as predominately speculative with respect to the issuer's continuing ability to meet principal and interest payments. The high yield bond market is relatively new, and many of the outstanding high yield bonds have not endured a lengthy business recession. A long-term track record on bond default rates such as that for investment grade corporate bonds, does not exist for the high yield market. Analysis of the creditworthiness of issuers of debt securities that are high yield bonds may be more complex than for issuers of higher quality debt securities, and the ability of a Portfolio to achieve its investment objective may, to the extent of investment in high yield bonds, be more dependent upon such creditworthiness analysis than would be the case if the Portfolio were investing in higher quality bonds. High yield bonds may be more susceptible to real or perceived adverse economic and competitive industry conditions than investment grade bonds. The prices of high yield bonds have been found to be less sensitive to interest- rate changes than higher-rated investments, but more sensitive to adverse economic downturns or individual corporate developments. A projection of an economic downturn or of a period of rising interest rates, for example, could cause a decline in high yield bond prices because the advent of a recession could lessen the ability of a highly leveraged company to make principal and interest payments on its debt securities. If an issuer of high yield bonds defaults, in addition to risking payment of all or a portion of interest and principal, a Portfolio may incur additional expenses to seek recovery. In the case of high yield bonds structured as zero-coupon or pay-in-kind securities, their market prices are affected to a greater extent by interest rate changes, and therefore tend to be more volatile than securities which pay interest periodically and in cash. The secondary market on which high yield bonds are traded may be less liquid than the market for higher grade bonds. Less liquidity in the secondary trading market could adversely affect the price at which a Portfolio could sell a high yield bond, and could adversely affect and cause large fluctuations in the daily net asset value of the Portfolio's shares. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the values and liquidity of high yield bonds, especially in a thinly-traded market. When secondary markets for high yield bonds are less liquid than the market for higher grade bonds, it may be more difficult to value the securities because such valuation may require more research, and elements of judgment may play a greater role in the valuation because there is less reliable, objective data available. There are also certain risks involved in using credit ratings for evaluating high yield bonds. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of high yield bonds. Also, credit rating agencies may fail to timely reflect subsequent events. Bank obligations in which all Portfolios may invest include certificates of deposit, bankers' acceptances, and fixed time deposits. Each Portfolio may also hold funds on deposit with its sub-custodian bank in an interest-bearing account for temporary purposes. Certificates of deposit are negotiable certificates issued against funds deposited in a commercial bank for a definite period of time and earning a specified return. Bankers' acceptances are negotiable drafts or bills of exchange, normally drawn by an importer or exporter to pay for specific merchandise, which are "accepted" by a bank, meaning, in effect, that the bank unconditionally agrees to pay the face value of the instrument on maturity. Fixed time deposits are bank obligations payable at a stated maturity date and bearing interest at a fixed rate. Fixed time deposits may be withdrawn on demand by the investor, but may be subject to early withdrawal penalties which vary depending upon market conditions and the remaining maturity of the obligation. There are no contractual restrictions on the right to transfer a beneficial interest in a fixed time deposit to a third party, although there is no market for such deposits. A Portfolio will not invest in fixed time deposits which are (i) not subject to prepayment, or (ii) which provide for withdrawal penalties upon prepayment (other than overnight deposits) if, in the aggregate, more than 15% of its assets would be invested in such deposits, repurchase agreements maturing in more than seven days, and other illiquid assets. A Portfolio will not invest in any security issued by a commercial bank unless: (i) the bank has total assets of at least U.S. $1 billion (U.S. $2 billion in the case of the Bond and Income Portfolio), or the equivalent in other currencies, or, in the case of domestic banks which do not have total assets of at least U.S. $1 billion, the aggregate investment made in any one such bank is limited to an amount, currently U.S. $100,000, insured in full by the Federal Deposit Insurance Corporation; (ii) in the case of U.S. banks, it is a member of the Federal Deposit Insurance Corporation; and (iii) in the case of foreign banks, the security is, in the opinion of the Adviser or the Portfolio's Portfolio Manager, of an investment quality comparable with other debt securities of similar maturities which may be purchased by the Portfolio. These limitations do not prohibit investments in securities issued by foreign branches of U.S. banks, provided such U.S. banks meet the foregoing requirements. All Portfolios may invest in short-term debt obligations of savings and loan associations. A Portfolio will not invest in any security issued by a savings and loan association unless: (i) the savings and loan association has total assets of at least $1 billion (U.S. $2 billion in the case of the Bond and Income Portfolio), or, in the case of savings and loan associations which do not have total assets of at least $1 billion, the aggregate investment made in any one savings and loan association is insured in full, currently up to $100,000, by the Savings Association Insurance Fund; (ii) the savings and loan association issuing the security is a member of the Federal Home Loan Bank System; and (iii) the institution is insured by the Savings Association Insurance Fund. A Portfolio will not purchase any security of a small bank or savings and loan association which is not readily marketable if, as a result, more than 15% of the value of its total assets would be invested in such securities, other illiquid securities, or securities without readily available market quotations, such as restricted securities and repurchase agreements maturing in more than seven days. The International Portfolio limits its investments in obligations of foreign banks (including U.S. branches of foreign banks) which at the time of investment (i) have more than U.S. $1 billion, or the equivalent in other currencies, in total assets; and (ii) in the opinion of the Portfolio's Portfolio Manager, are of an investment quality comparable to fixed income obligations in which the Portfolio may invest. There is no limitation on the amount of the Portfolio's assets which may be invested in obligations of foreign banks which meet the conditions set forth herein. Obligations of foreign banks involve somewhat different investment risks than those affecting obligations of U.S. banks, including: (i) the possibilities that their liquidity could be impaired because of future political and economic developments; (ii) their obligations may be less marketable than comparable obligations of U.S. banks; (iii) a foreign jurisdiction might impose withholding taxes on interest income payable on those obligations; (iv) foreign deposits may be seized or nationalized; (v) foreign governmental restrictions, such as exchange controls, may be adopted which might adversely affect the payment of principal and interest on those obligations; and (vi) the selection of those obligations may be more difficult because there may be less publicly available information concerning foreign banks or the accounting, auditing, and financial reporting standards, practices and requirements applicable to foreign banks may differ from those applicable to United States banks. Foreign banks are not generally subject to examination by any U.S. Government agency or instrumentality. The International Portfolio's investment in convertible securities, described below, that are purchased in furtherance of the Portfolio's investment objective, is not subject to the limitations described above with respect to bank obligations. All Portfolios may invest in U.S. dollar-denominated corporate debt securities of domestic issuers and the Money Market, High Yield Bond, Managed Bond, Growth LT, Multi-Strategy, and International Portfolios may invest in U.S. dollar-denominated debt securities of foreign issuers. The Growth LT, Multi-Strategy, and International Portfolios may also invest in debt securities of foreign issuers denominated in foreign currencies. The debt securities in which any Portfolio other than the Money Market Portfolio may invest are limited to corporate debt securities (corporate bonds, debentures, notes, and other similar corporate debt instruments) which meet the minimum ratings criteria set forth for that particular Portfolio, or, if not so rated, are, in the Portfolio Manager's opinion, comparable in quality to corporate debt securities in which a Portfolio may invest. The debt securities in which the Money Market Portfolio may invest are described in the discussion of the investment objective and policies of that Portfolio. The investment return on corporate debt securities reflects interest earnings and changes in the market value of the security. The market value of corporate debt obligations may be expected to rise and fall inversely with interest rates generally. There also exists the risk that the issuers of the securities may not be able to meet their obligations on interest or principal payments at the time called for by an instrument. The High Yield Bond, Managed Bond, Growth LT, Equity Income, Multi-Strategy, Bond and Income, and International Portfolios may invest in corporate debt securities rated Baa (Moody's) or BBB (S&P), or, if not rated by Moody's or S&P, of equivalent quality. Such securities are considered medium grade, and do not have economic characteristics that provide the high degree of security with respect to payment of principal and interest associated with higher rated bonds, and generally have some speculative characteristics. A bond will be placed in this rating category where interest payments and principal security appear adequate for the present, but economic characteristics that provide longer term protection may be lacking. The High Yield Bond and, to the extent of 10% of their assets, the Managed Bond Portfolio and Growth LT Portfolio, and to the extent of 5% of its assets, the International Portfolio, may invest in debt securities rated lower than Baa or BBB (although the Managed Bond Portfolio may not invest in securities rated lower than B), or, if not rated by Moody's or S&P, of equivalent quality. Such securities are not considered to be investment grade, and are regarded as predominately speculative with respect to the issuer's continuing ability to meet principal and interest payments. For more information on the risks of such securities, see the discussion of "High Yield Bonds" above. VARIABLE AND FLOATING RATE SECURITIES All Portfolios may invest in variable and floating rate securities which provide for a periodic adjustment in the interest rate paid on obligations. The terms of such obligations must provide that interest rates are adjusted periodically based upon an appropriate interest rate adjustment index as provided in the respective obligations. The adjustment intervals may be regular, and range from daily to annually, or may be event based, such as based on a change in the prime rate. All of the Portfolios may invest in commercial paper (including variable amount master demand notes). Each Portfolio other than the Money Market and Equity Portfolios may invest in commercial paper denominated in U.S. dollars, issued by U.S. corporations or foreign corporations and (1) rated at the date of investment Prime-1 or Prime-2 by Moody's or A-1 or A-2 by S&P, (2) if not rated by either Moody's or S&P, issued by a corporation having an outstanding debt issue rated Aa or better by Moody's or AA or better by S&P or (3) if not rated, are determined to be of an investment quality comparable to rated commercial paper in which a Portfolio may invest. If issued by a foreign corporation, such commercial paper is U.S. dollar-denominated and not subject at the time of purchase to foreign tax withholding. The International Portfolio may, however, invest in commercial paper denominated in foreign currencies. The Money Market Portfolio may invest in commercial paper that meets the standards for money market securities that Portfolio may acquire as described in the Prospectus in the section "Investment Objectives and Policies." The Equity Portfolio may invest in commercial paper (1) rated at the time of purchase Prime-1 by Moody's or A-1 by S&P or (2) if not rated by either Moody's or S&P, issued by a corporation having an outstanding debt issue rated Aa or better by Moody's or AA or better by S&P. Commercial paper obligations may include variable amount master demand notes. These are obligations that permit the investment of fluctuating amounts at varying rates of interest pursuant to direct arrangements between a Portfolio, as lender, and the borrower. These notes permit daily changes in the amounts borrowed. The lender has the right to increase the amount under the note at any time up to the full amount provided by the note agreement, or to decrease the amount, and the borrower may prepay up to the full amount of the note without penalty. Because variable amount master demand notes are direct lending arrangements between the lender and borrower, it is not generally contemplated that such instruments will be traded and there is no secondary market for these notes. However, they are redeemable (and thus immediately repayable by the borrower) at face value, plus accrued interest, at any time. In connection with master demand note arrangements, the Adviser or Portfolio Manager will monitor, on an ongoing basis, the earning power, cash flow, and other liquidity ratios of the borrower and its ability to pay principal and interest on demand. The Adviser or Portfolio Manager also will consider the extent to which the variable amount master demand notes are backed by bank letters of credit. These notes generally are not rated by Moody's or S&P; a Portfolio other than the Money Market Portfolio may invest in them only if the Adviser or Portfolio Manager believes that at the time of investment the notes are of comparable quality to the other commercial paper in which the Portfolio may invest. With respect to the Money Market Portfolio, determination of eligibility for the Portfolio will be in accordance with the standards described in the discussion of the Portfolio in the prospectus on "Investment Objectives and Policies." Master demand notes are considered by the Portfolio to have a maturity of one day unless the Adviser or Portfolio Manager has reason to believe that the borrower could not make immediate repayment upon demand. See the Appendix in the Prospectus for a description of Moody's and S&P ratings applicable to commercial paper. All Portfolios except the Money Market Portfolio may invest in convertible securities. The convertible securities in the Portfolio's portfolios are fixed- income securities which may be converted or exchanged at a stated exchange ratio into underlying shares of common stock. The exchange ratio for any particular convertible security may be adjusted from time to time due to stock splits, dividends, spin-offs, other corporate distributions, or scheduled changes in the exchange ratio. Convertible bonds and convertible preferred stocks, until converted, have general characteristics similar to both fixed- income and equity securities. Although to a lesser extent than with fixed- income securities generally, the market value of convertible securities tends to decline as interest rates increase and, conversely, tends to increase as interest rates decline. In addition, because of the conversion or exchange feature, the market value of convertible securities tends to vary with fluctuations in the market value of the underlying common stocks, and, therefore, also will react to variations in the general market for equity securities. A unique feature of convertible securities is that as the market price of the underlying common stock declines, convertible securities tend to trade increasingly on a yield basis, and so may not experience market value declines to the same extent as the underlying common stock. When the market price of the underlying common stock increases, the prices of the convertible securities tend to rise as a reflection of the value of the underlying common stock. While no securities investments are without risk, investments in convertible securities generally entail less risk than investments in common stock of the same issuer. As fixed-income securities, convertible securities are investments which provide for a stable stream of income with generally higher yields than common stocks. Of course, like all fixed-income securities there can be no assurance of current income because the issuers of the convertible securities may default in their obligations. Convertible securities, however, generally offer lower interest or dividend yields than non-convertible securities of similar quality because of the potential for capital appreciation. A convertible security, in addition to providing fixed-income, offers the potential for capital appreciation through the conversion feature which enables the holder to benefit from increases in the market price of the underlying common stock. In selecting the securities for a Portfolio, the Adviser or Portfolio Manager gives substantial consideration to the potential for capital appreciation of the common stock underlying the convertible securities. However, there can be no assurance of capital appreciation because securities prices fluctuate. Convertible securities generally are subordinated to other similar but non- convertible securities of the same issuer although convertible bonds, as corporate debt obligations, enjoy seniority in right of payment to all equity securities, and convertible preferred stock is senior to common stock, of the same issuer. However, because of the subordination feature, convertible bonds and convertible preferred stock typically have lower ratings than similar non- convertible securities. A "synthetic convertible" is created by combining distinct securities which possess the two principal characteristics of a true convertible, i.e., fixed- income ("fixed-income component") and the right to acquire equity securities ("convertibility component"). This combination is achieved by investing in non- convertible fixed-income securities (non-convertible bonds and preferred stocks) and in warrants, granting the holder the right to purchase a specified quantity of securities within a specified period of time at a specified price. However, the synthetic convertible differs from the true convertible security in several respects. Unlike a true convertible, which is a single security having a unitary market value, a synthetic convertible is comprised of two distinct securities, each with its own market value. Therefore, the "market value" of a synthetic convertible is the sum of the values of its fixed-income component and its convertibility component. For this reason, the value of a synthetic convertible and a true convertible security will respond differently to market fluctuations. More flexibility is possible in the assembly of a synthetic convertible than in the purchase of a convertible security in that its two components may be purchased separately. For example, a Portfolio Manager may purchase a warrant for inclusion in a synthetic convertible but temporarily hold short-term investments while postponing purchase of a corresponding bond pending development of more favorable market conditions. A holder of a synthetic convertible faces the risk that the price of the stock underlying the convertibility component will decline, causing a decline in the value of the warrant; should the price of the stock fall below the exercise price and remain there throughout the exercise period, the entire amount paid for the warrant would be lost. Since a synthetic convertible includes the fixed-income component as well, the holder of a synthetic convertible also faces the risk that interest rates will rise, causing a decline in the value of the fixed-income instrument. All Portfolios may invest in repurchase agreements, which entail the purchase of a portfolio eligible security from a bank or broker-dealer that agrees to repurchase the security at the Portfolio's cost plus interest within a specified time (normally one day). Repurchase agreements permit an investor to maintain liquidity and earn income over periods of time as short as overnight. If a Portfolio acquires securities from a bank or broker-dealer it may simultaneously enter into a repurchase agreement with the seller wherein the seller agrees at the time of sale to repurchase the security at a mutually agreed upon time and price. The term of such an agreement is generally quite short, possibly overnight or for a few days, although it may extend over a number of months (up to one year) from the date of delivery. The resale price is in excess of the purchase price by an amount which reflects an agreed upon market rate of return, effective for the period of time the Portfolio is invested in the security. This results in a fixed rate of return protected from market fluctuations during the period of the agreement. This rate is not tied to the coupon rate on the security subject to the repurchase agreement. If the party agreeing to repurchase should default and if the value of the securities held by a Portfolio should fall below the repurchase price, a loss could be incurred. Repurchase agreements will be entered into only where the underlying security is within the three highest credit categories assigned by established rating agencies (Aaa, Aa, or A by Moody's or AAA, AA, or A by S&P) or, if not rated by Moody's or S&P, are of equivalent investment quality as determined by the Adviser or Portfolio Manager, except that the Money Market Portfolio will enter into repurchase agreements only where the underlying securities are of the quality that is eligible for the Portfolio as described in the discussion of that Portfolio's investment objective and policies. Under the Investment Company Act of 1940 (the "1940 Act"), repurchase agreements are considered to be loans by the purchaser collateralized by the underlying securities. The Adviser or Portfolio Manager to a Portfolio monitors the value of the underlying securities at the time the repurchase agreement is entered into and at all times during the term of the agreement to ensure that its value always equals or exceeds the agreed upon repurchase price to be paid to the Portfolio. The Adviser or Portfolio Manager, in accordance with procedures established by the Board of Trustees, also evaluates the creditworthiness and financial responsibility of the banks and brokers or dealers with which the Portfolio enters into repurchase agreements. A Portfolio may not enter into a repurchase agreement having more than seven days remaining to maturity if, as a result, such agreements, together with any other securities which are not readily marketable, would exceed 15% of the total assets of the Portfolio. If the seller should become bankrupt or default on its obligations to repurchase the securities, a Portfolio may experience delay or difficulties in exercising its rights to the securities held as collateral and might incur a loss if the value of the securities should decline. A Portfolio also might incur disposition costs in connection with liquidating the securities. Each Portfolio may borrow up to certain limits. A Portfolio may not borrow if, as a result of such borrowing, the total amount of all money borrowed by the Portfolio exceeds 10% of the value of its net assets (at the time of such borrowing), or if borrowing for temporary purposes, such as to facilitate redemptions, 25% of the value of its net assets. These limits may be exceeded by 5% of the value of a Portfolio's net assets so that they are 15% and 30%, respectively, to the extent that a Portfolio purchases securities on a "when- issued" basis or enters into firm-commitment agreements to purchase securities, both of which are considered borrowings for purposes of the Fund's limits. This borrowing may be unsecured. Borrowing may exaggerate the effect on net asset value of any increase or decrease in the market value of a Portfolio. Money borrowed will be subject to interest costs which may or may not be recovered by appreciation of the securities purchased. A Portfolio also may be required to maintain minimum average balances in connection with such borrowing or to pay a commitment or other fee to maintain a line of credit; either of these requirements would increase the cost of borrowing over the stated interest rate. Reverse repurchase agreements will be included as borrowing subject to the borrowing limitations described above. REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS Among the forms of borrowing in which the High Yield Bond, Managed Bond, Government Securities, Growth LT, Bond and Income, and Equity Index Portfolios may engage is the entry into reverse repurchase agreements, which involves the sale of a debt security held by the Portfolio, with an agreement by that Portfolio to repurchase the security at a stated price, date and interest payment. A Portfolio will use the proceeds of a reverse repurchase agreement to purchase other money market instruments which either mature at a date simultaneous with or prior to the expiration of the reverse repurchase agreement or which are held under an agreement to resell maturing as of that time. The use of reverse repurchase agreements by a Portfolio creates leverage which increases a Portfolio's investment risk. If the income and gains on securities purchased with the proceeds of reverse repurchase agreements exceed the cost of the agreements, the Portfolio's earnings or net asset value will increase faster than otherwise would be the case; conversely, if the income and gains fail to exceed the costs, earnings or net asset value would decline faster than otherwise would be the case. A Portfolio will enter into a reverse repurchase agreement only when the interest income to be earned from the investment of the proceeds of the transaction is greater than the interest expense of the transaction. However, reverse repurchase agreements involve the risk that the market value of securities retained by the Portfolio may decline below the repurchase price of the securities sold by the Portfolio which it is obligated to repurchase. Under the 1940 Act, reverse repurchase agreements may be considered to be borrowings by the seller; accordingly, a Portfolio will limit its investments in reverse repurchase agreements consistent with the borrowing limits applicable to the Portfolio. See "Borrowing" for further information on these limits. A Portfolio may enter into reverse repurchase agreements with banks or broker-dealers. Entry into such agreements with broker-dealers requires the creation and maintenance of a segregated account consisting of U.S. Government securities or cash or cash equivalents equal in value to its obligations in respect of reverse repurchase agreements. FIRM COMMITMENT AGREEMENTS AND WHEN-ISSUED SECURITIES All Portfolios may enter into firm commitment agreements for the purchase of securities at an agreed upon price on a specified future date. A Portfolio may purchase new issues of securities on a "when-issued" basis, whereby the payment obligation and interest rate on the instruments are fixed at the time of the transaction. Such transactions might be entered into, for example, when the Adviser or Portfolio Manager to a Portfolio anticipates a decline in the yield of securities of a given issuer and is able to obtain a more advantageous yield by committing currently to purchase securities to be issued or delivered later. A Portfolio will not enter into such a transaction for the purpose of investment leverage. Liability for the purchase price--and all the rights and risks of ownership of the securities--accrue to the Portfolio at the time it becomes obligated to purchase such securities, although delivery and payment occur at a later date. Accordingly, if the market price of the security should decline, the effect of the agreement would be to obligate the Portfolio to purchase the security at a price above the current market price on the date of delivery and payment. During the time the Portfolio is obligated to purchase such securities it will maintain in a segregated account U.S. Government securities, high-grade debt obligations, or cash or cash equivalents of an aggregate current value sufficient to make payment for the securities. For the purpose of realizing additional income, each Portfolio, except the Equity Income, Multi-Strategy, and Equity Index Portfolios, may make secured loans of its portfolio securities to broker-dealers or U.S. banks provided: (i) such loans are secured continuously by collateral consisting of cash, cash equivalents, or U.S. Government securities maintained on a daily marked-to- market basis in an amount or at a market value at least equal to the current market value of the securities loaned; (ii) the Portfolio may at any time call such loans and obtain the securities loaned; (iii) the Portfolio will receive an amount in cash at least equal to the interest or dividends paid on the loaned securities; and (iv) the aggregate market value of securities loaned will not at any time exceed 25% of the total assets of the Portfolio. In addition, it is anticipated that the Portfolio may share with the borrower some of the income received on the collateral for the loan or that it will be paid a premium for the loan. It should be noted that in connection with the lending of its portfolio securities, the Portfolio is exposed to the risk of delay in recovery of the securities loaned or possible loss of rights in the collateral should the borrower become insolvent. In determining whether to lend securities, the Adviser or Portfolio Manager considers all relevant facts and circumstances including the creditworthiness of the borrower. Voting rights attached to the loaned securities may pass to the borrower with the lending of portfolio securities. However, the Portfolio intends to call loaned voting securities if important shareholder meetings are imminent. SHORT SALES AGAINST THE BOX The Equity Portfolio may enter into short sales "against the box." A short sale is made by selling a security the Portfolio does not own. A short sale is "against the box" when, at all times during which a short position is open, the Portfolio owns an equal amount of such securities, or owns securities giving it the right, without payment of future consideration, to obtain an equal amount of securities sold short. No more than 15% of the value of the Equity Portfolio's net assets will be subject to such short sales at any time. The Money Market, High Yield Bond, Growth LT, Equity Income, Multi-Strategy, Equity, Bond and Income, and International Portfolios may invest in restricted securities (including privately placed securities) but a Portfolio will not acquire such securities if they are illiquid and other securities that are illiquid, such as repurchase agreements maturing in more than seven days, if as a result they would comprise more than 15% of the value of the Portfolio's total assets, and in the case of the Money Market Portfolio, 10% of the value of its Portfolio assets. The privately placed securities in which these Portfolios may invest are called restricted securities because there are restrictions or conditions attached to their resale. Restricted securities may be sold only in a public offering with respect to which a registration statement is in effect under the Securities Act of 1933 or in a transaction exempt from such registration such as certain privately negotiated transactions. Where registration is required, the Portfolio may be obligated to pay all or part of the registration expenses and a considerable period may elapse between the time of the decision to sell and the time the Portfolio may be permitted to sell a security under an effective registration statement. If, during such a period, adverse market conditions were to develop, the Portfolio might obtain a less favorable price than prevailed when it decided to sell. Restricted securities will be priced at fair value as determined in good faith under the direction of the Board of Trustees. If through the appreciation of restricted securities or the depreciation of unrestricted securities, the Portfolio should be in a position where more than 15% of the value of its total assets are invested in restricted securities that are illiquid and other securities that are illiquid, the Portfolio will consider whether steps should be taken to assure liquidity. Certain restricted securities may be purchased by certain "qualified institutional buyers" without the necessity for registration of the securities. A Portfolio may acquire such a security without the security being treated as illiquid for purposes of the above-described limitation on acquisition of illiquid assets if the Portfolio Manager determines that the security is liquid under guidelines adopted by the Fund's Board of Trustees. Investing in such restricted securities could have the effect of increasing the level of the Portfolio's illiquidity to the extent that qualified institutional buyers become, for a time, uninterested in purchasing these securities. The Money Market, High Yield Bond, Managed Bond, Growth LT, Multi-Strategy, and International Portfolios may invest directly in U.S. dollar-denominated corporate debt securities of foreign issuers, certain foreign bank obligations and U.S. dollar-denominated obligations of foreign governments, foreign government agencies and international agencies. The Growth LT, Equity Income, Multi-Strategy and Equity Index Portfolios may invest in equity securities of foreign issuers if U.S. exchange listed or if otherwise included in the S&P 500. The Growth LT Portfolio may invest in U.S. exchange listed securities of foreign issuers and may invest up to 25% of its assets in foreign securities denominated in a foreign currency and not publicly traded in the United States. The International Portfolio may invest in equity securities of foreign corporations, nonconvertible fixed income securities denominated in foreign currencies, and in securities represented by European Depository Receipts ("EDRs"), Global Depositary Receipts ("GDRs"), or other securities convertible into equity securities of foreign issuers. The Growth LT Portfolio may also invest in EDRs and GDRs and other types of receipts of shares evidencing ownership of the underlying foreign securities. The Managed Bond and Government Securities Portfolios may each invest up to 10% of their assets in non-U.S. dollar-denominated debt securities of foreign issuers. All Portfolios may purchase American Depositary Receipts ("ADRs") which are dollar-denominated receipts issued generally by domestic banks and representing the deposit with the bank of a security of a foreign issuer. ADRs are publicly-traded on exchanges or over-the-counter in the United States. Investing in the securities of foreign issuers involves special risks and considerations not typically associated with investing in U.S. companies. These risks are intensified with respect to investments in emerging market countries. These include differences in accounting, auditing and financial reporting standards, generally higher commission rates on foreign portfolio transactions, expropriation, nationalization, or confiscatory taxation, adverse changes in investment or exchange control regulations, trade restrictions, political instability (which can affect U.S. investments in foreign countries), and potential restrictions on the flow of international capital. It may be more difficult to obtain and enforce judgments against foreign entities. Additionally, income (including dividends and interest) from foreign securities may be subject to foreign taxes, including foreign withholding taxes, and other foreign taxes may apply with respect to securities transactions. Transactions on foreign exchanges or over-the-counter markets may involve greater time from the trade date until settlement than for domestic securities transactions and, if the securities are held abroad, may involve the risk of possible losses through the holding of securities in custodians and depositories in foreign countries. Foreign securities often trade with less frequency and volume than domestic securities and therefore may exhibit greater price volatility. Changes in foreign exchange rates will affect the value of those securities which are denominated or quoted in currencies other than the U.S. dollar. Investing in ADRs may involve many of the same special risks associated with investing in securities of foreign issuers other than liquidity risks. There is generally less publicly available information about foreign companies comparable to reports and ratings that are published about companies in the United States. Foreign companies are also generally not subject to uniform accounting and auditing and financial reporting standards, practices, and requirements comparable to those applicable to U.S. companies. It is contemplated that most foreign securities will be purchased in over- the-counter markets or on stock exchanges located in the countries in which the respective principal offices of the issuers of the various securities are located, if that is the best available market. Foreign stock markets are generally not as developed or efficient as those in the United States. While growing in volume, they usually have substantially less volume than the New York Stock Exchange, and securities of some foreign companies are less liquid and more volatile than securities of comparable U.S. companies. Similarly, volume and liquidity in most foreign bond markets is less than in the United States and at times, volatility of price can be greater than in the United States. Fixed commissions on foreign stock exchanges are generally higher than negotiated commissions on U.S. exchanges, although the Portfolio will endeavor to achieve the most favorable net results on its portfolio transactions. There is generally less government supervision and regulation of stock exchanges, brokers, and listed companies than in the United States. With respect to certain foreign countries, there is the possibility of adverse changes in investment or exchange control regulations, nationalization, expropriation or confiscatory taxation, limitations on the removal of funds or other assets of the Portfolio, political or social instability, or diplomatic developments which could affect United States investments in those countries. Moreover, individual foreign economies may differ favorably or unfavorably from the United States' economy in such respects as growth of gross national product, rate of inflation, capital reinvestment, resource self-sufficiency, and balance of payments position. The dividends and interest payable on certain of the Portfolios' foreign portfolio securities may be subject to foreign withholding taxes, thus reducing the net amount of income available for distribution. Investors should understand that the expense ratio of the International Portfolio can be expected to be higher than investment companies investing in domestic securities since the cost of maintaining the custody of foreign securities and the rate of advisory fees paid by the Portfolio are higher. Investment in foreign securities also involves the risk of possible losses through the holding of securities in custodian banks and securities depositories in foreign countries. The Fund has entered into a Custody Agreement with Investors Fiduciary Trust Company ("IFTC"), a trust company chartered under the laws of Missouri, which has entered into a Subcustodial Agreement with The Chase Manhattan Bank, N.A., ("Chase") under which Chase, together with certain of its foreign branches and agencies and foreign banks and securities depositories acting as subcustodian to Chase, will maintain custody of the securities and other assets of foreign issuers for the Fund. Under these agreements, Chase and IFTC have agreed to use reasonable care in the safekeeping of these securities and to indemnify and hold harmless the Fund any loss which shall occur as a result of the failure of a foreign bank or securities depository holding such securities to exercise reasonable care in the safekeeping of such securities to the same extent as if the securities were held in New York. Pursuant to requirements of the Securities and Exchange Commission, Chase is required to use reasonable care in the selection of foreign subcustodians, and to consider the financial strength of the foreign subcustodian, its general reputation and standing in the country in which it is located, its ability to provide efficiently the custodial services required, and the relative costs for the services to be rendered by it. No assurance can be given that expropriation, nationalization, freezes, or confiscation of assets, which would impact assets of the Portfolio, will not occur, and shareholders bear the risk of losses arising from these or other events. As indicated in the Prospectus, the International Portfolio may invest in shares of investment companies organized to invest in foreign countries. Under the 1940 Act, the Portfolio may not own more than 3% of the outstanding voting stock of an investment company, invest more than 5% of the Portfolio's total assets in any one investment company, or invest more than 10% of the Portfolio's total assets in the securities of investment companies. The International Portfolio will invest in the securities of issuers domiciled or primarily traded in at least five foreign countries if the Portfolio has invested at least 80% of its net assets in foreign issuers. If the Portfolio has less than 20% of its net assets in foreign issuers, then all of such investment may be in issuers domiciled or primarily traded in one country. If the Portfolio has at least 20% but less than 40% of its net assets in foreign issuers, then such investment must be allocated to issuers domiciled or primarily traded in at least two foreign countries. Similarly, if the Portfolio has at least 40% but less than 60% of its net assets invested in foreign issuers such investment must be allocated to at least three foreign countries. Foreign investments must be allocated to at least four foreign countries if such investments comprise at least 60% but less than 80% of the Portfolio's net assets. The Portfolio will not invest more than 20% of its net assets in securities of issuers domiciled or primarily traded in any one country, except that the Portfolio may invest up to 35% of its net assets in issuers domiciled or primarily traded in any one of the following countries: Australia, Canada, France, Japan, the United Kingdom, or Germany. The Portfolio is not subject to any limit upon investment in issuers domiciled or primarily traded in the United States. Generally, the foreign exchange transactions of the Managed Bond, Government Securities, Growth LT, Multi-Strategy, and International Portfolios will be conducted on a spot, i.e., cash, basis at the spot rate for purchasing or selling currency prevailing in the foreign exchange market. This rate, under normal market conditions, differs from the prevailing exchange rate in an amount generally less than 0.15 of 1% due to the costs of converting from one currency to another. However, the Managed Bond, Government Securities, Growth LT, Multi-Strategy and International Portfolios have authority to deal in forward foreign exchange between currencies of the different countries in which the Portfolios will invest as a hedge against possible variations in the foreign exchange rate between these currencies. This is accomplished through contractual agreements to purchase or sell a specified currency at a specified future date and price set at the time of the contract. A Portfolio's dealings in forward foreign exchange will be limited to hedging involving either specific transactions or portfolio positions. Transaction hedging is the purchase or sale of forward foreign currency with respect to specific receivables or payables of a Portfolio arising from the purchase and sale of portfolio securities, the sale and redemption of shares of a Portfolio, or the payment of dividends and distributions by a Portfolio. Position hedging is the sale of forward foreign currency with respect to portfolio security positions denominated or quoted in such foreign currency. The Portfolios will not speculate in forward foreign exchange. Forward Foreign Currency Contracts. The Managed Bond, Government Securities, Growth LT, Multi-Strategy and International Portfolios may enter into forward foreign currency contracts only under two circumstances. First, when a Portfolio enters into a contract for the purchase or sale of a security denominated in a foreign currency, it may desire to "lock in" the U.S. dollar price of the security. By entering into a forward contract for the purchase or sale of the amount of foreign currency involved in the underlying security transactions for a fixed amount of dollars, a Portfolio will be able to protect itself against a possible loss resulting from an adverse change in the relationship between the U.S. dollar and the subject foreign currency during the period between the date the security is purchased or sold and the date on which payment in made or received. Second, when the Portfolio Manager of a Portfolio believes that the currency of a particular foreign country may suffer a substantial movement against another currency, it may enter into a forward contract to sell or buy the amount of the former foreign currency, approximating the value of some or all of the Portfolio's portfolio securities denominated in such foreign currency. The precise matching of the forward contract amounts and the value of the securities involved will not generally be possible since the future value of such securities in foreign currencies will change as a consequence of market movements in the value of those securities between the date the forward contract is entered into and the date it matures. The projection of short-term currency market movements is extremely difficult and the successful execution of a short-term hedging strategy is highly uncertain. In no event will a Portfolio enter into forward contracts under this second circumstance, or maintain a net exposure to such contracts, where the consummation of the contracts would obligate the Portfolio to deliver an amount of foreign currency in excess of the value of that Portfolio's portfolio securities or other assets denominated in that currency. In addition, a Portfolio will not enter into forward contracts under this second circumstance, if, as a result, the Portfolio will have more than 25% of the value of its total assets committed to the consummation of such contracts. Under normal circumstances, consideration of the prospect for currency parities will be incorporated into the longer term investment decisions made with regard to overall diversification strategies. A Portfolio's custodian bank will place cash or liquid equity or debt securities in a separate account of the Portfolio in an amount equal to the value of the Portfolio's total assets committed to the consummation of forward foreign currency exchange contracts entered into under the second circumstance, as set forth above. If the value of the securities placed in the separate account declines, additional cash or securities will be placed in the account on a daily basis so that the value of the account will equal the amount of the Portfolio's commitments with respect to such contracts. When a Portfolio Manager of a Portfolio believes that the currency of a particular foreign country may suffer a decline against the U.S. dollar, that Portfolio may enter into a forward contract to sell the amount of foreign currency approximating the value of some or all of the Portfolio's holdings denominated in such foreign currency. At the maturity of the forward contract to sell, the Portfolio may either sell the portfolio security and make delivery of the foreign currency or it may retain the security and terminate its contractual obligation to deliver the foreign currency by purchasing an "offsetting" contract with the same currency trader obligating the Portfolio to purchase, on the same maturity date, the same amount of the foreign currency. It is impossible to forecast with absolute precision the market value of portfolio securities at the expiration of the contract. Accordingly, it may be necessary for a Portfolio to purchase additional foreign currency on the spot market (and bear the expense of such purchase) if the market value of the security is less than the amount of foreign currency the Portfolio is obligated to deliver and if a decision is made to sell the security and make delivery of the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received upon the sale of the portfolio security if its market value exceeds the amount of foreign currency the Portfolio is obligated to deliver. If a Portfolio retains the portfolio security and engages in an offsetting transaction, the Portfolio will incur a gain or a loss (as described below) to the extent that there has been movement in forward contract prices. If the Portfolio engages in an offsetting transaction, it may subsequently enter into a new forward contract to sell the foreign currency. Should forward prices decline during the period between the Portfolio's entering into a forward contract for the sale of a foreign currency and the date it enters into an offsetting contract for the purchase of the foreign currency, the Portfolio will realize a gain to the extent the price of the currency it has agreed to sell exceeds the price of the currency it has agreed to purchase. Should forward prices increase, the Portfolio will suffer a loss to the extent the price of the currency it has agreed to purchase exceeds the price of the currency it has agreed to sell. A Portfolio's dealings in forward foreign currency exchange contracts will be limited to the transactions described above. Of course, a Portfolio is not required to enter into such transactions with regard to their foreign currency denominated securities and will not do so unless deemed appropriate by its Portfolio Manager. It also should be realized that this method of protecting the value of a Portfolio's holdings in securities against a decline in the value of a currency does not eliminate fluctuations in the underlying prices of the securities. It simply establishes a rate of exchange which one can achieve at some future point in time. Additionally, although such contracts tend to minimize the risk of loss due to a decline in the value of the hedged currency, at the same time they tend to limit any potential gain which might result from the value of such currency increase. Although a Portfolio values its shares in terms of U.S. dollars, it does not intend to convert its holdings of foreign currencies into U.S. dollars on a daily basis. It will do so from time to time, and investors should be aware of the costs of currency conversion. Although foreign exchange dealers do not charge a fee for conversion, they do realize a profit based on the difference (the "spread") between the prices at which they are buying and selling various currencies. Thus, a dealer may offer to sell a foreign currency to a Portfolio at one rate, while offering a lesser rate of exchange should the Portfolio desire to resell that currency to the dealer. The Growth LT Portfolio may also purchase and write options on foreign currencies, invest in foreign currency futures contracts, and purchase and write options thereon, as described below. In pursuing their investment objectives, the High Yield Bond, Managed Bond, Government Securities, Growth LT, Equity Income, and Multi-Strategy Portfolios may engage in the purchase and writing of put and call options on securities. In pursuing their investment objectives, the Growth LT, Equity Income, Multi- Strategy, and Equity Index Portfolios may purchase put and call options on stock indexes. The Equity Portfolio may write exchange-listed call options. Purchasing and Writing Options on Securities. The High Yield Bond, Managed Bond, Government Securities, Growth LT, Equity Income, and Multi-Strategy Portfolios may purchase and write put and call options on securities. A Portfolio may purchase and sell (write) (i) both put and call options on debt or other securities in standardized contracts traded on national securities exchanges, boards of trade, similar entities, or for which an established over- the-counter market exists; and (ii) agreements, sometimes called cash puts, which may accompany the purchase of a new issue of bonds from a dealer. The Equity Portfolio may only write call options that are traded on a national securities exchange, and it may purchase a call option on securities only to effect a "closing purchase transaction" (i.e., the purchase of a call covering the same underlying security and having the same exercise price and expiration date as a call previously written by the Equity Portfolio on which it wished to terminate its obligation). An option on a security is a contract that gives the holder of the option, in return for a premium, the right to buy from (in the case of a call) or sell to (in the case of a put) the writer of the option the security underlying the option at a specified exercise price at any time during the term of the option. The writer of an option on a security has the obligation upon exercise of the option to deliver the underlying security upon payment of the exercise price or to pay the exercise price upon delivery of the underlying security. A Portfolio may purchase put options on securities to protect holdings in an underlying or related security against a substantial decline in market value. Securities are considered related if their price movements generally correlate to one another. For example, the purchase of put options on debt securities held in a Portfolio will enable a Portfolio to protect, at least partially, an unrealized gain in an appreciated security without actually selling the security. In addition, the Portfolio will continue to receive interest income on such security. A Portfolio may purchase call options on securities to protect against substantial increases in prices of securities the Portfolio intends to purchase pending its ability to invest in such securities in an orderly manner. A Portfolio may sell put or call options it has previously purchased, which could result in a net gain or loss depending on whether the amount realized on the sale is more or less than the premium and other transaction costs paid on the put or call option which is sold. A Portfolio may also allow options to expire unexercised. Gains or losses on the Portfolios' transactions in securities index options depend primarily on price movements in the stock market generally (or, for narrow market indexes, in a particular industry or segment of the market) rather than the price movements of individual securities held by a Portfolio of the Fund. A Portfolio may sell securities index options prior to expiration in order to close out its positions in stock index options which it has purchased. A Portfolio may also allow options to expire unexercised. A Portfolio may write call options and put options only if they are "covered" or "secured." In the case of a call option on a security, the option is "covered" if the Portfolio owns the security underlying the call or has an absolute and immediate right to acquire that security without additional cash consideration (or, if additional cash consideration is required, cash or cash equivalents in such amount are placed in a segregated account by its custodian) upon conversion or exchange of other securities held by the Portfolio. A put is secured if the Portfolio maintains cash, cash equivalents or U.S. Government securities with a value equal to the exercise price in a segregated account or holds a put on the same underlying security at an equal or greater exercise price. In the case of options on certain U.S. Government securities, the Portfolio will maintain, in a segregated account with the Fund's Custodian, cash or cash equivalents, or U.S. Government securities with a value sufficient to meet its obligations under the call, or by other means which would permit immediate satisfaction of the Portfolio's obligation as writer of the option. Prior to exercise or expiration, an option may be closed out by an offsetting purchase or sale of an option of the same series. Prior to the earlier of exercise or expiration, an option may be closed out by an offsetting purchase or sale of an option of the same series (type, exchange, underlying security, exercise price, and expiration). There can be no assurance, however, that a closing purchase or sale transaction can be effected when the Portfolio desires. A Portfolio will realize a capital gain from a closing purchase transaction if the cost of the closing option is less than the premium received from writing the option, or, if it is more, the Portfolio will realize a capital loss. If the premium received from a closing sale transaction is more than the premium paid to purchase the option, the Portfolio will realize a capital gain or, if it is less, the Portfolio will realize a capital loss. The principal factors affecting the market value of a put or a call option include supply and demand, interest rates, the current market price of the underlying security in relation to the exercise price of the option, the volatility of the underlying security, and the time remaining until the expiration date. The premium paid for a put or call option purchased by a Portfolio is an asset of the Portfolio. The premium received for an option written by a Portfolio is recorded as a deferred credit. The value of an option purchased or written is marked-to-market daily and is valued at the closing price on the exchange on which it is traded or, if not traded on an exchange or no closing price is available, at the mean between the last bid and asked prices. Purchasing Options on Stock Indexes. The Growth LT, Equity Income, Multi- Strategy, and Equity Index Portfolios may purchase exchange traded put and call options on stock indexes. Like other options listed on United States securities exchanges, index options are issued by the Options Clearing Corporation (OCC). A stock index is a method of reflecting in a single number the market values of many different stocks or, in the case of value weighted indices that take into account prices of component stocks and the number of shares outstanding, the market values of many different companies. Stock indexes are compiled and published by various sources, including securities exchanges. An index may be designed to be representative of the stock market as a whole, of a broad market sector (e.g., industrials), or of a particular industry (e.g., electronics). An index may be based on the prices of all, or only a sample, of the stocks whose value it is intended to represent. A stock index is ordinarily expressed in relation to a "base" established when the index was originated. The base may be adjusted from time to time to reflect, for example, capitalization changes affecting component stocks. In addition, stocks may from time to time be dropped from or added to an index group. These changes are within the discretion of the publisher of the index. Different stock indexes are calculated in different ways. Often the market prices of the stocks in the index group are "value weighted;" that is, in calculating the index level, the market price of each component stock is multiplied by the number of shares outstanding. Because of this method of calculation, changes in the stock prices of larger corporations will generally have a greater influence on the level of a value weighted (or sometimes referred to as a capitalization weighted) index than price changes affecting smaller corporations. In general, index options are very similar to stock options, and are basically traded in the same manner. However, when an index option is exercised, the exercise is settled by the payment of cash--not by the delivery of stock. The assigned writer of a stock option is obligated to pay the exercising holder cash in an amount equal to the difference (expressed in dollars) between the closing level of the underlying index on the exercise date and the exercise price of the option, multiplied by a specified index "multiplier." A multiplier of 100, for example, means that a one-point difference will yield $100. In order to earn additional income on its portfolio securities or to protect partially against declines in the value of such securities, a Portfolio may write covered call options. The exercise price of a call option may be below, equal to, or above the current market value of the underlying security at the time the option is written. During the option period, a covered call option writer may be assigned an exercise notice by the broker-dealer through whom such call option was sold requiring the writer to deliver the underlying security against payment of the exercise price. This obligation is terminated upon the expiration of the option period or at such earlier time in which the writer effects a closing purchase transaction. Closing purchase transactions will ordinarily be effected to realize a profit on an outstanding call option, to prevent an underlying security from being called, to permit the sale of the underlying security, or to enable the Portfolio to write another call option on the underlying security with either a different exercise price or expiration date or both. In order to earn additional income or to facilitate its ability to purchase a security at a price lower than the current market price of such security, a Portfolio may write secured put options. During the option period, the writer of a put option may be assigned an exercise notice by the broker-dealer through whom the option was sold requiring the writer to purchase the underlying security at the exercise price. A Portfolio will enter only into options which are standardized and traded on a U.S. exchange or board of trade, or for which an established over-the-counter market exists. Risks of Options Transactions. There are several risks associated with transactions in options. For example, there are significant differences between the securities and options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve its objectives. A decision as to whether, when, and how to use options involves the exercise of skill and judgment, and even a well-conceived transaction may be unsuccessful to some degree because of market behavior or unexpected events. There can be no assurance that a liquid market will exist when a Portfolio seeks to close out an option position. If a Portfolio were unable to close out an option it had purchased on a security, it would have to exercise the option to realize any profit or the option may expire worthless. If a Portfolio were unable to close out a covered call option it had written on a security, it would not be able to sell the underlying security unless the option expired without exercise. As the writer of a covered call option, a Portfolio forgoes, during the option's life, the opportunity to profit from increases in the market value of the security covering the call option above the sum of the premium and the exercise price of the call. If trading were suspended in an option purchased by a Portfolio, the Portfolio would not be able to close out the option. If restrictions on exercise were imposed, the Portfolio might be unable to exercise an option it has purchased. With respect to index options, current index levels will ordinarily continue to be reported even when trading is interrupted in some or all of the stocks in an index group. In that event, the reported index levels will be based on the current market prices of those stocks that are still being traded (if any) and the last reported prices for those stocks that are not currently trading. As a result, reported index levels may at times be based on non-current price information with respect to some or even all of the stocks in an index group. Exchange rules permit (and in some instances require) the trading of index options to be halted when the current value of the underlying index is unavailable or when trading is halted in stocks accounts for more than a specified percentage of the value of the underlying index. In addition, as with other types of options, an exchange may halt the trading of index options whenever it considers such action to be appropriate in the interests of maintaining a fair and orderly market and protecting investors. If a trading halt occurs, whether for these or for other reasons, holders of index options may be unable to close out their positions and the options may expire worthless. Spread Transactions. The High Yield Bond Portfolio may purchase from and sell to securities dealers covered spread options. Such covered spread options are not presently exchange listed or traded. The purchase of a spread option gives the Portfolio the right to put, or sell, a security that it owns at a fixed dollar spread or fixed yield spread in relationship to another security that the Portfolio does not own, but which is used as a benchmark. The risk to the Portfolio in purchasing covered spread options is the cost of the premium paid for the spread option and any transaction costs. In addition, there is no assurance that closing transactions will be available. The purchase of spread options will be used to protect the Portfolio against adverse changes in prevailing credit quality spreads, i.e., the yield spread between high quality and lower quality securities. Such protection is only provided during the life of the spread option. The security covering the spread option will be maintained in a segregated account by the Fund's custodian. The Portfolio does not consider a security covered by a spread option to be "pledged" as that term is used in the Fund's policy limiting the pledging or mortgaging of its assets. The Growth LT and International Portfolios may buy and write options on foreign currencies for hedging purposes in a manner similar to that in which futures or forward contracts on foreign currencies will be utilized. For example, a decline in the U.S. dollar value of a foreign currency in which portfolio securities are denominated will reduce the U.S. dollar value of such securities, even if their value in the foreign currency remains constant. In order to protect against such diminutions in the value of portfolio securities, a Portfolio may buy put options on the foreign currency. If the value of the currency declines, the Portfolio will have the right to sell such currency for a fixed amount in U.S. dollars and will offset, in whole or in part, the adverse effect on its portfolio. Conversely, when a rise in the U.S. dollar value of a currency in which securities to be acquired are denominated is projected, thereby increasing the cost of such securities, a Portfolio may buy call options thereon. The purchase of such options could offset, at least partially, the effects of the adverse movements in exchange rates. As in the case of other types of options, however, the benefit to the Portfolio from purchases of foreign currency options will be reduced by the amount of the premium and related transaction costs. In addition, if currency exchange rates do not move in the direction or to the extent desired, the Portfolio could sustain losses on transactions in foreign currency options that would require the Portfolio to forgo a portion or all of the benefits of advantageous changes in those rates. A Portfolio may write options on foreign currencies for hedging purposes. For example, to hedge against a potential decline in the U.S. dollar value of foreign currency denominated securities due to adverse fluctuations in exchange rates, the Portfolio could, instead of purchasing a put option, write a call option on the relevant currency. If the expected decline occurs, the option will most likely not be executed and the diminution in value of portfolio securities will be offset by the amount of the premium received. Similarly, instead of purchasing a call option to hedge against a potential increase in the U.S. dollar cost of securities to be acquired, the Portfolio could write a put option on the relevant currency which, if rates move in the manner projected, will expire unexercised and allow the Portfolio to hedge the increased cost up to the amount of the premium. As in the case of other types of options, however, the writing of a foreign currency option will constitute only a partial hedge up to the amount of the premium. If exchange rates do not move in the expected direction, the option may be exercised and the Portfolio would be required to buy or sell the underlying currency at a loss which may not be offset by the amount of the premium. Through the writing of options on foreign currencies, the Portfolio also may lose all or a portion of the benefits which might otherwise have been obtained from favorable movements in exchange rates. A Portfolio may write covered call options on foreign currencies. A call option written on a foreign currency by the Portfolio is "covered" if the Portfolio owns the underlying foreign currency covered by the call or has an absolute and immediate right to acquire that foreign currency without additional cash consideration (or for additional cash consideration held in a segregated account by its custodian) upon conversion or exchange of other foreign currency held in its portfolio. A call option is also covered if the Portfolio has a call on the same foreign currency and in the same principal amount as the call written if the exercise price of the call held (i) is equal to or less than the exercise price of the call written or (ii) is greater than the exercise price of the call written, if the difference is maintained by the Portfolio in cash or high-grade liquid assets in a segregated account with the Fund's custodian. A Portfolio also may write call options on foreign currencies for cross- hedging purposes that would not be deemed to be covered. A call option on a foreign currency is for cross-hedging purposes if it is not covered but is designed to provide a hedge against a decline due to an adverse change in the exchange rate in the U.S. dollar value of a security which the Portfolio owns or has the right to acquire and which is denominated in the currency underlying the option. In such circumstances, the Portfolio collateralizes the option by maintaining, in a segregated account with the Fund's custodian, cash or high-grade liquid assets in an amount not less than the value of the underlying foreign currency in U.S. dollars marked-to-market daily. Foreign currency options are subject to the risks of the availability of a liquid secondary market described above, as well as the risks regarding adverse market movements, margining of options written, the nature of the foreign currency market, possible intervention by governmental authorities and the effects of other political and economic events. In addition, exchange- traded options on foreign currencies involve certain risks not presented by the over-the-counter market. For example, exercise and settlement of such options must be made exclusively through the Options Clearing Corporation ("OCC"), which has established banking relationships in applicable foreign countries for this purpose. As a result, the OCC may, if it determines that foreign governmental restrictions or taxes would prevent the orderly settlement of foreign currency option exercises, or would result in undue burdens on the OCC or its clearing member, impose special procedures on exercise and settlement, such as technical changes in the mechanics of delivery of currency, the fixing of dollar settlement prices or prohibitions on exercise. In addition, options on foreign currencies may be traded on foreign exchanges and over-the-counter in foreign countries. Such transactions are subject to the risk of governmental actions affecting trading in or the prices of foreign currencies or securities. The value of such positions also could be adversely affected by (i) other complex foreign political and economic factors, (ii) lesser availability than in the United States of data on which to make trading decisions, (iii) delays in a Portfolio's ability to act upon economic events occurring in foreign markets during non-business hours in the United States, (iv) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States, and (v) low trading volume. FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS The High Yield Bond, Managed Bond, Government Securities, Growth LT, Multi- Strategy, and International Portfolios may invest in interest rate futures and options thereon. The Growth LT, Equity Income, Multi-Strategy, Equity Index, and International Portfolios may invest in stock index futures and options thereon. Interest Rate Futures. (The High Yield Bond, Managed Bond, Government Securities, Growth LT, Multi-Strategy, and International Portfolios.) An interest rate futures contract is an agreement between two parties (buyer and seller) to take or make delivery of a specified quantity of financial instruments (such as GNMA certificates or Treasury bonds) at a specified price at a future date. In the case of futures contracts traded on U.S. exchanges, the exchange itself or an affiliated clearing corporation assumes the opposite side of each transaction (i.e., as buyer or seller). A futures contract may be satisfied or closed out by delivery or purchase, as the case may be, of the financial instrument or by payment of the change in the cash value of the index. Frequently, using futures to effect a particular strategy instead of using the underlying or related security will result in lower transaction costs being incurred. A public market exists in futures contracts covering various financial instruments including U.S. Treasury bonds, U.S. Treasury notes, GNMA certificates, three month U.S. Treasury bills, 90 day commercial paper, bank certificates of deposit, and Eurodollar certificates of deposit. As a hedging strategy a Portfolio might employ, a Portfolio would purchase an interest rate futures contract when it is not fully invested in long-term debt securities but wishes to defer their purchase for some time until it can orderly invest in such securities or because short-term yields are higher than long-term yields. Such purchase would enable the Portfolio to earn the income on a short-term security while at the same time minimizing the effect of all or part of an increase in the market price of the long-term debt security which the Portfolio intended to purchase in the future. A rise in the price of the long-term debt security prior to its purchase either would be offset by an increase in the value of the futures contract purchased by the Portfolio or avoided by taking delivery of the debt securities under the futures contract. A Portfolio would sell an interest rate futures contract in order to continue to receive the income from a long-term debt security, while endeavoring to avoid part or all of the decline in market value of that security which would accompany an increase in interest rates. If interest rates did rise, a decline in the value of the debt security held by the Portfolio would be substantially offset by the ability of the Portfolio to repurchase at a lower price the interest rate futures contract previously sold. While the Portfolio could sell the long-term debt security and invest in a short-term security, ordinarily the Portfolio would give up income on its investment, since long-term rates normally exceed short-term rates. Stock Index Futures. (The Growth LT, Equity Income, Multi-Strategy, Equity Index, and International Portfolios.) A stock index is a method of reflecting in a single number the market values of many different stocks or, in the case of capitalization weighted indices that take into account both stock prices and the number of shares outstanding, many different companies. An index fluctuates generally with changes in the market values of the common stocks so included. A stock index futures contract is a bilateral agreement pursuant to which two parties agree to take or make delivery of an amount of cash equal to a specified dollar amount multiplied by the difference between the stock index value at the close of the last trading day of the contract and the price at which the futures contract is originally purchased or sold. No physical delivery of the underlying stocks in the index is made. The Growth LT, Equity Income, Multi-Strategy, Equity Index, and International Portfolios may purchase and sell stock index futures contracts to hedge its securities portfolio. A Portfolio may engage in transactions in futures contracts only in an effort to protect it against a decline in the value of the Portfolio's portfolio securities or an increase in the price of securities that the Portfolio intends to acquire. For example, a Portfolio may sell stock index futures to protect against a market decline in an attempt to offset partially or wholly a decrease in the market value of securities that the Portfolio intends to sell. Similarly, to protect against a market advance when the Portfolio is not fully invested in the securities market, the Portfolio may purchase stock index futures that may partly or entirely offset increases in the cost of securities that the Portfolio intends to purchase. Futures Options. The High Yield Bond, Managed Bond, Government Securities, Growth LT, Multi-Strategy, and International Portfolios may purchase and sell (write) call and put futures options on interest rate futures. Futures options possess many of the same characteristics as options on securities. A futures option gives the holder the right, in return for the premium paid, to assume a long position (call) or short position (put) in a futures contract at a specified exercise price at any time during the period of the option. Upon exercise of a call option, the holder acquires a long position in the futures contract and the writer is assigned the opposite short position. In the case of a put option, the opposite is true. The Growth LT, Equity Income, Multi-Strategy, Equity Index, and International Portfolios may purchase put and call options on stock index futures. Options on stock index futures contracts give the purchaser the right, in return for the premium paid, to assume a position in a stock index futures contract (a long position if the option is a call and a short position if the option is a put) at a specified exercise price at any time during the period of the option. Upon exercise of the option, the delivery of the futures position by the writer of the option to the holder of the option will be accompanied by delivery of the accumulated balance in the writer's futures margin account which represents the amount by which the market price of the stock index futures contract, at exercise, exceeds (in the case of a call) or is less than (in the case of a put) the exercise price of the option on the stock index futures contract. If an option is exercised on the last trading day prior to the expiration date of the option, the settlement will be made entirely in cash equal to the difference between the exercise price of the option and the closing level of the index on which the futures contract is based on the expiration date. Purchasers of options who fail to exercise their options prior to the exercise date suffer a loss of the premium paid. A Portfolio other than the Growth LT or International Portfolios will only enter into futures contracts and futures options which are standardized and traded on an U.S. exchange, board of trade, or similar entity, or in the case of futures options, for which an established over-the-counter market exists. If a purchase or sale of a futures contract is made by a Portfolio, the Portfolio is required to deposit with its custodian (or broker, if legally permitted) a specified amount of cash or U.S. Government securities ("initial margin"). The margin required for a futures contract is set by the exchange on which the contract is traded and may be modified during the term of the contract. The initial margin is in the nature of a performance bond or good faith deposit on the futures contract which is returned to the Portfolio upon termination of the contract, assuming all contractual obligations have been satisfied. Each investing Portfolio expects to earn interest income on its initial margin deposits. A futures contract held by a Portfolio is valued daily at the official settlement price of the exchange on which it is traded. Each day the Portfolio pays or receives cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by a Portfolio but is instead settlement between the Portfolio and the broker of the amount one would owe the other if the futures contract expired. In computing daily net asset value, each Portfolio will mark to market its open futures positions. A Portfolio is also required to deposit and maintain margin with respect to put and call options on futures contracts written by it. Such margin deposits will vary depending on the nature of the underlying futures contract (and the related initial margin requirements), the current market value of the option, and other futures positions held by the Portfolio. Although some futures contracts call for making or taking delivery of the underlying securities, generally these obligations are closed out prior to delivery by offsetting purchases or sales of matching futures contracts (same exchange, underlying security, and delivery month). If an offsetting purchase price is less than the original sale price, the Portfolio realizes a capital gain, or if it is more, the Portfolio realizes a capital loss. Conversely, if an offsetting sale price is more than the original purchase price, the Portfolio realizes a capital gain, or if it is less, the Portfolio realizes a capital loss. The transaction costs must also be included in these calculations. Limitations. The Fund will comply with certain regulations of the Commodity Futures Trading Commission under which an investment company may engage in futures transactions and qualify for an exclusion from being a "commodity pool." Under these regulations, a Portfolio may only enter into a futures contract or purchase an option thereon (1) for bona fide hedging purposes and (2) for other purposes if, immediately thereafter, the initial margin deposits for futures contracts held by that Portfolio plus premiums paid by it for open futures option positions, less the amount by which any such positions are "in- the-money," would not exceed 5% of the Portfolio's total assets. A call option is "in-the-money" if the value of the futures contract that is the subject of the option exceeds the exercise price. A put option is "in-the-money" if the exercise price exceeds the value of the futures contract that is the subject of the option. When purchasing a futures contract, a Portfolio must maintain with its custodian in a segregated account (or broker, if legally permitted) cash, U.S. Government securities of other high quality liquid debt securities (including any margin) equal to the purchase price of such contract. When writing a call option on a futures contract, the Portfolio similarly will maintain with its custodian cash, U.S. Government securities or other high quality liquid debt securities (including any margin) equal to the amount such option is in-the- money until the option expires or is closed out by the Portfolio. When selling a futures contract or selling a call option on a futures contract, the Portfolio is required to maintain with its custodian high-quality liquid debt securities, cash, or U.S. Government securities (including any margin) equal to the market value of such contract or option, or to otherwise cover the position. A Portfolio may not maintain open short positions in futures contracts or call options written on futures contracts if, in the aggregate, the market value of all such open positions exceeds the current value of its portfolio securities, plus or minus unrealized gains and losses on the open positions, adjusted for the historical relative volatility of the relationship between the Portfolio and the positions. For this purpose, to the extent the Portfolio has written call options on specific securities it owns, the value of those securities will be deducted from the current market value of the securities portfolio. The Fund reserves the right to engage in other types of futures transactions in the future and to use futures and related options for other than hedging purposes to the extent permitted by regulatory authorities. If other types of options, futures contracts, or futures options are traded in the future, a Portfolio may also use such investment techniques, provided that the Board of Trustees determines that their use is consistent with the Portfolio's investment objective. Risks Associated with Futures and Futures Options. There are several risks associated with the use of futures contracts and futures options as hedging techniques. A purchase or sale of a futures contract may result in losses in excess of the amount invested in the futures contract. There can be significant differences between the securities and futures markets that could result in an imperfect correlation between the markets, causing a given hedge not to achieve its objectives. The degree of imperfection of correlation depends on circumstances such as variations in speculative market demand for futures and futures options on securities, including technical influences in futures trading and futures options, and differences between the portfolio securities being hedged and the instruments underlying the hedging vehicle in such respects as interest rate levels, maturities, conditions affecting particular industries, and creditworthiness of issuers. A decision as to whether, when, and how to hedge involves the exercise of skill and judgment and even a well- conceived hedge may be unsuccessful to some degree because of market behavior or unexpected interest rate trends. The price of futures contracts may not correlate perfectly with movement in the underlying security or stock index, due to certain market distortions. This might result from decisions by a significant number of market participants holding stock index futures positions to close out their futures contracts through offsetting transactions rather than to make additional margin deposits. Also, increased participation by speculators in the futures market may cause temporary price distortions. These factors may increase the difficulty of effecting a fully successful hedging transaction, particularly over a short time frame. With respect to a stock index futures contract, the price of stock index futures might increase, reflecting a general advance in the market price of the index's component securities, while some or all of the portfolio decline. If a Portfolio had hedged its portfolio against a possible decline in the market with a position in futures contracts on an index, it might experience a loss on its futures position until it could be closed out, while not experiencing an increase in the value of its portfolio securities. If a hedging transaction is not successful, the Portfolio might experience losses which it would not have incurred if it had not established futures positions. Similar risk considerations apply to the use of interest rate and other futures contracts. Futures exchanges may limit the amount of fluctuation permitted in certain futures contract prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous day's settlement price at the end of the current trading session. Once the daily limit has been reached in a futures contract subject to the limit, no more trades may be made on that day at a price beyond that limit. The daily limit governs only price movements during a particular trading day and therefore does not limit potential losses because the limit may work to prevent the liquidation of unfavorable positions. For example, futures prices have occasionally moved to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of positions and subjecting some holders of futures contracts to substantial losses. The Growth LT and International Portfolios may trade futures contracts and options on futures contracts not only on U.S. domestic markets, but also on exchanges located outside of the United States. Foreign markets may offer advantages such as trading in indices that are not currently traded in the United States. Foreign markets, however, may have greater risk potential than domestic markets. Unlike trading on domestic commodity exchanges, trading on foreign commodity exchanges is not regulated by the CFTC and may be subject to greater risk than trading on domestic exchanges. For example, some foreign exchanges are principal markets so that no common clearing facility exists and a trader may look only to the broker for performance of the contract. Trading in foreign futures or foreign options contracts may not be afforded certain of the protective measures provided by the Commodity Exchange Act, the CFTC's regulations, and the rules of the National Futures Association and any domestic exchange, including the right to use reparations proceedings before the CFTC and arbitration proceedings provided by the National Futures Association or any domestic futures exchange. Amounts received for foreign futures or foreign options transactions may not be provided the same protection as funds received in respect of transactions on United States futures exchanges. In addition, any profits that the Portfolio might realize in trading could be eliminated by adverse changes in the exchange rate of the currency in which the transaction is denominated, or the Portfolio could incur losses as a result of changes in the exchange rate. Transactions on foreign exchanges may include both commodities that are traded on domestic exchanges or boards of trade and those that are not. There can be no assurance that a liquid market will exist at a time when a Portfolio seeks to close out a futures or a futures option position, and that Portfolio would remain obligated to meet margin requirements until the position is closed. In addition, many of the contracts discussed above are relatively new instruments without a significant trading history. As a result, there can be no assurance that an active secondary market will develop or continue to exist. FOREIGN CURRENCY FUTURES AND OPTIONS THEREON The Growth LT and International Portfolios may enter into contracts for the purchase or sale for future delivery of foreign currencies ("foreign currency futures") and may purchase and write options on foreign currency futures. This investment technique will be used only to hedge against anticipated future changes in exchange rates which otherwise might adversely affect the value of the Portfolio's securities or adversely affect the prices of securities that the Portfolio has purchased or intends to purchase at a later date. The successful use of foreign currency futures will usually depend on the Portfolio Manager's ability to forecast currency exchange rate movements correctly. Should exchange rates move in an unexpected manner, the Portfolio may not achieve the anticipated benefits of foreign currency futures or may realize losses. The Growth LT, Equity Income, Multi-Strategy, Equity, Bond and Income, and High Yield Bond Portfolios may invest in warrants; however, not more than 10% of the market value of a Portfolio's assets (at the time of purchase), and in the case of the Equity Portfolio--5%, may be invested in warrants other than warrants acquired in units or attached to other securities. Warrants may be considered speculative in that they have no voting rights, pay no dividends, and have no rights with respect to the assets of the corporation issuing them. Warrants basically are options to purchase equity securities at a specific price valid for a specific period of time. They do not represent ownership of the securities, but only the right to buy them. Warrants differ from call options in that warrants are issued by the issuer of the security which may be purchased on their exercise, whereas call options may be written or issued by anyone. The prices of warrants do not necessarily move parallel to the prices of the underlying securities. Duration is a measure of average life of a bond on a present value basis, which was developed to incorporate a bond's yield, coupons, final maturity and call features into one measure. Duration is one of the fundamental tools that may be used by the Adviser or Portfolio Manager in fixed income security selection. In this discussion, the term "bond" is generally used to connote any type of debt instrument. Most notes and bonds have provided interest ("coupon") payments in addition to a final ("par") payment at maturity. Some obligations also feature call provisions. Depending on the relative magnitude of these payments, debt obligations may respond differently to changes in the level and structure of interest rates. Traditionally, a debt security's "term to maturity" has been used as a proxy for the sensitivity of the security's price to changes in interest rates (which is the "interest rate risk" or "volatility" of the security). However, "term to maturity" measures only the time until a debt security provides its final payment, taking no account of the pattern of the security's payments prior to maturity. Duration is a measure of the average life of a fixed-income security on a present value basis. Duration takes the length of the time intervals between the present time and the time that the interest and principal payments are scheduled or, in the case of a callable bond, expected to be received, and weights them by the present values of the cash to be received at each future point in time. For any fixed-income security with interest payments occurring prior to the payment of principal, duration is always less than maturity. In general, all other things being the same, the lower the stated or coupon rate of interest of a fixed-income security, the longer the duration of the security; conversely, the higher the stated or coupon rate of interest of a fixed-income security, the shorter the duration of the security. Although frequently used, the "term of maturity" of a bond is not a useful measure of the longevity of a bond's cash flow because it refers only to the time remaining to the repayment of principal or corpus and disregards earlier coupon payments. Thus, for example, three bonds with the same maturity may not have the same investment characteristics (such as risk or repayment time). One bond may have large coupon payments early in its life, whereas another may have payments distributed evenly throughout its life. Some bonds (such as zero coupon bonds) make no coupon payments until maturity. Clearly, an investor contemplating investing in these bonds should consider not only the final payment or sum of payments on the bond, but also the timing and magnitude of payments in order to make an accurate assessment of each bond. Maturity, or the term to maturity, does not provide a prospective investor with a clear understanding of the time profile of cash flows over the life of a bond. Another way of measuring the longevity of a bond's cash flow is to compute a simple average time to payment, where each year is weighted by the number of dollars the bond pays that year. This concept is termed the "dollar-weighted mean waiting time," indicating that it is a measure of the average time to payment of a bond's cash flow. The critical shortcoming of this approach is that it assigns equal weight to each dollar paid over the life of a bond, regardless of when the dollar is paid. Since the present value of a dollar decreases with the amount of time which must pass before it is paid, a better method might be to weight each year by the present value of the dollars paid that year. This calculation puts the weights on a comparable basis and creates a definition of longevity which is known as duration. A bond's duration depends upon three variables: (i) the maturity of the bond; (ii) the coupon payments attached to the bond; and (iii) the bond's yield to maturity. Yield to maturity, or investment return as used here, represents the approximate return an investor purchasing a bond may expect if he holds that bond to maturity. In essence, yield to maturity is the rate of interest which, if applied to the purchase price of a bond, would be capable of exactly reproducing the entire time schedule of future interest and principal payments. Increasing the size of the coupon payments on a bond, while leaving the maturity and yield unchanged, will reduce the duration of the bond. This follows from the fact that because bonds with higher coupon payments pay relatively more of their cash flows sooner, they have shorter durations. Increasing the yield to maturity on a bond (e.g., by reducing its purchase price), while leaving the terms to maturity and coupon payments unchanged, also reduces the duration of the bond. Because a higher yield leads to lower present values for more distant payments relative to earlier payments, and, to relatively lower weights attached to the years remaining to those payments, the duration of the bond is reduced. There are some situations where even the standard duration calculation does not properly reflect the interest rate exposure of a security. For example, floating and variable rate securities often have final maturities of ten or more years; however, their interest rate exposure corresponds to the frequency of the coupon reset. Another example where the interest rate exposure is not properly captured by duration is mortgage pass-throughs. The stated final maturity is generally 30 years but current prepayment rates are more critical in determining the securities' interest rate exposure. In these and other similar situations, the Adviser or Portfolio Manager to a Portfolio will use more sophisticated analytical techniques which incorporate the economic life of a security into the determination of its interest rate exposure. Futures, options, and options on futures have durations which, in general, are closely related to the duration of the securities which underlie them. Holding long futures or call option positions (backed by a segregated account of cash and cash equivalents) will lengthen the portfolio duration if interest rates go down and bond prices go up by approximately the same amount that holding an equivalent amount of the underlying securities would. Short futures or put option positions have durations roughly equal to the negative duration of the securities that underlie those positions, and have the effect of reducing portfolio duration if interest rates go up and bond prices go down by approximately the same amount that selling an equivalent amount of the underlying securities would. Each Portfolio's investment objective as set forth under "Investment Objectives and Policies," and the investment restrictions as set forth below, are fundamental policies of each Portfolio and may not be changed with respect to any Portfolio without the approval of a majority of the outstanding voting shares of that Portfolio. The vote of a majority of the outstanding voting securities of a Portfolio means the vote, at an annual or special meeting of (a) 67% or more of the voting securities present at such meeting, if the holders of more than 50% of the outstanding voting securities of such Portfolio are present or represented by proxy; or (b) more than 50% of the outstanding voting securities of such Portfolio, whichever is the less. Under these restrictions, a Portfolio may not: (i) invest in a security if, as a result of such investment, more than 25% of its total assets (taken at market value at the time of such investment) would be invested in the securities of issuers in any particular industry, except that this restriction does not apply to securities issued or guaranteed by the U.S. Government or its agencies or instrumentalities (or repurchase agreements (ii) with respect to 75% of its total assets, invest in a security if, as a result of such investment, more than 5% of its total assets (taken at market value at the time of such investment) would be invested in the securities of any one issuer, except that this restriction does not apply to securities issued or guaranteed by the U.S. Government or its agencies or (iii) invest in a security if, as a result of such investment, it would hold more than 10% (taken at the time of such investment) of the outstanding voting securities of any one issuer; (iv) purchase or sell real estate (although it may purchase securities secured by real estate or interests therein, or securities issued by companies which invest in real estate, or interests therein); (v) purchase or sell commodities or commodities contracts, except that, subject to restrictions described in the Prospectus and in the Statement of Additional Information (a) the Managed Bond, Equity Index, Government Securities, High Yield Bond, Growth LT, Equity Income, Multi-Strategy, and International Portfolios may engage in futures contracts and options on futures contracts, (b) all Portfolio may enter into foreign forward currency contracts; and (c) the Equity Index Portfolio may purchase and sell stock index futures, purchase options on stock indexes, and purchase options on stock index futures; (vi) with respect to the Money Market, Managed Bond, Government Securities, High Yield Bond, Equity Income, Multi-Strategy, Equity Index, and International Portfolios, purchase securities on margin (except for use of short-term credit necessary for clearance of purchases and sales of portfolio securities) but it may make margin deposits in connection with transactions in options, futures, (vii) borrow money or pledge, mortgage or hypothecate its assets, except that a Portfolio may: (a) borrow from banks but only if immediately after each borrowing and continuing thereafter there is asset coverage of 300%; and (b) enter into reverse repurchase agreements and transactions in options, futures, and options on futures as described in the Prospectus and in the Statement of Additional Information (the deposit of assets in escrow in connection with the writing of covered put and call options and the purchase of securities on a "when-issued" or delayed delivery basis and collateral arrangements with respect to initial or variation margin deposits for futures contracts will not be deemed to be pledges of a Portfolio's assets); (viii) lend any funds or other assets, except that a Portfolio may, consistent with its investment objective and policies: (a) invest in debt obligations including bonds, debentures or other debt securities, bankers' acceptances, and commercial paper, even though the purchase of such obligations may be deemed to be the making of loans; (b) enter into repurchase agreements and reverse repurchase agreements; and (c) lend its portfolio securities in an amount not to exceed 25% of the value of its total assets, provided such loans are made in accordance with applicable guidelines established by the Securities and Exchange Commission and the Fund's Trustees; (ix) act as an underwriter of securities of other issuers, except, when in connection with the disposition of portfolio securities, it may be deemed to be an underwriter under the federal securities laws; and (x) with respect to the Money Market, Managed Bond, Government Securities, High Yield Bond, Equity Income, Multi-Strategy, Equity Index, and International Portfolios, maintain a short position, or purchase, write, or sell puts, calls, straddles, spreads, or combinations thereof, except as set forth in the Prospectus and in the Statement of Additional Information for transactions in options, futures, and options on futures. Each Portfolio is also subject to the following restrictions and policies (which are not fundamental and may therefore be changed without shareholder approval) relating to the investment of its assets and activities. Unless otherwise indicated, a Portfolio may not: (i) invest for the purpose of exercising control or management; (ii) sell securities or property short, except short sales against the box; (iii) purchase warrants if immediately after and as a result of such purchase more than 10% of the market value of the total assets of the Portfolio would be (iv) with respect to the Growth LT, Equity, and Bond and Income Portfolios, purchase securities on margin (except for use of short-term credit necessary for clearance of purchases and sales of portfolio securities) but it may make margin deposits in connection with transactions in options, futures, and (v) with respect to the Growth LT, Equity, and Bond and Income Portfolios, maintain a short position, or purchase, write, or sell puts, calls, straddles, spreads, or combinations thereof, except as set forth in the Prospectus and in the Statement of Additional Information for transactions in options, futures, and options on futures; and (vi) invest in securities that are illiquid, or in repurchase agreements maturing in more than seven days, if as a result of such investment, more than 15% of the total assets of the Portfolio (taken at market value at the time of such investment) would be invested in such securities, and with respect to the Money Market Portfolio, more than 10% of the total assets of the Portfolio (taken at market value at the time of such investment) would be invested in such securities. Unless otherwise indicated, as in the restriction for borrowing or hypothecating assets of a Portfolio, for example, all percentage limitations listed above apply to each Portfolio only at the time into which a transaction is entered. Accordingly, if a percentage restriction is adhered to at the time of investment, a later increase or decrease in the percentage which results from a relative change in values or from a change in a Portfolio's net assets will not be considered a violation. For purposes of fundamental restriction (v) as set forth above, an option on a foreign currency shall not be considered a commodity or commodity contract. The Trustees and Executive Officers of the Fund, their business address, and principal occupations during the past five years are: * Mr. Sutton is an "interested person" of the Fund (as that term is defined in the Investment Company Act) because of his position with Pacific Mutual as shown above. Trustees other than those affiliated with Pacific Mutual or a Portfolio Manager, receive an annual fee of $6,000 and $1,250 for each Board of Trustees meeting attended plus $500 for each Audit, Policy, or Nominating Committee meeting attended, plus reimbursement of related expenses. In addition, the Chairman of the Fund's Audit Committee and Policy Committee each receives an additional annual fee of $1,000. The following table summarizes the aggregate compensation paid by the Fund to each Trustee who is not affiliated with Pacific Mutual or a Portfolio Manager in 1994. It also shows total compensation paid to these Trustees in 1994 by the Fund and PIMCO Advisors Institutional Funds, an investment company managed by an affiliate of Pacific Mutual for which Messrs. Nelson, Porter, and Richards (but not Mr. Sutton) also serve as trustees (collectively, "Fund Complex"). None of the Trustees or Officers directly own shares of the Fund. As of January 31, 1994, the Trustees and Officers as a group owned Variable Contracts that entitled them to give voting instructions with respect to less than 1% of the outstanding shares of the Fund. Pacific Mutual Life Insurance Company ("Pacific Mutual") serves as Investment Adviser to the Fund pursuant to an Investment Advisory Agreement ("Advisory Contract") between Pacific Mutual and the Fund. Pacific Mutual is responsible for administering the affairs of and supervising the investment program for the Fund. Pacific Mutual also furnishes to the Board of Trustees, which has overall responsibility for the business and affairs of the Fund, periodic reports on the investment performance of each Portfolio. Under the terms of the Advisory Contract, Pacific Mutual is obligated to manage the Fund's Portfolios in accordance with applicable laws and regulations. The Advisory Contract will continue in effect until November 9, 1995, and from year to year thereafter, provided such continuance is approved annually by (i) the holders of a majority of the outstanding voting securities of the Fund or by the Board of Trustees, and (ii) a majority of the Trustees who are not parties to such Advisory Contract or "interested persons" (as defined in the Investment Company Act of 1940, the "1940 Act") of any such party. The Advisory Contract was originally approved by the Board of Trustees, including a majority of the Trustees who are not parties to the Advisory Contract, or interested persons of such parties, at its meeting held on July 21, 1987, and by the shareholders of the Fund at a Meeting of Shareholders held on October 28, 1988. The Advisory Contract was also approved by the shareholders of the Equity Index Portfolio of the Fund at a Meeting of Shareholders of the Equity Index Portfolio held onApril 21, 1992. An addendum to the Advisory Contract was approved by the Board of Trustees, including a majority of the Trustees who are not parties to the Contract, or interested persons of such parties, at a meeting held on October 28, 1988. An Addendum to the Advisory Contract which increased the advisory fee schedule with respect to the High Yield Bond, Managed Bond, Government Securities, Equity Income, Multi-Strategy, and International Portfolios, and which included the Growth LT Portfolio as a Portfolio to which the Adviser will perform services under the Advisory Contract, was approved by the Board of Trustees, including a majority of the Trustees who are not parties to the Contract, or interested persons of such at a meeting held on September 29, 1993, and was approved by shareholders of the High Yield Bond, Managed Bond, Government Securities, Equity Income, Multi- Strategy, and International Portfolios at a Special Meeting of Shareholders on December 13, 1993. An Addendum to the Advisory Contract for the Equity Portfolio and Bond and Income Portfolio was approved by the Board of Trustees, including a majority of the Trustees who are not parties to the Advisory Contract or interested persons of such parties, at a meeting held on August 12, 1994, and by the sole shareholder of those Portfolios on September 6, 1994. The Advisory Contract may be terminated without penalty by vote of the Trustees or the shareholders of the Fund, or by the Adviser, on 60 days' written notice by either party to the Advisory Contract and will terminate automatically if assigned. The Fund pays the Adviser, for its services under the Agreement, a fee based on an annual percentage of the average daily net assets of each Portfolio. For the Money Market Portfolio, the Fund will pay to the Adviser a fee at an annual rate of .40% of the first $250 million of the average daily net assets of the Portfolio, .35% of the next $250 million of the average daily net assets of the Portfolio, and .30% of the average daily net assets of the Portfolio in excess of $500 million. For the High Yield Bond, Managed Bond, Government Securities, and Bond and Income Portfolios, the Fund will pay .60% of the average daily net assets of each of the Portfolios. For the Equity Income, Multi-Strategy, and Equity Portfolios, the Fund will pay .65% of the average daily net assets of each of the Portfolios. For the Growth LT Portfolio, the Fund will pay .75% of the average daily net assets of the Portfolio. For the International Portfolio, the Fund will pay .85% of the average daily net assets of the Portfolio. For the Equity Index Portfolio, the Fund will pay .25% of the first $100 million of the average daily net assets of the Portfolio, .20% of the next $100 million of the average daily net assets of the Portfolio, and .15% of the average daily net assets of the Portfolio in excess of$200 million. The fee shall be computed and accrued daily and paid monthly. Prior to January 1, 1994, the Fund paid the Adviser for its services under the Agreement a fee based on an annual percentage of the average daily net assets of each Portfolio as follows. For the High Yield Bond, Managed Bond, Government Securities, Equity Income, and Multi-Strategy Portfolios, the Fund paid .50% of the first $250 million of the average daily net assets of each of the Portfolios, .45% of the next $250 million of the average daily net assets of each of the Portfolios, and .40% of the average daily net assets of each of the Portfolios in excess of $500 million. For the International Portfolio, the Fund paid .65% of the first $250 million of the average daily net assets of the Portfolio, .60% of the next $250 million of the average daily net assets of the Portfolio, and .55% of the average daily net assets of the Portfolio in excess of$500 million. For the Money Market and Equity Index Portfolios, the Fund paid the Adviser a fee based on the same fee schedule as is currently in effect. Pacific Mutual has agreed, until at least December 31, 1995, to waive its fees or otherwise reimburse each Portfolio for its operating expenses to the extent that such expenses, exclusive of advisory fees, additional custodial charges associated with holding foreign securities, foreign taxes on dividends, interest, or gains, and extraordinary expenses, exceed 0.25% of the Portfolio's average daily net assets. Pacific Mutual began this expense reimbursement policy in April 1989. There can be no assurance that this policy will be continued beyond December 31, 1995. Net fees paid or owed to Pacific Mutual for 1994 were as follows: Money Market Portfolio--$208,743, High Yield Bond Portfolio--$94,365, Managed Bond Portfolio--$297,183, Government Securities Portfolio--$111,828, Growth LT Portfolio--$132,860, Equity Income Portfolio--$251,902, Multi-Strategy Portfolio--$304,896, Equity Index Portfolio--$79,401, and International Portfolio--$454,012. Net fees paid or owed to Pacific Mutual for 1993 (before the Addendum to the Advisory Contract that increased the fees for certain Portfolios was in effect) were as follows: Money Market Portfolio--$68,994, High Yield Bond Portfolio-- $62,112, Managed Bond Portfolio--$151,389, Government Securities Portfolio-- $80,256, Equity Income Portfolio--$121,504, Multi-Strategy Portfolio--$120,529, Equity Index Portfolio--$44,656, and International Portfolio--$144,024. Net fees paid or owed to Pacific Mutual for 1992 were as follows: Money Market Portfolio--$30,169, High Yield Bond Portfolio--$22,861, Managed Bond Portfolio--$74,703, Government Securities Portfolio--$23,514, Equity Income Portfolio--$47,643, Multi-Strategy Portfolio--$34,412, Equity Index Portfolio-- $0, and International Portfolio--$74,115. Net advisory and administrative fees, respectively, paid by the Equity Portfolio's predecessor--the Equity Series of Pacific Corinthian Variable Fund--were $401,325 and $120,397 in 1994, $415,347 and $124,604 in 1993, and $469,325 and $140,798 in 1992. Net advisory and administrative fees, respectively, paid by the Bond and Income Portfolio's predecessor--the Bond and Income Series of Pacific Corinthian Variable Fund--were $149,270 and $55,976 in 1994, $178,349 and $66,881 in 1993, and $211,515 and $79,318 in 1992. Pursuant to a Portfolio Management Agreement between the Fund, the Adviser, and Pacific Investment Management Company ("PIMCO"), 840 Newport Center Drive, Post Office Box 9000, Newport Beach, California 92660, PIMCO is the Portfolio Manager and provides investment advice and makes and implements investment decisions with respect to the Managed Bond Portfolio and Government Securities Portfolio. For the services provided, Pacific Mutual pays PIMCO a fee based on a percentage of each Portfolio's average daily net assets according to the following schedule: MANAGED BOND AND GOVERNMENT SECURITIES PORTFOLIOS PIMCO is registered as an investment adviser with the Securities and Exchange Commission ("SEC") and a commodity trading adviser with the Commodity Futures Trading Commission ("CFTC"). Such registration does not involve supervision by the SEC over investment advice or supervision by the CFTC over commodities trading. PIMCO is currently providing investment advisory services to the PIMCO Funds, PIMCO Commercial Mortgage Securities Trust, Inc., PIMCO Advisors Institutional Funds, the Harbor Bond Fund of the Harbor Fund, The Total Return Bond and the Intermediate-Term Bond Portfolios of the Target Portfolio Trust, the Fixed Income I Fund, Diversified Bond Fund, Fixed Income III Fund, and Multi-Strategy Bond Fund of the Frank Russell Investment Management Company, the PIMCO Total Return Bond Portfolio of the American Skandia Trust, the Government Income Portfolio of the Cambridge Portfolio Trust, the Total Return Fund of Fremont Mutual Funds, Inc., the fixed income segment of the Balanced Portfolio of the Pacific Corinthian Variable Fund, as well as to managed accounts consisting of proceeds from pension and profit sharing plans. Net fees paid or owed by Pacific Mutual to PIMCO in 1994 were $149,130 for the Managed Bond Portfolio and $106,476 for the Government Securities Portfolio, in 1993 were $159,860 for the Managed Bond Portfolio and $106,139 for the Government Securities Portfolio, and in 1992 were $115,405 for the Managed Bond Portfolio and $68,657 for the Government Securities Portfolio. Pursuant to a Portfolio Management Agreement between the Fund, the Adviser, and Janus Capital Corporation ("Janus"), 100 Fillmore Street, Suite 300, Denver, Colorado 80206-4923, Janus is the Portfolio Manager and provides investment advisory services to the Growth LT Portfolio. For the services provided, Pacific Mutual pays Janus a fee based on a percentage of the average daily net assets of the Growth LT Portfolio according to the following schedule: J.P. Morgan Investment is an investment manager for corporate, public, and union employee benefit funds, foundations, endowments, insurance companies, government agencies and the accounts of other institutional investors. A wholly owned subsidiary of J.P. Morgan & Co. Inc., J.P. Morgan Investment was incorporated in the state of Delaware on February 7, 1984 and commenced operations on July 2, 1984. It was formed from the Institutional Investment Group of Morgan Guaranty Trust Company of New York, also a subsidiary of J.P. Morgan & Co. Inc. Morgan acquired its first tax-exempt client in 1913 and its first pension account in 1940. Assets under management have grown to over $121 billion. With offices in London and Singapore, J.P. Morgan Investment draws from a worldwide resources base to provide comprehensive service to an international group of clients. Investment management activities in Japan, Australia, and Germany are carried out by affiliates, Morgan Trust Bank in Tokyo, J.P. Morgan Investment Management Australia Limited in Melbourne, and J.P. Morgan Investment GmbH in Frankfurt. J.P. Morgan Investment currently provides investment advisory services to the following investment companies: Global Money Fund, International Growth Fund and Growth and Income Fund of Sierra Trust Funds, Global Money Fund, International Growth Fund and Growth and Income Fund of The Sierra Variable Trust, Frank Russell Equity Q Fund and Frank Russell Quantitative Equity Fund of Frank Russell Investment Co., Preferred Fixed Income Fund and Preferred Money Market Fund of Caterpillar Investment Management Ltd., AST Money Market Fund of American Skandia Life Investment Management Inc., Benham European Government Bond Fund, Growth and Income Stock Portfolio of Northwestern Mutual Portfolio Fund, Inc., North American Funds International Growth and Income Portfolio of North American Life Insurance Company and Venture International Growth and Income Portfolio of North American Security Life Insurance Company. Net fees paid or owed by Pacific Mutual to J.P. Morgan Investment in 1994 were $190,312 for the Equity Income Portfolio and $212,060 for the Multi- Strategy Portfolio. From 1988 to 1993, Capital Guardian served as Portfolio Manager to the Equity Income and Multi-Strategy Portfolios. Net fees paid by Pacific Mutual to Capital Guardian for these Portfolios in 1993 were $103,788 for the Equity Income Portfolio and $108,861 for the Multi-Strategy Portfolio, and in 1992 were $75,696 for the Equity Income Portfolio and $65,117 for the Multi-Strategy Portfolio. Pursuant to a Portfolio Management Agreement between the Fund, the Adviser, and Greenwich Street Advisors Division of Smith Barney Mutual Funds Management Inc. ("Greenwich Street Advisors"), 338 Greenwich Street, 23rd Floor, New York, New York 10048, Greenwich Street Advisors serves as the Portfolio Manager and provides investment advisory service to the Equity Portfolio and Bond and Income Portfolio. For the services provided, Pacific Mutual pays a fee to Greenwich Street Advisors based on a percentage of each Portfolio's average daily net assets according to the following fee schedules: Greenwich Street Advisors has been in the investment counselling business since 1934 and renders investment advice to a wide variety of individual, institutional and investment company clients with aggregate assets under management as of December 31, 1994 in excess of $48 billion. Greenwich Street Advisors is a division of Smith Barney Mutual Fund's Management Inc. ("SBMFM"), a wholly-owned subsidiary of Smith Barney Holdings Inc., which is in turn a wholly-owned subsidiary of The Travelers Inc. The Travelers Inc. is a financial services holding company engaged, through its subsidiaries, principally in three business segments: (1) life and property and casualty insurance services,(2) investment services and (3) consumer finance services. Net fees paid or owed to Greenwich Street Advisors by the Equity Portfolio's predecessor the Equity Series of Pacific Corinthian Variable Fund--were $401,325 in 1994, $415,347 in 1993, and $469,325 in 1992. Net fees paid or owed to Greenwich Street Advisors by the Bond and Income Portfolio's predecessor-- the Bond and Income Series of Pacific Corinthian Variable Fund--were $149,270 in 1994, $178,349 in 1993, and $211,515 in 1992. The same fee schedules were in effect for the predecessors of the Equity Portfolio and Bond and Income Portfolio as are currently in effect. The Greenwich Street Advisors and its predecessors have been in the investment counseling business since 1934. SBMFM and its predecessors have been providing investment-advisory services to mutual funds since 1968. As of December 31, 1994 SBMFM manages approximately $54 billion of mutual funds. Pursuant to a Portfolio Management Agreement between the Fund, the Adviser and Bankers Trust Company ("BTC"), a wholly-owned subsidiary of Bankers Trust New York Corporation, 130 Liberty Street, New York, New York 10006, BTC is the Portfolio Manager and provides investment advisory services to the Equity Index Portfolio. For the services provided, Pacific Mutual pays a quarterly fee in advance to BTC, based on the net assets of the Equity Index Portfolio at the beginning of each calendar quarter in accordance with the following schedule: This fee is subject to a minimum annual fee of $50,000 for the calendar year 1994, and $75,000 for the calendar year 1995, and $100,000 for the calendar year 1996 and each year thereafter. Prior to October 18, 1994, the fee was subject to a minimum annual fee of $20,000. BTC is a wholly-owned subsidiary of Bankers Trust New York Corporation, the seventh largest bank holding company in the United States. The Global Investment Management Group of BTC, the department directly responsible for the management of the Equity Index Portfolio, as of June 30, 1994, managed assets approximating $165 billion. BTC is the investment adviser to the following registered investment companies: Short-Intermediate Fixed-Income Portfolio of Accessor Funds, Inc.; Full Maturity Fixed Income Portfolio of AHA Investment Funds, Inc.; MidCap Index Fund, Stock Index Fund and Small Cap Index Fund of American General Series Portfolio ("VALIC"); Asset Management Portfolio; Asset Management Portfolio II; Asset Management Portfolio III; the Equity Portfolio and the Fixed Income Portfolio of the Bank Fiduciary Funds; Capital Appreciation Portfolio; Capital Growth Portfolio; Cash Management Portfolio; Equity 500 Index Portfolio of BTC Institutional Funds; Global High Yield Portfolio; Hercules Latin American Value Fund; Intermediate Tax Free Portfolio; International Equity Portfolio; Latin American Equity Portfolio; Liquid Assets Portfolio; NY Tax Free Money Portfolio; Pacific Basin Equity Portfolio; Short/Intermediate Government Securities Portfolio; Short Term Securities Portfolio; Small Cap Portfolio; Tax Free Money Portfolio; Treasury Money Portfolio and Utility Portfolio. Net fees paid or owed by Pacific Mutual to BTC in 1994 were $50,000, in 1993 were $21,027, and in 1992 were $20,000. Pursuant to a Portfolio Management Agreement between the Fund, the Adviser, and Templeton Investment Counsel, Inc. ("Templeton"), Broward Financial Centre, Suite 2100, Fort Lauderdale, Florida 33394-3091, Templeton is the Portfolio Manager and provides investment advice with respect to the International Portfolio. Pacific Mutual pays a fee to Templeton based on a percentage of the Portfolio's average daily net assets according to the following fee schedule: Templeton is a Florida corporation with offices in Ft. Lauderdale, Florida, and affiliated research offices in New York, Hong Kong, Singapore, Edinburgh, Melbourne, Toronto, and the Bahamas. Templeton and its affiliates serve as advisers for over 150 registered investment companies. The Templeton provides investment management and advisory services to a worldwide client base, including mutual fund shareholders, foundations and endowments, employee benefit plans and individuals, As of December 31, 1994, the Templeton organization managed approximately $42.0 billion in assets, including over $5.4 billion invested in equity securities in emerging market countries, and over $570.9 million invested in fixed-income securities in those countries. Templeton is an indirect wholly-owned subsidiary of Templeton Worldwide, Inc., which is in turn, a wholly-owned subsidiary of Franklin Resources, Inc. ("Franklin"). Through its subsidiaries, Franklin is engaged in various aspects of the financial services industry. As of December 31, 1994, the Templeton/Franklin organization managed over $115 billion in assets worldwide. Net fees paid or owed by Pacific Mutual to Templeton for the International Portfolio in 1994 were $328,196. From 1988 to 1993, Nomura Capital Management, Inc. ("NCM") served as Portfolio Manager to the International Portfolio. Net fees paid by Pacific Mutual to NCM for the International Portfolio in 1993 were $157,869, and in 1992 were $119,790. The Portfolio Management Agreements are not exclusive, and PIMCO, Capital Guardian, BTC, Janus, J.P. Morgan Investment, Greenwich Street Advisors, and Templeton may provide and currently are providing investment advisory services to other clients, including other investment companies. Pacific Equities Network ("PEN") serves as the Fund's Distributor pursuant to a Distribution Contract (the "Distribution Contract") with the Fund. The Distributor is not obligated to sell any specific amount of Fund shares. PEN bears all expenses of providing services pursuant to the Distribution Contract including the costs of sales presentations, mailings, advertising, and any other marketing efforts by PEN in connection with the distribution or sale of the shares. The expenses incurred by the Fund with respect to each Portfolio in connection with the Fund's organization, its registration with the Securities and Exchange Commission and any states where registered, and the public offering of its shares were advanced on behalf of the Fund by the Adviser. These organizational expenses were deferred and amortized by the Fund's Portfolios over a period of 60 months. Similarly, the organizational expenses of Portfolios of the Fund that have been organized after the Fund commenced operations have been advanced on behalf of the Fund by the Adviser, and are deferred and amortized by the pertinent Portfolio over a period of 60 months from the commencement of operations of the Portfolio. See "Financial Statements." As of February 1, 1995, Pacific Mutual did not beneficially own shares of any of the Portfolios of the Fund. In the event that Pacific Mutual were to acquire a beneficial interest in any Portfolio, Pacific Mutual would exercise voting rights attributable to these shares in accordance with voting instructions received by Owners of the Policies issued by Pacific Mutual. To this extent, as of February 1, 1995, Pacific Mutual did not exercise control over any Portfolio. For information on purchase and redemption of shares, see "More on the Fund's Shares" in the Fund's Prospectus. The Fund may suspend the right of redemption of shares of any Portfolio and may postpone payment for more than seven days for any period: (i) during which the New York Stock Exchange is closed other than customary weekend and holiday closings or during which trading on the New York Stock Exchange is restricted; (ii) when the Securities and Exchange Commission determines that a state of emergency exists which may make payment or transfer not reasonably practicable; (iii) as the Securities and Exchange Commission may by order permit for the protection of the security holders of the Fund; or (iv) at any other time when the Fund may, under applicable laws and regulations, suspend payment on the redemption of its shares. If the Board of Trustees should determine that it would be detrimental to the best interests of the remaining shareholders of a Portfolio to make payment wholly or partly may pay the redemption price in whole or in part by a distribution in kind of securities from the portfolio of the Portfolio, in lieu of cash, in conformity with applicable rules of the Securities and Exchange Commission. If shares are redeemed in kind, the redeeming shareholder might incur brokerage costs in converting the assets into cash. Under the 1940 Act, the Fund is obligated to redeem shares solely in cash up to the lesser of $250,000 or 1 percent of its net assets during any 90-day period for any one shareholder. Investment decisions for the Fund and for the other investment advisory clients of the Adviser, or applicable Portfolio Manager, are made with a view to achieving their respective investment objectives. Investment decisions are the product of many factors in addition to basic suitability for the particular client involved (including the Fund). Thus, a particular security may be bought or sold for certain clients even though it could have been bought or sold for other clients at the same time. It also sometimes happens that two or more clients simultaneously purchase or sell the same security, in which event each day's transactions in such security are, insofar as possible, averaged as to price and allocated between such clients in a manner which in the opinion of the Adviser or Portfolio Manager is equitable to each and in accordance with the amount being purchased or sold by each. There may be circumstances when purchases or sales of portfolio securities for one or more clients will have an adverse effect on other clients. There is generally no stated commission in the case of fixed-income securities, which are traded in the over-the-counter markets, but the price paid by the Fund usually includes an undisclosed dealer commission or mark-up. In underwritten offerings, the price paid by the Fund includes a disclosed, fixed commission or discount retained by the underwriter or dealer. Transactions on U.S. stock exchanges and other agency transactions involve the payment by the Fund of negotiated brokerage commissions. Such commissions vary among different brokers. Also, a particular broker may charge different commissions according to such factors as the difficulty and size of the transaction. In the case of securities traded on some foreign stock exchanges, brokerage commissions may be fixed and the Adviser or Portfolio Manager may be unable to negotiate commission rates for these transactions. The Adviser or Portfolio Manager for a Portfolio places all orders for the purchase and sale of portfolio securities, options, and futures contracts for a Portfolio through a substantial number of brokers and dealers or futures commission merchants. In executing transactions, the Adviser or Portfolio Manager will attempt to obtain the best net results for a Portfolio taking into account such factors as price (including the applicable brokerage commission or dollar spread), size of order, the nature of the market for the security, the timing of the transaction, the reputation, experience and financial stability of the broker-dealer involved, the quality of the service, the difficulty of execution and operational facilities of the firms involved, and the firm's risk in positioning a block of securities. In transactions on stock exchanges in the United States, payments of brokerage commissions are negotiated. In effecting purchases and sales of portfolio securities in transactions on United States stock exchanges for the account of the Fund, the Adviser or Portfolio Manager may pay higher commission rates than the lowest available when the Adviser or Portfolio Manager believes it is reasonable to do so in light of the value of the brokerage and research services provided by the broker effecting the transaction, as described below. In the case of securities traded on some foreign stock exchanges, brokerage commissions may be fixed and the Adviser or Portfolio Manager may be unable to negotiate commission rates for these transactions. In the case of securities traded on the over-the-counter markets, there is generally no stated commission, but the price includes an undisclosed commission or markup. Consistent with the above policy of obtaining the best net results, a portion of the Equity Index Portfolio's brokerage and futures transactions may be conducted through BT Brokerage Corporation and BT Futures Corporation, respectively, both wholly-owned subsidiaries of Bankers Trust New commissions paid to BT Brokerage Corporation will not exceed 25% of the brokerage commission incurred per year by the Equity Index Portfolio. Smith Barney Inc. and its affiliates may serve as the Fund's broker in effecting portfolio transactions on a national securities exchange, and may retain commissions, in accordance with certain regulations of the Securities and Exchange Commission. Smith Barney Inc. may receive no more than 25% of the brokerage commission incurred per annum by any Portfolio managed by Greenwich Street Advisors. Some securities considered for investment by the Fund's Portfolios may also be appropriate for other clients served by the Adviser or Portfolio Manager. If a purchase or sale of securities consistent with the investment policies of a Portfolio and one or more of these clients served by the Adviser or Portfolio Manager is considered at or about the same time, transactions in such securities will be allocated among the Portfolio and clients in a manner deemed fair and reasonable by the Adviser or Portfolio Manager. Although there is no specified formula for allocating such transactions, the various allocation methods used by the Adviser or Portfolio Manager, and the results of such allocations, are subject to periodic review by the Fund's Adviser and Board of Trustees. It has for many years been a common practice in the investment advisory business for advisers of investment companies and other institutional investors to receive research services from broker-dealers which execute portfolio transactions for the clients of such advisers. Consistent with this practice, the Adviser or Portfolio Manager for a Portfolio may receive research services from many broker-dealers with which the Adviser or Portfolio Manager places the Portfolio's portfolio transactions. These services, which in some cases may also be purchased for cash, include such matters as general economic and security market reviews, industry and company reviews, evaluations of securities and recommendations as to the purchase and sale of securities. Some of these services may be of value to the Adviser or Portfolio Manager in advising its various clients (including the Portfolio), although not all of these services are necessarily useful and of value in managing a Portfolio. The advisory fee paid by the Portfolio is not reduced because the Adviser or Portfolio Manager and its affiliates receive such services. As permitted by Section 28(e) of the Securities Exchange Act of 1934, the Adviser or Portfolio Manager may cause a Portfolio to pay a broker-dealer, which provides "brokerage and research services" (as defined in the Act) to the Adviser or Portfolio Manager, an amount of disclosed commission for effecting a securities transaction for the Portfolio in excess of the commission which another broker-dealer would have charged for effecting that transaction. During the year 1994, the following Portfolios incurred brokerage commissions and markups on principal transactions as follows: the High Yield Bond Portfolio--$0, the Managed Bond Portfolio--$9,636, the Government Securities Portfolio--$5,652, the Equity Income Portfolio--$126,489, of which $84 (0.07%) was paid to BT Securities, an affiliate of Bankers Trust Company, the Multi- Strategy Portfolio--$77,944, of which $62 (0.08%) was paid to BT Securities, an affiliate of Bankers Trust Company, the Equity Portfolio--$318,235 of which $53,700 (16.87%) was paid to Smith Barney Inc. or its predecessors, and $5,100 (1.60%) was paid to Lehman Brothers Securities, the Bond and Income Portfolio-- $0, the Equity Index Portfolio--$6,337, the International Portfolio--$304,029, of which $515 (0.17%) was paid to J.P. Morgan Securities, an affiliate of J.P. Morgan Investment Management Inc., and the Growth LT Portfolio--$101,353, of which $259 (0.26%) was paid to J.P. Morgan Securities, an affiliate of J.P. Morgan Investment Management Inc. During the years 1993 and 1992, respectively, the following Portfolios incurred brokerage commissions as follows: the High Yield Bond Portfolio--$690 and $1,299, the Managed Bond Portfolio--$5,568 and $4,001, the Government Securities Portfolio--$4,548 and $3,267, the Equity Income Portfolio--$33,310 and $24,271, the Multi-Strategy Portfolio--$28,251 and $13,790, the Equity Portfolio--$418,458 of which $71,472 (17.08%) were paid to Smith Barney Inc. or its predecessors, and $537,146 of which $99,432 (18.51%) were paid to Smith Barney Inc. or its predecessors, the Bond and Income Portfolio--$0 and $0, the Equity Index Portfolio--$6,541 and $5,500, and the International Portfolio--$126,924 and $49,519. The Equity and Bond and Income Portfolios had not yet commenced operations as of December 31, 1994. Information for the Equity Portfolio and Bond and Income Portfolio is based on activity of the predecessor series of Pacific Corinthian Variable Fund, the assets of which were acquired by the Fund on December 31, 1994. For reporting purposes, each Portfolio's portfolio turnover rate is calculated by dividing the value of the lesser of purchases or sales of portfolio securities for the fiscal year by the monthly average of the value of portfolio securities owned by the Portfolio during the fiscal year. In determining such portfolio turnover, long-term U.S. Government securities are included. Short-term U.S. Government securities and all other securities whose maturities at the time of acquisition were one year or less are excluded. A 100% portfolio turnover rate would occur, for example, if all of the securities in the portfolio (other than short-term securities) were replaced once during the fiscal year. The portfolio turnover rate for each of the Portfolios will vary from year to year, depending on market conditions. It is anticipated that the rate of portfolio turnover as defined above for the Money Market Portfolio will be 0%, and for each of the other Portfolios will be approximately 100% under normal market conditions. For the Portfolios other than the Money Market Portfolio, portfolio turnover could be greater in periods of unusual market movement and volatility. For the years 1994, 1993, and 1992, respectively, the portfolio turnover rate for each of the Portfolios was as follows: Money Market Portfolio--0%, 0%, and 0%, High Yield Bond Portfolio--142%, 186%, and 186%, Managed Bond Portfolio--128%, 163%, and 90%, Government Securities Portfolio--233%, 402%, and 212%, Equity Income Portfolio--135%, 28%, and 19%, Multi-Strategy Portfolio--187%, 28%, and 17%, Equity Portfolio--179%, 230%, and 242%, Bond and Income Portfolio--32%, 42%, and 22%, International Portfolio--52%, 46%, and 39%, and Equity Index Portfolio--2%, 1%, and 4%. The portfolio turnover rate for the Growth LT Portfolio, which commenced operations on January 4, 1994, was 257% in 1994. Information for the Equity Portfolio and Bond and Income Portfolio is based on activity of the predecessor series of Pacific Corinthian Variable Fund, the assets of which were acquired by the Fund on December 31, 1994. As indicated under "Net Asset Value" in the Prospectus, the Fund's net asset value per share for the purpose of pricing purchase and redemption orders is determined at or about 4:00 P.M., New York City time, on each day the New York Stock Exchange is open for trading. Net asset value will not be determined on the following holidays: New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. With respect to the Portfolios that invest in foreign securities, the value of foreign securities that are traded on stock exchanges outside the United States are based upon the price on the exchange as of the close of business of the exchange immediately preceding the time of valuation. Securities traded in over-the-counter markets outside the United States are valued at the last available price in the over-the-counter market prior to the time of valuation. Trading in securities on exchanges and over- the-counter markets in European and Pacific Basin countries is normally completed well before 4:00 P.M., New York City time. In addition, European and Pacific Basin securities trading may not take place on all business days in New York. Furthermore, trading takes place in Japanese markets on certain Saturdays and in various foreign markets on days which are not business days in New York and on which the Fund's net asset value is not calculated. Quotations of foreign securities in foreign currencies are converted to U.S. dollar equivalents using the foreign exchange quotation in effect at the time net asset value is computed. The calculation of the net asset value of the Managed Bond, Government Securities, Growth LT, and International Portfolios may not take place contemporaneously with the determination of the prices of portfolio securities of foreign issuers used in such calculation. Further, under the Fund's procedures, the prices of foreign securities are determined using information derived from pricing services and other sources every day that the Fund values its shares. Prices derived under these procedures will be used in determining net asset value. Information that becomes known to the Fund or its agents after the time that net asset value is calculated on any business day may be assessed in determining net asset value per share after the time of receipt of the information, but will not be used to retroactively adjust the price of the security so determined earlier or on a prior day. Events affecting the values of portfolio securities that occur between the time their prices are determined and the time a Portfolio's net asset value is determined may not be reflected in the calculation of net asset value. If events materially affecting net asset value occur during such period, the securities would be valued at fair market value as determined by the management and approved in good faith by the Board of Trustees of the Fund. The Money Market Portfolio's portfolio securities are valued using the amortized cost method of valuation. This involves valuing a security at cost on the date of acquisition and thereafter assuming a constant accretion of a discount or amortization of a premium to maturity, regardless of the impact of fluctuating interest rates on the market value of the instrument. While this method provides certainty in valuation, it may result in periods during which value, as determined by amortized cost, is higher or lower than the price the Portfolio would receive if it sold the instrument. During such periods the yield to investors in the Portfolio may differ somewhat from that obtained in a similar investment company which uses available market quotations to value all of its portfolio securities. The Commission's regulations require the Money Market Portfolio to adhere to certain conditions. The Portfolio is required to maintain a dollar-weighted average portfolio maturity of 90 days or less, to limit its investments to instruments having remaining maturities of 13 months or less (except securities held subject to repurchase agreements having 13 months or less to maturity) and to invest only in securities that meet specified quality and credit criteria. All other Portfolios are valued as follows: Portfolio securities for which market quotations are readily available are stated at market value. Market value is determined on the basis of last reported sales price, or, if no sales are reported, the mean between representative bid and asked quotations obtained from a quotation reporting system or from established market makers. In other cases, securities are valued at their fair value as determined in good faith by the Board of Trustees of the Fund, although the actual calculations may be made by persons acting under the direction of the Board. Money market instruments are valued at market value, except that instruments maturing in sixty days or less are valued using the amortized cost method of valuation. With respect to the International Portfolio, the value of a foreign security is determined in its national currency based upon the price on the foreign exchange as of its close of business immediately preceding the time of valuation. Securities traded in over-the-counter markets outside the United States are valued at the last available price in the over-the-counter market prior to the time of valuation. Debt securities, including those to be purchased under firm commitment agreements (other than obligations having a maturity of sixty days or less at their date of acquisition), are normally valued on the basis of quotes obtained from brokers and dealers or pricing services, which take into account appropriate factors such as institutional-size trading in similar groups of securities, yield, quality, coupon rate, maturity, type of issue, trading characteristics, and other market data. Debt obligations having a maturity of sixty days or less are generally valued at amortized cost unless the amortized cost value does not approximate market value. Certain debt securities for which daily market quotations are not readily available may be valued, pursuant to guidelines established by the Board of Trustees, with reference to debt securities whose prices are more readily obtainable and whose durations are comparable to the securities being valued. When a Portfolio writes a put or call option, the amount of the premium is included in the Portfolio's assets and an equal amount is included in its liabilities. The liability thereafter is adjusted to the current market value of the option. The premium paid for an option purchased by the Portfolio is recorded as an asset and subsequently adjusted to market value. The values of futures contracts are based on market prices. Quotations of foreign securities in foreign currency are converted to U.S. dollar equivalents at the prevailing market rates quoted by the custodian on the morning of valuation. The Fund may, from time to time, include the yield and effective yield of its Money Market Portfolio, the yield of the remaining Portfolios, and the total return of all Portfolios in advertisements, sales literature, or reports to shareholders or prospective investors. Total return information for the Fund will not be advertised or included in sales literature unless accompanied by comparable performance information for a Separate Account to which the Fund offers its shares. Current yield for the Money Market Portfolio will be based on the change in the value of a hypothetical investment (exclusive of capital charges) over a particular 7-day period, less a pro-rata share of Portfolio expenses accrued over that period (the "base period"), and stated as a percentage of the investment at the start of the base period (the "base period return"). The base period return is then annualized by multiplying by 365/7, with the resulting yield figure carried to at least the nearest hundredth of one percent. "Effective yield" for the Money Market Portfolio assumes that all dividends received during an annual period have been reinvested. Calculation of "effective yield" begins with the same "base period return" used in the calculation of yield, which is then annualized to reflect weekly compounding pursuant to the following formula: Effective Yield = [(Base Period Return + 1) 365/7]-1 For the 7-day period ending December 31, 1994, the current yield of the Money Market Portfolio was 4.92% and the effective yield of the Portfolio was 5.04%. Quotations of yield for the remaining Portfolios will be based on all investment income per share earned during a particular 30-day period (including dividends and interest), less expenses accrued during the period ("net investment income"), and are computed by dividing net investment income by the maximum offering price per share on the last day of the period, according to the following formula: a = dividends and interest earned during the period, b = expenses accrued for the period (net of reimbursements), c = the average daily number of shares outstanding during the period that were entitled to receive dividends, and d = the maximum offering price per share on the last day of the period. For the 30 day period ended December 31, 1994, the yield of the remaining Portfolios that had commenced operations on or before that date was as follows: 9.08% for the High Yield Bond Portfolio, 6.09% for the Managed Bond Portfolio, 5.71% for the Government Securities Portfolio, 1.76% for the Growth LT Portfolio, 3.75% for the Multi-Strategy Portfolio, 1.24% for the Equity Income Portfolio, (0.34%) for the Equity Portfolio, 6.58% for the Bond and Income Portfolio, 0.29% for the International Portfolio, and 2.22% for the Equity Index Portfolio. Quotations of average annual total return for a Portfolio will be expressed in terms of the average annual compounded rate of return of a hypothetical investment in the Portfolio over certain periods that will include a period of one year (or, if less, up to the life of the Portfolio), calculated pursuant to the following formula: P (1 + T)n = ERV (where P = a hypothetical initial payment of $1,000, T = the total return for the period, n = the number of periods, and ERV = the ending redeemable value of a hypothetical $1,000 payment made at the beginning of the period). Quotations of total return may also be shown for other periods. All total return figures reflect the deduction of a proportional share of Portfolio expenses on an annual basis, and assume that all dividends and distributions are reinvested when paid. For the one year period ended December 31, 1994, the total return for each Portfolio that had commenced operations on or before that date was as follows: 3.76% for the Money Market Portfolio, 0.42% for the High Yield Bond Portfolio, (4.36%) for the Managed Bond Portfolio, (5.10%) for the Government Securities Portfolio, 13.25% for the Growth LT Portfolio (which commenced operations on January 4, 1994), (0.28%) for the Equity Income Portfolio, (1.50%) for the Multi-Strategy Portfolio, (2.87%) for the Equity Portfolio, (8.36%) for the Bond and Income Portfolio, 3.01% for the International Portfolio, and 1.05% for the Equity Index Portfolio. For the five year period ended December 31, 1994, the average annual total return for each Portfolio that had commenced operations on or before that date was as follows: 4.62% for the Money Market Portfolio, 11.96% for the High Yield Bond Portfolio, 8.02% for the Managed Bond Portfolio, 7.33% for the Government Securities Portfolio, 6.68% for the Equity Income Portfolio, 6.78% for the Multi-Strategy Portfolio, 8.67% for the Equity Portfolio, 8.71% for the Bond and Income Portfolio, and 3.00% for the International Portfolio. The Equity Index Portfolio did not begin operations until January 30, 1991, and the Growth LT Portfolio did not begin operations until January 4, 1994. For the ten year period ended December 31, 1994, the average annual total returns for the Equity Portfolio, and Bond and Income Portfolio were 13.02% and 11.17%, respectively. Based upon the period from the commencement of Fund operations on January 4, 1988 until December 31, 1994, the average annual total return for each Portfolio, except the Equity Index, Growth LT, Equity, and Bond and Income Portfolios, was as follows: 5.38% for the Money Market Portfolio, 10.30% for the High Yield Bond Portfolio, 8.86% for the Managed Bond Portfolio, 8.25% for the Government Securities Portfolio, 9.89% for the Equity Income Portfolio, 9.03% for the Multi-Strategy Portfolio, and 7.37% for the International Portfolio. Based upon the period from the commencement of the Equity Index Portfolio operations on January 30, 1991 until December 31, 1994, the average annual total return for the Equity Index Portfolio was 10.44%. Based upon the period from the commencement of operations of the Growth LT Portfolio on January 4, 1994 until December 31, 1994, the average annual total return for the Growth LT Portfolio was 13.41%. Based upon the period from the commencement of the first full year of operations of the Equity Portfolio and Bond and Income Portfolio on January 1, 1984, the average annual total return for each of these Portfolios was 12.87% and 11.67%, respectively. The performance results for the Equity Income, Multi-Strategy, and International Portfolios occurred when these Portfolios were advised by different Portfolio Managers. J.P. Morgan Investment began serving as Portfolio Manager to the Equity Income Portfolio and the Multi-Strategy Portfolio and Templeton began serving as Portfolio Manager to the International Portfolio on January 1, 1994. The performance results for the Equity Portfolio and Bond and Income Portfolio are based on the performance results of the predecessor series of Pacific Corinthian Variable Fund, the assets of which were acquired by the Fund on December 31, 1994. Performance information for a Portfolio may be compared, in advertisements, sales literature, and reports to shareholders to: (i) the Standard & Poor's 500 Stock Index ("S&P 500"), the Dow Jones Industrial Average ("DJIA"), for the Money Market Portfolio, Donoghue Money Market Institutional Averages; for those Portfolios with investments in fixed income securities, the Lehman Brothers Government Corporate Index; for the Government Securities Portfolio, the Lehman Brothers Government Bond Index; for the High Yield Bond Portfolio, the Salomon High Yield Bond Indexes; for the International Portfolio, Morgan Stanley Capital International's EAFE Index, which represents the stock markets of Europe, Australia, and the Far East; or other unmanaged indices, so that investors may compare a Portfolio's results with those of a group of unmanaged securities widely regarded by investors as representative of the securities markets in general; (ii) other groups of mutual funds tracked by Lipper Analytical Services, a widely used independent research firm which ranks mutual funds by overall performance, investment objectives, and assets, or tracked by other services, companies, publications, or persons who rank mutual funds on overall performance or other criteria; and (iii) the Consumer Price Index (measure for inflation) to assess the real rate of return from an investment in the Portfolio. Unmanaged indices may assume the reinvestment of dividends but generally do not reflect deductions for administrative and management costs and expenses. Quotations of yield or total return for the Fund will not take into account charges and deductions against any Separate Accounts to which the Fund shares are sold or charges and deductions against the Contracts issued by Pacific Mutual Life Insurance Company. The Portfolio's yield and total return should not be compared with mutual funds that sell their shares directly to the public since the figures provided do not reflect charges against the Separate Accounts or the Contracts. Performance information for any Portfolio reflects only the performance of a hypothetical investment in the Portfolio during the particular time period on which the calculations are based. Performance information should be considered in light of the Portfolio's investment objectives and policies, characteristics and quality of the portfolios and the market conditions during the given time period, and should not be considered as a representation of what may be achieved in the future. Each Portfolio intends to qualify annually and to elect to be treated as a regulated investment company under the Internal Revenue Code of 1986 (the "Code"). To qualify as a regulated investment company, each Portfolio generally must, among other things:(i) derive in each taxable year at least 90% of its gross income from dividends, interest, payments with respect to securities loans, and gains from the sale or other disposition of stock, securities or foreign currencies, or other income derived with respect to its business of investing in such stock, securities or currencies; (ii) derive in each taxable year less than 30% of its gross income from the sale or other disposition of certain assets held less than three months including stocks, securities, and certain foreign currencies, futures, options, and forward contracts; (iii) diversify its holdings so that, at the end of each quarter of the taxable year, (a) at least 50% of the market value of the Portfolio's assets is represented by cash, U.S. Government securities, the securities of other regulated investment companies and other securities, with such other securities of any one issuer limited for the purposes of this calculation to an amount not greater than 5% of the value of the Portfolio's total assets and 10% of the outstanding voting securities of such issuer, and (b) not more than 25% of the value of its total assets is invested in the securities of any one issuer (other than U.S. Government securities or the securities of other regulated investment companies); and (iv) distribute at least 90% of its investment company taxable income (which includes, among other items, dividends, interest, and net short- term capital gains in excess of any net long-term capital losses) each taxable year. As a regulated investment company, a Portfolio generally will not be subject to U.S. federal income tax on its investment company taxable income and net capital gains (any net long-term capital gains in excess of the sum of net short-term capital losses and capital loss carryovers from prior years), if any, that it distributes to shareholders. Each Portfolio intends to distribute to its shareholders, at least annually, substantially all of its investment company taxable income and any net capital gains. In addition, amounts not distributed by a Portfolio on a timely basis in accordance with a calendar year distribution requirement are subject to a nondeductible 4% excise tax. To avoid the tax, a Portfolio must distribute (or be deemed to have distributed) during each calendar year, (i) at least 98% of its ordinary income (not taking into account any capital gains or losses) for the calendar year, (ii) at least 98% of its capital gains in excess of its capital losses for the twelve month period ending on October 31 of the calendar year (adjusted for certain ordinary losses), and (iii) all ordinary income and capital gains for previous years that were not distributed during such years. To avoid application of the excise tax, each Portfolio intends to make its distributions in accordance with the calendar year distribution requirement. A distribution will be treated as paid on December 31 of the calendar year if it is declared by a Portfolio during October, November, or December of that year to shareholders of record on a date in such a month and paid by the Portfolio during January of the following calendar year. Such distributions will be taxable to shareholders (the Separate Accounts) for the calendar year in which the distributions are declared, rather than the calendar year in which the distributions are received. If a Portfolio invests in shares of a foreign investment company, the Portfolio may be subject to U.S. federal income tax on a portion of an "excess distribution" from, or of the gain from the sale of part or all of the shares in, such company. In addition, an interest charge may be imposed with respect to deferred taxes arising from such distributions or gains. Under the Code, gains or losses attributable to fluctuations in exchange rates which occur between the time a Portfolio accrues income or other receivables or accrues expenses or other liabilities denominated in a foreign currency and the time that Portfolio actually collects such receivables or pays such liabilities generally are treated as ordinary income or ordinary loss. Similarly, on disposition of debt securities denominated in a foreign currency and on disposition of certain futures contracts, forward contracts, and options, gains or losses attributable to fluctuations in the value of foreign currency between the date of acquisition of the security or contract and the date of disposition also are treated as ordinary gain or loss. These gains or losses, referred to under the Code as "Section 988" gains or losses, may increase or decrease the amount of a Portfolio's investment company taxable income to be distributed to its shareholders as ordinary income. The Treasury Department announced that it would issue future regulations or rulings addressing the circumstances in which a variable contract owner's control of the investments of a separate account may cause the contract owner, rather than the insurance company, to be treated as the owner of the assets held by the separate account. If the contract owner is considered the owner of the securities underlying the separate account, income and gains produced by those securities would be included currently in the contract owner's gross income. It is not known what standards will be set forth in the regulations or rulings. In the event that the rules or regulations are adopted there can be no assurance that the Portfolios will be able to operate as currently described in the Prospectus, or that the Trust will not have to change any Portfolio's investment objective or investment policies. While each Portfolio's investment objective is fundamental and may be changed only by a vote of a majority of its outstanding shares, the Trustees have reserved the right to modify the investment policies of the Portfolios as necessary to prevent any such prospective rules and regulations from causing the contract owners to be considered the owners of the shares of the Portfolio's underlying the Separate Accounts. Distributions of any investment company taxable income (which includes among other items, dividends, interest, and any net realized short-term capital gains in excess of net realized long-term capital losses) are treated as ordinary income for tax purposes in the hands of the shareholder (Separate Account). Net capital gains (the excess of any net long-term capital gains over net short- term capital losses) will, to the extent distributed, be treated as long-term capital gains in the hands of a Separate Account regardless of the length of time a Separate Account may have held the shares. The 30% limitation and the diversification requirements applicable to a Portfolio's assets may limit the extent to which a Portfolio will be able to engage in transactions in options, futures contracts, or forward contracts. Under each Portfolio's investment restrictions, a Portfolio may not invest in a security if, as a result of such investment, more than 25% of its total assets (taken at market value at the time of such investment) would be invested in the securities of issuers in any particular industry, except that this restriction does not apply to securities issued or guaranteed by the U.S. Government or its agencies or instrumentalities (or repurchase agreements with respect thereto). For purposes of complying with this restriction, the Fund, in consultation with its Portfolio Managers, utilizes its own industry classifications. The Fund is a Massachusetts business trust established under a Declaration of Trust dated May 4, 1987. The capitalization of the Fund consists solely of an unlimited number of shares of beneficial interest with a par value of $0.001 each. The Board of Trustees may establish additional Portfolios (with different investment objectives and fundamental policies) at any time in the future. Establishment and offering of additional Portfolios will not alter the rights of the Fund's shareholders. When issued, shares are fully paid, redeemable, freely transferable, and non-assessable by the Fund. Shares do not have preemptive rights or subscription rights. In liquidation of a Portfolio of the Fund, each shareholder is entitled to receive his pro rata share of the net assets of that Portfolio. Expenses incurred by the Equity Index Portfolio and Growth LT Portfolio in connection with the Fund's organization and establishment of those Portfolios and the public offering of the shares of those Portfolios, aggregated approximately $40,358 and $3,952, respectively. These costs have been deferred by the Equity Index and Growth LT Portfolios and are being amortized by it over a period of five years from the beginning of operations of those Portfolios. Shareholders of the Fund are given certain voting rights. Each share of each Portfolio will be given one vote, unless a different allocation of voting rights is required under applicable law for a mutual fund that is an investment medium for variable insurance products. Under the Declaration of Trust, the Fund is not required to hold annual meetings of Fund shareholders to elect Trustees or for other purposes. It is not anticipated that the Fund will hold shareholders' meetings unless required by law or the Declaration of Trust. In this regard, the Fund will be required to hold a meeting to elect Trustees to fill any existing vacancies on the Board if, at any time, fewer than a majority of the Trustees have been elected by the shareholders of the Fund. In addition, the Declaration of Trust provides that the holders of not less than two-thirds of the outstanding shares or other voting interests of the Fund may remove a person serving as Trustee either by declaration in writing or at a meeting called for such purpose. The Trustees are required to call a meeting for the purpose of considering the removal of a person serving as Trustee, if requested in writing to do so by the holders of not less than 10% of the outstanding shares or other voting interests of the Fund. The Fund's shares do not have cumulative voting rights. CUSTODIAN AND TRANSFER AGENCY AND DIVIDEND DISBURSING SERVICES Investors Fiduciary Trust Company ("IFTC") serves as Custodian for assets of the Fund. Pursuant to a sub-custody agreement between IFTC and The Chase Manhattan Bank, N.A. ("Chase"), Chase serves as subcustodian of the Fund for the custody of the foreign securities acquired by the Fund. Under the agreement, Chase may hold the foreign securities at its principal office at One Chase Manhattan Plaza, New York, New York 10081, and at Chase's branches, and subject to approval by the Board of Trustees, at a foreign branch of a qualified U.S. bank, an eligible foreign subcustodian, or an eligible foreign securities depository. Pursuant to rules or other exemptions under the Investment Company Act, the Fund may maintain foreign securities and cash for the Fund in the custody of certain eligible foreign banks and securities depositories. Selection of these foreign custodial institutions is made by the Board of Trustees, and is reviewed annually, following a consideration of a number of factors, including (but not limited to) the reliability and financial stability of the institution; the ability of the institution to perform capably custodial services for the Fund; the reputation of the institution in its national market; the political and economic stability of the country in which the institution is located; and further risks of potential nationalization or expropriation of Fund assets. Pacific Mutual provides dividend disbursing and transfer agency services to the Fund. The financial statements of the Fund as of December 31, 1994, including the notes thereto, are incorporated by reference in this Statement of Additional Information from the Annual Report of the Fund dated as of December 31, 1994. The financial statements have been audited by Deloitte & Touche LLP, except for information for the Equity Portfolio and Bond and Income Portfolio for years before 1994, which was audited by other independent public accountants. Deloitte & Touche LLP serves as the independent public accountants for the Fund. Deloitte & Touche LLP provides audit services and assistance and consultation in connection with Securities and Exchange Commission filings. The address of Deloitte & Touche LLP is 695 Town Center Drive, Suite 1200, Costa Mesa, California 92626. Dechert Price & Rhoads, 1500 K Street, N.W., Suite 500, Washington, D.C. 20005, passes upon certain legal matters in connection with the shares offered by the Fund and also acts as outside counsel to the Fund. This Statement of Additional Information and the Prospectus do not contain all the information included in the Fund's Registration Statement filed with the Securities and Exchange Commission under the Securities Act of 1933 with respect to the securities offered hereby, certain portions of which have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Registration Statement, including the exhibits filed therewith, may be examined at the offices of the Securities and Exchange Commission in Washington, D.C. Statements contained herein and in the Prospectus as to the contents of any contract or other documents referred to are not necessarily complete, and, in each instance, reference is made to the copy of such contract or other documents filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference.	497	497	1996-01-12T00:00:00	1996-01-11T20:37:40
0000896463-96-000004	0000896463-96-000004_0000.txt	UNITED STATES SECURITIES AND EXCHANGE COMMISSION QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended: November 30, 1995 Commission File No. 0-4016 (Exact name of Registrant as specified in its Charter) (State of Incorporation) (I.R.S. Employer Identification No.) 1205 DEARBORN DRIVE, COLUMBUS, OHIO 43085 (Address of Principal Executive Offices) (Zip Code) (Registrant's Telephone Number, Including Area Code) (Former Name, Former Address and Former Fiscal Year, If Changed From Last Report) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES __X__ NO Indicate the number of shares outstanding of each of the Issuer's classes of common stock, as of the latest practicable date. Common Stock, $.01 par value 90,779,668 Class Outstanding December 31, 1995 Consolidated Condensed Balance Sheets - November 30, 1995 and May 31, 1995.................................3 Consolidated Condensed Statements of Earnings - Three and Six Months Ended November 30, 1995 and 1994 .............4 Consolidated Condensed Statements of Cash Flows - Six Months Ended November 30, 1995 and 1994........................5 Notes to Consolidated Condensed Financial Statements...............6 Management's Discussion and Analysis of Results of Operations and Financial Condition......................7 (In Thousands, Except Per Share) Cash and cash equivalents ...................... $ 14,856 $ 2,003 Accounts receivable - net ...................... 185,223 216,443 Raw materials ................................. 117,230 142,738 Work in process and finished products ......... 57,589 58,140 Prepaid expenses and other current assets ...... 37,183 32,578 TOTAL CURRENT ASSETS .......................... 412,081 451,902 Investment in Unconsolidated Affiliates .......... 131,966 104,764 Other Assets ..................................... 24,017 25,381 Property, plant and equipment .................... 633,140 589,286 Less accumulated depreciation .................... 271,428 254,369 Property, Plant and Equipment - net ........... 361,712 334,917 TOTAL ASSETS .................................. $ 929,776 $ 916,964 Accounts payable ............................... $ 81,617 $ 87,329 employee benefit plans and related taxes ...... 26,440 31,741 Dividends payable .............................. 9,980 9,992 Other accrued items ............................ 7,688 8,597 Income taxes ................................... 6,159 2,709 Current maturities of long-term debt ........... 660 660 TOTAL CURRENT LIABILITIES ..................... 132,544 179,228 Other Liabilities ................................ 17,471 18,055 Long-Term Debt ................................... 83,146 53,476 Deferred Income Taxes ............................ 81,636 75,873 Common shares, $.01 par value .................. 908 908 Additional paid-in capital ..................... 104,280 102,733 foreign currency translation ................ (1,841) (1,017) Retained earnings ............................. 511,632 487,708 Total Shareholders' Equity .................... 614,979 590,332 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .... $ 929,776 $ 916,964 See notes to consolidated condensed financial statements. See notes to consolidated condensed financial statements. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS Net earnings ......................................... $ 47,696 $ 53,712 earnings to net cash provided (used) by operating activities: Provision for deferred income taxes ................ 5,763 6,621 Equity in undistributed net income of unconsolidated affiliates ........................ (19,576) (18,232) Changes in assets and liabilities: Accounts receivable ............................ 31,220 (1,035) Prepaid expenses and other current assets ...... (4,604) (1,691) Other assets ................................... 1,364 280 Accounts payable and accrued expenses .......... (8,472) (103) Other liabilities .............................. (584) (238) Net Cash Provided (Used) By Operating Activities ... 97,348 28,343 Investment in property, plant and equipment, net ..... (45,277) (36,397) Investment in unconsolidated affiliates .............. (8,290) -- Net Cash Used By Investing Activities .............. (53,567) (36,397) Proceeds from (payments on) short-term borrowings .... (38,200) 16,000 Proceeds from long-term debt ......................... 43,000 -- Principal payments on long-term debt ................. (13,330) (591) Proceeds from issuance of common shares .............. 1,618 2,013 Repurchase of common shares .......................... (4,024) -- Dividends paid ....................................... (19,992) (18,123) Net Cash Provided (Used) By Financing Activities ... (30,928) (701) Increase (decrease) in cash and cash equivalents ....... 12,853 (8,755) Cash and cash equivalents at beginning of period ....... 2,003 13,275 Cash and cash equivalents at end of period ............. $ 14,856 $ 4,520 See notes to consolidated condensed financial statements. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE A - MANAGEMENT'S OPINION In the opinion of management, the accompanying unaudited consolidated condensed financial statements contain all adjustments (consisting of a normal recurring nature) necessary to present fairly the financial position of Worthington Industries, Inc. and Subsidiaries (the Company) as of November 30, 1995 and May 31, 1995; the results of operations for the three and six months ended November 30, 1995 and 1994; and the cash flows for the six months then ended. The accounting policies followed by the Company are set forth in Note A to the consolidated financial statements in the 1995 Worthington Industries, Inc. Annual Report to Shareholders which is incorporated by reference in the Company's 1995 Form 10-K. NOTE B - INCOME TAXES The income tax rate is based on statutory federal and state rates, and an estimate of annual earnings adjusted for the permanent differences between reported earnings and taxable income. NOTE C - EARNINGS PER SHARE Earnings per common share for the three and six months ended November 30, 1995 and 1994 are based on the weighted average common shares outstanding during each of the respective periods. NOTE D - RESULTS OF OPERATIONS The results of operations for the three and six months ended November 30, 1995 and 1994 are not necessarily indicative of the results to be expected for the full year. For the three months ended November 30, 1995, net sales of $354.5 million were 2% lower and net earnings of $26.2 million and earnings per share of $.29 were 7% and 6%, respectively, lower than the results from last year's second quarter. For the first six months of fiscal 1996, net sales were $680.3 million, 4% below those of the same period last year. Net earnings of $47.7 million and earnings per share of $.53 were off 11% and 10%, respectively, from the first half of last year. Demand in most of the Company's markets softened this year from a strong fiscal 1995. The Company started to see improved market demand for its products in the second quarter, but results still reflect lower volume and prices from last year. Results for the second quarter and first six months of fiscal 1995 were driven principally by volume and selling price increases. Gross margin was down 9% for both the quarter and the six months. This was greater than the sales shortfall, primarily due to the soft selling price environment and the working down of more expensive inventory. Last year's gross margin outpaced the growth in sales due to higher operating efficiencies and selling price increases. Gross margin as a percentage of sales for the quarter was 15.0% compared to 16.0% last year and for the six months, 14.7% compared to 15.5%. Selling, general and administrative expense increased 5% for the quarter and 3% for the six months due to the inclusion of expenses for new operations offset by lower profit-sharing. Last year's expense was driven by higher profit sharing. As a percent of sales, this expense for the quarter was 6.1% compared to 5.7% last year and for the six months was 6.1% compared to 5.6%. Operating income was 16% lower for the quarter and six month periods. As a percentage of sales, operating income decreased to 8.9% from 10.3% for the quarter and to 8.6% from 9.9% for the six months. Interest expense decreased 22% for the three months and 5% for the six months. The average interest rate rose to 6.7% from 5.6% and average debt outstanding increased offset by $1,010,000 of capitalized interest for the six months. Average debt rose because of increased borrowings to support capital expenditures. Equity in net income of unconsolidated affiliates was up 21% for the quarter. Equity from Rouge Steel was up as a one time gain more than offset decreased operating earnings caused by lower industry demand and selling prices. Equity from Worthington Armstrong Venture was up significantly on increased volume in both the U.S. and Europe. This venture's French facility is expanding to meet demand and the new Las Vegas plant is in startup. The Acerex joint venture in Mexico started production in October and is shipping within Mexico and into the southwest U.S. Income taxes decreased in line with pre-tax earnings for both the three and six month periods as the effective tax rate for both years was 37.5%. The processed steel products segment saw decreases in sales and earnings for the second quarter and the first six months. Steel processing shipments, although improved from the first quarter, were below those of last year mainly due to lower automotive demand. Operating margins also remain lower due to the reduced volume and lower selling prices. Pressure cylinder's sales for the quarter were up, but results for the six months were below last year as increased demand for heating tanks did not fully offset lower shipments of refrigerant cylinders. Pressure cylinders had realized growth in most product lines in the prior year. Sales for the custom products segment were up for both the second quarter and six months; however, earnings were lower for both periods. The plastics operation increased sales and earnings as it continued to perform well despite overall lower industry automotive demand due to new automotive and appliance contracts. Volume from new jobs increased sales for precision metals above last year for both periods, but profits are lower due to inefficiencies caused by startups and specification changes on certain parts. The cast products segment results were down slightly for the quarter as demand has leveled somewhat from last year. This segment continues to perform well as sales and earnings remain above last year's strong six month numbers. Last year's results benefited from very strong railcar demand and high production levels. At November 30, 1995, the Company's current ratio was 3.1:1, up from 2.5:1 at May 31, 1995, as $30 million of short-term debt was replaced with long-term debt. Long-term debt increased to 10.7% from 7.4% of total capital (defined as long-term debt, deferred taxes and shareholders' equity.) Working capital was $279.5 million, 45% of the Company's total net worth, down from 46% at May 31, 1995. During the six months, the Company's cash position increased by $12.9 million. Cash provided by operating activities was $97.3 million, aided by a $26.1 million decrease in inventories and a $31.2 million decrease in accounts receivable, which occurred in part because of lower raw material costs and lower sales volume and prices. Days sales in accounts receivable was down 3 days from fiscal year-end and days of inventory was down modestly. Capital expenditures and investments in affiliates totaled $53.6 million and dividends paid were $20 million. The Company expects its operating results to improve during the year; however, borrowings may be needed to support anticipated capital expenditures. The Company has a $150 million committed, revolving credit agreement, of which $80 million was unused at November 30, 1995. Immediate borrowing capacity plus cash generated from operations should be more than sufficient to fund expected normal operating cash needs, dividends, debt payments and capital expenditures for existing businesses. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Registrant's Annual Meeting of Shareholders was held on September 21, 1995. In connection with the meeting, proxies were solicited. Following are the voting results on proposals considered and voted upon. 1. All nominees for Class of Directors whose term expires in 1998 were elected by the stockholders who were present or represented by proxy. of Director Authority to Vote Not Voted Robert J. Klein 76,152,495 65,984 -0- Katherine LeVeque 76,092,427 126,052 -0- John P. McConnell 76,155,495 62,984 -0- Robert B. McCurry 76,114,912 103,567 -0- Gerald B. Mitchell 76,133,988 84,491 -0- 2. The appointment of Ernst & Young LLP as the Registrant's independent auditors for the year ending May 31, 1996 was ratified by a majority of the votes entitled to be cast by the stockholders who were present or represented by proxy. FOR: 75,978,256 AGAINST: 65,520 ABSTAIN: 174,703 NOT VOTED: -0- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. A. Exhibits - Exhibit 27 Financial Data Schedule B. Reports on Form 8-K. There were no reports on Form 8-K during the three months ended November 30, 1995. Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: January 12, 1996 By: /S/DONALD G. BARGER, JR. Donald G. Barger, Jr.	10-Q	10-Q	1996-01-12T00:00:00	1996-01-12T10:22:23
0000950134-96-000105	0000950134-96-000105_0000.txt	<DESCRIPTION>AMENDMENT TO SC 14D-1 BALCOR REALTY INVEST. LTD.82 Tender Offer Statement Pursuant to Section 14(d)(1) of the Securities Exchange Act of 1934 Under the Securities Exchange Act of 1934 BALCOR REALTY INVESTORS LTD. - 82 WALTON STREET CAPITAL ACQUISITION CO., L.L.C. FMG ACQUISITION I, L.L.C. INSIGNIA FINANCIAL GROUP, INC. (Title of Class of Securities) (CUSIP Number of Class of Securities) (Name, Address and Telephone Number of Person Authorized to Receive Notices and Communications on Behalf of Bidders) Amendment No. 5 to Schedule 14D-1 This Amendment No. 5 constitutes (i) the final Amendment to the Tender Offer Statement on Schedule 14D-1 filed by Walton Street Capital Acquisition Co., L.L.C., a Delaware limited liability company (the "Purchaser"), with the Commission on November 16, 1995, as amended by Amendment No. 1 filed with the Commission on November 21, 1995, Amendment No. 2 filed with the Commission on December 5, 1995, Amendment No. 3 filed with the Commission on December 19, 1995 and Amendment No. 4 filed with the Commission on December 19, 1995; and (ii) the Statement on Schedule 13D of the Purchaser, WIG 82 Partners, FMG Acquisition I, L.L.C. and Insignia Financial Group, Inc. All capitalized terms used herein but not otherwise defined have the meanings ascribed to such terms in the Offer to Purchase dated November 16, 1995 (the "Offer to Purchase"), the First Supplement to the Offer to Purchase dated December 5, 1995 (the "First Supplement") and the related Letter of Acceptance (the "Letter of Acceptance," which together constitute the "Offer"). ITEM 6. INTEREST IN SECURITIES OF THE SUBJECT COMPANY. Item 6 is hereby amended by the following: (a) - (b) At 5:00 p.m., Eastern Standard Time, on Wednesday, January 3, 1996, the Offer expired pursuant to its terms. Based on information provided by the Depositary, a total of 6,581.64 Interests, representing approximately 9% of the outstanding Interests, were validly tendered and not withdrawn pursuant to the Offer. The Purchaser has accepted for payment all such Interests at the purchase price of $87 per Interest in cash. ITEM 11. MATERIAL TO BE FILED AS EXHIBITS. 99(g)(1) Agreement of Joint Filing, dated January 12, 1996, among the Purchaser, WIG 82 Partners, FMG Acquisition I, L.L.C. and Insignia Financial Group, Inc. After due inquiry and to the best of my knowledge and belief, I certify that the information set forth in this statement is true, complete and correct.	SC 14D1/A	SC 14D1/A	1996-01-12T00:00:00	1996-01-12T16:58:03
0000912057-96-000432	0000912057-96-000432_0000.txt	As filed with the Securities and Exchange Commission on January 12, 1996 CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of Report (Date of earliest event reported): December 28, 1995 (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) (State or other (Commission (I.R.S. Employer jurisdiction of File Number) Identification No.) 8888 Keystone Crossing, Suite 1200 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (317) 574-3531 (Former name or former address changed since last report) On December 28, 1995, Duke Realty Investments, Inc. (the "Company") and subsidiaries formed a joint venture with an institutional real estate investor and purchased 25 industrial buildings totaling approximately 2,250,000 square feet, primarily located in Park 100 Business Park in Indianapolis, Indiana. In addition, the Company purchased the joint venture interest of its partner in Parkwood Crossing in Indianapolis, Indiana, a suburban office development and announced certain other property acquisitions and expansions. Further details regarding these transactions are reflected in the press release which is attached as an exhibit to this report and incorporated herein by reference. The following exhibit is filed with this report: 20 Press Release dated December 28, 1995 Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. Date: January 12, 1996 By: /s/ Dennis D. Oklak	8-K	8-K	1996-01-12T00:00:00	1996-01-12T12:02:27
0000950130-96-000094	0000950130-96-000094_0007.txt	<DESCRIPTION>JOINT PROXY STATEMENT - PROSPECTUS +INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A + +REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE + +SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY + +OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT + +BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR + +THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE + +SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE + +UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF + SUBJECT TO COMPLETION, DATED JANUARY 11, 1996 TRUMP HOTELS & CASINO TRUMP HOTELS & CASINO RESORTS, INC. RESORTS, INC. TAJ MAHAL HOLDING CORP. SPECIAL MEETING OF STOCKHOLDERS OF TRUMP HOTELS & CASINO RESORTS, INC. TO BE SPECIAL MEETING OF STOCKHOLDERS OF TAJ MAHAL HOLDING CORP. TO BE HELD MARCH , This Joint Proxy Statement-Prospectus (the "Proxy Statement-Prospectus") is furnished in connection with the solicitation of proxies by the Board of Directors of Trump Hotels & Casino Resorts, Inc., a Delaware corporation ("THCR"), for use at a Special Meeting (including any and all adjournments or postponements thereof, the "THCR Special Meeting") of stockholders of THCR, and in connection with the solicitation of proxies by the Board of Directors of Taj Mahal Holding Corp., a Delaware corporation ("Taj Holding"), for use at a Special Meeting (including any and all adjournments or postponements thereof, the "Taj Holding Special Meeting") of stockholders of Taj Holding. The THCR Special Meeting will be held on March , 1996 at and the Taj Holding Special Meeting will be held on March , 1996 at . This Proxy Statement-Prospectus relates, among other things, to the proposed merger (the "Merger") of THCR Merger Corp., a Delaware corporation ("Merger Sub") and a wholly owned subsidiary of THCR, with and into Taj Holding pursuant to the Agreement and Plan of Merger, dated as of January 8, 1996 (the "Merger Agreement"), among THCR, Taj Holding and Merger Sub. As a result of the Merger and the related transactions discussed below, Trump Hotels & Casino Resorts Holdings, L.P., a Delaware limited partnership ("THCR Holdings") and a subsidiary of THCR, will wholly own Trump Taj Mahal Associates ("Taj Associates"), the owner and operator of the Trump Taj Mahal Casino Resort (the "Taj Mahal"). If the Merger is approved and consummated, each share of Class A Common Stock, par value $.01 per share, of Taj Holding ("Taj Holding Class A Common Stock") issued and outstanding immediately prior to the Effective Time of the Merger (as defined in the Merger Agreement) (other than treasury stock held by Taj Holding, shares owned by any direct or indirect subsidiary of Taj Holding and Dissenting Shares (as defined herein)) will be converted into the right to receive, at each holder's election, either (a) $30.00 in cash or (b) that number of shares of Common Stock, par value $.01 per share, of THCR ("THCR Common Stock") as is determined by dividing $30.00 by the Market Value. Market Value is defined as the average of the high and low per share sales prices on the New York Stock Exchange ("NYSE") of a share of THCR SEE "RISK FACTORS" BEGINNING ON PAGE FOR A DISCUSSION OF CERTAIN INFORMATION THAT SHOULD BE CONSIDERED IN CONNECTION WITH THE MERGER TRANSACTION (AS DEFINED HEREIN). This Proxy Statement-Prospectus also constitutes the Prospectus of THCR with respect to the shares of THCR Common Stock to be issued in connection with the Merger. The THCR Common Stock is listed on the NYSE under the symbol "DJT." On February , 1996, the last reported sales price of THCR Common Stock on the NYSE was $ . See "Market Price and Dividend Data." This Proxy Statement-Prospectus and the accompanying forms of proxy are first being mailed to stockholders of THCR and Taj Holding on or about February , 1996. NEITHER THIS TRANSACTION NOR THESE SECURITIES HAVE BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS PASSED UPON THE FAIRNESS OR MERITS OF THIS TRANSACTION OR UPON THE ACCURACY OR ADEQUACY OF THE INFORMATION CONTAINED IN THIS PROXY STATEMENT-PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. NEITHER THE NEW JERSEY CASINO CONTROL COMMISSION, THE INDIANA GAMING COMMISSION NOR ANY OTHER REGULATORY AUTHORITY HAS PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROXY STATEMENT-PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL. THE DATE OF THIS JOINT PROXY STATEMENT-PROSPECTUS IS FEBRUARY , 1996. Common Stock on the fifteen trading days immediately preceding the Effective Time of the Merger. No fractional shares of THCR Common Stock will be issued in the Merger. The Merger Agreement also contemplates the following transactions occurring in connection with the Merger: (a) the consummation of the offering by THCR of up to $140,000,000 of THCR Common Stock (and an amount to be issued pursuant to the underwriters' over- allotment option) (the "THCR Stock Offering") and the consummation of the offering by Trump Taj Mahal Funding, Inc. ("Taj Funding") of up to $750,000,000 aggregate principal amount of debt securities (the "Taj Notes") (the "Taj Note Offering," and, together with the THCR Stock Offering, the "Offerings"), the aggregate net proceeds of which will be used, together with available cash of Taj Associates, to (i) pay cash to those holders of Taj Holding Class A Common Stock electing to receive cash in the Merger, (ii) redeem Taj Funding's outstanding 11.35% Mortgage Bonds, Series A due 1999 (the "Bonds"), (iii) redeem the outstanding shares of Class B Common Stock, par value $.01 per share, of Taj Holding (the "Taj Holding Class B Common Stock") as required in connection with the redemption of the Bonds pursuant to the Amended and Restated Certificate of Incorporation of Taj Holding (the "Taj Holding Certificate of Incorporation"), (iv) purchase certain real property used in the operation of the Taj Mahal that is currently leased from Trump Taj Mahal Realty Corp. ("Realty Corp."), a corporation wholly owned by Donald J. Trump ("Trump"), and (v) make a payment to Bankers Trust Company ("Bankers Trust") to obtain releases of the liens and guarantees that Bankers Trust has with respect to Taj Associates; (b) the contribution by Trump to THCR Holdings and Taj Mahal Holdings LLC ("Taj Holdings LLC"), a subsidiary of THCR Holdings, of all of his direct and indirect ownership interests in Taj Associates; and (c) the contribution by THCR to THCR Holdings and Taj Holdings LLC of all of its indirect ownership interests in Taj Associates acquired in the Merger. The Merger is contingent upon the consummation of the other transactions contemplated by the Merger Transaction. As a result of the Merger Transaction, THCR's and Trump's beneficial equity interests in THCR Holdings will be approximately % and %, respectively. In addition, THCR will issue to Trump a warrant to purchase an aggregate of 1.8 million shares of THCR Common Stock, one third of which may be purchased on or prior to (i) the third anniversary of the issuance of the warrant at $30.00 per share, (ii) the fourth anniversary of the issuance of the warrant at $35.00 per share and (iii) the fifth anniversary of the issuance of the warrant at $40.00 per share The Merger and the related transactions discussed above are collectively referred to as the "Merger Transaction." NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN OR INCORPORATED BY REFERENCE IN THIS PROXY STATEMENT-PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION NOT CONTAINED HEREIN MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED. THIS PROXY STATEMENT-PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR THE SOLICITATION OF AN OFFER TO PURCHASE, ANY OF THE SECURITIES OFFERED BY THIS PROXY STATEMENT-PROSPECTUS, OR THE SOLICITATION OF A PROXY, IN ANY JURISDICTION TO OR FROM ANY PERSON TO OR FROM WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION OF AN OFFER, OR PROXY SOLICITATION IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS PROXY STATEMENT-PROSPECTUS NOR THE ISSUANCE OR SALE OF ANY SECURITIES HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE INFORMATION SET FORTH HEREIN SINCE THE DATE HEREOF OR INCORPORATED BY REFERENCE HEREIN SINCE THE DATE HEREOF. THCR has filed with the office of the Securities and Exchange Commission (the "SEC") in Washington, D.C., a Registration Statement on Form S-4 (the "Registration Statement") under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the securities offered hereby. The Registration Statement includes the Joint Proxy Statement of THCR and Taj Holding filed with the SEC in connection with the Merger Agreement. Trump, THCR, THCR Holdings, Taj Holding, TM/GP Corporation ("TM/GP") and Merger Sub have filed with the SEC a Rule 13e-3 Transaction Statement on Schedule 13E-3 (the "Schedule 13E-3") with respect to the Merger. This Proxy Statement- Prospectus does not contain all of the information set forth in the Registration Statement and the Schedule 13E-3, certain portions of which have been omitted as permitted by the rules and regulations of the SEC. Such additional information can be inspected at, and obtained from, the SEC in the manner set forth below. For further information pertaining to the securities offered hereby and to Trump, THCR, THCR Holdings, Taj Holding, TM/GP and Merger Sub, reference is made to the Registration Statement and to the Schedule 13E-3, including, in each case, the exhibits filed as parts thereof. THCR, THCR Holdings, Taj Holding, Taj Associates and Taj Funding are subject to the informational reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, accordingly, have filed reports and other information with the SEC. Reports, proxy statements and other information of THCR, THCR Holdings, Taj Holding, Taj Associates and Taj Funding filed with the SEC, as well as the Registration Statement and the Schedule 13E-3, are available for inspection and copying at the public reference facilities maintained by the SEC at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 and at certain regional offices of the SEC located at Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60621-2511 and 7 World Trade Center, New York, New York 10048. Copies of such material can be obtained from the Public Reference Section of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates. The THCR Common Stock is listed on the New York Stock Exchange, and reports and other information concerning THCR can be inspected at the offices of the New York Stock Exchange, 20 Broad Street, New York, New York 10005. The units consisting of $1,000 principal amount of Bonds and one share of Taj Holding Class B Common Stock (the "Units") are listed on the American Stock Exchange, and reports and other information concerning Taj Holding, Taj Associates and Taj Funding can be inspected at the offices of the American Stock Exchange, 86 Trinity Place, New York, New York 10006. The following is a summary of certain of the information contained in this Proxy Statement-Prospectus and is qualified in its entirety by the more detailed information and financial statements included elsewhere herein. Certain capitalized terms used herein are defined elsewhere in the Proxy Statement-Prospectus. Unless otherwise indicated, the term "THCR" as used herein includes THCR and its subsidiaries and the term "Taj Holding" includes Taj Holding and its direct and indirect interests in Taj Associates. Stockholders of THCR and Taj Holding are urged to read the entire Proxy Statement-Prospectus and Annexes hereto in their entirety. The Merger Transaction is designed to combine into one entity two "Four Star" Atlantic City casino hotels operated by Trump, as well as a riverboat gaming project currently under development approximately 25 miles southeast of downtown Chicago (the "Indiana Riverboat"), creating one of the largest casino entertainment companies in the United States. Upon consummation of the Merger Transaction, THCR will own and operate the Trump Taj Mahal Casino Resort, currently Atlantic City's largest casino hotel, and the Trump Plaza Hotel and Casino ("Trump Plaza"), which will be the largest casino hotel in Atlantic City upon completion of its ongoing expansion program (the "Trump Plaza Expansion"). As part of the Merger Transaction, the maturity of Taj Associates' long-term indebtedness will be extended by refinancing the Bonds with the Taj Notes, providing the Taj Mahal with greater financial flexibility to undertake an expansion program to increase its hotel room inventory and casino floor space and expand its parking facilities (the "Taj Mahal Expansion"). In addition, THCR's ownership and operation of the Indiana Riverboat, to be located at Buffington Harbor on Lake Michigan, will give it a presence in the greater Chicago metropolitan area market which is one of the most successful new gaming markets in the United States. THCR will also continue to be the exclusive vehicle through which Trump will engage in new gaming activities in both emerging and established gaming jurisdictions. THCR believes the acquisition of the Taj Mahal will strengthen THCR's position as a leader in the casino entertainment industry. The Merger Transaction will enhance THCR's presence in the growing Atlantic City market, which, in terms of gaming revenues, has demonstrated a ten year compound annual growth rate of 6.2% and a growth rate of 9.5% for calendar year 1995 versus calendar year 1994. After giving effect to the Merger Transaction and the Trump Plaza Expansion, THCR will have approximately one-quarter of Atlantic City's casino square footage, slot machines, table games and hotel room inventory. The combination of the Taj Mahal with THCR's existing and planned operations will provide opportunities for operational efficiencies, economies of scale and benefits from the talent, expertise and experience of management at the operating entities. Management believes that the marquee status of the "Trump" name, along with the critical mass resulting from the Merger Transaction, will allow THCR to compete more effectively for prime gaming licenses in other jurisdictions. The following table profiles THCR's casino and hotel capacity following the consummation of the Merger Transaction: (1) Scheduled to be completed early in the second quarter of 1996. (2) Plans for the Taj Mahal Expansion, scheduled to be completed in phases from the fourth quarter of 1996 through the second quarter of 1999, are preliminary and subject to modification. (3) Excludes a 12,000 square foot poker, keno and race simulcasting room. (4) Includes 150 rooms which were opened at Trump Plaza East on October 30, 1995. THCR will continue to capitalize on the widespread recognition of the "Trump" name and its association with high quality amenities and first class service. To achieve this end, THCR will seek to provide a broadly diversified gaming and entertainment experience consistent with the "Trump" name and reputation for quality, tailored to the gaming patron in each market. THCR will also seek to benefit from the "Trump" name in connection with efforts to expand and to procure new gaming opportunities in the United States and abroad. Trump Hotels & Casino Resorts. THCR owns and operates Trump Plaza, a luxury casino hotel located on The Boardwalk in Atlantic City, and is currently developing the Indiana Riverboat. THCR's strategy is to capitalize on Trump Plaza's reputation for excellence, as well as to meet both existing demand and the increase in demand that management anticipates will result from the increased number of available rooms and infrastructure improvements that are currently being implemented to enhance further the "vacation destination appeal" of Atlantic City. The ongoing Trump Plaza Expansion, scheduled to be completed early in the second quarter of 1996, involves the renovation and integration into Trump Plaza of a hotel located adjacent to Trump Plaza's main tower ("Trump Plaza East") and the former Trump Regency Hotel ("Trump World's Fair"), and the construction of new gaming space, retail operations and entertainment venues. Upon completion of the Trump Plaza Expansion, Trump Plaza's hotel room inventory and casino floor space will be the largest in Atlantic City. The following table details the plans for the Trump Plaza Expansion: (1) Includes the 2,000 square foot area which will connect the existing facility with Trump Plaza East and the 75 slot machines to be included in this area. (2) Includes 150 rooms which were opened on October 30, 1995. The Indiana Riverboat, currently scheduled to open for business early in the second quarter of 1996, will feature an approximately 280-foot luxury yacht with approximately 37,000 square feet of gaming space, will contain 1,500 slot machines and 73 table games and will be one of the largest riverboat casinos in the United States. The Indiana Riverboat's principal market will be the approximately 6.8 million people residing within 50 miles of Buffington Harbor in the northern Indiana suburban and Chicago metropolitan areas. Taj Holding. Taj Holding has no business operations and serves as a holding company for a 50% investment in Taj Associates. Taj Associates owns and operates the Taj Mahal, a luxury casino hotel located on The Boardwalk in Atlantic City. The Taj Mahal is currently the largest casino hotel in Atlantic City, and has ranked first among all Atlantic City casinos in terms of total gaming revenues, table revenues and slot revenues since it commenced operations. The Taj Mahal capitalizes on the widespread recognition and marquee status of the "Trump" name and its association with high quality amenities and first class service as evidenced by its "Four Star" Mobil Travel Guide rating. Management believes that the breadth and diversity of the Taj Mahal's casino, entertainment and convention facilities will enable the Taj Mahal to benefit from the growth of the Atlantic City market. The Taj Mahal consists of a 42-story hotel tower and contiguous low-rise structure, sited on approximately 17 acres of land. The Taj Mahal has 1,250 guest rooms (including 242 suites), 15 restaurants, six lounges, parking for approximately 4,600 cars, an 18-bay bus terminal and approximately 65,000 square feet of ballroom, meeting room and pre-function area space. The Taj Mahal is currently contemplating adding new themed restaurants to be owned and operated by nationally recognized restaurant operators, including the Rainforest Cafe. In addition, the Taj Mahal features a 20,000-square-foot multi-purpose entertainment complex known as the Xanadu Theater with seating capacity for approximately 1,200 people, which can be used as a theater, and exhibition hall (the "Taj Entertainment Complex") and the Mark Etess Arena, which comprises an approximately 63,000-square-foot exhibition hall facility. The Taj Mahal regularly engages well-known musicians and entertainment personalities and will continue to emphasize weekend marquee events such as Broadway revues, high visibility sporting events, international festivals and contemporary concerts to maximize casino traffic and to maintain the highest level of glamour and excitement at the Taj Mahal. Following the consummation of the Merger Transaction, THCR plans to undertake an expansion plan at the Taj Mahal. It is currently expected that the Taj Mahal Expansion will be funded out of the Taj Mahal's cash from operations and borrowings and will be completed in phases from the fourth quarter of 1996 through 1999. The Taj Mahal Expansion, the plans for which are preliminary and subject to change, involves the construction of a 2,200 space expansion of the Taj Mahal's existing self-parking facilities and a new arena on a surface parking area located adjacent to the Taj Mahal, each scheduled to be completed in the fourth quarter of 1996; the conversion of the current site of the Mark Etess Arena into a new 60,000-square-foot circus-themed casino with 2,500 slot machines, to be completed in 1997; and the construction of two new 640 room hotel towers adjacent to the Taj Mahal's existing hotel tower, the first of which is scheduled to be completed in 1997, and the second of which is scheduled to begin construction following the completion of the first tower and be completed in 1999. See "Risk Factors--Trump Plaza Expansion and the Taj Mahal Expansion." Time, Place and Date. A Special Meeting of THCR stockholders will be held at on March , 1996, at 10:00 a.m., local time. A Special Meeting of Taj Holding stockholders will be held at on March , 1996, at 10:00 a.m., local time. Purpose of the Special Meetings. At the THCR Special Meeting, holders of THCR Common Stock and Class B Common Stock, par value $.01 per share, of THCR ("THCR Class B Common Stock") will be asked to approve the Merger Transaction, which approval will constitute approval and adoption of the Merger Agreement. Stockholders of THCR will also consider and vote upon any other matter that may properly come before the THCR Special Meeting. At the Taj Holding Special Meeting, holders of Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Class C Common Stock, par value $.01 per share, of Taj Holding ("Taj Holding Class C Common Stock") will be asked to approve and adopt the Merger Agreement. Stockholders of Taj Holding will also consider and vote upon any other matter that may properly come before the Taj Holding Special Meeting. Votes Required; Record Date. Approval of the Merger Transaction will require the affirmative vote of (i) the holders of a majority of the outstanding shares of THCR Common Stock (excluding directors and executive officers of THCR and their affiliates) voting as a separate class (representing the approval of a majority of THCR's unaffiliated stockholders); and (ii) the holders of shares representing a majority of the outstanding voting power of the THCR Common Stock and THCR Class B Common Stock voting together as a single class. Only holders of record of THCR Common Stock and THCR Class B Common Stock at the close of business on February , 1996 (the "THCR Record Date") are entitled to vote at the THCR Special Meeting. As of the THCR Record Date (i) directors and executive officers of THCR and their affiliates had the power to vote shares representing approximately % of the outstanding shares of THCR Common Stock; and (ii) Trump had the power to vote 100% of the outstanding shares of THCR Class B Common Stock, representing approximately 40% of the combined voting power of the shares of THCR Common Stock and THCR Class B Common Stock. All of such officers, directors and affiliates have indicated that they intend to vote their shares for approval of the Merger Transaction. Trump has agreed with THCR to vote his shares of THCR Class B Common Stock for approval of the Merger Transaction and at the THCR Special Meeting such shares will be voted accordingly. See "The THCR Special Meeting." Approval and adoption of the Merger Agreement will require the affirmative vote of the holders of a majority of the outstanding shares of each of the Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock, each voting as a separate class. Only holders of record of Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock at the close of business on February , 1996 (the "Taj Holding Record Date") are entitled to vote at the Taj Holding Special Meeting. As of the Taj Holding Record Date (i) directors and executive officers of Taj Holding and their affiliates had the power to vote shares representing approximately % of the Taj Holding Class A Common Stock; (ii) directors and executive officers of Taj Holding and their affiliates had the power to vote shares representing approximately % of the Taj Holding Class B Common Stock; and (iii) Trump had the power to vote 100% of the outstanding shares of Taj Holding Class C Common Stock. All of such officers, directors and affiliates have indicated that they intend to vote their shares for approval and adoption of the Merger Agreement. Trump has agreed with Taj Holding to vote his shares of Taj Holding Class C Common Stock for approval and adoption of the Merger Agreement and at the Taj Holding Special Meeting such shares will be voted accordingly. See "The Taj Holding Special Meeting." As of the Taj Holding Record Date, there were 1,350,000 shares of Taj Holding Class A Common Stock outstanding, each of which entitles the holder thereof to one vote per share. Pursuant to an agreement, dated as of October 6, 1995 (the "Class A Agreement"), the holders of 701,840 shares of Taj Holding Class A Common Stock (representing approximately 52% of the outstanding shares of Taj Holding Class A Common Stock) agreed to vote such shares in favor of the Merger and at the Taj Holding Special Meeting, such shares will be voted accordingly. See "Special Factors--Background of the Merger Transaction." In considering whether to vote for approval of the Merger Transaction or approval and adoption of the Merger Agreement, as applicable, stockholders should be aware that certain members of the Board of Directors and management of each of THCR, Taj Holding and certain of their affiliates have interests which may present them with actual or potential conflicts of interest in connection with the Merger Transaction. Trump is the Chairman of the Board of Directors of THCR and Taj Holding and currently is the beneficial owner of approximately 40% and 50% of THCR and Taj Associates, respectively. Furthermore, in connection with the Merger Transaction, certain debt obligations of Trump and certain of his affiliates will be satisfied, and certain guarantees of indebtedness by Trump and certain of his affiliates will be released. See "Risk Factors--Interests of Certain Members of the Boards of Directors of THCR and Taj Holding," "--Conflicts of Interest" and "Special Factors--Interests of Certain Persons in the Merger Transaction." RECOMMENDATIONS OF THE BOARDS OF DIRECTORS The Board of Directors of THCR and the Special Committee of the Board of Directors of THCR, consisting of its three independent directors (the "THCR Special Committee"), have considered the terms and conditions of the Merger Transaction and certain other information, including the opinion of THCR's financial advisor, and have determined that the proposed Merger Transaction is fair to, and in the best interests of, THCR, and have unanimously approved the terms of the Merger Transaction and the Merger Agreement. ACCORDINGLY, THE BOARD OF DIRECTORS OF THCR RECOMMENDS THAT THE STOCKHOLDERS OF THCR VOTE FOR APPROVAL OF THE MERGER TRANSACTION. In order for the Merger to be approved by the Board of Directors of Taj Holding, it must be approved by both a majority of the entire Board of Directors of Taj Holding and a majority of the Class B Directors of Taj Holding (the "Class B Directors"). After considering the terms and conditions of the proposed Merger Agreement and certain other information, including the opinion of Taj Holding's financial advisor and the Class A Agreement, the Board of Directors of Taj Holding (including the Class B Directors) determined that the proposed Merger is fair to, and in the best interests of, Taj Holding and the holders of Taj Holding Class A Common Stock, and unanimously approved the terms of the Merger Agreement. ACCORDINGLY, THE BOARD OF DIRECTORS OF TAJ HOLDING RECOMMENDS THAT THE STOCKHOLDERS OF TAJ HOLDING VOTE FOR APPROVAL AND ADOPTION OF THE MERGER AGREEMENT. For more information on the considerations and recommendations of the Board of Directors of each of THCR and Taj Holding, see "Special Factors--Background of the Merger Transaction," "--Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction" and "-- Interests of Certain Persons in the Merger Transaction." Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") was retained by THCR to render its opinion to the THCR Special Committee as to the fairness to THCR, from a financial point of view, of the aggregate consideration to be paid by THCR pursuant to the transactions contemplated by the Merger Agreement. At a meeting of the THCR Special Committee held on January 8, 1996 to consider and vote on the Merger Transaction, DLJ delivered its written opinion to the effect that, as of such date, the aggregate consideration to be paid by THCR pursuant to the transactions contemplated by the Merger Agreement is fair, from a financial point of view, to THCR. A copy of the full written opinion of DLJ, dated January 8, 1996, is attached to this Proxy Statement-Prospectus as Annex B, and is incorporated herein by reference and should be read carefully in its entirety. See "Risk Factors--Limitations Inherent in Fairness Opinions" and "Special Factors--Opinions of the Financial Advisors." Rothschild Inc. ("Rothschild") was retained by Taj Holding to render its opinion to the Board of Directors of Taj Holding, including the Class B Directors, as to the fairness, from a financial point of view, of the consideration to be received by the holders of Taj Holding Class A Common Stock in connection with the Merger Transaction. At a meeting of the Board of Directors of Taj Holding held on January 8, 1996 to consider and vote on the Merger, Rothschild delivered its written opinion to the effect that, as of such date, the consideration to be received by the holders of Taj Holding Class A Common Stock in connection with the Merger Transaction, is fair, from a financial point of view, to the holders of Taj Holding Class A Common Stock. A copy of the full written opinion of Rothschild, dated January 8, 1996, is attached to this Proxy Statement-Prospectus as Annex C, and is incorporated herein by reference and should be read carefully in its entirety. See "Risk Factors--Limitations Inherent in Fairness Opinions" and "Special Factors-- Opinions of the Financial Advisors." Terms of the Merger. The Merger Agreement provides that, subject to the satisfaction or waiver of the conditions to the Merger, Merger Sub will be merged with and into Taj Holding in accordance with the Delaware General Corporation Law ("DGCL") whereupon the separate existence of Merger Sub will cease and Taj Holding will be the surviving corporation in the Merger (the "Surviving Corporation"). The Merger will become effective on such date as a certificate of merger for the Merger (the "Certificate of Merger") is accepted for filing by the Secretary of State of the State of Delaware in accordance with the DGCL or at such time thereafter as provided in the Certificate of Merger (the "Effective Time"). Conversion of Outstanding Shares. At the Effective Time, (i) each share of Taj Holding Class A Common Stock outstanding immediately prior to the Effective Time will, except as otherwise provided in the Merger Agreement, be converted into and represent the right to receive, at the holder's election, either (x) $30.00 in cash (the "Cash Consideration") or (y) that number of shares of THCR Common Stock as is determined by dividing $30 by the Market Value (the "Stock Consideration" and collectively with the Cash Consideration, the "Merger Consideration"); (ii) each share of Taj Holding Class C Common Stock to the Effective Time will be contributed by Trump to Taj Holding and canceled; (iii) each share of Taj Holding Class A Common Stock held by Taj Holding as treasury stock immediately prior to the Effective Time or owned by any direct or indirect subsidiary of Taj Holding immediately prior to the Effective Time will be canceled, and no conversion or payment will be made with respect thereto; and (iv) each share of common stock of Merger Sub outstanding immediately prior to the Effective Time will be converted into and represent the right to receive one fully paid and nonassessable share of common stock of the Surviving Corporation. Market Value is defined as the average of the high and low per share sales prices of the THCR Common Stock during the fifteen trading days immediately preceding the Effective Time. No fractional shares of THCR Common Stock will be issued in the Merger. Election Procedures. Each holder of Taj Holding Class A Common Stock will receive an election form (the "Election Form") together with this Proxy Statement-Prospectus permitting each holder of Taj Holding Class A Common Stock to elect to receive only Stock Consideration or only Cash Consideration. Any holder of Taj Holding Class A Common Stock who wishes to receive Cash Consideration must send the Election Form properly completed to the Exchange Agent (as defined) on or before 5:00 p.m. on the business day prior to the Taj Holding Special Meeting or such other date as determined by THCR and Taj Holding (the "Election Deadline"). Holders of the Taj Holding Class A Common Stock who (i) fail to complete properly the Election Form, (ii) fail to send the Election Form to the Exchange Agent prior to the Election Deadline or (iii) make no election, shall be deemed to have elected to receive the Stock Consideration. Any Election Form may be revoked prior to the Election Deadline by submitting a new Election Form to the Exchange Agent. Conditions to the Merger. The respective obligations of Taj Holding, THCR and Merger Sub to consummate the transactions contemplated by the Merger Agreement are subject to the fulfillment at or prior to the Effective Time of certain conditions which may be waived in whole or in part to the extent permitted by applicable law, including, among other conditions, (i) consummation of the transactions contemplated by the Merger Transaction; (ii) the Merger Agreement shall have been duly approved by the requisite votes of the stockholders of THCR and Taj Holding; (iii) the receipt of certain regulatory approvals, including approval under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act") and the approval of the New Jersey Casino Control Commission (the "CCC"); (iv) the number of shares of Taj Holding Class A Common Stock for which written demand for appraisal has been properly made pursuant to Section 262 of the DGCL shall not have exceeded 5% of the total number of shares of Taj Holding Class A Common Stock outstanding immediately prior to the Effective Time; and (v) the shares of THCR Common Stock to be issued pursuant to the Merger shall have been approved for listing on the NYSE, subject to official notice of issuance. The obligation of THCR to consummate the Merger is also subject to the Market Value of the THCR Common Stock being $20.00 or more. Termination. The Merger Agreement may be terminated and the Merger may be abandoned at any time prior to the Effective Time (i) by joint written consent of Taj Holding and THCR; (ii) by either Taj Holding or THCR and Merger Sub if certain conditions of the Merger have not been satisfied or waived at such time as such condition is no longer capable of satisfaction; or (iii) by any party to the Merger Agreement if the Merger has not been consummated on or before June 30, 1996. The Offerings; Sources and Uses. The Merger Transaction includes the Offerings, the aggregate net proceeds of which will be used, together with available cash of Taj Associates, to (i) pay cash to those holders of Taj Holding Class A Common Stock electing to receive cash in the Merger ($40.5 million assuming all such holders elect Cash Consideration); (ii) redeem the outstanding Bonds at a redemption price equal to 100% of the principal amount thereof (approximately $780 million assuming a redemption date of March 31, 1996), plus accrued interest to the date of redemption; (iii) redeem the outstanding shares of Taj Holding Class B Common Stock, as required in connection with the Bond redemption, at the redemption price of $.50 per share (approximately $400,000 in the aggregate); (iv) purchase, for $50 million in cash and 500,000 shares of THCR Common Stock, certain real property that is currently leased by Taj Associates from Realty Corp., a corporation wholly owned by Trump, including land underlying the Taj Entertainment Complex, land adjacent to the Taj Mahal used by it for surface parking and bus terminals, the pier located across The Boardwalk from the Taj Mahal (the "Steel Pier"), and a warehouse complex (collectively, the "Specified Parcels"); and (v) pay Bankers Trust $10 million to obtain releases of the liens and guarantees that Bankers Trust has in connection with certain outstanding indebtedness owed by Trump to certain lenders, including Bankers Trust (the "Bankers Trust Indebtedness"). See "Special Factors--Related Merger Transactions." Specified Parcels Purchase. The Specified Parcels are currently leased by Taj Associates from Realty Corp. for approximately $3.3 million per year. See "Business of Taj Holding--Certain Indebtedness--First Fidelity Loan/Specified Parcels." Realty Corp. has outstanding indebtedness of approximately $78 million owing to First Fidelity Bank, National Association, New Jersey ("First Fidelity") (the "First Fidelity Loan") which is due November 15, 1999. The First Fidelity Loan is currently secured on a first lien basis by the Specified Parcels, and Taj Associates has previously guaranteed the repayment of the First Fidelity Loan up to a maximum of $30 million. Trump has also previously personally guaranteed (up to a maximum of approximately $19.2 million), and pledged his direct and indirect equity interests in Taj Associates as collateral for, the First Fidelity Loan. As mortgagee, First Fidelity has the right to terminate the lease on the Specified Parcels, under certain circumstances, in the event the First Fidelity Loan is not paid when due. See "Business of Taj Holding--Certain Indebtedness--First Fidelity Loan/Specified Parcels." In order to secure future use of the Specified Parcels and eliminate all future lease payments on the Specified Parcels, Taj Associates expects to cause the First Fidelity Loan to be satisfied through the payment of $50 million in cash and 500,000 shares of THCR Common Stock and purchase the Specified Parcels from Realty Corp. for a nominal amount by exercising a purchase option with respect to the Specified Parcels. Upon consummation of the purchase of the Specified Parcels, (i) the lease relating to the Specified Parcels will be terminated, thus eliminating Taj Associates' rental obligations thereunder; (ii) the $30 million guaranty by Taj Associates of the First Fidelity Loan will be released; and (iii) Trump's guaranty of such indebtedness will be released and First Fidelity will relinquish its lien on Trump's direct and indirect equity interests in Taj Associates. The Specified Parcels may be part of the collateral securing the Taj Notes. See "Business of Taj Holding--Certain Indebtedness--First Fidelity Loan/Specified Parcels." Consent and Release Payment. As part of the Merger Transaction, Taj Associates will pay $10 million to Bankers Trust in respect of certain of the Bankers Trust Indebtedness. The Bankers Trust Indebtedness is currently secured by, among other things, a promissory note from Trump Taj Mahal, Inc. ("TTMI"), a corporation wholly owned by Trump and the holder of a 49.995% general partnership interest in Taj Associates, to Trump (the "TTMI Note"), as well as a lien on Trump's direct and indirect equity interests in Taj Associates. In exchange for such payment, Bankers Trust will consent to the Merger Transaction and release its lien on Trump's direct and indirect equity interests in Taj Associates and the pledge of the TTMI Note. See "Business of Taj Holding-- Certain Indebtedness--TTMI Note." Trump Contribution and Consideration. In connection with the Merger Transaction, Trump will contribute or cause to be contributed all of his direct and indirect equity interests in Taj Associates (representing a 50% economic interest) to THCR Holdings and Taj Holdings LLC by contributing to THCR Holdings his shares (consisting of 50% of the outstanding capital stock) of The Trump Taj Mahal Corporation ("TTMC"), the holder of a .01% general partnership interest in Taj Associates, and causing TTMI to contribute to THCR Holdings and Taj Holdings LLC, TTMI's 49.995% general partnership interest in Taj Associates. In addition, Trump will contribute to Taj Holding all of his Taj Holding Class C Common Stock, which will be canceled pursuant to the Merger Agreement. The Taj Holding Class C Common Stock provides Trump with the ability to elect a majority of the members of the Board of Directors of, and thereby control, Taj Holding. It also affords Trump separate class voting rights in certain events, including the consummation of the Merger. The Taj Services Agreement (as defined herein), pursuant to which Trump has received or will receive $1,862,000, $1,353,000 and $1,566,000 during the years ended 1995, 1994 and 1993, respectively, as compensation for services rendered to Taj Associates, will also be terminated in connection with the Merger Transaction. Trump, through TTMI, has the right to reduce the equity interest of the Taj Holding Class A Common Stock in Taj Associates from 50% to 20% by causing Taj Associates to make a payment to the holders of the Bonds in an amount calculated to provide them with a cumulative return equal to approximately 14% per annum (the "14% Payment"). If the 14% Payment is made (which can occur only if the Bonds are retired, redeemed or paid in full), Trump would beneficially own 80% of Taj Associates. Moreover, the 14% Payment is permitted to be financed with Taj Associates' borrowings. In connection with the Merger Transaction, TTMI does not intend to exercise its right to cause Taj Associates to make such payment and such right will terminate upon the redemption of the Bonds. In exchange for the contribution by Trump and TTMI to THCR Holdings and Taj Holdings LLC, Trump's directly held limited partnership interest in THCR Holdings will be modified and TTMI will receive a limited partnership interest in THCR Holdings. As a result of the Merger Transaction, Trump's aggregate beneficial ownership of limited partnership interests in THCR Holdings will decrease from 40% to %, with a % interest held directly by TTMI (assuming a price of $ per share of THCR Common Stock as the Market Value in connection with the Merger and as the public offering price in the THCR Stock Offering). Trump's limited partnership interest in THCR Holdings represents his economic interest in the assets and operations of THCR Holdings and is convertible, at Trump's option, into 6,666,667 shares of THCR Common Stock (representing approximately 40% of the outstanding shares of THCR Common Stock after giving effect to such conversion). Upon consummation of the Merger Transaction (assuming a price of $ per share of THCR Common Stock as the Market Value in connection with the Merger and as the public offering price in the THCR Stock Offering). Trump's and TTMI's limited partnership interests in THCR Holdings will be convertible into shares of THCR Common Stock, representing approximately % of the then outstanding shares of THCR Common Stock upon consummation of the Merger Transaction. At the time that TTMI becomes a limited partner of THCR Holdings, THCR will issue shares of THCR Class B Common Stock to TTMI. THCR Class B Common Stock has voting power equivalent to the voting power of the THCR Common Stock into which a THCR Class B Common Stockholder's limited partnership interest in THCR Holdings is convertible. The THCR Class B Common Stock is not entitled to dividends or distributions. Upon conversion of all or any portion of the THCR Holdings limited partnership interest into shares of THCR Common Stock, the corresponding voting power of the THCR Class B Common Stock (equal in voting power to the number of shares of THCR Common Stock issued upon such conversion) will be proportionately diminished. Concurrent with the consummation of the Merger Transaction, THCR will issue to Trump a warrant to purchase an aggregate of 1.8 million shares of THCR Common Stock, one third of the underlying shares of which may be purchased on or prior to (i) the third anniversary of the issuance of the warrant at $30.00 per share, (ii) the fourth anniversary of the issuance of warrant at $35.00 per share and (iii) the fifth anniversary of the issuance of the warrant at $40.00 per share. THCR Contribution and Consideration. In connection with the Merger Transaction, THCR will cause TM/GP, which will become an indirect wholly owned subsidiary of THCR after the Effective Time and which holds a 49.995% general partnership interest in Taj Associates, to contribute to THCR Holdings and Taj Holdings LLC its general partnership interest in Taj Associates, and will cause Taj Holding, which will become a direct wholly owned subsidiary of THCR after the Effective Time, to contribute to TM/GP and will then cause TM/GP to contribute to THCR Holdings the shares (consisting of 50% of the outstanding capital stock) of TTMC held by Taj Holding. As a result of the Merger Transaction, THCR's beneficial equity interest in THCR Holdings will increase from 60% to %, including % interest held directly by TM/GP (assuming a $ of THCR Common Stock as the Market Value in connection with the Merger and as the public offering price in the THCR Stock Offering). Redemption of Taj Holding Class B Common Stock. The Taj Holding Class B Common Stock is essentially a nonparticipating stock issued as part of a Unit in connection with the Bonds that entitles the holders thereof to elect the Class B Directors, to vote on matters presented to the stockholders of Taj Holding and to separately approve certain matters. The Taj Holding Certificate of Incorporation provides that the outstanding shares of Taj Holding Class B Common Stock must be redeemed at such time as the Bonds are redeemed, defeased or paid, at the redemption price of $.50 per share. In connection with the Merger Transaction, Taj Holding will cause each outstanding share of Taj Holding Class B Common Stock to be redeemed at the redemption price of $.50 per share in accordance with the provisions of the Taj Holding Certificate of Incorporation. DISSENTING STOCKHOLDERS' RIGHTS OF APPRAISAL Under Delaware law, appraisal rights with respect to the Merger may be available to stockholders of Taj Holding. Appraisal rights with respect to the Merger are only available if such holders (i) neither vote for approval of the Merger Transaction nor consent thereto in writing; and (ii) comply with the other statutory requirements of the DGCL. See "Dissenting Stockholders' Rights of Appraisal" and "Annex D." Stockholders of THCR are not entitled to appraisal rights with respect to the Merger. In deciding whether to approve the Merger Transaction or approve and adopt the Merger Agreement, as applicable, and, with respect to the holders of Taj Holding Class A Common Stock, to elect Cash Consideration or Stock Consideration, the stockholders of THCR and Taj Holding should carefully evaluate the matters set forth herein, including those under the heading "Risk Factors." Factors to be considered include: (i) the high leverage and fixed charges of THCR and Taj Holding; (ii) THCR's holding company structure, the risk in refinancing and repayment of indebtedness, and the need for additional financing; (iii) the restrictions imposed on certain activities by certain debt instruments; (iv) the recent results of Trump Plaza and the Taj Mahal; (v) risks associated with the Trump Plaza Expansion and the Taj Mahal Expansion; (vi) risks relating to the Indiana Riverboat; (vii) competition in the gaming industry; (viii) conflicts of interest; (ix) control by and the involvement of Trump; (x) reliance on certain key personnel; (xi) the strict regulation by gaming authorities, including the potential disqualification of holders of THCR Common Stock; (xii) considerations with respect to the acquisition and development of additional gaming ventures; (xiii) limitations on THCR's license of the "Trump" name; (xiv) certain potential fraudulent conveyance risks; (xv) interests in the Merger Transaction of certain members of the Boards of Directors of THCR and Taj Holding; (xvi) limitations inherent in the fairness opinions of DLJ and Rothschild; (xvii) the shares of THCR Common Stock eligible for future sale; (xviii) the dilutive effect of the Merger Transaction on existing holders of THCR Common Stock; and (xix) the trading markets and potential volatility of the market price of the shares of THCR Common Stock. The listing on the NYSE, subject to official notice of issuance, of the shares of THCR Common Stock to be issued pursuant to the Merger Agreement is a condition to the consummation of the Merger. On January 8, 1996, the last sales price of THCR Common Stock reported on the NYSE was $21 3/4 per share and the last sales price of a Unit as reported on the American Stock Exchange ("Amex") was $98 per $100 principal amount of Bonds. The initial public announcement of the Merger Transaction occurred after the close of trading on such date. The Taj Holding Class B Common Stock and the Bonds trade together as Units and may not be transferred separately. On , 1996, the last sales price of THCR Common Stock was $ per share and the last sales price of a Unit was $ per $100 principal amount of Bonds. There is no established market for the Taj Holding Class A Common Stock or the Taj Holding Class C Common Stock. See "Market Price and Dividend Data." The rights of stockholders of Taj Holding are currently governed by Delaware law, the Taj Holding Certificate of Incorporation and the Amended and Restated By-Laws of Taj Holding (the "Taj Holding By-Laws"). Upon consummation of the Merger, holders of Taj Holding Class A Common Stock who receive THCR Common Stock in the Merger will become stockholders of THCR, which is also a Delaware corporation, and their rights as stockholders of THCR will be governed by Delaware law, the Amended and Restated Certificate of Incorporation of THCR (the "THCR Certificate of Incorporation") and the Amended and Restated By-Laws of THCR (the "THCR By-Laws"). For a discussion of the various differences between the rights of stockholders of Taj Holding and the rights of stockholders of THCR, see "Comparison of Stockholder Rights." CERTAIN FEDERAL INCOME TAX CONSIDERATIONS Holders of Taj Holding Class A Common Stock and holders of Taj Holding Class B Common Stock and Bonds should consult their tax advisers concerning the tax implications of the Merger Transaction and of the ownership and disposition of their stock or debt interests under applicable state, local, foreign income and other tax laws. The exchange of Taj Holding Class A Common Stock for cash or THCR Common Stock in the Merger is anticipated to be a taxable event for the holders thereof, and the redemption of the Bonds and the Taj Holding Class B Common Stock will be taxable events for the holders thereof. The Merger is expected to be accounted for as a "purchase" for accounting and reporting purposes and Trump's contributions of all of his direct and indirect ownership interests in Taj Associates are expected to be accounted for using carry over basis accounting. Certain aspects of the Merger Transaction will require notification to, and/or approvals from, certain federal and state regulatory authorities. Consummation of the Merger is conditioned upon, among other things, receipt of certain regulatory approvals including approval under the HSR Act and the approval of the CCC. See "Regulatory Matters." SUMMARY FINANCIAL INFORMATION OF THCR The following tables set forth (a) certain historical consolidated financial information of Trump Plaza Associates ("Plaza Associates") and Trump Plaza Holding Associates ("Plaza Holding") (predecessors of THCR) for each of the five years ended December 31, 1990 through 1994 and the nine month periods ended September 30, 1994 and certain historical consolidated financial information of THCR for the period from inception (June 12, 1995) to September 30, 1995 (unaudited) (see Note 1 below) and (b) unaudited pro forma financial information of THCR (giving effect to the June 1995 Offerings (as defined) see Note 1). The unaudited pro forma information also gives effect to the Merger Transactions (including the effects of the redemption of the Bonds, the Offerings and the consolidation of Taj Associates in THCR's financial financial information of Plaza Holding and Plaza Associates as of December 31, 1993 and 1994 and for the years ended December 31, 1992, 1993 and 1994 as set forth below has been derived from the audited consolidated financial statements of Plaza Holding and Plaza Associates included elsewhere in this Proxy Statement-Prospectus. The historical financial information of Plaza Holding and Plaza Associates for the years ended December 31, 1990 and 1991 as set forth has been derived from the audited consolidated financial statements of Plaza Holding and Plaza Associates not included in this Proxy Statement-Prospectus. The unaudited financial information as of September 30, 1994 and 1995 and for the periods then ended has been derived from the unaudited condensed consolidated financial statements included elsewhere in this Proxy Statement- Prospectus and in the opinion of management, includes all adjustments, consisting of only normal, recurring adjustments, necessary to present fairly the financial position, results of operations and changes in cash flows for the periods presented. The results of these interim periods are not necessarily indicative of the operating results for a full year. The pro forma Statement of Operations Data and Other Data give effect to the Merger Transaction as if it had occurred on January 1, 1994 and the pro forma Balance Sheet Data gives effect to the same as if the same had occurred on September 30, 1995. The pro forma financial information should not be considered indicative of actual results that would have been achieved had the transactions occurred on the date or for the period indicated and does not purport to indicate results of operations as of any future date or for any future period. All financial information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations of THCR," "Unaudited Pro Forma Financial Information" and the consolidated and condensed financial statements and the related notes thereto included elsewhere in this Proxy Statement-Prospectus. Note 1: THCR was incorporated on March 28, 1995 and conducted no operations until June 12, 1995, when THCR issued $140,000,000 of Common Stock (the "June 1995 Stock Offering") and contributed the proceeds therefrom to THCR Holdings in exchange for an approximately 60% general partnership interest in THCR Holdings. At the consummation of the June 1995 Stock Offering, Trump contributed his 100% beneficial interest in Plaza Funding, Plaza Holding and Plaza Associates, the owner and operator of Trump Plaza, to THCR Holdings for an approximately 40% limited partnership interest in THCR Holdings. The financial data as of September 30, 1995 and for the period ended September 30, 1995 reflect the operations of THCR from inception (June 12, 1995) to September 30, 1995. (a) Net loss for the year ended December 31, 1990, includes income of $2.4 million resulting from the settlement of a lawsuit relating to a boxing match. Net loss for the year ended December 31, 1991, includes a $10.9 million charge associated with the rejection of the lease of the former Trump Regency Hotel and $4.0 million of costs associated with certain litigation. Net income for 1992 includes $1.5 million of costs associated with certain litigation. Net income for the years ended December 31, 1993 and 1994, and the nine months ended September 30, 1994 and the period from inception (June 12, 1995) to September 30, 1995, includes $3.9, $4.9, $3.7 and $1.3 million, respectively, of real estate taxes and leasing costs associated with Trump Plaza East. (b) EBITDA represents income from operations before interest expense, taxes, depreciation, amortization, restructuring costs, net expenses of Trump World's Fair, non-cash compensation charges associated with awards to the President of THCR under the 1995 Stock Incentive Plan, the non-cash write- down of New Jersey Casino Reinvestment Development Authority ("CRDA") investments. EBITDA should not be construed as an alternative to net income or any other measure of performance determined in accordance with generally accepted accounting principles or as an indicator of THCR operating performance, liquidity or cash flows generated by operating, investing and financing activities. Management has included information concerning EBITDA as management understands that it is used by certain investors as one measure of THCR's historical ability to service its debt. (c) Capital expenditures attributable to Trump Plaza East were approximately $2.8 million and $8.9 million for the years ended December 31, 1993 and 1994, and $6.2 million for the nine months ended September 30, 1994, and $9.4 million for the period from inception (June 12, 1995) to September 30, 1995. Includes $ million and $ million related to the Trump Plaza Expansion for the nine months ended September 30, 1994 and 1995, respectively. (d) For purposes of computing this ratio, earnings consist of loss before income taxes, extraordinary items, minority interest and fixed charges, adjusted to exclude capitalized interest. Fixed charges consist of interest expense, including amounts capitalized, preferred partnership distribution requirements and the portion of operating lease rental expense that is representative of the interest factor (deemed to be one-third of operating lease rental expense). Earnings were insufficient to cover fixed charges for the years ended 1990, 1991, 1994, and the nine months ended September 30, 1994 and, on a pro forma basis, for the year ended 1994 and the nine months ended September 30, 1995. (e) Reflects reclassification in 1991 of indebtedness relating to outstanding mortgage bonds as a current liability due to then existing events of default. (f) Atlantic City industry data has been compiled from information filed with and published by the CCC and is unaudited. (g) Table drop represents the total dollar value of chips purchased for table games for the period indicated. (h) Market share represents the total Trump Plaza gaming revenues expressed as a percentage of total Atlantic City gaming revenues. (i) Fair share is the percentage of the total number of gaming units (table games and slot machines) in Trump Plaza to the total number of gaming units in casino hotels in Atlantic City. (j) Efficiency is the ratio of Trump Plaza's market share to its fair share. (k) Slot revenue is shown on the cash basis and excludes amounts reserved for progressive jackpot accruals. (l) Does not give effect to any return on investment from the net proceeds of the June 1995 Offerings. (m) Pro forma earnings per share assumes weighted average shares outstanding as of September 30, 1995, shares awarded to the President of the Company pursuant to the 1995 Stock Incentive Plan and shares to be issued in the THCR Stock Offering. (n) The expansion of 13,000 square feet was commenced in April 1994 and completed at the end of that year. (o) The Pro Forma Statement of Operations Data and Other Data give effect to the Merger Transaction as if same had occurred on January 1, 1994 and the Pro Forma Balance Sheet Data gives effect to the Merger Transaction as if same had occurred on September 30, 1995. SUMMARY FINANCIAL INFORMATION OF TAJ ASSOCIATES Taj Holding has no business operations and serves as a holding company for a 50% investment in Taj Associates. Therefore, historical financial information for Taj Holding is not presented below. The audited consolidated financial statements of Taj Holding as of December 31, 1993 and 1994 and for the years ended December 31, 1992, 1993 and 1994 are included elsewhere in this Proxy Statement-Prospectus. The following table sets forth certain historical consolidated financial information of Taj Associates for each of the five years ended December 31, 1990 through 1994 and for the nine months ended September 30, 1994 and 1995. The financial information of Taj Associates as of December 31, 1990, 1991, 1992, 1993 and 1994 and for the years then ended set forth below has been derived from the audited consolidated financial statements of Taj Associates. The audited financial information as of December 31, 1993 and 1994 and for the years ended December 31, 1992, 1993 and 1994 are included elsewhere in this Proxy Statement-Prospectus. The financial information as of September 30, 1994 and 1995 and for each of the nine months then ended has been derived from the unaudited consolidated financial statements of Taj Associates included elsewhere in this Proxy Statement-Prospectus and in the opinion of management, includes all adjustments, consisting of only normal, recurring adjustments, necessary to present fairly the financial position, results of operations and changes in cash flows for the periods presented. This information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations of Taj Associates," "Unaudited Pro Forma Financial Information" and the consolidated financial statements and the related notes thereto included elsewhere in this Proxy Statement-Prospectus. (a) The Taj Mahal was substantially completed and opened to the public on April 2, 1990. (b) Taj Associates and Taj Funding completed the 1991 Taj Restructuring on October 4, 1991, which may affect the comparability of prior periods. (c) EBITDA represents income from operations before depreciation, amortization, restructuring costs, the non-cash write-down of CRDA investments and a nonrecurring cost of a litigation settlement. EBITDA should not be construed as an alternative to net income or any other measure of performance determined in accordance with generally accepted accounting principles or as an indicator of Taj Associates' operating performance, liquidity or cash flows generated by operating, investing and financing activities. Management has included information concerning EBITDA, as management understands that it is used by certain investors as one measure of Taj Associates' historical ability to service its debt. (d) For purposes of computing this ratio, earnings consist of loss before income taxes and extraordinary items and fixed charges, adjusted to exclude capitalized interest. Fixed charges consist of interest expense, including amounts capitalized, partnership distribution requirements and the portion of operating lease rental expense that is representative of the interest factor (deemed to be one-third of operating lease rental expense). (e) The years ended December 31, 1991, 1992, 1993, 1994 and the nine months ended September 30, 1994 and 1995 include approximately $528,124, $550,140, $580,464, $611,533, $606,509 and $643,135 of Bonds, net of discount of approximately $201,334, $188,162, $172,417, $153,597, $158,622 and $137,108, respectively, which is being accreted as additional interest expense to maturity and results in an effective interest rate of approximately 18.0%. See Note 2 of Notes to Consolidated Financial Statements of Taj Associates. (f) Long-term debt of $720,715 had been reclassified to current maturities as of December 31, 1990. (g) Atlantic City industry data has been compiled from information filed with and published by the CCC and is unaudited. (h) Table drop represents the total dollar value of chips purchased for table games for the period indicated. (i) Table and slot revenues represent the amount of money that a casino retains (or wins) out of the total amount wagered at table games and slot machines, respectively. (j) Market share represents the total Taj Mahal gaming revenues expressed as a percentage of total Atlantic City gaming revenues. (k) Fair share is the percentage of the total number of gaming units (table games or slot machines) in the Taj Mahal to the total number of gaming units in casinos in Atlantic City. (l) Efficiency is the ratio of the Taj Mahal's market share to its fair share. (m) Slot revenue is shown on the cash basis and excludes amounts reserved for progressive jackpot accruals. CORPORATE AND FINANCIAL STRUCTURE AND ORGANIZATION The Taj Mahal is currently beneficially owned by Taj Holding and Trump. Taj Holding currently beneficially owns a 50% equity interest in Taj Associates, the partnership that directly owns and operates the Taj Mahal, through its ownership of (i) all of the outstanding capital stock of TM/GP, which owns a 49.995% equity interest in Taj Associates, and (ii) 50% of the outstanding capital stock of TTMC, which owns a .01% equity interest in Taj Associates. Trump currently beneficially owns the other 50% equity interest in Taj Associates through his ownership of (i) all of the outstanding capital stock of TTMI, which owns a 49.995% equity interest in Taj Associates, and (ii) 50% of the outstanding capital stock of TTMC. Taj Associates, the guarantor of the Bonds, wholly owns Taj Funding, the issuer of the Bonds. Upon consummation of the Merger Transaction, THCR Holdings will wholly own Taj Associates through its ownership of a 99% equity interest in Taj Holdings LLC and all of the capital stock of TTMC, which will own a 1% equity interest in Taj Holdings LLC. In connection with the Merger Transaction, THCR Holdings and THCR Funding will designate Taj Associates, Taj Funding, Taj Holdings LLC and TTMC as unrestricted subsidiaries (each, an "Unrestricted Subsidiary") under the indenture pursuant to which the Senior Notes were issued. THCR is currently the sole general partner and Trump is currently the sole limited partner of THCR Holdings. THCR has the exclusive rights, responsibilities and discretion in the management and control of THCR Holdings. THCR is a holding company with no independent operations, the principal asset of which is its general partnership interest in THCR Holdings. THCR Holdings is also a holding company with no independent operations. THCR Holdings' principal assets are its ownership interests in its subsidiaries. THCR Holdings' subsidiaries include Trump Indiana, Plaza Associates, Trump Plaza Funding, Inc. ("Plaza Funding"), Plaza Holding, Trump Plaza Holding, Inc. ("Plaza Holding Inc.") and Trump Hotels & Casino Resorts Funding, Inc. ("THCR Funding"). Plaza Associates owns and operates Trump Plaza and is the guarantor of the 10 7/8% Mortgage Notes due 2001 (the "Plaza Mortgage Notes"). Plaza Funding is the issuer of the Plaza Mortgage Notes and owns a 1% equity interest in Plaza Associates. Plaza Holding owns a 99% equity interest in Plaza Associates, and Plaza Holding Inc. owns a 1% equity interest in Plaza Holding. THCR Funding, together with THCR Holdings, are the co-obligors of the 15 1/2% Senior Secured Notes due 2005 (the "Senior Notes"). Trump Indiana has a 50% equity interest in Buffington Harbor Riverboats, LLC ("BHR"). Merger Sub, a wholly owned subsidiary of THCR, was formed for the purpose of effecting the Merger and has not conducted any other business. Taj Holdings LLC will be formed as a Delaware limited liability company prior to the consummation of the Merger Transaction for the purpose of holding the 99% equity interest in Taj Associates that it will acquire in the Merger Transaction. The remaining 1% of Taj Associates will be owned by TTMC, which will be a wholly owned subsidiary of THCR Holdings upon the consummation of the Merger Transaction, thereby giving THCR Holdings beneficial ownership of 100% of the equity of Taj Associates. TM/GP, a wholly owned subsidiary of Taj Holding, currently serves as the managing general partner of Taj Associates. To effect the Merger Transaction, the Amended and Restated Partnership Agreement of THCR Holdings (the "THCR Holdings Partnership Agreement") will be amended to allow THCR to use the proceeds from the THCR Stock Offering as discussed herein and to add TM/GP and TTMI as limited partners. An amendment of the THCR Holdings Partnership Agreement requires the approval of Trump, who will be the sole limited partner at the time of amendment, and a majority of the members of the THCR Special Committee. See "Description of the THCR Holdings Partnership Agreement." THCR, a Delaware corporation, was incorporated on March 28, 1995. Merger Sub, a Delaware corporation, was incorporated on January 5, 1996. The principal executive offices of THCR, THCR Holdings and Merger Sub are located at Mississippi Avenue and The Boardwalk, Atlantic City, New Jersey 08401, and their telephone number is (609) 441-6060. Taj Holding, a Delaware corporation, was incorporated on December 18, 1990. The principal executive offices of Taj Holding and TM/GP are located at 1000 The Boardwalk, Atlantic City, New Jersey 08401, and their telephone number is (609) 449-5540. [CHART OMITTED. GRAPHIC DEPICTS THE CURRENT OWNERSHIP STRUCTURE OF THCR AND TAJ HOLDING AND THEIR RESPECTIVE SUBSIDIARIES] OWNERSHIP STRUCTURE AFTER THE MERGER TRANSACTION [CHART OMITTED. GRAPHIC DEPICTS THE CURRENT OWNERSHIP STRUCTURE OF THCR AND ITS SUBSIDIARIES AFTER THE MERGER TRANSACTION] In deciding whether to approve the Merger Transaction or approve and adopt the Merger Agreement, as applicable, and in the case of the holders of Taj Holding Class A Common Stock, whether to elect Cash Consideration or Stock Consideration, the stockholders of THCR and Taj Holding should carefully evaluate the following risk factors and the information and financial statements provided elsewhere in this Proxy Statement-Prospectus. HIGH LEVERAGE AND FIXED CHARGES Upon consummation of the Merger Transaction, THCR and its subsidiaries will have a substantial amount of indebtedness on a consolidated basis. At September 30, 1995, after giving pro forma effect to the Merger Transaction, THCR's consolidated indebtedness for borrowed money would have totaled approximately $1.28 billion, including $155 million aggregate principal amount of Senior Notes, $330 million aggregate principal amount of Plaza Mortgage Notes, $750 million aggregate principal amount of Taj Notes (collectively, the "Notes"), and approximately $45 million of indebtedness owed by Taj Associates to National Westminster Bank U.S.A. ("NatWest") pursuant to the loan agreement, dated as of November 3, 1989 (as amended, the "NatWest Loan"). See "Special Factors--Sources and Uses of Funds in the Merger Transaction," "Business of THCR--Certain Indebtedness of THCR" and "Business of Taj Holding--Description of Certain Indebtedness." As a result of their designations as Unrestricted Subsidiaries, Taj Holdings LLC, Taj Associates, Taj Funding and TTMC will not be subject to the Senior Note Indenture, including the covenants and restrictions contained therein, and THCR Holdings and THCR Funding will not derive any benefits (for covenant purposes) from Taj Associates' operations. The Senior Note Indenture, however, would restrict THCR Holdings and THCR Funding from providing Taj Associates and Taj Funding with cash and/or credit support. Accordingly, as long as the Senior Notes (or other similar indebtedness) are outstanding, Taj Associates and Taj Funding will be required to satisfy their obligations, including the obligations under the Taj Notes and future indebtedness incurred in connection with the Taj Mahal Expansion, through cash generated by Taj Associates' operations and through permitted borrowings and refinancings. See "--Holding Company Structure; Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing." In addition, no direct or indirect partner, stockholder, employee, officer or director, as such, past, present or future, of either of Taj Associates or Taj Funding or any successor entity will have any personal liability in respect of the obligations of Taj Associates and Taj Funding under the indenture with respect to which the Taj Notes will be issued (the "Taj Mortgage Note Indenture") or the Taj Notes by reason of the status as such partner, stockholder, employee, officer or director. The Senior Note Indenture has a similar provision. Assuming that the Merger Transaction had been consummated on January 1, 1994, THCR's consolidated pro forma earnings would have been insufficient to cover fixed charges by $52.4 million for the year ended December 31, 1994 and $3.3 million for the nine months ended September 30, 1995. Assuming the Merger Transaction had been consummated on January 1, 1994, Taj Associates' pro forma earnings would have been insufficient to cover fixed charges by $17.9 million for the year ended December 31, 1994 and Taj Associates would have had a pro forma ratio of earnings to fixed charges of 1.05x for the nine months ended September 30, 1995, respectively. Interest on the Senior Notes and the Plaza Mortgage Notes is, and interest on the Taj Notes will be, payable semiannually in cash. The ability of THCR Holdings and THCR Funding, Plaza Associates (as guarantor) and Plaza Funding, Taj Associates (as guarantor) and Taj Funding to pay cash interest on the Senior Notes, the Plaza Mortgage Notes and the Taj Notes, respectively, will be dependent upon the ability of THCR and its subsidiaries (in the case of the Senior Notes and the Plaza Mortgage Notes) and Taj Associates and Taj Funding (in the case of the Taj Notes) to generate enough cash flow from operations sufficient for such purposes and will be subject to the risks associated with refinancing and repayment of indebtedness described below. See "--Holding Company Structure; Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing," "--Recent Results--Trump Plaza," and "--Recent Results--Taj Mahal." In addition, under the terms of their indebtedness, the ability of THCR Holdings and THCR Funding, Plaza Associates and Taj Associates to make distributions or other payments to holders of their equity interests is and will be severely limited. See "--Restrictions on Certain Activities." At September 30, 1995, Plaza Associates' Consolidated Net Worth (as defined in the indenture pursuant to which the Plaza Mortgage Notes were issued (the "Plaza Mortgage Note Indenture")) was approximately $83.7 million. If Plaza Associates' Consolidated Net Worth should fall below negative $25.0 million, Plaza Funding or Plaza Associates would be required to make an offer (a "Deficiency Offer") to acquire 10% of the aggregate principal amount of the Plaza Mortgage Notes, plus accrued interest to the date of purchase. There can be no assurance that Plaza Funding or Plaza Associates would have sufficient liquidity to fund a Deficiency Offer if one were required to be made. Taj Associates has a working capital facility (the "Working Capital Facility") which matures in 1999 and permits borrowings of up to $25.0 million. Obligations under the Working Capital Facility are secured to the extent of such obligations by a mortgage on the assets of Taj Associates senior to the lien of any mortgage that may secure the Taj Notes (the "Taj Note Mortgage") and any mortgage that may secure the guarantee of Taj Associates with respect to the Taj Notes. During 1994 and 1995, no amounts were borrowed under the Working Capital Facility. If Taj Associates were to draw on the entire amount of funds available to it under the Working Capital Facility, the aggregate principal amount of Taj Associates' indebtedness would be increased by an additional $25.0 million, and such additional indebtedness, together with any accrued and unpaid interest thereon, would be senior in right of payment to the Taj Notes. The substantial indebtedness and fixed charges of THCR and Taj Associates may limit their respective ability to respond to changing business and economic conditions, to fund capital expenditures for future expansion or otherwise, either through cash flow or additional indebtedness, to absorb adverse operating results or to maintain their facilities at an operating level which will continue to attract patrons. Future operating results are subject to significant business, economic, regulatory and competitive uncertainties and contingencies, many of which are outside their control. THCR and Taj Associates, as the case may be, may be required to reduce or delay planned capital expenditures, sell assets, restructure debt or raise additional equity to meet principal repayment and other obligations of it and its subsidiaries in later years. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of THCR--Liquidity and Capital Resources" and "Management's Discussion and Analysis of Financial Condition and Results of Operations of Taj Associates--Liquidity and Capital Resources." There is no assurance that any of these alternatives could be effected on satisfactory terms, if at all. See "--Holding Company Structure; Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing." Furthermore, such alternatives could impair their competitive position, reduce cash flow and have a material adverse effect on their results of operations. HOLDING COMPANY STRUCTURE; RISK IN REFINANCING AND REPAYMENT OF INDEBTEDNESS; THCR is a holding company, the principal asset of which is its general partnership interest in THCR Holdings, and has no independent means of generating revenue. As a holding company, THCR depends on distributions and other permitted payments from THCR Holdings to meet its cash needs. In addition, THCR Holdings is a holding company, the principal assets of which are the shares of capital stock and partnership interest of its subsidiaries. Dividends and distributions received with respect to equity interests in subsidiaries of THCR Holdings are the sole source of funds which are available to THCR Holdings to meet its obligations, including its obligations under the Senior Notes. The payment of dividends and distributions by subsidiaries, including by THCR Holdings, however, is significantly restricted by certain covenants contained in debt agreements and other agreements to which such subsidiaries are subject and may be restricted by other agreements entered into in the future and by applicable law. See "--Restrictions on Certain Activities" and "Description of the THCR Holdings Partnership Agreement." The ability of THCR Holdings and THCR Funding, Plaza Associates and Plaza Funding, and Taj Associates and Taj Funding to pay their respective indebtedness when due will depend upon their ability either to generate cash from operations sufficient for such purpose or to refinance such indebtedness on or before the date on which it becomes due. THCR management does not currently anticipate being able to generate sufficient cash flow from operations to repay a substantial portion of the principal amount of the Senior Notes or Plaza Mortgage Notes, and Taj Associates management does not currently anticipate being able to generate sufficient cash flow from operations to repay a substantial portion of the principal amount of the Taj Notes. Thus, the repayment of the principal amount of the Notes will likely depend primarily upon the ability to refinance the Notes when due. The future operating performance and the ability to refinance the Notes will be subject to the then prevailing economic conditions, industry conditions and numerous other financial, business and other factors, many of which are beyond the control of THCR and Taj Associates. There can be no assurance that the future operating performance of THCR Holdings and THCR Funding, Plaza Associates and Plaza Funding, and Taj Associates and Taj Funding, as the case may be, will be sufficient to meet these repayment obligations or that the general state of the economy, the status of the capital markets generally or the receptiveness of the capital markets to the gaming industry and to THCR will be conducive to refinancing the Notes or other attempts to raise capital. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of THCR--Liquidity and Capital Resources" and "Management's Discussion and Analysis of Financial Condition and Results of Operations of Taj Associates-- Liquidity and Capital Resources." The cost to THCR for the development of the Indiana Riverboat through the commencement of its operations, which includes the land, the vessel, gaming equipment, a pavilion for staging and ticketing and restaurant facilities, berthing and support facilities and parking facilities, is expected to be approximately $84 million and is expected to open early in the second quarter of 1996. THCR initially anticipated spending $59 million prior to the commencement of the Indiana Riverboat's operations for the vessel, gaming equipment and initial berthing and support facilities, and also anticipated spending an additional $27 million in the second phase to be completed by mid- 1997, which would feature a pavilion for staging and ticketing and restaurant facilities, berthing and support facilities and expanded parking. To facilitate the Indiana Riverboat's operations from the opening day and to avoid disruptive construction at the site for an additional year, THCR determined to accelerate the second phase of the project and complete both phases prior to commencing operations. THCR anticipates obtaining the additional $25 million in financing to complete the accelerated development of the Indiana Riverboat through the commencement of its operations in the form of $5 million in additional vessel financing, $10 million in mortgage financing or from an unsecured working capital facility and $10 million in operating leases. Trump Indiana is seeking commitments for this additional financing, although no commitments are currently in place. During its initial five-year license term, an additional $69 million of funds (consisting of approximately $48 million for construction of a hotel and other amenities and $21 million in infrastructure improvements and other municipal uses) will be required to be spent by Trump Indiana, which is expected to be funded with cash from operations or additional borrowings. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of THCR-- Liquidity and Capital Resources." THCR also contemplates obtaining an aggregate of approximately $17.5 million of equipment financing in connection with the acquisition of slot machines and related gaming equipment for Trump Plaza's existing facilities, Trump World's Fair and Trump Plaza East. Commitments for only a portion of this financing are currently in place. The failure of THCR to obtain all or a significant portion of the financings discussed above may have a material adverse effect on THCR. The Senior Note Indenture and the Plaza Mortgage Note Indenture impose restrictions on the activities of THCR Holdings and its subsidiaries, and on Plaza Associates and Plaza Funding, respectively. The Taj Note Indenture will impose restrictions on the activities of Taj Associates and its subsidiaries. In addition, the NatWest Loan and the Working Capital Facility impose restrictions on the activities of Taj Associates and Taj Funding. Generally, the restrictions contained in these instruments relate to the incurrence of additional indebtedness, the distribution of cash and/or property to partners, the repayment or repurchase of pari passu or junior securities, the maintenance of required net worth, investments, mergers and sales of assets and the creation of liens. These restrictions could limit the ability of THCR (including Plaza Associates and Trump Indiana), and Taj Associates, as the case may be, to respond to changing business and economic conditions. A failure to comply with any of these obligations could also result in an event of default under the Senior Note Indenture, the Plaza Mortgage Note Indenture or the Taj Note Indenture, which could permit acceleration of the Notes and acceleration of certain other indebtedness of THCR or Taj Associates under other instruments that may contain cross-acceleration or cross-default provisions. The activities of Trump are restricted by certain debt agreements under which he is personally obligated. These agreements impose restrictions on Trump and certain of his affiliates, relating to, among other things, incurrence of additional indebtedness, the creation of liens, mergers and sales of assets, investments, leases, issuance of equity interests, affiliate transactions and capital expenditures. As a result, certain transactions in which Trump may wish to engage involving his ownership interest in THCR or its affiliates may require the prior consent of such lenders. See "--Control and Involvement of Trump." Trump Plaza. Plaza Associates had net losses of $5.3 million, $29.2 million, $35.8 million (including an extraordinary loss of $38.2 million) and $8.9 million for the nine months ended September 30, 1994 and the years ended December 31, 1991, 1992, and 1994, respectively, and net income of $0.4 million (including an extraordinary loss of $9.3 million) for the nine months ended September 30, 1995 and $9.3 million for the year ended December 31, 1993 (including an extraordinary gain of $4.1 million). In 1991, Plaza Associates began to experience liquidity problems, principally due to amortization requirements of its long-term debt. On May 29, 1992, Plaza Associates and Plaza Funding completed a restructuring (the "1992 Plaza Restructuring"), the purpose of which was to improve the amortization schedule and extend the maturity of Plaza Associates' indebtedness. In June 1993, Plaza Associates, Plaza Funding and Plaza Holding completed a refinancing, the purpose of which was to enhance Plaza Associates' liquidity and to position Plaza Associates for a subsequent deleveraging transaction. See "Business of THCR--The 1992 Plaza Restructuring." THCR management believes that the deterioration in results experienced in 1990 and 1991 was attributable primarily to a recession in the Northeast and increased industry competition, primarily due to the opening of the Taj Mahal in April 1990, which had a disproportionate impact on Trump Plaza as compared to certain other Atlantic City casinos due in part to the common use of the "Trump" name. See "Business of THCR--Trump Plaza--Trump Plaza Business Strategy." Taj Mahal. Taj Associates had net losses of $31.3 million, $13.7 million, $35.1 million, $22.5 million and $36.7 million for the nine months ended September 30, 1994 and 1995 and the years ended December 31, 1992, 1993 and 1994, respectively. From the opening of the Taj Mahal in April 1990 through the spring of 1991, cash generated from Taj Associates' operations was insufficient to cover its fixed charges. As a result, Taj Associates failed to provide Taj Funding with sufficient funds to meet its debt servicing needs. During 1991, Taj Funding, Taj Associates and Taj Associates' then existing general partners (TTMI and TTMC) restructured their existing indebtedness (the "1991 Taj Restructuring"). Pursuant to the terms of the 1991 Taj Restructuring, Taj Funding's 14% First Mortgage Bonds, Series A, due 1998 (the "Old Bonds") were exchanged for the Bonds and certain modifications were made to the terms of bank borrowings and amounts owed to both Trump and his affiliates. In addition, approximately 50% of the ownership interest in Taj Associates was transferred indirectly to the holders of the Old Bonds. See "Business of Taj Holding--The 1991 Taj Restructuring." TRUMP PLAZA EXPANSION AND THE TAJ MAHAL EXPANSION Construction and Regulatory Approvals. The Trump Plaza Expansion is expected to be completed early in the second quarter of 1996 and the Taj Mahal Expansion, the plans for which are preliminary and subject to change, is expected to be completed in phases from the fourth quarter of 1996 through the second quarter of 1999. Construction projects, however, such as those contemplated by the Trump Plaza Expansion and the Taj Mahal Expansion, can entail significant development and construction risks including, but not limited to, labor disputes, shortages of material and skilled labor, weather environmental problems, geological problems, construction, demolition, excavation, zoning or equipment problems and unanticipated cost increases, any of which could give rise to delays or cost overruns. There can be no assurance that THCR and Taj Associates will receive the licenses and regulatory approvals necessary to undertake, in the case of the Taj Mahal Expansion, and to complete, in the case of each of the Trump Plaza Expansion and the Taj Mahal Expansion, their respective expansion plans, or that such licenses and regulatory approvals will be obtained within the anticipated time frames. On October 30, 1995, Plaza Associates opened 150 of the rooms and suites at Trump Plaza East. Plaza Associates intends to open the remainder of the rooms and suites and the casino at Trump Plaza East in the first quarter of 1996, although there can be no assurance that such openings will occur by such time. The Trump Plaza Expansion and the Taj Mahal Expansion will each require various licenses and regulatory approvals, including the approval of the CCC. Furthermore, the New Jersey Casino Control Act (the "Casino Control Act") requires that additional guest rooms be put in service within a specified time period after any such casino expansion. If Plaza Associates or Taj Associates completed any casino expansion and subsequently did not complete the requisite number of additional guest rooms within the specified time period, such party might have to close all or a portion of the expanded casino in order to comply with regulatory requirements, which could have a material adverse effect on the results of operations and financial condition of Plaza Associates or Taj Associates, as applicable. In addition, in order to operate the additional casino space contemplated by the Taj Mahal Expansion, Taj Associates must obtain, among other regulatory approvals, the approval of the CCC and determinations by the CCC that the Taj Mahal's additional casino space, together with its current casino space, is a "single room" under the Casino Control Act and that the operation of this additional casino space by Taj Associates will not constitute undue economic concentration of Atlantic City casino operations. Taj Associates will file a petition with the CCC seeking such declaratory rulings. See "Regulatory Matters--New Jersey Gaming Regulations--Casino Licensee" and "Regulatory Matters--New Jersey Gaming Regulations--Approved Hotel Facilities." Trump Plaza East. On June 24, 1993, Plaza Associates acquired a five-year option to purchase the fee and leasehold interests comprising Trump Plaza East (the "Trump Plaza East Purchase Option"). In October 1993, Plaza Associates assumed the leases associated with Trump Plaza East. Until such time as the Trump Plaza East Purchase Option is exercised or expires, Plaza Associates is obligated to pay the net expenses associated with Trump Plaza East. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of THCR--Liquidity and Capital Resources" and "Certain Transactions--Plaza Associates--Trump Plaza East." During the nine months ended September 30, 1995 and the year ended December 31, 1994, Plaza Associates incurred approximately $3.2 million and $4.9 million, respectively, of such expenses. Under the Trump Plaza East Purchase Option, Plaza Associates has the right to acquire the fee interest in Trump Plaza East for a purchase price of $28.0 million through December 31, 1996 increasing by $1.0 million annually thereafter until expiration on June 30, 1998. Should THCR determine to acquire Trump Plaza East, up to $30.0 million of internally generated funds and/or additional financing would be required to fund the acquisition pursuant to the existing purchase option. There can be no assurance that such financing would be available on attractive terms, if at all. In addition, the exercise of the Trump Plaza East Purchase Option may require the consent of certain of Trump's personal creditors, and there can be no assurance that such consent will be obtained at the time Plaza Associates desires to exercise the Trump Plaza East Purchase Option. The CCC has required that Plaza Associates exercise the Trump Plaza East Purchase Option no later than July 1, 1996. Plaza Associates intends to request that the CCC extend the July 1, 1996 deadline for exercising the Trump Plaza East Purchase Option, although there can be no assurance that such extension will be granted. Failure of THCR to acquire Trump Plaza East, to obtain an extension of the July 1, 1996 deadline or to obtain an extension of the existing lease of the premises beyond its current June 30, 1998 expiration date would have a material adverse effect on THCR. See "Certain Transactions--Plaza Associates-- Trump Plaza East." Plaza Associates has already begun development of Trump Plaza East. If Plaza Associates is unable to finance the purchase price of Trump Plaza East pursuant to the Trump Plaza East Purchase Option, any amounts expended with respect to Trump Plaza East, including payments under the Trump Plaza East Purchase Option and the lease pursuant to which Plaza Associates leases Trump Plaza East, and any improvements thereon, would inure to the benefit of the owner of Trump Plaza East and not to Plaza Associates and would increase the cost of demolition of any improvements for which Plaza Associates would be liable. As of September 30, 1995, Plaza Associates had capitalized approximately $9.3 million in construction costs related to Trump Plaza East. If the development of Trump Plaza East is not successful, THCR would be required to write off the capitalized construction costs associated with the project. In September 1993, Trump (as predecessor in interest to Plaza Associates under the lease for Trump Plaza East) entered into a sublease (the "Time Warner Sublease") with Time Warner pursuant to which Time Warner subleased the entire first floor of retail space at Trump Plaza East for a Warner Brothers Studio Store which opened in July 1994. Rent under the Time Warner Sublease is currently accruing and will not become due and payable to Plaza Associates until the satisfaction of certain conditions designed to protect Time Warner from the termination of the Time Warner Sublease by reason of the termination of Plaza Associates' leasehold estate in Trump Plaza East or the foreclosure of a certain mortgage and until Time Warner's unamortized construction costs are less than accrued rent. No assurances can be made that such conditions will be satisfied. In addition, Time Warner may terminate the Time Warner Sublease at any time beginning two years after the commencement date in the event that gross sales for the store do not meet certain threshold amounts or at any time if Plaza Associates fails to operate a first class hotel on Trump Plaza East. No assurances can be made that Trump Plaza East will continually be operated as a first class hotel or that sales for the Warner Brothers Studio Store will exceed the threshold amounts. See "Certain Transactions-- Plaza Associates--Trump Plaza East." Trump World's Fair. The ongoing renovation of Trump World's Fair is currently expected to be completed early in the second quarter of 1996, although there can be no assurance that the project will be completed by such time. Upon the completion of such renovation, THCR intends to operate Trump World's Fair as a casino hotel. In order to operate the casino space in Trump World's Fair, Plaza Associates must obtain all necessary regulatory approvals, including approval of the CCC, which approval cannot be assured. Plaza Associates has applied for a separate casino license with respect to Trump World's Fair. The CCC was required to determine that the operation of the casino by Plaza Associates will not result in undue economic concentration in Atlantic City. On May 18, 1995, the CCC ruled that the operation of Trump World's Fair by Plaza Associates will not result in undue economic concentration. Although this determination is a required condition precedent to the CCC's ultimate issuance of a casino license for Trump World's Fair, and management believes that a casino license will ultimately be issued for Trump World's Fair, there can be no assurance that the CCC will issue this casino license or what conditions may be imposed, if any, with respect thereto. See "Regulatory Matters--New Jersey Gaming Regulations--Casino Licensee" and "Regulatory Matters--New Jersey Gaming Regulations--Approved Hotel Facilities." Although construction at Trump World's Fair has commenced, if the costs of developing, constructing, equipping and opening Trump World's Fair exceed the proceeds allocated from the June 1995 Offerings (as defined) for such expenditures, Plaza Associates may be forced to rely on alternative methods of financing, which could impair the competitive position of the Trump Plaza and reduce Plaza Associates' cash flow. See "--High Leverage and Fixed Charges," "--Holding Company Structure; Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing" and "--Restrictions on Certain Activities." The Taj Mahal. It is expected that the Taj Mahal Expansion will be funded out of the Taj Mahal's cash from operations and borrowings. It is contemplated that the Taj Note Indenture will permit the incurrence by Taj Associates of up to $ million of additional indebtedness to finance the Taj Mahal Expansion, subject to certain restrictions and conditions. No commitments are currently in place with respect to financing any of the Taj Mahal Expansion. If the operations of the Taj Mahal do not generate the anticipated cash flow to fund the Taj Mahal Expansion, the ability to complete such expansion will depend on the ability of Taj Associates to obtain financing for such purposes in addition to that currently contemplated. There can be no assurance that Taj Holding will be able to generate sufficient cash flow from operations or to obtain financing on terms satisfactory to Taj Holding, if at all. In addition, any indebtedness incurred in connection with the Taj Mahal Expansion in addition to the $ million to be permitted to be incurred under the Taj Note Indenture would be subject to the limitations set forth in the Taj Note Indenture. See "--High Leverage and Fixed Charges," "--Holding Company Structure; Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing," "--Restrictions on Certain Activities" and "Business of Taj Holding--Business Strategy--The Taj Mahal Expansion." New Venture Risk. The Indiana Riverboat is a start-up development. Trump Indiana's operations are subject to all of the many risks inherent in the establishment of a new business enterprise, including unanticipated construction, permitting, licensing or operating problems with the riverboat and land-based, berthing and support facilities, as well as the ability of THCR to market and operate a new venture in a new gaming jurisdiction. Although construction has begun on the Indiana Riverboat, there can be no assurance that the Indiana Riverboat will become operational or that such project will be completed on budget or on schedule. Furthermore, construction projects, such as the Indiana Riverboat, entail significant risks. See "-- Considerations with Respect to the Acquisition or Development of Additional Gaming Ventures." Northern Indiana is a new gaming market. The success of gaming in a market which has never supported gaming operations cannot be guaranteed or accurately predicted. The number of patrons of a riverboat casino in a new gaming jurisdiction like northern Indiana and the propensity of these patrons to wager cannot be predicted with any degree of certainty and there can be no assurance that THCR will be able to operate the Indiana Riverboat in a profitable manner. While THCR and its management have substantial experience in operating gaming properties in New Jersey, THCR has never been involved in constructing or operating riverboat casinos, and there is no operating history with respect to THCR's proposed operation at Buffington Harbor, Indiana. THCR's future operating results at Buffington Harbor will depend upon THCR's ability to complete and open gaming facilities on schedule and several other factors over which THCR will have little or no control, including, without limitation, general economic conditions, gaming taxes, the availability of ancillary facilities to support gaming visitors, competition, the availability of adequately trained gaming employees and the ability to obtain and maintain the necessary licenses and permits. There can be no assurance that THCR's operations will prove successful or that THCR will be able to generate sufficient revenues from such operations or attain and maintain profitable operations. In addition, THCR is unable to predict whether seasonality will have a material effect on the operations of the Indiana Riverboat. Trump Indiana and Barden-Davis Casinos, LLC ("Barden"), an entity beneficially owned by Don H. Barden, a developer based in Detroit without significant gaming experience, are the two holders of certificates of suitability for Buffington Harbor. Trump Indiana and Barden have entered into an agreement (the "BHR Agreement") relating to the joint ownership, development and operation of all common land-based and waterside operations in support of each of Trump Indiana's and Barden's separate riverboat casinos at Buffington Harbor. Trump Indiana and Barden will each be equally responsible for the development and operating expenses at such site and THCR will be dependent on the ability of Barden to pay for its share of all future expenses. There can be no assurance that THCR or Trump Indiana will be able to fund from operations or to finance on terms satisfactory to THCR or Trump Indiana any such required expenditures or, if available, such other indebtedness would be permitted under existing debt instruments of THCR. Furthermore, there can be no assurance that Barden will be able to fund its portion of such expenses. Additionally, if either Trump Indiana or Barden causes, permits or suffers an event of default under the BHR Agreement to continue for more than 270 days, including the failure to make a capital contribution or to fulfill any other obligation thereunder within 30 days after written notice, the nondefaulting party will have the right to acquire the defaulting party's interest in BHR for a purchase price of $1,000,000. THCR has capitalized and will continue to capitalize certain costs associated with the expansion of its gaming operations in Indiana and other jurisdictions. As of September 30, 1995, THCR and its predecessors had capitalized approximately $23.7 million in development and pre-opening costs solely in connection with the Indiana Riverboat operation. THCR's policy is to capitalize pre-opening costs, such as site identification and evaluation, salaries and overhead and marketing, in addition to construction costs, based primarily on its experience with new project developments. If the development of the Indiana Riverboat or any other pending or future new venture is not successful, THCR will be required to write off the capitalized costs. In addition, THCR anticipates obtaining additional financing prior to the opening of the Indiana Riverboat early in the second quarter of 1996, although no commitments are currently in place. See "Risk Factors--Holding Company Structure; Risk in Refinancing and Repayment of Indebtedness; Need for Additional Refinancing." Environmental Risks. The Indiana Riverboat is located in an area on Lake Michigan known as Buffington Harbor. Buffington Harbor had been the site of industrial operations, which prior operations or activities have or may have resulted in pollution or contamination of the environment. As the owner and operator of the Indiana Riverboat, Trump Indiana and THCR could be held liable under certain legal theories for the costs of cleaning up, as well as certain damages resulting from, past or present spills, disposals or other releases of hazardous or toxic substances or wastes on, in or from the site, regardless of whether either party knew of, or was responsible for, the presence of such substances or wastes at the site. Neither THCR nor Trump Indiana has a source of indemnity for any such liability. However, THCR believes, based on third- party engineering reports, that the costs of any remedial activities would not be significant. Maritime and Weather Considerations. Under the provisions of Title 46 of the United States Code, the design, construction and operation of the Indiana Riverboat are subject to regulation and approval by the U.S. Coast Guard. Prior to the commencement of operations, a Certificate of Inspection and a Certificate of Documentation must be obtained from the U.S. Coast Guard. As a condition of the issuance of a Certificate of Inspection, the U.S. Coast Guard may, among other things, require changes in the design or construction of the Indiana Riverboat that may materially increase the cost of construction and/or materially delay the completion of construction and the commencement of operations. All shipboard employees of Trump Indiana employed on U.S. Coast Guard regulated vessels, including those not involved with the actual operation of the vessel, such as dealers, cocktail hostesses and security personnel, may be subject to certain federal legislation relating to maritime activity, which, among other things, exempts those employees from state limits on workers' compensation awards. THCR expects that it will have adequate insurance to cover employee claims. The Indiana Riverboat is anticipated to be a cruising riverboat on Lake Michigan, which, among other things, would require a U.S. Coast Guard hull inspection at five-year intervals. Operating on Lake Michigan will expose the Indiana Riverboat to marine hazards such as unpredictable currents, floods or other severe weather conditions and a heavy volume of maritime traffic. THCR anticipates that adequate maritime insurance coverage will be obtained for the Indiana Riverboat; however, the occurrence of a catastrophic loss in excess of coverage would have a material adverse effect on THCR. Trump Indiana's revenues will be derived from its riverboat and land-based facilities. A riverboat could be lost from service due to casualty, mechanical failure or extended or extraordinary maintenance or inspection. The loss of a vessel from service for an extended period of time could adversely affect Trump Indiana's operations. Business activity at any location could also be adversely affected by a flood or other severe weather conditions. Flooding in particular, as well as other severe weather conditions, could make THCR's vessel more difficult or impossible to board, or even result in a prolonged or total loss of a gaming vessel, either of which could have a material adverse effect on THCR. Although THCR expects to maintain insurance against casualty losses resulting from severe weather, the insurance coverage maintained may not adequately compensate THCR for losses, including loss of profits, resulting from severe weather. Competition in the Atlantic City casino hotel market is intense. Trump Plaza and the Taj Mahal compete with each other and with the other casino hotels located in Atlantic City, including the other casino hotel owned by Trump, Trump's Castle Casino Resort ("Trump's Castle"). See "--Conflicts of the Taj Mahal are located on The Boardwalk, approximately 1.2 miles apart from each other. At present, there are 12 casino hotels located in Atlantic City, including the Taj Mahal and Trump Plaza, all of which compete for patrons. In addition, there are several sites on The Boardwalk and in the Atlantic City Marina area on which casino hotels could be built in the future and various applications for casino licenses have been filed and announcements with respect thereto made from time to time (including a proposal by Mirage Resorts, Inc.), although neither THCR nor Taj Holding are aware of any current construction on such sites by third parties. No new casino hotels have commenced operations in Atlantic City since 1990, although several existing casino hotels have recently expanded or are in the process of expanding their operations. While management of THCR and Taj Holding believe that the addition of hotel capacity would be beneficial to the Atlantic City market generally, there can be no assurance that such expansion would not be materially disadvantageous to either Trump Plaza or the Taj Mahal. There also can be no assurance that the Atlantic City development projects which are planned or underway will be completed. Total Atlantic City gaming revenues have increased over the past three years, although at varying rates. Although all 12 Atlantic City casinos reported increases in gaming revenues in 1992 as compared to 1991, THCR and Taj Holding believe that this was due, in part, to the depressed industry conditions in 1991. In 1993, nine casinos experienced increased gaming revenues compared to 1992 (including the Taj Mahal), while three casinos (including Trump Plaza) experienced decreased revenues. In 1994, ten casinos experienced increased gaming revenues compared to 1993 (including the Taj Mahal), while two casinos (including Trump Plaza) experienced decreased revenues. During the first nine months of 1995, all 12 casinos experienced increased gaming revenues compared to the first nine months of 1994. In 1990, the Atlantic City casino industry experienced a significant increase in room capacity and in available casino floor space, including the rooms and floor space made available by the opening of the Taj Mahal. The effects of such expansion were to increase competition and to contribute to a decline in 1990 in gaming revenues per square foot. In 1990, the Atlantic City casino industry experienced a decline in gaming revenues per square foot of 5.0%, which trend continued in 1991, although at the reduced rate of 2.9%. In 1992, however, the Atlantic City casino industry experienced an increase of 6.9% in gaming revenues per square foot from 1991. Gaming revenues per square foot increased by 1.4% for 1993 (excluding poker and race simulcast rooms, which were introduced for the first time in such year), compared to 1992. In 1994, gaming revenues per square foot decreased 2.5% (or 4.5%, including square footage devoted to poker, keno and race simulcasting). The 1994 decline was due, in part, to the increase in casino floor space in Atlantic City as a result of expansion of a number of casinos and to the severe weather conditions which affected the Northeast during the winter of 1994. Between April 30, 1993 and September 30, 1995, many operators in Atlantic City expanded their facilities in connection with the June 1993 legalization of simulcasting and poker, increasing total casino square footage by approximately 183,000 square feet (23.6%) of which, approximately 73,000 square feet, is currently devoted to poker, keno and race simulcasting. During this same period, 176 poker tables and 5,967 slot machines were added. See "Atlantic City Market." Trump Plaza and the Taj Mahal also compete, or will compete, with facilities in the northeastern and mid- Atlantic regions of the United States at which casino gaming or other forms of wagering are currently, or in the future may be, authorized. To a lesser extent, Trump Plaza and the Taj Mahal face competition from gaming facilities nationwide, including land-based, cruise line, riverboat and dockside casinos located in Colorado, Illinois, Indiana, Iowa, Louisiana, Minnesota, Mississippi, Missouri, Nevada, South Dakota, Ontario (Windsor), the Bahamas, Puerto Rico and other locations inside and outside the United States, and from other forms of legalized gaming in New Jersey and in its surrounding states such as lotteries, horse racing (including off-track betting), jai alai, bingo and dog racing, and from illegal wagering of various types. New or expanded operations by other persons can be expected to increase competition and could result in the saturation of certain gaming markets. In September 1995, New York introduced a keno lottery game, which is played on video terminals that have been set up in approximately 1,800 bars, restaurants and bowling alleys across the state. In addition to competing with other casino hotels in Atlantic City and elsewhere, by virtue of their proximity to each other and the common aspects of certain of their respective marketing efforts, including use of the "Trump" name, Plaza and the Taj Mahal compete directly with each other for gaming patrons. Although management does not intend to operate Trump Plaza and the Taj Mahal to the competitive detriment of each other, the effect may be that Trump Plaza and the Taj Mahal will operate to the competitive detriment of each other. THCR anticipates that the Indiana Riverboat will compete primarily with riverboats and other casinos in the northern Indiana suburban and Chicago metropolitan area and throughout portions of the states of Indiana, Illinois, Michigan, Ohio and Wisconsin (the "Great Lakes Market"). In addition to competing with Barden's riverboat at the shared Buffington Harbor site, the Indiana Riverboat will compete with a riverboat in Hammond, Indiana, which is being developed by the owner and operator of the Empress Riverboat Casino in Joliet, Illinois, a riverboat in East Chicago, Indiana, which is being developed by Showboat, Inc. and with the riverboat expected to be licensed in the nearby community of Michigan City, Indiana. To a lesser degree, the Indiana Riverboat will compete with the six additional riverboats expected to be licensed in the rest of Indiana. At present there are four other riverboat casino operations in the Chicago area (three of which operate two riverboats each, with each operator limited to 1,200 gaming positions in the aggregate). In addition, a casino opened during 1994 in Windsor, Ontario, across the river from Detroit, and Detroit is considering several proposals for casinos in its downtown area. Although THCR believes that there is sufficient demand in the market to sustain the Indiana Riverboat, there can be no assurance to that effect. There can be no assurance that either Indiana or Illinois, or both, will not authorize additional gaming licenses, including for the Chicago metropolitan area. See "--The Indiana Riverboat." In addition, Trump Plaza and the Taj Mahal face, and the Indiana Riverboat will face, competition from casino facilities in a number of states operated by federally recognized Native American tribes. Pursuant to the Indian Gaming Regulatory Act ("IGRA"), which was passed by Congress in 1988, any state which permits casino style gaming (even if only for limited charity purposes) is required to negotiate gaming compacts with federally recognized Native American tribes. Under IGRA, Native American tribes enjoy comparative freedom from regulation and taxation of gaming operations, which provides them with an advantage over their competitors, including Trump Plaza, the Taj Mahal and the Indiana Riverboat. See "Competition." Legislation permitting other forms of casino gaming has been proposed, from time to time, in various states, including those bordering New Jersey. Plans to begin operating slot machines at race tracks in the State of Delaware are underway, including the slot machines currently operating at the Dover Downs and Delaware Park race tracks. Six states have presently legalized riverboat gambling while others are considering its approval, including New York and Pennsylvania, and New York City is considering a plan under which it would be the embarking point for gambling cruises into international waters three miles offshore. Several states are considering or have approved large scale land- based casinos. Additionally, Las Vegas experienced significant expansion in 1993 and 1994, with additional capacity planned and currently under construction. The operations of Trump Plaza and the Taj Mahal could be adversely affected by such competition, particularly if casino gaming were permitted in jurisdictions near or elsewhere in New Jersey or in other states in the Northeast. In December 1993, the Rhode Island Lottery Commission approved the addition of slot machine games on video terminals at Lincoln Greyhound Park and Newport Jai Alai, where poker and blackjack have been offered for over two years. Currently, casino gaming, other than Native American gaming, is not allowed in other areas of New Jersey or in Connecticut, New York or Pennsylvania. On November 17, 1995, a proposal to allow casino gaming in Bridgeport, Connecticut, was voted down by that state's senate. A New York State Assembly plan has the potential of legalizing non- Native American gaming in portions of upstate New York. Essential to this plan is a proposed New York State constitutional amendment that would legalize gambling. To amend the New York Constitution, the next elected New York State Legislature must repass a proposal legalizing gaming and a statewide referendum, held no sooner than November 1997, must approve the constitutional amendment. To the extent that legalized gaming becomes more prevalent in New Jersey or other jurisdictions near Atlantic City, competition would intensify. In particular, in the past, proposals have been introduced to legalize gaming in other locations, including Philadelphia. In addition, legislation has from time to time been introduced in the New Jersey State Legislature relating to types of statewide legalized gaming, such as video games with small wagers. To date, no such legislation, which may require a state constitutional amendment, has been enacted. Legislation has also been introduced on numerous occasions in recent years to expand riverboat gaming in Illinois, including by authorizing new sites in the Chicago area with which the Indiana Riverboat would compete and by otherwise modifying existing regulations to decrease or eliminate certain restrictions such as gaming position limitations. To date, no such legislation has been enacted. THCR and Taj Holding are unable to predict whether any such legislation, in New Jersey, Illinois or elsewhere, will be enacted or whether, if passed, it would have a material adverse impact on their respective results of operations or financial condition. THCR believes that competition in the gaming industry, particularly the riverboat and dockside gaming industry, is based on the quality and location of gaming facilities, the effectiveness of marketing efforts, and customer service and satisfaction. Although management of THCR believes that the location of the Indiana Riverboat will allow THCR to compete effectively with other casinos in the geographic area surrounding its casino, THCR expects competition in the casino gaming industry to be intense as more casinos are opened and new entrants into the gaming industry become operational. Furthermore, new or expanded operations by other persons can be expected to increase competition for existing and future operations and could result in a saturation of certain gaming markets. Trump is currently the beneficial owner of 100% of Trump's Castle, which competes directly with the Taj Mahal and Trump Plaza, and Trump could, under certain circumstances, have an incentive to operate Trump's Castle to the competitive detriment of the Taj Mahal and Trump Plaza. Trump has certain interests in the Merger Transaction that may be deemed to differ from stockholders generally. See "--Interests of Certain Members of the Board of Directors of THCR and Taj Holding" and "Special Factors--Interests of Certain Persons in the Merger Transaction." Trump and TC/GP, Inc. ("TC/GP"), a corporation beneficially owned by Trump, have entered into a services agreement (the "Trump's Castle Services Agreement") with Trump's Castle Associates ("TCA"), the partnership that owns and operates Trump's Castle, pursuant to which TC/GP has agreed to provide marketing, advertising and promotional and other similar and related services to Trump's Castle. Pursuant to the Trump's Castle Services Agreement, in respect of any matter or matters involving employees, contractors, entertainers, celebrities, vendors, patrons, marketing programs, promotions, special events, or otherwise, Trump will, and will cause his affiliates to the best of his ability and consistent with his fiduciary obligations to TCA, Trump Plaza and the Taj Mahal to, act fairly and in a commercially reasonable manner so that on an annual overall basis (x) neither Trump Plaza nor the Taj Mahal shall realize a competitive advantage over Trump's Castle, by reason of any activity, transaction or action engaged in by Trump or his affiliates and (y) Trump's Castle shall not be discriminated against. Trump serves as the Chairman of the Board of THCR pursuant to an Executive Agreement entered into by Trump, THCR and THCR Holdings (the "Trump Executive Agreement"). Pursuant to the terms of the Trump Executive Agreement, Trump provides to THCR, from time to time, when reasonably requested, marketing, advertising, promotional and other similar and related services with respect to the operation and business of THCR. The Trump Executive Agreement continues in effect (i) for an initial term of five years, and (ii) thereafter, for a three-year rolling term until either Trump or THCR provides notice to the other of its election not to continue extending the term, in which case the term of the Trump Executive Agreement will end three years from the date such notice is given. The Trump Executive Agreement also provides that Trump may devote time and effort to the Taj Mahal and Trump's Castle and, subject to the terms of a Contribution Agreement, dated as of June 12, 1995, by and between Trump and THCR Holdings (the "Contribution Agreement"), to other business matters, and that the Trump Executive Agreement will not be construed to restrict Trump from operating the Taj Mahal and Trump's Castle in a commercially reasonable manner and/or having an interest therein or conducting any other activity not prohibited under the Contribution Agreement. See "Management of THCR--Employment Agreements" and "Description of the THCR Holdings Partnership Agreement." Pursuant to the terms of a services agreement (the "TPM Services Agreement") between Plaza Associates and Trump Plaza Management Corp., a corporation beneficially owned by Trump ("TPM"), TPM provides certain advisory services to Plaza Associates. See "Certain Transactions." Trump is subject to certain loan agreements which contain covenants that relate to his equity interests in THCR and Taj Associates. See "--Control and Involvement of Trump." In connection with the Merger Transaction, Trump is seeking to obtain from his personal creditors, among other things, releases of liens on his direct and indirect equity interests in Taj Associates, which releases are required to consummate the Merger Transaction. See "Special Factors--Related Merger Transactions" and "Business of Taj Holding--Certain Indebtedness." Nicholas L. Ribis, the Chief Executive Officer of THCR and Taj Associates, is also the Chief Executive Officer of TCA, the partnership that owns and operates Trump's Castle. Messrs. Robert M. Pickus and John P. Burke, officers of THCR, are each executive officers of TCA and Taj Associates. Mr. Burke is an officer of TM/GP. In addition, Messrs. Trump, Ribis and Burke serve on one or more of the governing bodies of THCR, Taj Holding, TCA and their affiliated entities. Mr. Pickus serves on one or more of the governing bodies of Taj Holding and TCA. As a result of Trump's interests in three competing Atlantic City casino hotels, the common chief executive officer and other common officers, a conflict of interest may be deemed to exist, including by reason of such persons' access to information and business opportunities possibly useful to any or all of such casino hotels. Furthermore, Trump has agreed that he will pursue, develop, control and conduct all new gaming activities through THCR. Although no specific procedures have been devised for resolving conflicts of interest confronting, or which may confront, Trump, such persons and all the casinos affiliated with Trump, Messrs. Trump, Ribis, Pickus and Burke have informed THCR and Taj Holding that they will not engage in any activity which they reasonably expect will harm THCR, Taj Holding or their respective affiliates or is otherwise inconsistent with their obligations as officers and directors of THCR, Taj Holding or their affiliates. See "Certain Transactions." CONTROL AND INVOLVEMENT OF TRUMP Upon consummation of the Merger Transaction, through his beneficial ownership of the THCR Class B Common Stock, Trump will control approximately % of the total voting power of THCR (assuming a price of $ per share of THCR Common Stock as Market Value in connection with the Merger and as the public offering price in the THCR Stock Offering). THCR believes that the involvement of Trump in the affairs of THCR is an important factor that will affect the prospects of THCR. Following the Merger Transaction, Trump will continue to pursue, develop, control and conduct all of his gaming business (except for Trump's Castle) through THCR. See "--Conflicts of Interest." Although Trump has no obligation to contribute funds to THCR or THCR Holdings and is not providing any personal guarantees in connection with the Merger Transaction, THCR management believes that Trump's financial condition and general business success together with the public's perception of such success may be relevant to the success of THCR due, in part, to the marquee value of the "Trump" name. Trump is engaged, through various enterprises, in a wide range of business activities. During 1989, 1990, 1991 and 1992, certain of Trump's businesses, including businesses for which Trump supplied personal guarantees, experienced financial difficulties that necessitated a comprehensive financial restructuring of certain of his properties and holdings, including Trump's interests in Trump Plaza, Trump's Castle and the Taj Mahal, and his personal indebtedness. See "Management of THCR" and "Management of Taj Holding." Since 1990, Trump has engaged in a series of transactions designed to reduce his personal indebtedness. However, Trump will continue to have a substantial amount of personal indebtedness following the Merger Transaction, most of which has a scheduled maturity in 1998. Bankers Trust, an affiliate of BT Securities Corporation ("BT Securities"), which has rendered financial advisory services to THCR and Taj Holding in the past, is a significant creditor of Trump and will be receiving a payment of $10 million in connection with the Merger Transaction in order to release certain liens and guarantees. See "Special Factors--Related Merger Transactions" and "Business of Taj Holding--Certain Indebtedness--TTMI Note." Trump will have ongoing requirements to make payments of principal and interest on his outstanding indebtedness following the consummation of the Merger Transaction. In addition, the agreements with respect to Trump's indebtedness generally contain comprehensive covenants and events of default which relate to the operations of certain of his affiliates. If such covenants are breached or if events of default otherwise occur, either of which could occur at any time, such indebtedness could be subject to acceleration by the applicable lenders. Any such acceleration could have a material adverse effect on Trump and could trigger an obligation to make a repurchase offer with respect to certain of the Notes by the issuers thereof. Furthermore, a substantial portion of Trump's assets consist of real property or interests in regulated enterprises, which may affect the liquidity of such assets. Trump has advised THCR and Taj Holding that he is actively pursuing all reasonable means of providing for the repayment or rescheduling of such indebtedness. There can be no assurance that Trump will be successful in repaying or rescheduling his indebtedness or that his assets will appreciate sufficiently to provide a source of repayment for such indebtedness. Trump's ability to repay his indebtedness is subject to significant business, economic, regulatory and competitive uncertainties, many of which are beyond his control. Any failure by Trump to repay or reschedule his indebtedness or to otherwise maintain financial stability may have a material adverse effect on THCR and, under such circumstances, could adversely affect the ability to provide for the payment of interest or principal on the Notes, or to refinance the Notes on the respective maturities thereof. Moreover, if the CCC at any time finds Trump to be financially unstable under the Casino Control Act, the CCC is authorized to take any necessary public action to protect the public interest, including the suspension or revocation of the casino licenses of Plaza Associates and/or Taj Associates. Any jurisdiction in which THCR may seek to conduct gaming operations would likely have similar regulations. See "--Strict Regulation by Gaming Authorities" and "Regulatory Matters." In order to consummate the Merger Transaction, Trump will need to obtain certain consents and waivers from his creditors, which creditors have a security interest in his financial interest in Taj Associates. The prior consent of such creditors is a condition to consummation of the Merger Transaction. The THCR Certificate of Incorporation and THCR By-Laws contain provisions which may have the effect of delaying, deferring or preventing a change in control of THCR. In addition, the Senior Note Indenture and the Plaza Mortgage Note Indenture contain, and the Taj Note Indenture will contain, provisions relating to certain changes of control of THCR and THCR Holdings, Plaza Associates and Taj Associates, respectively. Upon the occurrence of such a change of control, the respective issuer would be obligated to make an offer to purchase all of the respective Notes then outstanding at a purchase price equal to 101% of the principal amount thereof plus accrued and unpaid interest. There can be no assurance that funds necessary to effect such a purchase would be available if such an event were to occur. To the extent required under the Plaza Mortgage Note Indenture, Trump will retain the right to control the management of Plaza Associates for as long as Trump continues to own beneficially 20% or more of the voting power of THCR and no other holder beneficially owns a greater percentage of such voting power. See "Description of the THCR Holdings Partnership Agreement." Because of the control of Trump as described above, the value of the THCR Common Stock may be less than it would otherwise be absent such control. The ability of THCR and Taj Associates to operate successfully is dependent, in part, upon the continued services of certain of its employees, including Nicholas L. Ribis, the President, Chief Executive Officer and Chief Financial Officer of THCR, the Chief Executive Officer of THCR Holdings and the Chief Executive Officer of Taj Associates. Mr. Ribis' employment agreements with THCR and THCR Holdings on the one hand and Taj Associates on the other will expire on June 7, 2000 and September 25, 1996, respectively (subject to earlier termination upon the occurrence of certain events). There can be no assurance that a suitable replacement for Mr. Ribis could be found in the event of a termination of his employment. A shortage of skilled management- level employees currently exists in the gaming industry which may make it difficult and expensive to attract and retain qualified employees. In addition, Mr. Ribis and certain other executives of THCR and Taj Holding currently allocate their time among THCR's and Taj Holding's various operations as well as certain other enterprises owned by Trump. Following the consummation of the Merger Transaction, Mr. Ribis will devote approximately 75% of his professional time to the affairs of THCR. See "Management of THCR" and "Management of Taj Holding." STRICT REGULATION BY GAMING AUTHORITIES The ownership and operation of the gaming related businesses of Plaza Associates and Taj Associates are subject to strict state regulation under the Casino Control Act. Plaza Associates and Taj Associates and their various officers and other qualifiers have received the licenses, permits and authorizations required to operate Trump Plaza and the Taj Mahal, respectively. Failure to maintain or obtain the requisite casino licenses would have a material adverse effect on THCR and Taj Holding. On June 22, 1995, the CCC renewed Taj Associates' casino license through March 31, 1999 and renewed Plaza Associates' casino license through June 30, 1999. No assurance can be given as to the term for which the CCC will renew these licenses or as to what license conditions, if any, may be imposed by the CCC in connection with any future renewals. The Merger Transaction is subject to approval by the CCC. See "Regulatory Matters--New Jersey Gaming Regulation." In January 1996, the Indiana Gaming Commission (the "IGC") extended Trump Indiana's certificate of suitability constituting approval of the application for a riverboat owner's license for a riverboat to be docked at Buffington Harbor, on Lake Michigan in Indiana. The certificate of suitability is valid until June 28, 1996, and may be further extended upon written application to and approval of the IGC. A riverboat owner's license will only be issued upon satisfaction of the conditions of the certificate of suitability and the requirements of the gaming laws, which include completion of the Indiana Riverboat, acquisition of necessary permits or approvals from federal, state and local authorities and readiness to commence operations. Pursuant to the terms of the certificate of suitability, Trump Indiana must comply with certain other requirements imposed by the IGC, including a requirement that Trump Indiana invest an aggregate of $153 million in the Indiana Riverboat and certain related projects and certain economic development projects and pay certain incentive fees based on percentages of gaming revenues and earnings to the City of Gary, Indiana. Failure to comply with the foregoing conditions and/or failure to commence riverboat excursions as may be required by the IGC may result in the expiration of the certificate of suitability. There can be no assurance that THCR and/or Trump Indiana will be able to comply with the terms of the certificate of suitability, that it will be further extended if operations do not commence by June 28, 1996 or that a riverboat owner's license for the Indiana Riverboat will ultimately be granted. Further, the IGC may place restrictions, conditions or requirements on the permanent riverboat owner's license. If granted, such license would be for an initial term of five years and renewable annually thereafter. With respect to certain land-based, berthing and support facilities as currently planned, Trump Indiana would also be dependent on the ability of Barden to obtain the requisite licenses and fund its portion of joint development and operating costs. In October 1994, the U.S. Attorney General's Office in Indiana notified the IGC that a federal law passed in 1951, commonly known as the Johnson Act, prohibits gaming vessels from cruising anywhere on the Great Lakes, including portions of Lake Michigan falling within Indiana's borders and jurisdiction. The IGC has requested further consideration on this matter by the Department of Justice. Recently adopted state legislation and pending Federal legislation may also affect the foregoing. See "Regulatory Matters--Indiana Gaming Regulations--Excursions." Any jurisdiction in which THCR may seek to conduct gaming operations would be likely to require THCR to apply for and obtain regulatory approvals with respect to the construction, design and operational features of the gaming facilities it intends to operate in that jurisdiction. The obtaining of such licenses and approvals may be time consuming and expensive and cannot be assured. THCR believes that the availability of significant additional revenue through taxation is one of the primary reasons that Indiana and other jurisdictions have legalized gaming. THCR's current gaming operations are, and any future gaming operations are likely to be, subject to significant taxes and fees in addition to normal federal and state corporate income taxes, and such taxes and fees are subject to increase at any time. Any material increase in these taxes or fees would adversely affect THCR. The Casino Control Act imposes substantial restrictions on the ownership of securities of THCR and Taj Holding. A shareholder may be required to meet the qualification provisions of the Casino Control Act relating to financial sources and/or security holders. Each institutional investor (as defined in the Casino Control Act) seeking a waiver of qualification must execute a certification which will be provide, to the New Jersey Division of Gaming Enforcement and the CCC. Pursuant to the provisions of the Casino Control Act, the THCR Certificate of Incorporation provides that all securities of THCR are held subject to the condition that, if a holder thereof is found to be disqualified by the CCC pursuant to the provisions of the Casino Control Act, such holder shall (a) dispose of his interest in THCR; (b) not receive any dividends or interest upon any such securities; (c) not exercise, directly or through any trustee or nominee, any right conferred by such securities; and (d) not receive any remuneration in any form from the casino licensee for services rendered or otherwise. See "Regulatory Matters--New Jersey Gaming Regulations." Pursuant to IGC proposed rules, any person acquiring 5% or more of THCR Common Stock (or for certain institutional investors, a greater percentage) must be found suitable by the IGC. The IGC has the authority to require a finding of suitability with respect to any stockholder regardless of the percentage of ownership. In this regard, the THCR Certificate of Incorporation provides that THCR may redeem any shares of THCR's capital stock held by any person or entity whose holding of shares may cause the loss or non- reinstatement of a governmental license held by THCR. Such redemption shall be at the lesser of the price at which the stock was purchased or the market price (as defined in the THCR Certificate of Incorporation). See "Regulatory Matters--Indiana Gaming Regulations--Indiana Gaming Commission." CONSIDERATIONS WITH RESPECT TO THE ACQUISITION OR DEVELOPMENT OF ADDITIONAL THCR's growth strategy includes the acquisition, development, ownership and/or management of dockside, riverboat and/or land-based casinos in emerging and established gaming jurisdictions. THCR's plans for development and acquisition of gaming ventures in addition to Trump Plaza, the Indiana Riverboat and the Taj Mahal are speculative at this time, as THCR has no present plans to acquire or develop any other specific gaming venture other than the Taj Mahal. The availability of new gaming opportunities is largely dependent on the legality of gaming in various states, and gaming is currently prohibited throughout most of the United States. Moreover, the recent expansion of the legalization of gaming may not continue. Legislation relating to gaming has been introduced and failed to pass in the legislatures in a number of states, including Connecticut and Florida. For these and other reasons, no assurance can be given that attractive opportunities to develop new operations will be available to THCR or that THCR will be able to take advantage of any opportunity that does arise. To engage in multiple projects or larger scale development activities, THCR will need to obtain financing from third parties and may require additional managerial resources. There can be no assurance that additional financing or managerial talent will be available or, if available, that it would be on terms satisfactory to THCR. Incurrence of such indebtedness would also be subject to restrictions under debt instruments of THCR. See "--High Leverage and Fixed Charges" and "--Restrictions on Certain Activities." In addition, THCR would need to obtain additional sites and licenses to operate such gaming facilities and competition for suitable sites and for licenses is usually intense. No assurance can be given that THCR will be able to obtain desirable sites or necessary licenses or successfully overcome the regulatory, financial, business and other problems inherent in the construction and operation of any new gaming venture. Construction projects, such as those proposed in connection with the development of new gaming ventures, including those currently proposed by Plaza Associates, Trump Indiana and Taj Associates, entail significant risks, including shortages of materials or skilled labor, unforeseen engineering, environmental or geological problems, work stoppages, weather interference, floods, unanticipated cost increases, the inability to commence operations as scheduled and other problems. The number and scope of the licenses and approvals required to complete the construction of any project, such as a hotel and other destination resort facilities, are extensive, including, without limitation, the approval of state and local land-use authorities and the acquisition of building and zoning permits. Unexpected concessions required by local, state or federal regulatory authorities could involve significant additional costs and delay scheduled openings of facilities. There can be no assurance that THCR will receive the licenses and approvals necessary to undertake or complete any of its development plans, or that such licenses and approvals will be obtained within the anticipated time frame. LIMITATIONS ON LICENSE OF THE TRUMP NAME Subject to certain restrictions, THCR has the exclusive right (except with respect to Trump's Castle and the Taj Mahal (during the period prior to the consummation of the Merger Transaction)) to use the "Trump" name and likeness in connection with gaming and related activities pursuant to a trademark license agreement between Trump and THCR (the "License Agreement"). See "Business of THCR--Trademark/Licensing." THCR's rights under the License Agreement are secured by a security interest in the names "Trump," "Donald Trump" and "Donald J. Trump" (including variations thereon, the "Trump Names") and related intellectual property rights (collectively, the "Marks") for use in connection with casino services, pursuant to a security agreement (the "Trademark Security Agreement"). If there were a default under the License Agreement or the Trademark Security Agreement, THCR would have rights, subject to the requirements of applicable state law, to enforce the rights and remedies contained in the Trademark Security Agreement. In the event of a foreclosure sale of the Marks, the net amount realized in such sale by THCR might not yield the full amount of damages that THCR could sustain as a result of the default. In addition, the existence of rights of others to the use of the Trump Names, including pursuant to the existing security interests with respect to trademarks associated with Trump's Castle as well as to any other security interests in trademarks for non-gaming hotels, could adversely affect the ability of THCR to realize the benefits of the Trademark Security Agreement. THCR's right to repossess and dispose of the Marks upon a breach of the License Agreement may be significantly impaired if the owner of the Marks were to become the subject of a case under the United States Bankruptcy Code (the "Bankruptcy Code") prior to THCR's having repossessed and disposed of the Marks. Under the Bankruptcy Code, secured creditors, such as THCR, are automatically stayed from repossessing or disposing of their collateral without bankruptcy court approval. Moreover, the Bankruptcy Code permits a defaulting debtor to retain and continue to use the collateral if the secured creditor is given "adequate protection" of its interest in the collateral. Such adequate protection under the Bankruptcy Code may take various forms, including the granting of a replacement lien or other relief that will enable the secured creditor to realize the "indubitable equivalent" of its interest in the collateral. Accordingly, it is impossible to predict whether or when THCR would repossess or dispose of the Marks, or whether or to what extent THCR would then be compensated for any delay in payment or loss of value of the Marks through the requirement of "adequate protection" if the owner of the Marks were to become the subject of a bankruptcy or reorganization case. Furthermore, the License Agreement could be rejected in connection with a bankruptcy of the licensor if, in the business judgment of a trustee or the licensor, as debtor-in-possession, rejection of the contract would benefit the licensor's estate. In the event of such rejection, THCR could assert a claim for damages, secured by THCR's lien on the Marks. THE POSSIBLE APPLICATION OF FRAUDULENT CONVEYANCE LAWS TO THE MERGER The Merger Transaction may be subject to review under relevant federal and state fraudulent conveyance laws if a bankruptcy or reorganization case were commenced or a lawsuit (including in circumstances where bankruptcy is not involved) were commenced by or on behalf of unpaid creditors, if such creditors were to exist, of THCR, THCR Holdings, Taj Holding, Taj Funding, Taj Associates, Trump or TM/GP (each a "Transaction Participant"), as the case may be, at some future date. The laws vary among the various jurisdictions. In general, under these laws, if a court were to find that, at the time property was transferred, an obligation was incurred or a security interest was granted, either (i) such property was transferred or such obligation was incurred or security interest granted with the intent of hindering, delaying or defrauding creditors, or (ii) both (a) the entity transferring the property or incurring the obligation or granting such security interest received less than reasonably equivalent or fair value or consideration in exchange for such property, the incurrence of such obligation or the granting of such security interest and (b) the entity (x) was insolvent or was rendered insolvent by reason thereof, (y) was engaged in a business or transaction for which its remaining assets constituted unreasonably small capital, or (z) intended to incur, or believed, or reasonably should have believed, that it would incur, debts beyond its ability to pay such debts as they matured (as all of the foregoing terms are defined in or interpreted under the fraudulent conveyance statutes) (a "Fraudulent Conveyance"), such court could impose legal and equitable remedies, including (A) subordination of the obligation to presently existing and future indebtedness of the entity, (B) avoidance of the issuance of the obligation or granting of the security interest, and direction of the repayment of any amounts paid from the proceeds thereof to a fund for the benefit of the entity's creditors or (C) taking of other action detrimental to the transferees of the property or holders of the instruments evidencing the entity's obligations. The measures of insolvency for purposes of determining whether a Fraudulent Conveyance occurred would vary depending upon the laws of the relevant jurisdiction and upon the valuation assumptions and methodology applied by the court. Generally, however, an entity would be considered insolvent for purposes of the foregoing if the sum of the entity's debts, including contingent unliquidated and unmatured liabilities, is greater than all the entity's property at a fair valuation, or if the present fair saleable value of the entity's assets is less than the amount that would be required to pay the probable liability on its existing debts as they become absolute and matured. THCR and Taj Holding believe that each Transaction Participant will receive reasonably equivalent and fair value in connection with the applicable transactions involved in the Merger Transaction. It is possible, however, that a court could conclude differently. Notwithstanding such possibility, however, each of THCR and Taj Holding believe that at the time of, or as a result of, the consummation of the transactions comprising the Merger Transaction, such entity and its subsidiaries (i) will not be insolvent or rendered insolvent under the foregoing standards; (ii) will not be engaged in a business or transaction for which its remaining assets constitute unreasonably small capital; and (iii) do not intend to incur, and do not believe that it will or would (subject to the discussion regarding the likely need to refinance the Taj Notes at maturity as described herein under "--Holding Company Structure; Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing") incur, debts beyond its ability to pay such debts as they mature. Consequently, THCR and Taj Holding believe that even if one or more elements of the transactions were deemed to involve the transfer of property, the incurrence of an obligation or the grant of a security interest for less than reasonably equivalent or fair value, a Fraudulent Conveyance would not occur. INTERESTS OF CERTAIN MEMBERS OF THE BOARDS OF DIRECTORS OF THCR AND TAJ In considering the recommendation of the Board of Directors of THCR and the Board of Directors of Taj Holding with respect to the Merger Transaction and the Merger Agreement, respectively, certain members thereof have certain interests in the Merger Transaction in addition to those of stockholders generally. Trump is the Chairman of the Board of Directors of THCR and Taj Holding and currently is the beneficial owner of approximately 40% and 50% of THCR and Taj Associates, respectively. Furthermore, in connection with the Merger Transaction, certain debt obligations of Trump and of his affiliates will be satisfied, and certain guarantees of indebtedness by Trump and certain of his affiliates will be released. See "Special Factors--Related Merger Transactions," "Special Factors--Interests of Certain Persons in the Merger Transaction" and "Business of Taj Holding--Certain Indebtedness." LIMITATIONS INHERENT IN FAIRNESS OPINIONS The fairness opinion of DLJ dated January 8,1996 included as Annex B and the summary thereof included in this Proxy-Statement Prospectus describes the limitations on scope, factors considered and basis for the conclusions reached. See "Special Factors--Opinions of the Financial Advisors." DLJ was not asked to, and did not, express any opinion as to whether another transaction with Taj Holding and its affiliates could be obtained on more favorable terms to THCR than the Merger Transaction. The limitations contained in the fairness opinion should be considered carefully and stockholders should note that the fairness opinion does not constitute a recommendation on how stockholders should vote on the proposals submitted at the THCR Special Meeting or Taj Holding Special Meeting. Developments after January 8, 1996 may affect DLJ's fairness opinion. The fairness opinion of Rothschild dated January 8, 1996 included as Annex C and the summary thereof included in this Proxy Statement-Prospectus describes the limitations on scope, factors considered and basis for the conclusions reached. See "Special Factors--Opinions of the Financial Advisors." Rothschild was not asked to, and did not, express any opinion as to whether another transaction with THCR or its affiliates or any other entity could be obtained on more favorable terms to the holders of Taj Holding Class A Common Stock than the Merger Transaction. The limitations contained in the fairness opinion should be considered carefully and stockholders should note that the fairness opinion does not constitute a recommendation on how stockholders should vote on the proposals submitted at the THCR Special Meeting or Taj Holding Special Meeting. Rothschild was not asked to, and did not, express any opinion as to whether the terms of the Merger are fair to the holders of Taj Holding Class B Common Stock or the holder (Trump) of the Taj Holding Class C Common Stock. Developments after January 8, 1996 may affect Rothschild's fairness opinion. See "Special Factors--Background of the Merger Transaction." SHARES ELIGIBLE FOR FUTURE SALE Immediately following completion of the Merger Transaction there will be shares of THCR Common Stock outstanding (assuming all of the holders of Taj Holding elect Stock Consideration and a Market Value of $ in connection with the Merger) ( shares if the underwriters' over-allotment option with respect to the THCR Stock Offering is exercised in full), but excluding (i) shares of THCR Common Stock (subject to certain adjustments) issuable upon conversion of Trump's limited partnership interest in THCR Holdings, (ii) an additional shares of THCR Common Stock reserved for issuance pursuant to the 1995 Stock Plan (as defined) and (iii) the THCR Class B Common Stock, which shares are not entitled to dividends or distributions and represent Trump's, and will represent TTMI's, voting interest and become nonvoting to the extent of a conversion of their interest in THCR Holdings. Of those shares outstanding, an aggregate of shares sold in the THCR Stock Offering, issued to First Fidelity and issued in the Merger ( shares if the underwriters' over-allotment option with respect to the THCR Stock Offering is exercised in full), will be freely tradeable without restriction or future registration under the Securities Act, unless purchased by an "affiliate" (as defined in the Securities Act) of THCR, which shares will be subject to resale limitations of Rule 144 promulgated under the Securities Act ("Rule 144"). The remaining shares outstanding upon completion of the Merger Transaction will not have been registered under the Securities Act and are restricted securities within the meaning of Rule 144 ("Restricted Shares"), except that such shares and the shares of THCR Common Stock issuable upon conversion of limited partnership interests in THCR Holdings, will have certain registration rights. See "Description of the THCR Holdings Partnership Agreement--Exchange and Registration Rights." Restricted Shares cannot be sold publicly in the absence of such registration, unless sold pursuant to an exemption under the Securities Act, such as the exemption provided by Rule 144. It is expected that THCR and certain stockholders will agree not to sell or otherwise dispose of such shares or securities convertible into or exercisable or exchangeable for THCR Common Stock for days after the date of the THCR Stock Offering without the prior written consent of DLJ as the lead underwriter of the THCR Stock Offering. Upon expiration of the applicable lock-up agreement with the underwriters, the shares subject and covered thereby will be eligible for sale subject to the restrictions contained in the Securities Act and the rules and regulations promulgated thereunder, including Rule 144. Sales of substantial amounts of THCR Common Stock in the public market subsequent to the Merger Transaction, or the perception that such sales could occur, could adversely affect the prevailing market price of the THCR Common Stock and could impair THCR's ability to raise capital through the sale of equity securities. EFFECT OF MERGER TRANSACTION ON HOLDERS OF THCR COMMON STOCK In connection with the Merger Transaction, THCR will issue up to shares of THCR Common Stock to holders of Taj Holding Class A Common Stock in the Merger, 500,000 shares to First Fidelity, in connection with the purchase of the Specified Parcels, and up to shares of THCR Common Stock pursuant to THCR Stock Offering (assuming a price of $ per share of THCR Common Stock as the Market Value in connection with the Merger and as the public offering price in the THCR Stock Offering). As required pursuant to the terms of the THCR Holdings Partnership Agreement, Trump's beneficial ownership of limited partnership interests in THCR Holdings will be adjusted to be convertible into approximately shares of THCR Common Stock in connection with the Merger Transaction. As a result of these issuances, the existing THCR Common Stock holders' percentage of ownership of THCR could be diluted up to %. Accordingly, the voting power of existing holders of THCR Common Stock would be diluted by such amount. TRADING MARKETS; POTENTIAL VOLATILITY OF MARKET PRICE The THCR Common Stock began trading in June 1995, and since that time its price has fluctuated substantially. The price at which the THCR Common Stock will trade in the future will depend upon a number of factors, including, without limitation, THCR's historical and anticipated operating results (including the timing of the openings related to the various expansion projects), overall Atlantic City gaming results and general market and economic conditions, several of which factors are beyond the control of THCR. In addition, factors such as quarterly fluctuations in THCR's financial and operating results, announcements by THCR or others, and developments affecting THCR, its customers, the Atlantic City market or the gaming industry generally, could cause the market price of the THCR Common Stock to fluctuate substantially. BACKGROUND OF THE MERGER TRANSACTION From August 1993 through June 1994, representatives of Trump and Taj Associates negotiated with representatives of Putnam Investment Management, Inc. ("Putnam"), acting for certain affiliated funds which at the time beneficially owned a substantial amount of Units and Taj Holding Class A Common Stock, Prudential Securities Inc. ("Prudential"), and certain other substantial holders of Units and Taj Holding Class A Common Stock to explore the feasibility of a recapitalization of Taj Associates under which substantially all of the indebtedness of Taj Associates and its affiliated entities would be exchanged or refinanced and Trump would acquire all the equity interests in Taj Holding not then owned by him. These negotiations resulted on March 8, 1994 in the execution by Trump, Taj Associates, Taj Funding and Taj Holding of a letter with Putnam (the "March 8 Letter") which set forth the parties' understanding of the discussions that had taken place regarding the recapitalization proposal and which indicated that those terms were generally satisfactory. The March 8 Letter provided for a restructuring transaction that would have included (i) an exchange offer with the holders of the Bonds (the "Bondholders") for an equivalent principal amount of new bonds with an interest rate of 11 7/8% (with an adjustment downwards if certain parent company financing were repaid), a cash payment of $7.5 million to exchanging Bondholders and an additional $15 million principal amount of new bonds to be issued to exchanging Bondholders, (ii) an acquisition by Trump of all the Taj Holding Class A Common Stock for a cash price of $29.50 per share, (iii) the repayment of the First Fidelity Loan, the NatWest Loan and the TTMI Note and (iv) an equity financing that would raise between $115 and $125 million of proceeds which, together with approximately $35 million of cash on hand, would be used to fund the cash requirements for the transaction. Pursuant to the March 8 Letter, the exchange offer would have required that a minimum of 90% of the principal amount of Bonds be tendered for exchange and that the maturity date for the new bonds be set at ten years. On March 22, 1994, at a meeting of the Board of Directors of Taj Holding at which Jefferies & Company, Inc. ("Jefferies"), Taj Holding's financial advisor at the time, and Andrews & Kurth L.L.P., special counsel to the Class B Directors of Taj Holding (the "Special Counsel") were present, representatives of Trump discussed with the Board of Directors of Taj Holding the background and terms of the proposed recapitalization as provided in the March 8 Letter. Jefferies also indicated its preliminary view that the merger consideration was fair, from a financial point of view, to the holders of Taj Holding Class A Common Stock. On March 26, 1994, Jefferies delivered a preliminary copy of its report. The Board of Directors of Taj Holding then met (with Jefferies present telephonically) on March 28, 1994 to discuss the proposed recapitalization and Jefferies' report thereon and requested certain additional analyses from Jefferies, which were provided on March 29, 1994. On March 30, 1994, the Class B Directors separately discussed the financial advisor's report (including such additional analyses) with representatives of Jefferies and, later that day, the entire Board of Directors of Taj Holding met telephonically to discuss the proposed recapitalization and the financial advisor's report. At the conclusion of such meeting, the Board of Directors of Taj Holding voted unanimously to approve and recommend the proposed 1994 recapitalization. During the summer of 1994, the parties determined not to proceed with the proposed 1994 recapitalization, as Trump had been informed by several Bondholders, who held in excess of 15% of the outstanding principal amount of the Bonds, that they were not interested in pursuing the recapitalization on the proposed terms. Thus, the parties believed that they would not be able to achieve the 90% condition of the exchange offer. On January 24, 1995, representatives of Taj Associates contacted the Special Counsel to the Class B Directors of Taj Holding to indicate that they wished to schedule a meeting of the Board of Directors of Taj Holding for the purpose of discussing a proposal for a recapitalization of Taj Associates and its affiliated entities in early February. On February 2, 1995, a meeting of the Board of Directors of Taj Holding was held to discuss the proposed recapitalization of Taj Associates and its affiliated entities, which would include the contribution by Trump of Trump Indiana. The Board of Directors of Taj Holding was presented with a proposed plan of recapitalization (the "February 2 Proposal") in which (i) each $1,000 principal amount of Bonds would be exchanged for $750 principal amount of new Taj Funding mortgage notes and twenty shares of common stock of TTMI, (ii) all shares of Taj Holding Class B Common Stock associated with the exchanged Bonds would be redeemed at the required redemption price of $.50 per share, (iii) in a merger transaction, each share of Taj Holding Class A Common Stock (other than shares as to which appraisal rights are perfected) would be converted into and represent the right to receive four shares of common stock of TTMI, and each share of Taj Holding Class B Common Stock (other than shares associated with any Bonds exchanged in the exchange offer and any shares as to which appraisal rights are perfected) would be converted into and represent the right to receive $.50 in cash, (iv) Trump Indiana would become a wholly owned subsidiary of TTMI and would guarantee new mortgage notes, and (v) the NatWest Loan and the Taj Associates--First Fidelity Guarantee (as defined) would be exchanged for new mortgage notes and new common stock on the same basis as the Bonds. Without passing on the merits of the February 2 Proposal, the Board of Directors of Taj Holding authorized the officers of Taj Holding to begin the preparation of documentation relating to the February 2 Proposal, asked Rothschild and BT Securities to provide certain additional information in connection with the February 2 Proposal prior to the regularly scheduled board meeting on February 9, 1995, and agreed to consider the retention of Rothschild and BT Securities at such Board of Directors meeting. On February 9, 1995, the Board of Directors of Taj Holding held a meeting and approved the retention of Rothschild and BT Securities to serve as financial advisors in connection with a recapitalization plan based on the February 2 Proposal. On February 13, 1995, Taj Holding, Taj Funding, Taj Associates, TTMI and TTMC entered into an agreement with BT Securities and Rothschild, pursuant to which BT Securities and Rothschild were retained as financial advisors in connection with such recapitalization plan. Upon execution of the agreement, BT Securities and Rothschild were paid $240,000 and $160,000, respectively. This agreement with Rothschild and BT Securities was subsequently terminated. Trump subsequently informed Taj Holding during the week of March 7, 1995 that he had determined not to contribute Trump Indiana in connection with the transaction contemplated by the February 2 Proposal, but instead to include the contribution of Trump Indiana as part of a proposed recapitalization involving Trump Plaza (which was accomplished in connection with the June 1995 Offerings). On April 3, 1995, a meeting of the Board of Directors of Taj Holding was held to discuss a proposed recapitalization of Taj Associates and its affiliated entities which would not involve Trump Indiana. Rothschild and BT Securities presented to the directors a proposed plan of recapitalization (the "April 3 Proposal") in which (i) each $1,000 principal amount of Bonds would be exchanged for (a) $750 principal amount of new Taj Funding mortgage notes and (b) twenty shares of new common stock of TTMI, (ii) all shares of Taj Holding Class B Common Stock associated with the Bonds would be redeemed at the required redemption price of $.50 per share, (iii) in a merger transaction, each share of Taj Holding Class A Common Stock (other than shares as to which appraisal rights are perfected) would receive $12 in cash and each share of Taj Holding Class B Common Stock (other than shares associated with any Bonds exchanged in the exchange offer and any shares as to which appraisal rights are perfected) would be converted into and represent the right to receive $.50 in cash, (iv) the NatWest Loan and the TTMI Note would be exchanged for new mortgage notes and new common stock on the same basis as the Bonds and (v) Taj Associates would purchase the Taj Entertainment Complex, the Steel Pier and a warehouse complex from Realty Corp. and the associated Taj Associates-First Fidelity Guarantee would be released in exchange for $22.5 million principal amount of new mortgage notes and 600,000 shares of new common stock. The Board of Directors of Taj Holding was not asked to take and took no further action with respect to the April 3 Proposal. At the July 13, 1995 meeting of the Board of Directors of Taj Holding, the Board invited Rothschild, BT Securities and DLJ to discuss generally the desirability of refinancing Taj Associates' indebtedness. During the summer of 1995, members of management of Taj Holding approached certain holders of Taj Holding Class A Common Stock about a potential recapitalization transaction of Taj Associates, which could involve a merger of the Taj Mahal with THCR. These holders indicated their general support for such a transaction. At the September 27, 1995 meeting of the Board of Directors of Taj Holding, at which DLJ, BT Securities and Rothschild were present, the Board discussed a proposal (the "September 27 Proposal") which provided for a merger of Taj Holding with a subsidiary of THCR with Taj Holding becoming a subsidiary of THCR, the payment to the holders of Taj Holding Class A Common Stock (at such holders' option) of $30.00 in cash or $30.00 in THCR Common Stock in the event shares of THCR Common Stock are made available by THCR, the redemption of the Bonds and redemption of the Taj Holding Class B Common Stock, the contribution by Trump of his interests in Taj Associates, the elimination of the First Fidelity Loan, TTMI Note and NatWest Loan and the issuance of new mortgage notes by Taj Funding with a longer maturity and greater covenant flexibility than the Bonds. At the September 27 meeting, the Board of Directors of Taj Holding approved the execution of the Class A Agreement with certain holders of Taj Holding Class A Common Stock pursuant to which such holders would agree to vote in favor of the proposed merger. The Class A Agreement was entered into on October 6, 1995 by Taj Associates, Taj Funding and Taj Holding and Putnam, Prudential, Hamilton Partners, L.P., Grace Brothers, Ltd., SC Fundamental Value Fund, L.P. and SC Fundamental Value BVI Ltd., the holders of approximately 52% of the Taj Holding Class A Common Stock. These holders also agreed not to dispose of their shares of Class A Common Stock except pursuant to such recapitalization, other than through sales to third parties who agree to be bound by the Class A Agreement. Taj Associates, Taj Funding and Taj Holding paid $701,840 to these holders of Taj Holding Class A Common Stock and agreed to pay them an additional $701,840 if the proposed recapitalization does not occur prior to March 15, 1996. The Class A Agreement expires on April 30, 1996. Neither Trump nor THCR is a party to the Class A Agreement. In connection with the approval of the Class A Agreement by the Board of Directors of Taj Holding, Trump agreed to reimburse the appropriate entity for any and all fees paid to holders of Taj Holding Class A Common Stock pursuant to the Class A Agreement in the event that Trump voted his shares in THCR against, or, if the Board of Directors of THCR was requested to vote, and Trump (as a director) voted against, or if such Board was not requested to vote on, the transaction outlined in the September 27 Proposal. At a meeting of the Board of Directors of THCR held on October 3, 1995, representatives of management of THCR and Willkie Farr & Gallagher ("Willkie Farr"), counsel to THCR in connection with the Merger Transaction, which firm has historically (but not in connection with the negotiation of the Merger Agreement and certain other matters related to the Merger Transaction) served as counsel to Taj Associates and its affiliates, discussed with the Board of Directors the transactions outlined in the September 27 Proposal and the Class A Agreement. In early October 1995, Special Counsel was retained to represent Taj Holding in connection with the negotiation of the Merger Agreement, in addition to representing the Class B Directors generally. On November 6, 1995, representatives of Special Counsel met with representatives of THCR and Willkie Farr to discuss the timing and mechanics of effecting the proposed transaction referred to in the September 27 Proposal. Thereafter, representatives of THCR, Taj Holding, Willkie Farr and Special Counsel commenced preparation of this Proxy Statement-Prospectus and other documents related to the Merger Transaction, including the Merger Agreement. During November and December 1995 and January 1996, DLJ, BT Securities, Rothschild and counsel to DLJ participated in sessions where drafts of this Proxy Statement-Prospectus and drafts of the Merger Agreement were discussed. On December 4, 1995, following receipt of a draft of the Proxy Statement- Prospectus, the Class B Directors met telephonically with Special Counsel. Special Counsel reviewed with the Class B Directors the proposed terms of the Merger Transaction as described in such draft and updated the Class B Directors on the status of discussions with representatives of THCR. The Class B Directors then discussed the retention of a financial advisor, and determined that, given Rothschild's knowledge of Taj Holding and Taj Associates, its prior retention with respect to the February 2 proposal and its expertise in such matters, it would be appropriate for Rothschild to be retained by Taj Holding to serve as financial advisor in connection with the Merger and to render a fairness opinion. Special Counsel discussed with the Class B Directors certain changes in the Merger Agreement which Special Counsel recommended, including a separate class vote of the holders of the Taj Common Stock to approve the Merger, although such vote was not specifically required by the Taj Holding Certificate of Incorporation. Subsequently, Rothschild entered into a retention agreement with Taj Holding. On December 8, 1995, Special Counsel met telephonically with Ropes & Gray, counsel to the holders of Taj Holding Class A Common Stock who are parties to the Class A Agreement. Such counsel confirmed that the Class A Agreement was reached through arms-length negotiations and accurately represents the desires of the parties thereto. At a meeting of the Board of Directors of THCR held on December 11, 1995, representatives of THCR, Willkie Farr, DLJ and BT Securities discussed with the Board of Directors of THCR the Merger Transaction as described in the draft of the Proxy Statement-Prospectus previously distributed to the Board, including the contribution by Trump to THCR of his direct and indirect equity interests in Taj Associates. Willkie Farr updated the Board of Directors of THCR on the status of discussions with Special Counsel to the Class B Directors of Taj Holding. The Board of Directors of THCR also reviewed the approval process and the timing of the proposed Merger Transaction. The Board of Directors of THCR determined that as a result of the affiliated nature of the proposed transaction, the THCR Special Committee and the Board of Directors of THCR each would separately review, analyze and vote on the proposed Merger Transaction, and that an investment banking firm be retained to render an opinion to the THCR Special Committee as to the fairness of the consideration to be paid by THCR in the proposed Merger Transaction. Following a presentation of the proposed Merger Transaction by DLJ, the Board of Directors of THCR discussed (without Trump being present) the potential benefits to THCR in connection with the proposed transaction. On December 14, 1995, Special Counsel met telephonically with representatives of Rothschild to discuss the timing for a written report and the analyses to be used in the preparation of such report. Later that same day, the Class B Directors again met telephonically with Special Counsel. Special Counsel updated the Class B Directors on the status of the transaction, including certain proposed changes thereto, and the status of negotiations concerning various requested modifications to the Merger Agreement. Special Counsel also reported to the Class B Directors regarding the conversation with the counsel to the holders of Taj Holding Class A Common Stock and the discussion with Rothschild. On December 18, 1995, the Board of Directors of THCR (other than Trump), Willkie Farr and management of THCR met telephonically to discuss the status of the proposed Merger Transaction, the approval process to be employed, as well as an update on negotiations with Taj Holding. The Board of Directors of THCR discussed the retention of DLJ as financial advisor to THCR to, among other things, render an opinion to the THCR Special Committee as to fairness of the consideration to be paid by THCR in the Merger Transaction. The Directors determined that given DLJ's knowledge of THCR and Taj Associates, and its expertise in such matters, DLJ would be appropriate to serve as financial advisor and to render a fairness opinion. Following this discussion, the Board of Directors concluded that, in order to maximize procedural fairness, the proposed Merger Transaction be submitted to a vote of all unaffiliated stockholders of THCR in addition to the vote of all of THCR's stockholders required by Delaware law. On December 21, 1995, Rothschild presented to the Board of Directors of Taj Holding its preliminary written report on the Merger, which is discussed below (the "Rothschild Report"). On December 21, 1995, the Taj Holding Class B Directors met telephonically together with Special Counsel to review generally the Rothschild Report, the latest draft of the Merger Agreement and the status of the requested modifications to the Merger Agreement. Later that day, at a telephonic meeting of the entire Board of Directors of Taj Holding at which Rothschild, Special Counsel and Willkie Farr were present, representatives of the Board of Directors of Taj Holding discussed the terms of the proposed Merger as described in a draft Joint Proxy Statement-Prospectus distributed December 15, 1995. Rothschild described the Rothschild Report in detail and responded to questions from members of the Board of Directors of Taj Holding with respect thereto. On December 22, 1995, the Board of Directors of THCR (other than Trump), Willkie Farr and management of THCR met telephonically to discuss and review the proposed Merger Transaction and status of negotiations with Special Counsel to the Class B Directors of Taj Holding. On January 3, 1996, DLJ was engaged by THCR to act as THCR's exclusive financial advisor in connection with the Merger Transaction. On January 4, 1996, the THCR Special Committee met with DLJ, Willkie Farr and the General Counsel of THCR to discuss the Merger Transaction. At such meeting, DLJ presented its preliminary written report on the terms of the Merger Transaction and its fairness analysis, which is discussed below (the "DLJ Report"), and responded to questions from members of the THCR Special Committee. Following DLJ's presentation, the THCR Special Committee requested certain additional information from DLJ and THCR, which information was provided to the Special Committee during the period from January 4 to January 8, 1996. Immediately following the meeting of the THCR Special Committee, the Board of Directors of THCR met to discuss the status of the proposed Merger Transaction and the DLJ Report. The DLJ Report may be inspected at THCR's principal executive offices. On January 4, 1996, the Class B Directors held a meeting with representatives of Rothschild and Special Counsel and discussed the status of the Merger Agreement and an updated version of the Rothschild Report including certain additional analyses which had been requested. Later that day, the entire Board of Directors met with Rothschild, Special Counsel and Willkie Farr present, to discuss the Merger and an updated version of the Rothschild Report and to ask questions of Rothschild. In addition, in light of the fact that Trump was to receive a warrant to purchase shares of THCR Common Stock concurrent with the consummation of the Merger, the Class B Directors requested Nicholas L. Ribis, Taj Holding's Vice President, to request that THCR provide additional consideration to the holders of Taj Holding Class A Common Stock. During the period through January 8, 1996, representatives of Taj Holding, Special Counsel, THCR and Willkie Farr continued to negotiate the Merger Agreement and the terms of the Merger. Among other things, it was agreed that the Merger would be subject to the approval of the holders of the Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock, each voting as a separate class. It was also agreed that (i) Taj Holding would be able to furnish information to, and participate in negotiations with, certain persons concerning an alternative proposal for the acquisition of Taj Holding, if the Class B Directors, by a majority vote, determined in their good faith judgement that such action would be appropriate in furtherance of the best interests of stockholders, and (ii) the Merger Agreement could be terminated by Taj Holding, acting through the Class B Directors, if the Class B Directors shall have withdrawn or modified their approval or recommendation of the Merger Agreement or the Merger in order to permit Taj Holding to execute an agreement to effect a proposal for the acquisition of Taj Holding determined by the Class B Directors to be more favorable to the Taj Holding stockholders than the transactions contemplated by the Merger Agreement. On January 8, 1996, the Class B Directors of Taj Holding held a telephonic meeting, with Rothschild and Special Counsel present, to review the proposed Merger. During the meeting, Rothschild delivered its written opinion that the consideration to be received by the holders of Taj Holding Class A Common Stock in connection with the Merger Transaction, is fair, from a financial point of view, to the holders of Taj Holding Class A Common Stock. At the conclusion of such meeting, the Class B Directors determined that the proposed Merger is fair to, and in the best interests of, the holders of the Taj Holding Class A Common Stock, and voted unanimously to approve the Merger and recommend that stockholders vote to approve and adopt the Merger Agreement. Later that day, the entire Board of Directors of Taj Holding held a telephonic meeting, with Rothschild, Special Counsel and Willkie Farr present, to review the proposed Merger. During the meeting, the Board of Directors of Taj Holding was informed by Mr. Ribis, that, in response to the request made by the Class B Directors at the previous meeting, THCR would not consider giving any additional consideration to Taj Holding's stockholders. At the conclusion of the meeting, the Board of Directors determined that the proposed Merger is fair to, and in the best interests of, Taj Holding and the holders of Taj Holding Class A Common Stock, and voted unanimously to approve the Merger and recommend that Taj Holding's stockholders vote to approve and adopt the Merger Agreement. The Board of Directors of Taj Holding did not determine whether the terms of the Merger are fair to, or in the best interests of, the holders of Taj Holding Class B Common Stock or the holder (Trump) of Taj Holding Class C Common Stock. The Board of Directors of Taj Holding recognized that the redemption price for the Taj Holding Class B Common Stock is established by the Taj Holding Certificate of Incorporation at $0.50 per share and that such stock must be redeemed in connection with the redemption of the Bonds, which is a condition to the Merger. The Taj Holding Board of Directors also recognized that all the outstanding shares of Taj Holding Class C Common Stock are beneficially owned by Trump, who is a director of Taj Holding and has the ability to elect a majority of the members of the Board of Directors of Taj Holding, and who had an opportunity to negotiate the terms of the Merger Transaction on his own behalf as they relate to the Taj Holding Class C Common Stock. On January 8, 1996, the THCR Special Committee met telephonically with DLJ, Willkie Farr and the General Counsel of THCR to further discuss the DLJ Report. During the meeting, DLJ delivered its written opinion that the aggregate consideration to be paid by THCR pursuant to the transactions contemplated by the Merger Agreement is fair to THCR from a financial point of view. After discussing the opinion with DLJ and considering the elements of the Merger Transaction, the THCR Special Committee voted unanimously to approve the Merger Transaction. Immediately following the THCR Special Committee meeting, the Board of Directors of THCR met telephonically to discuss the Merger Transaction and the DLJ Report. At the conclusion of such meeting, the THCR Board of Directors voted unanimously to approve and recommend the Merger Transaction and the Merger Agreement. RECOMMENDATIONS OF THE BOARD OF DIRECTORS; REASONS FOR THE MERGER TRANSACTION; FAIRNESS OF THE MERGER TRANSACTION Taj Holding. On January 8, 1996, the members of the Board of Directors of Taj Holding unanimously determined that the Merger is fair to and in the best interest of Taj Holding and the holders of Taj Holding Class A Common Stock and recommended that such stockholders of Taj Holding approve and adopt the Merger Agreement. In determining to recommend approval and adoption of the Merger Agreement and the transactions contemplated thereby and in approving the Merger Agreement, the Board of Directors considered a number of factors, including but not limited to the factors discussed below. (a) In determining that the Proposed Merger is fair to, and in the best interest of, Taj Holding and the holders of Taj Holding Class A Common Stock, and in deciding to recommend that such Stockholders vote to approve and adopt the Merger Agreement, the Board of Directors considered: (i) discussions with Rothschild regarding generally, the financial condition, results of operations and business of Taj Mahal, Taj Holding's principal asset, which are summarized below under the caption "--Opinions of the Financial Advisors," (ii) discussions with Rothschild with respect to the industry in which Taj Holding operates, as well as the recent results of operations (iii) the oral and written presentations of Rothschild described below under "Opinion of Financial Advisor" and its written opinion dated January 8, 1996 to the effect that, as of the date of such opinion and based upon the matters set forth therein, the consideration to be received by the holders of the Taj Holding Class A Common Stock, in connection with the Merger Transaction, is fair, to such holders from a financial point of view, (iv) that the consummation of the Merger is conditioned upon the affirmative vote of a majority of the outstanding shares of Taj Holding Class A Common Stock, even though such right is not provided in the Taj (v) that the Merger Consideration was the subject of arm's-length negotiations between members of management of Taj Holding, on the one hand, and certain significant holders of the Taj Holding Class A Common Stock, on the other hand, (vi) that the holders of approximately 52% of the Taj Holding Class A Common Stock entered into the Class A Agreement pursuant to which they agreed to vote in favor of the Merger, (vii) that, in order to retain the ability to achieve greater value for the holders of Taj Holding Class A Common Stock, Taj Holding negotiated the ability to furnish information to, and participate in negotiations with, certain persons concerning alternative proposals for the acquisition of Taj Holding, if the Class B Directors, by a majority vote, determined in their good faith judgment that such action would be appropriate in furtherance of the best interests of the stockholders. It was further agreed that the Merger Agreement could be terminated by Taj Holding, acting through the Class B Directors, if the Class B Directors shall have withdrawn or modified their approval or recommendation of the Merger Agreement or the Merger in order to permit Taj Holding to execute an agreement to effect a proposal for the acquisition of Taj Holding which the Class B Directors determined to be more favorable to the Taj Holding stockholders than the transactions contemplated by the Merger Agreement. The ability to ultimately consummate such an alternative acquisition, however, would be subject to the approval of the entire Board of Directors of Taj Holding and the stockholders of Taj Holding, including Trump as the beneficial owner of all the outstanding shares of Taj Holding Class C Common Stock. (viii) the fact that the holders of the Taj Holding Class A Common Stock will have the opportunity to elect to receive cash for their shares and achieve immediate liquidity, (ix) that, in any alternative transaction, the possibility exists that Taj Associates could make the 14% Payment (none of which would be payable to the holders of the Taj Holding Class A Common Stock), thereby substantially diluting the value of the equity interest in Taj Associates represented by the Taj Holding Class A Common Stock, and (x) the fact that there currently is not, and historically there has not been, an established trading market for the Taj Holding Class A Common Stock. (b) In deciding to recommend that the holders of Taj Holding Class B Common Stock vote to approve and adopt the Merger Agreement, the Board of Directors considered: (i) that each share of Taj Holding Class B Common Stock trades as part of a Unit and, therefore, that there is no separate trading market for the Taj Holding Class B Common Stock, (ii) that the Taj Holding Certificate of Incorporation requires payment of the $.50 per share Taj upon the purchase, payment or defeasance of the Bond with which such share trades, and (iii) that the consummation of the Merger is conditioned upon the affirmative vote of a majority of the outstanding shares of Taj Holding Class B Common Stock, even though such Taj Holding Class B Common Stock would be redeemed prior to the Effective Time. With respect to the Taj Holding Class A Common Stock, the factors discussed above were considered by the Board of Directors of Taj Holding in the following manner: (a) The Board of Directors of Taj Holding considered as favorable to its decision and placed special emphasis on the matters set forth in items (a)(iii), (iv), (v), (vi) and (vii) above. The Board of Directors of Taj Holding relied on, actively discussed and requested, received and considered additional analyses regarding the presentation by Rothschild described herein under "--Opinions of the Financial Advisors--Taj Holding- Opinion of Rothschild". (b) The Board of Directors of Taj Holding considered as favorable to its decision the fact that the holders of a majority of the Taj Holding Class A Common Stock entered into the Class A Agreement and agreed to vote their shares in favor of the Merger, and that all holders of the Taj Holding Class A Common Stock will be given the right to vote on the Merger, even though such right is not provided in the Taj Holding Certificate of Incorporation. (c) The Board of Directors of Taj Holding considered as favorable to its decision the matters set forth in items (a)(i) and (ii) above. In connection therewith, the Board of Directors of Taj Holding reviewed Taj Holding's historical operating results, the forecasts utilized by Rothschild in preparing the Rothschild Report, and presentations by Taj Holding's management concerning the prospects for the Taj Mahal. In these deliberations, the Board of Directors of Taj Holding recognized that, as a result of the Merger the holders of Taj Holding Class A Common Stock electing Cash Consideration would not have the ability to participate in the future growth of Taj Holding. (d) In considering the Rothschild Report, the Board of Directors of Taj Holding considered the various projections prepared by management and considered by Rothschild in arriving at their recommendation. See "Additional Information." With respect to the Taj Holding Class B Common Stock, the Board of Directors gave equal weight to the factors discussed in items (b)(i) through (iii) above. The Board of Directors of Taj Holding did not determine whether the terms of the Merger are fair to, or in the best interests of, the holders of Taj Holding Class B Common Stock or the holder (Trump) of Taj Holding Class C Common Stock. The Board of Directors of Taj Holding recognized that the redemption price for the Taj Holding Class B Common Stock is established by the Taj Holding Certificate of Incorporation at $0.50 per share and that such stock must be redeemed in connection with the redemption of the Bonds, which is a condition to the Merger. The Taj Holding Board of Directors also recognized that all the outstanding shares of Taj Holding Class C Common Stock are beneficially owned by Trump, who is a director of Taj Holding and has the ability to elect a majority of the members of the Board of Directors of Taj Holding, and who had an opportunity to negotiate the terms of the Merger Transaction on his own behalf as they relate to the Taj Holding Class C Common Stock. The Board of Directors of Taj Holding considered each of the factors listed above during the course of its deliberations prior to approving the Merger Agreement. The Board of Directors of Taj Holding evaluated the factors listed above in light of its knowledge of the business and operations of the Taj Mahal and its business judgment. In view of the wide variety of factors considered in connection with its evaluation of the Merger, the Board of Directors of Taj Holding found it impracticable to, and did not, quantify or otherwise attempt to assign relative weights to the specific factors considered in making its determinations. The Board of Directors of Taj Holding believes that the Merger is procedurally fair, because (i) the Board of Directors of Taj Holding retained a financial advisor to render an opinion as to whether the consideration to be paid in the Merger was fair from a financial point of view to the holders of the Taj Holding Class A Common Stock, and Rothschild, the financial advisor so retained, rendered such an opinion, (ii) of the availability to holders of Taj Holding Class A Common Stock of appraisal rights under the DGCL, (iii) of the fact that the Merger will not be consummated unless the conditions to the Merger are satisfied or waived, including a vote in favor of the Merger by holders of a majority of the Taj Holding Class A Common Stock and Taj Holding Class B Common Stock, each voting as a separate class, and (iv) Taj Holding, in order to retain the ability to achieve greater value for the holders of the Taj Holding, negotiated the ability to furnish information to, and participate in negotiations with, persons concerning alternative proposals for the acquisition of Taj Holding, if the Class B Directors by a majority vote determine in their good faith judgment that such action is appropriate in furtherance of the best interests of stockholders. It was further agreed that the Merger Agreement could be terminated by Taj Holding, acting through the Class B Directors, if the Class B Directors shall have withdrawn or modified their approval or recommendation of the Merger Agreement or the Merger in order to permit Taj Holding to execute an agreement to effect a proposal for the acquisition of Taj Holding, which the Class B Directors determined to be more favorable to the Taj Holding stockholders than the transaction contemplated by the Merger Agreement. The ability to ultimately consummate such an alternative acquisition, however, would be subject to the approval of the entire Board of Directors of Taj Holdings and the stockholders of Taj Holding, including Trump as the beneficial owner of all the outstanding shares of Taj Holding Class C Common Stock. A copy of the written opinion of Rothschild delivered to the Board of Directors of Taj Holding, including the Class B Directors, which sets forth the assumptions made, matters considered and limits of the review by Rothschild in rendering its opinion, is attached to this Proxy Statement- Prospectus as Annex C. Stockholders are urged to read this opinion in its entirety. These materials are available for inspection and copying at the principal executive offices of Taj Associates. THCR. On January 8, 1996, the THCR Special Committee and the Board of Directors of THCR each determined that the Merger Transaction was fair to, and in the best interests of, THCR and unanimously approved the terms of the Merger Transaction and the Merger Agreement. Accordingly, the Board of Directors of THCR recommends that the stockholders of THCR vote for approval of the Merger Transaction. In making their respective determinations and recommendations concerning the Merger Transaction, which determinations and recommendations are the product of the business judgment of the respective members thereof, exercised in light of their fiduciary duties to THCR and THCR's stockholders, the THCR Special Committee and the Board of Directors of THCR considered a number of factors, including but not limited to the following factors discussed below: (a) Knowledge of THCR's and Taj Associates' business, operations, properties, assets, financial condition, operating results and future prospects, the current conditions in, and the future prospects of, the Atlantic City market and gaming markets outside of Atlantic City, and the competitive positions of each of Trump Plaza and the Taj Mahal in the Atlantic City market, all of which indicated that the acquisition of Taj Associates would make a good strategic fit with THCR, and that the combination would create a company that will be better positioned than either would be separately to compete both in Atlantic City and for prime gaming licenses in other jurisdictions. (b) The potential for synergies from combining THCR with Taj Associates, which the THCR Special Committee and the Board of Directors of THCR believe would have a favorable impact on long-term value for THCR's stockholders. (c) The Merger Agreement includes as a condition the consummation of the THCR Stock Offering and the Taj Note Offering on terms acceptable to THCR. A related factor in the considerations of the THCR Special Committee and the Board of Directors of THCR was that the Merger Transaction includes the refinancing of the Bonds with the Taj Notes which will extend the maturity of Taj Associates' debt and provide financial flexibility thereby. Additionally, the Merger Agreement includes as a condition to THCR's obligation to consummate the Merger that the Market Value of THCR Common Stock equal $20.00 or more. (d) The Merger Transaction requires the approval of a majority of the unaffiliated public stockholders of THCR through a separate class vote. (e) Discussions with DLJ regarding the financial condition, results of operations and business of the Taj Mahal, as well as the industry in which the Taj Mahal and THCR operate; the discussions also included a review of the recent results of the Taj Mahal. (f) The oral presentations of DLJ described below under "--Opinions of the Financial Advisors--THCR-Opinion of DLJ" and its written opinion, dated January 8, 1996, to the THCR Special Committee to the effect that, as of the date of such opinion, and based on the matters set forth therein, the aggregate consideration to be paid by THCR pursuant to the transactions contemplated by the Merger Agreement is fair to THCR from a financial point of view. Furthermore, the THCR Special Committee was satisfied with the scope of the review and analysis performed by DLJ and believed that DLJ had performed competently and professionally. (g) With respect to the purchase of the Specified Parcels from Realty Corp., that (i) the properties are integral to the Taj Associates Expansion, (ii) the related $30 million guaranty of Taj Associates will be released, (iii) the lease relating to the Specified Parcels will be terminated, thus eliminating Taj Associates $3.3 million annual rental payment obligations thereunder, and (iv) a recent appraisal indicating that the market value of the Specified Parcels ranged from approximately $80 million to $95 million. (h) The payment to Bankers Trust was required to obtain the consent of Bankers Trust to the Merger and the release of its liens on Trump's direct and indirect equity interests in Taj Associates. (i) That Trump beneficially owns a 50% equity interest in Taj Associates and, through his ownership of the Taj Class C Common Stock, elects a majority of the Directors of Taj Holding and thus controls Taj Holding; and that in the Merger Transaction, Trump's beneficially equity interests in Taj Associates will be contributed to Trump Holding and Taj Holdings LLC and the Taj Holding Class Common Stock will be canceled. (j) The fact that Trump controls approximately 40% of the voting power of THCR before the Merger Transaction and will control approximately the same percentage following the consummation of the Merger Transaction. The THCR Special Committee and the Board of Directors of THCR viewed this Trump's continued significant holdings as a positive factor given that the association of THCR with Trump is believed to enhance the status of THCR due to the widespread recognition of the "Trump" name and its association with high quality amenities and first class services. (k) Certain risks associated with the proposed Merger Transaction, as set forth under "Risk Factors." The THCR Special Committee and the Board of Directors of THCR considered each of the factors listed above during the course of their deliberations prior to approving the Merger Transaction. In view of the wide variety of factors considered, neither the THCR Special Committee nor the Board of Directors of THCR found it practicable to quantify or otherwise attempt to assign relative weights to the specific factors considered in making their determinations. The THCR Special Committee and the Board of Directors of THCR believe that the factors discussed above in paragraphs (a) through (g), (i) and (j) supported their decision to approve the Merger Transaction and outweighed the risks associated therewith referred to in paragraph (k). Each of THCR, THCR Holdings, Trump and Merger Sub reasonably believes that the Merger Transaction is fair to the holders of Taj Holding Class A Common Stock for the reasons identified by the Board of Directors of Taj Holding in making its determination as to fairness. OPINIONS OF THE FINANCIAL ADVISORS Taj Holding--Opinion of Rothschild. Rothschild has delivered its written opinion, dated January 8, 1996, that, from a financial point of view, the consideration to be received by the holders of Taj Holding Class A Common Stock, in connection with the Merger Transaction (as constituted as of the above mentioned date), is fair to such holders. The full text of the written opinion of Rothschild dated January 8, 1996 which sets forth the assumptions made, the matters considered and the review undertaken with regard to such opinion, is attached as Annex C to this Proxy Statement-Prospectus. Stockholders are urged to read the opinion in its entirety. Rothschild's opinion is directed only to the fairness of the consideration to be received by the holders of the Taj Holding Class A Common Stock and does not constitute a recommendation to any holder of shares of Taj Holding Class A Common Stock, Taj Holding Class B Common Stock, or Taj Holding Class C Common Stock as to how the holder should vote. The summary of Rothschild's opinion set forth in this Proxy Statement-Prospectus is qualified in its entirety by reference to the full text of such opinion. In arriving at its opinion, Rothschild (i) reviewed the proposed terms and conditions of the Merger Transaction as set forth in the Merger Agreement, (ii) considered certain publicly available information relating to Taj Holding, (iii) considered and reviewed certain other financial and business information relating to Taj Holding and THCR, including financial forecasts provided to Rothschild by Taj Holding, (iv) considered and reviewed financial and business information including financial projections provided to Rothschild by THCR and (v) met with Taj Holding's and THCR's managements to discuss the businesses of Taj Holding and THCR, respectively. Rothschild also considered certain financial and market information for THCR and compared that data with similar data for other publicly-traded companies in businesses similar to those of also considered such other information, financial studies, analyses and investigations and financial, economic and market criteria that it deemed relevant. Rothschild's analyses were not adjusted for the dilution that would result from a possible 14% Payment. Furthermore, Rothschild's analyses did not reflect the Taj Mahal Expansion because without the Merger Transaction, or consent by the holders of the Bonds, Taj Holding would be unable to finance such a program. In addition, Rothschild did not make an independent evaluation or appraisal of any of the assets of Taj Holding, but was furnished with an appraisal by Appraisal Group International ("AGI") in March 1994 regarding the value of the Taj Mahal and AGI's appraisal in December 1995 regarding various parcels of land owned by Realty Corp. Rothschild was not requested to, and did not, solicit third party offers to acquire all or any part of Taj Holding, nor, to Rothschild's knowledge, has any interest in making such an offer been presented by any third party, including in response to the public disclosure regarding the Class A Agreement. Rothschild was also not asked to, and did not, express any opinion as to whether another transaction with THCR or its affiliates, or with any other entity, might provide more favorable terms to the holders of Taj Holding Class A Common Stock than the Merger Transaction. Rothschild's opinion was necessarily based solely upon information available to it and business, market, economic and other conditions as they existed on, and could be evaluated as of, the date of such opinion. In connection with its review and the preparation of its written opinion, Rothschild did not independently verify any of the foregoing information and relied on such information being complete and accurate in all material respects. Rothschild also relied upon certain projections furnished by Taj Holding's management, which it assumed had been reasonably prepared on bases reflecting the best currently available estimates and judgments of Taj Holding's management as to the future financial performance of Taj Holding. No representation can be made with respect to the ability of Taj Associates to achieve any projected results in the range of those projected by Taj Holding's management. The projections prepared by Taj Holding's management reflect their best available estimates and judgments at the time of preparation as to possible ranges of results in the forecasted periods based upon varying assumptions. The various forecasts present a wide range of possible results which are subject to a number of uncertainties. The following is a summary of the analyses that Rothschild utilized in arriving at its opinion as to the fairness of the consideration to be received by the holders of Taj Holding Class A Common Stock in connection with the Merger Transaction from a financial point of view, and that Rothschild discussed with the Board of Directors of Taj Holdings at its December 21, 1995 and January 4, 1996 meetings. Valuation of Taj Holding. For purposes of its opinion as to the fairness of the consideration to be received by holders of Taj Holding Class A Common Stock in connection with the Merger Transaction from a financial point of view, Rothschild employed three principal valuation methodologies: a publicly traded comparable company analysis, a discounted cash flow analysis, and a comparable transaction analysis. The methodologies used by Rothschild as described to the Board of Directors of Taj Holding at its December 21, 1995 and January 4, 1996 meetings, are described below. Publicly Traded Comparable Company Analysis. Rothschild reviewed the financial, operating and market performance of the following group of seven Atlantic City gaming companies with that of Taj Holding: Aztar Corporation, Bally Entertainment Corporation, Hollywood Casino Corporation, Harrah's Entertainment, Inc., Griffin Gaming & Entertainment, Inc., Showboat, Inc., and THCR (the "Core Comparable Group"). Rothschild also reviewed and compared the financial, operating and market performances of two other established jurisdiction gaming companies: Circus Circus Enterprises, Inc. and Mirage Resorts, Inc. Rothschild examined certain publicly available or estimated financial data of the Core Comparable Group, including, but not limited to, net revenues, EBITDA (earnings before interest, taxes, depreciation and amortization), EBIT (earnings before interest and tax), net income available to common, earnings per share, depreciation and amortization, interest expense, and capital expenditures. Rothschild also examined and compared various operating and credit ratios and certain capitalization data including, but not limited to, leverage ratios, interest coverage, and net debt to EBITDA. Rothschild also reviewed market data, including various trading multiples such as market capitalization to EBITDA and EBIT and stock price to earnings per share, equity market value to net cash flow (net income plus depreciation and amortization). Market capitalization is defined as the market value of a company's equity securities, plus preferred equity at liquidation value (including redeemable), plus the face value of all debt, plus minority interest, less cash and marketable securities. Taj Holding EBITDA and EBIT multiples are pro forma for the elimination of lease payments made to Realty Corp. and payments made under the Taj Services Agreement but before consideration of potential operating synergies and other cost reductions. The Core Comparable Group's market capitalization to latest twelve month ("LTM") EBITDA multiple ranged from 3.6x to 11.6x (with a mean and median of approximately 7.0x) and 6.5x for Taj Holding. The Core Comparable Group's market capitalization to estimated 1995 EBITDA multiple ranged from 4.2x to 7.5x (with a mean and median of approximately 6.0x and 6.5x, respectively) and 6.8x for Taj Holding. The Core Comparable Group's market capitalization to estimated 1996 EBITDA multiple ranged from 3.9x to 6.7x (with a mean and median of approximately 5.5x) and 5.9x for Taj Holding. The Core Comparable Group's market capitalization to estimated 1995 EBIT multiple ranged from 5.4x to 17.4x (with a mean and median, of approximately 11.0x and 9.0x, respectively) and 9.9x for Taj Holding. The Core Comparable Group's market capitalization to estimated 1995 revenues multiple ranged from 0.9x to 2.4x (with a mean and median of approximately 1.5x) and 1.7x for Taj Holdings. Rothschild drew no specific conclusion for this analysis but subjectively factored its observations from this analysis into its qualitative assessment of the relevant facts and circumstances. In addition, Rothschild considered other financial data (including margins and growth rates) as well as certain operating information such as fundamental gaming performance and efficiency ratios, for the Core Comparable Group. Discounted Cash Flow Analysis. Using a discounted cash flow analysis, Rothschild estimated the present value of the future cash flows that Taj Holding could be expected to produce over a five-year period from 1996 through 2000 under various assumptions and in accordance with Taj Holding's management projections excluding any incremental benefits or costs associated with the Merger Transaction or from an expansion of the Taj Mahal. Rothschild determined the value for the Taj Holding Class A Common Stock by adding (i) the present value (using discount rates ranging from 12.0% to 15.0%) of the five-year unleveraged free cash flows of Taj Holding and (ii) the present value of Taj Holding's 2000 terminal value, and subtracting (iii) the current debt outstanding net of any excess cash available. The terminal values were determined by multiplying 2000's projected EBITDA by a range of multiples determined based on the Core Comparable Group, as contained in the Publicly Traded Comparable Company Analysis (ranging from 4.5 times to 5.5 times 2000's EBITDA). Rothschild drew no specific conclusion from this analysis but subjectively factored its observations from this analysis into its qualitative assessment of the relevant facts and circumstances. Comparable Transaction Analysis. Rothschild reviewed selected acquisitions in the gaming industry, including among others, Caesar's World Inc./ITT Corp., Sahara Resorts/Sahara Casino Partners, Hilton Hotels/Bally's Grand, and Caesar's World/Caesar's New Jersey and considered various acquisition multiples such as transaction value to EBITDA and EBIT, offer price to earnings per share and equity offer value to net cash flow. Rothschild reviewed the Caesars World transaction because it is the most recently completed large gaming merger and acquisition transaction with significant Atlantic City operations. The Caesars World transaction is not, however, directly comparable to the Merger Transaction. The Comparable Transactions' transaction value to LTM EBITDA multiple ranged from 4.6x to 9.5x (with a mean, including the Caesars World transaction, of approximately 6.0x, and 5.5x without the Caesars World transaction, and a median of approximately 5.5x) and 6.5x for the Merger Transaction. Rothschild drew no specific conclusion from this analysis but subjectively factored its observations from this analysis into its qualitative assessment of the relevant facts and circumstances. Pro Forma Merger Analysis. Rothschild analyzed certain pro forma effects resulting from the Merger Transaction. In conducting its analysis, Rothschild relied upon certain assumptions described above and the financial projections provided by the managements of THCR and Taj Holding. Rothschild also reviewed, without independent verification, the estimates prepared by the respective managements of THCR and Taj Holding of cost reductions achievable as a result of the Merger Transaction. Rothschild also reviewed without independent verification, the estimates prepared by the management of Taj Holding of the projected effects of the Taj Mahal Expansion on operating results. Additionally, using the financial information and projections provided to Rothschild by Taj Holding's and THCR's respective managements, Rothschild reviewed the accretion of or dilution to THCR's 1996 and 1997 pro forma projected earnings per share resulting from the Merger Transaction; specifically, the elimination of lease payments to Realty Corp. and fees attributable to the Taj Services Agreement. This analysis revealed that the Merger Transaction would be generally dilutive to pro forma 1996 and 1997 earnings per share on the basis described. Rothschild drew no specific conclusion from this analysis but subjectively factored its observations from this analysis into its qualitative assessment of the relevant facts and circumstances. Other Factors. Rothschild considered such other factors as the fact that there is no established trading market for the shares of Taj Holding Class A Common Stock. However, Rothschild is aware of limited privately negotiated transactions in shares of Taj Holding Class A Common Stock. Rothschild considered and reviewed the financial terms of a recent privately negotiated block trade of shares of Taj Holding Class A Common Stock. Furthermore, consideration was also given to the net book value and liquidation value of Taj Holding. In arriving at its written opinion dated January 8, 1996 and in discussing its opinion with the Board of Directors of Taj Holding (including the Class B Directors), Rothschild performed certain financial analyses, portions of which are summarized above. The summary set forth above does not purport to be a complete description of Rothschild's analyses. Rothschild believes that its analyses must be considered as a whole and that selecting portions of its analyses could create an incomplete view of the process underlying the opinion. In addition, Rothschild may have given various analyses more or less weight than other analyses, and may have deemed various assumptions more or less probable than other assumptions, so that the ranges of valuations resulting from any particular analysis described above should not be taken to be Rothschild's view of the actual value of Taj Holding. The preparation of a fairness opinion is a complex process involving subjective judgments and is not necessarily susceptible to partial analysis or summary description. No company or transaction used in the publicly traded comparable company analysis or the comparable transaction analysis summarized above is identical to Taj Holding or the Merger Transaction. Accordingly, any such analysis of the value of the consideration paid to holders of Taj Holding Class A Common Stock involves complex considerations and judgments concerning differences in the potential financial and operating characteristics of the comparable companies as well as other factors relating to the trading and the acquisition values of the comparable companies. These and other limitations, including potential regulatory restrictions on gaming ownership, may detract from the usefulness of other publicly traded comparable company multiples or multiples from prior gaming acquisitions as valuation methodologies. In performing its analyses, Rothschild made numerous assumptions with respect to industry performance, general business, economic, market and financial conditions and other matters, many of which are beyond the control of Taj Holding and all of which are beyond the control of Rothschild. The results of the analyses performed by Rothschild are not necessarily indicative of actual values, which may be significantly more or less favorable than suggested by such analyses. The analyses described above were prepared solely as part of Rothschild's analysis of the fairness of the consideration to the holders of Taj Holding Class A Common Stock. The analyses do not purport to be appraisals or to reflect the prices at which Taj Holding might actually be sold or the actual trading value of Taj Holding and its affiliates' securities. Rothschild is a nationally recognized investment banking firm and is continually engaged in the valuation of businesses and their securities in connection with mergers, acquisitions, restructurings, leveraged buy-outs, and capital markets activities and in valuations for estate, corporate and other purposes. The Board of Directors of Taj Holding selected Rothschild to act as its financial advisor on the basis of Rothschild's reputation and Rothschild's familiarity with Taj Holding and the gaming industry in general and its experience in the restructuring of other public companies in similar types of transactions. In February 1995, Rothschild was retained, together with BT Securities, to act as financial advisor to Taj Holding and certain of its affiliates in connection with a proposed restructuring pursuant to which Rothschild received a $160,000 fee. Such retention has been terminated. In addition, Rothschild has previously acted as financial advisor to the Committee of Bondholders of Taj Funding in connection with the 1991 Restructuring of TTMC, Taj Funding, Taj Associates and TTMI for which it had received customary compensation for such advisory activities and, during the preceding two years, has performed investment banking and other financial advisory services for entities affiliated with Trump for which customary compensation was received. For rendering its opinion to the Board of Directors of Taj Holding, including the Class B Directors, and evaluating the financial aspects of the Merger Transaction, Rothschild has received a $300,000 fee and will be reimbursed for its reasonable out-of-pocket expenses and indemnified against certain liabilities, including liabilities arising under federal securities laws. In connection with a Taj Associates recapitalization proposal discussed in 1994, Taj Associates obtained an appraisal from AGI (the "AGI Report"), which concluded that the going concern value of the Taj Mahal, as of March 18, 1994, was approximately $1.1 billion. In the opinion of AGI, the AGI Report, which is subject to certain assumptions and qualifications, was prepared in conformity with the regulations of the Office of Thrift Supervision of the U.S. Department of the Treasury, the Uniform Standards of Professional Appraisal Practice, and the Office of the Comptroller of the Currency's written appraisal guidelines. In the course of its determination of the Taj Mahal's going concern value, AGI reviewed data relating to the subject property, Atlantic County and Atlantic City in general, the neighborhood of the site, the Atlantic City casino/hotel market, the past operating history of casino/hotels similar to the Taj Mahal, zoning, real estate taxes and assessments and the highest and best use for the property. AGI opined that the going concern value of the Taj Mahal, as of March 18, 1994, was approximately $1.1 billion. For purposes of the AGI Report, going concern value was defined as the value created by a proven property operation, with the subject property considered as a separate entity to be valued with a specific business establishment, which, in the case of the Taj Mahal, is as an operating casino/hotel facility. In reaching its conclusion with respect to the going concern value of the Taj Mahal, AGI considered the three generally recognized methods of valuing real estate, namely, (i) the cost approach, in which all improvements to the subject property are replaced as if new and any accrued depreciation is deducted to arrive at a net improvement value, (ii) the sales comparison approach, which is based upon a comparison of sales of similar properties, taking into consideration their minor differences and major similarities, and (iii) the capitalization of income approach, which converts the net operating income attributable to the real estate, after all expenses, into a valuation estimate. The capitalization of income approach capitalizes the income by an appropriate method and rate as derived from a market study of similar properties and/or competitive investments. Of the three valuation methods, AGI selected the capitalization of income approach as the basis for arriving at a going concern value because it provides the most reliable indication of value for an income producing property. AGI's value conclusion is based solely on the utilization of the capitalization of income approach. AGI concluded that annuity capitalization, utilizing the discounted cash flow technique, was the most appropriate method of capitalization. Such technique was comprised of five steps: (i) projection of the investment holding period in respect of the Taj Mahal, (ii) projection of annual casino revenues for the Taj Mahal for each year of the holding period, (iii) selection of a yield rate in order to discount to present value the projected cash flow and eventual value of the property upon reversion, (iv) projection of the reversionary, or residual, value of the property at the end of the projection period and (v) calculation of the net present value of the Taj Mahal to reflect its worth as an investment assuming (a) a required rate of return, (b) the property achieving cash flows as projected and (c) a reversion value of the property as projected. In implementing steps (i) through (v) above, AGI first utilized a 10-year holding period for the investment based on the conclusion that such amount of time was long enough to model the Taj Mahal's performance but short enough to reasonably estimate the expected income and expenses of the real estate. AGI then determined future casino revenues for the Taj Mahal by analyzing historical operating data, market share and revenue growth for the Taj Mahal and for the gaming industry in Atlantic City in general. Based on the foregoing, AGI projected income and expenses of the Taj Mahal for the years 1994 through 2004. Based upon an assumed growth rate of 4.0% per year, AGI projected that the Taj Mahal's total revenues would increase from $518.0 million in 1994 to $766.8 million in 2004. Based upon, among other things, the assumption that casino expense, the largest single expense category for the Taj Mahal, would remain constant at 45.0% of gross revenues, AGI projected that the Taj Mahal's gross operating profit would increase from $159.7 million to $225.9 million, and cash flow before debt service would increase from $123.9 million to $170.5 million, over the same period. Based on the fact that investors in real estate typically require a return several hundred basis points above what can be achieved in the financial markets, and that, in AGI's experience, return requirements for transactions involving casino and hotel facilities have ranged from 600 to 800 basis points above medium quality corporate bonds, AGI determined that an appropriate discount rate for the Taj Mahal would be in the range of approximately 13.0% to 16.0%. Based on the foregoing analysis, and taking into consideration the higher risk associated with investments in similar casino/hotel properties and AGI's cash flow projections for the Taj Mahal, AGI determined that, in the case of the Taj Mahal, a 15.0% discount rate would be appropriate. AGI then determined the reversionary value of the Taj Mahal by capitalizing the projected 11th year (2004) cash flow of the Taj Majal, which was $170.5 million, by a terminal rate of 10.0%. Such rate was selected based on the range of terminal rates currently employed by the market (from 8.0% to 11.0%) and taking into consideration the increased investment risks associated with a casino/hotel. Utilizing the 10.0% terminal rate, and assuming sales costs of 3.0%, AGI concluded that the net sale value of the Taj Mahal in 2004, the final year of the projections, would be approximately $1.65 billion. AGI then applied the 15.0% discount rate to the projected cash flow of the Taj Mahal for each year of the projected 10-year holding period, as well as to the net sales proceeds assumed to be received from a sale of the Taj Mahal in the eleventh year. Such calculation resulted in a total present worth for the Taj Mahal equal to $1.105 billion. Based on this figure, AGI concluded that the going concern value of the Taj Mahal as of March 18, 1994 was approximately $1.1 billion. The AGI Report assumed, among other things, that (i) Taj Associates holds good and marketable title to the property on which the Taj Mahal is located, (ii) information furnished to AGI by third parties is reliable, (iii) there are no hidden or unapparent conditions of the property, subsoil or structures that would render the property more or less valuable and (iv) there is full compliance with all applicable federal, state and local environmental regulations and laws and all applicable zoning and use regulations and restrictions, unless otherwise stated, defined and considered in the AGI Report. An appraisal is an estimate or opinion of value and cannot be relied upon as a precise measure of value of worth. The amount that Taj Associates might realize from the sale of the Taj Mahal maybe more or less than its appraised value. AGI did not solicit any offers or inquiries with respect to the Taj Mahal from potential purchasers, and therefore, the AGI Report should not be read to suggest that a buyer was, in fact, available or if one were available, that it would be willing to pay the appraised value. Accordingly, no assurance can be given as to the value which could be obtained from the sale of the Taj Mahal. Additionally, whatever the value of the Taj Mahal may be in a sale under the conditions assumed in the AGI Report, a sale under distress conditions would likely result in a substantially lower price. AGI has been engaged in the real estate appraisal business for approximately 40 years, maintaining offices in New York, New Jersey and Florida and employing 10 full-time appraisers. AGI has prior experience in appraising casino hotel properties in Atlantic City (including the Resorts Casino Hotel and Trump Plaza and Trump's Castle) and numerous casinos in Las Vegas, Nevada and in performing appraisals in conformity with regulations governing federal savings institutions. AGI was selected by management on the basis of its experience and expertise in evaluating income-producing properties, including hotels and casino hotels. The services performed by AGI were performed in accordance with the Code of Professional Ethics and the Standards of Professional Practice of the Appraisal Institute and the Uniform Standards of Professional Appraisal Practice of the Appraisal Foundation. AGI has no financial or other interest, direct or indirect, present or prospective, in the Taj Mahal or a personal interest or bias with respect to Taj Associates or any of its affiliates. AGI's employment and compensation were not contingent upon the amount of the valuation or on any action or event resulting from the analyses, opinions or conclusions in, or the use of, the AGI Report. In consideration for its services rendered to Taj Associates in connection with the AGI Report, AGI received a fee from Taj Associates of approximately $50,000. During the past six years, AGI has conducted a prior appraisal of the Taj Mahal for Taj Associates as well as appraisals of six other properties owned or controlled by Trump. AGI has performed appraisals of Trump Plaza for Plaza Associates, of Trump's Castle for TCA, of Crystal Palace for The Trump Organization, of Trump Tower for the Trump Organization, of The Plaza Hotel in New York City for Citibank, N.A. and of Mar-A-Lago Club for Trump. AGI received an aggregate of approximately $181,000 for performing such appraisals. A copy of the AGI Report has been filed as an Exhibit to the Schedule 13E-3 (copies of which can be obtained from the Public Reference Section at the SEC at prescribed rates). Holders of shares of Taj Holding Class A Common Stock should read the AGI report in its entirety for a description of the matters considered and procedures followed. In December of 1995, AGI provided a report to Taj Associates (the "AGI Specified Parcels Report") which concluded that the market value of the Specified Parcels was in the range of $80.2 million and $95.6 million. THCR--Opinion of DLJ. As part of its role as financial advisor to THCR, DLJ was asked to render an opinion to the THCR Special Committee as to the fairness to THCR of the aggregate consideration, as described below, to be paid by THCR in the transactions contemplated by the Merger Agreement. DLJ delivered to the THCR Special Committee its written opinion that, based upon, and subject to, the assumptions, factors, limitations and other matters set forth in its opinion, as of January 8, 1996, the aggregate consideration to be paid by THCR pursuant to the transactions contemplated by the Merger Agreement (as described therein) is fair to THCR from a financial point of view. The DLJ fairness opinion does not constitute a recommendation to any holder as to how to vote on the Merger Transaction and by its terms provides that no person other than the Special Committee may rely upon such opinion. DLJ assumed, with the THCR Special Committee's consent, that both the consideration to be paid and the consideration to be received by THCR pursuant to the Merger Agreement and the transactions contemplated thereby is as set forth in this paragraph. Not more than 4,550,000 (less the Reduced Amount (as defined below)) shares of THCR Common Stock (or equivalents of such shares) will be issued by THCR (excluding any shares of THCR Common Stock issued pursuant to the THCR Stock Offering), warrants to purchase not more than 600,000, 600,000 and 600,000 shares of THCR Common Stock at exercise prices not less than $30.00, $35.00 and $40.00 per share, respectively, and which will have a maturity of three, four and five years, respectively, will be issued by THCR, and not more than $60 million in cash plus the Cash Consideration will be expended (exclusive of any transaction fees and expenses). For purposes of DLJ's fairness opinion, the Reduced Amount shall be equal to a number of shares of THCR Common Stock determined by dividing (a) the Cash Consideration received by the holders of the Taj Holding Class A Common Stock in the transactions contemplated by the Merger Agreement by (b) $20.00. Upon consummation of the transactions contemplated by the Merger Agreement, (i) THCR will receive additional general partnership interests in THCR Holdings for contributing or causing its subsidiaries to contribute its total direct and indirect beneficial ownership of Taj Associates to THCR Holdings in an amount calculated pursuant to the THCR Holdings Partnership Agreement, (ii) THCR Holdings will be the beneficial owner of 100% of the outstanding equity of Taj Associates free and clear of any liens and encumbrances, (iii) immediately after giving effect to the transactions contemplated by the Merger Agreement, THCR will own the Specified Parcels free and clear of any liens and encumbrances and the lease between Taj Associates and Realty Corp. relating to the Specified Parcels shall terminate and Taj Associates shall no longer be obligated to make any payments to Realty Corp. and/or First Fidelity in connection with such Specified Parcels and (iv) the Taj Services Agreement will be terminated. DLJ assumed, with the THCR Special Committee's consent, that Taj Holdings LLC, TTMC, Taj Associates and Taj Funding will not have more than $800 million of net indebtedness (i.e., aggregate face value of outstanding indebtedness (including accrued cash interest and non-cash interest) less available cash (excluding any cage or restricted cash collectively on their balance sheets immediately prior to the consummation of the transactions contemplated by the Agreement. DLJ also assumed, with the THCR Special Committee's consent, that for the purposes of its opinion, the price of the THCR Common Stock will be no less than $20.00 per share (before deducting any underwriting discounts or commissions). THE FULL TEXT OF THE WRITTEN OPINION OF DLJ ADDRESSED TO THE THCR SPECIAL COMMITTEE DATED JANUARY 8, 1996 IS ATTACHED HERETO AS ANNEX B. HOLDERS OF THCR COMMON STOCK ARE URGED TO READ THE DLJ FAIRNESS OPINION IN ITS ENTIRETY FOR THE ASSUMPTIONS MADE, THE MATTERS CONSIDERED AND THE LIMITS OF THE REVIEW MADE BY DLJ. THE FOLLOWING DISCUSSION OF THE DLJ FAIRNESS OPINION IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FULL TEXT OF ANNEX B. DLJ did not make any recommendation as to the form or amount of consideration to be paid by THCR pursuant to the transactions contemplated by the Merger Agreement. Such consideration was determined by arm's-length negotiations among THCR, Donald Trump, Taj Holding and the other parties to the Class A Agreement in which negotiations DLJ advised THCR management. DLJ's opinion does not constitute an opinion as to the prices at which the THCR Common Stock will actually trade at any time, including the Effective Time. No restrictions or limitations were imposed by THCR or its affiliates upon DLJ with respect to the investigations made or the procedures followed by DLJ in rendering its opinion. DLJ was not requested to, and did not, solicit alternate transactions with third parties. In arriving at its opinion, DLJ reviewed a draft of the Merger Agreement and a draft of this Proxy Statement-Prospectus. DLJ also reviewed financial and other information that was publicly available or furnished to it by THCR and Taj Associates, including discussions with their respective managements. Included in the information provided to DLJ were certain financial projections of THCR and Taj Associates prepared by management of THCR and Taj Associates, respectively. In addition, DLJ compared certain financial and securities data of Taj Associates with various other companies whose securities are traded in the public markets, reviewed historical stock prices and trading volumes of THCR Common Stock, reviewed prices and financial data implied by the consideration paid in other business combinations and conducted such other financial studies, analyses and investigations DLJ deemed appropriate for the purposes of its opinion. DLJ also reviewed the draft pro forma combined condensed financial information for THCR and Taj Associates and the description of the business of each contained in the draft Proxy Statement- Prospectus. In rendering its opinion, DLJ, with the THCR Special Committee's consent, relied upon and assumed the accuracy, completeness and fairness of all of the financial and other information that was available to it from public sources, that was provided to it by THCR and Taj Associates or their respective representatives or that was otherwise reviewed by DLJ. DLJ also, with the THCR Special Committee's consent, assumed that the financial projections supplied to it were reasonably prepared on bases reflecting the best currently available estimates and judgments of the managements of THCR and Taj Associates as to the future operating and financial performance of THCR and Taj Associates. In particular, DLJ relied upon the estimates of the respective management of THCR and Taj Associates of the operating synergies and other cost reductions achievable as a result of the Merger Transaction. DLJ was not asked to assume, and did not assume, any responsibility for making any independent evaluation or appraisal of the assets or liabilities of THCR, Taj Associates or the Specified Parcels or for making any independent verification of any information reviewed by it, and DLJ did not independently verify any of such information. DLJ relied as to all legal matters with respect to THCR, Taj Holding and Taj Associates upon the advice of counsel to THCR. DLJ's opinion is necessarily based on economic, market, financial and other conditions as they existed on, and on the information made available to it as of, the date of its opinion. Although subsequent developments may affect its opinion, DLJ does not have any obligation to update, revise or reaffirm its no opinion as to the fairness of the allocation of the aggregate consideration to be paid by THCR among the parties receiving such consideration, DLJ has assumed that each of the companies shall have all appropriate licenses and permits upon consummation of the Merger Transaction, including all gaming licenses to conduct its business as conducted or proposed to be conducted. The following is a summary of certain factors considered and principal financial analyses performed by DLJ to arrive at its January 8, 1996 opinion and does not purport to be a complete description of the analyses performed by DLJ. DLJ performed certain procedures, including each of the financial analyses described below, and reviewed with the management of THCR and Taj Associates the assumptions on which such analysis were based and other factors, including the current and projected financial results of such companies. General. DLJ reviewed the financial terms contained in a draft of the Merger Agreement. DLJ assumed, with THCR's consent, that the price of the Common Stock will be not less than $20 per share (before deducting any underwriting fees and commissions). DLJ also reviewed (a) THCR's (i) Forms 10-Q for the quarters ended June 30 and September 30, 1995 and (ii) prospectuses for the June 1995 Stock Offering and the public offering of $155 million aggregate principal amount of Senior Notes (the "June 1995 Note Offering" together with the June 1995 Stock Offering, the "June 1995 Offerings"), (b) Taj Holding's (i) Form 10-K for the year ended December 31, 1994, (ii) Forms 10-Q for the quarters ended March 31, June 30 and September 31, 1995 and (iii) Form 8-K filed October 18, 1995 and (c) Taj Associates' (i) Form 10-K for the year ended December 31, 1994 and (ii) Forms 10-Q for the quarters ended March 31, June 30 and September 30, 1995. DLJ also reviewed the historical trading performance and trading volume of THCR Common Stock from the date of its initial public offering to December 22, 1995. DLJ also made a comparison of the historical trading performance of THCR Common Stock against (i) the Standard & Poors 400 Stock Index and against a DLJ constructed index of gaming companies (the "Gaming Index"). DLJ selected the following companies whose equity securities are publicly traded for inclusion in the Gaming Index based upon qualitative factors which DLJ deemed relevant based upon its experience in the gaming industry: Aztar Corporation, Bally Entertainment Corporation, Griffin Gaming & Entertainment, Inc., Harrah's Entertainment, Inc. Hollywood Casino Corporation, MGM Grand, Inc., Mirage Resorts, Incorporated, Rio Hotel & Casino, Inc. and Stratosphere Corporation. DLJ also reviewed the financial terms of a recent privately negotiated block trade of Taj Holding Class A Common Stock. Pro Forma Merger Analysis. DLJ analyzed certain pro forma effects resulting from the Merger Transaction. In conducting its analysis, DLJ relied upon the assumptions described above and the financial projections provided by the managements of THCR and Taj Associates. DLJ also reviewed, without independent verification, the estimates prepared by the respective managements of THCR and Taj Associates of operating synergies and other costs reductions achievable by combining the operations of THCR and Taj Associates. DLJ also reviewed, without independent verification, the estimates prepared by the management of Taj Associates of the projected effects of the Taj Mahal Expansion on operating results. DLJ analyzed the pro forma effect of such operating synergies, other cost reductions, and the Taj Mahal Expansion on earnings per share of THCR. Additionally, using the financial information and projections (normalized for non-recurring items) provided to DLJ by Taj Associates' and THCR's respective managements, DLJ reviewed the accretion of or dilution to THCR's 1995 pro forma earnings per share and 1996 and 1997 projected earnings per share resulting from the Merger Transaction. DLJ's analysis separately considered accretion/dilution (i) on an unadjusted basis, (ii) giving effect to the synergies and other cost reductions estimated by THCR's and Taj Associates' management, (iii) giving effect to the Taj Mahal Expansion and (iv) giving effect to the Taj Mahal Expansion and the synergies referred to in (ii) above. This analysis revealed that the Merger Transaction would be (a) dilutive to pro forma 1995 earnings per share, except on the basis described in (ii) above, projected 1996 earnings per share, and 1997 projected earnings per share on an unadjusted basis and (b) accretive to pro forma 1995 earnings per share on the basis described in (ii) above and 1997 projected earnings per share on each basis described in (ii) through (iv) above. DLJ also considered the effect on its analysis of a 10% and a 25% negative variance between actual results and the results projected by THCR's management. DLJ drew no specific conclusion from this analysis but subjectively factored its observations from this analysis into its qualitative assessment of the relevant facts and circumstances. Analysis of Certain Other Publicly Traded Companies. To provide contextual data and comparative market information, DLJ compared selected historical earnings and operating and financial ratios for Taj Associates to corresponding data and ratios of certain gaming companies whose securities are publicly traded. In conducting its analysis DLJ compared the ratios implied by the aggregate consideration to be paid by THCR in the transactions contemplated by the Merger Agreement (with and without accounting for the synergies and other costs reductions projected by THCR's and Taj Associates' management) to the ratios implied from the market valuation of companies comprising the Gaming Index. DLJ also separately compared the ratios implied by the aggregate consideration to be paid by THCR in the transactions contemplated by the Merger Agreement to the ratios implied from the market valuation of Bally Entertainment Corporation ("Bally Entertainment"); this comparison was made because of the concentration of Bally Entertainment's revenue base in the Atlantic City market. Although DLJ used these companies for comparison purposes, none of such companies, including but not limited to, Bally Entertainment, is directly comparable to Taj Associates or THCR, respectively. Data and ratios considered included: the ratio of enterprise value to latest twelve month ("LTM") revenues, LTM EBITDA, LTM EBIT, 1996 projected EBITDA, the ratio of market price to 1995 projected net income, the ratio of market price to 1996 projected net income and the ratio of market price to book value. All projected information for the companies in the Gaming Index and Bally Entertainment was obtained from Institutional Broker's Estimate Service, a third-party service which summarizes the estimates made by analysts employed by several investment banking firms and from the published reports of research analysts employed by investment banking firms, including analysts employed by DLJ. Enterprise value is defined as the sum of the face value of a company's debt plus the market value of its equity securities less excess cash. DLJ made a subjective assessment of the cash position of each company in the Gaming Index for the purpose of making an estimate of excess cash. EBITDA is earnings before interest, taxes, depreciation and amortization and was selected for analysis by DLJ because it is a widely used estimate of cash flows generated by operations. EBIT is earnings before interest and taxes and was selected by DLJ because it is a measure of operating performance. The ratio of enterprise value to LTM revenues ranged from 0.8x to 2.6x for the companies included in the Gaming Index, was 1.9x for Bally Entertainment and was 1.7x for Taj Associates (both with and without consideration of operating synergies and other cost reductions). The ratio of enterprise value for the companies included in the Gaming Index to LTM EBITDA ranged from 4.5x to 11.2x, was 7.1x for Bally Entertainment, was 6.8x for Taj Associates without giving effect to synergies and other cost reductions and was 6.0x for Taj Associates after giving effect to operating synergies and other cost reductions. The ratio of enterprise value for the companies included in the Gaming Index to LTM EBIT ranged from 6.0x to 17.3x, was 10.1x for Bally Entertainment, was 10.0x for Taj Associates without giving effect to synergies and other cost reductions and was 8.4x for Taj Associates after giving effect to operating synergies and other cost reductions. The ratio of enterprise value to 1996 projected EBITDA ranged from 4.1x to 8.4x for the companies included in the Gaming Index, was 6.0x for Bally Entertainment, was 5.9x for Taj Associates without giving effect to synergies and other cost reductions and was 5.3x for Taj Associates after giving effect to operating synergies and other cost reductions. The ratio of price to book value for the companies included the Gaming Index ranged form 0.8x to 4.1x, was 1.4x for Bally Entertainment and was 2.2x for Taj Associates. DLJ also separately considered the effects of the transaction costs associated with the Merger Transaction on these ratios. DLJ drew no specific conclusion from this analysis but subjectively factored its observations from this analysis into its qualitative assessment of the relevant facts and circumstances. Comparable Merger and Acquisition Analysis. DLJ reviewed the implied valuation multiples of: (i) selected merger and acquisition transactions including the majority of casino hotel company transactions completed since 1984 (the "Casino Resort Transactions"), (ii) selected single property merger and acquisition transactions in the gaming industry since 1984 (the "Single Property Transactions") and (iii) ITT's acquisition of Caesars World in 1995 (the "Caesars Transaction"). DLJ made the analysis referred to in (iii) above because it is the most recent, completed, large gaming merger and acquisition transaction with significant Atlantic City operations. Neither the Caesars Transaction nor the transactions described in (i) and (ii) above are directly comparable to the Merger or the Merger Transaction. DLJ compared the ratios implied by the aggregate consideration to be paid by THCR in the transactions contemplated by the Merger Agreement ("the Transaction") (with and without accounting for the synergies and other cost reductions estimated by THCR's and Taj Associates' respective managements) to the ratios implied by mean (calculated excluding the high and low multiple) of the Casino Resort Transactions, the mean (calculated excluding the high and low multiple) of the Single Property Transactions and the Caesars Transaction. The ratio of enterprise value implied by the consideration paid to LTM Revenues for the mean of the Casino Resort Transactions was 1.6x, 1.4x for the mean of the Single Property Transactions, 1.8x for the Caesars Transaction and 1.7x for the Transaction (both with and without giving effect to synergies and other cost reductions). The ratio of enterprise value implied by the consideration paid to LTM EBITDA for the mean of the Casino Transactions was 8.7x, 8.4x for the mean of the Single Property Transactions, 9.1x for the Caesars Transaction, 6.8x in the Transaction without giving effect to synergies and other cost reductions and 6.0x in the Transaction after giving effect to the synergies and other cost reductions. The ratio of enterprise value implied by the consideration paid to LTM EBIT was 12.2x for the mean of the Casino Resort Transactions, 11.0x for the mean of the Single Property Transactions, 13.5x the Caesars Transaction, 10.0x for the Transaction without giving effect to synergies and other cost reductions and 8.4x for the Transaction after giving effect to the synergies and other cost reductions. The multiple of equity value to book value was also compared and was 2.9x for the Caesars Transaction and 2.2x in the Transaction. DLJ drew no specific conclusion from this analysis but subjectively factored its observations from this analysis into its qualitative assessment of the relevant facts and circumstances. Discounted Cash Flow Valuation Analysis. DLJ performed a discounted cash flow analysis of Taj Associates. In conducting its analysis, DLJ relied on certain assumptions, financial projections and other information provided by the managements of THCR and Taj Associates. DLJ preformed its analysis using Taj Associates' management's estimates of future performance of the Taj Mahal and the future results of operations of Taj Associates (including and excluding the Taj Mahal Expansion). DLJ selected a range of terminal exit multiples of 5.0 to 10.0 times EBITDA and a range of weighted average cost of capital from 8% to 13% based upon its subjective judgments about, among other things, the capital markets, Taj Associates prospects and the gaming industry. The terminal exit multiple represents an estimate of the value of Taj Associates earnings at the end of the five year period covered by Taj Associates' management's projections. This analysis implied an enterprise value of Taj Associates ranging from $1,417 million to $2,022 million and $1,149 million to $1,544 million, with and without the Taj Mahal Expansion, respectively. DLJ drew no specific conclusion from this analysis but subjectively factored its observations from this analysis into its qualitative assessment of the relevant facts and circumstances. Contribution Analysis. DLJ reviewed the relative contribution to THCR after the Merger Transaction of THCR, as a stand alone enterprise, and Taj Associates, as a stand alone enterprise. DLJ relied upon estimates of 1995, 1996 and 1997 financial information provided by THCR's and Taj Associates' respective managements. THCR and Taj Associates provided 46.7% and 53.3%, respectively, of the combined enterprise value; these ratios would be 47.8% and 52.2%, respectively, if the costs of the Merger and the THCR Stock Offering were excluded. The projections made by Taj Associates' and THCR's management reveal, over the three year period, that THCR would provide from 37.3% to 54.2% of combined revenues; from 34.4% to 49.0% of combined EBITDA and from 37.0% to 50.0% of combined EBIT. On a corresponding basis Taj Associates would provide from 62.7% to 45.8% of combined revenues, from 65.6% to 51.0% of combined EBITDA and from 63.0% to 50.0% of combined EBIT. Taj Associates will contribute 55.0% of combined book value to THCR after the Merger Transaction. DLJ drew no specific conclusion from this analysis but subjectively factored its observations from this analysis into its qualitative assessment of the relevant facts and circumstances. The summary set forth above does not purport to be a complete description of the analyses performed and factors considered by DLJ. The preparation of a fairness opinion involves various determinations as to the most appropriate and relevant methods of financial analysis and the application of these methods to the particular circumstances and, therefore, such an opinion is not readily susceptible to summary description. Accordingly, notwithstanding the separate factors summarized above, DLJ believes that its analysis must be considered as a whole and that selecting portions of its analysis and the factors considered by it, without considering all analyses and factors, could create an incomplete view of the evaluation process underlying its opinions. Furthermore, in arriving at its fairness opinion, DLJ did not attribute any particular weight to any analysis, or factor considered by it, but rather made subjective and qualitative judgments as to the significance and relevance of and factor. In performing its analyses, DLJ made numerous assumptions with respect to industry performance, business and economic conditions and other matters. The analyses performed by DLJ are not necessarily indicative of actual values or future results, which may be significantly more or less favorable than suggested by such analyses. THCR selected DLJ as its financial advisor because DLJ is a nationally recognized investment banking firm and the principals of DLJ have substantial experience in transactions similar to the Merger, are familiar with THCR and its business and are familiar with the gaming industry. As part of its investment banking business, DLJ is continually engaged in the valuation of businesses and their securities in connection with mergers and acquisitions. In the ordinary course of business, DLJ actively trades the debt and equity securities of THCR, Taj Associates and their respective subsidiaries for its own account and for the accounts of its customers and, accordingly, may at any time hold a long or short position in such securities. Pursuant to the terms of an engagement letter THCR has agreed to pay DLJ a fee of $1,500,000 for rendering its fairness opinion. In addition, THCR has agreed to pay DLJ $4,500,000 upon consummation of the Merger; this fee may be reduced, at THCR's option to $2,500,000 in exchange for a specific allocation to DLJ of a portion of the underwriting commissions payable in connection with the Taj Note Offering. THCR has also agreed to reimburse DLJ for its out-of- pocket expenses (including the reasonable fees and expenses of DLJ's counsel) incurred in connection with its engagement (exclusive of expenses incurred in connection with the Offerings), and to indemnify DLJ and certain of its related persons against certain liabilities in connection with its engagement, including liabilities under the federal securities laws. The terms of the fee arrangement with DLJ, which DLJ and THCR believe are customary in transactions of this nature, were negotiated at arm's length between THCR and DLJ, and the THCR Special Committee and the Board of Directors of THCR was made aware of such arrangement, including the fact that a significant portion of the aggregate fee payable to DLJ is contingent upon consummation of the Merger. DLJ has been engaged to act as lead manager for the THCR Stock Offering and the Taj Note Offering for which DLJ will receive customary fees. Over the past two years, DLJ has rendered a variety of investment banking services to Trump and his affiliated entities for which it has received or will receive customary fees aggregating to $11.9 million (such amount includes fees for acting as lead manager for the June 1995 Offerings and for financial advisory services rendered in connection with the formation of THCR and excludes fees for services rendered in connection with the Merger Transaction). PURPOSE AND STRUCTURE OF THE MERGER TRANSACTION The purpose of the Merger Transaction is for THCR Holdings to acquire beneficial ownership of 100% of the equity of Taj Associates for the reasons described in "Special Factors--Background of the Merger Transaction" and "Special Factors--Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction." The Merger Transaction is designed to combine into one entity two "Four Star" Atlantic City casino hotels, operated by Trump, as well as the Indiana Riverboat, thereby creating one of the largest casino entertainment companies in the United States. THCR believes the acquisition of the Taj Mahal will strengthen THCR's position as a leader in the casino entertainment industry. THCR further believes that the combination of the Taj Mahal with THCR's existing and planned operations will provide opportunities for operational efficiencies, economies of scale and benefits from the talent, expertise and experience of management at the operating entities, and that the Merger Transaction will enhance THCR's presence in the growing Atlantic City market. The Merger will be effected by the merger of Merger Sub with and into Taj Holding. Upon the consummation of the Merger Transaction, including the contributions by Trump, TTMI, THCR and TM/GP, THCR Holdings will acquire beneficial ownership of 100% of the equity of Taj Associates. The Merger Transaction has been structured to ensure that THCR Holdings acquires 100% of the equity of Taj Associates through a series of substantially simultaneous transactions. The Merger Transaction is being undertaken at this time based upon current market conditions and the recent performance of Taj Associates and THCR, which contribute to the feasibility of the Merger Transaction. Although Taj Holding has in the past considered several recapitalization transactions, none of such recapitalizations were implemented. See "Special Factors--Background to the Merger Transaction." Other than certain variations of the current structure, THCR, THCR Holdings, Merger Sub and Taj Holdings LLC did not consider any alternatives to the Merger Transaction. The Offerings. The consummation of the Taj Note Offering and the THCR Stock Offering will occur simultaneously with, and will be conditioned upon, the closing of the Merger. There can be no assurance that the Taj Note Offering and the THCR Stock Offering will be able to be consummated on terms satisfactory to THCR. To the extent that holders of Taj Holding Class A Common Stock elect Stock Consideration, THCR will proportionately reduce the number of shares offered pursuant to the THCR Stock Offering and issue shares directly to such holders. In the event that either of such offerings is not consummated, THCR would pursue any other alternatives available to it at the time. The aggregate net proceeds, together with available cash of Taj Associates, will be used to (i) pay cash to those holders of Taj Holding Class A Common Stock electing to receive cash in the Merger ($40.5 million assuming all such holders elect Cash Consideration); (ii) redeem the outstanding Bonds at a redemption price equal to 100% of the principal amount thereof, (approximately $780 million assuming a redemption date of March 31, 1996), plus accrued interest to the date of redemption; (iii) redeem the outstanding shares of Taj Holding Class B Common Stock, as required in connection with the Bond redemption, at the redemption price of $.50 per share (approximately $400,000 in the aggregate); (iv) purchase, for $50 million in cash and 500,000 shares of THCR Common Stock, the Specified Parcels from Realty Corp.; and (v) pay to Bankers Trust $10 million to obtain releases of the liens and guarantees that Bankers Trust has in connection with certain of the Bankers Trust Indebtedness. THCR currently intends the Offerings to consist of the issuance in underwritten transactions of up to $140,000,000 of THCR Common Stock (including an over-allotment option) and up to $750,000,000 of aggregate principal amounts of Taj Notes with up to a ten year maturity. However, such financing could also involve public or private issuances of debt (including convertible debt or debt accompanied by warrants) and/or equity securities or foreign or domestic bank loans. THCR and its financial advisors have not yet determined the precise composition and terms of the foregoing financing. The actual amounts of debt and equity of various types raised will depend upon a number of factors, including market conditions, the price of THCR Common Stock and other factors beyond the control of THCR management. The interest rates on any debt financing could be fixed or floating, and such financing could require prepayments prior to maturity, periodically and/or result of asset dispositions, excess cash flow or issuances of equity. To the extent the Taj Note Offering involves commitments for future loans, such commitments may be conditioned on continued compliance by Taj Associates with the terms of the loan agreements and the absence of material adverse change in Taj Associates' business. Subject to the terms of existing indentures, any debt financing may be secured by some or all of Taj Associates' assets. Events of default resulting in acceleration of the maturity of any debt financing are likely to include failure to make required payments, breaches of covenants or representations, default with respect to other debt securities, failure to satisfy judgments and certain events of bankruptcy or insolvency. Any debt financing is likely to include a change of control provision and restrictive covenants prohibiting or limiting, among other things, mergers, sales of assets, making of acquisitions and other investments, capital expenditures, transactions with affiliates, entry into new lines of business, the incurrence of additional debt and liens and the payment of dividends. Non-compliance could result in the acceleration of such indebtedness. Specified Parcels Purchase. The Specified Parcels are currently leased by Taj Associates from Realty Corp. for approximately $3.3 million per year. See "Business of Taj Holding--Certain Indebtedness--First Fidelity Loan/Specified Parcels." Realty Corp. has outstanding indebtedness of approximately $78 million owing to First Fidelity in respect of the First Fidelity Loan which is due November 15, 1999. The First Fidelity Loan is currently secured on a first lien basis by the Specified Parcels, and Taj Associates has previously guaranteed the repayment of the First Fidelity Loan up to a maximum of $30 million. Trump has also personally previously guaranteed (up to a maximum of approximately $19.2 million), and pledged his direct and indirect equity interests in Taj Associates as collateral for, the First Fidelity Loan. As mortgagee, First Fidelity has the right, under certain circumstances, to terminate the lease on the Specified Parcels in the event the First Fidelity Loan is not paid when due. See "Business of Taj Holding--Certain Indebtedness--First Fidelity Loan/Specified Parcels." In order to secure future use of the Specified Parcels and eliminate all future lease payments on the Specified Parcels, Taj Associates expects to cause the First Fidelity Loan to be satisfied through the payment of $50 million in cash and 500,000 shares of THCR Common Stock and purchase the Specified Parcels from Realty Corp. for a nominal amount by exercising a purchase option with respect to the Specified Parcels. Upon consummation of the purchase of the Specified Parcels, (i) the lease relating to the Specified Parcels will be terminated, thus eliminating Taj Associate's rental obligations thereunder; (ii) the $30 million guaranty by Taj Associates of the First Fidelity Loan will be released; and (iii) Trump's guaranty of such indebtedness will be released and First Fidelity will relinquish its lien on Trump's direct and indirect equity interest in Taj Associates. The Specified Parcels may be part of the collateral securing the Taj Notes. See "Business of Taj Holdings--Certain Indebtedness--First Fidelity Loan/Specified Parcels." Consent and Release Payment. As part of the Merger Transaction, Taj Associates will pay $10 million to Bankers Trust in respect of certain of the Bankers Trust Indebtedness. The Bankers Trust Indebtedness is currently secured by, among other things, the TTMI Note, as well as a lien on Trump's direct and indirect equity interests in Taj Associates. In exchange for such payment, Bankers Trust will consent to the Merger Transaction and release its lien on Trump's direct and indirect equity interests in Taj Associates and the pledge of the TTMI Note. See "Business of Taj Holding--Certain Indebtedness-- TTMI Note." Trump Contribution and Consideration. In connection with the Merger Transaction, Trump will contribute to THCR Holdings his shares (consisting of 50% of the outstanding capital stock) of TTMC, the holder of a .01% general partnership interest in Taj Associates, and will cause TTMI to contribute to THCR Holdings and Taj Holdings LLC TTMI's 49.995% general partnership interest in Taj Associates. In addition, Trump will contribute to Taj Holding all of his Taj Holding Class C Common Stock, which will be canceled pursuant to the Merger Agreement. The Taj Holding Class C Common Stock provides Trump with the ability to elect a majority of the Board of Directors of, and thereby control, Taj Holding. It also affords Trump separate class voting rights in certain events, including the consummation of the Merger. The Taj Services Agreement, pursuant to which Trump has received or will receive $1,862,000, $1,353,000 and $1,566,000 during the years ended 1995, 1994 and 1993, respectively, as compensation for services rendered to Taj Associates, will also be terminated in connection with the Merger Transaction. In exchange for the contribution by Trump and TTMI to THCR Holdings and Taj Holdings LLC, Trump's directly held limited partnership interest in THCR Holdings will be modified and TTMI will receive a limited partnership interest in THCR Holdings. As a result of the Merger Transaction, Trump's aggregate beneficial ownership of limited partnership interests in THCR Holdings will decrease from 40% to %, with a % interest held directly by TTMI (assuming a price of $ per share of THCR Common Stock as the Market Value in connection with the Merger and as the public offering price in the THCR Stock Offering). Trump's limited partnership interest in THCR Holdings represents his economic interest in the assets and operations of THCR Holdings, and is convertible, at Trump's option, into 6,666,667 shares of THCR Common Stock (representing approximately 40% of the outstanding shares of THCR Common Stock after giving effect to such conversion). Upon consummation of the Merger Transaction (assuming a price of $ per share of THCR Common Stock as the Market Value in connection with the Merger and as the public offering price in the THCR Stock Offering), Trump's and TTMI's limited partnership interests in THCR Holdings will be convertible into shares of THCR Common Stock, representing approximately % of the then outstanding shares of THCR Common Stock. At the time that TTMI becomes a limited partner of THCR Holdings, THCR will issue shares of THCR Class B Common Stock to TTMI. THCR Class B Common Stock has voting power equivalent to the voting power of the THCR Common Stock into which a THCR Class B Common Stockholder's limited partnership interest in THCR Holdings is convertible. The THCR Class B Stock is not entitled to dividends or distributions. Upon conversion of all or any portion of a THCR Holdings limited partnership interest into shares of THCR Common Stock, the corresponding voting power of the THCR Class B Common Stock held (equal in voting power to the number of shares of THCR Common Stock issued upon such conversion) will be proportionately diminished. In connection with the Merger Transaction, THCR will issue to Trump a warrant to purchase an aggregate of 1.8 million shares of THCR Common Stock, one third of the underlying shares of which may be purchased on or prior to (i) the third anniversary of the issuance of the warrant at $30.00 per share, (ii) the fourth anniversary of the issuance of the warrant at $35.00 per share and (iii) the fifth anniversary of the issuance of the warrant at $40.00 per share. Upon consummation of the Merger Transaction, with respect to the shares underlying the warrant to be issued to Trump, Trump will be granted registration rights comparable to those he currently has with respect to the shares of THCR Common Stock issuable upon conversion of his limited partnership interest in THCR Holdings. See "Description of THCR Holdings Partnership Agreement." THCR Contribution and Consideration. In connection with the Merger Transaction, THCR will cause TM/GP, which will be an indirect wholly owned subsidiary of THCR after the Effective Time, and which holds 49.995% general partnership interest in Taj Associates, to contribute to THCR Holdings and Taj Holdings LLC its general partnership interest in Taj Associates, and will cause Taj Holding to contribute to TM/GP and will then cause TM/GP to contribute to THCR Holdings the shares (consisting of 50% of the outstanding capital stock) of TTMC held by Taj Holding. As a result of the Merger Transaction, THCR's beneficial equity interest in THCR Holdings will increase from 60% to %, including a % interest held directly by TM/GP (assuming a $ price per share of THCR Common Stock as the Market Value in connection with the Merger and as the public offering price in the THCR Stock Offering). SOURCES AND USES OF FUNDS IN THE MERGER TRANSACTION The following table sets forth the sources and uses of funds for the Merger Transaction (assuming a March 31, 1996 consummation). (/1/Assumes)all holders of Taj Holding Class A Common Stock elect Stock Consideration. (/2/Includes)the value of the shares of THCR Common Stock into which the limited partnership interests in THCR Holdings to be issued to Trump and TTMI in connection with the Merger Transaction will be convertible. (/3/Assumes)a price of $20.00 per share of THCR Common Stock. (/4/Excludes)accrued interest through the redemption date. CERTAIN EFFECTS OF THE MERGER TRANSACTION; OPERATIONS OF TAJ ASSOCIATES AFTER Upon consummation of the Merger Transaction, THCR will wholly own Taj Holding and TM/GP, and THCR Holdings will wholly own Taj Associates through THCR Holdings' 99% ownership of Taj Holdings LLC and 100% ownership of TTMC. THCR Holdings will then have a 100% interest in Taj Associates, including its net book value at September 30, 1995 and net loss for the nine months ended September 30, 1995, which were $52,899 and $(13,708), respectively, and THCR and Trump will have a % beneficial interest and % beneficial interest in Taj Associates, respectively, through their direct and indirect ownership of THCR Holdings. As of September 30, 1995, Trump's 50% interest in Taj Associates' net book value and net loss for the nine months ended September 30, 1995 amounted to $26,449 and $(6,854), respectively, TM/GP's 49.995% interest in Taj Associates' net book value at September 30, 1995 and net loss for the nine months ended September 30, 1995 amounted to $26,446 and $(6,853), respectively, and THCR, THCR Holdings, Merger Sub and Taj Holdings LLC did not have any interest in Taj Associates. Upon consummation of the Merger Transaction, THCR's % beneficial interest in Taj Associates' pro forma net book value as of September 30, 1995 and pro forma net loss for the nine months ended September 30, 1995 will be $ and $ , respectively (including TM/GP's % interest), and Trump's % beneficial interest in Taj Associates' pro forma net book value as of September 30, 1995 and net income for the nine months ended September 30, 1995 will be $ and $ , respectively (including TTMI's % interest). If all holders of Taj Holding Class A Common Stock elect Stock Consideration (assuming a price of $ per share of THCR Common Stock as the Market Value in connection with the Merger and as the public offering price in the THCR Stock Offering), upon consummation of the Merger Transaction (and assuming that the over-allotment option to be granted in connection with the THCR Stock Offering is exercised in full), such holders would hold approximately % of the outstanding shares of THCR Common Stock and would share in Taj Associates' earnings and growth through their investment in THCR. Holders of Taj Holding Class A Common Stock electing Cash Consideration would not continue to share in such earnings and growth as such holders would receive cash in the Merger. In connection with the Merger Transaction, THCR will cause TM/GP, the holder of a 49.995% general partnership interest in Taj Associates, to contribute to Taj Holdings LLC TM/GP's general partnership interest in Taj Associates, and will cause Taj Holding to contribute to TM/GP and will then cause TM/GP to contribute to THCR Holdings the shares of TTMC held by Taj Holding at the time of the Merger. Upon consummation of the Merger, the directors of Merger Sub will become the directors of the Surviving Corporation. At the Effective Time, the directors of TM/GP, other than Messrs. Trump, Ribis and Pickus, will resign as directors of TM/GP. Taj Associates' current officers and management team will continue to operate the Taj Mahal, and as a wholly owned subsidiary of THCR Holdings, the officers of THCR, the managing general partner of THCR Holdings, will oversee Taj Associates' management. It is expected that following the Merger Transaction, the business and operations of Taj Associates will be continued substantially as they are currently being conducted, other than undertaking the Taj Mahal Expansion. Following the consummation of the Merger Transaction, the registration under the Exchange Act of the Taj Holding Class A Common Stock and Taj Holding Class B Common Stock will be terminated and the Units will be delisted from the Amex. This termination of registration under the Exchange Act would make the provisions of the Exchange Act, such as the requirement to file periodic reports with the SEC, no longer applicable to Taj Holding. Taj Associates and Taj Funding, however, will continue to file periodic reports with the SEC under the Exchange Act as required in connection with the Taj Notes. Certain officers and directors of Taj Holding and certain officers and employees of Taj Associates have participated in negotiating the provisions of the Merger Transaction. These employees have received no additional compensation for such services. INTERESTS OF CERTAIN PERSONS IN THE MERGER TRANSACTION General. In considering the recommendation of the Board of Directors of THCR and the Board of Directors of Taj Holding with respect to the Merger Transaction, certain members thereof have certain interests in the Merger Transaction in addition to those of stockholders generally. Of the nine members of the Board of Directors of Taj Holding, two (Trump and Nicholas L. Ribis) are also directors of THCR, and two (Robert M. Pickus and John P. Burke) are executive officers of THCR and, therefore, may be deemed to have a conflict with respect to the Merger Transaction, given that THCR is the other party to the Merger Agreement and THCR Holdings will acquire 100% of the equity of Taj Associates if the Merger Transaction is consummated. In addition, Messrs. Kelly, First, Ribis and Trump are directors of Realty Corp. Furthermore, Mr. Ribis, the Chief Executive Officer of Taj Associates and Vice President of Taj Holding and TM/GP, is THCR's President, Chief Executive Officer and Chief Financial Officer, Mr. Pickus, the Executive Vice President of Corporate and Legal Affairs of Taj Associates, is THCR's Executive Vice President and Secretary, and Mr. Burke, Vice President of TM/GP, is THCR's Corporate Treasurer. See "Management of THCR" and "Management of Taj Holding." In addition to Trump's position as the Chairman of the Board of THCR and Taj Holding, he currently owns 50% of the equity of Taj Associates and approximately 40% of THCR Holdings. In consideration for the contribution of his interests in Taj Associates, Trump will receive certain consideration which is different from the consideration to be received by the holders of Taj Holding Class A Common Stock in the Merger. See "--Related Merger Transactions." To the best knowledge of THCR, THCR Holdings, Merger Sub, Taj Holdings LLC, TM/GP and Taj Holding, no director or officer of any of THCR, THCR Holdings, Merger Sub, Taj Holdings LLC, TM/GP or Taj Holding beneficially owns any shares of Taj Holding Class A Common Stock or Taj Holding Class B Common Stock, except as set forth "Security Ownership of Certain Beneficial Owners and Management of THCR" and "Security Ownership of Certain Beneficial Owners and Management of Taj Holding." Indemnification of Directors and Officers; Insurance. Pursuant to the Merger Agreement, for a period of six years after the Effective Time, each of the Surviving Corporation and TM/GP will, and THCR will cause each of the Surviving Corporation and TM/GP to, provide to the former officers and directors of Taj Holding (the "Taj Holding Indemnified Parties") indemnification as provided in the THCR Certificate of Incorporation and THCR By-Laws in effect as of the date of the Merger Agreement. In addition, THCR has agreed, and has agreed to cause the Surviving Corporation and TM/GP to agree, that until six years from the Effective Time, unless otherwise required by law, the certificate of incorporation and by-laws of the Surviving Corporation and TM/GP shall not be amended, repealed or modified to reduce or limit the rights of indemnity afforded to the present and former directors, officers and employees of Taj Holding and TM/GP (including, without limitation, with respect to the Merger Transaction) or the ability of the Surviving Corporation or TM/GP to indemnify such persons, nor to hinder, delay or make more difficult the exercise of such rights of indemnity or the ability to indemnify. The Merger Agreement further provides that for such six years after the Effective Time, the Surviving Corporation and TM/GP shall, and THCR shall cause the Surviving Corporation and TM/GP to, purchase and maintain in effect directors' and officers' liability insurance policies covering the Taj Holding Indemnified Parties on terms no less favorable than the terms of the current insurance policies' coverage or, if such directors' and officers' liability insurance is unavailable for an amount not greater than 150% of the premium paid by Taj Holding (on an annualized basis) for directors' and officers' liability insurance during the period from January 1, 1996 to the Effective Time (the "Current D&O Premium"), the Surviving Corporation and TM/GP shall obtain as much insurance as can be obtained for a premium not in excess (on an annualized basis) of such amount. See "The Merger Agreement-- Idemnification and Insurance." CERTAIN FEDERAL INCOME TAX CONSEQUENCES Holders of Taj Holding Class A Common Stock and holders of Taj Holding Class B Common Stock and Bonds should consult their tax advisers concerning the tax implications of the Merger Transaction and of the ownership and disposition of their stock or debt interests under applicable state, local, foreign income and other tax laws. The exchange of Taj Holding Class A Common Stock for cash or THCR Common Stock in the Merger and the redemption of the Bonds and the Taj Holding Class B Common Stock is anticipated to be a taxable event for the holders thereof. This Proxy Statement-Prospectus is being furnished to the stockholders of THCR in connection with the THCR Special Meeting and to the stockholders of Taj Holding in connection with the Taj Holding Special Meeting. The THCR Special Meeting will be held at 10:00 a.m. on March , 1996 at . The Taj Holding Special Meeting will be held at 10:00 a.m. on March , 1996 at . This Proxy Statement-Prospectus and the accompanying forms of proxy are first being mailed to stockholders on or about February , 1996. At the THCR Special Meeting, holders of THCR Common Stock and THCR Class B Common Stock will be asked to approve the Merger Transaction, which approval will constitute approval and adoption of the Merger Agreement. At the THCR Special Meeting, stockholders of THCR will also consider and vote upon such other matters as may properly be brought before the THCR Special Meeting. THE BOARD OF DIRECTORS OF THCR HAS UNANIMOUSLY APPROVED THE TERMS OF THE MERGER TRANSACTION AND THE MERGER AGREEMENT AND RECOMMENDS A VOTE FOR APPROVAL OF THE MERGER TRANSACTION. RECORD DATE; VOTING RIGHTS; PROXIES The Board of Directors of THCR has fixed the close of business on February , 1996 as the THCR Record Date for determining holders entitled to notice of and to vote at the THCR Special Meeting. The proposed issuance of shares of THCR Common Stock to be issued as part of the THCR Stock Offering will occur after the THCR Record Date and such shares will not be entitled to vote at the Special Meeting. As of the THCR Record Date, there were 10,066,667 shares of THCR Common Stock issued and outstanding, each of which entitles the holder thereof to one vote per share and there were 1,000 shares of THCR Class B Common Stock issued and outstanding (all of which were held by Trump), each of which entitles the holder thereof to 6,666,667 votes per share. The voting power of the shares of THCR Class B Common Stock held by Trump equals the voting power of the number of shares of THCR Common Stock issuable upon the conversion of Trump's limited partnership interest in THCR Holdings into THCR Common Stock. The THCR Class B Common Stock is intended to provide Trump with a voting interest in THCR which is proportionate to his equity interest in THCR Holdings' assets represented by his limited partnership interest. THCR does not know of any matters other than as described in the Notice of Special Meeting that are to come before the THCR Special Meeting. All shares of THCR Common Stock and THCR Class B Common Stock represented by properly executed proxies will, unless such proxies have previously been revoked, be voted in accordance with the instructions indicated in such proxies. IF NO INSTRUCTIONS ARE INDICATED, SUCH SHARES WILL BE VOTED FOR APPROVAL OF THE MERGER TRANSACTION. If any other matter or matters are properly presented for action before the THCR Special Meeting, the persons named in the enclosed form of proxy and acting thereunder will have the discretion to vote on such matters in accordance with their best judgment, unless such authorization is withheld. A stockholder who has given a proxy may revoke it at any time prior to its exercise by giving written notice thereof to the Secretary of THCR, by signing and returning a later dated proxy, or by voting in person at the THCR Special Meeting; however, mere attendance at the THCR Special Meeting will not itself have the effect of revoking the proxy. The presence in person or by proxy of the holders of the shares representing a majority of the outstanding voting power of the THCR Common Stock and THCR Class B Common Stock is necessary to constitute a quorum in connection with the transaction of business at the THCR Special Meeting. Shares for which duly executed proxies have been received but with respect to which holders of shares have abstained from voting are counted in determining the shares present at the THCR Special Meeting. Approval of the Merger Transaction will require the affirmative vote of (i) the holders of a majority of the outstanding shares of THCR Common Stock (excluding directors and executive officers of THCR and their affiliates) voting as a separate class (representing the approval of a majority of THCR's unaffiliated stockholders); and (ii) the holders of shares representing a majority of the outstanding voting power of THCR Common Stock and THCR Class B Common Stock voting together as a single class. As of the THCR Record Date, (i) directors and executive officers of THCR and their affiliates had the power to vote shares representing approximately % of the outstanding shares of THCR Common Stock; and (ii) Trump had the power to vote 100% of the outstanding shares of THCR Class B Common Stock, representing approximately 40% of the voting power of the shares of THCR Class A Common Stock and THCR Class B Common Stock. All of such officers, directors and affiliates have indicated that they intend to vote their shares for approval of the Merger Transaction. Pursuant to the Trump/THCR Voting Agreement, Trump has agreed to vote his shares of THCR Class B Common Stock for approval of the Merger Transaction and at the THCR Special Meeting, such shares will be voted accordingly. For purposes of determining whether the Merger Transaction has received the required number of votes for approval at the THCR Special Meeting, abstentions will have the same effect as a negative vote. In instances where recordholders, such as brokers, are prohibited from exercising discretionary authority for beneficial owners who have not returned a proxy, those shares will not be counted in determining the shares present at the meeting and entitled to vote with respect to that matter and will have the same effect as a negative vote. THCR will bear the costs of soliciting proxies from its stockholders. In addition to the use of the mails, proxies may be solicited by the directors and officers of THCR by personal interview, telephone or telegram. Such directors and officers will not receive additional compensation for such solicitation but may be reimbursed for out-of-pocket expenses incurred in connection therewith. THCR has retained MacKenzie Partners, Inc., a proxy soliciting firm, to assist in the solicitation of proxies and will pay such firm a fee, estimated not to exceed $15,000 plus reimbursement of reasonable out-of-pocket expenses, which are not expected to exceed $15,000. Arrangements may also be made with brokerage firms and other custodians, nominees and fiduciaries to forward proxy solicitation materials to the beneficial owners of shares of THCR Common Stock held of record by such persons, in which case THCR will reimburse such brokerage firms, custodians, nominees and fiduciaries for reasonable out-of-pocket expenses incurred by them in connection therewith. THE TAJ HOLDING SPECIAL MEETING At the Taj Holding Special Meeting, the holders of Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock will be asked to approve and adopt the Merger Agreement. At the Taj Holding Special Meeting, stockholders of Taj Holding will also consider and vote upon such other matters as may properly be brought before the Taj Holding Special Meeting. THE BOARD OF DIRECTORS OF TAJ HOLDING HAS UNANIMOUSLY APPROVED THE TERMS OF THE MERGER AND RECOMMENDS A VOTE FOR APPROVAL AND ADOPTION OF THE MERGER AGREEMENT. RECORD DATE; VOTING RIGHTS; PROXIES The Board of Directors of Taj Holding has fixed the close of business on February , 1996 as the Taj Holding Record Date for determining the holders entitled to notice of and to vote at the Taj Holding Special Meeting. As of the Taj Holding Record Date, there were 1,350,000 shares of Taj Holding Class A Common Stock, 780,242 shares of Taj Holding Class B Common Stock and 1,350,000 shares of Taj Holding Class C Common Stock (all of which were held by Trump) issued and outstanding, each of which entitles the holder thereof to one vote per share. Taj Holding does not know of any other matters other than as described in the Notice of Special Meeting that are to come before the Taj Holding Special Meeting. All shares of Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock represented by properly executed proxies will, unless such proxies have previously been revoked, be voted in accordance with the instructions indicated in such proxies. IF NO INSTRUCTIONS ARE INDICATED, SUCH SHARES WILL BE VOTED FOR APPROVAL AND ADOPTION OF THE MERGER AGREEMENT. If any other matter or matters are properly presented for action before the Taj Holding Special Meeting, the persons named in the enclosed form of proxy and acting thereunder will have the discretion to vote on such matters in accordance with their best judgment, unless such authorization is withheld. A stockholder who has given a proxy may revoke it at any time prior to its exercise by giving written notice thereof to the Secretary of Taj Holding, by signing and returning a later dated proxy, or by voting in person at the Taj Holding Special Meeting; however, mere attendance at the Taj Holding Special Meeting will not itself have the effect of revoking the proxy. The presence in person or by proxy of the holders of a majority of the outstanding shares of each of the Taj Holding Class B Common Stock and Taj Holding Class C Common Stock is necessary for the transaction of business at the Taj Holding Special Meeting. Shares for which duly executed proxies have been received but with respect to which holders of shares have abstained from voting are counted in determining the shares present at the Taj Holding Special Meeting. Approval and adoption of the Merger Agreement will require the affirmative vote of the holders of a majority of the outstanding shares of each of the Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock, each voting as a separate class. As of the Taj Holding Record Date, (i) directors and executive officers of Taj Holding and their affiliates had the power to vote shares representing approximately % of the Taj Holding Class A Common Stock; (ii) directors and executive officers of Taj Holding and their affiliates had the power to vote shares representing approximately % of the Taj Holding Class B Common Stock; and (iii) Trump had the power to vote 100% of the outstanding shares of Taj Holding Class C Common Stock. All of such officers, directors and affiliates have indicated that they intend to vote their shares for approval and adoption of the Merger Agreement. Pursuant to the Trump/Taj Holding Voting Agreement, Trump has agreed to vote his shares of Taj Holding Class C Common Stock for approval and adoption of the Merger Agreement and at the Taj Holding Special Meeting, such shares will be voted accordingly. Pursuant to the Class A Agreement, the holders of 701,840 shares of Taj Holding Class A Common Stock (representing approximately 52% of the outstanding shares of Taj Holding Class A Common Stock) agreed to vote in favor of the Merger Agreement and at the Taj Holding Special Meeting, such shares will be voted accordingly. For purposes of determining whether the Merger Agreement has received the required number of votes for approval at the Taj Holding Special Meeting, abstentions will have the same effect as a negative vote. In instances where recordholders, such as brokers, are prohibited from exercising discretionary authority for beneficial owners who have not authorized the vote on a matter, those shares will not be counted in determining the shares present at the meeting and entitled to vote with respect to that matter and will have the same effect as a negative vote. Taj Holding will bear the costs of soliciting proxies from its stockholders. In addition to the use of the mails, proxies may be solicited by the directors and officers of Taj Holding by personal interview, telephone or telegram. Such directors and officers will not receive additional compensation for such solicitation but may be reimbursed for out-of-pocket expenses incurred in connection therewith. Taj Holding has retained MacKenzie Partners, Inc., a proxy soliciting firm, to assist in the solicitation of proxies and will pay such firm a fee, estimated not to exceed $15,000, plus reimbursement of reasonable out-of-pocket expenses, which are not expected to exceed $15,000. Arrangements may also be made with brokerage firms and other custodians, nominees and fiduciaries to forward proxy solicitation materials to the beneficial owners of shares of Taj Holding Class A Common Stock and Taj Holding Class B Common Stock held of record by such persons, in which case Taj Holding will reimburse such brokerage firms, custodians, nominees and fiduciaries for reasonable out-of-pocket expenses incurred by them in connection therewith. Each holder of Taj Holding Class A Common Stock will receive an Election Form together with this Proxy Statement-Prospectus permitting each holder of Taj Holding Class A Common Stock to elect to receive only Stock Consideration or only Cash Consideration. Any holder of Taj Holding Class A Common Stock who wishes to receive Cash Consideration must send the Election Form properly completed to the Exchange Agent on or before 5:00 p.m. on the Election Deadline. Holders of the Taj Holding Class A Common Stock who (i) fail to complete properly the Election Form, (ii) fail to send the Election Form to the Exchange Agent prior to the Exchange Deadline or (iii) make no election, shall be deemed to have elected to receive the Stock Consideration. Any Election Form may be revoked prior to the Election Deadline by submitting a new Election Form to the Exchange Agent. HOLDERS OF TAJ HOLDING CLASS A COMMON STOCK AND TAJ HOLDING CLASS B COMMON STOCK SHOULD NOT SEND THEIR STOCK CERTIFICATES WITH THEIR PROXY CARDS. HOLDERS OF TAJ HOLDING CLASS A COMMON STOCK WHO WISH TO RECEIVE CASH CONSIDERATION MUST SEND THE ELECTION FORM TO THE EXCHANGE AGENT ON OR BEFORE THE ELECTION DEADLINE. SEE "THE MERGER AGREEMENT--ELECTION PROCEDURES." The following description of certain terms of the Merger Agreement is only a summary and does not purport to be complete. This discussion is qualified in its entirety by reference to the complete text of the Merger Agreement, a copy of which is attached hereto as Annex A and incorporated herein by reference. Stockholders of THCR and Taj Holding are urged to read the Merger Agreement in its entirety. The Merger Agreement provides that, subject to the satisfaction or waiver of the conditions to the Merger contained therein, Merger Sub will be merged with and into Taj Holding, in accordance with the DGCL, whereupon the separate existence of Merger Sub will cease and Taj Holding will become the Surviving Corporation. At the Effective Time, the conversion of Taj Holding Class A Common Stock and the conversion of shares of the Common Stock of Merger Sub will be effected as described below. The current certificate of incorporation and by-laws of Merger Sub will become the certificate of incorporation and by- laws of the Surviving Corporation, except that the certificate of incorporation of the Surviving Corporation will be amended to change the name of Merger Sub to "Taj Mahal Holding Corp." The directors of Merger Sub immediately prior to the Effective Time will become the directors of the Surviving Corporation and the officers of Taj Holding immediately prior to the Effective Time will become the officers of the Surviving Corporation, in each case until their respective successors are duly elected and qualified. The Merger Agreement provides that the closing of the Merger (the "Closing") will take place as promptly as practicable (and in any event within two business days) after satisfaction or waiver of certain terms and conditions, including conditions to Closing, contained in the Merger Agreement. A soon as practicable after the Closing, Taj Holding and Merger Sub will file, or cause to be filed, a certificate of merger with the Secretary of State of the State of Delaware (the "Certificate of Merger"). The Effective Time will be the time such filing is accepted for filing by the Secretary of State of the State of Delaware or at such other time as set forth in the Certificate of Merger. The Merger Agreement provides that, at the Effective Time, (i) each share of Taj Holding Class A Common Stock outstanding immediately prior to the Effective Time will, except as otherwise provided in the Merger Agreement, be converted into and represent the right to receive, at the holder's election, either $30.00 in cash or that number of fully paid nonassessable shares of THCR Common Stock determined by dividing $30 by the Market Value; (ii) all shares of Taj Holding Class C Common Stock outstanding immediately prior to the Effective Time will be canceled; and (iii) each share of the Common Stock of Merger Sub outstanding immediately prior to the Effective Time will be converted into and represent the right to receive one fully paid and nonassessable share of Common Stock, par value $0.01 per share, of the Surviving Corporation. "Market Value" is defined in the Merger Agreement as the average of the high and low per share sales prices of the THCR Common Stock during the fifteen trading days immediately preceding the Effective Time or, if THCR and Taj Holding mutually agree, during any such other period as agreed under the Class A Agreement. Immediately prior to the Effective Time, Taj Holding will cause each share of Taj Holding Class B Common Stock outstanding prior to such time to be redeemed at $.50 per share in accordance with the provisions of the Taj Holding Certificate of Incorporation and the Bond Indenture. Each share of Taj Holding Class A Common Stock held by Taj Holding as treasury stock immediately prior to the Effective Time or owned by any direct or indirect subsidiary of Taj Holding immediately prior to the Effective Time will be canceled, and no conversion or payment will be made with respect thereto. The Merger Agreement provides that, prior to the Effective Time, THCR and Taj Holding Prior will designate Continental Stock Transfer & Trust Company, or another mutually acceptable bank or trust company, to act as the Exchange Agent. Taj Holding will, or will cause the Exchange Agent to, send the Election Form, in form satisfactory to THCR, to each holder of Taj Holding Class A Common Stock together with this Proxy Statement- Prospectus. Each Election Form will permit each holder of Taj Holding Class A Common Stock (or the beneficial owner through appropriate and customary documentation and instructions) to elect to receive either the Stock Consideration or the Cash Consideration. Taj Holding will use its best efforts to make available one or more Election Forms as may be reasonably requested by all persons who become holders (or beneficial owners) of Taj Holding Class A Common Stock between the record date established for purposes of the Taj Holding Special Meeting and the Election Deadline. Any holder of Taj Holding Class A Common Stock who wishes to receive Cash Consideration in lieu of Stock Consideration must send the Election Form properly completed to the Exchange Agent at the address set forth in the Election Form on or before the Election Deadline. Holders of the Taj Holding Class A Common Stock who (i) fail to complete properly the Election Form, (ii) fail to send the Election Form to the Exchange Agent prior to the Election Deadline or (iii) make no election, will be deemed to have elected to receive the Stock Consideration. Any Election Form may be revoked prior to the Election Deadline by submitting a new Election Form to the Exchange Agent. In addition, all Election Forms will automatically be deemed revoked if the Exchange Agent is notified in writing by Taj Holding and THCR that the Merger has been abandoned or the Merger Agreement has been terminated. Subject to the terms of the Merger Agreement, the determination of the Exchange Agent will be binding and conclusive as to whether or not the Election Form has been properly or timely submitted or revoked. Neither the Exchange Agent, Taj Holding, THCR nor Merger Sub will be under any obligation to notify any person of any defect in an Election Form or the revocation thereof. SURRENDER AND PAYMENT; EXCHANGE FUND The Merger Agreement provides that, as soon as practicable after the Effective Time, THCR will instruct the Exchange Agent to mail to each holder of a certificate or certificates evidencing shares of Taj Holding Class A Common Stock (other than Dissenting Shares) (the "Taj Holding Certificates") (i) a letter of transmittal (which will specify that delivery will be effected, and risk of loss and title to the Taj Holding Certificates will pass, only upon proper delivery of such Taj Holding Certificates to the Exchange Agent) and (ii) instructions to effect the surrender of the Taj Holding Certificates in exchange for Merger Consideration. Each holder of Taj Holding Class A Common Stock, upon surrender to the Exchange Agent of such holder's Taj Holding Certificates with the letter of transmittal, duly executed, and such other customary documents as may be required pursuant to such instructions, will be given the amount to which such holder is entitled to, pursuant to the Merger Agreement, of (i) certificates evidencing shares of THCR Common Stock (the "THCR Certificates") as payment of the Stock Consideration, (ii) cash as payment of the Cash Consideration (without any interest accrued thereon), (iii) dividends or distributions declared or made on the THCR Common Stock after the Effective Time and payable between the Effective Time and the time of such surrender (the "THCR Dividends") and/or (iv) cash for payment of fractional shares of THCR Common Stock (as described below). Until so surrendered, each Taj Holding Certificate will after the Effective Time represent for all purposes only the right to receive THCR Certificates or cash, as the case may be. After the Effective Time, there will be no further registration of transfers of Taj Holding Class A Common Stock. THCR will establish reasonable procedures for the delivery of THCR Certificates or cash, as the case may be, to holders of Taj Holding Class A Common Stock whose Taj Holding Certificates have been lost, destroyed or mutilated. At the Closing, THCR will deposit in trust with the Exchange Agent, for the benefit of the holders of Taj Holding Class A Common Stock, the appropriate amount to which such holders are entitled, pursuant to the Merger Agreement, of THCR Certificates for payment of the Stock Consideration, cash for payment of the Cash Consideration, THCR Dividends, if any, and cash for payment of fractional shares of THCR Common Stock (collectively, the "Exchange Fund"). The Exchange Agent will, pursuant to irrevocable instructions, make the payments to the holders of the Taj Holding Class A Common Stock as set forth in the Merger Agreement. The Exchange Agent will not be entitled to vote or exercise any rights of ownership with respect to the THCR Common Stock held by it from time to time, except that it will hold all THCR Dividends paid or distributed for the accounts of the persons entitled thereto. If any delivery of the Merger Consideration is to be made to a person other than the registered holder of the Taj Holding Certificates surrendered in exchange therefor, it will be a condition to such delivery that the Taj Holding Certificate so surrendered will be properly endorsed or be otherwise in proper form for transfer and that the person requesting such delivery will (i) pay to the Exchange Agent any transfer or other taxes required as a result of delivery to a person other than the registered holder or (ii) establish to the satisfaction of the Exchange Agent that such tax has been paid or is not payable. Any portion of the Exchange Fund that remains undistributed to the holders of the Taj Holding Class A Common Stock for 180 days after the Effective Time will be delivered to THCR upon demand. Any holder of Taj Holding Class A Common Stock who has not complied with the exchange provisions of the Merger Agreement within 180 days after the Effective Time will have no further claim upon the Exchange Agent and will thereafter look only to THCR for conversion or payment, as the case may be, of the Merger Consideration, THCR Dividends and fractional shares of THCR Common Stock. If a Taj Holding Certificate has not been surrendered prior to the date on which any receipt of Merger Consideration, THCR Dividends or cash for payment of fractional shares of THCR Common Stock would otherwise escheat to or become the property of any governmental agency, such Taj Holding Certificate will, to the extent permitted by applicable law, be deemed to be canceled and no money or other property will be due to the holder thereof. The Exchange Agent will invest cash in the Exchange Fund, as directed by THCR, on a daily basis, provided that all such investments will be in obligations of or guaranteed by the United States of America with remaining maturities not exceeding 180 days, in commercial paper obligations receiving the highest rating from either Moody's Investors Services, Inc. or Standard & Poor's Ratings Group, or in certificates of deposit or banker's acceptances of commercial banks with capital exceeding $500 million (collectively, "Permitted Investments"). The maturities of Permitted Investments will be such as to permit the Exchange Agent to make prompt payment to former stockholders of Taj Holding entitled thereto as contemplated by the Merger Agreement. THCR will promptly replenish the Exchange Fund to the extent of any losses incurred as a result of Permitted Investments. Any interest and other income resulting from such investments will be paid to THCR. If for any reason (including losses) the Exchange Fund is inadequate to pay the amounts to which holders of Taj Holding Class A Common Stock will be entitled under the Merger Agreement, THCR will in any event be liable for payment thereof. The Exchange Fund will not be used for any purpose not specifically provided for in the Merger Agreement. DIVIDENDS; LIABILITY; NO FURTHER RIGHTS FOR HOLDERS ELECTING CASH No THCR Dividend will be paid to persons entitled to receive certificates representing THCR Common Stock pursuant to the Merger Agreement until such persons surrender their Taj Holding Certificates. Upon such surrender, THCR Dividends will be paid to the person in whose name the THCR Certificate will be issued. In no event will the person entitled to receive such dividends or distributions be entitled to receive interest on such dividends or distributions. Notwithstanding the foregoing, neither the Exchange Agent nor any party to the Merger Agreement will be liable to a holder of Taj Holding Class A Common Stock for any shares of THCR Common Stock or dividends or distributions thereon delivered to a governmental agency pursuant to any applicable escheat or similar laws. Holders of Taj Holding Class A Common Stock who elect to receive the Cash Consideration or who will receive cash for payment of fractional shares of THCR Common Stock will, upon properly surrendering their Taj Holding Certificates, be deemed to have been paid in full satisfaction of all rights pertaining to the shares or fractions thereof exchanged for cash theretofore. No fractional shares of THCR Common Stock will be issued in connection with the Merger. In lieu of any such fractional share, each holder of THCR Common Stock who would otherwise have been entitled to a fractional share of THCR Common Stock upon surrender of certificates for exchange will be paid cash (without interest) in an amount equal to the Market Value of such fractional shares. As soon as practicable after the determination of the amount of cash to be paid to former holders of Taj Holding Class A Common Stock in lieu of any fractional interests, the Exchange Agent will make available such amounts to such former holders. Notwithstanding any other provision of the Merger Agreement to the contrary, shares of Taj Holding Class A Common Stock that are outstanding immediately prior to the Effective Time and which are held by holders who have not voted in favor of the Merger or consented thereto in writing and who will have demanded properly in writing appraisal for such shares in accordance with Section 262 of the DGCL and who have not withdrawn such demand or otherwise have forfeited appraisal rights (collectively, the "Dissenting Shares") will not be converted into or represent the right to receive the Merger Consideration. Such holders will be entitled to receive payment of the appraised value of such shares, except that all Dissenting Shares held by holders who have failed to perfect or who effectively have withdrawn or lost their rights to appraisal of such shares under such Section 262 will thereupon be deemed to have been converted into and to have become exchangeable, as of the Effective Time, for the right to receive, without any interest thereon, the Stock Consideration, upon surrender of the Taj Holding Certificates evidencing such shares. Taj Holding will give THCR (i) prompt notice of any demands for appraisal received by Taj Holding, withdrawals of such demands, and any other instruments served pursuant to the DGCL and received by Taj Holding and (ii) the opportunity to direct all negotiations and proceedings with respect to demands for appraisal under the DGCL. Taj Holding will not, except with the prior written consent of THCR, make any payment with respect to any demands for appraisal, or offer to settle, or settle, any such demands. The obligations of Taj Holding, THCR and Merger Sub to consummate the transactions contemplated by the Merger Agreement are subject to the fulfillment at or prior to the Effective Time of certain conditions, any or all of which may be waived in whole or in part, to the extent permitted by applicable law, including that, (i) the Merger Agreement will have been duly approved and adopted by the affirmative vote of a majority of the outstanding shares of (x) Taj Holding Class B Common Stock and Taj Holding Class C Common Stock, each voting as a separate class, in accordance with the DGCL and the Taj Holding Certificate of Incorporation, and (y) Taj Holding Class A Common Stock, voting as a separate class; (ii) the Merger Transaction will have been duly approved by the affirmative vote of a majority of the outstanding shares of (x) THCR Common Stock and THCR Class B Common Stock, voting as a single class, in accordance with the DGCL and the THCR Certificate of Incorporation, and (y) THCR Common Stock (other than shares held by officers and directors of THCR and their affiliates), voting as a separate class; (iii) all filings required to be made prior to the Effective Time with, and all consents, approvals, permits and authorizations required to be obtained prior to the Effective Time from, governmental and regulatory authorities (including, without limitation, Gaming Authorities) in connection with the execution and delivery of the Merger Agreement and the consummation of the transactions contemplated thereby by Taj Holding, THCR and Merger Sub will have been made or obtained (as the case may be) without restrictions, except where the failure to obtain such consents, approvals, permits and authorizations could not be reasonably be expected to have a material adverse effect; (iv) no court or governmental or regulatory authority of competent jurisdiction (including, without limitation, Gaming Authorities) will have enacted, issued, promulgated, enforced or entered any statute, rule, regulation, judgment, decree, injunction or other order (whether temporary, preliminary or permanent) or taken any action that prohibits the consummation of the transactions contemplated by the Merger Agreement; provided, however, that the parties invoking this condition will use their best efforts to have any such judgment, decree, injunction or order vacated; (v) the shares of THCR Common Stock to be issued pursuant to the Merger will have been approved for listing on the NYSE, subject to official notice of issuance; and (vi) the waiting period applicable to the consummation of the Merger under the HSR Act will have expired or been terminated. The obligation of Taj Holding to consummate the transactions contemplated by the Merger Agreement is also subject to the fulfillment at or prior to the Effective Time of certain other conditions, any or all of which may be waived in whole or in part to the extent permitted by applicable law, including that, (i) the Taj Note Offering will have been consummated on terms reasonably acceptable to Taj Holding; (ii) the consent of certain of Taj Associates' creditors necessary to consummate the Merger Transaction will have been obtained; (iii) Taj Holding LLC or any other person to which part or all of the assets of Taj Holding or any of its subsidiaries has been or will be transferred will have assumed (without releasing the Surviving Corporation or TM/GP) the indemnification and other obligations of the Surviving Corporation and TM/GP set forth in the Merger Agreement; (iv) each of THCR and Merger Sub will have performed in all material respects all of its respective obligations under the Merger Agreement required to be performed by them at or prior to the Effective Time; (v) each of the representations and warranties of each of THCR and Merger Sub contained in the Merger Agreement and in any certificate or other writing delivered by THCR and Merger Sub pursuant thereto will be true in all material respects at and as of the Effective Time, as if made at and as of such time (except to the extent it relates to a particular date); and (vi) Taj Holding will have received a certificate from THCR and Merger Sub, signed by an executive officer of THCR and Merger Sub, respectively, to the effect set forth in clauses (iv) and (v) of this paragraph. The obligation of each of THCR and Merger Sub to consummate the transactions contemplated by the Merger Agreement is also subject to the fulfillment at or prior to the Effective Time of certain conditions, any or all of which may be waived in whole or in part to the extent permitted by applicable law, including that, (i) the Market Value of the THCR Common Stock will be $20.00 or more; (ii) the Offerings will have been consummated on terms acceptable to THCR; (iii) the purchase of the Specified Parcels will have been consummated on terms acceptable to THCR, the obligations relating to the outstanding indebtedness of Realty Corp. to First Fidelity will have been satisfied and the releases of the liens and guarantees relating to such indebtedness will have been obtained; (iv ) the payment to Bankers Trust of $10 million contemplated as part of the Merger Transaction will have been made and the releases of the liens and guarantees that Bankers Trust has with respect to Taj Associates (including Trump's direct and indirect ownership interest therein) and with respect to the TTMI Note will have been obtained; (v) Trump will have contributed, or caused to be contributed, to THCR Holdings and Taj Holdings LLC all of his direct and indirect ownership interests in Taj Associates on terms acceptable to THCR; (vi) the number of shares of Taj Holding Class A Common Stock for which written demand for appraisal has been properly made pursuant Section 262 of the DGCL will have not exceeded 5% of the total number of shares of Taj Holding Class A Common Stock outstanding immediately prior to the Effective Time; (vii) the Registration Statement containing this Proxy Statement-Prospectus will have been declared effective and no stop order suspending effectiveness will have been issued, no action, suit, proceeding or investigation by the SEC to suspend the effectiveness thereof will have been initiated and be continuing, and all necessary approvals under blue sky or other state securities laws, the Securities Act or the Exchange Act relating to the issuance or trading of the THCR Common Stock will have been received; (viii) the consent of certain of Trump's creditors necessary to consummate the Merger Transaction will have been obtained; (ix) Taj Holding will have performed in all material respects all of its obligations under the Merger Agreement required to be performed by it at or prior to the Effective Time; (x) each of the representations and warranties of Taj Holding contained in the Merger Agreement and in any certificate or other writing delivered by Taj Holding pursuant thereto will be true in all material respects at and as of the Effective Time, as if made at and as of such time (except to the extent it relates to a particular date); and (xi) THCR and Merger Sub will have received a certificate signed by an executive officer of Taj Holding to the effect set forth in clauses (ix) and (x) of this paragraph. The Merger Agreement contains various representations and warranties of THCR, Merger Sub and Taj Holding relating to, among other things, the following matters (which representations and warranties are subject, in certain cases, to specified exceptions): (i) due organization, corporate power, standing and similar corporate matters; (ii) capitalization; (iii) subsidiaries; (iv) reports and other documents filed with the SEC, and the accuracy of the information contained therein, including financial statements; (v) the absence of certain changes or events having a material adverse effect on the financial condition, business or results of operations of each party; (vi) authorization, execution, delivery, performance and enforceability of the Merger Agreement and the transactions contemplated thereby; (vii) the absence of any conflict with their respective certificates of incorporation and by- laws and compliance with applicable laws; (viii) the absence of any consent, waiver or authorization that would have a material adverse effect on the financial condition, business or results of operations of each party; (ix) the absence of any litigation having a material adverse effect on the financial condition, business or results of operations of each party; (x) payment of taxes and filing of tax returns; (xi) material contracts and leases; (xii) the absence of any material untrue statements or omissions in the Registration Statement containing this Proxy Statement-Prospectus and in the Schedule 13E-3 and the Registration Statements relating to the THCR Stock Offering and the Taj Note Offering; (xiii) the inapplicability of Section 203 of the DGCL; (xiv) the receipt of opinions from financial advisors; (xv) the absence of brokerage or finder's fees, except those payable to Rothschild and DLJ; (xvi) the existence of the Trump/Taj Holding Voting Agreement and the Trump/THCR Voting Agreement; (xvii) the right of Taj Holding and Taj Funding to redeem the Bonds; and (xviii) the due authorization of, and lack of preemptive or similar rights with respect to the shares of THCR Common Stock to be issued in connection with the Merger. Pursuant to the terms of the Merger Agreement, from and after the date thereof and until the Effective Time, Taj Holding will, and will cause each of its subsidiaries to, conduct its business solely in the ordinary course consistent with past practice and, without the prior written consent of THCR, Taj Holding will not, and will cause each of its subsidiaries not to, except as required or permitted pursuant to the terms of the Merger Agreement or as contemplated in Taj Holding's previous filings with the SEC or by the terms of the Merger Transaction, (i) make any material change in the conduct of its businesses and operations or enter into any transaction other than in the ordinary course of business consistent with past practice, or make any investment other than a Permitted Investment (as such term is defined in the Bond Indenture); (ii) make any change in its certificate of incorporation or by-laws, issue any additional shares of capital stock or equity securities, grant any option, warrant or right to acquire any capital stock or equity securities, issue any security convertible into or exchangeable for its capital stock, alter in any material respect the terms of any of its outstanding securities, or make any change in its outstanding shares of capital stock or in its capitalization, whether by reason of a reclassification, recapitalization, stock split or combination, exchange or readjustment of shares, stock dividend or otherwise; (iii) incur, assume or guarantee any indebtedness for borrowed money, issue any notes, bonds, debentures or other corporate securities or grant any option, warrant or right to purchase any thereof; provided, however, that Taj Funding may consummate the Taj Note Offering; (iv) make any sale, assignment, transfer, abandonment or other conveyance of any of its assets or any part thereof, except in the ordinary course of business consistent with past practices; (v) subject any of its assets, or any part thereof, to any lien or suffer such to be imposed other than such liens as may arise in the ordinary course of business consistent with past practice or by operation of law; (vi) redeem, retire, purchase or otherwise acquire, directly or indirectly, any shares of its capital stock or declare, set aside or pay any dividends or other distribution in respect of such shares; (vii) increase the compensation payable or to become payable to its executive officers or employees, except for increases in the ordinary course of business in accordance with past practices, or grant any severance or termination pay to, or enter into any employment or severance agreement (other than in the ordinary course of business) with, any director or executive officer, or establish, adopt, enter into or amend in any material respect or take action to accelerate any rights or benefits under any collective bargaining, bonus, profit sharing, thrift, compensation, stock option, restricted stock, pension, retirement, deferred compensation, employment, termination, severance or other plan, agreement, trust fund, policy or arrangement for the benefit of any director, executive officer or employee; (viii) take any other action that would cause any of the representations and warranties made in the Merger Agreement not to remain true and correct; or (ix) commit itself to do any of the foregoing. In addition, from the date of the Merger Agreement through the Effective Time, Taj Holding and will cause its subsidiaries not to, pay or declare any dividend or make any distribution with respect to any of their equity interests except as contemplated in connection with the Merger Transaction. In addition, from and after the date of the Merger Agreement and until the Effective Time, THCR will, and will cause each of its subsidiaries to, conduct its business solely in the ordinary course consistent with past practice and, without the prior written consent of Taj Holding, THCR will not, and will cause each of its subsidiaries not to, except as required or permitted pursuant to the terms of the Merger Agreement or as contemplated in THCR's previous filings with the SEC or by the terms of the Merger Transaction, (i) make any material change in the conduct of its businesses and operations or enter into any transaction other than in the ordinary course of business consistent with past practice; (ii) make any change in its certificate of incorporation or by-laws, or make any material change in its outstanding shares of capital stock or in its capitalization, whether by reason of a reclassification, recapitalization, stock split or combination, exchange or readjustment of shares, stock dividend or otherwise; (iii) take any other action that would cause any of the representations and warranties made in the Merger Agreement not to remain true and correct; or (iv) commit itself to do any of the foregoing. Pursuant to the terms of the Merger Agreement, each of THCR and Taj Holding agreed (i) to prepare and file with the SEC this Proxy Statement-Prospectus and to make all necessary filings with respect to the transactions contemplated by the Merger under applicable state and federal securities laws; (ii) to take all necessary actions to convene the THCR Special Meeting and the Taj Holding Special Meeting, respectively; (iii) to deliver to each of their respective stockholders this Proxy Statement-Prospectus and related proxy card and, in the case of Taj Holding, the Election Form; (iv) to use reasonable efforts to deliver to the other "comforts letters" of their respective independent accountants, dated and delivered the date on which the registration statement containing this Proxy Statement-Prospectus will become effective; (v) to give the other access to information and personnel and to keep, subject to certain exceptions, such information confidential; (vi) to notify the other upon the occurrence of certain specified events; and (vii) to use their best efforts to file or cause to be filed as soon as practicable notifications under the HSR Act in connection with the Merger, and to respond as promptly as practicable to any inquiries received from the Federal Trade Commission and the Antitrust Division of the Department of Justice for additional information or documentation and to respond as promptly as practicable to all inquiries and requests received from any State Attorney General or other governmental authority in connection with antitrust matters. Taj Holding also agreed to cause (i) the redemption of the Bonds immediately after the Effective Time and (ii) Taj Associates' general counsel to deliver to THCR at the Closing a certificate (satisfactory to counsel for THCR) identifying all holders of Taj Holding Class A Common Stock who were, to the best of his knowledge and after being advised by outside counsel, affiliates (for purposes of Rule 145 under the Securities Act) of Taj Holding at the time of the Taj Special Meeting. THCR also agreed to use its best efforts to list on the NYSE, subject to official notice of issuance, the THCR Common Stock to be issued pursuant to the Merger. Subject to the terms and conditions of the Merger Agreement, each of the parties thereto further agreed to use all reasonable efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable under applicable laws and regulations to consummate and make effective the transactions contemplated by the Merger Agreement, including using all reasonable efforts to obtain all necessary waivers, consents and approvals, to effect all necessary registrations and filings (including, but not limited to, filings with all applicable governmental agencies) and to lift any injunction or other legal bar to the transactions contemplated by the Merger Agreement (and, in such case, to proceed with the transactions contemplated by the Merger Agreement as expeditiously as possible), subject, however, to the appropriate vote of the respective stockholders or stockholder, as the case may be, of Taj Holding, THCR and Merger Sub. The Merger Agreement provides that subject to the fiduciary duties of the Board of Directors of Taj Holding, as advised by its Special Counsel, neither Taj Holding nor any of its subsidiaries will, directly or indirectly, take (nor will Taj Holding authorize or permit its subsidiaries, officers, directors, employees, representatives, investment bankers, attorneys, accountants or other agents or affiliates, to take) any action (i) to knowingly encourage, solicit or initiate the submission of any Acquisition Proposal (as defined in the Merger Agreement), (ii) to enter into any agreement with respect to any Acquisition Proposal or (iii) to participate in any way in discussions or negotiations with, or furnish any information to, any person in connection with, or take any other action to facilitate any inquiries or the making of any proposal that constitutes, or may reasonably be expected to lead to, any Acquisition Proposal. Taj Holding will promptly communicate to the other parties to the Merger Agreement any solicitation by or of Taj Holding and the terms of any proposal or inquiry, including the identity of the person and its affiliates making the same, that it may receive in respect of any such transaction, or of any such information requested from it or of any such negotiations or discussions being sought to be initiated with it. Notwithstanding the paragraph above, pursuant to the Merger Agreement, Taj Holding may, directly or indirectly, furnish information and access, in each case in response to unsolicited requests therefor, to any person or entity pursuant to appropriate confidentiality agreements, and may participate in discussions and negotiate with such person or entity concerning any Acquisition Proposal involving Taj Holding or any direct or indirect subsidiary of Taj Holding, if the Taj Holding Class B Directors by a majority vote determine in their good faith judgment that such action is appropriate in furtherance of the best interests of stockholders. The Merger Agreement provides that, for a period of six years from the Effective Time, each of the Surviving Corporation and TM/GP will, and THCR will cause the Surviving Corporation and TM/GP to, provide the Taj Holding Indemnified Parties indemnification as set forth in the certificate of incorporation and by-laws of THCR as in effect as of the date of the Merger Agreement. THCR agreed, and caused the Surviving Corporation and TM/GP to agree, that until six years from the Effective Time, unless otherwise required by law, the certificate of incorporation and by-laws of the Surviving Corporation and TM/GP will not be amended, repealed or modified to reduce or limit the rights of indemnity afforded to the present and former directors, officers and employees of Taj Holding and TM/GP (including, without limitation, with respect to the transactions contemplated by the Merger Agreement), or the ability of the Surviving Corporation or TM/GP to indemnify them, nor to hinder, delay or make more difficult the exercise of such rights of indemnity or the ability to indemnify. Should any claim or claims be made against any present or former director, officer, employee or agent of Taj Holding or TM/GP, arising from his services as such, within six years of the Effective Time, the provisions of the Merger Agreement with respect to indemnification and the certificate of incorporation and the by-laws of the Surviving Corporation and TM/GP will continue in effect until the final disposition of all such claims. In the event the Surviving Corporation or TM/GP or any of their respective successors or assigns (i) consolidates with or merges into any other person and will not be the continuing or surviving corporation or entity of such consolidation or merger or (ii) transfers all or substantially all of its properties and assets to any person, then and in each such case, proper provision will be made so that the successors and assigns of the Surviving Corporation or TM/GP, as the case may be, will assume all of the obligations set forth in the Merger Agreement. In addition, for a period of six years after the Effective Time, the Surviving Corporation and TM/GP will, and THCR will cause the Surviving Corporation and TM/GP to, purchase and maintain in effect directors' and officers' liability insurance policies covering the Taj Holding Indemnified Parties on terms no less favorable than the terms of the current insurance policies coverage. Notwithstanding the foregoing, if the directors' and officers' liability insurance referred to in this paragraph is unavailable for the Current D&O Premium, the Surviving Corporation and TM/GP will obtain as much insurance as can be obtained for a premium not in excess (on an annualized basis) of the Current D&O Premium. In the event any claim is made against present or former directors, officers or employees of Taj Holding or TM/GP that is covered or potentially covered by insurance, THCR agrees, and will cause the Surviving Corporation and TM/GP to agree, to do nothing that would forfeit, jeopardize, restrict or limit the insurance coverage available for that claim until the final disposition of that claim unless otherwise required by law or their respective certificate of incorporation or by-laws. The provisions in the Merger Agreement regarding indemnification and insurance are intended to be for the benefit of, and will be enforceable by, the Taj Holding Indemnified Parties, their heirs and personal representatives and will be binding on THCR and the Surviving Corporation and their respective successors and assigns. The Merger Agreement may be terminated and the Merger may be abandoned at any time prior to the Effective Time (whether before or after approval of the Merger Agreement by the respective stockholders of Taj Holding or THCR) (i) by joint written consent of Taj Holding and THCR; (ii) by Taj Holding if the conditions to the obligation of Taj Holding to consummate the Merger have not been satisfied or waived by Taj Holding at such time as such condition is no longer capable of satisfaction; (iii) by THCR and Merger Sub if any of the conditions to the obligations of THCR and Merger Sub to consummate the Merger have not been satisfied or waived by THCR and Merger Sub at such time as such condition is no longer capable of satisfaction; (iv) by Taj Holding, acting through the Taj Holding Class B Directors, if the Taj Holding Class B Directors shall have withdrawn or modified their approval or recommendation of the Merger Agreement or the Merger in order to permit Taj Holding to execute an agreement to effect an Acquisition Proposal determined by the Taj Holding Class B Directors to be more favorable to the Taj Holding stockholders than the transactions contemplated hereby; or (v) by either party if the Merger has not been consummated on or before June 30, 1996; provided, however, that a party may not terminate the Merger Agreement pursuant to this clause if the failure of such party to fulfill any of its obligations under the Merger Agreement will have been the reason that the Merger will not have been consummated on or before said date. In the event of termination of the Merger Agreement, there will be no liability on the part of any party thereto (except for the willful breach of the Merger Agreement); provided, however, that certain terms of the Merger Agreement, including indemnification for brokerage fees, confidentiality and the payment of fees and expenses will survive the termination. The Merger Agreement provides that, whether or not the Merger is consummated, all costs and expenses incurred in connection therewith and the transactions contemplated thereby will be paid equally by Taj Holding and THCR; provided, however, that all costs and expenses incurred in connection with (i) printing, filing and distributing the Registration Statement filed with the SEC in connection with the THCR Stock Offering and (ii) any filings in connection with the HSR Act, will be borne solely by THCR. The Merger Agreement provides that it may be amended by the parties thereto by action of each of their respective Boards of Directors, at any time prior to the Effective Time; provided, however, that any such amendment made after the adoption of the Merger Agreement by the stockholders of Taj Holding or THCR will not, without further approval of such stockholders (i) alter or change the amount, kind or manner of payment of Merger Consideration, (ii) alter or change any term of the certificate of incorporation of the Surviving Corporation (except as otherwise provided in the Merger Agreement) or (iii) change any other terms or conditions of the Merger Agreement, if any of such changes, alone or in the aggregate, would materially and adversely affect the stockholders of Taj Holding or THCR. Any amendment to the Merger Agreement must be in writing signed by all the parties thereto. The Merger Agreement also provides that, at any time prior to the Effective Time, Taj Holding, THCR and Merger Sub may, unless otherwise set forth in the Merger Agreement, (i) extend the time for the performance of any agreement of the other party or parties thereto, (ii) waive any accuracy in the representations and warranties contained therein or in any document delivered pursuant thereto or (iii) waive compliance with any agreement or condition of the other party or parties hereto contained therein. Any agreement on the part of any party to any such extension or waiver will be effective only if set forth in a writing signed on behalf of such party and delivered to the other party or parties. No failure or delay by any party in exercising any right, power or privilege under the Merger Agreement will operate as a waiver thereof nor will any single or partial exercise thereof preclude any other right, power or privilege. DISSENTING STOCKHOLDERS' RIGHTS OF APPRAISAL The DGCL sets forth certain rights and remedies applicable to stockholders of record of Taj Holding (each, a "Stockholder") who may object to the Merger. These rights are available only to stockholders holding shares through the Effective Date of the Merger (the "Dissenting Shares") if the Merger is completed, provided that Stockholders comply with Section 262 of the DGCL. Stockholders of THCR are not entitled to appraisal rights with respect to the Merger. Set forth below is a summary of Stockholders' rights as provided by Section 262 of the DGCL. A copy of Section 262 of the DGCL is attached to this Proxy Statement-Prospectus as Annex D. The following discussion is not a complete statement of the law relating to appraisal rights and is qualified in its entirety by reference to Annex D. This discussion and Annex D should be reviewed carefully by any holder who wishes to exercise statutory appraisal rights or who wishes to preserve the right to do so, because the failure to comply with the procedures set forth herein or therein will result in the loss of such appraisal rights. Any Stockholder who contemplates the assertion of appraisal rights is urged to consult his own counsel. Under Section 262 of the DGCL, when a merger is to be submitted for approval at a meeting of stockholders, not less than 20 days prior to the meeting, a constituent corporation must notify each of the holders of its stock for which appraisal rights are available that such appraisal rights are available and include in each such notice a copy of Section 262. This Proxy Statement- Prospectus shall constitute such notice to Stockholders. Stockholders who desire to exercise their appraisal rights must satisfy all of the following conditions. Any such Stockholder must be a stockholder of record of Taj Holding from the date he makes a written demand for appraisal (as described below) through the Effective Time and must continuously hold his Dissenting Shares throughout the period between such dates. A written demand for appraisal of the Dissenting Shares must be delivered to the Secretary of Taj Holding before the taking of the vote of Stockholders on the Merger Agreement. Such vote will take place at the Taj Holding Special Meeting. The demand will be sufficient if it reasonably informs Taj Holding of the identity of the Stockholder and that the Stockholder intends thereby to demand the appraisal of his Dissenting Shares. This written demand for appraisal of Dissenting Shares must be in addition to and separate from any proxy or vote abstaining from or voting against the Merger Agreement. Although a Stockholder must vote against, abstain from voting, or fail to vote on the Merger Agreement to preserve his rights to appraisal, such vote against, failure to vote, or abstention from voting will not, of itself, constitute a demand for appraisal within the meaning of Section 262 of the DGCL. Holders of Dissenting Shares electing to exercise their appraisal rights under Section 262 of the DGCL must neither vote for approval of the Merger Agreement nor consent thereto in writing. A Stockholder who signs and returns a proxy card without expressly specifying a vote against approval of the Merger Agreement or a direction to abstain, by checking the applicable box on the proxy card enclosed herewith, will effectively have thereby waived such Stockholder's appraisal rights as to those shares because, in the absence of express instructions to the contrary, such Dissenting Shares will be voted in favor of the Merger Agreement. Accordingly, a Stockholder who desires to perfect his appraisal rights with respect to any Dissenting Shares must, as one of the procedural steps involved in such perfection, either (i) refrain from executing and returning a proxy card and from voting in person in favor of the Merger Agreement or (ii) check either the "Against" or the "Abstain" box next to the proposal on such card or affirmatively vote in person against the Merger Agreement or register in person an abstention with respect thereto. A demand for appraisal must be executed by or for the Stockholder, fully and correctly, exactly as such Stockholder's name appears on the certificate or certificates representing his Dissenting Shares. If the Dissenting Shares are owned of record by more than one person, as in a joint tenancy or tenancy in common, such demand must be executed by all joint owners. An authorized agent, including an agent for two or more joint owners, may execute the demand for appraisal for a Stockholder; however, the agent must identify the record owner and expressly disclose the fact that, in exercising the demand, such person is acting as agent for the record owner. If a Stockholder holds Dissenting Shares through a broker who in turn holds the shares through a central securities depository nominee, a demand for appraisal of such Dissenting Shares must be made by or on behalf of the depository nominee and must identify the depository nominee as the holder of record. A record owner, such as a broker, fiduciary or other nominee who holds Dissenting Shares as a nominee for others, may exercise appraisal rights with respect to the Dissenting Shares held for all or less than all beneficial owners of Dissenting Shares as to which such person is the record owner. In such case, the written demand must set forth the number of Dissenting Shares covered by such demand. Where the number of Dissenting Shares is not expressly stated, the demand will be presumed to cover all Dissenting Shares outstanding in the name of such record owner. A person having a beneficial interest in Dissenting Shares that are held of record in the name of another person must act promptly to cause the record holder to follow the steps summarized herein properly and in a timely manner to perfect whatever appraisal rights are available. A Stockholder who elects to exercise appraisal rights must mail or deliver his written demand to: Nicholas F. Moles, Esq., Secretary, Taj Mahal Holding Corp., c/o Trump Taj Mahal Casino Resort, 1000 The Boardwalk, Atlantic City, NJ 08401. The written demand for appraisal must specify the Stockholder's name and mailing address, the number of Dissenting Shares owned, and a statement that the Stockholder is thereby demanding appraisal of his Dissenting Shares. Within ten days after the Effective Time, the Surviving Corporation will provide notice of the Effective Time to all Stockholders who have complied with Section 262 of the DGCL. Upon written request, the Surviving Corporation will furnish each Stockholder who has complied with the requirements of Section 262 of the DGCL a statement setting forth the aggregate number of Dissenting Shares not voted in favor of the Merger Agreement with respect to which demands for appraisal have been received and the aggregate number of holders of such Dissenting Shares. Within 120 days after the Effective Time, either the Surviving Corporation or any Stockholder who has complied with the required conditions of Section 262 of the DGCL may file a petition in the Delaware Court of Chancery (the "Chancery Court"), with a copy served on the Surviving Corporation in the case of a petition filed by a Stockholder, demanding a determination of the fair value of the Dissenting Shares of all dissenting Stockholders. There is no present intent on the part of THCR to file an appraisal petition and Stockholders seeking to exercise appraisal rights should not assume that the Surviving Corporation will file such a petition or that the Surviving Corporation will initiate any negotiations with respect to the fair value of the Dissenting Shares. Accordingly, Stockholders who desire to have their Dissenting Shares appraised should initiate any petitions necessary for the perfection of their appraisal rights within the time periods and in the manner prescribed in Section 262 of the DGCL. Within 120 days after the Effective Time, any Stockholder who has theretofore complied with the applicable provisions of Section 262 of the DGCL will be entitled, upon written request, to receive from the Surviving Corporation a statement setting forth the aggregate number of Dissenting Shares not voting in favor of the Merger Agreement and with respect to which demands for appraisals were received by Taj Holding and the number of holders of such Dissenting Shares. Such statement must be mailed within 10 days after written request therefor has been received by the Surviving Corporation. Within 20 days of the filing of a petition by a Stockholder with the Chancery Court, or contemporaneous with the filing of a petition by the Surviving Corporation, the Surviving Corporation must file with the Chancery Court a verified list containing the names and addresses of the Stockholders who have demanded payment for their Dissenting Shares and with whom agreements as to the value of their Dissenting Shares have not been reached. If a petition for appraisal is timely filed, all Stockholders who have complied with Section 262 of the DGCL will become entitled to such a determination. The Chancery Court will hold a hearing on such petition through which it will determine which Stockholders are entitled to appraisal rights and will appraise the Dissenting Shares owned by such Stockholders. The Chancery Court may require Stockholders who have demanded an appraisal for the Dissenting Shares and who hold such Dissenting Shares represented by certificates to submit their certificates to the Register in Chancery for notation thereon of the pendency of the appraisal proceedings; if any such Stockholder fails to comply with such direction, the Chancery Court may dismiss the proceedings as to such Stockholder. Where proceedings are not dismissed, the appraisal will be based upon the Chancery Court's determination of the fair value of such Dissenting Shares exclusive of any element of value arising from the accomplishment or expectation of the Merger, together with a fair rate of interest, if any, to be paid upon the amount determined to be the fair value. In determining fair value, the Chancery Court is to take into relevant factors. In Weinberger v. UOP, Inc., decided in 1983, the Delaware Supreme Court discussed the factors that could be considered in determining fair value in an appraisal proceeding, stating that "proof of value by any techniques or methods which are generally considered acceptable in the financial community and otherwise admissible in court" should be considered and that "[f]air price obviously requires consideration of all relevant factors involving the value of a company. . . ." The Delaware Supreme Court stated that in making this determination of fair value, the court must consider market value, asset value, dividends, earnings prospects, the nature of the enterprise and any other facts which could be ascertained as of the date of the merger which throw any light on future prospects of the merged corporation. In Weinberger, the Delaware Supreme Court stated that "elements of future value, including the nature of the enterprise, which are known or susceptible of proof as of the date of the merger and not the product of speculation, may be considered." Section 262 of the DGCL, however, provides that fair value is to be "exclusive of any element of value arising from the accomplishment or expectation of the merger." Stockholders considering seeking appraisal should recognize that the fair value of the Dissenting Shares determined under Section 262 of the DGCL could be more than, the same as or less than the consideration that Stockholders are entitled to receive pursuant to the Merger Agreement if they do not seek appraisal of their Dissenting Shares, and opinions of investment banking firms as to fairness, from a financial point of view, are not opinions as to fair value under Section 262 of the DGCL. The cost of the appraisal proceeding may be determined by the Chancery Court and levied against the parties as the Chancery Court deems equitable in the circumstances, including, if the Chancery Court found equitable justification therefor, against the Surviving Corporation or any affiliate thereof which may be a party to the proceeding. Upon application of a dissenting Stockholder, the Chancery Court may order that all or a portion of the expenses incurred by any dissenting Stockholder in connection with the appraisal proceeding, including without limitation, reasonable attorneys' fees and the fees and expenses of experts, be charged pro rata against the value of all the Dissenting Shares entitled to appraisal. In the absence of such a determination or assessment, each party bears its own expenses. Any Stockholder who has duly demanded appraisal in compliance with Section 262 of the DGCL will not, after the Effective Time, be entitled to vote his Dissenting Shares for any purpose, subject to such demand or to receive payment of dividends or other distributions on such Dissenting Shares, except for dividends or distributions payable to Stockholders of record at a date prior to the Effective Time. At any time within 60 days after the Effective Time, any Stockholder shall have the right to withdraw such demand for appraisal and to accept the terms offered in the Merger Agreement; after this period, the Stockholder may withdraw such demand for appraisal only with the consent of the Surviving Corporation. If no petition for appraisal is filed with the Chancery Court within 120 days after the Effective Time, Stockholders' rights to appraisal shall cease, and all Stockholders shall be entitled to receive only the consideration provided in the Merger Agreement. Inasmuch as the Surviving Corporation will have no obligation to file such a petition and THCR has no present intention to do so, any Stockholder who desires such a petition to be filed is advised to file it on a timely basis. Any Stockholder may withdraw such Stockholder's demand for appraisal by delivering to the Surviving Corporation a written withdrawal of such demand for appraisal and acceptance of the Merger, except (i) that any such attempt to withdraw made more than 60 days after the Effective Time will require written approval of the Surviving Corporation and (ii) that no appraisal proceeding in the Chancery Court shall be dismissed as to any Stockholder without the approval of the Chancery Court, and such approval may be conditioned upon such terms as the Chancery Court deems just. UNAUDITED PRO FORMA FINANCIAL INFORMATION (I) TRUMP TAJ MAHAL ASSOCIATES AND TRUMP TAJ MAHAL FUNDING, INC. (II) TRUMP HOTELS & CASINO RESORTS, INC. AND (III) TRUMP HOTELS & CASINO RESORTS, INC. AND TRUMP TAJ MAHAL ASSOCIATES UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS The Unaudited Pro Forma Consolidated Balance Sheets of (i) Taj Associates, (ii) THCR and (iii) THCR and Taj Associates as of September 30, 1995 and the Unaudited Pro Forma Consolidated Statements of Operations for the year ended December 31, 1994 and for the nine months ended September 30, 1995 (the "Unaudited Pro Forma Financial Statements") are set forth below. The Unaudited Pro Forma Consolidated Balance Sheets have been prepared assuming the Merger Transaction had occurred on September 30, 1995. The Unaudited Pro Forma Consolidated Statements of Operations have been prepared assuming that the Merger Transaction had occurred on January 1, 1994. The Unaudited Pro Forma Financial Statements are presented for informational purposes only and do not purport to present what the respective Balance Sheets would have been had the Merger Transaction, in fact, occurred on September 30, 1995 or what the respective results of operations for the year ended December 31, 1994 and the nine months ended September 30, 1995 would have been had the Merger Transaction, in fact, occurred on January 1, 1994 or to project the respective results of operations for any future period. The Unaudited Pro Forma Consolidated Balance Sheet and Statements of Operations of Taj Associates included on pages 87 to 91 give effect to (a) the redemption of the Bonds and the Taj Holding Class B Common Stock, (b) the Taj Note Offering, (c) the contribution by THCR of the net proceeds of the THCR Stock Offering to Taj Associates, (d) the "push down" of the purchase accounting adjustments associated with the Merger to Taj Associates, (e) the termination of the Taj Services Agreement, (f) the cancellation of payments to Realty Corp. and First Fidelity in connection with the acquisition of the Specified Parcels, and (g) the payment to Bankers Trust to obtain releases of the liens and guarantees that Bankers Trust has with respect to Taj Associates. The Unaudited Pro Forma Consolidated Balance Sheet and Statements of Operations of THCR included on pages 92 to 95 give effect to (h) the THCR Stock Offering and the contribution of the net proceeds therefrom to Taj Associates as described in (c) above, and the Statement of Operations gives effect to (i) the June 1995 Offerings which reflect the formation and initial financing of THCR and THCR Holdings and their acquisition of Trump Plaza and Trump Indiana. The adjustments referred to in (i) above are required because the historical audited and historical unaudited financial information included in this Proxy Statement-Prospects for THCR, for all periods before June 12, 1995, does not give effect to the transactions described in (i) above. The Unaudited Consolidated Pro Forma Balance Sheet and Consolidated Statements of Operations of THCR and Taj Associates included on pages 96 to 99 give effect to the (j) consolidation of Taj Associates, which will be an indirect wholly owned subsidiary of THCR Holdings after the Merger Transaction. These Unaudited Pro Forma Financial Statements assume that all holders of Taj Holding Class A Stock elect to receive Stock Consideration in the Merger; if this assumption is not accurate the size of the THCR Offering will be increased to the extent of Cash consideration paid in the Merger (the maximum THCR Offering size is $140 million). The Merger is expected to be accounted for as a "purchase" for accounting and reporting purposes and Trump's contributions of all of his direct and indirect ownership interests in Taj Associates are expected to be accounted for using carry over basis accounting. The Unaudited Pro Forma Financial Statements should be read in conjunction with the Financial Statements and related notes thereto included elsewhere in this Proxy Statement-Prospectus and the information set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations of THCR" and "Management's Discussion and Analysis of Financial Condition and Results of Operations of Taj Associates." UNAUDITED PRO FORMA FINANCIAL INFORMATION TRUMP TAJ MAHAL ASSOCIATES AND TRUMP TAJ MAHAL FUNDING, INC. PRO FORMA CONSOLIDATED BALANCE SHEET UNAUDITED PRO FORMA FINANCIAL INFORMATION TRUMP TAJ MAHAL ASSOCIATES AND TRUMP TAJ MAHAL FUNDING, INC. PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1994 (DOLLARS IN THOUSANDS) TRUMP TAJ MAHAL ASSOCIATES AND TRUMP TAJ MAHAL FUNDING, INC. PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION (DOLLARS IN THOUSANDS) (a) To record the issuance of $750,000 aggregate principal amount of Taj Mortgage Notes with interest at a rate of 12%. The Taj Mortgage Notes are assumed to be issued at face value. (b) To record the redemption of the Bonds which had a face value of $780,243 and a book value of $643,135 as of September 30, 1995, and an extraordinary loss of $137,498 relating to the redemption of the Bonds including the redemption of the Taj Holding Class B Common Stock (see note (c) below). (c) To record the payment of $.50 for the redemption of each share of Taj Holding Class B Common Stock as an extraordinary loss. (d) To record the payment of accrued interest on the redemption of the Bonds as of September 30, 1995. (e) To record the payment of transaction expenses which are expected to be approximately $27,000 and consist of the following: (f) To record the net proceeds from the THCR Stock Offering and the issuance of the common stock for the purchase of the Specified Parcels, which will be subsequently contributed to Taj Associates. (g) To record the payment to Bankers Trust to obtain releases of the liens and guarantees that Bankers Trust has with respect to Taj Associates. (h) To record the purchase of the Specified Parcels and the release of the Taj Associates-First Fidelity Guarantee, the elimination of the lease payments on the Specified Parcels and the additional depreciation on the purchase. (i) To record the purchase of the Taj Holding Class A Common Stock by THCR which is being pushed down to the Taj Mahal's books as an adjustment to property plant and equipment. (j) To record 50% of the historical negative book value of Taj Associates, as adjusted for the pro forma extraordinary loss on the redemption of the Bonds, as part of the push down of the cost of the purchase of the Taj Holding Class A Common Stock by THCR. No adjustment is required for Trump's 50% interest since his contribution is recorded using the carry over basis of accounting. (k) To eliminate the capital deficit of the Taj Mahal as a result of the push down of the cost of the purchase of Taj Holding Class A Common Stock by THCR. This adjustment represents the accumulated deficit after the adjustments for the Taj Note Offering of $208,364 less the $42,300 as described in footnote (j). (l) To record adjustments to historical interest expense to give effect to the Merger Transaction as follows: A 0.25% increase in the interest rate on the Taj Notes would result in a $1,875 and a $1,406 increase in interest expense for the year ended December 31, 1994 and the nine months ended September 30, 1995, respectively. (m) To record the elimination of the fee resulting from the termination of the Taj Services Agreement. (n) To record the additional depreciation expense resulting from the allocation of the purchase price to property and equipment. The purchase price is being allocated as follows: $47,615 to land and $78,660 to building based upon an appraisal and the amount allocated to building is being depreciated over the remaining life of the building (35 years). (o) Excludes the effect of the extraordinary loss of $137,498 upon the redemption of the Bonds. See notes (b) and (c). UNAUDITED PRO FORMA FINANCIAL INFORMATION TRUMP HOTELS & CASINO RESORTS, INC. PRO FORMA CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 1995 (DOLLARS IN THOUSANDS) UNAUDITED PRO FORMA FINANCIAL INFORMATION TRUMP HOTELS & CASINO RESORTS, INC. PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1994 (DOLLARS IN THOUSANDS) UNAUDITED PRO FORMA FINANCIAL INFORMATION TRUMP HOTELS & CASINO RESORTS, INC. PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 (DOLLARS IN THOUSANDS) NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION THCR and THCR Holdings were formed in March 1995 and commenced operations on June 12, 1995 with the consummation of the June 1995 Stock Offering and the June 1995 Note Offering. (a) To record the purchase of Taj Holding Class A Common Stock through the issuance of THCR Common Stock and with available cash. (b) To record the proceeds from the THCR Stock Offering which will be subsequently contributed to Taj Associates, net of transaction expenses which are expected to be approximately $13,000 and consist of the following: (c) To record additional general and administrative expenses relating to the operations of THCR Holdings, Trump Indiana and THCR. (d) To record interest income on a $3,000 note receivable from Trump at prime plus 1%. (e) To record interest expense relating to the Senior Notes. (f) To reflect interest expense on amounts obtained under the equipment and vessel financing line. To date, THCR has obtained a commitment for $15,000 and has obtained advances of $6,800 at a rate of 10.5%. Although THCR expects to borrow additional amounts, no assurances can be given that such financing will be available. (g) To eliminate interest expense (including amortization of deferred financing costs) on the PIK Notes which were redeemed with the proceeds from the offering of the June 1995 Stock Offering. (h) To reflect the amortization of deferred financing costs associated with the Senior Notes. (i) To eliminate minority interest as pro forma adjustments result in a loss at THCR Holdings and there is no minority interest basis on the THCR Balance Sheet. UNAUDITED PRO FORMA FINANCIAL INFORMATION TRUMP HOTELS & CASINO RESORTS, INC. AND TRUMP TAJ MAHAL ASSOCIATES PRO FORMA CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 1995 (DOLLARS IN THOUSANDS) UNAUDITED PRO FORMA FINANCIAL INFORMATION TRUMP HOTELS & CASINO RESORTS, INC. AND TRUMP TAJ MAHAL ASSOCIATES PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1994 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE INFORMATION) UNAUDITED PRO FORMA FINANCIAL INFORMATION TRUMP HOTELS & CASINO RESORTS, INC. AND TRUMP TAJ MAHAL ASSOCIATES PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE INFORMATION) NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION (a) To record the elimination of THCR's investment in the Taj Mahal resulting from the contribution of the proceeds of the THCR Stock Offering to Taj Associates. (b) To record the elimination of THCR's investment in the Taj Mahal resulting from the purchase of Taj Holding Class A Common Stock. (c) Weighted average number of shares include the number of shares outstanding on September 30, 1995, shares awarded to the Chief Executive Officer pursuant to the 1995 Stock Incentive Plan and the shares to be issued in this offering. (d) No amounts attributable to the minority interest in THCR Holdings have been recorded since there is no minority interest basis on the balance sheet of THCR to absorb such losses. (e) Excludes the extraordinary loss upon the redemption of the Bonds and the Taj Holding Class B Common Stock. The following table sets forth certain historical consolidated financial information of Plaza Associates and Plaza Holding (predecessors of THCR) for each of the five years ended December 31, 1990 through 1994 and for the nine- month period ended September 30, 1994 and certain historical consolidated financial information of THCR for the period from inception (June 12, 1995) to September 30, 1995 (unaudited) (See Note 1 below). The historical financial information of Plaza Holding and Plaza Associates as of December 31, 1993 and 1994 and for the years ended December 31, 1992, 1993 and 1994 as set forth below has been derived from the audited consolidated financial statements of Plaza Holding and Plaza Associates included elsewhere in this Proxy Statement- Prospectus. The historical financial information of Plaza Holding and Plaza Associates as of December 31, 1990, 1991 and 1992 and for the years ended December 31, 1990 and 1991 as set forth below has been derived from the audited consolidated financial statements of Plaza Holding and Plaza Associates not included in this Proxy Statement-Prospectus. The unaudited financial information as of September 30, 1994 and 1995 and the periods then ended has been derived from the unaudited condensed consolidated financial statements included elsewhere in this Proxy Statement- Prospectus and in the opinion of management, includes all adjustments, consisting of only normal, recurring adjustments, necessary to present fairly the financial position, results of operations and changes in cash flows for the periods presented. The results of these interim periods are not necessarily indicative of the operating results for a full year. All financial information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations of THCR," "Unaudited Pro Forma Financial Information" and the consolidated and condensed financial statements and the related notes thereto included elsewhere in this Proxy Statement-Prospectus. Note 1: THCR was incorporated on March 28, 1995 and conducted no operations until the June 1995 Stock Offering and contributed the proceeds therefrom to THCR Holdings in exchange for an approximately 60% general partnership interest in THCR Holdings. At the consummation of the June 1995 Stock Offering, Trump contributed his 100% beneficial interest in Plaza Funding, Plaza Holding and Plaza Associates, the owner and operator of Trump Plaza, to THCR Holdings for an approximately 40% limited partnership interest in THCR Holdings. In addition, Trump contributed to THCR Holdings all of his existing interests and rights to new gaming activities in both emerging and established gaming jurisdictions, including Trump Indiana. The financial data as of September 30, 1995 and for the period ended September 30, 1995 reflect the operations of THCR from inception (June 12, 1995) to September 30, 1995. (a) Other non-operating (income) expense for the year ended December 31, 1990 includes income of $2.4 million resulting from the settlement of a lawsuit relating to a boxing match. Other non-operating (income) expense for the year ended December 31, 1991 includes a $10.9 million charge associated with the rejection of the lease associated with the former Trump Regency Hotel and $4.0 million of costs associated with certain litigation. Other non-operating (income) expense for 1992 includes $1.5 million of costs associated with certain litigation. Other non-operating (income) expense for the years ended December 31, 1993 and 1994 and for the nine months ended September 30, 1994 and 1995 includes $3.9, $4.9, 3.7 and 1.3 million, respectively, of real estate taxes and leasing costs associated with Trump Plaza East. (b) Earnings per share is based on the weighted average number of shares of THCR Common Stock and common stock equivalents including shares awarded to the Chief Executive Officer under a phantom stock unit award. The shares of THCR Class B Common Stock owned by Trump have no economic interest and, therefore, are not considered. (c) Reflects reclassification in 1991 of indebtedness relating to outstanding mortgage bonds as a current liability due to then existing events of default. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF Set forth below is a discussion and analysis of the financial condition and results of operations of Plaza Associates, which THCR Holdings acquired in June 1995. Neither THCR nor any of its subsidiaries has any significant operating history, other than Plaza Associates. The partnership agreement governing THCR Holdings provides that all business activities of THCR must be conducted through THCR Holdings or subsidiary partnerships or corporations. RESULTS OF OPERATIONS FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1995 AND Gaming revenues were $224,499,000 for the nine months ended September 30, 1995, an increase of $27,431,000 or 13.9% from gaming revenues of $197,068,000 for the comparable period in 1994. This increase in gaming revenues consisted of an increase in both table games and slot revenues. While the first nine months of 1994 were adversely affected by unfavorable winter weather, construction and management turnover, management believes that the increase in gaming revenues in 1995 is also due to an increased level of demand evident in the Atlantic City market generally, as well as management's marketing and other initiatives, the introduction of new slot machines and table games, the addition of bill acceptors on slot machines, and an increase in casino floor square footage. Slot revenues were $152,318,000 for the nine months ended September 30, 1995, an increase of $24,534,000 or 19.2% from slot revenues of $127,784,000 for the comparable period in 1994. This increase was primarily due to an increase in casino floor square footage and the introduction of new slot machines, as well as management's marketing and other initiatives. Table games revenues were $72,181,000 for the nine months ended September 30, 1995, an increase of $2,897,000 or 4.2% from table games revenues of $69,284,000 for the comparable period in 1994. Table games drop (i.e., the dollar value of chips purchased) increased by 5.0% for the nine months ended September 30, 1995 from 1994. Other revenues were $55,261,000 for the nine months ended September 30, 1995, an increase of $5,133,000 or 10.2% from other revenues of $50,128,000 for the comparable period in 1994. Other revenues include revenues from rooms, food, beverage and miscellaneous items. The increase primarily reflects increases in food and beverage revenues attendant to increased levels of gaming activity and increased promotional expenses. Promotional allowances were $28,611,000 for the nine months ended September 30, 1995, an increase of $3,481,000 or 13.9% from promotional allowances of $25,130,000 for the comparable period in 1994. This increase is primarily attributable to an increase in gaming activity during the nine months ended September 30, 1995. Gaming costs and expenses were $121,987,000 for the nine months ended September 30, 1995, an increase of $17,887,000 or 17.2% from gaming costs and expenses of $104,100,000 for the comparable period in 1994. This increase was primarily due to increased promotional and operating expense and taxes associated with increased levels of gaming revenues during the nine months ended September 30, 1995. General and administrative expenses were $51,073,000 for the nine months ended September 30, 1995, a decrease of $3,855,000 or 7.0% from general and administrative expenses of $54,928,000 for the comparable period in 1994. This decrease is primarily the result of cost containment measures. Income from operations was $48,217,000 for the nine months ended September 30, 1995, an increase of $14,265,000 or 42.0% from income from operations of $33,952,000 for the comparable period in 1994. Other non-operating expense was $3,847,000 for the nine months ended September 30, 1995, an increase of $118,000 from other non-operating expense of $3,729,000 for the comparable period in 1994. This increase is attributable to costs associated with Trump Plaza East. The extraordinary loss of $9,250,000 for the nine months ended September 30, 1995 relates to the redemption and write-off of unamortized deferred financing costs relating to the repurchase and redemption on June 12, 1995 of all of the 12 1/2% Pay-in-Kind Notes due 2003 of Plaza Holding (the "PIK Notes") and related warrants to acquire PIK Notes (the "PIK Note Warrants"). RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993 Gaming revenues were $261.5 million for the year ended December 31, 1994, a decrease of $2.6 million or 1.0% from gaming revenues of $264.1 million in 1993, although gaming revenues increased for the industry generally in Atlantic City for the year ended December 31, 1994 compared to the year ended December 31, 1993. This decrease in gaming revenues consisted of a reduction in both table games and slot revenues. These results were impacted by a number of major ice and snow storms throughout the northeastern United States, during the three months ended March 31, 1994 which severely restricted travel in the region. Bad weather also impacted the Atlantic City market's results for the three months ended March 31, 1993; however, the weather during the comparable period in 1994 was much more severe. The decrease in gaming revenues was also due in part to disruptions caused by an expansion of the casino floor which created operating inefficiencies by temporarily disrupting the normal flow of patrons upon entrance to the casino, as well as detracting from the overall appearance of the casino floor. Also, in 1994 Trump Plaza experienced turnover of certain key management positions which had a negative impact on operations. This negative impact was mitigated by the end of 1994 as new management was hired and began implementing new policies and marketing programs. See "Business of THCR--Trump Plaza--Trump Plaza Business Strategy" and "Management of THCR--Employment Agreements." Slot revenues were $168.7 million for the year ended December 31, 1994, a decrease of $1.8 million or 1.1% from slot revenues of $170.5 million in 1993. This decrease was due in part to the sensitivity of slot revenues to certain of the factors specified in the foregoing paragraph. Plaza Associates elected to discontinue certain progressive slot programs, thereby reversing certain accruals into revenue which had the effect of improving slot revenue by $0.6 million for the year ended December 31, 1994. Table games revenues were $92.8 million for the year ended December 31, 1994, a decrease of $0.8 million or 0.9% from table games revenues of $93.6 million in 1993. This decrease was primarily due to a reduction in table games drop by $26.7 million or 4.3% for the year ended December 31, 1994 from 1993, offset by an increase in the table game hold percentage (the percentage of table drop retained by Plaza Associates) to 15.5% for the year ended December 31, 1994 from 14.9% in 1993. During the year ended December 31, 1994, gaming credit extended to customers was approximately 17% of overall table play, a decrease of 1% from 1993. At December 31, 1994, gaming receivables amounted to approximately $13.7 million, a decrease of approximately $2.3 million from 1993, with allowances for doubtful gaming receivables of approximately $8.5 million, a decrease of approximately $1.9 million from 1993. Other revenues were $66.9 million for the year ended December 31, 1994, a decrease of $2.3 million or 3.3% from other revenues of $69.2 million in 1993. This decrease in other revenues primarily reflects decreases in food and beverage revenue resulting from changes in bus couponing. Promotional allowances were $33.3 million for the year ended December 31, 1994, an increase of $0.5 million or 1.5% from $32.8 million in 1993. This increase is attributable to increased marketing and promotional activities. Gaming costs and expenses were $139.5 million for the year ended December 31, 1994, an increase of $2.6 million or 1.9% from gaming costs and expenses of $136.9 million in 1993. This increase was primarily due to increased marketing costs instituted toward the end of 1994. These marketing programs consisted of increased bus programs and direct marketing activities. The increase in marketing costs was offset by decreased gaming taxes associated with the decreased levels of gaming activity and revenues from 1993. General and administrative expenses were $73.1 for the year ended December 31, 1994, an increase of $1.5 million or 2.1% from general and administrative expenses of $71.6 million in 1993. This increase resulted primarily from $1.1 million in cash associated with donations to the New Jersey Casino Reinvestment Development Authority (the "CRDA") for the year ended December 31, 1994. Income from operations was $43.4 million for the year ended December 31, 1994, a decrease of $6.2 million or 12.5% from income from operations of $49.6 million for 1993. Net interest expense was $48.2 million for the year ended December 31, 1994, an increase of $8.3 million or 20.8% from net interest expense of $39.9 million in 1993. This increase is primarily attributable to increased interest expenses associated with the Plaza Mortgage Notes and the PIK Notes which were outstanding for all of 1994. Other non-operating expense was $4.9 million (including $3.1 million of leasing costs) for the year ended December 31, 1994, an increase of $1.0 million or 25.6% from other non-operating expense of $3.9 million in 1993. This increase is directly attributable to twelve months of costs associated with Trump Plaza East. See Note 6 to the accompanying Financial Statements of Plaza Holding and Plaza Associates. RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1993 AND 1992 Gaming revenues were $264.1 million for the year ended December 31, 1993, a decrease of $1.3 million or 0.5% from gaming revenues of $265.4 million for 1992. This decrease in gaming revenues consisted of a reduction in table games revenues, which was partially offset by an increase in slot revenues. These results were impacted by major snow storms during February and March, which severely restricted travel in the region. The decrease in revenues was also attributable, in part, to the revenues derived from "high roller" patrons from the Far East during 1992, which did not recur in 1993, due in part to the decision to de-emphasize marketing efforts directed at "high roller" patrons from the Far East and also to the effects of the adverse economic conditions in that region. Slot revenues were $170.5 million for the year ended December 31, 1993, an increase of $1.0 million or 0.6% from slot revenues of $169.5 million in 1992. Plaza Associates elected to discontinue certain progressive slot jackpot programs thereby reversing certain accruals into revenues which had the effect of improving slot revenue by $4.1 million for the year ended December 31, 1992. Excluding the aforementioned adjustment, slot revenues would have resulted in a $5.0 million or 3.0% improvement over 1992. Plaza Associates believes that its improvement in slot revenues reflects its intensified slot marketing efforts directed towards patrons who tend to wager more per slot play and general growth in the industry. See "Business of THCR--Trump Plaza Business Strategy." Table games revenues were $93.6 million for the year ended December 31, 1993, a decrease of $2.3 million or 2.4% from table games revenues of $95.9 million in 1992. This decrease was primarily due to a reduction in table games drop by 9.2% for the year ended December 31, 1993 from 1992, offset by an increase in the table games hold percentage to 14.9% for the year ended December 31, 1993 from 13.9% in 1992. The reduction in table game drop was due to the large dollar amounts wagered during 1992 by certain foreign customers. During the year ended December 31, 1993, gaming credit extended to customers was approximately 18.0% of overall table play, a decrease of 9.6% from 1992. At December 31, 1993, gaming receivables amounted to approximately $16.0 million, a decrease of approximately $4.5 million from 1992, with allowances for doubtful gaming receivables of approximately $10.4 million, a decrease of approximately $3.6 million from 1992. Other revenues were $69.2 million for the year ended December 31, 1993, a decrease of $4.1 million or 5.6% from other revenues (excluding revenues from the former Trump Regency Hotel, now known as Trump World's Fair, at such time operated by Plaza Associates) of $73.3 million in 1992. The decrease in other revenues primarily reflects a $2.1 million adjustment to the outstanding gaming chip liability in 1992 (this amount had been offset in gaming cost and expenses with a specific reserve provision for casino uncollectible accounts receivable), as well as decreases in food and beverage revenues attendant to reduced levels of gaming activity, and reduced promotional allowances. Promotional allowances were $32.8 million for the year ended December 31, 1993, a decrease of $2.1 million or 5.9% from promotional allowances of $34.9 million in 1992. This decrease is primarily attributable to a reduction in table gaming activity as well as Plaza Associates' focusing its marketing efforts during the period towards patrons who tend to wager more frequently and in larger denominations. Gaming costs and expenses were $136.9 million for the year ended December 31, 1993, a decrease of $9.4 million, or 6.4% from gaming costs and expenses of $146.3 million in 1992. This decrease was primarily due to a $4.8 million decrease in gaming bad debt expense as well as decreased promotional and operating expenses and taxes associated with decreased levels of gaming activity and revenues. Other costs and expenses were $24.8 million for the year ended December 31, 1993, an increase of $1.1 million or 4.7% from other costs and expenses of $23.7 million in 1992. General and administrative expenses were $71.6 million for the year ended December 31, 1993, a decrease of $3.8 million or 5.1% from general and administrative expenses of $75.5 million in 1992. This decrease resulted primarily from a $2.4 million real estate tax charge resulting from a reassessment by local authorities of prior years' property values incurred during 1992 and overall cost reductions related to cost containment efforts. Income from operations was $49.6 million for the year ended December 31, 1993, an increase of $7.0 million or 16.4% from income from operations (excluding the operations of the former Trump Regency Hotel and before restructuring costs) of $42.6 million for 1992. In addition to the items described above, 1993 costs and expenses were lower as a result of the absence of the costs and expenses associated with the 1992 Plaza Restructuring and the former Trump Regency Hotel which were incurred in 1992. Net interest expense was $39.9 million for the year ended December 31, 1993, an increase of $8.5 million or 27.2% from net interest expense of $31.4 million in 1992. This is attributable to the interest expense associated with the 1993 refinancing. Other non-operating expenses were $3.9 million for the year ended December 31, 1993, an increase of $2.4 million or 164.9% from non-operating expense of $1.5 million in 1992. This increase is directly attributable to costs associated with Trump Plaza East. See Note 6 to the accompanying Financial Statements of Plaza Holding and Plaza Associates. In August 1990, Plaza Associates entered into a triple net lease with an affiliate pursuant to which Plaza Associates began operating the former Trump Regency Hotel as a non-casino hotel. During such period of operation, losses attributable to the former Trump Regency Hotel aggregating approximately $14.1 million adversely affected the results of operations of Plaza Associates. Pursuant to the 1992 Plaza Restructuring, Plaza Associates ceased operating the former Trump Regency Hotel as of September 30, 1992. The offerings of the Plaza Mortgage Notes, PIK Notes and PIK Note Warrants in connection with the 1993 refinancing resulted in an extraordinary gain of $4.1 million for the year ended December 31, 1993, which reflects the excess of carrying value of the former Trump Regency Hotel obligation over the amount of the settlement payment, net of related prepaid expenses. The 1992 Plaza Restructuring resulted in an extraordinary loss of $38.2 million for the year ended December 31, 1992, which reflects a $32.8 million accounting adjustment to carry the bonds and preferred stock issued in the 1992 Plaza Restructuring on Plaza Associates' balance sheet at fair market value based upon then current rates of interest. Plaza Associates also wrote off certain deferred financing charges and costs of $5.4 million. General. On June 12, 1995, THCR consummated the June 1995 Stock Offering of 10,000,000 shares of THCR Common Stock at the offering price of $14.00 per share, resulting in aggregate gross proceeds to THCR of $140,000,000, and THCR Holdings and THCR Funding consummated the June 1995 Note Offering. The proceeds to THCR from the June 1995 Stock Offering were contributed by THCR to THCR Holdings in return for an approximately 60% general partnership interest in THCR Holdings. THCR Holdings, in turn, has used net proceeds from the June 1995 Offerings through September 30, 1995 for the following purposes: (a) repurchase and redemption of the PIK Notes and PIK Note Warrants (including accrued interest payable) for $86,209,000, (b) exercise of the option to acquire Trump World's Fair (the "Trump World's Fair Purchase Option") for $58,150,000, (c) construction costs at Trump Plaza East of $2,500,000 and (d) construction and land acquisition costs of $23,772,000 for the Indiana Riverboat. The balance of the proceeds will be used for the completion of the construction at Trump Plaza, Trump Plaza East, Trump World's Fair and the Indiana Riverboat, as well as for general corporate purposes. Each of the Plaza Mortgage Note Indenture and the Senior Note Indenture restricts the ability of Plaza Associates, Trump Indiana and other subsidiaries of THCR Holdings to make distributions to partners or pay dividends, as the case may be, unless certain financial ratios are achieved. Further, given the rapidly changing competitive environment and the risks associated with THCR's proposed expansion plans, THCR's future operating results are highly conditional and could fluctuate significantly. Moreover, as a condition to the June 1995 Note Offering, THCR Holdings and THCR Funding entered into a Cash Collateral and Disbursement Agreement (the "Cash Collateral Agreement") with First Bank National Association in its respective capacities as Trustee and Disbursement Agent (each as defined therein). The Cash Collateral Agreement called for initial deposits to custodial accounts which are restricted in use for (a) Trump Indiana for the ship and land projects, (b) Trump Plaza construction projects, including the exercise of the Trump World's Fair Purchase Option and construction projects at Trump Plaza East and Trump World's Fair and (c) the first two interest payments on the Senior Notes. As of September 30, 1995, $24,225,000 is restricted for the first two interest payments on the Senior Notes and is reflected as restricted cash in THCR's condensed consolidated balance sheets. The balance of funds restricted for Trump Indiana, Trump Plaza East and Trump World's Fair is approximately $9,725,000, $12,650,000 and $49,375,000, respectively, at September 30, 1995, and is reflected as cash restricted for future construction as a non-current asset in THCR's balance sheets. With these restricted funds, as well as cash flow from operating activities, and the financings discussed above (some of which still remain to be obtained), THCR management believes that sufficient funds will be available to complete the projects that are currently in development. In addition, Plaza Associates may be obligated to comply with certain proposed regulations of the Occupational Safety and Health Administration ("OSHA"), if adopted. THCR is unable to estimate the cost, if any, to Plaza Associates of such compliance. See "Regulatory Matters--Other Laws and Regulations." Trump Plaza, Trump World's Fair and Trump Plaza East. Cash flow from operating activities is Plaza Associates' principal source of liquidity. For the year ended December 31, 1994, and the nine-month period ended September 30, 1995 net cash from operating activities was $20.0 million and $32.4 million, respectively. Capital expenditures of $86.6 million for the nine-month period ended September 30, 1995 increased approximately $72.0 million from the comparable period in 1994 and was primarily attributable to the purchase of Trump World's Fair for $60.0 million and $2.2 million of related renovation expenditures. Also, expenditures for renovation costs associated with Trump Plaza East were $14.2 million for the nine months ended September 30, 1995 versus $5.9 million for the comparable period in 1994. These expenditures were funded from cash flows from operating activities. Capital expenditures of $20.5 million for the year ended December 31, 1994 increased approximately $10.4 million from 1993 and were primarily attributable to the casino expansion, purchase of additional slot machines, construction of the new baccarat pit for Trump Plaza and refurbishing costs associated with Trump Plaza East. These expenditures were financed from funds generated from operations. Capital expenditures for 1993 and 1992 were $10.1 million and $8.6 million, respectively. Previously, Plaza Associates provided for significant capital expenditures which concentrated on the renovation of the casino floor and certain restaurants, hotel rooms and the hotel lobby. See "Business of THCR--Facilities and Amenities." Plaza Associates has approximately $2.1 million of indebtedness maturing through September 30, 1996. THCR management expects that this debt will be repaid with cash from operating activities. At September 30, 1995, THCR had combined working capital of $16.6 million, which included a receivable from the CRDA for $4.2 million for reimbursable improvements made to the Trump Plaza East. At December 31, 1994, Plaza Associates had a combined working capital deficit totaling $7.1 million, compared to a combined working capital deficit of $1.5 million at December 31, 1993. At September 30, 1995, Plaza Associates had a combined working capital deficit totaling approximately $1.7 million, compared to a combined working capital deficit of $7.1 million at December 31, 1994. In 1993, Plaza Associates received the approval of the CCC, subject to certain conditions, for the expansion of its hotel facilities at Trump Plaza East. As part of the Trump Plaza Expansion, management has commenced the expansion and renovation of rooms at Trump Plaza East, and on October 30, 1995, opened 150 rooms and suites at Trump Plaza East. This opening of rooms and suites was ahead of schedule and under the budget set for this part of the expansion. THCR intends to open the remainder of the rooms and suites and the casino at Trump Plaza East in the first quarter of 1996. There can be no assurances that such openings will occur and, if so, that the completion of such construction will be either under budget or ahead of schedule. Trump World's Fair renovations are scheduled for completion at the end of the first quarter or early in the second quarter of 1996. See "Risk Factors--High Leverage and Fixed Charges," "--Trump Plaza Expansion and the Taj Mahal Expansion," "--The Indiana Riverboat" and "--Considerations with Respect to the Acquisition or Development of Additional Gaming Ventures." As a result of the Trump Plaza Expansion, Plaza Associates will be permitted, subject to certain conditions, to increase, and is in the process of increasing, Trump Plaza's casino floor space to 90,000 square feet. Plaza Associates petitioned the CCC to permit it to increase such space to 100,000 square feet pursuant to a statutory amendment which became effective January 25, 1995. In its May 18, 1995 declaratory rulings with respect to this petition, the CCC determined, among other things, that the approved hotel comprised of Trump Plaza's main tower and Trump Plaza East is permitted to contain a maximum of 100,000 square feet of casino space. Plaza Associates added to Trump Plaza approximately 9,000 square feet in April 1994, 1,000 square feet in July 1994, 3,000 square feet in December 1994 and 25,000 square feet in June 1995. At September 30, 1995, the total casino square footage was approximately 73,000 square feet. Pursuant to the Trump Plaza East Purchase Option, which expires on June 30, 1998, Plaza Associates may purchase both the fee and leasehold interests comprising Trump Plaza East. See "Certain Transactions--Plaza Associates-- Trump Plaza East." Until such time as the Trump Plaza East Purchase Option is exercised or expires, Plaza Associates is obligated to pay the net expenses associated with Trump Plaza East, including, without limitation, current real estate taxes (approximately $1.2 million per year based upon current assessed valuation) and annual lease payments of $3.1 million per year. Under the Trump Plaza East Purchase Option, Plaza Associates has the right to acquire Trump Plaza East for a purchase price of $28.0 million through December 31, 1996, increasing by $1.0 million annually thereafter until expiration on June 30, 1998. In addition, Plaza Associates has the right of first offer upon any proposed sale of all or any portion of the fee interest in Trump Plaza East during the term of the Trump Plaza East Purchase Option (the "Right of First Offer") . Under the terms of the Trump Plaza East Purchase Option, if Plaza Associates defaults in making payments due under the Trump Plaza East Purchase Option, Plaza Associates would be liable to the grantor of the Trump Plaza East Purchase Option for the sum of (a) the present value of all remaining payments to be made by Plaza Associates pursuant to the Trump Plaza East Purchase Option during the term thereof and (b) the cost of demolition of all improvements then located at Trump Plaza East, unless such improvements had been accepted in writing by the grantor. See "Risk Factors--Trump Plaza Expansion and the Taj Mahal Expansion." Plaza Associates has no definitive plans with respect to exercising the Trump Plaza East Purchase Option. THCR management believes that the net proceeds of the June 1995 Offerings and equipment financings allocated to Trump Plaza East and cash flow from operations should be sufficient to complete the planned renovations of Trump Plaza and Trump Plaza East at a remaining cost, at September 30, 1995, of $12.7 million as contemplated by the Trump Plaza Expansion. However, additional financing will be required should THCR propose to exercise the Trump Plaza East Purchase Option, and there can be no assurance that such financing will be available on attractive terms, if at all. THCR anticipates incurring equipment financing for a portion of the gaming equipment at Trump Plaza East. Commitments are currently in place with respect to some of such financing, and THCR believes that it will be able to obtain the remainder of such financing on customary terms acceptable to THCR, although there can be no assurance given to that effect. Pursuant to the Right of First Offer, Plaza Associates has ten days after receiving written notice from the grantor of the proposed sale to commit to exercise the right to acquire Trump Plaza East at the lesser of the proposed sale price and the applicable exercise price under the Trump Plaza East Purchase Option. If Plaza Associates commits to exercise the Right of First Offer, it has ten days from the date of the commitment to deposit $3,000,000 with the grantor, to be credited towards the purchase price or to be retained by the grantor if the closing, through no fault of the grantor, does not occur within ninety days (or, subject to certain conditions, 120 days) of the date of the commitment. There can be no assurance that Plaza Associates would have the liquidity necessary to exercise its Right of First Offer on a timely basis should it be required. Pursuant to the terms of the TPM Services Agreement, in consideration for services provided, Plaza Associates pays TPM each year an annual fee of $1.0 million in equal monthly installments and reimburses TPM on a monthly basis for all reasonable out-of-pocket expenses incurred by TPM in performing its obligations under the TPM Services Agreement, up to certain amounts. Approximately $1.3 million and $1.2 million of payments under the TPM Services Agreement were charged to expense for the years ended December 31, 1994 and 1993, respectively, and approximately $1,012,000 and $961,000 were charged to the nine-month periods ended September 30, 1995 and 1994, respectively. Payments received under the TPM Services Agreement are currently pledged by TPM to secure lease payments for a helicopter that TPM makes available to Plaza Associates. Pending approval by the lessor of the helicopter, it is currently contemplated that the stock of TPM will be transferred by Trump to THCR Holdings, which will in turn assume the lease and related obligations, as well as become entitled to all amounts payable under the TPM Services Agreement. See "Certain Transactions." Approximately $58 million of the net proceeds of the June 1995 Offerings was used to exercise the Trump World's Fair Purchase Option. THCR believes that the net proceeds of the June 1995 Offerings, together with additional equipment financing, will be sufficient to fund the additional approximately $51.6 million required to complete renovation of and open Trump World's Fair early in the second quarter of 1996, although there can be no assurance given to that effect. Associated with the openings of Trump World's Fair and Trump Plaza East, management anticipates incurring approximately $ of pre-opening costs, which will be expensed at the time of such openings. Trump Indiana. Pursuant to the terms of the certificate of suitability originally issued to Trump Indiana on December 9, 1994, as extended, Trump Indiana must comply with certain statutory and other requirements imposed by the IGC. Failure to comply with the foregoing conditions and/or failure to commence riverboat excursions by June 28, 1996, may result in the revocation of the certificate of suitability. There can be no assurance that THCR and/or Trump Indiana will be able to comply with the terms of the certificate of suitability, or that a riverboat owner's license will ultimately be granted. In addition to the approximately $84 million anticipated to be spent prior to commencing the operations of the Indiana Riverboat early in the second quarter of 1996, during its initial five-year license term, an additional $69 million of funds (consisting of approximately $48 million for the construction of a hotel and other amenities and $21 million for infrastructure improvements and other municipal uses) will be required to be spent by Trump Indiana in connection with the Indiana Riverboat facility and related commitments, including commitments required in connection with the licensure process. The sources of the initial $84 million include, and are anticipated to include: $34 million from the proceeds of the June 1995 Offerings, $20 million from vessel financing, $10 million from equipment financing, $10 million from a mortgage on Trump Indiana's interest in the Buffington Harbor site or from an unsecured working capital facility and $10 million from operating leases. Trump Indiana has received commitments for $15 million in vessel financing and $10 million in slot machine financing.Trump Indiana is seeking commitments for the additional financing required to commence the operations of the Indiana Riverboat. The remaining $69 million required to be spent is expected to be funded with cash from operations or additional borrowings. See "Risk Factors--The Indiana Riverboat." On August 30, 1995, Trump Indiana entered into a loan and security agreement with debis Financial Services, Inc. ("dFS") pursuant to which dFS will provide, subject to the terms and conditions thereof, $15 million in financing for the gaming vessel, which is currently under construction. As of December 31, 1995, dFS has provided Trump Indiana with approximately $6.8 million pursuant to such agreement. Any other projects pursued by THCR in the future would require additional funds. There can be no assurance that sufficient funds will be available either from cash generated by operating activities or from additional financing sources for such projects. Trump Indiana and Barden entered into the BHR Agreement relating to the formation of BHR. Pursuant to the BHR Agreement, BHR will own, develop and operate all common land-based and waterside operations in support of each of Trump Indiana's and Barden's separate riverboat casinos at Buffington Harbor. Trump Indiana and Barden will each be equally responsible for the development and operating expenses of BHR. Upon its formation, BHR was capitalized with the contribution by Trump Indiana of ownership of the Buffington Harbor site and the contribution by Barden of $6.75 million. Barden has subsequently contributed approximately $14 million for construction costs to equal the costs previously funded by Trump Indiana; thereafter, Trump Indiana and Barden will share all of the development and operating expenses of BHR equally. There can be no assurance that THCR or Trump Indiana will be able to fund from operations or to finance on terms satisfactory to THCR or Trump Indiana any future required expenditures or, if available, other such indebtedness would be permitted under existing debt instruments of THCR. Furthermore, THCR will also be dependent on the ability of Barden to pay for its share of the development and operating expenses of BHR and there can be no assurance that Barden will be able to fund such expenses. Associated with the opening of the Indiana Riverboat, Management anticipates incurring $ of pre-opening costs, which will be expensed at the time of such openings. See "Risk Factors--The Indiana Riverboat." THCR. THCR has no independent means of generating revenues and its sole source of liquidity is distributions and other permitted payments from THCR Holdings. As of December 31, 1995, THCR did not have any long or short-term indebtedness, and is not anticipated to have any in the near future. THCR Holdings has agreed that all expenses of THCR shall, to the maximum extent practicable, be paid directly by THCR Holdings. Any other expenses paid directly by THCR are required to be reimbursed promptly by THCR Holdings and are deemed to be expenses of THCR Holdings. The gaming industry in Atlantic City is seasonal, with the heaviest activity at Trump Plaza occurring during the period from May through September. Consequently, THCR's operating results during the two quarters ending in March and December would not likely be as profitable as the two quarters ending in June and September. THCR has no operating history in Indiana, and is unable to predict seasonality with respect to the Indiana Riverboat. There was no significant impact on Plaza Associates' operations as a result of inflation during the first nine months of 1995, and during 1994, 1993 or 1992. THCR, through THCR Holdings and its subsidiaries, owns and operates Trump Plaza, a luxury casino hotel located on The Boardwalk in Atlantic City and the Indiana Riverboat, a gaming project currently under development at Buffington Harbor on Lake Michigan. THCR management believes THCR benefits from the following factors: . THE "TRUMP" NAME. THCR capitalizes on the widespread recognition of the "Trump" name and its association with high quality amenities and first class service. To this end, THCR provides a broadly diversified gaming and entertainment experience consistent with the "Trump" name and reputation for quality, tailored to the gaming patron in each market. THCR also benefits from the "Trump" name in connection with its efforts to expand and to procure new gaming opportunities in the United States and abroad. . TRUMP PLAZA EXPANSION. THCR is currently enhancing further Trump Plaza's position as an industry leader by increasing its gaming space and hotel capacity while maintaining its commitment to first class customer service. This strategy is designed to capitalize on Trump Plaza's reputation for excellence, as well as to meet both existing demand and the anticipated demand from the increased number of available rooms and infrastructure improvements that are currently being implemented to enhance further the "vacation destination appeal" of Atlantic City. The Trump Plaza Expansion is expected to be completed early in the second quarter of 1996 and to include the renovation and integration into Trump Plaza of Trump Plaza East and Trump World's Fair, together with additional casino space, retail operations and entertainment venues. On October 30, 1995, THCR opened nearly 50% of the rooms and suites in Trump Plaza East. This opening of 150 rooms and suites was ahead of schedule and under the budget set for this part of the expansion. THCR intends to open the remaining rooms and suites and the casino at Trump Plaza East in the first quarter of 1996. Renovations are ongoing at Trump World's Fair and THCR expects that the renovations at Trump World's Fair will be completed early in the second quarter of 1996. Upon completion of Trump World's Fair, Trump Plaza's casino floor space would be the largest in Atlantic City, increasing from 75,000 square feet to an aggregate of approximately 139,340 square feet of gaming space, housing a total of approximately 4,300 slot machines and 142 table games. Trump Plaza's hotel capacity would increase to a total of 1,404 guest rooms from 555 rooms, making Trump Plaza's guest room inventory the largest in Atlantic City. . INDIANA RIVERBOAT. Trump Indiana has received site approval and a certificate of suitability to develop a gaming project in Buffington Harbor, on Lake Michigan, approximately 25 miles southeast of downtown Chicago. Trump Indiana was the first recipient of a certificate of suitability in Indiana and is one of 11 riverboat gaming projects permitted under current Indiana law, with only five of these to be located in northern Indiana. The Indiana Riverboat is currently on schedule to open for business early in the second quarter of 1996. Trump Indiana and Barden have entered into the BHR Agreement providing for the formation of BHR, which will own, develop and operate all common land- based and waterside operations in support of each of Trump Indiana's and Barden's separate riverboat casinos at Buffington Harbor. The Indiana Riverboat is planned to have approximately 37,000 square feet of gaming space and feature 1,500 slot machines and 73 table games, and will be one of the largest riverboat casinos in the United States. The Indiana Riverboat's principal market will be the approximately 6.8 million people residing within 50 miles of the Indiana Riverboat in the northern Indiana suburban and Chicago metropolitan areas. Approximately 11.2 million and 24.2 million people live within a 100- and 200-mile radius of the site. . NEW "TRUMP" GAMING VENTURES. THCR explores opportunities to establish additional gaming operations, particularly in jurisdictions where the legalization of casino gaming is relatively recent or is anticipated. THCR management believes that Trump's involvement with THCR facilitates THCR's expansion efforts, as THCR plans to capitalize on the "Trump" name and what management believes to be its marquee value in seeking new casino opportunities. THCR, through THCR Holdings and its subsidiaries, is the exclusive vehicle for new gaming ventures by Trump, subject to the terms of certain agreements governing this relationship and Trump's relationship with Trump's Castle. See "--Trademark/Licensing" and "Management of THCR--Employment Agreements." THCR management believes that Trump Plaza's "Four Star" Mobil Travel Guide rating and "Four Diamond" American Automobile Association rating reflect the high quality amenities and services that Trump Plaza provides to its casino patrons and hotel guests. These amenities and services include a broad selection of dining choices, headline entertainment, deluxe accommodations, tennis courts and swimming and health spa facilities. Trump Plaza's management team has recently launched a variety of new initiatives designed to increase the level of gaming activity generally at its casino and to attract casino patrons who tend to wager more frequently and in larger denominations than the typical Atlantic City patron. These initiatives include targeted marketing and advertising campaigns directed to select groups of customers in the Boston-New York-Washington, D.C. corridor, the introduction of new slot machines and table games and the addition of bill acceptors on slot machines. The Trump Plaza Expansion. THCR management believes that as a result of the Trump Plaza Expansion and Trump Plaza's strategic location, Trump Plaza is well positioned to become one of the premier host properties in Atlantic City. The Trump Plaza Expansion is currently scheduled to be completed early in the second quarter of 1996 and would increase Trump Plaza's prime central frontage on The Boardwalk to nearly a quarter of a mile. THCR management also believes that the construction of the new convention center and tourist corridor linking the new convention center with The Boardwalk will enhance the desirability of Atlantic City generally and, as a result of Trump Plaza's central location, will benefit Trump Plaza in particular. In addition, THCR management expects to be able to take advantage of recent gaming regulatory changes that will allow casino space to be directly visible and accessible from The Boardwalk. Trump Plaza's location on The Boardwalk at the end of the main highway into Atlantic City makes it highly accessible for "drive-in" and "walk-in" patrons. THCR is in the process of renovating and integrating into Trump Plaza, Trump World's Fair, located on The Boardwalk adjacent to the existing Atlantic City Convention Center, which is next to Trump Plaza, at a remaining cost of $51.6 million as of September 30, 1995. Upon completion, Trump World's Fair would add 49,340 square feet of casino floor space directly accessible from The Boardwalk and 500 hotel rooms, connected with the current Trump Plaza hotel and casino facility by an enclosed walkway overlooking The Boardwalk. Renovations are ongoing at Trump World's Fair and THCR expects, although there can be no assurances, that the renovations at Trump World's Fair will be completed early in the second quarter of 1996. THCR management believes that Trump World's Fair represents an attractive expansion opportunity and use of capital, particularly relative to what management estimates it would cost to construct a comparable facility. Commencement of operations at Trump World's Fair is contingent upon, among other things, obtaining certain regulatory approvals. See "Risk Factors--Trump Plaza Expansion and the Taj Mahal Expansion." Trump Plaza is also in the process of renovating and integrating into Trump Plaza a hotel tower, Trump Plaza East, located adjacent to Trump Plaza's existing facility, at a remaining cost of approximately $25.2 million. On October 30, 1995, THCR opened nearly 50% of the rooms and suites in Trump Plaza East. This opening of 150 rooms and suites was ahead of schedule and under the budget set for this part of the expansion. THCR intends to open the remaining rooms and suites and the casino at Trump Plaza East in the first quarter of 1996. There can be no assurances that such openings will occur and, if so, that the completion of such construction will be either under budget or ahead of schedule. When completed, Trump Plaza East will have 15,000 square feet of casino space and 349 hotel rooms. Trump Plaza currently leases Trump Plaza East and has an option to acquire it from an unaffiliated entity. See "Certain Transactions--Plaza Associates--Trump Plaza East." Trump Plaza East will be reconfigured to provide a new entranceway to Trump Plaza directly off Atlantic City Expressway. Management believes the increased hotel capacity as a result of the Trump Plaza Expansion will enable it better to meet demand and accommodate its casino guests, as well as to host additional and larger conventions and corporate meetings. The following table details plans for the Trump Plaza Expansion: (1) Includes the 2,000 square foot area which will connect the existing facility with Trump Plaza East, and the 75 slot machines to be included in this area. (2) Includes 150 rooms which were opened on October 30, 1995. In July 1994, Time Warner opened its second largest Warner Brothers Studio Store pursuant to a sublease of the entire first floor of retail space on The Boardwalk at Trump Plaza East (approximately 17,000 square feet). THCR management believes that the commitment of Time Warner at Trump Plaza East, together with other nationally known retail, restaurant and entertainment establishments expected to participate in the Trump Plaza Expansion, evidences the continued growth of, and highlights Trump Plaza's favored place within, the Atlantic City casino market. Main Tower. The casino in the existing facility of Trump Plaza (the "Main Tower") currently offers 97 table games and 2,400 slot machines. In addition to the casino, the Main Tower consists of a 31-story tower with 555 guest rooms, including 62 suites. The Main Tower also offers 10 restaurants, a 750- seat cabaret theater, four cocktail lounges, 28,000 square feet of convention, ballroom and meeting room space, a swimming pool, tennis courts and a health spa. The entry level of the Main Tower includes a cocktail lounge, two gift shops, a deli, a coffee shop, an ice cream parlor and a buffet. The casino level houses the casino, a fast food restaurant, an exclusive slot lounge for high-end patrons and a new oceanfront baccarat gaming area. Upon completion, an enclosed walkway will connect Trump Plaza at the casino level with the Atlantic City Convention Center and with Trump World's Fair. The Main Tower's guest rooms are located in a tower which affords most guest rooms a view of the ocean. While rooms are of varying size, a typical guest room consists of approximately 400 square feet. Trump Plaza also features 16 one-bedroom suites, 28 two-bedroom suites and 18 "Super Suites." The Super Suites are located on the top two floors of the Main Tower and offer luxurious accommodations and 24-hour butler and maid service. The Super Suites and certain other suites are located on the "Club Level" which requires guests to use a special elevator key for access, and contains a lounge area (the "Club Level Lounge") that offers food and bar facilities. The Main Tower is connected by an enclosed pedestrian walkway to a 10-story parking garage, which can accommodate approximately 2,650 cars, and contains 13 bus bays, a comfortable lounge, a gift shop and waiting area (the "Transportation Facility"). The Transportation Facility provides patrons with immediate access to the casino, and is located directly off of the main highway into Atlantic City. Trump World's Fair. Upon completion of the renovation early in the second quarter of 1996, Trump World's Fair will be connected to the Main Tower by an enclosed walkway overlooking The Boardwalk and will add an additional 500 hotel rooms to Trump Plaza. In addition, Trump World's Fair will be outfitted with approximately 49,340 square feet of casino floor space housing approximately 1,550 slot machines and 33 table games. In addition to the casino, Trump World's Fair will feature three restaurants, including a state- of-the-art buffet, a cocktail lounge, convention, ballroom and meeting room space, a swimming pool and a health spa. The enclosed walkway will run through a portion of the Atlantic City Convention Center, which is located between Trump World's Fair and the Main Tower. In this connection, Plaza Associates has acquired an easement with regard to portions of the Atlantic City Convention Center. See "--Properties--Trump World's Fair" and "Regulatory Matters--New Jersey Gaming Regulations--Approved Hotel Facilities." Trump Plaza East. Plaza Associates is in the process of renovating and integrating Trump Plaza East, which is located directly adjacent to the Main Tower, into Trump Plaza. The hotel will be opened in stages beginning with the hotel rooms, of which 150 were opened on October 30, 1995. This construction was completed ahead of schedule under the budget for this part of the expansion. THCR intends to open the remaining rooms and suites and the casino at Trump Plaza East in the first quarter of 1996. In addition, the hotel has retail space fronting The Boardwalk. Trump has entered into a 10-year sublease agreement with Time Warner pursuant to which Time Warner has subleased the entire first floor of the retail space (approximately 17,000 square feet) located at Trump Plaza East for a Warner Brothers Studio Store which opened in July 1994. The second floor, directly connected to the Main Tower, will house 15,000 square feet of distinctly themed casino floor space with 400 slot machines and one pit of 13 table games. Plaza Associates is obligated to either pay a tax to the CRDA of 2.5% of its gross casino revenues (excluding revenues from casino operations at Trump World's Fair during its first year of operation, and including such revenues at all times after its first year of operation) or to obtain investment tax credits in an amount equal to 1.25% of its gross casino revenues. In 1993, Plaza Associates obtained approval from the CRDA for $14.1 million of funding with respect to the demolition of certain structures at Trump Plaza East and the construction of certain improvements on the site. Recently, the New Jersey Superior Court ruled that the CRDA exceeded its statutory authority in granting such approval. The ruling is being appealed by Plaza Associates, but there can be no assurance as to the success of such appeal. See "--Legal Proceedings--Trump Plaza East." General. A primary element of Trump Plaza's business strategy is to seek to attract patrons who tend to wager more frequently and in larger denominations than the typical Atlantic City gaming customer ("high-end players"). Such high-end players typically wager $5 or more per play in slots and $25 or more per play in table games. In order to attract more high-end gaming patrons to Trump Plaza in a cost-effective manner, Plaza Associates has refocused its marketing efforts. Commencing in 1991, Plaza Associates substantially curtailed costly "junket" marketing operations which involved attracting groups of patrons to the facility on an entirely complimentary basis (e.g., by providing free air fare, gifts and room accommodations). In the fall of 1992, Plaza Associates decided to de-emphasize marketing efforts directed at "high roller" patrons from the Far East, who tend to wager $50,000 or more per play in table games. Plaza Associates determined that the potential benefit derived from these patrons did not outweigh the high costs associated with attracting such players and the resultant volatility in the results of operations of Trump Plaza. Revenues derived from high roller patrons have declined since 1992, although management believes that such revenue loss has not had a significant impact on profitability for the reasons discussed above. In addition, this shift in marketing strategy has allowed Plaza Associates to focus its efforts on attracting the high-end players. After a period of turnover in management in 1994, Plaza Associates hired a new president and chief operating officer for Trump Plaza, as well as several other senior managers. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of THCR--Results of Operations for the Years Ended December 31, 1994 and 1993" and "Management of THCR--Employment Agreements." The new management team at Trump Plaza is dedicated to continuing Trump Plaza's long-standing commitment to maintaining high quality amenities, while at the same time pursuing an aggressive new strategy focusing on strategic expansion and customer service. Trump Plaza's management team commenced the Trump Plaza Expansion in 1995 and has recently launched a variety of new initiatives designed to increase the level of casino gaming activity generally at its casino and, in particular, to attract casino patrons who tend to wager more frequently and in larger denominations than the typical Atlantic City patron. These initiatives include targeted marketing and advertising campaigns directed to select groups of customers in the Boston-New York-Washington, D.C. corridor, the introduction of new slot machines and table games and the addition of bill acceptors on slot machines. Gaming Environment. In recent years, there has been an industry trend towards fewer table games and more slot machines. For the Atlantic City casino industry, revenue from slot machines increased from 54.6% of the industry gaming revenue in 1988 to 67.0% of the industry gaming revenue in 1994. Trump Plaza experienced a similar increase, with slot revenue increasing from 51.2% of gaming revenue in 1988 to 64.5% of gaming revenue in 1994. In response to this trend, Trump Plaza has devoted more of its casino floor space to slot machines. In April 1993, Trump Plaza removed 12 table games from the casino floor and replaced them with 75 slot machines. Moreover, as part of its program to attract high-end slot players, Plaza Associates created "Fifth Avenue Slots," a separate high-end slot area that includes approximately 70 slot machines (most of which provide for $5 or more per play), an exclusive lounge for high-end patrons and other amenities. Trump Plaza pursues a continuous preventative maintenance program that emphasizes the casino, hotel rooms and public areas in Trump Plaza. These programs are designed to maintain the attractiveness of Trump Plaza to its gaming patrons. Trump Plaza continuously monitors the configuration of the casino floor and the games it offers to patrons with a view towards making changes and improvements. Trump Plaza's casino floor has clear, large signs for the convenience of patrons. As new games have been approved by the CCC, Plaza Associates has integrated such games into its casino operations to the extent it deems appropriate. "Comping" Strategy. In order to compete effectively with other Atlantic City casino hotels, Plaza Associates offers complimentary drinks, meals, room accommodations and/or travel arrangements to its patrons ("complimentaries" or "comps"). Management monitors Trump Plaza's policy on complimentaries so as to provide comps primarily to patrons with a demonstrated propensity to wager at Trump Plaza. Entertainment. Trump Plaza offers headline entertainment as part of its strategy to attract high-end and other patrons. Trump Plaza offers headline entertainment weekly during the summer and monthly during the off- season, and also features other entertainment and revue shows. Player Development/Casino Hosts. Plaza Associates currently employs gaming representatives in New Jersey, New York and other states, as well as several international representatives, to promote Trump Plaza to prospective gaming patrons. Player development personnel host special events, offer incentives and contact patrons directly in an effort to attract high-end table game patrons from the United States, Canada and South America. Trump Plaza's casino hosts assist patrons on the casino floor, make room and dinner reservations and provide general assistance. They also solicit Trump Card (the frequent player slot card) sign-ups in order to increase Plaza Associates marketing base. Promotional Activities. The Trump Card constitutes a key element in Trump Plaza's direct marketing program. Subject to regulatory constraints, the Trump Card will be used in all of THCR's gaming facilities so as to build a national database of gaming patrons. Slot machine players are encouraged to register for and utilize their personalized Trump Card to earn various complimentaries based upon their level of play. The Trump Card is inserted during play into a card reader attached to the slot machine for use in computerized rating systems. THCR's computer systems record data about the cardholders, including playing preferences, frequency and denomination of play and the amount of gaming revenues produced. Trump Plaza designs promotional offers, conveyed via direct mail and telemarketing, to patrons expected to provide revenues based upon their historical gaming patterns. Such information is gathered on slot wagering by the Trump Card and on table game wagering by the casino game supervisors. Promotional activities include the mailing of vouchers for complimentary slot play. Trump Plaza also utilizes a special events calendar (e.g., birthday parties, sweepstakes and special competitions) to promote its gaming operations. Plaza Associates conducts slot machine and table game tournaments in which cash prizes are offered to a select group of players invited to participate in the tournament based upon their tendency to play. Such players tend to play at their own expense during "off-hours" of the tournament. At times, tournament players are also offered special dining and entertainment privileges that encourage them to remain at Trump Plaza. Bus Program. Trump Plaza has a bus program, which transports approximately 2,400 gaming patrons per day during the week and 3,500 per day on the weekends. Trump Plaza's bus program offers incentives and discounts to certain scheduled and chartered bus customers. Trump Plaza's Transportation Facility contains 13 bus bays and is connected by an enclosed pedestrian walkway to Trump Plaza. The Transportation Facility provides patrons with immediate access to the casino, and contains a comfortable lounge area for patrons waiting for return buses. Credit Policy. Historically, Trump Plaza has extended credit to certain qualified patrons. For the years ended December 31, 1992, 1993 and 1994 and the nine months ended September 30, 1995 credit play as a percentage of total dollars wagered was approximately 28%, 18%, 17%, and 18%, respectively. As part of Trump Plaza's new business strategy and in response to the general economic downturn in the Northeast, Trump Plaza has imposed stricter standards on applications for new or additional credit and has reduced credit to international patrons. Such stricter standards in the extension of credit have contributed to the reduction of credit play as a percentage of total dollars wagered and has led to improved quality of the credit extended. The gaming industry in Atlantic City is seasonal, with the heaviest activity at Trump Plaza during the period from May through September, and with December and January showing substantial decreases in activity. Revenues have been significantly higher on Fridays, Saturdays, Sundays and holidays than on other days. Plaza Associates has approximately 3,800 employees of whom approximately 1,100 are covered by collective bargaining agreements. THCR management believes that its relationships with its employees are satisfactory. Certain of Plaza Associates employees must be licensed under the Casino Control Act. See "Regulatory Matters--New Jersey Gaming Regulations--Qualification of Employees." Plaza Funding has no employees. In April 1993, the National Labor Relations Board (the "NLRB") found that Plaza Associates had violated the National Labor Relations Act (the "NLRA") in the context of a union organizing campaign by table game dealers of Plaza Associates in association with the Sports Arena and Casino Employees Union Local 137, a/w Laborers' International Union of North America, AFL-CIO ("Local 137"). In connection with such finding, Plaza Associates was ordered to refrain from interfering with, restraining, or coercing employees in the exercise of the rights guaranteed them by Section 7 of the NLRA, to notify its employees of such rights and to hold an election by secret ballot among its employees regarding whether they desire to be represented for collective bargaining by Local 137. The election was held on May 20 and 21, 1994 and the vote, which has been certified by the NLRB, was in favor of management and against representation by Local 137. The Indiana Riverboat is expected to feature an approximately 280-foot luxury yacht containing approximately 37,000 square feet of gaming space with 1,500 slot machines, 73 table games and capacity of approximately 2,450 passengers and 300 employees. The site adjacent to the Indiana Riverboat is anticipated to include surface parking for approximately 3,000 automobiles and certain other infrastructure improvements. The cost to THCR for the development of the Indiana Riverboat, which includes the land, the vessel, gaming equipment, a pavilion for staging and ticketing and restaurant facilities, berthing and support facilities and parking facilities, is expected to be approximately $84 million through the planned opening early in the second quarter of 1996. THCR initially anticipated spending $59 million prior to the commencement of the Indiana Riverboat's operations for the vessel, gaming equipment and initial berthing and support facilities, and also anticipated spending an additional $27 million in the second phase to be completed by mid-1997, which would feature a pavilion for staging and ticketing and restaurant facilities, berthing and support facilities and expanded parking. To facilitate the Indiana Riverboat's operations from the opening day and to avoid disruptive construction at the site for an additional year, THCR determined to accelerate the second phase of the project and complete both phases prior to commencing operations. On August 30, 1995, Trump loan and security agreement with dFS, pursuant to which dFS has agreed, subject to the terms and conditions thereof, to provide $15 million in financing for the gaming vessel which is substantially constructed. In addition, THCR has further committed in the licensure process to construct a hotel facility and other amenities (at an approximate cost of $48 million) and to fund approximately $21 million of infrastructure improvements and other municipal uses. The Indiana Riverboat site is approximately 25 miles from downtown Chicago. In addition, the cities of Indianapolis, Fort Wayne, Toledo and Grand Rapids are each within a 175-mile radius of the Indiana Riverboat location. THCR believes the Indiana Riverboat will benefit from (i) its location and size, (ii) its strategy of developing, together with Barden, an array of entertainment, retail and restaurant attractions, and coordinating cruise schedules and (iii) the widespread recognition of the "Trump" name and what management believes to be its reputation for quality. Gaming facilities in Illinois are limited at present to 1,200 gaming positions under current regulations in Illinois, which THCR believes will put Illinois properties at a competitive disadvantage to larger facilities such as the Indiana Riverboat. THCR expects to draw on these competitive advantages and to capitalize on its experience in gaming activities in Atlantic City in order to create an outstanding gaming and entertainment experience. THCR expects to focus its marketing efforts for the Indiana Riverboat on the middle market, which makes up the majority of the gaming population in the Great Lakes Market. The middle market constitutes a broad segment of casino patrons who come to a casino for exciting recreation and entertainment and who typically wager less, on an individual basis, than high-end patrons. Through the use of the "Trump" name and systematic marketing programs, THCR will seek to attract drive-in customers to the facility. Casinos currently operating in the Great Lakes Market have been achieving operating results which exceed levels in other new gaming markets in terms of win per unit. THCR believes that these operating levels indicate that the Great Lakes Market will be capable of absorbing significant capacity expansion in the future. Under current gaming laws in Indiana, all games typically available in Atlantic City casinos will be permitted on the Indiana Riverboat. The riverboat casinos in Indiana will be permitted to stay open 24 hours per day, 365 days per year and to extend credit and accept credit charge cards, with no loss or wagering limits. It is anticipated that the Indiana Riverboat would make approximately six daily cruises of two to three hours in duration each. Indiana gaming laws permit gambling while cruising and during each 30-minute period during passenger embarkation and disembarkation. The foregoing may be subject to the adoption of proposed amendments to applicable Federal legislation and clarification or interpretation of recently enacted state legislation. See "Regulatory Matters--Indiana Gaming Regulations--Excursions." THCR believes that competition in the gaming industry, particularly the riverboat and dockside gaming industry, is based on the quality and location of gaming facilities, the effectiveness of marketing efforts, and customer service and satisfaction. Although management of THCR believes that the location of the Indiana Riverboat will allow THCR to effectively compete with other casinos in the geographic area surrounding its casino, THCR expects competition in the casino gaming industry to be intense as more casinos are opened and new entrants into the gaming industry become operational. Barden and Trump Indiana are the holders of the certificates of suitability in Buffington Harbor. Barden is an entity beneficially owned by Don H. Barden, a developer based in Detroit without significant gaming experience. Pursuant to the BHR Agreement, BHR will own, develop and operate all common land-based and waterside operations in support of Trump Indiana's and Barden's separate riverboat casinos at Buffington Harbor. Trump Indiana and Barden will each be equally responsible for the development and the operating expenses of BHR. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of THCR--Liquidity and Capital Resources." On June 29, 1995, Trump Indiana acquired, pursuant to the Agreement of Sale (the "Site Sale Agreement") with Lehigh Portland Cement Company ("Lehigh"), dated May 10, 1995, approximately 88 acres of land at Buffington Harbor for $13.5 million (the "Site Purchase Price"). Pursuant to the Site Sale Agreement, Lehigh also granted Trump Indiana a ten year lease for the initial use of certain of Lehigh's property adjacent to the Buffington Harbor site for the docking of the Indiana Riverboat vessel. Trump Indiana will make no lease payments to Lehigh during the first 30 months of the lease. In the event that the use of this property continues beyond the initial 30- month period, Lehigh will be entitled to receive a license fee in an amount equal to $125,000 per month for each month Trump Indiana uses Lehigh's property during the remaining term of the lease. In 1994, the City of Gary (the "City") commenced a legal proceeding in Lake County Superior Court of Indiana captioned City Of Gary v. Lehigh Portland Cement Company, et al., in which the City sought to exercise its eminent domain power to acquire certain of Lehigh's property, including the Buffington Harbor site, for the purpose of using the land as a gaming venture. On May 12, 1995, the court ruled in favor of the City. Consummation of the condemnation process is subject to additional conditions. However, on May 27, 1995, THCR entered into a Memorandum of Understanding (the "MOU") with the City pursuant to which the City agreed to take all necessary steps to dismiss the condemnation suit following the closing of the Site Sale Agreement. This proceeding was dismissed with prejudice in July 1995. THCR and Trump Indiana further agreed, among other things, to (i) pay to the City $205,000 as reimbursement for certain costs and expenses incurred by the City, and pay certain additional costs and expenses to be incurred by the City in connection with the dismissal of its condemnation suit; (ii) use best efforts to negotiate and complete by June 20, 1995 a long-term ground lease pursuant to which the City would lease the Buffington Harbor Site to Trump Indiana for a period of 99 years with rent at $1.00 per year (the "Buffington Harbor Lease"), (iii) transfer title to the Buffington Harbor Site to the City in consideration of $1.00 upon closing the Site Sale Agreement, provided the Buffington Harbor Lease is then effective; (iv) use best efforts to negotiate and complete by July 25, 1995 a development agreement with the City in order to confirm Trump Indiana's undertakings to the City pursuant to its certificate of suitability and (v) commence construction at the Buffington Harbor site by the later of June 30, 1995 or such date on which all permits and approvals necessary for the development and operation of the Buffington Harbor site have been obtained, and use best efforts to commence gaming operations within ninety (90) days of commencement of construction. To date, THCR and Trump Indiana have complied with the terms of the MOU. On September 29, 1995, Trump Indiana, Barden and the City entered into an agreement modifying the MOU (the "Amended MOU"). The Amended MOU permits Trump Indiana and Barden to retain ownership of the 88 acre parcel at Buffington Harbor to be utilized for their riverboat operations. On December 9, 1994, the IGC issued to Trump Indiana a certificate of suitability for a riverboat owner's license for a riverboat to be docked in Buffington Harbor, Indiana. The certificate of suitability constitutes approval of the application of Trump Indiana for a riverboat owner's license. In January 1996, the IGC extended Trump Indiana's certificate of suitability until June 28, 1996. Pursuant to the terms of the certificate of suitability, during such period, Trump Indiana must comply with certain statutory and other requirements imposed by the IGC. In addition, as a condition to the certificate of suitability, Trump Indiana has committed to invest $153 million in the Indiana Riverboat and certain related projects and certain economic development projects and to pay to the City a 1% of gross gaming revenue fee, intended to be used by the City for security and public safety purposes, and an additional fee ranging from (i) 2% to 4% of the gross gaming revenue depending on the amount of gross gaming revenues generated or (ii) 2% to 18% of net income before taxes depending on the amount of Trump Indiana's net income before taxes, whichever is greater. Failure to comply with the foregoing conditions and/or failure to commence riverboat excursions by such time as required by the IGC could result in the revocation of the certificate of suitability. There can be no assurance that THCR and/or Trump Indiana will be able to comply with the terms of the certificate of suitability, that it will be further extended if operations do not commence by June 28, 1996 or that a riverboat owner's license will ultimately be granted. The riverboat owner's license will only be issued upon satisfaction of the conditions of the certificate of suitability and the requirements of the gaming laws, which include the completion of the Indiana Riverboat, acquisition of necessary permits or approvals from federal, state and local authorities and readiness to commence operations. See "Regulatory Compliance Requirements." If granted, such license would be for an initial term of five years and renewable annually thereafter. With respect to certain land-based facilities, THCR would also be dependent on the ability of Barden to obtain the requisite licenses and fund its portion of joint construction costs. Trump Indiana has entered into a Sales and Construction Agreement with Atlantic Marine, Inc. ("AMI") for the purchase and construction of the Indiana Riverboat vessel (the "Construction Agreement") for $24 million (the "Vessel Contract Price"). Pursuant to the Construction Agreement, Trump Indiana paid 10% of the Vessel Contract Price to AMI and AMI ordered materials and commenced construction of the vessel. The vessel will remain the property of AMI until the Vessel Contract Price is paid in full. All risk of damage to or destruction of the vessel and all liability to or for labor employed during its construction will be the responsibility of AMI. Pursuant to the Construction Agreement, AMI will not be responsible for (i) any negligent construction or defects in the vessel after nine months from the date of acceptance of the vessel by Trump Indiana upon completion of the construction or (ii) any incidental or consequential damages. Development of the Indiana Riverboat project will require THCR to (a) acquire rights to traverse, use and/or improve certain parcels of property owned by third parties, in order to gain direct, construction and emergency access to the property, and (b) acquire access to water, sewer, gas, electric and other necessary utility services which presently cannot provide service to the site and which may require extension of existing utility service facilities across existing rights of way and other property owned by third parties. There can be no assurance that THCR will obtain the rights, utility services, licenses, permits and approvals necessary to undertake or complete its development plans, or that such rights, utility services, licenses, permits and approvals will be obtained within the anticipated time frame. Before the Indiana Riverboat becomes operational, additional definitive agreements must be negotiated and executed, gaming facilities must be constructed and a number of further conditions must be satisfied (including the licensing of THCR, Barden and their respective employees and the receipt of all requisite permits). There can be no assurance that the Indiana Riverboat will become operational. See "--Indiana Riverboat," "Risk Factors-- The Indiana Riverboat," "--Competition," and "Regulatory Matters--Indiana Gaming Regulations." THCR believes that competition in the gaming industry, particularly the riverboat and dockside gaming industry, is based on the quality and location of gaming facilities, the effectiveness of marketing efforts, and customer service and satisfaction. Although management of THCR believes that the location of the Indiana Riverboat will allow THCR to compete effectively with other casinos in the geographic area surrounding its casino, THCR expects competition in the casino gaming industry to be intense as more casinos are opened and new entrants into the gaming industry become operational. See "Competition." THCR has no operating history in Indiana and is unable to predict seasonality with respect to the Indiana Riverboat. Casino gaming is currently permitted in a number of other states, as well as on Native American lands in a number of other states. New or expanded operations by other persons can be expected to increase competition for THCR's existing and future operations and could result in the saturation of certain gaming markets. THCR explores opportunities to establish additional gaming operations, particularly in jurisdictions where the legalization of casino gaming is relatively recent or is anticipated. There can be no assurance as to whether, or the point at which, THCR will be successful in commencing gaming operations in any particular jurisdiction. The results of THCR's efforts to establish such operations will depend upon the level of competition for available opportunities, THCR's financial resources and other factors which may be beyond THCR's control, including the decision of various jurisdictions to establish or expand legalized casino gaming and risks associated with construction. See "Risk Factors--Considerations with Respect to the Acquisition or Development of Additional Gaming Ventures." Plaza Associates owns and leases several parcels of land in and around Atlantic City, New Jersey, each of which is used in connection with the operation of Trump Plaza and each of which is subject to the liens of the mortgages associated with the Plaza Mortgage Notes (collectively, the "Plaza Mortgages") and certain other liens. Upon its acquisition, Trump Plaza East would also become subject to the Plaza Mortgages. One of the Plaza Mortgages (the "Plaza Note Mortgage") and related assignments of assets encumber the real property owned and leased by Plaza Associates and substantially all of Plaza Associates' other assets, all of which constitute Trump Plaza and its related properties, and secure a note from Plaza Associates to Plaza Funding in the same principal amount of the Plaza Mortgage Notes (the "Plaza Associates Note"). Plaza Funding has assigned the Plaza Note Mortgage and Plaza Associates Note to the trustee under the Plaza Mortgage Note Indenture. Another of the Plaza Mortgages (the "Plaza Guarantee Mortgage") and related assignments of assets of Plaza Associates encumber the real property and assets of Plaza Associates described above, senior to the liens of the Plaza Note Mortgage, and secure Plaza Associates' non-recourse guarantee (the "Plaza Guarantee") of the Plaza Mortgage Notes. The Plaza Mortgage Note Indenture and the Plaza Mortgages are herein collectively referred to as the "Plaza Mortgage Note Agreements." Plaza Casino Parcel. The Main Tower is located on The Boardwalk in Atlantic City, New Jersey, next to the existing Atlantic City Convention Center. It occupies the entire city block (approximately 2.38 acres) bounded by The Boardwalk, Mississippi Avenue, Pacific Avenue and Columbia Place (the "Plaza Casino Parcel"). The Plaza Casino Parcel consists of four tracts of land, one of which is owned by Plaza Associates and three of which are leased to Plaza Associates pursuant to three non-renewable ground leases, each of which expires on December 31, 2078 (each, a "Plaza Ground Lease"). Trump Seashore Associates ("Trump Seashore"), Seashore Four Associates ("Seashore Four") and Plaza Hotel Management Company (each, a "Plaza Ground Lessor") are the owners/lessors under such respective Ground Leases (respectively, the "TSA Lease," "SFA Lease" and "PHMC Lease"; the land which is subject to the Ground Leases (which includes Additional Parcel 1, as defined) is referred to collectively as the "Plaza Leasehold Tracts" and individually as a "Plaza Leasehold Tract"). Trump Seashore Associates and Seashore Four Associates are 100% beneficially owned by Trump and are, therefore, affiliates of THCR. The Plaza Ground Leases provide that each Plaza Ground Lessor may encumber its fee estate with mortgage liens, but any such fee mortgage will not increase the rent under the applicable Plaza Ground Lease and must be subordinate to such Plaza Ground Lease. Accordingly, any default by a Plaza Ground Lessor under any such fee mortgage will not result in a termination of the applicable Plaza Ground Lease but would permit the fee mortgagee to bring a foreclosure action and succeed to the interests of the Plaza Ground Lessor in the fee estate, subject to Plaza Associates' leasehold estate under such Plaza Ground Lease. Each Plaza Ground Lease also specifically provides that the Plaza Ground Lessor may sell its interest in the applicable Plaza Leasehold Tract, but any such sale would be made subject to Plaza Associates' interest in the applicable Plaza Ground Lease. On August 1, 1991, as security for indebtedness owed to a third party, Trump Seashore transferred its interest in the TSA Lease to United States Trust Company of New York ("UST"), as trustee for the benefit of such third party creditor. The trust agreement among UST, Trump Seashore and such creditor provides that the trust shall terminate on the earlier of (i) August 1, 2012 or (ii) the date on which such third party creditor certifies to UST that all principal, interest and other sums due and owing from Trump Seashore to such third party creditor have been paid. On September 20, 1995, Trump Seashore and its third party lender entered into a mortgage note modification and extension agreement, pursuant to which Trump Seashore and such third party lender extended the term of the indebtedness described above, which matured in October 1993, to September 30, 1996, and increased the interest rate to be paid on such indebtedness to one and one-half percent in excess of the interest rate stated by such third party lender to be its prime rate. Each Plaza Ground Lease contains options pursuant to which Plaza Associates may purchase the Plaza Leasehold Tract covered by such Plaza Ground Lease at certain times during the term of such Plaza Ground Lease under certain circumstances. The purchase price pursuant to each option is specified in the applicable Plaza Ground Lease. The Plaza Ground Leases are "net leases" pursuant to which Plaza Associates, in addition to the payment of fixed rent, is responsible for all costs and expenses with respect to the use, operation and ownership of the Plaza Leasehold Tracts and the improvements now, or which may in the future be, located thereon, including, but not limited to, all maintenance and repair costs, insurance premiums, real estate taxes, assessments and utility charges. The improvements located on the Plaza Leasehold Tracts are owned by Plaza Associates during the terms of the respective Plaza Ground Leases and upon the expiration of the term of each Plaza Ground Lease (for whatever reason), ownership of such improvements will vest in the Plaza Ground Lessor. If a bankruptcy case is filed by or commenced against a Plaza Ground Lessor under applicable bankruptcy law, the trustee in bankruptcy in a liquidation or reorganization case under the applicable bankruptcy law, or a debtor-in- possession in a reorganization case under the applicable bankruptcy law, has the right, at its option, to assume or reject the Plaza Ground Lease of the debtor-lessor (subject, in each case, to court approval). If the Plaza Ground Lease is assumed, the rights and obligations of Plaza Associates thereunder, and the rights of the trustee with respect to the Plaza Mortgage Notes (the "Plaza Mortgage Note Trustee") as leasehold mortgagee under the Plaza Mortgage Note Agreements, would continue in full force and effect. If the Plaza Ground Lease is rejected, Plaza Associates would have the right, at its election, either (i) to treat the Plaza Ground Lease as terminated, or (ii) to continue in possession of the land and improvements under the Plaza Ground Lease for the balance of the term thereof and at the rental set forth therein (with a right to offset against such rent any damages caused by the Plaza Ground Lessor's failure to thereafter perform its obligations under such Plaza Ground Lease). The Plaza Mortgage Note Agreements provide that if a Plaza Ground Lease is rejected, Plaza Associates assigns to the Plaza Mortgage Note Trustee its rights to elect whether to treat the Plaza Ground Lease as terminated or to remain in possession of the leased premises. In the case of the Plaza Ground Leases, the rejection of a Plaza Ground Lease by a trustee in bankruptcy or debtor-lessor (as debtor-in-possession) may result in termination of any options to purchase the fee estate of the debtor-lessor and the Plaza Mortgage Note Trustee's option (as leasehold mortgagee as described above), if the Plaza Ground Lease is terminated, to enter into a new lease directly with the lessor. In addition, under an interpretation of New Jersey law, it is possible that a court would regard such options as separate contracts and, therefore, severable from the Plaza Ground Lease. In such event, the trustee in bankruptcy or debtor-lessor (as debtor-in-possession) could assume the Plaza Ground Lease, while rejecting some or all of such options under the Ground Lease. Parking Parcels. Plaza Associates owns a parcel of land (the "Plaza Garage Parcel") located across the street from the Plaza Casino Parcel and along Pacific Avenue in a portion of the block bounded by Pacific Avenue, Mississippi Avenue, Atlantic Avenue and Missouri Avenue. Plaza Associates has constructed on the Plaza Garage Parcel a 10-story parking garage capable of accommodating approximately 2,650 cars and which includes offices and a bus transportation center with bays accommodating up to 13 buses at one time. An enclosed pedestrian walkway from the parking garage accesses Trump Plaza at the casino level. Parking at the parking garage is available to Trump Plaza's guests, as well as to the general public. One of the tracts comprising a portion of the Plaza Garage Parcel is subject to a first mortgage on Plaza Associates' fee interest in such tract. As of September 30, 1995, such mortgage secured indebtedness had an approximate outstanding principal balance of $1.4 million. Plaza Associates leases, pursuant to the PHMC Lease, a parcel of unimproved land located on the northwest corner of the intersection of Mississippi and Pacific Avenues consisting of approximately 11,800 square feet ("Additional Parcel 1") and owns another parcel on Mississippi Avenue adjacent to Additional Parcel 1 consisting of approximately 5,750 square feet (the "Bordonaro Parcel"). In addition to the Plaza Mortgages, the Bordonaro Parcel is encumbered by a first mortgage securing indebtedness having an outstanding principal balance, as of September 30, 1995, of approximately $110,000. Additional Parcel 1 and the Bordonaro Parcel are presently paved and used for surface parking. Plaza Associates also owns five parcels of land, aggregating approximately 43,300 square feet, and subleases one parcel consisting of approximately 3,125 square feet. All of such parcels are contiguous and are located along Atlantic Avenue, in the same block as the Plaza Garage Parcel. They are used for signage and surface parking and are not encumbered by any mortgage liens other than those of the Plaza Mortgages. Warehouse Parcel. Plaza Associates owns a warehouse and office facility located in Egg Harbor Township, New Jersey containing approximately 64,000 square feet of space (the "Egg Harbor Parcel"). The Egg Harbor Parcel is encumbered by a first mortgage having an outstanding principal balance, as of September 30, 1995, of approximately $1.5 million and is encumbered by the Plaza Mortgages. Trump Plaza East. In September 1993, Trump (as predecessor in interest to Plaza Associates under the lease for Trump Plaza East) entered into the Time Warner Sublease with Time Warner pursuant to which Time Warner subleased the entire first floor of retail space for a new Warner Brothers Studio Store which opened in July 1994. The Time Warner Sublease provides for a 10-year term which expires on the last day of the month immediately preceding the tenth anniversary of the commencement date and contains two 5-year renewal options exercisable by Time Warner. Time Warner renovated the premises in connection with opening the studio store. Rent under the Time Warner Sublease is currently accruing and will not become due and payable to Plaza Associates until the satisfaction of certain conditions designed to protect Time Warner from the termination of the Time Warner Sublease by reason of the termination of Plaza Associates' leasehold estate in Trump Plaza East or the foreclosure of a certain mortgage and until Time Warner's unamortized construction costs are less than accrued rent. No assurances can be made that such conditions will be satisfied. In addition, Time Warner may terminate the Time Warner Sublease at any time after two years after the commencement date in the event that gross sales for the store do not meet certain threshold amounts or at any time if Plaza Associates fails to operate a first class hotel on Trump Plaza East. See "Certain Transactions--Plaza Associates--Trump Plaza East." Trump World's Fair. Pursuant to an easement agreement with The New Jersey Sports and Exposition Authority ("NJSEA"), Plaza Associates has an exclusive easement over, in and through the portions of the Atlantic City Convention Center to be used as the pedestrian walkway connecting the Main Tower and Trump World's Fair. The easement is for a 25-year term and may be renewed at the option of Plaza Associates for one additional 25-year period. In consideration of the granting of the easement, Plaza Associates must pay to NJSEA the sum of $2,000,000 annually, such annual payment to be adjusted every five years to reflect changes in the consumer price index. Plaza Associates will have the right to terminate the easement agreement at any time upon six months' notice to NJSEA in consideration of a termination payment of $1,000,000. See also "Certain Transactions--Plaza Associates--Trump World's Fair" and "Regulatory Matters--New Jersey Gaming Regulations--Approved Hotel Facilities." Superior Mortgages. The liens securing the indebtedness on the Plaza Garage Parcel, the Bordonaro Parcel and the Egg Harbor Parcel (all of such liens are collectively called the "Existing Senior Plaza Mortgages") are all senior to the liens of the Plaza Mortgages. The principal amount currently secured by such Existing Senior Plaza Mortgages as of September 30, 1995 is, in the aggregate, approximately $3.1 million. Plaza Associates has financed or leased and from time to time will finance or lease its acquisition of furniture, fixtures and equipment. The lien in favor of any such lender or lessor may be superior to the liens of the Plaza Mortgages. Trump Tower. THCR Holdings has entered into a ten year lease with The Trump- Equitable Fifth Avenue Company, a corporation wholly owned by Trump, dated as of July 1, 1995, for the lease of office space in The Trump Tower in New York City, which THCR Holdings may use for its general, executive and administrative offices. The fixed rent is $115,000 per year, paid in monthly installments, for the period from July 1, 1995 to June 30, 2000 and will be $129,250 per year, paid in monthly installments, for the period from July 1, 2000 to June 30, 2005. In addition, THCR Holdings will pay as additional rent a portion of the taxes for each tax year. THCR Holdings has the option to terminate this lease upon ninety days written notice and payment of $32,312.50. Indiana Riverboat. See "--Indiana Riverboat." Pursuant to the License Agreement, Trump granted to THCR the world-wide right and license to use the Marks in connection with casino and gaming activities and related services and products. The license is exclusive, subject to existing licenses of the Marks to the Taj Mahal and Trump's Castle. The License Agreement does not restrict or restrain Trump from the right to use or further license the Trump Names in connection with services and products other than casino services and products. The license is for a term of the later of: (i) 20 years; (ii) such time as Trump and his affiliates no longer hold a 15% or greater voting interest in THCR; or (iii) such time as Trump ceases to be employed or retained pursuant to an employment, management, consulting or similar services agreement with THCR. Upon expiration of the term of the License, Trump will grant THCR a non- exclusive license for a reasonable period of transition on terms to be mutually agreed upon between Trump and THCR. Trump's obligations under the License Agreement are secured by a security agreement, pursuant to which Trump granted THCR a first priority security interest in the Marks for use in connection with casino services, as well as related hotel, bar and restaurant services. See "Risk Factors--Limitations on License of the Trump Name." In 1991, Trump Plaza experienced liquidity problems. THCR management believes that those liquidity problems were attributable, in part, to an overall deterioration in the Atlantic City gaming market, as indicated by reduced rates of casino revenue growth for the industry for the two prior years, aggravated by an economic recession in the Northeast. In addition, increased casino gaming capacity in Atlantic City, due in part to the opening of the Taj Mahal in April 1990, may also have contributed to Trump Plaza's liquidity problems. In order to alleviate its liquidity problem, pursuant to the 1992 Plaza Restructuring, Plaza Associates and Plaza Funding restructured their indebtedness through a prepackaged plan of reorganization under Chapter 11 of the Bankruptcy Code. The purpose of the 1992 Plaza Restructuring was to improve the amortization schedule and extend the maturity of Plaza Associates' indebtedness by (i) eliminating the sinking fund requirement on Plaza Funding's 12 7/8% Mortgage Bonds, due 1998 (the "Original Plaza Bonds"), (ii) extending the maturity of such indebtedness from 1998 to 2002, (iii) lowering the interest rate from 12 7/8% per annum to 12% per annum, (iv) reducing the aggregate principal amount of the indebtedness under the Original Plaza Bonds and certain other indebtedness from $250 million to $225 million and (v) eliminating certain other indebtedness by reconstituting such debt in part as new bonds (the "Successor Plaza Bonds") and in part as Stock Units (as defined). The 1992 Plaza Restructuring was necessitated by the inability to either generate cash flow or obtain additional financing sufficient to make the scheduled sinking fund payment on the Original Plaza Bonds. In connection with the 1992 Plaza Restructuring, each holder of $1,000 principal amount of Original Plaza Bonds and such other indebtedness received (i) $900 principal amount of Successor Plaza Bonds, (ii) 12 Stock Units, each representing one share of Common Stock and one share of Preferred Stock of Plaza Funding (the "Stock Units") and (iii) cash payments of approximately $58.65, reflecting accrued interest. On May 29, 1992, Plaza Funding, which theretofore had no interest in Plaza Associates, received a 50% beneficial interest in TP/GP, Inc. ("Trump Plaza GP"), and Plaza Funding and Trump Plaza GP were admitted as partners of Plaza Associates. Plaza Funding also issued approximately three million Stock Units to holders of the Original Plaza Bonds and certain other indebtedness. Pursuant to the terms of the Plaza Associates partnership agreement, Plaza Funding was issued a preferred partnership interest, which provided Plaza Funding with partnership distributions designed to pay dividends on, and the redemption price of, the Stock Units. Trump Plaza GP became the managing general partner of Plaza Associates, and, through its Board of Directors, managed the affairs of Plaza Associates. Trump Plaza GP was subsequently merged with and into Plaza Funding, which became the managing general partner of Plaza Associates. The Successor Plaza Bonds and the Stock Units were redeemed in 1993 out of the proceeds of a refinancing designed to enhance Trump Plaza's liquidity and to position the Trump Plaza for a subsequent deleveraging transaction. The 1993 refinancing included (i) the sale by Plaza Funding of $330 million in aggregate principal amount of Plaza Mortgage Notes and (ii) the sale by Plaza Holding of $60 million aggregate principal amount of PIK Notes and PIK Note Warrants to acquire an aggregate of $12 million in principal amount of additional PIK Notes. Upon consummation of the refinancing, Plaza Funding held a 1% equity interest in Plaza Associates and Plaza Holding held a 99% equity interest. THCR Holdings and THCR Funding (the "THCR Obligors") are the issuers of $155 million principal amount of Senior Notes. The Senior Notes are the joint and several obligations of the THCR Obligors. Interest on the Senior Notes is payable semiannually in arrears. The Senior Notes mature on June 15, 2005. The Senior Notes are not redeemable prior to June 15, 2000, except pursuant to a Required Regulatory Redemption (as defined in the Senior Note Indenture). Thereafter, the Senior Notes may be redeemed at the option of the THCR Obligors, in whole or in part, at any time on or after June 15, 2000 at the redemption prices set forth in the Senior Note Indenture, together with accrued and unpaid interest to the date of redemption. In addition, upon the occurrence of a Senior Note Change of Control (as defined in the Senior Note Indenture), each holder of Senior Notes may require the THCR Obligors to repurchase such holder's Senior Notes at 101% of the principal amount thereof, together with accrued and unpaid interest to the date of repurchase. The obligations of the THCR Obligors under the Senior Note Indenture are secured by (1) an assignment and pledge to the Trustee under the Senior Note Indenture (the "Senior Note Trustee") of (a) 99% of the general partnership interests in Plaza Associates, (b) 100% of the capital stock of Plaza Funding (the holder of the remaining 1% general partnership interest in Plaza Associates, which 1% is pledged exclusively for the benefit of the holders of the Mortgage Notes), (c) 100% of the general partnership interests in Plaza Holding, (d) 100% of the capital stock of Plaza Holding Inc., (e) 100% of the capital stock of Trump Indiana, (f) 100% of the capital stock of THCR Funding, (g) other equity interests issued from time to time by THCR Holdings or any of its subsidiaries, excluding Unrestricted Subsidiaries, and (h) promissory notes issued by THCR Holdings or any of its subsidiaries, excluding Unrestricted Subsidiaries, from time to time directly owned or acquired by THCR Holdings; (2) certain remaining net proceeds from the June 1995 Offerings; and (3) certain proceeds from time to time received, receivable or otherwise distributed in respect of the assets described in clauses (1) and (2) above (collectively, the "Collateral"). The security interests in the Collateral are first priority security interests and are exclusive except to the extent required by the Plaza Mortgage Note Indenture to equally and ratably secure the Plaza Mortgage Notes with respect to any of the direct or indirect equity interests in Plaza Associates, Plaza Funding, Plaza Holding and Plaza Holding Inc. Any equity interests in subsidiaries of THCR Holdings, excluding equity interests in Unrestricted Subsidiaries, which are acquired by THCR Holdings will be assigned and pledged to the Senior Note Trustee and the security interests granted in such equity interests will be exclusive, first priority security interests. In connection with the Merger Transaction, THCR will designate Taj Holdings LLC, TTMC, Taj Associates and Taj Funding as Unrestricted Subsidiaries under the Senior Note Indenture. In addition to the Senior Notes, $330 million of the Plaza Mortgage Notes remain outstanding. The Plaza Mortgage Notes were issued by Plaza Funding, with Plaza Associates providing a full and unconditional guaranty thereof. The Plaza Mortgage Notes will mature in 2001 and bear interest semiannually in arrears. The Plaza Mortgage Notes are subject to redemption at any time on or after June 15, 1998, at the option of Plaza Funding or Plaza Associates, in whole or in part, at the redemption prices set forth in the Plaza Mortgage Note Indenture. In addition, upon the occurrence of a Plaza Mortgage Note Change of Control (as defined in the Plaza Mortgage Note Indenture), each holder of Plaza Mortgage Notes may require Plaza Funding or Plaza Associates to repurchase such holder's Plaza Mortgage Notes at 101% of the principal amount thereof, together with accrued and unpaid interest to the date of repurchase. Plaza Funding's and Plaza Associates' obligations under the Plaza Mortgage Note Indenture are secured principally by (i) the Plaza Note Mortgage encumbering substantially all of Plaza Associates' assets (see "--Properties") and (ii) the pledge by Plaza Funding of its 1% general partnership interest in Plaza Associates and, equally and ratably with the Senior Notes to the extent required by the Plaza Mortgage Note Indenture, by a pledge of (x) THCR Holdings' 99% general partnership interest in Plaza Holding, (y) Plaza Holding's 99% general partnership interest in Plaza Associates, and (z) 100% of the capital stock of Plaza Funding and Plaza Holding Inc. (the holder of the remaining 1% of Plaza Holding). In addition to the foregoing, THCR's consolidated long-term indebtedness includes approximately $3.1 million of outstanding mortgage notes described under "--Properties" as of September 30, 1995. General. Plaza Associates, its partners, certain members of its former Executive Committee, and certain of its employees, have been involved in various legal proceedings. In general, Plaza Associates has agreed to indemnify such persons and entities against any and all losses, claims, damages, expenses (including reasonable costs, disbursements and counsel fees) and liabilities (including amounts paid or incurred in satisfaction of settlements, judgments, fines and penalties) incurred by them in said legal proceedings. Such persons and entities are vigorously defending the allegations against them and intend to vigorously contest any future proceedings. Trump Plaza East. From monies made available to it, the CRDA is required to set aside $100 million for investment in hotel development projects in Atlantic City undertaken by casino licensees which result in the construction or rehabilitation of at least 200 hotel rooms by December 31, 1996. These investments are to fund up to 35% of the cost to casino licensees of such projects. See "Regulatory Matters--New Jersey Gaming Regulations--Investment Alternative Tax Obligations." Plaza Associates made application for such funding to the CRDA with respect to its proposed construction and rehabilitation of the Trump Plaza East hotel rooms and related Boardwalk and second level facilities, proposed demolition of an existing hotel expansion structure attached thereto and development of an appurtenant public park, roadway and parking area on the site thereof and proposed acquisition of the entire project site. The CRDA, in rulings through January 10, 1995, approved the hotel development project and, with respect to same, reserved to Plaza Associates the right to take investment tax credits in an amount equal to 27% ($14.1 million) of $52.4 million of eligible estimated project development costs. In October 1994, following a September 1994 CCC ruling authorizing same, Plaza Associates advised the CRDA of its intention to, without affecting either the project development costs or the tax credits, locate approximately 15,000 square feet of casino space on the second floor of Trump Plaza East and was advised by the CRDA that its proposed use of such space would not affect the approval of the hotel development project. As part of its approval and on the basis of its powers of eminent domain, the CRDA, during 1994, initiated five condemnation proceedings in the Superior Court of New Jersey, Atlantic County, to acquire certain small parcels of land within the project site. The defendants in three of those matters, with respect to parcels which impact only the public park and parking areas, Casino Reinvestment Development Authority v. Banin, et al., Docket No. ATL-L-2676-94, Casino Reinvestment Development Authority v. Sabatini, et al., Docket No. ATL-L-2976-94, and Casino Reinvestment Development Authority v. Coking, et al., Docket No. ATL-L-2974-94, asserted numerous defenses to the condemnation complaints and filed counterclaims against CRDA and third-party complaints against Plaza Associates alleging, inter alia, an improper exercise of CRDA power for private purposes and conspiracy between the CRDA and Plaza Associates. After the filing of briefs and a hearing, a New Jersey Superior Court judge issued an opinion that the Trump Plaza East acquisition and renovation was not eligible for CRDA funding and, as a result, the CRDA could not exercise its power of eminent domain because the project included casino floor space. The court, by order dated April 18, 1995, dismissed the condemnation complaints with prejudice. On April 17, the same judge dismissed the counterclaims and third-party complaints without prejudice. Notices of appeal were filed with the New Jersey Superior Court, Appellate Division on April 21, 1995 by the CRDA and on April 24, 1995 by Plaza Associates. On May 1, 1995, the Casino Association of New Jersey on behalf of its members, 11 of the 12 Atlantic City casino hotels, filed a motion to intervene or, in the alternative, for leave to appear as an amicus curiae. Briefs have been filed by all parties and the matter now awaits the scheduling of oral arguments. The completion of the planned renovations of Trump Plaza East is not dependent upon the utilization of CRDA funding or upon the CRDA's acquisition of the real estate subject to the condemnation proceedings. Plaza Associates intends to pursue this appeal vigorously and believes it will be successful, based in part on the March 29, 1995 opinion of the New Jersey Office of Legislative Services ("OLS"), which serves as legal counsel to the New Jersey State Legislature, that N.J.S.A. 5:12-173.8 empowered the CRDA to approve and fund projects such as Trump Plaza East and, in part, on the fact that Section 173.8 expressly exempts hotel development projects from the statutory limitation with respect to any CRDA investment or project which directly and exclusively benefits the casino hotel or related facility. In a related matter, Vera Coking, et al. v. Atlantic City Planning Board and Trump Plaza Associates, Docket No. ATL-L-339-94, the Atlantic City Planning Board's approval of the Trump Plaza East renovation was challenged on various grounds. In July, 1994, a New Jersey Superior Court judge upheld the Atlantic City Planning Board approvals with respect to the hotel renovation component of Trump Plaza East and the new roadway but invalidated the approval of the valet parking lot and the public park because Plaza Associates lacked site control with respect to the small parcels of land CRDA sought to condemn. Plaintiff appealed the court's decision upholding the approval of the hotel renovation and new roadway and Plaza Associates cross-appealed the court's decision invalidating the approval of the public park and valet parking area. Plaza Associates with- drew its cross-appeal and plaintiff's appeal is pending in the Superior Court of New Jersey, Appellate Division, Docket No. A-1511-94- T1. Plaza Associates received land-use approval for and has constructed the valet parking area after deletion of the small parcels. In another related matter, Josef Banin and Vera Coking v. Atlantic City Planning Board and Trump Plaza Associates, Docket No. L-2188-95, the land-use approval for this area has been challenged on various grounds. Plaza Associates filed its answer to the complaint denying the allegations of the complaint. The land use approval involves certain minor amendments to the previously granted site plan approvals for the hotel renovation component of Trump Plaza East and the new roadway. The amendments included certain design changes with respect to the Trump Plaza East and certain design changes to the roadway. The amendments did not require any variance relief and the amendments fully complied with the Land Use Ordinance of the City of Atlantic City. The plaintiffs allege the Atlantic City Planning Board acted in an arbitrary and capricious manner in approving the amendments and further argue that the chairperson of the Atlantic City Planning Board had a conflict of interest in hearing the matter because of her status as an employee of the CRDA, the entity that had approved certain funding for the project. The plaintiffs have filed their brief in this matter and Plaza Associates has filed its response brief. The matter is scheduled for oral argument on January 26, 1996. It is likely the court will rule on the matter on that date. Penthouse Litigation. On April 3, 1989, BPHC Acquisition, Inc. and BPHC Parking Corp. (collectively, "BPHC") filed a third-party complaint (the "Complaint") against Plaza Associates and Trump. The Complaint arose in connection with the action entitled Boardwalk Properties, Inc. and Penthouse International Ltd. v. BPHC Acquisition, Inc. and BPHC Parking Corp., which was instituted on March 20, 1989 in the New Jersey Superior Court, Chancery Division, Atlantic County. The suit arose in connection with the conditional sale by Boardwalk Properties, Inc. ("BPI") (or, with respect to certain of the property, BPI's agreement to sell) to Trump of BPI's fee and leasehold interests in (i) Trump Plaza East, (ii) an approximately 4.2-acre parcel of land located on Atlantic Avenue, diagonally across from Trump Plaza's parking garage (the "Columbus Plaza Site") which was then owned by an entity in which 50% of the interests were each owned by BPHC and BPI and (iii) an additional 1,462-square foot parcel of land located within the area of Trump Plaza East (the "Bongiovanni Site"). Prior to BPI entering into its agreement with Trump, BPI had entered into agreements with BPHC which provided, among other things, for the sale to BPHC of Trump Plaza East, as well as BPI's interest in the Columbus Plaza Site, assuming that certain contingencies were satisfied by a certain date. Additionally, by agreement between BPHC and BPI, in the event BPHC failed to close on Trump Plaza East, BPHC would convey to BPI the Bongiovanni Site. Upon BPHC's failure to close on Trump Plaza East, BPI entered into its agreement with Trump pursuant to which it sold Trump Plaza East to Trump and instituted a lawsuit against BPHC for specific performance to compel BPHC to transfer to BPI, BPHC's interest in the Columbus Plaza Site and Bongiovanni Site, as provided for in the various agreements between BPHC and BPI and in the agreement between BPI and Trump. The Complaint alleged that Plaza Associates and/or Trump engaged in the following activities: civil conspiracy, violations of the New Jersey Antitrust Act, violations of the New Jersey RICO statute, malicious interference with contractual relations, malicious interference with prospective economic advantage, inducement to breach a fiduciary duty and malicious abuse of process. The relief sought in the Complaint included, among other things, compensatory damages, punitive damages, treble damages, injunctive relief, the revocation of all of Plaza Associates' and Trump's casino licenses, the revocation of Plaza Associates' current Certificate of Partnership, the revocation of any other licenses or permits issued to Plaza Associates and Trump by the State of New Jersey, and a declaration voiding the conveyance by BPI to Trump of BPI's interest in Trump Plaza East, as well as BPI's and/or Trump's rights to obtain title to the Columbus Plaza Site. On October 13, 1993, a final judgment as to Trump and Plaza Associates was filed. That judgment dismissed each and every claim against Trump and Plaza Associates. The case remained open as to final resolution of all claims between BPI and BPHC. Following the entry of a subsequent judgment as to those claims, BPHC and BPI have settled all claims between them. BPHC is pursuing its appeal as to Trump and Plaza Associates but only as to its money damages claims of interference with contract and prospective economic advantage and of inducing BPI to breach its fiduciary duty to BPHC. All other claims raised in BPHC's complaint as to Trump and Plaza Associates and dismissed by the October 13, 1993 judgment have been finally determined in favor of Trump and Plaza Associates. All briefs due in connection with BPHC's appeal have been filed. No argument date has been set. Other Litigation. Various legal proceedings are now pending against Plaza Associates. THCR considers all such proceedings to be ordinary litigation incident to the character of its business and not material to its business or financial condition. The majority of such claims are covered by liability insurance (subject to applicable deductibles), and THCR believes that the resolution of these claims, to the extent not covered by insurance, will not, individually or in the aggregate, have a material adverse effect on the financial condition or results of operations of THCR. Plaza Associates is also a party to various administrative proceedings involving allegations that it has violated certain provisions of the Casino Control Act. THCR believes that the final outcome of these proceedings will not, either individually or in the aggregate, have a material adverse effect on THCR or on the ability of Plaza Associates to otherwise retain or renew any casino or other licenses required under the Casino Control Act for the operation of Trump Plaza. At this juncture the prospects of a favorable outcome in actions described above cannot be assessed. Plaza Associates intend to vigorously contest the allegations made against it. SELECTED HISTORICAL FINANCIAL INFORMATION OF TAJ ASSOCIATES Taj Holding has no business operations and serves as a holding company for a 50% investment in Taj Associates. Therefore, historical financial information is not presented below. The audited consolidated financial statements of Taj Holding as of December 31, 1993 and 1994 and for the years ended December 31, 1992, 1993 and 1994 are included elsewhere in this Proxy Statement-Prospectus. The following table sets forth certain historical consolidated financial information of Taj Associates for each of the five years ended December 31, 1990 through 1994 and for the nine-month periods ended September 30, 1994 and 1995 (unaudited). The historical financial information of Taj Associates as of December 31, 1993 and 1994, and for the years ended December 31, 1992, 1993 and 1994 as set forth below has been derived from the audited consolidated financial statements of Taj Associates included elsewhere in this Proxy Statement-Prospectus. The historical financial information of Taj Associates as of December 31, 1990, 1991 and 1992, and for the years ended December 31, 1990 and 1991 as set forth below has been derived from the audited consolidated financial statements of Taj Associates not included in this Proxy Statement-Prospectus. The unaudited financial information as of September 30, 1994 and 1995, and the nine months then ended has been derived from the unaudited condensed consolidated financial statements included elsewhere in this Proxy Statement- Prospectus and in the opinion of management, includes all adjustments, consisting of only normal, recurring adjustments, necessary to present fairly the financial position, results of operations and changes in cash flows for the periods presented. The results of these interim periods are not necessarily indicative of the operating results for a full year. All financial information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations of Taj Associates," "Unaudited Pro Forma Financial Information" and the consolidated and condensed financial statements and related notes thereto included elsewhere in this Proxy Statement-Prospectus. (a) Operations commenced on April 2, 1990. Results of operations for 1990 are not necessarily indicative of the operating results for a full year. (b) The extraordinary gain of $259,618 for the year ended December 31, 1991 reflects a $204,276 accounting adjustment to carry the old Bonds at fair market value based on current interest rates at the date of issuance (effective rate of approximately 18%), and $20,000 related to settlement of the subcontractors' note payable, with the balance representing a discharge of accrued interest on indebtedness. (c) Long-term debt of $720,175 as of December 31, 1990 had been classified as a current liability. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF TAJ ASSOCIATES Taj Holding has no business operations and serves as a holding company for a 50% investment in Taj Associates. Therefore, the following is a discussion of the results of operations of Taj Associates. RESULTS OF OPERATIONS FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1995 AND Net revenues were approximately $417.3 million for the nine months ended September 30, 1995, an increase of $30.8 million or 8.0% from net revenues of $386.5 million for the comparable period in 1994. This increase was primarily due to an increase in gaming revenues. Gaming revenues comprise the major component of net revenues and consist of win from table games, poker, slot machines, horserace simulcasting and keno. Total gaming revenues were $377.4 million for the nine months ended September 30, 1995, an increase of $32.1 million or 9.3% from total gaming revenues of $345.3 million for the comparable period in 1994. These revenues represent a market share of 13.4% of the Atlantic City gaming market in each of the nine months ended September 30, 1995 and 1994, based on figures filed with the CCC. Table game win was approximately $148.8 million for the nine months ended September 30, 1995, an increase of $16.8 million or 12.7% from table game win of $132.0 million for the comparable period in 1994. Dollars wagered at table games was $866.6 million for the nine months ended September 30, 1995, an increase of $30.3 million or 3.6% from dollars wagered at table games from $836.3 million for the comparable period in 1994. Table win percentage was 17.2% for the nine months ended September 30, 1995, an increase from 15.8% in 1994. Table win percentage, which represents the percentage of dollars wagered retained by Taj Associates, tends to be fairly constant over the long term, but may vary significantly in the short term, due to large wagers by "high rollers." The win percentage for the nine months ended September 30, 1995 is significantly above Taj Associates' and the industry's historical win percentage, and it is likely that Taj Associates' win percentage will decrease in the future. During the twelve months ending December 31, 1994 and 1993, Taj Associates' win percentage was approximately 16.4% and 16.3% respectively, while the Atlantic City average was approximately 15.8% and 15.6% respectively. Slot win was $212.9 million for the nine months ended September 30, 1995, an increase of $13.8 million or 6.9% from slot win of $199.1 million for the comparable period in 1994. Dollars wagered in slot machines was $2.55 billion for the nine months ended September 30, 1995, an increase of $286.3 million or 12.6% from dollars wagered in slot machines of $2.26 billion for the comparable period in 1994. This increase was offset by a decrease in slot win percentage to 8.3% for the nine months ended September 30, 1995, from 8.8% for the comparable period in 1994. The increase in slot machine wagering and the reduced slot win percentage is consistent with the industry trend in Atlantic City in recent years. In addition to table game and slot revenues, Taj Associates' Keno/Poker/Simulcasting operations generated approximately $13.3 million in poker revenues, $1.0 million of simulcasting revenue and $1.3 million of keno revenue for the nine months ended September 30, 1995, compared to $12.3 million of poker revenue, $1.1 million of simulcasting revenue and $0.9 million of keno revenue for the corresponding period in 1994. Keno operations commenced June 15, 1994. Increases in gaming revenues during the first three quarters of 1995 over the comparable period of 1994 were attributable primarily to (i) the increase in dollars wagered on slots relative to the depressed 1994 levels caused by severe winter weather during the first three months of the year, (ii) the increase in dollars wagered on table games and the improved win percentage, both of which were substantially attributable to international high level players and (iii) the general growth of the Atlantic City market. Nongaming revenues consist primarily of room, food, beverage and entertainment. For the nine months ended September 30, 1995 and 1994, these revenues totaled $87.4 million and $90.0 million, respectively. Room revenue of approximately $33.0 million in 1995 was the result of an occupancy rate of 92.0% and an average room rate of $105.28. In 1994, room revenue of $32.2 million was the result of an occupancy rate of 93.9% and an average room rate of $100.45. In the food and beverage outlets, Taj Associates generated revenues of approximately $42.9 million and $44.1 million during the first nine months of 1995 and 1994, respectively. The approximately $1.2 million decrease is primarily attributable to a 1.0% decrease in the number of persons served and a decrease in the average food check to $11.56 in 1995 from $11.62 in 1994. The decrease in food and beverage revenue reflects both fewer complimentaries offered to patrons (which are recorded both as revenue and as a promotional allowance) and reduced food prices designed to stimulate cash sales. The decrease in other revenue of approximately $2.3 million was primarily attributable to a decrease in entertainment revenue of approximately $1.8 million resulting from fewer events and an increased emphasis on promoter sponsored entertainment events in 1995 versus events sponsored by Taj Associates in 1994. Promotional allowances were $47.5 million for the nine months ended September 30, 1995, a decrease of $1.3 million from promotional allowances of $48.8 million for the comparable period in 1994. Promotional allowances were 10.2% of gross revenues in 1995 compared to 11.2% in 1994, reflecting Taj Associates' efforts to increase control over complimentaries while increasing gaming revenues. Gaming expenses increased approximately $12.3 million or 6.2% for the nine months ended September 30, 1995 from the comparable period in 1994, primarily due to increased marketing/promotional costs associated with increased gaming revenues. Both room and food and beverage expenses remained generally constant. General and administrative expenses decreased primarily due to the nonrecurrence of costs for settlement of litigation which were incurred during 1994. Costs for settlement of litigation for the nine months ended September 30, 1995 decreased by approximately $3.7 million or 100% to $0 from the comparable period of 1994. Depreciation expense increased in 1995 compared to 1994 due to increased capital expenditures on replacement furniture, fixtures and equipment and the shorter lives associated therewith. Total operating expenses as a percentage of net revenue decreased to 82.6% for the nine months ended September 30, 1995 compared to 86.0% for the comparable period in 1994. The $2.0 million or 2.3% increase in interest expense is attributable to (i) the increased amount of principal outstanding resulting from the issuance of Bonds to satisfy the Additional Amount (as defined in the Bond Indenture) and (ii) the increased accretion of the discount on the Bonds as they approach maturity. These amounts were partially offset by a decrease in costs incurred for uncompleted refinancing efforts during the period. As a result of the foregoing factors, income from operations was $72.4 million for the nine months ended September 30, 1995, an increase of $18.2 million or 33.6% from income from operations of $54.2 million for the comparable period of 1994. RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993 Net revenues were $517.2 million for the year ended December 31, 1994, an increase of $18.3 million or 3.7% from net revenues of $498.9 million for the year ended December 31, 1993. Gaming revenues, which comprise the major component of total revenues and consist of win from table games, poker, slot machines, horserace simulcasting and keno, were approximately $461.6 million in 1994, an increase of $19.5 million or 4.4% from gaming revenues of $442.1 million in 1993. The increase in gaming revenues occurred while the overall Atlantic City gaming industry experienced an increase in gaming revenue of 3.9%. These revenues represent a market share of the Atlantic City market of approximately 13.5% in each of 1994 and 1993, based on figures filed with the CCC. Table game win was approximately $184.7 million for the year ended December 31, 1994, an increase of $11.3 million or 6.5% from table game win of $173.4 million in 1993. Dollars wagered at table games was $1,125.0 million in 1994, an increase of $63.0 million or 5.9% from dollars wagered at table games of $1,062.0 million in 1993. Table win percentage (i.e., percentage of dollars wagered that were retained by Taj Associates) increased to 16.4% in 1994 from 16.3% in 1993. For the year ended December 31, 1994, slot win was approximately $257.9 million, a decrease of $2.4 million or 0.9% from slot win of $260.3 million in 1993. The decrease was largely due to a decrease in the slot win percentage. Slot win percentages were 8.8% in 1994 and 9.3% in 1993. Dollars wagered at slot machines were $2,940.1 million in 1994, an increase of $82.2 million or 2.9% from the dollars wagered at slot machines of $2,857.9 million in 1993. The decrease in slot win percentage and the increase in slot machine wagering is consistent with the industry trend in Atlantic City in recent years. In addition to table game and slot revenues, Taj Associates' newly opened Keno room and expanded Poker/Simulcasting operations generated approximately $16.3 million of revenues from poker, $1.4 million of revenues from simulcasting and $1.3 million of revenues from Keno in 1994 compared to approximately $7.5 million in poker revenue and $0.8 million in simulcasting revenue for the year ended December 31, 1993. Poker/Simulcasting operations commenced in June 1993 while Keno operations commenced on June 15, 1994. Nongaming revenues consist primarily of room, food, beverage and entertainment revenues. Nongaming revenues were $117.7 million for the year ended December 31, 1994, an increase of $4.4 million or 3.9% from nongaming revenues of $113.3 million in 1993. This increase was attributable primarily to an increase in food and beverage revenue of approximately $2.1 million or 3.8%, and an increase in room revenue of approximately $1.2 million or 2.9%. Food and beverage revenue and room revenue was $58.0 million and $41.8 million, respectively, for the fiscal year ended December 31, 1994, an increase from food and beverage revenue and room revenue of $56.0 million and $40.7 million, respectively, in 1993. The increase in food and beverage revenue was partially attributable to the increase of the average food check to $11.68 in 1994 from $10.82 in 1993 and the increased banquet functions associated with gaming promotions. Room occupancy was 92.4% and 92.5% and the average room rate was $99.19 and $96.38 for the years ended December 31, 1994 and 1993, respectively. Promotional allowances were $62.2 million in 1994, an increase of $5.8 million from promotional allowances of $56.4 million in 1993. Promotional allowances were 10.7% of gross revenues in 1994 compared to 10.2% of gross revenues in 1993, reflecting the more aggressive marketing posture necessary in order to maintain or achieve increases in gaming revenues comparable to 1993. Gaming expenses were $260.5 million in 1994, an increase of $22.9 million or 9.6% from gaming expenses of $237.6 million in 1993, primarily due to increase marketing promotional costs directed at slot machine and table game play and operating expenses associated with the new or expanded games of poker, simulcasting and keno. During the year ended December 31, 1994, room expenses increased slightly and food and beverage expenses decreased slightly over the comparable period in 1993, reflecting continuing cost controls in this area. General and administrative expenses increased slightly, primarily due to costs associated with a settlement of outstanding litigation, offset by decreases in real property taxes resulting from settlement of appeals. Costs for settlement of litigation were approximately $3.7 million in 1994, an increase of $3.7 million or 100% from 1993. Real property taxes were $12.2 million in 1994, a decrease of approximately $4.9 million or 28.7% from real property taxes of $17.1 million for 1993. Were it not for these items, costs in this category would have increased approximately $2.0 million over the comparable period of 1993. Depreciation expense has increased in 1994 compared to 1993 due to increased capital expenditures on replacement furniture, fixtures and equipment and the shorter lives associated therewith. Total operating expenses as a percentage of net revenue increased to 85.2% in 1994 from 83.1% in 1993. Interest expense was $115.3 million in 1994, an increase of $6.9 million from interest expense of $108.4 million in 1993. The increase is attributable to the increased amount of principal outstanding resulting from the issuance of the Bonds to satisfy the Additional Amount (as defined), the increased accretion of discount on the Bonds as they approach maturity and professional fees incurred during the first six months of 1994 related to the proposed recapitalization, which was not consummated. As a result of the foregoing factors, income from operations was $76.6 million in 1994, a decrease of $7.9 million or 9.3% from income from operations of $84.5 million in 1993. Taj Associates experienced a net loss of $36.7 million for 1994 as compared to a net loss of $22.5 million for 1993. RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1993 AND 1992 Net revenues for the year ended December 31, 1993 totaled $498.9 million, an increase of $29.1 million or 6.2% from net revenues of $469.8 million in 1993. Gaming revenues, which comprise the major component of total revenues and consist of win from table games, poker, slot machines and horserace simulcasting were approximately $442.1 million in 1993, an increase of $28.1 million or 6.8% from gaming revenues of $414.0 million in 1992. These revenues represented a market share in the Atlantic City gaming market of 13.5% in 1993 and 12.9% in 1992, based on figures filed with the CCC. The increase in Taj Associates' gaming revenues and market share occurred while the overall Atlantic City gaming industry experienced an increase in gaming revenue of only 2.9%. Management believes the increase in gaming revenues was attributable primarily to Taj Associates' expanded slot marketing efforts, increased table game win percentage (i.e., percentage of dollars wagered that were retained by Taj Associates) and the addition of poker and horserace simulcasting operations. Table game win was approximately $173.4 million in 1993, an increase of $4.3 million or 2.6% from table game win of $169.1 million in 1992. Although dollars wagered at table games decreased by $5.6 million or 0.5% in 1993, to $1,062.0 million in 1993 from $1,067.6 million in 1992, the decrease was offset by an increase in table win percentage (i.e., percentage of dollars wagered that were retained by Taj Associates) of 16.3% in 1993 from 15.8% in 1992. Slot win was approximately $260.3 million for the year ended December 31, 1993, an increase of $15.4 million or 6.3% from slot win of $244.9 million in 1992. The increase was largely due to an increase in dollars wagered. Slot win percentages were 9.3% in 1993 and 9.8% in 1992. The decrease in table wagering compared to the increase in slot machine wagering and the reduced slot win percentage is consistent with industry activity in 1993 and with the industry trend in recent years. In addition to table game and slot revenues, Taj Associates' poker and horserace simulcasting operations, which opened June 29, 1993, generated $7.5 million of revenues from poker and $0.8 million of revenues from simulcasting for the year ended December 31, 1993. Nongaming revenues were approximately $113.3 million for the year ended December 31, 1993, a decrease of $3.7 million or 3.2% from nongaming revenues of $117.0 million in 1992. This decrease in revenue was attributable primarily to a decrease in food and beverage revenue of approximately $3.5 million or 5.9%, and a slight decrease in room revenue of $0.3 million or 0.7%. Food and beverage revenue was $56.0 million for the year ended December 31, 1993, a decrease of $3.5 million from food and beverage revenue of $59.5 million in 1992. The decline in the food and beverage revenue was primarily attributable to management's decision to reduce the use of promotional coupons in certain food outlets to increase profitability. Accordingly, the number of persons served decreased approximately 10.4% in 1993 while the average food check increased to $10.82 in 1993 from $10.60 in 1992. Room revenue, room occupancy and average room rate were approximately $40.7 million, 92.5% and $96.38, respectively, compared to $41.0 million, 91.2% and $98.32, respectively in 1992. The reduced room rate in 1993 was part of the continuation of various marketing plans initially implemented in 1992 to increase occupancy and enhance gaming activity. Promotional allowances were $56.4 million in 1993, compared to $61.3 million in 1992. Promotional allowances were 10.2% of gross revenues in 1993 compared to 11.5% of gross revenues in 1992, reflecting the reduction in promotional food coupons discussed above. Gaming expenses were $237.6 million in 1993, an increase of approximately $10.2 million or 4.5% from gaming expenses of $227.4 million in 1992, primarily due to increased marketing promotional costs directed at slot machine play and operating expenses associated with the addition of poker and year ended 1993, room expenses increased slightly over the comparable period in 1992. The decrease in food and beverage expenses were volume related, but did not decrease proportionately to the decrease in sales because of the continued increase in the cost of labor, food and beverage expenses which were not fully passed on to patrons through increased prices. General and administrative expenses increased slightly, by approximately $0.6 million or 0.6%, primarily due to increased costs required to support the expanded operations. Total operating expenses as a percentage of net revenue declined to 83.1% in 1993 compared to 85.5% in 1992. Interest expense was $108.4 million in 1993, an increase of $4.4 million from interest expense of $104.0 million in 1992. The increase was primarily attributable to the increased accretion of discount on the Bonds, and the portion of interest on the Bonds payable in the form of additional principal amounts of the Bonds. Income from operations was $84.5 million for 1993, an increase of $16.5 million or 24.1% from income from operations of $68.0 million in 1992, primarily as a result of continuing efforts to maintain cost controls. Taj Associates experienced a net loss of $22.5 million for the year ended December 31, 1993 as compared to a net loss of $35.1 million for 1992. Working Capital. Cash flow from operations provides Taj Associates with its ability to meet debt service obligations and capital expenditure programs along with adequate operating liquidity. Cash flow from operating activities for the nine months ending September 30, 1995 was $73.3 million compared with $40.6 million in 1994, due primarily to the increase in gaming revenues. Cash flow from operating activities for the twelve months ended December 31, 1994 was $33.4 million compared with $48.6 million in 1993, which is attributable primarily to the decrease in income from operations. Cash flow from operating activities for the twelve months ended December 31, 1992 was $31.8 million compared with $48.6 million in 1993. Working capital at September 30, 1995 increased by $22.9 million to approximately $63.6 million from approximately $40.7 million at December 31, 1994. From December 31, 1993 to December 31, 1994 working capital grew by $11.7 million, from a working capital surplus of approximately $29.0 million at December 31, 1993 to a working capital surplus of approximately $40.7 million at December 31, 1994. From December 31, 1992 to December 31, 1993, working capital grew by $18.5 million, to approximately $29.0 million at December 31, 1993 from approximately $10.5 million at December 31, 1992. These improvements are the result of increases in cash, casino receivables, inventories, or credits toward future property taxes. Pursuant to the terms of the Taj Reorganization Plan and the Bond Indenture, Taj Associates was permitted to obtain a $25 million working capital facility, a $50 million senior line of credit (the "Senior Line of Credit") and a $25 million standby letter of credit (the "Standby Letter of Credit") secured by certain assets of Taj Associates, including the Taj Mahal, on a basis senior to the lien of the mortgage securing the Bonds. On November 14, 1991, Taj Associates entered into a working capital facility (the "Working Capital Facility") provided by Foothill Capital Corporation ("Foothill"). The Working Capital Facility permits borrowings of up to $25 million. Obligations under the Working Capital Facility are secured by a mortgage on the assets of Taj Associates senior to the lien of mortgage securing the Bonds. In September 1994, Taj Associates extended the maturity from 1996 to November 1999, in consideration of the modification of certain of the terms of the Working Capital Facility. Interest for borrowings under the Working Capital Facility accrues at the rate of prime plus 3% (11.75% at September 30, 1995) with a minimum interest rate of 0.666% per month, and is payable monthly. Amounts borrowed under the Working Capital Facility must be repaid by November 14, 1999. The Working Capital Facility also provides for fees applicable to the commitment, maintenance, and unused portions of the Working Capital Facility. During 1993 and 1994 and the first nine months of 1995, there were no borrowings under the Working Capital Facility. To date, Taj Associates has not sought to obtain the Senior Line of Credit or the Standby Letter of Credit and there can be no assurances as to whether and on what terms Taj Associates could obtain the Senior Line of Credit or the Standby Letter of Credit. Capital Expenditures. Capital expenditures during the nine months ended September 30, 1995 totaled approximately $19.5 million compared to $15.7 million for the comparable period in 1994. Capital expenditures totaled approximately $12.1 million, $16.8 million and $23.0 million for the years ended 1992, 1993 and 1994, respectively. Major capital expenditures for 1992 included an on-site food storeroom, restaurant and room renovations, casino floor reconfiguration and continuing construction of the Taj Entertainment Complex. Major capital expenditures for 1993 included parking garage upgrades, restaurant and room renovations, carpet replacement, and ongoing casino floor reconfiguration, including additional slot machines, completion of the Taj Entertainment Complex and modification of existing space to accommodate the new games of race simulcasting and poker. Major capital expenditures for 1994 included the expansion of the poker room, the addition of the game of keno to the casino floor, relocation of the lobby cocktail lounge, construction of a new slot player's club, continued casino floor reconfiguration, purchase of new slot machines and hotel room renovations. Taj Associates' capital budget for fiscal 1995 totaled approximately $26.0 million which was financed by cash flow from operations and includes provision for hotel tower and room renovations, carpet replacement, ongoing casino floor reconfiguration including 1,300 replacement slot machines, new telephone reservation equipment and limousines. Taj Associates may be obligated to expend up to $30 million in improvements to the Steel Pier in order to maintain its Coastal Area Facilities Review Act ("CAFRA") Permit, which is a condition to its casino license. In March 1993, Taj Associates obtained a modification of its CAFRA Permit providing for the extension of the required commencement and completion dates of these improvements for one year based upon an interim use of the Steel Pier for an amusement park. Taj Associates received an additional one-year extension, in March 1995, of the required commencement and completion dates of the improvements based upon the same interim use of the Steel Pier for an amusement park pursuant to a sublease with an amusement park operator. Taj Associates is currently seeking further modification of its obligations under the CAFRA Permit. See "Business of Taj Holding--Properties--Steel Pier." In addition, Taj Associates may be obligated to comply with certain proposed regulations of the OSHA, if adopted. Taj Associates is unable to estimate the cost, if any, to Taj Associates of such compliance. See "Regulatory Matters--Other Laws and Regulations." Taj Associates' capital expenditures historically included a component to expand the facility as well as maintain its first class operation. Historically, amounts necessary to maintain the first class nature of the facility were approximately $9.7 million, $6.4 million and $19.2 million for the years ended 1992, 1993 and 1994, respectively. The capital budget for 1995 included approximately $24.0 million to maintain Taj Associates' facilities. Debt Service. As a result of the consummation of the Taj Reorganization Plan on October 4, 1991, Taj Associates' liquidity problem was alleviated. The improvement in liquidity was accomplished through a lowering of the interest rate on certain of Taj Associates' long-term indebtedness, including its Old Bonds and, in the case of the Bonds, the deferral of the due date of a portion of accrued interest thereon through the issuance from time to time of additional Bonds. The effect of this debt restructuring was to reduce the minimum cash interest expense on its long-term indebtedness, although total interest expense (inclusive of pay-in-kind interest) increased as a result of the 1991 Taj Restructuring. Taj Associates remains a highly leveraged enterprise with total borrowings at September 30, 1995 in the amount of $826.1 million. Net of the unamortized discount on the Bonds in the amount of $137.1 million and current maturities of $0.9 million, the net long term indebtedness is approximately $688.1 million. At September 30, 1995, after giving effect to the Merger Transaction, on a pro forma basis, Taj Associates' total borrowings would have been $795.9. Upon consummation of the Merger Transaction, Taj Associates' aggregate outstanding indebtedness will consist of $750 million of Taj Notes, approximately $45 million due under the NatWest Loan and $0.9 million of other obligations. In addition, upon consummation of the Merger Transaction, the Taj Associates--First Fidelity Guarantee (as defined) will be released in connection with the purchase of the Specified Parcels by Taj Associates. See "Business of Taj Holding--Certain Indebtedness--First Fidelity Loan/Specified Parcels." Assuming industry conditions do not deteriorate substantially, Taj Holding management believes that, as a result of cash provided from operations, together with its current cash and cash investment balance, it will have sufficient cash flow for the next twelve months to meet its debt service requirements, capital expenditure program and have sufficient operating liquidity. Interest on the Bonds must be paid in cash at the rate of 9.375% payable semi-annually on May 15 and November 15 (the "Mandatory Cash Interest Amount"). Effective May 15, 1992 and annually thereafter, in addition to this Mandatory Cash Interest Amount, an additional amount of interest in cash or additional Bonds or a combination thereof is payable equal to the difference between 11.35% of the outstanding principal amount of the Bonds and the sum of the Mandatory Cash Interest Amount payable on that date and the immediately preceding November 15 (the "Additional Amount"). To the extent that there is excess available cash flow ("EACF") of Taj Associates for the immediately preceding calendar year, Taj Funding will pay the Additional Amount in cash up to 10.28% and the balance thereof may be paid at the option of Taj Associates in cash or additional Units, provided that an equivalent amount of cash is used to purchase or redeem Units. Additional Bonds issued on October 4, 1991 amounted to approximately $7.2 million. For the period from the issuance of the Bonds, October 4, 1991 through December 31, 1992, there was no EACF. The Additional Amounts due for the period from October 4, 1991 through May 15, 1992 and for the period from May 15, 1992 to May 15, 1993 of approximately $8.8 million and $14.6 million, respectively, were paid entirely in Bonds. Taj Associates satisfied the Additional Amount due May 15, 1994 in the amount of approximately $14.9 million through the issuance of approximately $12.2 million in Bonds and the payment of the approximately $2.6 million balance in cash. Taj Funding satisfied the Additional Amount due May 15, 1995 through the issuance of approximately $15.1 million in Bonds. Taj Holding satisfied its cash interest obligations due in 1995 (including the Mandatory Cash Interest Amount) with cash flow from operations. Interest expense for the years ended December 31, 1992, 1993 and 1994 and the nine months ended September 30, 1994 and 1995 consisted of the following (in thousands): Management believes, based upon current levels of operations, that although following the consummation of the Merger Transaction Taj Associates will continue to be highly leveraged, as a result of the Merger Transaction it will have the ability to pay interest on the Taj Notes and Taj Associates' other indebtedness and to pay other liabilities with funds from operations (and, if necessary, from the Working Capital Facility) for the next twelve months. However, there can be no assurance to that effect. See "Risk Factors--High Leverage and Fixed Charges." In addition, Taj Holding does not currently anticipate that Taj Associates will be able to generate sufficient cash flow from its operations to repay a substantial portion of the principal amount of the Taj Notes. Thus the repayment of the Taj Notes is likely to be dependent primarily upon Taj Associates' ability to refinance the Taj Notes when due. There can be no assurance that the status of the capital markets or Taj Associates' operating performance in the future will be conducive to refinancing the Taj Mortgage Notes or other attempts to raise capital. See "Risk Factors--Holding Company Structure; Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing." Following the consummation of the Merger Transaction, the Taj Mahal plans to undertake an expansion plan of its existing operations, which plans are preliminary and subject to change. It is currently expected that the expansion will be funded out of cash from operations and borrowings and is scheduled to be completed in phases by the end of the second quarter of 1999. The Taj Mahal Expansion involves the construction of two new 640 room hotel towers adjacent to the Taj Mahal's existing hotel tower, a 2,200 space expansion of the Taj Mahal's existing self-parking facilities, conversion of the Mark Etess Arena into a new 60,000 square foot circus-themed casino with 2,500 slot machines, and construction of a new arena on a surface parking area located adjacent to the Taj Mahal. The following table summarizes the different phases of the Taj Mahal Expansion with their associated capital costs and expected completion dates: (/1/Construction)on the second hotel tower is to start after the completion and opening of the first tower. In addition, the Taj Mahal is contemplating adding new nationally recognized themed restaurants, including the Rainforest Cafe. Construction costs for each of the three themed restaurants will be the obligation of the lessees. The lease for the Rainforest Cafe will require Taj Associates to contribute $2.5 million towards construction after the project is completed and the restaurant opens for business. Taj Holding's sole source of liquidity is from distributions from Taj Associates. As of September 30, 1995, Taj Holding did not have any long or short-term indebtedness, and is not anticipated to have any in the near future. The Taj Associates partnership agreement (the "Taj Partnership Agreement") currently provides that Taj Associates shall make distributions (i) at the direction of TM/GP and (ii) to each partner to enable such partner to pay its taxes arising out of its interest in the partnership ("Tax Distributions"). In addition, the Taj Partnership Agreement requires Taj Associates to distribute to TM/GP ("Expense Distributions") amounts necessary to permit TM/GP or Taj Holding (a) to make payments (generally for indemnification of officers and directors) that TM/GP or Taj Holding are required to make pursuant to the terms of TM/GP's Certificate of Incorporation and the Taj Holding Certificate of Incorporation, (b) to pay fees to Directors (including fees for serving on a committee), (c) to pay all other expenses of TM/GP and Taj Holding, and (d) to permit Taj Holding to redeem the Taj Holding Class B Common Stock when required to make such a redemption pursuant to the terms of the Taj Holding Certificate of Incorporation. It is anticipated that the Taj Partnership Agreement will be amended in connection with the Merger Transaction in certain technical respects. For the years ended December 31, 1992, 1993, 1994, and the nine months ended September 30, 1995, Taj Holding received distributions from Taj Associates of approximately $1.8 million, $1.7 million, $2.2 million, and $1.2 million, respectively. The Bond Indenture prohibits Taj Associates from making any distributions other than Tax Distributions and Expense Distributions during such time as the Bonds are outstanding. The Taj Holding Certificate of Incorporation requires Taj Holding to redeem each outstanding share of Taj Holding Class B Common Stock at a redemption price of $.50 per share (adjusted to reflect stock splits, combinations and dividends since the original date of issuance) at such time as the principal amount of Bonds with respect to which such share was issued is redeemed, defeased, or paid in full. Pursuant to the Stock Issuance Agreement, dated as of October 4, 1991 (the "Stock Issuance Agreement"), Taj Holding has agreed to issue and deliver to Taj Funding such number of additional shares of Taj Holding Class B Common Stock as Taj Funding may request to enable Taj Funding to pay interest on the Bonds in the form of additional Units in accordance with the terms of the Bond Indenture. In accordance with the Stock Issuance Agreement, Taj Holding issued an additional 8,844 shares of Taj Holding Class B Common Stock on May 15, 1992, 14,579 additional shares of Taj Holding Class B Common Stock on May 15, 1993, 12,249 shares of Taj Holding Class B Common Stock on May 15, 1994 and 15,112 shares of Taj Holding Class B Common Stock on May 15, 1995. The gaming industry in Atlantic City is seasonal, with the heaviest activity at the Taj Mahal occurring during the period from May through September. Consequently, Taj Associates' operating results during the two quarters ending in March and December would not likely be as profitable as the two quarters ending in June and September. There was no significant impact on Taj Associates' operations as a result of inflation during the first nine months of 1995, and during 1994, 1993 or 1992. Taj Holding has no business operations and serves as a holding company for a 50% investment in Taj Associates. Taj Associates owns and operates the Taj Mahal, a luxury casino hotel located on The Boardwalk in Atlantic City. The Taj Mahal is currently the largest casino hotel facility in Atlantic City, and has ranked first among all Atlantic City casinos in terms of total gaming revenues, table revenues and slot revenues since it commenced operations in 1990. The Taj Mahal capitalizes on the widespread recognition and marquee status of the "Trump" name and its association with high quality amenities and first class service as evidenced by its "Four Star" Mobil Travel Guide rating. Management believes that the breadth and diversity of the Taj Mahal's casino, entertainment and convention facilities and its status as a "must see" attraction will enable the Taj Mahal to benefit from the expected continued growth of the Atlantic City market. The Taj Mahal currently features Atlantic City's largest casino, with 120,000-square-feet of gaming space, 162 table games and 3,550 slot machines. In addition, the Taj Mahal has a 12,000-square-foot poker, keno, race simulcasting room with 61 poker tables, which was added in 1993 and expanded in 1994. The casino's offerings include blackjack, craps, roulette, baccarat, red dog, sic-bo, pai gow, pai gow poker, caribbean stud poker and big six. In December 1995, the Taj Mahal opened an Asian themed table game area which offers 16 popular Asian table games catering to the Taj Mahal's growing Asian clientele. In addition, as a special bonus to high-end players, Taj Associates offers three clubs for the exclusive use of select customers: the Maharajah Club for table game players, the Presidents Club for high-end slot players, and the Bengal Club for other preferred slot players. The Taj Mahal consists of a 42-story hotel tower and contiguous low-rise structure, sited on approximately 17 acres of land. The Taj Mahal has 1,250 guest rooms (including 242 suites), 15 restaurants, six lounges, parking for approximately 4,600 cars, an 18-bay bus terminal and approximately 65,000- square-feet of ballroom, meeting room and pre-function area space. The Taj Mahal is currently contemplating adding new themed restaurants to be owned and operated by nationally recognized restaurant operators, including the Rainforest Cafe. In addition, the Taj Mahal features the Taj Entertainment Complex, a 20,000-square-foot multi-purpose entertainment complex known as the Xanadu Theater with seating capacity for approximately 1,200 people, which can be used as a theater, concert hall, boxing arena or exhibition hall, and the Mark Etess Arena, which comprises an approximately 63,000-square foot exhibition hall facility. The Xanadu Theater and the Mark Etess Arena have allowed the Taj Mahal to offer longer running, more established productions that cater to the tastes of the Taj Mahal's high-end international guests, and has afforded the Taj Mahal more flexibility in the use of its facilities for sporting and other headline programs. The Taj Mahal regularly engages well- known musicians and entertainment personalities and will continue to emphasize weekend marquee events such as Broadway revues, high visibility sporting events, international festivals and contemporary concerts to maximize casino traffic and to maintain the highest level of glamour and excitement at the Taj Mahal. Management believes that the Taj Mahal's 1,250-room capacity and vast casino, entertainment, convention and exhibition space, including the Mark Etess Arena, make it a highly attractive convention facility and destination resort facility at which visitors may stay for extended periods. In addition to its normal advertising, Taj Associates actively promotes the Taj Mahal with various local chambers of commerce, travel agencies which specialize in convention travel and various corporate travel departments in order to attract convention business. General. In recent years, under the direction of Trump and the management team led by Nicholas L. Ribis, its Chief Executive Officer, Taj Associates has completed construction of the Taj Entertainment Complex, reconfigured and expanded the casino floor to provide race simulcasting, poker wagering and the new game of keno, opened an Asian themed table game area and increased the number of poker tables and slot machines. Taj Associates continually monitors operations to adapt to and anticipate industry trends. Since 1994, the Taj Mahal has embarked on a strategy to renovate all of its hotel guest rooms and corridors by April 1996 and to replace all of its existing slot machines by the middle of 1996 with new, more efficient machines with bill collectors. A primary element of the Taj Mahal's business strategy is to attract patrons who tend to wager more frequently and in larger denominations than the typical Atlantic City gaming customer ("high-end players"). Such high-end players typically wager $5 or more per play in slots and $100 or more per play in table games. As a result of these and other initiatives, Taj Associates has had strong recent operating results, with net revenues for the nine months ended September 30, 1995 approximately 8% higher than the period in 1994. In addition, slot revenues also increased in the nine months ended September 30, 1995, a 6.9% increase over the comparable period in 1994. The Taj Mahal's total gaming revenues represent a 13.4% share of the Atlantic City gaming market in the nine months ended September 30, 1995 and 1994, resulting in part from Atlantic City's highest table game efficiency and win per unit per day during such time. The Taj Mahal Expansion. Following the consummation of the Merger Transaction, THCR plans to undertake an expansion plan at the Taj Mahal to meet both existing demand and the increase in demand that management anticipates will result from the increased number of rooms and infrastructure improvements that are currently being implemented to enhance further the "vacation destination appeal" of Atlantic City. It is currently expected that the Taj Mahal Expansion will be funded out of the Taj Mahal's cash from operations and borrowings, and will be completed in phases from the fourth quarter of 1996 through 1999. The Taj Mahal Expansion, the plans for which are preliminary and subject to change, involves the construction of a 2,200 space expansion of the Taj Mahal's existing self-parking facilities and a new arena on a surface parking area located adjacent to the Taj Mahal, each scheduled to be completed in the fourth quarter of 1996; the conversion of the current site of the Mark Etess Arena into a new 60,000-square foot circus-themed casino with 2,500 slot machines, to be completed in 1997; and the construction of two new 640 room hotel towers adjacent to the Taj Mahal's existing hotel tower, the first of which is scheduled to be completed in 1997, and the second of which is scheduled to begin construction following the completion of the first tower and be completed in 1999. See "Risk Factors--Trump Plaza Expansion and The Taj Mahal Expansion--The Taj Mahal." Gaming Environment. The Taj Mahal's management continues to capitalize on the Taj Mahal's status as the largest facility in Atlantic City and a "must see" attraction, while maintaining the attractiveness of the property and providing a comfortable gaming experience. In 1994, the Taj Mahal completed a major redecoration of the hotel lobby, a casino floor expansion and a reconfiguration, as well as the addition of a new mid-level player slot club. The casino floor expansion and reconfiguration accommodated the addition of keno, an additional 4 poker tables and 163 slot machines. Taj Holding management believes that this renovation represents a significant improvement by creating an uninterrupted view from the lobby to the casino floor. Approximately 2,050 new slot machines were placed in service during 1994 and 1995 to replace older models. Taj Holding management anticipates that it will continue to replace all older slot machines early in 1996. In addition, in June 1993, the Taj Mahal completed a 10,000-square foot poker and simulcast area (which was subsequently enlarged to 12,000 square feet), which features 61 poker tables in the largest poker room in Atlantic City. For the year ended December 31, 1994, the Taj Mahal captured approximately 40.7% of the total Atlantic City poker revenues. Taj Holding management continuously monitors the configuration of the casino floor and the games it offers to patrons with a view towards making changes and improvements. For example, the Taj Mahal's casino floor has clear, large signs for the convenience of patrons. Additionally, as new games have been approved by the CCC, management has integrated such games to the extent it deems appropriate. In 1994, the Taj Mahal introduced the newly-approved games of keno and caribbean stud poker and in 1995 introduced the game of pai gow. Entertainment. Taj Holding believes headline entertainment, as well as other entertainment and revue shows, is an effective means of attracting and retaining gaming patrons. The August 1993 completion of the Xanadu Theater has allowed the Taj Mahal to offer longer running, more established productions the tastes of the Taj Mahal's high-end international guests. The additional theater has also afforded the Taj Mahal more flexibility in the use of its larger entertainment arena for sporting and other headline programs. The Taj Mahal regularly engages well-known musicians and entertainment personalities and will continue to emphasize weekend "marquee" events such as Broadway revues, high visibility sporting events, festivals and contemporary concerts to maintain the highest level of glamour and excitement. Mid-week uses for the facilities include convention events and casino marketing sweepstakes. The Taj Mahal also includes the Mark Etess Arena, which comprises an approximately 63,000 square-foot exhibition hall facility. "Comping" Strategy. In order to compete effectively with other casino hotels, the Taj Mahal offers complimentaries. In 1991 and 1992, the Taj Mahal increased promotional activities and complimentaries to its targeted patrons in response to a difficult economic environment and increased capacity in the Atlantic City market. Currently, the policy at the Taj Mahal is to focus promotional activities, including complimentaries, on middle and upper middle market "drive in" patrons who visit Atlantic City frequently and have proven to be the most profitable market segment. Additionally, as a result of increased regulatory flexibility, Taj Associates has implemented a cash comping policy to high-end players in order to compete with similar practices in Las Vegas and to attract international business. Player Development. Taj Associates employs sales representatives as a means of attracting high-end slot and table gaming patrons to the property. Taj Associates currently employs numerous gaming representatives in New Jersey, New York and other states, as well as several international representatives, to host special events, offer incentives and contact patrons directly in the United States, Canada and South America. In addition, targeted marketing to international clientele will be continued and expanded through new sales representatives in Latin America, Mexico, Europe, the Far East and the Middle East. As a special bonus to high-end players, Taj Associates offers three clubs for the exclusive use of select customers: the Maharajah Club for table game players, the Presidents Club for high-end slot players, and the Bengal Club for other preferred slot players. The casino hosts assist patrons on the casino floor, make room and dinner reservations and provide general assistance. They also solicit Trump Card (the frequent player card) sign-ups in order to increase the Taj Mahal's marketing base. Taj Associates also plans to continue the development of its slot and coin programs through direct mail and targeted marketing campaigns emphasizing the high-end player. "Motorcoach Marketing," the Taj Mahal's customer bus-in program, has been an important component of player development and will continue to focus on tailoring its player base and maintaining a low-cost package. Promotional Activities. The Trump Card, a player identification card, constitutes a key element in the Taj Mahal's direct marketing program. Both table and slot machine players are encouraged to register for and utilize their personalized Trump Card to earn various complimentaries and incentives based on their level of play. The Trump Card is inserted during play into a card reader attached to the table or slot machine for use in computerized rating systems. These computer systems record data about the cardholder, including playing preferences, frequency and denomination of play and the amount of gaming revenues produced. Sales and management personnel are able to monitor the identity and location of the cardholder and the frequency and denomination of such cardholder's play. They can also use this information to provide attentive service to the cardholder while the patron is on the casino floor. The Taj Mahal designs promotional offers, conveyed via direct mail and telemarketing, to patrons expected to provide revenues based upon their historical gaming patterns. Such information is gathered on slot wagering by the Trump Card and on table game wagering by the casino games supervisor. Promotional activities at the Taj Mahal include the mailing of vouchers for complimentary slot play and utilization of a special events calendar (e.g., birthday parties, sweepstakes and special competitions) to promote its gaming operations. The Taj Mahal conducts slot machine and table game tournaments in which cash prizes are offered to a select group of players invited to participate in the tournament based upon their tendency to play. Special events such as "Slot Sweepstakes" and "bingo" are designed to increase mid-week business and will continue to be emphasized throughout 1996. Players at these tournaments tend to play at their own expense during "off-hours" of the tournament. At times, tournament players are also offered special dining and entertainment privileges that encourage them to remain at the Taj Mahal. Credit Policy. Historically, the Taj Mahal has extended credit on a discretionary basis to certain qualified patrons. For the years ended December 31, 1992, 1993 and 1994 and the nine months ended September 30, 1995, the Taj Mahal's credit play as a percentage of total dollars wagered was approximately 26.0%, 23.5%, 22.8% and 22.9%, respectively. Since 1991, the Taj Mahal has successfully attracted high-end table game patrons through its "junket" marketing operations and has undertaken a marketing effort aimed at high-end international table game patrons, which increased credit play as a percentage of total dollars in 1991 and early 1992. Since the initial success of these marketing efforts, the Taj Mahal has been more selective in its extension of credit, thereby decreasing credit play as a percentage of gaming revenues in 1992, 1993 and 1994. Taj Associates owns and leases several parcels of land in Atlantic City, New Jersey, each of which is used in connection with the operation of the Taj Mahal and each of which is encumbered by the Amended Mortgage securing the Bonds and the mortgage securing the $25 million Working Capital Facility. Upon consummation of the Merger Transaction, these parcels of land may also secure the Taj Notes. All of the following properties (other than certain property underlying the casino parcel, which is owned by Taj Associates) comprised the Specified Parcels. The Casino Parcel. The land comprising the site upon which the Taj Mahal is located consists of approximately 17 acres, which are bounded by The Boardwalk to the south, Maryland Avenue to the east, Pennsylvania Avenue to the west and which extends to the north towards Pacific Avenue for approximately three- quarters of a city block on the western portion of the site and two-thirds of a city block on the eastern portion of the site. Construction was substantially completed and the Taj Mahal was opened to the public on April 2, 1990. Taj Entertainment Complex. The Taj Entertainment Complex is situated in a parcel of land leased from Realty Corp. and features a 20,000 square foot multi-purpose entertainment complex known as the Xanadu Theater with seating capacity for approximately 1,200 people, which can be used as a theater, concert hall, boxing arena or exhibition hall. Steel Pier. Taj Associates leases the Steel Pier from Realty Corp. A condition imposed on Taj Associates' CAFRA Permit (which, in turn, is a condition of Taj Associates' casino license) initially required that Taj Associates begin construction of certain improvements on the Steel Pier by October 1992, which improvements were to be completed within 18 months of commencement. Taj Associates initially proposed a concept to improve the Steel Pier, the estimated cost of which improvements was $30 million. Such concept was approved by the New Jersey Department of Environmental Protection and Energy ("NJDEPE"), the agency which administers CAFRA. In March 1993, Taj Associates obtained a modification of its CAFRA Permit providing for the extension of the required commencement and completion dates of the improvements to the Steel Pier for one year based upon an interim use of the Steel Pier for an amusement park. Taj Associates received an additional one- year extension, in March 1995, of the required commencement and completion dates of the improvements of the Steel Pier based upon the same interim use of the Steel Pier as an amusement park pursuant to a sublease ("Pier Sublease") with an amusement pier operator ("Pier Subtenant"). The Pier Sublease provides for a five-year lease term through December 31, 1999. However, Taj Associates may terminate the Pier Sublease after December 31 of each year if written notice of termination is given to the Pier Subtenant on or before September 1 of such year. Taj Associates is currently seeking further modification to its obligations under the CAFRA Permit. Office and Warehouse Space. Taj Associates owns an office building located on South Pennsylvania Avenue adjacent to the Taj Mahal. In addition, Taj Associates, in April 1991, purchased for approximately $1.7 million certain facilities of Trump's Castle Associates which are presently used for fleet maintenance and limousine services, and for office space which it leases to a commercial tenant. Taj Associates has entered into a lease with The Trump-Equitable Fifth Avenue Co., a corporation wholly owned by Trump, for the lease of office space in The Trump Tower in New York City, which Taj Associates uses as a marketing office. The monthly payments under the lease had been $1,000, and the premises were leased at such rent for four months in 1992, the full twelve months in 1993 and 1994 and eight months in 1995. On September 1, 1995, the lease was renewed for a term of five years with an option for Taj Associates to cancel the lease on September 1 of each year, upon six months' notice and payment of six months' rent. Under the renewed lease, the monthly payments are $2,184. Parking. The Taj Mahal provides parking for approximately 4,600 cars of which 3,600 spaces are located in indoor parking garages and 1,000 spaces are located on land leased to Taj Associates by Realty Corp. In addition, Taj Associates entered into a lease agreement with Trump's Castle Associates to share its employee parking facilities. In connection with the Taj Mahal Expansion, Taj Associates will expand its self-parking facilities by 2,200 spaces. The gaming industry in Atlantic City traditionally has been seasonal, with its strongest performance occurring from May through September, and with December and January showing substantial decreases in activity. Revenues have been significantly higher on Fridays, Saturdays, Sundays and holidays than on other days. Taj Associates has approximately 6,100 employees for the operation of the Taj Mahal, of which approximately 1,850 employees are represented by collective bargaining agreements. Taj Associates believes that its relationships with its employees are satisfactory and that its staffing levels are sufficient to provide first-rate service. Since opening in April 1990, during which time some collective bargaining agreements with various unions have expired prior to the execution of new agreements, the business of Taj Associates has not been interrupted due to any labor disputes. The collective bargaining agreement with HERE Local 54, which covers substantially all of Taj Associates' hotel and restaurant employees, was renegotiated in September 1994 and will expire on September 14, 1999. Certain Taj Associates employees must be licensed under the Casino Control Act. See "Regulatory Matters--New Jersey Gaming Regulations--Qualification of Employees." During 1990 and 1991, Taj Associates experienced liquidity problems. Taj Holding believes that these problems were attributable, in part, to an overall deterioration in the Atlantic City gaming market, as indicated by reduced rates of casino revenue growth for the industry for the two prior years, aggravated by an economic recession in the Northeast and the Persian Gulf War, as well as the risks inherent in the establishment of a new business enterprise. Comparatively, excessive casino gaming capacity in Atlantic City may also have contributed to Taj Associates' liquidity problems. As a result of Taj Associates' liquidity problems, Taj Funding failed to make its November 15, 1990 and May 15, 1991 interest payments on its Old Bonds, resulting in an event of default under the indenture with respect to such Old Bonds. During 1990 and 1991, Taj Associates also failed to pay certain principal and interest installments on certain indebtedness due under its loan with NatWest. In order to alleviate its liquidity problems, during 1991, TTMC, Taj Funding, Taj Associates and TTMI (together, the "Debtors") restructured their indebtedness through the 1991 Taj Restructuring, which was a "prepackaged" plan of reorganization under Chapter 11 of the Bankruptcy Code. At the time, the Debtors believed that there was no alternative to their liquidity problems other than filing petitions under the Bankruptcy Code. Taj Associates had been unable to obtain additional financing, and Taj Funding was restricted from amending the payment terms of the Old Bonds outside of a case under the Bankruptcy Code without the unanimous consent of the holders thereof. The purpose of the 1991 Taj Restructuring was to improve the amortization schedule and extend the maturity of Taj Associates' indebtedness by reducing and deferring the Debtors' annual debt service requirements by (i) restructuring Taj Associates' and affiliated entities' long-term indebtedness to NatWest, First Fidelity and Bankers Trust, and (ii) issuing the Bonds with an overall lower rate of interest as compared with Taj Funding's Old Bonds. Upon consummation of the 1991 Taj Restructuring on October 4, 1991, Taj Associates issued to the holders of the Old Bonds a general partnership interest representing 49.995% of the equity of Taj Associates. Such holders in turn contributed such partnership interest to Taj Holding. Taj Funding also issued the Units to the holders of the Old Bonds. As part of the 1991 Taj Restructuring, TM/GP, which has no other assets, received a 49.995% partnership interest in Taj Associates from Taj Holding. Trump also contributed to Taj Holding a 50% ownership interest in TTMC, which owns a .01% interest in Taj Associates, in exchange for the Taj Holding Class C Common Stock, as described below. At the time of these transfers, Taj Holding issued 1,350,000 shares of Taj Holding Class A Common Stock and 729,458 shares of Taj Holding Class B Common Stock to the holders of the Old Bonds and 1,350,000 shares of Taj Holding Class C Common Stock to Trump. In accordance with the terms of the Bond Indenture, a portion of the interest on the Bonds may be paid in additional Bonds. At May 15, 1992, 1993, 1994 and 1995, 8,844 Units comprised of $8,844,000 of Bonds and 8,844 shares of Taj Holding Class B Common Stock, 14,579 Units comprised of $14,579,000 of Bonds and 14,579 shares of Taj Holding Class B Common Stock, 12,249 Units comprised of $12,249,000 of Bonds and 12,249 shares of Taj Holding Class B Common Stock, and 15,112 Units comprised of $15,112,000 of Bonds and 15,112 shares of Taj Holding Class B Common Stock, respectively, were issued in lieu of the payment of a portion of the cash interest on the outstanding Bonds. Currently, the holders of Taj Holding Class B Common Stock are entitled to elect four of the nine members of Taj Holding's Board of Directors and Trump, as holder of the Taj Holding Class C Common Stock, is entitled to elect the remaining five directors. The Taj Holding Class A Common Stock has no voting rights until such time as the Bonds are redeemed, defeased or paid in full. However, except upon Taj Holding's liquidation, only the Taj Holding Class A Common Stock is entitled to distributions and dividends, if any, made by Taj Holding. The Taj Holding Class B Common Stock must be redeemed at a price of $.50 per share when the Bonds with which they were issued, are paid, redeemed or defeased. Set forth below is a summary of certain debt instruments to which affiliates of Taj Holding are parties prior to the Merger Transaction. In connection with the 1991 Taj Restructuring, Taj Funding and Taj Holding issued Units, each of which was comprised of $1,000 principal amount of Bonds and one share of Taj Holding Class B Common Stock. Pursuant to the Bond Indenture, Taj Funding may issue up to $860 million of Bonds. On October 4, 1991, at the time the Units were issued, the principal amount of Bonds issued was $729,458,000. Terms. As of September 30, 1995, the principal amount of Bonds issued was $780,242,000. The Bonds have a stated maturity date of November 15, 1999. The Bonds bear interest at 11.35% per annum. Interest on the Bonds is due semi- annually on each November 15 and May 15. Interest on the Bonds must be paid in each interest payment date at a rate of 9.375% per annum, and, in addition, effective May 15, 1992, and annually thereafter, an additional amount of interest in cash or additional Bonds or a combination thereof, is payable in an amount to increase the interest paid to 11.35% per annum. Guarantee. The obligations of Taj Funding to pay the principal of, premium, if any, and interest on the Bonds are guaranteed by Taj Associates. Security. The Bonds are secured by an assignment by Taj Funding to the trustee under the Bond Indenture (the "Taj Bond Trustee") of a promissory note, dated as of October 4, 1991, issued by Taj Associates to Taj Funding (the "Taj Bond Partnership Note") in a principal amount of $675 million, with payment terms substantially similar to the payment terms of the Bonds, which is in turn secured by an amended mortgage, dated as of October 4, 1991, by Taj Associates as mortgagor and Taj Funding as mortgagee, securing payment of the Taj Bond Partnership Note, as amended to reflect the terms of the Bonds (the "Amended Mortgage"), which has been assigned to the Taj Bond Trustee and encumbers Taj Associates' interest in the Taj Mahal and substantially all of the other assets of Taj Associates, excluding certain furniture, furnishings, fixtures, machinery and equipment which is subject to the lien of the NatWest Loan. In addition, the Taj Bond Partnership Note is secured by a second, subordinated lien on all the real estate owned by Realty Corp. Moreover, Taj Associates has acquired an option to purchase the real estate owned by Realty Corp., and such option has been assigned to the Taj Bond Trustee as security for the Bonds. Covenants. The Bond Indenture contains certain restrictive covenants which restrict, among other things, the activities of Taj Funding and Taj Associates; the ability of Taj Associates to enter into certain leases; the incurrence of additional debt (including a covenant limiting payments on long- term debt); the creation of liens; the payment of dividends and distributions on and repurchases of capital stock and partnership interests and other restricted payments; consolidations, mergers and conveyances and transfers of property and assets; transactions with affiliates; investments of Taj Funding and Taj Associates; and the waiver of stay extension and usury laws. Treatment Under the Merger Transaction. The principal and accrued and unpaid interest on the outstanding Bonds will be paid in full in connection with the Merger Transaction. Concurrently with the retirement of the Bonds, the outstanding shares of Taj Holding Class B Common Stock will be redeemed in accordance with their terms, at a redemption price of $.50 per share. On November 3, 1989, Taj Associates entered into the NatWest Loan, which provided financing of $50,000,000 for certain items of furniture, fixtures and equipment installed in the Taj Mahal. On October 4, 1991, in connection with the 1991 Taj Restructuring, the NatWest Loan was amended in order to, among other things, modify the interest rate and other payment terms. Terms. As of September 30, 1995, the principal amount of the NatWest Loan was $44,986,000, and the interest rate was 9.375% per annum. Principal and interest on the NatWest Loan are payable as follows: (i) on the last business day of each month until the earlier of the last business day of October 1999 or the date the NatWest Loan, together with all interest thereon, is paid in full, the sum of $416,667, to be applied first in respect of accrued interest on the NatWest Loan and thereafter, to the extent available, in reduction of the principal of the NatWest Loan; provided, however, up to $525,000 of such payments received by NatWest in any year shall be paid to either First Fidelity or Bankers Trust for application by First Fidelity in payment of obligations of Taj Associates to First Fidelity, and by Bankers Trust on behalf of Taj Associates on behalf of TTMI in payment of interest on the TTMI Note. Such amounts paid by NatWest shall not have been applied by NatWest in payment of the principal of, interest on or any other sums due in respect of the NatWest Loan or otherwise payable to NatWest; (ii) on May 15 of each year (if any of the principal of or interest on the NatWest Loan is then outstanding), commencing on May 15, 1992, to and including May 15, 1999, an amount (the "EACF Payment") equal to 16.5% (or, if the First Fidelity Loan shall have been paid in full on or prior to any such May 15, 20%) of Excess Available Cash Flow (as defined in the Bond Indenture) for the preceding calendar year in excess of the Additional Amount (as defined in the Bond Indenture) payable on such May 15 (such remaining Excess Available Cash Flow, the "Remaining EACF Amount"), if any, to be applied first in reduction of then accrued but unpaid interest on, and then to principal of the NatWest Loan; and (iii) on November 15, 1999, the outstanding principal of and all accrued but unpaid interest on the NatWest Loan. Security. The NatWest Loan is secured by a first priority lien on the furniture, fixtures and equipment acquired with the proceeds of the NatWest Loan plus any after-acquired furniture, fixtures and equipment that replaces such property, or of the same type; provided, however, that the NatWest Loan may be subordinated to a lien to secure purchase money financing of such after-acquired property which does not exceed 50% of the purchase price of such after-acquired property. Remedies upon Events of Default. Upon the occurrence of an event of default under the NatWest Loan, including, without limitation, the sale of any real estate owned by Realty Corp. for less than the release price set forth in First Fidelity Loan (as defined below) without the prior written consent of NatWest, NatWest may accelerate any and all indebtedness outstanding under the NatWest Loan. Treatment Under the Merger Transaction. The NatWest Loan will remain outstanding following the consummation of the Merger Transaction subject to obtaining the consent of NatWest. On November 22, 1988, First Fidelity, Realty Corp. and Trump, as guarantor, entered into the First Fidelity Loan in the aggregate principal amount of $75,000,000. Pursuant to an amendment to the First Fidelity Loan, effective as of October 4, 1991, the rate of interest payable was modified, the dates of payment of principal and interest were deferred and accrued interest in the amount of $1,773,750 was capitalized. As of September 30, 1995, the principal amount outstanding on the First Fidelity Loan was approximately $78 million. Unpaid principal and accrued interest on the First Fidelity Loan is due and payable on November 15, 1999, unless otherwise extended in connection with the extension of the maturity of the Bonds. Taj Associates currently leases the Specified Parcels from Realty Corp., a corporation wholly owned by Trump, pursuant to an Amended and Restated Lease Agreement, dated as of October 4, 1991 (the "Specified Parcels Lease"). Pursuant to the Specified Parcels Lease, Taj Associates is obligated to pay Realty Corp. $3.3 million plus 3.5% of the Remaining EACF Amount per year. Such annual payment, however, is reduced by (i) all of the Base Fees and the first $75,000 of the Incentive Fees payable to Trump pursuant to the Taj Services Agreement and assigned by Trump to First Fidelity (which amounts were $575,000 in 1995) and (ii) the portion of monies payable by Taj Associates to NatWest to be remitted to First Fidelity (which amounts were $525,000 in 1995). The Specified Parcels Lease expires on December 31, 2023, however, the lease may be terminated prior to such date following a foreclosure or similar proceeding on the Specified Parcels by First Fidelity, the holder of a first mortgage lien on the Specified Parcels which secures the First Fidelity Loan (the "First Fidelity Mortgage") or any other mortgagee thereof. The Specified Parcels Lease provides that, upon payment of the First Fidelity Loan, and upon discharge of the First Fidelity Mortgage, Taj Associates may purchase the Specified Parcels for ten dollars. Payment of the First Fidelity Loan is guaranteed by a guarantee (limited to any deficiency in the amount owed under the First Fidelity Loan when due, up to a maximum of $30 million) by Taj Associates (the "Taj Associates-First Fidelity Guarantee"), a personal guarantee by Trump (pursuant to which First Fidelity has agreed to forbear from asserting any personal claim with respect thereto in excess of approximately $19.2 million) (the "Trump-First Fidelity Guarantee") and limited recourse guarantees by TTMC (the "TTMC-First Fidelity Guarantee") and TTMI (as amended, the "TTMI-First Fidelity Guarantee" and, together with the Trump-First Fidelity Guarantee and the TTMC-First Fidelity Guarantee, the "Other First Fidelity Guarantees"). The Other First Fidelity Guarantees are secured by pledges by Trump of 62.5% of his Taj Holding Class C Common Stock, TTMC Common Stock and TTMI Common Stock and all of his shares of Realty Corp. Common Stock, and pledges by TTMI and TTMC of 62.5% and 31.25%, respectively, of their equity and financial interests as general partners in Taj Associates (all such interests pledged to First Fidelity as security for the Other First Fidelity Guarantees are referred to herein as the "Other First Fidelity Guarantee Collateral"). First Fidelity's recourse under the TTMC- First Fidelity Guarantee and the TTMI-First Fidelity Guarantee is limited to the collateral pledged by TTMC and TTMI, respectively. Upon the satisfaction in full of the obligations due under the First Fidelity Loan at a negotiated amount of $50 million and 500,000 shares of THCR Common Stock, Taj Associates will purchase the Specified Parcels from Realty Corp. In connection therewith, First Fidelity will (i) release and discharge Realty Corp. from the First Fidelity Loan and release its lien on the Specified Parcels, (ii) release Taj Associates from the Taj Associates-First Fidelity Guarantee, (iii) release each of Trump, TTMC and TTMI from their respective obligations under the Other First Fidelity Guarantees and (iv) release its lien on the Other First Fidelity Guarantee Collateral. In addition, the purchase of the Specified Parcels will eliminate Taj Associates' current obligations under the Specified Parcels Lease and the termination rights with respect to the Specified Parcels Lease, thereby facilitating the Taj Mahal Expansion by securing the future use of the Specified Parcels by Taj Associates. It is anticipated that holders of the Taj Notes will have a security interest in the Specified Parcels. On April 30, 1990, Trump loaned $25 million to Taj Associates on an unsecured basis, in exchange for a note payable to Trump (the "Old Taj Associates Note"). The Old Taj Associates Note was pledged to certain lenders to Trump, including Bankers Trust, as security for certain of Trump's personal indebtedness. On October 4, 1991, in connection with the 1991 Taj Restructuring and in order to facilitate the reorganization of Taj Associates and certain of its affiliates, the Old Taj Associates Note was canceled and, in lieu thereof, TTMI, a corporation wholly owned by Trump which was formed for the purpose of holding a general partnership interest in Taj Associates, executed the TTMI Note, a promissory note payable to Trump in the principal amount of $27,188,000. At such time, in order to secure the Bankers Trust Indebtedness, Trump pledged to certain lenders, including Bankers Trust, his right, title and interest in the TTMI Note. As additional security for the Bankers Trust Indebtedness, Trump pledged to Bankers Trust all of his shares of Taj Holding Class C Common Stock, TTMC Common Stock and TTMI Common Stock, which pledges are subordinate, in part, to the liens of First Fidelity in such collateral. In addition, TTMI and TTMC have each guaranteed the repayment of the Bankers Trust Indebtedness, which limited recourse guarantees are secured by pledges by TTMI and TTMC to Bankers Trust of 100% and 50%, respectively, of their equity and financial interests as general partners in Taj Associates, which pledges are subordinate, in part, to the liens of First Fidelity in such collateral. In connection with the Merger Transaction, Bankers Trust will receive $10 million from Taj Associates in respect of certain of the Bankers Trust Indebtedness. Upon such payment, Bankers Trust will release (i) its lien on the TTMI Note, (ii) its liens on the remaining collateral pledged by Trump to Bankers Trust and (iii) TTMI and TTMC from their respective obligations as guarantors of certain of Trump's personal indebtedness and the liens securing such obligations. Background and Terms. On November 14, 1991, Taj Associates entered into the Working Capital Facility with Foothill in the amount of $25,000,000, which is secured by a lien on Taj Associates' assets senior to the lien of the Bond Mortgage securing the Bonds. On September 1, 1994, Taj Associates and Foothill maturity to November 13, 1999, in consideration of modifications of the terms of the facility. Borrowings under the Working Capital Facility bear interest at a rate equal to the prime lending rate plus 3%, with a minimum of 0.666% per month. The agreement further provides for a .75% annual fee and a .50% unused line fee. As of December 31, 1994, no amounts were outstanding under the Working Capital Facility. Events of Default. The occurrence of any of the following events constitute an event of default under the Working Capital Facility: (i) failure to pay principal, interest, fees, charges or reimbursements due to Foothill, when due and payable or when declared due and payable; (ii) failure or neglect to perform certain duties and covenants under the agreement; (iii) any material portion of Taj Associates' assets is attached, seized, subjected to a writ or distress warrant, levied upon, or comes into the possession of any judicial officer or assignee and such attachment or writ is not dismissed within 60 days; (iv) an insolvency proceeding is commenced by Taj Associates; (v) an insolvency proceeding is commenced against Taj Associates, and is not dismissed within 60 days; (vi) Taj Associates is enjoined, restrained, or in any way prevented by certain governmental agencies from continuing to conduct all or any material part of its business affairs; (vii) Taj Associates fails to pay certain liens, levies or assessments on the payment date thereof; (viii) certain judgments or claims in excess of $500,000 become a lien or encumbrance upon a material portion of Taj Associates' assets; (ix) Taj Associates defaults in payments owing to NatWest or the Bond Trustee; (x) Taj Associates makes unauthorized payments on debt subordinated to the Working Capital Facility; (xi) misrepresentations are made by Taj Associates to Foothill in any warranty, representation, certificate, or report; (xii) certain ERISA violations which could have a material adverse effect on the financial condition of Taj Associates; or (xiii) Taj Associates incurs or enters into a commitment to incur any indebtedness which is secured by Taj Associates assets subject to the working capital facility. Remedies upon Event of Default. Upon the occurrence of an event of default, Foothill may, at its election, without notice of its election and without demand, do any one or more of the following: (i) declare all obligations immediately due and payable; (ii) cease advancing money or extending credit; (iii) terminate the Working Capital Facility without affecting Foothill's rights and security interest in Taj Associates assets; (iv) settle disputes and claims directly with certain Taj Associates debtors; (v) make such payments and perform such acts as Foothill deems necessary to protect its security interests; (vi) set off amounts owed under the Working Capital Facility by other Taj Associates accounts or deposits held by Foothill; (vii) prepare for sale and sell, after giving proper notice, Taj Associates assets securing the Working Capital Facility in a commercially reasonable manner; (viii) exercise its rights under certain mortgage and assignment documents between Taj Associates and Foothill; (ix) credit bid and purchase at any public sale subject to the provisions of the Casino Control Act; (x) any deficiency which exists after disposition of Taj Associates assets securing the Working Capital Facility will be paid immediately by Taj Associates; any excess will be returned to Taj Associates, without interest. Treatment under the Merger Transaction. The Working Capital Facility may remain outstanding following the consummation of the Merger Transaction and Foothill's consent would be required in such event. General. Taj Holding, TM/GP, TTMI and TTMC are not parties to any material legal proceedings. Taj Associates, its partners, certain members of the former Executive Committee, Taj Funding, TTMI and certain of their employees are or were involved in various legal proceedings, some of which are described below. Taj Associates and Taj Funding have agreed to indemnify such persons and entities against any and all losses, claims, damages, expenses (including reasonable costs, disbursements and counsel fees) and liabilities (including amounts paid or incurred in satisfaction of settlements, judgments, fines and penalties) incurred by them in said legal proceedings. Such persons and entities are vigorously defending the allegations against them and intend to vigorously contest any future proceedings. Bondholder Litigation. Between June 1990 and October 1990 six purported class actions were commenced on behalf of the holders of Taj Funding's Old Bonds, which were outstanding prior to the consummation of the Plan, and the publicly traded bonds of Trump's Castle and Trump Plaza. In December 1990 all six cases were consolidated in the United States District Court for the District of New Jersey. On February 8, 1991, the plaintiffs in the consolidated action filed an amended and consolidated complaint with respect to the Taj Mahal. This complaint named as defendants Donald J. Trump, Robert S. Trump, Harvey I. Freeman, Taj Associates, Taj Funding, TTMI, The Trump Organization and Merrill Lynch, Pierce, Fenner & Smith, Inc., and purported to be brought on behalf of those who either purchased Old Bonds or who would be deprived of interest on the Old Bonds pursuant to the Plan. The complaint alleged violations of Sections 11 and 12 of the Securities Act and Section 10(b) and Rule 10b-5 of the Exchange Act against all defendants and breach of fiduciary duty and common law false advertising against various defendants and sought compensatory damages in an unspecified amount. Taj Associates and the other defendants moved to dismiss the amended and consolidated complaint on or about January 28, 1992. On June 2, 1992 the Court granted the defendants' motion to dismiss. Plaintiffs thereafter appealed the dismissal of the consolidated action. On October 14, 1993, the United States Court of Appeals for the Third Circuit affirmed the District Court's dismissal of the amended complaint. On March 7, 1994, the U.S. Supreme Court denied the plaintiffs' petition for a writ of certiorari. Atlantic City Lease Agreement. The City of Atlantic City is currently disputing Taj Associates' termination of a lease agreement relating to employee parking. On March 29, 1990, Taj Associates entered into a lease agreement with the City of Atlantic City pursuant to which Taj Associates leased a parcel of land containing approximately 1,300 spaces for employee intercept parking at a cost of approximately $1 million. In addition, Taj Associates has expended in excess of $1.4 million in improving the site. The permit under which the lease is operated was issued by NJDEPE on December 20, 1989 for five years and contains several conditions, one of which required Taj Associates to find another location "off-island" for employee parking by April 2, 1992. NJDEPE extended this condition for two successive one-year periods through April 2, 1994. On November 14, 1994, as a result of the non-renewal of the permit, Taj Associates notified the City that the lease agreement had become inoperative and was therefore being canceled as of December 20, 1994. Taj Associates subsequently obtained "off-island" parking with Trump's Castle Associates sufficient to meet its employee parking requirements. The City has indicated in a letter to Taj Associates that it contests the cancellation of the lease agreement and claims certain extensions to the permit apply, to which Taj Associates does not agree. Other Litigation. Various legal proceedings are now pending against Taj Associates. Taj Holding considers all such proceedings to be ordinary litigation incident to the character of its business. The majority of such claims are covered by liability insurance (subject to applicable deductibles), and Taj Holding believes that the resolution of these claims, to the extent not covered by insurance, will not, individually or in the aggregate, have a material adverse effect on the financial condition or results of operations of Taj Holding. The Atlantic City gaming market has demonstrated continued growth despite the recent proliferation of new gaming venues across the country. The 12 casino hotels in Atlantic City generated approximately $3.43 billion in gaming revenues in 1994, an approximately 3.6% increase over 1993 gaming revenues of approximately $3.31 billion, despite the effects of unfavorable winter weather in the first quarter of 1994. For the first eleven months of 1995, which experienced milder winter weather in the first three months compared to the same period in 1994, gaming revenues for the 12 casino hotels in the Atlantic City market were approximately $3.48 billion, an increase of approximately 10.1% from the comparable period in 1994. From 1989 to 1994, total gaming revenues in Atlantic City have increased 22%, while hotel rooms increased only slightly during that period. Occupancy levels in Atlantic City increased to historic highs in 1994, reaching 88%, up from 83% in 1989. Although total visitor volume to Atlantic City remained relatively constant in 1994, the volume of bus customers dropped to 8.1 million in 1994, continuing a decline from 13.1 million in 1989. The volume of customers traveling by other means to Atlantic City has grown from 18.9 million in 1989 to 24.7 million in 1994. Total Atlantic City slot revenues increased 3.7% in 1994, continuing a solid trend of increases over the past five years. From 1989 through 1994, slot revenue growth in Atlantic City has averaged 7.9% per year. Total table revenue increased 1% in 1994, while table game revenue from 1989 to 1994 has decreased on average 2.6% per year. Management believes the slow growth in table revenue is primarily attributable to two factors. First, the slot product has been significantly improved over the last five years. Dollar bill acceptors, new slot machines, video poker and blackjack and other improvements have increased the popularity of slot play among a wider universe of casino patrons. Casino operators in Atlantic City have added slot machines in favor of table games due to increased public acceptance of slot play and due to slot machines' comparatively higher profitability as a result of lower labor and support costs. Since 1990, the number of slot machines in Atlantic City has increased 28%, while the number of table games has decreased by 17%. Slot revenues increased from 58% of total casino revenues in 1990 to 67% in 1994. The second reason for historic slow growth in table revenue is that table game players are typically higher end players and are more likely to be interested in overnight stays and other amenities. During peak season and weekends, room availability in Atlantic City is currently inadequate to meet demand, making it difficult for casino operators to aggressively promote table play. Casino revenue growth in Atlantic City has lagged behind that of other traditional gaming markets, principally Las Vegas, for the last five years. Both THCR management and Taj Holding management believe that this relatively slow growth is partially attributable to two key factors. First, the regulatory environment and infrastructure problems in Atlantic City have made it more difficult and costly to operate. Total regulatory costs and tax levies in New Jersey have exceeded Nevada since inception, and there is generally a higher level of regulatory oversight in New Jersey than in Nevada. The infrastructure problems, manifested by impaired accessibility of the casinos, downtown Atlantic City congestion and the condition of the areas surrounding the casinos, have made Atlantic City less attractive to the gaming customer. Secondly, there have been no significant additions to hotel capacity in Atlantic City since 1990. Las Vegas visitor volumes have increased, in part, due to the continued addition of new hotel capacity. Both markets have exhibited a strong correlation between hotel room inventory and total casino revenues. Despite lower overall growth rates than the Las Vegas market, both THCR management and Taj Holding management believe that Atlantic City possesses similar revenue and cash flow generation capabilities. The approximately $3.18 billion of gaming revenue produced by the 12 casino hotels in Atlantic City in the first ten months of 1995 exceeded the approximately $2.60 billion of gaming revenues produced by the 19 largest casino hotels on the Las Vegas Strip, even though the Atlantic City casino hotels have less than one-quarter the number of hotel rooms of the Las Vegas Strip casino hotels. Win per unit figures in Atlantic City are at a significant premium to Las Vegas win per unit performance, primarily due to the constrained supply of gaming positions in Atlantic City compared to Las Vegas. The regulatory environment in Atlantic City has improved recently. Most significantly, 24-hour gaming has been approved, poker and keno have been added and regulatory burdens have been reduced. In particular, Bill A61 was passed in January of 1995, which has eliminated duplicative regulatory oversight and channeled operator's funds from regulatory support into CRDA uses. Administrative costs of regulation will be reduced while increasing funds available for new development. In addition to the planned casino expansions, major infrastructure improvements have begun. The CRDA is currently overseeing the development of the "tourist corridor" that will link the new convention center with The Boardwalk and will, when completed, feature an entertainment and retail complex. The tourist corridor is scheduled to be completed in conjunction with the completion of the new convention center. Trump Plaza is adjacent to the existing Atlantic City Convention Center and will also be one of the closest casino hotels to the new convention center, which as currently planned would hold approximately 500,000 square feet of exhibit and pre-function space, 45 meeting rooms, food-service facilities and a 1,600-car underground parking garage. The Taj Mahal is approximately 1.5 miles from the site of the new convention center. When completed, the new approximately $290 million convention center would be the largest exhibition space between New York City and Washington, D.C. It will be located at the base of the Atlantic City Expressway and is currently planned to open in January 1997. The State of New Jersey is also implementing an approximately $125 million capital plan to upgrade and expand the Atlantic City International Airport. Both THCR management and Taj Holding management believe that recent gaming regulatory reforms will serve to permit future reductions in operating expenses of casinos in Atlantic City and to increase the funds available for additional infrastructure development through the CRDA. Due principally to an improved regulatory environment, general improvement of economic conditions in 1993 and 1994 and high occupancy rates, significant investment in the Atlantic City market has been initiated and/or announced. Bally recently bought a boardwalk lot for $7.5 million, the Sands just completed a major renovation, and in December of 1994, approval by the CRDA was given to TropWorld to add 626 hotel rooms and the Grand for 295 rooms (both of which are under construction) and the Taj Mahal for 1,280 rooms and a 1,500 space parking garage. Overall, various casinos in the market have applied to the CRDA for funding to construct 3,400 new hotel rooms. Both THCR management and Taj Holding management believe that these increases in hotel capacity, together with infrastructure improvements, will be instrumental in stimulating future revenue growth in the Atlantic City market. See "Competition." Competition in the Atlantic City casino hotel market is intense. Trump Plaza and the Taj Mahal compete with each other and with the other casino hotels located in Atlantic City, including the other casino hotel owned by Trump, Trump's Castle. See "Risk Factors--Conflicts of Interest." Trump Plaza and the Taj Mahal are located on The Boardwalk, approximately 1.2 miles apart from each other. At present, there are 12 casino hotels located in Atlantic City, including the Taj Mahal and Trump Plaza, all of which compete for patrons. In addition, there are several sites on The Boardwalk and in the Atlantic City Marina area on which casino hotels could be built in the future and various applications for casino licenses have been filed and announcements with respect thereto made from time to time (including a proposal by Mirage Resorts, Inc.), although neither THCR nor Taj Holding are aware of any current construction on such sites by third parties. No new casino hotels have commenced operations in Atlantic City since 1990, although several existing casino hotels have recently expanded or are in the process of expanding their operations. While management of THCR and Taj Holding believe that the addition of hotel capacity would be beneficial to the Atlantic City market generally, there can be no assurance that such expansion would not be materially disadvantageous to either Trump Plaza or the Taj Mahal. There also can be no assurance that the Atlantic City development projects which are planned or underway will be completed. Trump Plaza and the Taj Mahal also compete, or will compete, with facilities in the northeastern and mid- Atlantic regions of the United States at which casino gaming or other forms of wagering are currently, or in the future may be, authorized. To a lesser extent, Trump Plaza and the Taj Mahal face competition from gaming facilities nationwide, including land-based, cruise line, riverboat and dockside casinos located in Colorado, Illinois, Indiana, Iowa, Louisiana, Minnesota, Mississippi, Missouri, Nevada, South Dakota, Ontario (Windsor), the Bahamas, Puerto Rico and other locations inside and outside the United States, and from other forms of legalized gaming in New Jersey and in its surrounding states such as lotteries, horse racing (including off-track betting), jai alai, bingo and dog racing, and from illegal wagering of various types. New or expanded operations by other persons can be expected to increase competition and could result in the saturation of certain gaming markets. In September 1995, New York introduced a keno lottery game, which is played on video terminals that have been set up in 1,800 bars, restaurants and bowling alleys across the state. In addition to competing with other casino hotels in Atlantic City and elsewhere, by virtue of their proximity to each other and the common aspects of certain of their respective marketing efforts, including use of the "Trump" name, Trump Plaza and the Taj Mahal compete directly with each other for gaming patrons. Although management does not intend to operate Trump Plaza and the Taj Mahal to the competitive detriment of each other, the effect may be that Trump Plaza and the Taj Mahal will operate to the competitive detriment of each other. THCR anticipates that the Indiana Riverboat will compete primarily with riverboats and other casinos in the northern Indiana suburban and Chicago metropolitan area and throughout the Great Lakes Market. In addition to competing with Barden's riverboat at the Buffington Harbor site, the Indiana Riverboat will compete with a riverboat in Hammond, Indiana, which is being developed by the owner and operator of the Empress Riverboat Casino in Joliet, Illinois, a riverboat in East Chicago, Indiana, which is being developed by Showboat, Inc. and with the riverboat expected to be licensed in the nearby community of Michigan City, Indiana. To a lesser degree, the Indiana Riverboat will compete with the six additional riverboats expected to be licensed in the rest of Indiana. At present there are four other riverboat casino operations in the Chicago area (three of which operate two riverboats each, with each operator limited to 1,200 gaming positions in the aggregate). In addition, a casino opened during 1994 in Windsor, Ontario, across the river from Detroit, and Detroit is considering several proposals for casinos in its downtown area. Although THCR believes that there is sufficient demand in the market to sustain the Indiana Riverboat, there can be no assurance to that effect. There can be no assurance that either Indiana or Illinois, or both, will not authorize additional gaming licenses, including for the Chicago metropolitan area. See "Risk Factors--The Indiana Riverboat." In addition, Trump Plaza and the Taj Mahal face, and the Indiana Riverboat will face, competition from casino facilities in a number of states operated by federally recognized Native American tribes. Pursuant to IGRA, any state which permits casino style gaming (even if only for limited charity purposes) negotiate gaming contracts with federally recognized Native American tribes. Under IGRA, Native American tribes enjoy comparative freedom from regulation and taxation of gaming operations, which provides them with an advantage over their competitors, including Trump Plaza, the Taj Mahal and the Indiana Riverboat. In 1991, the Mashantucket Pequot Nation opened a casino facility in Ledyard, Connecticut, located in the far eastern portion of such state, an approximately three-hour drive from New York City and an approximately two and one-half hour drive from Boston, which currently offers 24-hour gaming and contains over 3,100 slot machines. The Mashantucket Pequot Nation has announced various expansion plans, including its intention to build another casino in Ledyard together with hotels, restaurants and a theme park. In addition, the Mohegan Nation has commenced construction of a casino resort to be located 10 miles from the Ledyard casino. The Mohegan Nation resort will be built and managed by Sun International, an entity headed by a South African investor, is scheduled to be as large as the Ledyard casino and is scheduled to open in October 1996. There can be no assurance that any continued expansion of gaming operations by the Mashantucket Pequot Nation or that any commencement of gaming operations by the Mohegan Nation would not have a materially adverse impact on Trump Plaza's or the Taj Mahal's operations. A group in New Jersey calling itself the "Ramapough Indians" has applied to the U.S. Department of the Interior to be Federally recognized as a Native American tribe, which recognition would permit it to require the State of New Jersey to negotiate a gaming compact under IGRA. In 1993, the Bureau of Indian Affairs denied the Ramapough Indians Federal recognition. The Ramapough Indians have appealed the decision. Similarly, a group in Cumberland County, New Jersey calling itself the "Nanticoke Lenni Lenape" tribe has filed a notice of intent with the Bureau of Indian Affairs seeking formal Federal recognition as a Native American tribe. Also, it has been reported that a Sussex County, New Jersey businessman has offered to donate land he owns there to the Oklahoma-based Lenape/Delaware Indian Nation which originated in New Jersey and already has Federal recognition but does not have a reservation in New Jersey. The Lenape/Delaware Indian Nation has signed an agreement with the town of Wildwood, New Jersey to open a casino; however, the plan requires federal and state approval in order to proceed. In July 1993, the Oneida Nation opened a casino featuring 24-hour table gaming and electronic gaming systems, but without slot machines, near Syracuse, New York, and has announced an intention to open expanded gaming facilities. Representatives of the St. Regis Mohawk Nation signed a gaming compact with New York State officials for the opening of a casino, without slot machines, in the northern portion of the state close to the Canadian border. The St. Regis Mohawks have also announced their intent to open a casino at the Monticello Race Track in the Catskill Mountains region of New York, however, any Indian gaming operation in the Catskills is subject to the approval of the Governor of New York. The Narragansett Nation of Rhode Island, which has Federal recognition, is negotiating a casino gaming compact with Rhode Island. The Aquinnah Wampanoags Tribe is seeking to open a casino in New Bedford, Massachusetts. Other Native American nations are seeking Federal recognition, land and negotiation of gaming compacts in New York, Pennsylvania, Connecticut and other states near Atlantic City. The Pokagon Band of Potawatomi Indians of southern Michigan and northern Indiana has been federally recognized as an Indian tribe. In September 1995, the Pokagon Band of Potawatomi Indians signed a gaming compact with the governor of Michigan to build a land-based casino in southwestern Michigan and also entered into an agreement with Harrah's Entertainment, Inc. to develop and manage the casino. Legislation permitting other forms of casino gaming has been proposed, from time to time, in various states, including those bordering New Jersey. Plans to begin operating slot machines at race tracks in the state of Delaware are underway, including the slot machines currently operating at the Dover Downs and Delaware Park race tracks. Six states have presently legalized riverboat gambling while others are considering its approval, including New York and Pennsylvania, and New York City is considering a plan under which it would be the embarking point for gambling cruises into international waters three miles offshore. Several states are considering or have approved large scale land- based casinos. Additionally, Las Vegas experienced significant expansion in 1993 and 1994, with additional capacity planned and currently under construction. The operations of Trump Plaza and the Taj Mahal could be adversely affected by such competition, particularly if casino gaming were permitted in jurisdictions near or elsewhere in New Jersey or in other states in the Northeast. In December 1993, the Rhode Island Lottery Commission approved the addition of slot machine games on video terminals at Lincoln Greyhound Park and Newport Jai Alai, where poker and blackjack have been offered for over two years. Currently, casino gaming, other than Native American gaming, is not allowed in other areas of New Jersey or in Connecticut, New York or Pennsylvania. On November 17, 1995, a proposal to allow casino gaming in Bridgeport, Connecticut, was voted down by that state's Senate. A New York State Assembly plan has the potential of legalizing non- Native American gaming in portions of upstate New York. Essential to this plan is a proposed New York State constitutional amendment that would legalize gambling. To amend the New York Constitution, the next elected New York State Legislature must repass a proposal legalizing gaming and a statewide referendum, held no sooner than November 1997, must approve the constitutional amendment. To the extent that legalized gaming becomes more prevalent in New Jersey or other jurisdictions near Atlantic City, competition would intensify. In particular, a proposal has been introduced to legalize gaming in Philadelphia and other locations in Pennsylvania. In addition, legislation has from time to time been introduced in the New Jersey State Legislature relating to types of statewide legalized gaming, such as video games with small wagers. To date, no such legislation, which may require a state constitutional amendment, has been enacted. Legislation has also been introduced on numerous occasions in recent years to expand riverboat gaming in Illinois, including by authorizing new sites in the Chicago area with which the Indiana Riverboat would compete and by otherwise modifying existing regulations to decrease or eliminate certain restrictions such as gaming position limitations. To date, no such legislation has been enacted. THCR and Taj Holding are unable to predict whether any such legislation, in New Jersey, Illinois or elsewhere, will be enacted or whether, if passed, it would have a material adverse impact on their respective results of operations or financial condition. THCR believes that competition in the gaming industry, particularly the riverboat and dockside gaming industry, is based on the quality and location of gaming facilities, the effectiveness of marketing efforts, and customer service and satisfaction. Although management of THCR believes that the location of the Indiana Riverboat will allow THCR to compete effectively with other casinos in the geographic area surrounding its casino, THCR expects competition in the casino gaming industry to be intense as more casinos are opened and new entrants into the gaming industry become operational. Furthermore, new or expanded operations by other persons can be expected to increase competition for existing and future operations and could result in a saturation of certain gaming markets. The Merger is subject to the expiration or termination of the applicable waiting period under the HSR Act. Under the HSR Act and the rules promulgated thereunder by the Federal Trade Commission (the "FTC"), the Merger may not be consummated until notifications have been given and certain information has been furnished to the Antitrust Division of the Department of Justice (the "Antitrust Division") and the applicable waiting period has expired or been terminated. On , 1996, THCR and Taj Holding filed Notification and Report forms under the HSR Act with the FTC and the Antitrust Division. On , 1996, the FTC and the Antitrust Division granted early termination of the waiting period under the HSR Act with respect to the Merger effective immediately. At any time before or after consummation of the Merger, notwithstanding that early termination of the waiting period under the HSR Act has been granted, the Antitrust Division of the FTC could take such action under the antitrust laws as it deems necessary or desirable in the public interest, including seeking to enjoin the consummation of the Merger or seeking divestiture of substantial assets of THCR or Taj Holding. Private parties may also seek to take legal action under the antitrust laws under certain circumstances. Based on information available to them, THCR and Taj Holding believe that the Merger can be effected in compliance with the federal antitrust laws. However, there can be no assurance that a challenge to the consummation of the Merger on antitrust grounds will not be made or that, if such a challenge were made, THCR and Taj Holding would prevail or would not be required to accept certain adverse conditions in order to consummate the Merger. The following is only a summary of the applicable provisions of the Casino Control Act of the State of New Jersey, the Riverboat Gambling Act of the State of Indiana, and certain other laws and regulations. It does not purport to be a full description thereof and is qualified in its entirety by reference to the New Jersey Casino Control Act, the Indiana Riverboat Gambling Act and such other laws and regulations. Each of THCR and Taj Holding believes that it and its respective affiliates are in material compliance with all applicable laws, rules and regulations discussed below. In general, the Casino Control Act and its implementing regulations contain detailed provisions concerning, among other things: the granting and renewal of casino licenses; the suitability of the approved hotel facility, and the amount of authorized casino space and gaming units permitted therein; the qualification of natural persons and entities related to the casino licensee; the licensing of certain employees and vendors of casino licensees; rules of the games; the selling and redeeming of gaming chips; the granting and duration of credit and the enforceability of gaming debts; management control procedures, accounting and cash control methods and reports to gaming agencies; security standards; the manufacture and distribution of gaming equipment; the simulcasting of horse races by casino licensees; equal employment opportunities for employees of casino operators, contractors of casino facilities and others; and advertising, entertainment and alcoholic beverages. Casino Control Commission. The ownership and operation of casino/hotel facilities in Atlantic City are the subject of strict state regulation under the Casino Control Act. The CCC is empowered to regulate a wide spectrum of gaming and non-gaming related activities and to approve the form of ownership and financial structure of not only a casino licensee, but also its entity qualifiers and intermediary and holding companies and any other related entity required to be qualified ("CCC Regulations"). Operating Licenses. Taj Associates was issued its initial casino license in April 1990. On June 22, 1995, the CCC renewed Taj Associates' casino license through March 31, 1999. Plaza Associates was issued its initial casino license on May 14, 1984. On June 22, 1995, the CCC renewed Plaza Associates' casino license through June 30, 1999. Management believes that a casino license will ultimately be issued for Trump World's Fair, although there can be no assurance that the CCC will issue this casino license or what conditions may be imposed, if any, with respect thereto. Casino Licensee. No casino hotel facility may operate unless the appropriate license and approvals are obtained from the CCC, which has broad discretion with regard to the issuance, renewal, revocation and suspension of such licenses and approvals, which are non-transferable. The qualification criteria with respect to the holder of a casino license include its financial stability, integrity and responsibility; the integrity and adequacy of its financial resources which bear any relation to the casino project; its good character, honesty and integrity; and the sufficiency of its business ability and casino experience to establish the likelihood of a successful, efficient casino operation. The casino licenses currently held by Taj Associates and Plaza Associates are renewable for periods of up to four years. The CCC may reopen licensing hearings at any time, and must reopen a licensing hearing at the request of the Antitrust Division. No person may be the holder of a casino license if the holding will result in undue economic concentration in Atlantic City casino operations by that person. On May 17, 1995, the CCC adopted a regulation defining the criteria for determining undue economic concentration which codifies the content of existing CCC precedent with respect to the subject. In April 1995, Plaza Associates petitioned the CCC for certain approvals. In its May 18, 1995 declaratory rulings with respect to such petition, the CCC, among other things, (i) determined that Trump World's Fair is an approved hotel permitted to contain a maximum of 60,000 square feet of casino space, that the 40,000 square feet of casino space therein is a single room and that its operation by Plaza Associates would not result in undue economic concentration in Atlantic City casino operations; (ii) approved the operation of Trump World's Fair by Plaza Associates under a separate casino license subject to an application for and the issuance of such license and approved the proposed easement agreements with respect to the proposed enclosed Atlantic City Convention Center walkway; (iii) approved in concept the proposed physical connection and integrated operation by Plaza Associates of the Main Tower, Trump Plaza East and Trump World's Fair; and (iv) determined that the approved hotel comprised of the Main Tower and Trump Plaza East is permitted to contain a maximum of 100,000 square feet of casino space. In addition, on December 13, 1995, Plaza Associates received CCC authorization for 49,340 square feet of casino space at Trump World's Fair. A separate Plaza Associates casino license with respect to Trump World's Fair would have a renewable term of one year for each of its first three years and thereafter be renewable for periods of up to four years. Plaza Associates has made application for such separate casino license with respect to Trump World's Fair but there can be no assurance that the CCC will issue this casino license or what conditions may be imposed, if any, with respect thereto. See "Risk Factors--Trump Plaza Expansion and the Taj Mahal Expansion." To be considered financially stable, a licensee must demonstrate the following ability: to pay winning wagers when due; to achieve an annual gross operating profit; to pay all local, state and federal taxes when due; to make necessary capital and maintenance expenditures to insure that it has a superior first-class facility; and to pay, exchange, refinance or extend debts which will mature or become due and payable during the license term. The CCC is required to review and approve a transaction such as the Merger Transaction with regard to the financial stability standards. In the event a licensee fails to demonstrate financial stability, the CCC may take such action as it deems necessary to fulfill the purposes of the Casino Control Act and protect the public interest, including: issuing conditional licenses, approvals or determinations; establishing an appropriate cure period; imposing reporting requirements; placing restrictions on the transfer of cash or the assumption of liabilities; requiring reasonable reserves or trust accounts; denying licensure; or appointing a conservator. See "--New Jersey Gaming Regulations--Conservatorship." THCR and Taj Holding believe that, upon consummation of the Merger Transaction, Taj Associates and Plaza Associates will each have, and will each continue to have, adequate financial resources to meet the financial stability requirements of the CCC for the foreseeable future. Taj Associates and Plaza Associates plan to petition the CCC to approve the transactions contemplated by the Merger Transaction. It is a condition to the consummation of the Merger that the Merger Transaction is approved by the CCC. Pursuant to the Casino Control Act, CCC Regulations and precedent, no entity may hold a casino license unless each officer, director, principal employee, person who directly or indirectly holds any beneficial interest or ownership in the licensee, each person who in the opinion of the CCC has the ability to control or elect a majority of the board of directors of the licensee (other than a banking or other licensed lending institution which makes a loan or holds a mortgage or other lien acquired in the ordinary course of business) and any lender, underwriter, agent or employee of the licensee or other person whom the CCC may consider appropriate, obtains and maintains qualification approval from the CCC. Qualification approval means that such person must, but for residence, individually meet the qualification requirements as a casino key employee. Pursuant to a condition of its casino license, payments by Plaza Associates to or for the benefit of any related entity or partner, with certain exceptions, are subject to prior CCC approval; and, if Plaza Associates' cash position falls below $5.0 million for three consecutive business days, Plaza Associates must present to the CCC and the Division evidence as to why it should not obtain a working capital facility in an appropriate amount. Control Persons. An entity qualifier or intermediary or holding company, such as Taj Holding, TM/GP, Plaza Holding, Plaza Holding Inc., Plaza Funding, THCR Holdings, THCR Funding or THCR is required to register with the CCC and meet the same basic standards for approval as a casino licensee; provided, however, that the CCC, with the concurrence of the Director of the Antitrust Division, may waive compliance by a publicly-traded corporate holding company with the requirement that an officer, director, lender, underwriter, agent or employee thereof, or person directly or indirectly holding a beneficial interest or ownership of the securities thereof individually qualify for approval under casino key employee standards so long as the CCC and the Director of the Antitrust Division are, and remain, satisfied that such officer, director, lender, underwriter, agent or employee is not significantly involved in the activities of the casino licensee, or that such security holder does not have the ability to control the publicly-traded corporate holding company or elect one or more of its directors. Persons holding five percent or more of the equity securities of such holding company are presumed to have the ability to control the company or elect one or more of its directors and will unless this presumption is rebutted, be required to individually qualify. Equity securities are defined as any voting stock or any security similar to or convertible into or carrying a right to acquire any security having a direct or indirect participation in the profits of the issuer. Financial Sources. The CCC may require all financial backers, investors, mortgagees, bond holders and holders of notes or other evidence of indebtedness, either in effect or proposed, which bear any relation to any casino project, including holders of publicly-traded securities of an entity which holds a casino license or is an entity qualifier, subsidiary or holding company of a casino licensee (a "Regulated Company"), to qualify as financial sources. In the past, the CCC has waived the qualification requirement for holders of less than 15% of a series of publicly-traded mortgage bonds so long as the bonds remained widely distributed and freely traded in the public market and the holder had no ability to control the casino licensee. Taj Associates will petition the CCC for a determination that the Taj Notes will be widely distributed and freely traded in the public market. There can be no assurance, however, that the CCC will grant such a petition, will determine that the holders of Taj Notes have no ability to control Taj Associates as a casino licensee or will continue the practice of granting such waivers and, in any event, the CCC may require holders of less than 15% of a series of debt to qualify as financial sources even if not active in the management of the issuer or casino licensee. Institutional Investors. An institutional investor ("Institutional Investor") is defined by the Casino Control Act as any retirement fund administered by a public agency for the exclusive benefit of Federal, state or local public employees; any investment company registered under the Investment Company Act of 1940, as amended; any collective investment trust organized by banks under Part Nine of the Rules of the Comptroller of the Currency; any closed end investment trust; any chartered or licensed life insurance company or property and casualty insurance company; any banking and other chartered or licensed lending institution; any investment advisor registered under the Investment Advisers Act of 1940, as amended; and such other persons as the CCC may determine for reasons consistent with the policies of the Casino Control Act. An Institutional Investor may be granted a waiver by the CCC from financial source or other qualification requirements applicable to a holder of publicly- traded securities, in the absence of a prima facie showing by the Antitrust Division that there is any cause to believe that the holder may be found unqualified, on the basis of CCC findings that: (i) its holdings were purchased for investment purposes only and, upon request by the CCC, it files a certified statement to the effect that it has no intention of influencing or affecting the affairs of the issuer, the casino licensee or its holding or intermediary companies; provided, however, that the Institutional Investor will be permitted to vote on matters put to the vote of the outstanding security holders; and (ii) if (x) the securities are debt securities of a casino licensee's holding or intermediary companies or another subsidiary company of the casino licensee's holding or intermediary companies which is related in any way to the financing of the casino licensee and represent either (A) 20% or less of the total outstanding debt of the company, or (B) 50% or less of any issue of outstanding debt of the company, (y) the securities are equity securities and represent less than 10% of the equity securities of a casino licensee's holding or intermediary companies, or (z) the securities so held exceed such percentages, upon a showing of good cause. There can be no assurance, however, that the CCC will make such findings or grant such waiver and, in any event, an Institutional Investor may be required to produce for the CCC or the Antitrust Division upon request, any document or information which bears any relation to such debt or equity securities. Generally, the CCC requires each institutional holder seeking waiver of qualification to execute a certification to the effect that (i) the holder has reviewed the definition of Institutional Investor under the Casino Control Act and believes that it meets the definition of Institutional Investor; (ii) the holder purchased the securities for investment purposes only and holds them in the ordinary course of business; (iii) the holder has no involvement in the business activities of, and no intention of influencing or affecting the affairs of the issuer, the casino licensee or any affiliate; and (iv) if the holder subsequently determines to influence or affect the affairs of the issuer, the casino licensee or any affiliate, it shall provide not less than 30 days' prior notice of such intent and shall file with the CCC an application for qualification before taking any such action. If an Institutional Investor changes its investment intent, or if the CCC finds reasonable cause to believe that it may be found unqualified, the Institutional Investor may take no action with respect to the security holdings, other than to divest itself of such holdings, until it has applied for interim casino authorization and has executed a trust agreement pursuant to such an application. See "--New Jersey Gaming Regulations--Interim Casino Authorization." Declaratory Rulings. Taj Associates and Plaza Associates will petition the CCC for declaratory rulings approving the Merger Transaction and determining, among other things, that after consummation thereof, Taj Associates and Plaza Associates will continue to satisfy the CCC's financial stability requirements; Trump will continue to demonstrate his financial stability; the Regulated Companies and natural person qualifiers are qualified; the certificates of incorporation and partnership agreements of the Regulated Companies contain required provisions with respect to the transfer of securities and qualification of security holders under the Casino Control Act; the Taj Notes are publicly traded securities and that CCC approval of the issuance or subsequent transfer of the securities is not required; that the individual holders of the Taj Notes need not be qualified as financial sources, and their qualification may be waived by the CCC and that qualification of the holders of THCR Common Stock be waived by the CCC. Ownership and Transfer of Securities. The Casino Control Act imposes certain restrictions upon the issuance, ownership and transfer of securities of a Regulated Company and defines the term "security" to include instruments which evidence a direct or indirect beneficial ownership or creditor interest in a Regulated Company including, but not limited to, mortgages, debentures, security agreements, notes and warrants. Currently, each of TM/GP, TTMC, Taj Holding, Taj Funding, Taj Associates, TTMI, certain other entities that own the Taj Holding Class A Common Stock or the Taj Holding Class B Common Stock, Plaza Funding, Plaza Holding, Plaza Holding Inc., Plaza Associates, THCR Holdings, THCR Funding and THCR are deemed to be a Regulated Company, and instruments evidencing a beneficial ownership or creditor interest therein, including partnership interest, are deemed to be the securities of a Regulated Company. If the CCC finds that a holder of such securities is not qualified under the Casino Control Act, it has the right to take any remedial action it may deem appropriate, including the right to force divestiture by such disqualified holder of such securities. In the event that certain disqualified holders fail to divest themselves of such securities, the CCC has the power to revoke or suspend the casino license affiliated with the Regulated Company which issued the securities. If a holder is found unqualified, it is unlawful for the holder (i) to exercise, directly or through any trustee or nominee, any right conferred by such securities, or (ii) to receive any dividends or interest upon such securities or any remuneration, in any form, from its affiliated casino licensee for services rendered or otherwise. With respect to non-publicly-traded securities, the Casino Control Act and CCC Regulations require that the corporate charter or partnership agreement of a Regulated Company establish a right in the CCC of prior approval with regard to transfers of securities, shares and other interests and an absolute right in the Regulated Company to repurchase at the market price or the purchase price, whichever is the lesser, any such security, share or other interest in the event that the CCC disapproves a transfer. With respect to publicly-traded securities, such corporate charter or partnership agreement is required to establish that any such securities of the entity are held subject to the condition that, if a holder thereof is found to be disqualified by the CCC, such holder shall dispose of such securities. Interim Casino Authorization. Interim casino authorization is a process which permits a person who enters into a contract to obtain property relating to a casino operation or who obtains publicly-traded securities relating to a casino licensee to close on the contract or own the securities until plenary licensure or qualification. During the period of interim casino authorization, the property relating to the casino operation or the securities is held in trust. Whenever any person enters into a contract to transfer any property which relates to an ongoing casino operation, including a security of the casino licensee or a holding or intermediary company or entity qualifier, under circumstances which would require that the transferee obtain licensure or be qualified under the Casino Control Act, and that person is not already licensed or qualified, the transferee is required to apply for interim casino authorization. Furthermore, except as set forth below with respect to publicly traded securities, the closing or settlement date in the contract at issue may not be earlier than the 121st day after the submission of a complete application for licensure or qualification together with a fully executed trust agreement in a form approved by the CCC. If, after the report of the Antitrust Division and a hearing by the CCC, the CCC grants interim authorization, the property will be subject to a trust. If the CCC denies interim authorization, the contract may not close or settle until the CCC makes a determination on the qualifications of the applicant. If the CCC denies qualification, the contract will be terminated for all purposes and there will be no liability on the part of the transferor. If, as the result of a transfer of publicly-traded securities of a licensee, a holding or intermediary company or entity qualifier of a licensee or a financing entity of a licensee, any person is required to qualify under the Casino Control Act, that person is required to file an application for licensure or qualification within 30 days after the CCC determines that qualification is required or declines to waive qualification. The application must include a fully executed trust agreement in a form approved by the CCC or, in the alternative, within 120 days after the CCC determines that qualification is required, the person whose qualification is required must divest such securities as the CCC may require in order to remove the need to qualify. The CCC may grant interim casino authorization where it finds by clear and convincing evidence that: (i) statements of compliance have been issued pursuant to the Casino Control Act; (ii) the casino hotel is an approved hotel in accordance with the Casino Control Act; (iii) the trustee satisfies qualification criteria applicable to key casino employees, except for residency; and (iv) interim operation will best serve the interests of the public. When the CCC finds the applicant qualified, the trust will terminate. If the CCC denies qualification to a person who has received interim casino authorization, the trustee is required to endeavor, and is authorized, to sell, assign, convey or otherwise dispose of the property subject to the trust to such persons who are licensed or qualified or shall themselves obtain interim casino authorization. Where a holder of publicly-traded securities is required, in applying for qualification as a financial source or qualifier, to transfer such securities to a trust in application for interim casino authorization and the CCC thereafter orders that the trust become operative: (i) during the time the trust is operative, the holder may not participate in the earnings of the casino hotel or receive any return on its investment or debt security holdings; and (ii) after disposition, if any, of the securities by the trustee, proceeds distributed to the unqualified holder may not exceed the lower of their actual cost to the unqualified holder or their value calculated as if the investment had been made on the date the trust became operative. Approved Hotel Facilities. The CCC may permit a licensee, such as Taj Associates and Plaza Associates, to increase its casino space if the licensee agrees to add a prescribed number of qualifying sleeping units within two years after the commencement of gaming operations in the additional casino space. However, if the casino licensee does not fulfill such agreement due to conditions within its control, the licensee will be required to close the additional casino space, or any portion thereof that the CCC determines should be closed. Persons who are parties to the lease for an approved hotel building or who have an agreement to lease a building which may in the judgment of the CCC become an approved hotel building are required to hold a casino license unless the CCC, with the concurrence of the Attorney General of the State of New Jersey, determines that such persons do not have the ability to exercise significant control over the building or the operation of the casino therein. Agreements to lease an approved hotel building or the land under the building must be for a durational term exceeding 30 years, must concern 100% of the entire approved hotel building or the land upon which it is located and must include a buy-out provision conferring upon the lessee the absolute right to purchase the lessor's entire interest for a fixed sum in the event that the lessor is found by the CCC to be unsuitable. In its May 18, 1995 declaratory rulings with respect to the proposed enclosed Atlantic City Convention Center walkway to Trump World's Fair, the CCC, among other things, approved the proposed easement agreements with respect to such walkway and determined, with the concurrence of the Attorney General, that no CCC license is required to grant the easement and that the easements satisfy the durational term requirement and need not concern 100% of the entire approved hotel building or include such a buy-out provision. See "Business of THCR--Properties--Trump World's Fair." Agreement for Management of Casino. Each party to an agreement for the management of a casino is required to hold a casino license, and the party who is to manage the casino must own at least 10% of all the outstanding equity securities of the casino licensee. Such an agreement shall: (i) provide for the complete management of the casino; (ii) provide for the unrestricted power to direct the casino operations; and (iii) provide for a term long enough to ensure the reasonable continuity, stability and independence and management of the casino. License Fees. The CCC is authorized to establish annual fees for the renewal of casino licenses. The renewal fee is based upon the cost of maintaining control and regulatory activities prescribed by the Casino Control Act, and may not be less than $200,000 for a four-year casino license. Additionally, casino licensees are subject to potential assessments to fund any annual operating deficits incurred by the CCC or the Antitrust Division. There is also an annual license fee of $500 for each slot machine maintained for use or in use in any casino. Gross Revenue Tax. Each casino licensee is also required to pay an annual tax of 8% on its gross casino revenues. For the years ended December 31, 1992, 1993 and 1994 and for the nine months ended September 30, 1995, Plaza Associates' gross revenue tax was approximately $21.0 million, $21.3 million, $21.0 million and $18.1 million, respectively, and its license, investigations and other fees and assessments totaled approximately $4.7 million, $4.0 million, $4.2 million and $3.2 million, respectively. For the years ended December 31, 1992, 1993 and 1994 and for the nine months ended September 30, 1995, Taj Associates' gross revenue tax was approximately $33.0 million, $35.4 million, $36.7 million and $30.3 million, respectively, and its license, investigations and other fees and assessments totaled approximately $5.3 million, $5.2 million, $5.2 million and $3.8 million, respectively. Investment Alternative Tax Obligations. An investment alternative tax imposed on the gross casino revenues of each licensee in the amount of 2.5% is due and payable on the last day of April following the end of the calendar year. A licensee is obligated to pay the investment alternative tax for a period of 30 years. Estimated payments of the investment alternative tax obligation must be made quarterly in an amount equal to 1.25% of estimated gross revenues for the preceding three-month period. Investment tax credits may be obtained by making qualified investments or by the purchase of bonds issued by the CRDA. CRDA bonds may have terms as long as fifty years and bear interest at below market rates, resulting in a value lower than the face value of such CRDA bonds. For the first ten years of its tax obligation, the licensee is entitled to an investment tax credit against the investment alternative tax in an amount equal to twice the purchase price of bonds issued to the licensee by the CRDA. Thereafter, the licensee is (i) entitled to an investment tax credit in an amount equal to twice the purchase price of such bonds or twice the amount of its investments authorized in lieu of such bond investments or made in projects designated as eligible by the CRDA and (ii) has the option of entering into a contract with the CRDA to have its tax credit comprised of direct investments in approved eligible projects which may not comprise more than 50% of its eligible tax credit in any one year. From the monies made available to the CRDA, the CRDA is required to set aside $100 million for investment in hotel development projects in Atlantic City undertaken by a licensee which result in the construction or rehabilitation of at least 200 hotel rooms by December 31, 1996. These monies will be held to fund up to 35% of the cost to casino licensees of expanding their hotel facilities to provide additional hotel rooms, a portion of which will be required to be available upon the opening of the new Atlantic City convention center and dedicated to convention events. The CRDA has determined at this time that eligible casino licensees will receive up to 27% of the cost of additional hotel rooms out of these monies set aside and may, in the future, increase the percentage to no greater than 35%. Minimum Casino Parking Charges. As of July 1, 1993, each casino licensee was required to pay the New Jersey State Treasurer a $1.50 charge for every use of a parking space for the purpose of parking, garaging or storing motor vehicles in a parking facility owned or leased by a casino licensee or by any person on behalf of a casino licensee. This amount is paid into a special fund established and held by the New Jersey State Treasurer for the exclusive use of the CRDA. Plaza Associates and Taj Associates currently charge their respective parking patrons $2.00 in order to make their required payments to the New Jersey State Treasurer and cover related expenses. Amounts in the special fund will be expended by the CRDA for eligible projects in the corridor region of Atlantic City related to improving the highways, roads, infrastructure, traffic regulation and public safety of Atlantic City or otherwise necessary or useful to the economic development and redevelopment of Atlantic City in this regard. Atlantic City Fund. On each October 31 during the years 1996 through 2003, each casino licensee shall pay into an account established in the CRDA and known as the Atlantic City Fund, its proportional share of an amount related to the amount by which annual operating expenses of the CCC and the Antitrust Division are less than a certain fixed sum. Additionally, a portion of the investment alternative tax obligation of each casino license for the years 1994 through 1998 allocated for projects in Northern New Jersey shall be paid into and credited to the Atlantic City Fund. Amounts in the Atlantic City Fund will be expended by the CRDA for economic development projects of a revenue producing nature that foster the redevelopment of Atlantic City other than the construction and renovation of casino hotels. Conservatorship. If, at any time, it is determined that TM/GP, TTMC, Taj Holding, Taj Funding, Taj Associates, TTMI, Plaza Associates, Plaza Funding, Plaza Holding Inc., Plaza Holding, THCR, THCR Holdings, THCR Funding or any other entity qualifier has violated the Casino Control Act or that any of such entities cannot meet the qualification requirements of the Casino Control Act, such entity could be subject to fines or the suspension or revocation of its license or qualification. If Taj Associates' or Plaza Associates' license is suspended for a period in excess of 120 days or revoked, or if the CCC fails or refuses to renew such casino license, the CCC could appoint a conservator to operate and dispose of Taj Associates' or Plaza Associates' casino hotel facilities. A conservator would be vested with title to all property of Taj Associates or Plaza Associates relating to the casino and the approved hotel subject to valid liens and/or encumbrances. The conservator would be required to act under the direct supervision of the CCC and would be charged with the duty of conserving, preserving and, if permitted, continuing the operation of the casino hotel. During the period of the conservatorship, a former or suspended casino licensee is entitled to a fair rate of return out of net earnings, if any, on the property retained by the conservator. The CCC may also discontinue any conservatorship action and direct the conservator to take such steps as are necessary to effect an orderly transfer of the property of a former or suspended casino licensee. It would be the obligation of the conservator to continue the debt service payments on the Taj Associates Note, but no assurance can be given that the conservator would have sufficient funds available to do so. Qualification of Employees. Certain employees of Taj Associates and Plaza Associates must be licensed by or registered with the CCC, depending on the nature of the position held. Casino employees are subject to more stringent requirements than non-casino employees and must meet applicable standards pertaining to financial stability, integrity and responsibility, good character, honesty and integrity, business ability and casino experience and New Jersey residency. These requirements have resulted in significant competition among Atlantic City casino operators for the services of qualified employees. Gaming Credit. Taj Associates' and Plaza Associates' casino games are conducted on a credit as well as cash basis. Gaming debts arising in Atlantic City in accordance with applicable regulations are enforceable in the courts of the State of New Jersey. The extension of gaming credit is subject to regulations that detail procedures which casinos must follow when granting gaming credit and recording counter checks which have been exchanged, redeemed or consolidated. Control Procedures. Gaming at the Taj Mahal and Trump Plaza is conducted by trained and supervised personnel. Taj Associates and Plaza Associates employ extensive security and internal controls. Security checks are made to determine, among other matters, that job applicants for key positions have had no criminal history or associations. Security controls utilized by the surveillance department include closed circuit video camera to monitor the casino floor and money counting areas. The count of moneys from gaming also is observed daily by representatives of the CCC. Indiana Gaming Commission. The ownership and operation of riverboat gaming operations in Indiana are subject to strict state regulation under the Riverboat Gambling Act and the administrative rules promulgated thereunder. The IGC is empowered to administer, regulate and enforce the system of riverboat gaming established under the Riverboat Gambling Act and has jurisdiction and supervision over all riverboat gaming operations in Indiana, as well as all persons on riverboats where gaming operations are conducted. The IGC is empowered to regulate a wide variety of gaming and non-gaming related activities, including the licensing of suppliers to, and employees at, riverboat gaming operations and to approve the form of ownership and financial structure of not only riverboat owner and supplier licensees, but also their entity qualifiers, and intermediary and holding companies. Indiana is a new gaming jurisdiction and the emerging regulatory framework is not yet complete. The IGC has adopted certain final rules and has published others in proposed or draft form which are proceeding through the review and final adoption process. The IGC also has indicated its intent to publish additional proposed rules in the future. The IGC has broad rulemaking power, and it is impossible to predict what effect, if any, the amendment of existing rules, the finalization of currently new rules might have on the operations of the Indiana Riverboat or THCR. The following reflects both adopted and proposed regulations. Further, the Indiana General Assembly has the power to promulgate new laws and implement amendments to the Riverboat Gambling Act, which could materially affect the operation or economic viability of the gaming industry in Indiana. Certificate of Suitability. On December 9, 1994, the IGC issued to Trump Indiana a "Certificate of Suitability" for a riverboat owner's license for a riverboat to be docked in Buffington Harbor, Indiana. The certificate of suitability constitutes approval of the application of Trump Indiana for a riverboat owner's license. The IGC extended Trump Indiana's certificate of suitability until June 28, 1996. Pursuant to the terms of the certificate of suitability, during such period, Trump Indiana must comply with certain statutory and other requirements imposed by the IGC. In addition, as a condition to the certificate of suitability, Trump Indiana has committed to invest $153 million in the Indiana Riverboat and certain related projects and to pay certain incentive fees to the City of Gary, Indiana. Failure to comply with the foregoing conditions and/or failure to commence riverboat excursions as required by the IGC may result in revocation of the certificate of suitability. There can be no assurance that THCR and/or Trump Indiana will be able to comply with the terms of the certificate of suitability, that it will be further extended if operations do not commence as required by the IGC or that a riverboat owner's license for the Indiana Riverboat will ultimately be granted or subsequently renewed. Riverboat Owner's License. No one may operate a riverboat gaming operation in Indiana without holding a riverboat owner's license. The certificate of suitability received by Trump Indiana on December 9, 1994 and most recently extended through June 28, 1996, means that Trump Indiana received a written document issued by the Executive Director of the IGC that indicates that Trump Indiana has been chosen for licensure if Trump Indiana meets certain requirements within the interim compliance period as established by the IGC. The interim compliance period is the period of time between the issuance of the certificate of suitability and the issuance of a permanent riverboat owner's license or the notice of denial thereof. Interim Compliance Requirements. Interim compliance requires, among other things: obtaining a permit to develop the riverboat gaming operation from the United States Army Corps of Engineers, which permit was obtained on October 10, 1995; obtaining a valid certificate of inspection from the United States Coast Guard for the vessel on which the riverboat gaming operation will be conducted; applying for and receiving the appropriate permits or certificates from the Indiana Alcoholic Beverage Commission, Indiana Fire Marshall, and other appropriate local, state and federal agencies which issue permits including, but not limited to, health permits, building permits and zoning permits; closing the financing necessary to complete the development of the gaming operation; posting a bond in compliance with the applicable law; obtaining the insurance deemed necessary by the IGC; receiving licensure for electronic gaming devices and other gaming equipment under applicable law; submitting an emergency response plan in compliance with applicable laws; and taking any other action that the IGC deems necessary for compliance under Indiana gaming laws. Further, the IGC may place restrictions, conditions or requirements on the permanent riverboat owner's license. An owner's initial license expires five years after the effective date of the license, and unless the owner's license is terminated, expires or is revoked, the owner's license may be renewed annually by the IGC upon satisfaction of certain conditions contained in the Riverboat Gambling Act. Transfer of Riverboat Owner's License. Pursuant to IGC proposed rules, an ownership interest in a riverboat owner's license shall not be transferred unless the transfer complies with applicable law, and no riverboat gaming operation may operate unless the appropriate licenses and approvals are obtained from the IGC. Under current Indiana law, a maximum of 11 owner's licenses may be in effect at any time. No person or entity may simultaneously own an interest in more than two riverboat owner's licenses. A person or entity may simultaneously own up to 100% in one riverboat owner's license and no more than 10% in a second riverboat owner's license. A riverboat owner's licensee must possess a level of skill, experience, or knowledge necessary to conduct a riverboat gaming operation that will have a positive economic impact on the host site, as well as the entire State of Indiana. Additional representative, but not exclusive, qualification criteria with respect to the holder of a riverboat owner's license include character, reputation, financial integrity, the facilities or proposed facilities for the conduct of riverboat gaming including related non-gaming projects such as hotel development, and the good faith affirmative action plan to recruit, train and upgrade minorities and women in all employment classifications. The IGC shall require persons holding owner's licenses to adopt policies concerning the preferential hiring of residents of the city in which the riverboat docks for riverboat jobs. The IGC has broad discretion in regard to the issuance, renewal, revocation, and suspension of licenses and approvals, and the IGC is empowered to regulate a wide variety of gaming and non-gaming related activities, including the licensing of suppliers to, and employees at, riverboat gaming operations, and to approve the form of ownership and financial structure of not only riverboat owner and supplier licensees, but also their subsidiaries and affiliates. A riverboat owner's licensee or any other person may not lease, hypothecate, borrow money against or loan money against a riverboat owner's license. An ownership interest in a riverboat owner's licensee may only be transferred in accordance with the regulations promulgated under the Riverboat Gambling Act. An applicant for the approval of a transfer of a riverboat owner's license must comply with application procedures prescribed by the IGC, present evidence that it meets or possesses the standards, qualifications and other criteria under Indiana gaming laws that it meets all requirements for a riverboat owner's license, and pay an investigative fee in the amount of $50,000 with the application. If the IGC denies the application to transfer an ownership interest, it shall issue notice of denial to the applicant, and, unless, specifically stated to the contrary, a notice of denial of an application for transfer shall not constitute a finding that the applicant is not suitable for licensure. A person who is served with notice of denial under this rule may request an administrative hearing. Control Persons and Operational Matters. The IGC has implemented strict regulations with respect to the suitability of riverboat license owners, their key personnel and their employees similar to the CCC regulations and precedent. The IGC utilizes a "class-based" licensing structure that subjects all individuals associated with Trump Indiana to varying degrees of background investigations. Likewise, comprehensive security measures, including video surveillance by both random and fixed cameras, are required in the casino and money counting areas. Additionally, the IGC has delineated procedures for the reconciliation of the daily revenues and tax remittance to the state as further detailed below. Tax. The IGC has imposed a tax on admissions to gaming excursions at a rate of three dollars for each person admitted to the gaming excursion. This admission tax is imposed upon the license owner conducting the gaming excursion on a per-person basis without regard to the actual fee paid by the person using the ticket, with the exception that no tax shall be paid by admittees who are actual and necessary officials, employees of the licensee or other persons actually working on the riverboat. The IGC may suspend or revoke the license of a riverboat owner's licensee that does not submit the payment or the tax return form regarding admission tax within the required time established by the IGC. A tax is imposed on the adjusted gross receipts received from gaming authorized under the Riverboat Gambling Act at a rate of 20% of the amount of the adjusted gross receipts. Adjusted gross receipts is defined as the total of all cash and property (including checks received by a licensee), whether collected or not, received by a licensee from gaming operations less the total of all cash paid out as winnings to patrons including a provision for uncollectible gaming receivables as is further set forth in the Riverboat Gambling Act. The IGC may, from time to time, impose other fees and assessments on riverboat owner licensees. In addition, all use, excise and retail taxes apply to sales aboard riverboats. Excursions. Generally, gaming may not be conducted while a riverboat is docked, other than during the 30-minute periods for passenger embarkation and disembarkation. The Riverboat Gambling Act, as originally enacted, provided an exception if weather conditions or water conditions present a danger to the riverboat and authorized the IGC to adopt rules to provide other exceptions. In October 1994, the U.S. Attorney General's Office in Indiana notified the IGC that a Federal law commonly known as the Johnson Act prohibits gaming vessels from cruising anywhere on the Great Lakes, including portions of Lake Michigan falling within Indiana's borders and jurisdiction. Since that time, the IGC has requested further consideration on this matter by the Department of Justice, although no response has been provided to date. On May 9, 1995, the House of Representatives approved H.R. 1361, which includes a provision exempting vessels beginning a voyage in Indiana, and remaining within the territorial jurisdiction of Indiana, from certain provisions of the Johnson Act. There can be no assurance that H.R. 1361 will be enacted into law. Further, it is uncertain whether any such legislation, as enacted, will exempt vessels operating on Lake Michigan from all aspects of the Johnson Act or will address all concerns raised by the Department of Justice. In addition, the Indiana General Assembly has passed Senate Enrolled Act No. 572 and House Enrolled Act No. 1722, each of which have become law. Both Senate Enrolled Act No. 572 and House Enrolled Act No. 1722 include amendments which prevent the Commission from adopting rules permitting gaming operations to take place while a riverboat is docked. However, Senate Enrolled Act No. 572 includes an express provision in the statute allowing gaming operations to take place while a riverboat is docked if a determination is made in writing that a condition exists that would cause a violation of Federal law if a riverboat were to cruise. This same provision was not included in House Enrolled Act No. 1722. On May 15, 1995, the IGC adopted a resolution acknowledging the nonconforming provisions of Senate Enrolled Act No. 572 and House Enrolled Act No. 1722, and adopted a resolution to the effect that the IGC would give effect to the provisions of Senate Enrolled Act No. 572. It is possible that these nonconforming provisions may be reconciled by the Indiana General Assembly upon its reconvening of the Indiana General Assembly in January 1996. There can be no assurance that the nonconforming provisions in the Riverboat Gambling Act will be corrected in a favorable manner. Further, although the IGC has determined to give effect to favorable provisions of Senate Enrolled Act No. 572, there can be no assurance that commencement of gaming operations by Trump Indiana while the riverboat is docked would not be subject to challenge as a violation of Indiana law, or that commencement of gaming operations by Trump Indiana while cruising on Lake Michigan would not be subject to challenge as a violation of the Johnson Act. Restricted Contracts. Under proposed IGC rules, no riverboat licensee or riverboat license applicant may enter into or perform any contract or transaction in which it transfers or receives consideration which is not commercially reasonable or which does not reflect the fair market value of the goods or services rendered or received as determined at the time the contract is executed. Any contract entered into by a riverboat licensee or riverboat license applicant that exceeds the total dollar amount of $50,000 shall be a written contract. A riverboat license applicant means an applicant for a riverboat owner's license that has been issued a certificate of suitability. Without first complying with the procedures established by the Executive Director of the IGC regarding the notice of intention to enter into restricted contracts, no riverboat licensee or riverboat license applicant may enter into any contract, among others, which is described as follows: any contract to acquire (by lease, rental or purchase) any gaming equipment or supplies; any contract which relates to maintenance or servicing of electronic gaming devices; any contract which relates to the provision of security to the riverboat gaming operation; any contract in which the goods or services are valued at more than $100,000 with the same party during a 12-month period; any contract in which the goods or services are valued at more than $50,000 and for which the riverboat licensee or riverboat license applicant did not solicit and consider competitive offerors to supply the goods or services; and any other contract, identified by the IGC so that the IGC may insure the contracts are for a fair market value and were competitively negotiated. Finance. Pursuant to IGC proposed rules, any person (other than an institutional investor) acquiring 5% or more of any class of voting securities of a publicly traded corporation that owns a riverboat owner's license or 5% or more of the beneficial interest in a riverboat licensee, directly or indirectly, through any class of the voting securities of any holding or intermediary company of a riverboat licensee shall apply to the IGC for finding of suitability within 45 days after acquiring the securities. Each institutional investor who, and individually or in association with others, acquires, directly or indirectly, 5% or more of any class of voting securities of a publicly-traded corporation that owns a riverboat owner's license or 5% or more of the beneficial interest in a riverboat licensee through any class of the voting securities of any holding or intermediary company of a riverboat licensee shall notify the IGC within 10 days after the institutional investor acquires the securities and shall provide additional information and may be subject to a finding of suitability as required by the IGC. Under Indiana gaming laws, an institutional investor who would otherwise be subject to a suitability finding shall, within 45 days after acquiring the interests, submit the following information: a description of the institutional investor's business and a statement as to why the institutional investor satisfies the definitional requirements of an institutional investor under Indiana gaming rule requirements; a certification made under oath that the voting securities were acquired and are held for investment purposes only and were acquired and are held in the ordinary course of business as an institutional investor; the name, address, telephone number, social security number or federal tax identification number of each person who has the power to direct or control the institutional investor's exercise of its voting rights as a holder of voting securities of the riverboat licensee; the name of each person who beneficially owns 5% or more of the institutional investor's voting securities or equivalent; a list of the institutional investor's affiliates; a list of all securities of the riverboat licensee that are or were beneficially owned by the institutional investor or its affiliates within the preceding one year; a disclosure of all criminal and regulatory sanctions imposed during the preceding ten years; a copy of any filing made under 16 U.S.C. 18(a); and any other additional information the IGC may request to insure compliance with Indiana gaming laws. Each institutional investor who, individually or in association with others, acquires, directly or indirectly, the beneficial ownership of 15% or more of any class of voting securities of a publicly-traded corporation that owns a riverboat owner's license or 15% or more of the beneficial interest in a riverboat licensee through any class of voting securities of any holding company or intermediary company of a riverboat licensee shall apply to the IGC for a finding of suitability within 45 days after acquiring the securities. The THCR Certificate of Incorporation provides that THCR may redeem any shares of the THCR's capital stock held by any person or entity whose holding of shares may cause the loss or nonreinstatement of a governmental license held by THCR. As defined in the THCR Certificate of Incorporation, such redemption shall be at the lesser of the market price of the stock or the price at which the stock was purchased. Under Indiana gaming laws, an institutional investor means any of the following: a retirement fund administered by a public agency for the exclusive benefit of federal, state, or local public employees; an investment company registered under the Investment Company Act of 1940; a collective investment trust organized by banks under Part 9 of the Rules of the Comptroller of the Currency; a closed end investment trust; a chartered or licensed life insurance company or property and casualty insurance company; a banking, chartered or licensed lending institution; an investment adviser registered under the Investment Advisers Act of 1940; and other entity the IGC determines constitutes an institutional investor. The IGC may in the future promulgate regulations with respect to the qualification of other financial backers, mortgagees, bond holders, holders of indentures, or other financial contributors. Minority and Women Business Participation. Indiana gaming laws provide that the opportunity for full minority and women's business enterprise participation in the riverboat industry in Indiana is essential to social and economic parity for minority and women business persons. The IGC has the power to review compliance with the goals of participation by minority and women business persons and impose appropriate conditions on licensees to insure that goals for such business enterprises are met. Under proposed administrative rules, a riverboat licensee or a riverboat license applicant shall designate certain minimum percentages of the value of its contracts for goods and services to be expended with minority business enterprises and women's business enterprises such that 10% of the dollar value of the riverboat licensee's or the riverboat license applicant's contracts be expended with minority business enterprises and 5% of the dollar value of the riverboat licensee's or the riverboat license applicant's contracts be expended with women's business enterprises. Expenditures with minority and women business enterprises are not mutually exclusive. IGC Action. All licensees subject to the jurisdiction of the IGC have a continuing duty to maintain suitability for licensure. The IGC may initiate an investigation or disciplinary action or both against a licensee about whom the commission has reason to believe is not maintaining suitability for licensure, is not complying with licensure conditions, and/or is not complying with Indiana gaming laws or regulations. The IGC may suspend, revoke, restrict, or place conditions on the license of a licensee; require the removal of a licensee or an employee of a licensee; impose a civil penalty or take any other action deemed necessary by the IGC to insure compliance with Indiana gaming laws. The U.S. Department of the Treasury has adopted regulations pursuant to which a casino is required to file a report of each deposit, withdrawal, exchange of currency, gambling tokens or chips, or other payments or transfers by, through or to such casino which involves a transaction in currency of more than $10,000 per patron, per gaming day. Such reports are required to be made on forms prescribed by the Secretary of the Treasury and are filed with the Commissioner of the Internal Revenue Service (the "Service"). In addition, THCR and Taj Associates are each required to maintain detailed records (including the names, addresses, social security numbers and other information with respect to its gaming customers) dealing with, among other items, the deposit and withdrawal of funds and the maintenance of a line of credit. In the past, the Service had taken the position that gaming winnings from table games by nonresident aliens were subject to a 30% withholding tax. The Service, however, subsequently adopted a practice of not collecting such tax. Recently enacted legislation exempts from withholding tax table game winnings by nonresident aliens, unless the Secretary of the Treasury determines by regulation that such collections have become administratively feasible. As the result of an audit conducted by the U.S. Department of Treasury, Office of Financial Enforcement, Plaza Associates was alleged to have failed to timely file the "Currency Transaction Report by Casino" in connection with 65 individual currency transactions in excess of $10,000 during the period from October 31, 1986 to December 10, 1988. Plaza Associates paid a fine of $292,500 in connection with these violations. Plaza Associates has revised its internal control procedures to ensure continued compliance with these regulations. From 1992 through 1995, the Service conducted an audit of "Currency Transaction Reports by Casino" filed by Taj Associates for the period from April 2, 1990 through December 31, 1991. The U.S. Department of Treasury has received a report detailing the audit as well as the response of Taj Associates. Taj Associates is awaiting comments from the U.S. Department of Treasury as to any potential violations. The Indiana Riverboat site is located near, or adjacent to and may include protected wetlands which may subject THCR to obligations or liabilities in connection with wetlands mitigation or protection. See "Risk Factors--The Indiana Riverboat." On April 5, 1994, OSHA proposed a regulation that would require, inter alia, that employers who permit smoking in workplaces establish designated smoking areas, permit smoking only in such areas, and assure that designated smoking areas be enclosed, exhausted directly to the outside, and maintained under negative pressure sufficient to contain tobacco smoke within the designated area. Plaza Associates has estimated construction costs to build enclosed, exhausted, negative-pressure smoking rooms in Trump Plaza to be $1.5 million for its casino and $2.5 million for its restaurants. Plaza Associates has also estimated construction costs to provide negative-pressure exhaust systems for Trump Plaza hotel rooms to be $1,500 per room; however, management believes that it is highly unlikely that the regulation, if promulgated, would require hotel rooms to be equipped with exhaust systems if smoking is prohibited in the rooms during housekeeping and maintenance activities. If the regulation is promulgated and is applicable to Trump Plaza hotel rooms, the number of rooms that would be affected is not known at this time. Taj Associates is unable to estimate the cost, if any, of compliance with these proposed regulations and is unable to determine if the cost, if any, of such compliance would have a material adverse effect on Taj Associates. THCR and Taj Associates are subject to other federal, state and local regulations and, on a periodic basis, must obtain various licenses and permits, including those required to sell alcoholic beverages in the State of New Jersey as well as in other jurisdictions. Management of THCR and Taj Holding believe all required licenses and permits necessary to conduct business of THCR and Taj Associates have been obtained for operations in the State of New Jersey. THCR expects to be subject to similar rigorous regulatory standards in each other jurisdiction in which it seeks to conduct gaming operations. There can be no assurance that regulations adopted, permits required or taxes imposed, by other jurisdictions will permit profitable operations by THCR in those jurisdictions. In addition, the federal Merchant Marine Act of 1936 and the federal Shipping Act of 1916 and the applicable regulations thereunder contain provisions designed to prevent persons who are not citizens of the United States, as defined therein, from beneficially owning more than 25% of the capital stock of any entity operating a vessel on the Great Lakes. The following table sets forth certain information concerning each of THCR's directors and executive officers: Donald J. Trump--Mr. Trump, 49 years old, has been Chairman of the Board of THCR and THCR Funding since their formation in 1995. Mr. Trump is also Chairman of the Board of Directors, President and Treasurer of Plaza Funding and the managing general partner of Plaza Associates. Trump was a 50% shareholder, Chairman of the Board of Directors, President and Treasurer of Trump Plaza GP and the managing general partner of Plaza Associates prior to its merger into Plaza Funding in June 1993. Trump was Chairman of the Executive Committee and President of Plaza Associates from May 1986 to May 1992 and was a general partner of Plaza Associates until June 1993. Trump has been a director and President of Plaza Holding Inc. since February 1993 and was a partner in Plaza Holding from February 1993 until June 1995. Trump has been Chairman of the Board and a Class C Director of Taj Holding and TM/GP since October 1991; President and Treasurer of Taj Holding since March 4, 1991; Chairman of the Board of Directors, President and Treasurer of Taj Funding and TTMI since June 1988; sole director, President and Treasurer of TTMC since March 1991; Chairman of the Executive Committee of Taj Associates from June 1988 to October 1991; and President and Director of Realty Corp. since May 1986. Trump has been Chairman of the Board of Partner Representatives of TCA, the partnership that owns Trump's Castle, since May 1992; and was Chairman of the Executive Committee of TCA from June 1985 to May 1992. In addition, Trump is the managing general partner of TCA. Trump is also the President of The Trump Organization, which has been in the business, through its affiliates and subsidiaries, of acquiring, developing and managing real estate properties for more than the past five years. Trump was a member of the Board of Directors of Alexander's Inc. from 1987 to March 1992. Mr. Trump's business address is c/o The Trump Organization, 725 Fifth Avenue, New York, NY, 10022. Nicholas L. Ribis--Mr. Ribis, 51 years old, has been President, Chief Executive Officer, Chief Financial Officer, and a director of THCR, THCR Holdings and THCR Funding since their formation in 1995. Mr. Ribis has been the Chief Executive Officer of Plaza Associates since February 1991, was President from April 1994 to February 1995, and was a member of the Executive Committee of Plaza Associates from April 1991 to May 29, 1992 and was a director and Vice President of Trump Plaza GP from May 1992 until its merger into Plaza Funding in June 1993. Mr. Ribis has been Vice President of Plaza Funding since February 1995 and Vice President of Plaza Holding Inc. since February 1995. Mr. Ribis has served as a director of Plaza Holding Inc. since June 1993 and of Plaza Funding since July 1993. Mr. Ribis has been a Class C Director and Vice President of TM/GP and Taj Holding since October 1991; Chief Executive Officer of Taj Associates since February 1991; Vice President of Taj Funding since September 1991; Vice President of TTMI since February 1991 and Secretary of TTMI since September 1991; Director of Realty Corp. since October 1991; and a member of the Executive Committee of Taj Associates from April 1991 to October 1991. He has also been Chief Executive Officer of TCA since March 1991; member of the Executive Committee of TCA from April 1991 to May 1992; member of the Board of Partner Representatives of TCA since May 1992; and has served as the Vice President and Assistant Secretary of Trump's Castle Hotel & Casino, Inc. an entity beneficially owned by Trump, since December 1993 and January 1991, respectively. Mr. Ribis has served as Vice President of TC/GP, Inc. since December 1993 and had served as Secretary of TC/GP, Inc. from November 1991 to may 1992. Mr. Ribis has been Vice President of Trump Corp. since September 1991. From January 1993 to January 1995 Mr. Ribis served as the Chairman of the Casino Association of New Jersey and has been a member of the Board of Trustees of the CRDA since October 1993. From January 1980 to January 1991, Mr. Ribis was Senior Partner in, and since February 1991, is Counsel to, the law firm of Ribis, Graham & Curtin, which serves as New Jersey legal counsel to all of the above-named companies and certain of their affiliated entities. Mr. Ribis' business address is c/o Trump Hotels & Casino Resorts, Inc., 725 Fifth Avenue, New York, NY 10022. Robert M. Pickus--Mr. Pickus, 41 years old, has been Executive Vice President and Secretary of THCR since its formation in 1995. He has also been the Executive Vice President of Corporate and Legal Affairs of Plaza Associates since February 16, 1995. From December 1993 to February 1995, Mr. Pickus was the Senior Vice President and General Counsel of Plaza Associates and, since April 1994, he has been the Vice President and Assistant Secretary of Plaza Funding and Assistant Secretary of Plaza Holding Inc. Mr. Pickus has been the Executive Vice President of Corporate and Legal Affairs of Taj Associates since February 1995, and a Class C Director of Taj Holding and TM/GP since November 1995. He was the Senior Vice President and Secretary of Trump's Castle Funding, Inc. from June 1988 to December 1993 and General Counsel of TCA from June 1985 to December 1993. Mr. Pickus was also Secretary of Trump's Castle Hotel & Casino, Inc., an entity beneficially owned by Trump, from October 1991 until December 1993. Mr. Pickus has been the Executive Vice President of Corporate and Legal Affairs of TCA Associates since February 1995 and a member of the Board of Partner Representatives of TCA since October 1995. Mr. Pickus' business address is c/o Trump Hotel & Casino Resorts, Inc., Mississippi Avenue and the Boardwalk, Atlantic City NJ, 08401. John P. Burke--Mr. Burke, 48 years old, has been Corporate Treasurer of THCR, THCR Holdings and THCR Funding since their formation in 1995. He has also been Corporate Treasurer of Plaza Associates and Taj Associates since October 1991. Mr. Burke has been a Class C Director of TM/GP and Taj Holding and Vice President of TM/GP since October 1991. Mr. Burke has been the Corporate Treasurer of TCA since October 1991, the Vice President of TCA, Trump's Castle Funding, Inc., TC/GP, Inc. and Trump's Castle Hotel & Casino, Inc. since December 1993, and the Vice President-Finance of The Trump Organization since September 1990. Mr. Burke was an Executive Vice President and Chief Administrative Officer of Imperial Corporation of America from April 1989 through September 1990. Mr. Burke's business address is c/o Trump Hotels & Casino Resorts, Inc., 725 Fifth Avenue, New York, NY 10022. Wallace B. Askins--Mr. Askins, 64 years old, has been a director of THCR since June 1995. He has also been a director of Plaza Funding and Plaza Holding Inc. since April 11, 1994, and has been a partner representative of the Board of Partner Representatives of TCA since May 1992. Mr. Askins served as a director of TC/GP, Inc. from May 1992 to December 1993. From 1987 to November 1992, Mr. Askins served as Executive Vice President, Chief Financial Officer and as a director of Armco Inc. Mr. Askins also serves as a director of EnviroSource, Inc. Mr. Askins' address is 20 Shadowbrook Lane, Morristown, NJ 07960. Don M. Thomas--Mr. Thomas, 64 years old, has been a director of THCR since June 1995. He has also been the Senior Vice President of Corporate Affairs of the Pepsi-Cola Bottling Co. of New York since January 1985. Mr. Thomas was the Acting Chairman, and a Commissioner, of the CRDA from 1985 through 1987, and a Commissioner of the CCC from 1980 through 1984. From 1974 through 1980, Mr. Thomas served as Vice President, General Counsel of the National Urban League. From 1966 through 1974, Mr. Thomas served in various capacities with Chrysler Corporation rising to the level of President-Auto Dealerships. Mr. Thomas was an attorney with American Airlines from 1957 through 1966. Mr. Thomas was a director of Trump Plaza GP until its merger into Plaza Funding in June 1993 and has been a director of Plaza Funding and Plaza Holding Inc. since June 1993. Mr. Thomas is an attorney licensed to practice law in the State of New York. Mr. Thomas' business address is c/o Pepsi-Cola Bottling Co., 46-00 5th Street, Long Island City, NY 11101. Peter M. Ryan--Mr. Ryan, 58 years old, has been a director of THCR since June 1995. He has also been the President of each of The Marlin Group, LLC and The Brookwood Carrington Fund, LLC, real estate financial advisory groups, since January 1995. Prior to that, Mr. Ryan was the Senior Vice President of Manhattan Bank for more than five years. Mr. Ryan has been a director of the Childrens Hospital FTD since October 1995. Mr. Ryan's business address is c/o The Marlin Group, 101 Park Avenue, Suite 2506, New York, NY 10178. The officers of THCR serve at the pleasure of the Board of Directors of THCR. All of the persons listed above are citizens of the United States and have been qualified or licensed by the CCC. Trump and Nicholas L. Ribis served as either executive officers and/or directors of Taj Associates and its affiliated entities when such parties filed their petition for reorganization under Chapter 11 of the Bankruptcy Code on July 17, 1991. The Second Amended Joint Plan of Reorganization of such parties was confirmed on August 28, 1991, and was declared effective on October 4, 1991. Trump, Nicholas L. Ribis, John P. Burke and Robert M. Pickus also served as Executive Committee members, officers and/or directors of TCA and its affiliated entities at the time such parties filed a petition for reorganization under Chapter 11 of the Bankruptcy Code on March 9, 1992. The First Amended Joint Plan of Reorganization of such parties was confirmed on May 5, 1992, and was declared effective on May 29, 1992. Trump, Nicholas L. Ribis and John P. Burke served as either executive officers and/or directors of Plaza Associates and its affiliated entities when such parties filed their petition for reorganization under Chapter 11 of the Bankruptcy Code in March 1992. The First Amended Joint Plan of Reorganization of such parties was confirmed on April 30, 1992, and was declared effective on May 29, 1992. Trump was a partner of Plaza Operating Partners Ltd. when it filed a petition for reorganization under Chapter 11 of the Bankruptcy Code on November 2, 1992. The plan of reorganization for Plaza Operating Partners Ltd. was confirmed on December 11, 1992 and declared effective in January 1993. John P. Burke was Executive Vice President and Chief Administrative Officer of Imperial Corporation of America, a thrift holding company whose major subsidiary, Imperial Savings, was seized by the Resolution Trust Corporation in February 1990. Subsequently, in February 1990, Imperial filed a petition for reorganization under Chapter 11 of the Bankruptcy Code. THCR is the general partner of THCR Holdings. As the managing general partner of THCR Holdings, THCR will generally have the exclusive rights, responsibilities and discretion in the management and control of THCR Holdings. Upon consummation of the Merger Transaction, TM/GP will also be a general partner of THCR Holdings. See "Special Factors--Related Merger Transactions" and "Description of THCR Holdings Partnership Agreement." Plaza Funding is the managing general partner of Plaza Associates, the partnership that owns and operates Trump Plaza. The Board of Directors of each of Plaza Funding and Plaza Holding Inc. consists of Messrs. Trump, Ribis, Wallace B. Askins and Don M. Thomas. The Plaza Mortgage Note Indenture requires that two directors of each of Plaza Funding and Plaza Holding Inc. be persons who would qualify as "Independent Directors" as such term is defined by the American Stock Exchange, Inc. (the "Independent Directors"). Set forth below, are the names, ages, positions and offices held with Plaza Funding and Plaza Associates and a brief account of the business experience during the past five years of each of the executive officers of Plaza Funding and Plaza Associates other than those who are also directors or executive officers of THCR. Barry J. Cregan--Mr. Cregan, 41 years old, has been Chief Operating Officer of Plaza Associates since September 19, 1994 and President since March 1995. Since February 21, 1995, Mr. Cregan has been Vice President of Plaza Funding and Plaza Holding Inc. Prior to accepting these positions at Trump Plaza, Mr. Cregan was President of The Plaza Hotel in New York for approximately three years. Prior to joining The Plaza Hotel, he was Vice President of Hotel Operations at Trump's Castle in Atlantic City. In addition, Mr. Cregan has worked for Hilton and Hyatt in executive capacities as well as working in Las Vegas and Atlantic City in executive capacities. Mr. Cregan's business address is c/o Trump Plaza Hotel & Casino, Mississippi Avenue and The Boardwalk, Atlantic City, NJ, 08401. Francis X. McCarthy, Jr.--Mr. McCarthy, 42 years old, was Vice President of Finance and Accounting of Trump Plaza GP from October 1992 until June 1993, the date of Trump Plaza GP's merger into Plaza Funding, was Senior Vice President of Finance and Administration of Plaza Associates from August 1990 to June 1994 and has been Executive Vice President of Finance and Administration since June 1994; Chief Accounting Officer of Plaza Funding since May 1992; Vice President and Chief Financial Officer of Plaza Funding since July 1992 and Assistant Treasurer of Plaza Funding since March 1991. Mr. McCarthy previously served in a variety of financial positions for Greate Bay Hotel and Casino, Inc. from June 1980 through August 1990. Mr. McCarthy's business address is c/o Trump Plaza Hotel and Casino, Mississippi Avenue and The Boardwalk, Atlantic City, NJ, 08401. Fred A. Buro--Mr. Buro, 38 years old, has been the Senior Vice President of Marketing of Plaza Associates since May 1994. Mr. Buro previously served as the President of Casino Resources, Inc., a casino marketing, management and development organization from 1991 through 1994. Prior to that, Mr. Buro served from 1984 through 1991 as the President of a professional services consulting firm. Mr. Buro's business address is c/o Trump Plaza Hotel and Casino, Mississippi Avenue and The Boardwalk, Atlantic City, NJ 08401. James A. Rigot--Mr. Rigot, 43 years old, has been Executive Vice President of Casino Operations of Plaza Associates since November 1994. Mr. Rigot served as Vice President of Casino Operations of TropWorld Casino and Entertainment Resort from July 1989 through November 1994. From January 1989 through July 1989, Mr. Rigot was Assistant Casino Manager of Resorts Casino Hotel. Mr. Rigot's business address is c/o Trump Plaza Hotel and Casino, Mississippi Avenue and The Boardwalk, Atlantic City, NJ 08401. Kevin S. Smith--Mr. Smith, 38 years old, has been the Vice President, General Counsel of Plaza Associates since February 1995. Mr. Smith was previously associated with Cooper Perskie April Niedelman Wagenheim & Levenson, an Atlantic City law firm specializing in trial litigation. From 1989 until February 1992, Mr. Smith handled criminal trial litigation for the State of New Jersey, Department of Public Defender, assigned to the Cape May and Atlantic County Conflict Unit. Mr. Smith's business address is c/o Trump Plaza Hotel and Casino, Mississippi Avenue and The Boardwalk, Atlantic City, NJ 08401. Patrick J. O'Malley--Mr. O'Malley, 41 years old, has been the Executive Vice President of Hotel Operations of Plaza Associates since September 1995. Prior to joining Trump Plaza, from September 1994 until September 1995, Mr. O'Malley was President of the Plaza Hotel in New York City. From December 1989 until September 1994, Mr. O'Malley was the Vice President of Finance of the Plaza Hotel in New York City. Prior to joining the Plaza Hotel in New York City, from 1986 to 1989, Mr. O'Malley was a Regional Financial Controller for the Four Seasons Hotel and Resorts, Ltd. From 1979 to 1986, Mr. O'Malley worked in the Middle East and Europe as Hotel Controller for Marriot International Hotels. Mr. O'Malley's business address is c/o Trump Plaza Hotel and Casino, Mississippi Avenue and The Boardwalk, Atlantic City, NJ 08401. All of the persons listed above have been licensed by the CCC. General. Because THCR was formed in 1995, there was no salary or bonus paid to, deferred or accrued for the benefit of, THCR's Chief Executive Officer or any of the four remaining most highly compensated executive officers (whose annual salary and bonus exceeded $100,000 for the year ended December 31, 1995 (collectively, the "Executive Group")) by THCR or THCR Holdings prior to or during the fiscal year ended December 31, 1994. Similarly, no member of the Executive Group received any other annual compensation, restricted stock awards, stock options, stock appreciation rights ("SARs"), long-term incentive performance ("LTIP") payouts or other compensation from THCR or THCR Holdings prior to or for the fiscal year ended December 31, 1994. All cash compensation paid to the Executive Group in respect of services provided to THCR since its inception was paid and will continue to be paid by THCR Holdings in accordance with the THCR Holdings Partnership Agreement. See "Description of the THCR Holdings Partnership Agreement." 1995 Stock Incentive Plan. The Board of Directors of THCR adopted the 1995 Stock Incentive Plan (the "1995 Stock Plan"), pursuant to which, directors, employees and consultants of THCR and certain of its subsidiaries and affiliates who have been selected as participants are eligible to receive awards of various forms of equity-based incentive compensation, including stock options, stock appreciation rights, stock bonuses, restricted stock awards, performance units and phantom stock, and awards consisting of combinations of such incentives. The 1995 Stock Plan is administered by the Stock Incentive Plan Committee of the Board of Directors of THCR (the "Stock Incentive Plan Committee"). Subject to the provisions of the 1995 Stock Plan, the Stock Incentive Plan Committee has sole discretionary authority to interpret the 1995 Stock Plan and to determine the type of awards to grant, when, if and to whom awards are granted, the number of shares covered by each award and the terms and conditions of the award. Options granted under the 1995 Stock Plan may be "incentive stock options" ("ISOs"), within the meaning of Section 422 of the Code, or nonqualified stock options ("NQSOs"). The vesting, exercisability and exercise price of the options are determined by the Stock Incentive Plan Committee when the options are granted, subject to a minimum price in the case of ISOs of the Fair Market Value (as defined in the 1995 Stock Plan) of the Common Stock on the date of grant and a minimum price in the case of NQSOs of the par value of THCR Common Stock. In the discretion of the Stock Incentive Plan Committee, the option exercise price may be paid in cash or in shares of THCR Common Stock or other property having a fair market value on the date of exercise equal to the option exercise price, or by delivering to THCR a copy of irrevocable instructions to a stockbroker to deliver promptly to THCR an amount of sale or loan proceeds sufficient to pay the exercise price. Except as provided by the Stock Incentive Plan Committee in an underlying stock option agreement, in the event of a Change of Control (as defined in the 1995 Stock Plan or in the stock option agreement), all options subject to such agreement will be fully exercisable. The 1995 Stock Plan permits the Stock Incentive Plan Committee to grant SARs, either alone or in connection with an option. An SAR entitles its holder to be paid an amount equal to the fair market value of THCR Common Stock subject to the SAR on the date of exercise of the SAR, less the exercise price of the related stock option in the case of an SAR granted in connection with a stock option, or the fair market value of one share of stock on the date the SAR was granted, in the case of an SAR granted independent of an option. Shares of THCR Common Stock covered by a restricted stock award are issued to the recipient at the time the award is granted, but are subject to forfeiture in the event continued employment and/or other restrictions and conditions established by the Stock Incentive Plan Committee at the time the award is granted are not satisfied. Unless otherwise determined by the Stock Incentive Plan Committee, a recipient of a restricted stock award has the same rights as an owner of THCR Common Stock, including the right to receive cash dividends and to vote the shares. A performance unit or phantom stock award provides for the future payment of cash or the issuance of shares of THCR Common Stock to the recipient if continued employment and/or other performance objectives established by the Stock Incentive Plan Committee at the time of grant are attained. The 1995 Stock Plan also provides that performance unit and phantom stock awards may be settled in cash, in the discretion of the Stock Incentive Plan Committee and if indicated in the applicable award agreement, on each date on which shares of THCR Common Stock covered by the awards would otherwise have been delivered or become unrestricted, in an amount equal to the fair market value of such shares on such date. Except as provided in a particular award agreement, in the event of a Change in Control (as defined in the 1995 Stock Plan), notwithstanding any vesting schedule with respect to an award of options, SARs, phantom stock units or restricted stock, such options or SAR will become immediately exercisable with respect to the shares subject to such option or SAR, and restrictions with respect to such phantom stock units or shares of restricted stock will immediately expire. In addition, payment will be made as determined by the Stock Incentive Plan Committee with respect to performance units. The 1995 Stock Plan also provides for the grant of unrestricted stock bonus awards. THCR has reserved 1,000,000 shares of THCR Common Stock for issuance under the 1995 Stock Plan, provided, however, that in the event of changes in the outstanding stock or the capital structure of THCR, adjustments will be made by the Stock Incentive Plan Committee as to (i) the number, price or kind of a stock or other consideration subject to outstanding awards and (ii) the maximum number of shares of stock subject to all awards under the 1995 Stock Plan. In 1995, the Stock Incentive Plan Committee granted to Nicholas L. Ribis, under the 1995 Stock Plan: (a) a stock bonus award of 66,667 shares of THCR Common Stock, which was fully vested when issued, (b) a phantom stock unit award of 66,666 units, entitling Mr. Ribis to receive 66,666 shares of THCR Common Stock on June 12, 1997, subject to certain conditions, and (c) an award of NQSOs entitling Mr. Ribis to purchase 133,333 shares of the THCR Common Stock, subject to certain conditions (including vesting at a rate of 20% per year over a five-year period). The options have an exercise price of $14.00 per share. Summary Compensation Table. The following table sets forth information regarding compensation paid to or accrued by all the executive officers of THCR, for each of the last three completed fiscal years. Compensation accrued during one year and paid in another is recorded under the year of accrual. Because THCR was formed in 1995, compensation for the years ended December 31, 1994 and 1993 reflect solely the compensation paid or accrued to these individuals as executive officers of Plaza Associates. Historically, Plaza Associates has not provided its executive officers with participation in stock-based compensation plans or long-term incentive plans and, accordingly, such information is not reflected in the table below. Compensation for the year ended December 31, 1995 includes compensation paid or accrued to these individuals as executive officers of THCR and Plaza Associates. (1) All the executive officers in this table are also executive officers of Taj Holding; the compensation from this entity is not included in this table. See "Management of Taj Holding--Executive Compensation." (2) Represents the dollar value of annual compensation not properly categorized as salary or bonus, including amounts reimbursed for income taxes. Following SEC rules, perquisites and other personal benefits are not included in this table because the aggregate amount of that compensation is less than the lesser of $50,000 or 10% of the total of salary and bonus for each member of the Executive Group. (3) The amounts listed represent amounts paid by Plaza Associates to TPM, a corporation beneficially owned by Trump, for services provided under the TPM Services Agreement. Payments received by TPM under the TPM Services Agreement are currently pledged by TPM to secured lease payments for a helicopter that TPM makes available to Plaza Associates. See "Certain Transactions--Plaza Associates--TPM Services Agreement." Trump is not an employee of Plaza Associates and receives no compensation from Plaza Associates other than pursuant to the TPM Services Agreement. (4) Represents vested and unvested contributions made by Plaza Associates to Trump Plaza Hotel and Casino Retirement Savings Plan. Funds accumulated for an employee under this plan consist of a certain percentage of the employee's compensation plus Plaza Associates' employer matching contributions equaling 50% of the participant's contributions, are retained until termination of employment, attainment of age 59 1/2 or financial hardship, at which time the employee may withdraw his or her vested funds. (5) Mr. Ribis devotes a majority of his time to the affairs of THCR. See "-- Employment Agreements." (6) As of December 31, 1995, Mr. Ribis held 66,666 phantom stock units issued pursuant to the Stock Incentive Plan. These units had a value as of December 31, 1995 of $1,433,319. These phantom stock units were issued to Mr. Ribis in connection with his employment agreement with THCR. Each phantom stock unit entitles Mr. Ribis to one share of THCR Common Stock on the vesting date of the phantom stock unit. All of the phantom stock units are scheduled to vest on June 12, 1997. Vesting will accelerate in the event of Mr. Ribis' termination of employment with THCR (i) because of his death or disability, (ii) by THCR without cause, or (iii) voluntarily by Mr. Ribis under circumstances which constitute a constructive termination. Alternatively, the phantom stock units may expire prior to June 12, 1997 in the event Mr. Ribis voluntarily terminates his employment with THCR under circumstances which do not constitute constructive termination or if he is terminated by THCR with cause. Dividend equivalents with respect to the phantom stock units will be credited to a bookkeeping account on behalf of Mr. Ribis and will be paid out in cash at the time the phantom stock units vest or will expire along with the phantom stock units. The following table sets forth options granted to Mr. Ribis in 1995. No other member of the Executive Group received stock options in 1995. THCR did not issue any stock appreciation rights in 1995. This table also sets forth the hypothetical gains that would exist for the options at the end of their ten-year terms at assumed annual rates of stock appreciation of 5% and 10%. The actual future value of the options will depend on the market value of the THCR Common Stock. OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth the number of shares covered by options held by Mr. Ribis and the value of the options as of December 31, 1995. Mr. Ribis was the only member of the Executive Group who held options in 1995. None of these options were exercisable in 1995. Trump serves as the Chairman of the Board of THCR pursuant to the Executive Agreement. In consideration for Trump's services under the Trump Executive Agreement, Trump receives a salary of $1 million per year. Pursuant to the terms of the Trump Executive Agreement, Trump provides to THCR, from time to time, when reasonably requested, marketing, advertising, professional and other similar and related services with respect to the operation and business of THCR. The Trump Executive Agreement continues in effect (i) for an initial term of five years, and (ii) thereafter, for a three-year rolling term until either Trump or THCR provides notice to the other of its election not to continue extending the term, in which case the term of the Trump Executive Agreement will end three years from the date such notice is given. The Trump Executive Agreement also provides that Trump may devote time and effort to the Taj Mahal and Trump's Castle and, subject to the terms of the Contribution Agreement (as defined), to other business matters, and that the Trump Executive Agreement will not be construed to restrict Trump from operating the Taj Mahal and Trump's Castle in a commercially reasonable manner and/or having an interest therein or conducting any other activity not prohibited under the Contribution Agreement. See "Risk Factors--Conflicts of Interest" and "Description of the THCR Holdings Partnership Agreement." Plaza Associates had an employment agreement with Nicholas L. Ribis (the "Ribis Plaza Agreement") pursuant to which Mr. Ribis acted as Chief Executive Officer of Plaza Associates. The Ribis Plaza Agreement provided for an annual salary of $550,000 with annual increases of 10% on each anniversary. Mr. Ribis received a $250,000 signing bonus. Pursuant to the terms of the Ribis Plaza Agreement, in the event Plaza Associates engaged in an offering of common shares to the public, Plaza Associates and Mr. Ribis would agree to negotiate new compensation arrangements to include equity participation for Mr. Ribis. As a result of the June 1995 Offerings, THCR and THCR Holdings entered into a revised employment agreement with Mr. Ribis (the "Revised Ribis Plaza Agreement") to replace the Ribis Plaza Agreement, pursuant to which he agreed to serve as President and Chief Executive Officer of THCR and Chief Executive Officer of THCR Holdings. The term of the Revised Ribis Plaza Agreement is five years and Mr. Ribis is required to devote the majority of his professional time to the affairs of THCR, as measured on a quarterly basis, based on a 40-hour work week. Under the Revised Ribis Plaza Agreement, Mr. Ribis's annual salary is $907,500, which is 50% of the aggregate current annual base salary ($1,815,000) that Mr. Ribis receives as Chief Executive Officer of THCR ($907,500), Taj Mahal ($453,750) and Trump's Castle ($453,750). Following the consummation of the Merger Transaction, Mr. Ribis will devote 75% of his professional time to the operations of THCR, Plaza Associates and Taj Associates, and his annual salary will be $1,361,250 per year with respect to his services to these entities. See "Management of Taj Holding--Employment Agreements." Mr. Ribis will continue to receive $453,750 per year with respect to his services to Trump's Castle. In 1995, the Stock Incentive Plan Committee granted to Mr. Ribis, under the 1995 Stock Plan: (a) a stock bonus award of 66,667 shares of THCR Common Stock, which was fully vested when issued, (b) a phantom stock unit award of 66,666 units, entitling him to receive 66,666 shares of THCR Common Stock on June 12, 1997, subject to certain conditions, and (c) an award of NQSOs entitling Mr. Ribis to purchase 133,333 shares of the THCR Common Stock at an exercise price of $14.00 per share. The options will vest at the rate of 20% per year over a five-year period, and be subject to certain other conditions. In the event Mr. Ribis's employment is terminated by THCR other than for "cause" or if he incurs a "constructive termination without cause" (as each term is defined in the Revised Ribis Plaza Agreement), Mr. Ribis will receive a severance payment equal to one year's base salary, and the phantom stock units and options will become fully vested. The phantom stock units will also automatically vest upon the death or disability of Mr. Ribis. The Revised Ribis Plaza Agreement also provides for up to an aggregate of $2.0 million of loans to Mr. Ribis to be used by him to pay his income tax liability in connection with stock options, phantom stock units and stock bonus awards, which loans will be forgiven, including both principal and interest, in the event of a "Change of Control" (as defined in the Revised Ribis Plaza Agreement). The Revised Ribis Plaza Agreement also provides certain demand and piggyback registration rights for THCR Common Stock issued pursuant to the foregoing. Mr. Ribis is also Chief Executive Officer of Taj Associates and TCA, the partnerships that own the Taj Mahal and Trump's Castle, and receives compensation from such entities for such services as set forth above. Pursuant to the Revised Ribis Agreement, he is required to devote the majority of his time to the affairs of THCR, and following the consummation of the Merger Transaction, Mr. Ribis will devote approximately 75% of his professional time to THCR. All other executive officers of Plaza Associates, except Messrs. Burke and Pickus, devote substantially all of their time to the business of Plaza Associates. THCR Holdings has an employment agreement with Robert M. Pickus (the "Pickus Agreement") pursuant to which he serves as Executive Vice President and General Counsel. The Pickus Agreement, which expires on July 9, 1998 if not extended, provides for annual compensation of $275,000 plus bonus. Employment may be terminated only for "cause" (as defined in the Pickus Agreement), which includes revocation of Mr. Pickus' casino key employee license by the CCC and conviction of a crime. Upon termination for cause, Mr. Pickus will receive only compensation earned to the date of termination. Directors of THCR who are also employees or consultants of THCR and its affiliates receive no directors fees. Non-employee directors are paid an annual directors fee of $50,000, plus $2,000 per meeting attended plus reasonable out-of-pocket expenses incurred in attending these meetings, provided that directors currently serving on the Board of Directors of Plaza Funding or Plaza Holding Inc. receive no additional compensation. All such fees are reimbursed to THCR by THCR Holdings in accordance with the THCR Holdings Partnership Agreement. COMMITTEES OF THE BOARD OF DIRECTORS THCR has an Executive Committee, an Audit Committee, a Special Committee, a Stock Incentive Plan Committee and a Compensation Committee. The Executive Committee is composed of Messrs. Trump and Ribis. The Audit Committee and the Special Committee are composed of Messrs. Askins, Ryan and Thomas, each of whom is an independent director of THCR. The Stock Incentive Plan Committee is composed of Messrs. Trump, Askins, Ryan and Thomas. The Compensation Committee is composed of Messrs. Trump, Ribis, Askins and Thomas. The Special Committee was established pursuant to the THCR By-Laws and the THCR Holdings Partnership Agreement and is empowered to vote on any matters which require approval of a majority of the independent directors of THCR, including affiliated transactions. See "Description of the THCR Holdings Partnership Agreement." COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Trump and certain affiliates have engaged in certain related party transactions. See "Certain Transactions." In general, the compensation of executive officers of THCR is determined by the Compensation Committee of the Board of Directors of THCR. No officer or employee of THCR, other than Messrs. Trump and Ribis, who serves on the Board of Directors of THCR, participated in the deliberations of the Board of Directors of THCR concerning executive compensation. The SEC requires issuers to disclose the existence of any other corporation in which both (i) an executive officer of the registrant serves on the board of directors and/or compensation committee, and (ii) a director of the registrant serves as an executive officer. Messrs. Ribis, Pickus and Burke, executive officers of THCR, have served on the board of directors of other entities in which members of the Board of Directors of THCR (namely, Messrs. Trump and Ribis) served and continue to serve as executive officers. Management believes that such relationships have not affected the compensation decisions made by the Board of Directors of THCR in the last fiscal year. Messrs. Trump and Ribis serve on the Board of Directors of Plaza Funding, the managing general partner of Plaza Associates, of which Messrs. Trump and Ribis are executive officers. Messrs. Trump and Ribis also serve on the Board of Directors of Plaza Holding Inc., of which Messrs. Trump, Ribis and Burke are also executive officers. Trump is not compensated by such entities for serving as an executive officer, however, he has entered into a personal services agreement with Plaza Associates and THCR. Messrs. Ribis and Burke are not compensated by the foregoing entities, however, they are compensated by Plaza Associates for their service as executive officers. Messrs. Ribis, Pickus and Burke serve on the Board of Directors of Taj Holding, which holds an indirect equity interest in Taj Associates, the partnership that owns the Taj Mahal, of which Messrs. Trump and Ribis are executive officers. Such persons also serve on the Board of Directors of TM/GP, the managing general partner of Taj Associates, of which Messrs. Trump and Ribis are executive officers. Mr. Ribis is compensated by Taj Associates for his services as its Chief Executive Officer. See "Management of Taj Holding--Employment Agreements." Mr. Ribis also serves on the Board of Directors of Realty Corp., which leases certain real property to Taj Associates, of which Trump is an executive officer. Trump, however, does not receive any compensation for serving as an executive officer of Realty Corp. Mr. Ribis receives compensation from TCA for acting as its Chief Executive Officer. See "Management of Taj Holding-- Employment Agreements." All decisions affecting the business and affairs of Taj Associates, including the operation of the Taj Mahal, are determined currently by TM/GP, the managing general partner of Taj Associates. Upon consummation of the Merger Transaction, Taj Associates will be managed by Taj Holdings LLC which will be its managing general partner and the governance procedures described in the following paragraphs will no longer be applicable. Pursuant to the Taj Holding Certificate of Incorporation, the certificate of incorporation of TM/GP and the DGCL, the terms of the transactions relating to the Merger, to the extent they contemplate action by TM/GP or Taj Associates, must be approved by (i) the entire Board of Directors of Taj Holding, (ii) the holders of Taj Holding Class B Common Stock and Taj Holding Class C Common Stock, each voting as a separate class, (iii) the Class B Directors of TM/GP (which are the same as the Class B Directors of Taj Holding), (iv) the entire Board of Directors of TM/GP (which consists of the Class B Directors and Class C Directors of Taj Holding), (v) the holders of the Class B Common Stock of TM/GP, par value $.01 per share (the "TM/GP Class B Common Stock"), and (vi) the stockholders of TM/GP. Taj Holding is the sole holder of TM/GP's capital stock which consists solely of TM/GP Class B Common Stock and Class C Common Stock, par value $.01 per share (the "TM/GP Class C Common Stock"). Pursuant to the Taj Holding Certificate of Incorporation, the Class B Directors of Taj Holding and the Class C Directors of Taj Holding vote the TM/GP Class B Common Stock and the TM/GP Class C Common Stock, respectively. The Board of Directors of TM/GP is comprised of nine directors, consisting of four TM/GP Class B Directors and five TM/GP Class C Directors. The TM/GP Class C Directors are elected indirectly by Trump and the TM/GP Class B Directors are elected indirectly by the holders of the Bonds. Trump, Nicholas L. Ribis, Steven R. Busch, Robert M. Pickus and John P. Burke currently serve as the TM/GP Class C Directors, and Harold First, John K. Kelly, Robert J. McGuire and Roy E. Posner currently serve as the TM/GP Class B Directors. Trump serves as Chairman of the Board, President and Treasurer of TM/GP. Nicholas L. Ribis and John P. Burke serve as Vice Presidents of TM/GP, and Nicholas F. Moles serves as Secretary of TM/GP. The officers of TM/GP serve at the pleasure of the Board of Directors of TM/GP. The Board of Directors of Taj Holding consists of the same four TM/GP Class B Directors and five TM/GP Class C Directors. The holders of the Taj Holding Class B Common Stock elect the four Class B Directors of Taj Holding, who, pursuant to the Taj Holding Certificate of Incorporation are required to vote the TM/GP Class B Common Stock to elect themselves as the four Class B Directors of TM/GP. Similarly, Trump, the holder of the Taj Holding Class C Common Stock, elects the five Class C Directors of Taj Holding, who, pursuant to the Taj Holding Certificate of Incorporation are required to vote the TM/GP Class C Common Stock to elect themselves as the five Class C Directors of TM/GP. Any change in the composition of the Board of Directors of Taj Holding will result in a concomitant change in the Board of Directors of TM/GP. The Board of Directors of Taj Holding does not have a nominating or compensation committee or any committees performing similar functions. Trump serves as Chairman of the Board, President and Treasurer of Taj Holding. Nicholas L. Ribis serves as Taj Holding's Vice President and Nicholas F. Moles serves as Taj Holding's Secretary. The officers of Taj Holding serve at the pleasure of the Board of Directors of Taj Holding. Both Taj Holding and TM/GP have an Audit Committee on which one Class C Director, John P. Burke, serves with two Class B Directors, Harold First and Robert J. McGuire. Upon consummation of the Merger, and until successors are duly elected or appointed, (i) Messrs. Trump, Ribis, and Pickus, the current directors of Merger Sub, will become the directors of the Surviving Corporation, and (ii) the current officers of Taj Holding will become the officers of the Surviving Corporation. According to the terms of the Taj Holding Certificate of Incorporation, the Class B Directors of Taj Holding are required to resign upon redemption of the Bonds. In addition, upon the consummation of the Merger Transaction, the existing directors of TM/GP, other than Messrs. Trump, Ribis and Pickus, will resign. The following table sets forth certain information concerning each of Taj Holding's directors and executive officers and a key employee of Taj Associates: Set forth below are the names, ages, positions and offices held with Taj Holding and a brief account of the business experience during the past five years of each of the executive officers and directors of Taj Holding and certain key employees of Taj Associates. Each of such persons is a citizen of the United States and has been approved and/or licensed by the CCC. With respect to Messrs. Trump, Ribis, Pickus and Burke, please see the information set forth in "Management of THCR". R. Bruce McKee--Mr. McKee, 50 years old, has been acting Chief Operating Officer of Taj Associates since October 1995; Senior Vice President, Finance of Taj Associates since July 1993; Vice President, Finance of Taj Associates from September 1990 through June 1993; Assistant Treasurer of Taj Funding, TM/GP, Taj Holding, Realty Corp., TTMC and TTMI since October 1991; Vice President of Finance of Elsinore Shore Associates, the owner and operator of the Atlantis Casino Hotel, Atlantic City, from April 1984 to September 1990; and Treasurer of Elsinore Finance Corp., Elsinore of Atlantic City and Elsub Corp. from June 1986 to September 1990. The Atlantis Casino Hotel now constitutes the portion of Trump Plaza known as Trump World's Fair. Mr. McKee's business address is c/o Trump Taj Mahal Casino Resort 1000 The Boardwalk, Atlantic City, New Jersey 08401 Nicholas F. Moles--Mr. Moles, 42 years old, has been Assistant Secretary of Taj Holding and TM/GP from October 1991 to February 1995; Secretary of Taj Holding and TM/GP since February 1995; Senior Vice President, Law and General Counsel of Taj Associates since June 1993; Assistant Secretary of Taj Funding since October 1991 and Assistant Secretary of TTMI since January 1989. From May 1986 to May 1988, Mr. Moles was General Counsel of Plaza Associates and was Vice President and General Counsel of Plaza Associates from May 1988 to December 1988. Mr. Moles was Vice President and General Counsel of Elsinore Shore Associates from May 1985 to May 1986 and was Director and Assistant Secretary of Elsinore Finance Corporation from November 1985 to May 1986. Mr. Moles' business address is c/o Trump Taj Mahal Casino Resort 1000 The Boardwalk, Atlantic City, New Jersey 08401. Steven R. Busch--Mr. Busch, 49 years old, has been a Class C Director of TM/GP and Taj Holding since January 1995. Since May 1994, Mr. Busch has been an independent economic and financial consultant. From March 1989 to April 1994, Mr. Busch was an Executive Vice President of Shearson Lehman Brothers Inc. and Senior Vice President & Senior Credit Officer, Boston Safe Deposit and Trust Company (an affiliate of Shearson Lehman Brothers Inc). Mr. Busch's address is 135 East 71st Street, New York, New York 10021. Larry W. Clark--Mr. Clark, 50 years old, has been Executive Vice President, Casino Operations of Taj Associates since November 1991; Senior Vice President, Casino Operations of Taj Associates from May 1991 to November 1991; Vice President, Casino Administration of Taj Associates from April 1991 to May 1991 and from January 1990 to November 1990; Vice President, Casino Operations, Dunes Hotel & Country Club from November 1990 to April 1991, and was Director of Casino Marketing and Vice President, Casino Operations, Showboat Hotel & Casino from November 1988 to January 1990. Mr. Clark's business address is 1000 The Boardwalk, Atlantic City, New Jersey 08401. Rudy E. Prieto--Mr. Prieto, 51 years old, has been Executive Vice President, Operations of Taj Associates since December 1995. Prior to joining the Taj Mahal, Mr. Prieto was Executive Vice President and Chief Operating Officer for Elsinore Corporation from May 1995 to November 1995; Senior Vice President in charge of the development of the Mojave Valley Resort for Elsinore Corporation from April 1994 to April 1995 and Executive Vice President and Assistant General Manager for the Tropicana Resort and Casino from May 1988 to October 1994. Mr. Prieto's business address is c/o Trump Taj Mahal Casino Resort, 1000 The Boardwalk, Atlantic City, New Jersey 08401. Walter Kohlross--Mr. Kohlross, 52 years old, has been Senior Vice President, Food & Beverage of Taj Associates since April 1992; Vice President, Food & Beverage of Taj Associates from April 1991 to April 1992 and from November 1988 to November 1990, and was Vice President, Operations of Taj Associates from November 1990 to April 1991. Mr. Kohlross' business address is c/o Trump Taj Mahal Casino Resort, 1000 The Boardwalk, Atlantic City, New Jersey 08401. Richard D. Kline--Mr. Kline, 50 years old, has been Senior Vice President, Hotel Operations of Taj Associates since September 1994; Vice President, Hotel Operations of Taj Associates from June 1993 to September 1994, and was Vice President, Property Management of Taj Associates from March 1992 to June 1993. From 1966 to 1992, Mr. Kline held a variety of command and staff positions in the United States Army, and retired with the rank of Colonel. Mr. Kline's business address is c/o Trump Taj Mahal Casino Resort, 1000 The Boardwalk, Atlantic City, New Jersey 08401. Harold First--Mr. First, 59 years old, has been a Class B Director of TM/GP and Taj Holding since October 1991. Mr. First was a Director of Trans World Airlines, Inc. from December 1990 through January 1993; Director of ACF Industries, Inc. from February 1991 through December 1992; Vice Chairman of the Board of Directors of American Property Investors, Inc., the general partner of American Real Estate Partners, L.P. from March 1991 through December 1992; Member of Board of Directors of Realty Corp. since October 1991; Member of Supervisory Board of Directors of Memorex Telex N.V. since February 1992; member of Board of Directors of Cadus Pharmaceutical Corporation since April 1995; member of Board of Directors of Tel-Save Holdings, Inc. since September 1995; and Chief Financial Officer of Icahn Holding Corporation and related entities from December 1990 through December 1992. Since January 1993, Mr. First has been employed as an independent financial consultant. Mr. First's business address is c/o KPMG Peat Marwick, LLP, 345 Park Avenue, New York, New York 10154. John K. Kelly--Mr. Kelly, 46 years old, has been a Class B Director of TM/GP, Taj Holding and Realty Corp. since October 1991. Mr. Kelly has been Senior Vice President/General Counsel of Ocean Federal Savings Bank, a federally chartered mutual savings bank, since April 1988. Mr. Kelly's business address is c/o Ocean Federal Savings Bank, 74 Brick Boulevard, Brick, New Jersey 08723. Robert J. McGuire--Mr. McGuire, 59 years old, has been a Class B Director of TM/GP and Taj Holding since October 1991. Mr. McGuire has been President of Kroll Associates, a management consulting firm, since 1989, Director of Emigrant Savings Bank since 1988 and a Director of GTI Holding Corp. since 1989. Mr. McGuire's business address is c/o Kroll Associates, 900 Third Avenue, New York, New York 10022. Roy E. Posner--Mr. Posner, 62 years old, has been a Class B Director of TM/GP and Taj Holding since October 1991. Mr. Posner has been Senior Vice President and Chief Financial Officer of the Loews Corporation since 1986, and is a member of the Board of Directors of Bulova Systems and Instruments Corp.Mr. Posner's business address is c/o Loews Corporation, 667 Madison Avenue, 7th Floor, New York, New York 10021. Nicholas J. Niglio--Mr. Niglio, 49 years old, has been Senior Vice President, Casino Marketing of Taj Associates since October 31, 1995. From February 6, 1995 to October 31, 1995, Mr. Niglio was Vice President, International Marketing of Taj Associates. Prior to joining Taj Associates, Mr Niglio was Executive Vice President of International Marketing/Player Development for TCA, the partnership that owns and operates Trump's Castle from October 1993 until February 1995. Prior to that, Mr. Niglio served as President of Eastern Operations of Caesars World Marketing Corporation for three years. Prior to that he served as Vice President--Casino Manager at Caesars Atlantic City for three years. Mr. Niglio's business address is c/o Trump Taj Mahal Casino Resort, 1000 The Boardwalk, Atlantic City, New Jersey 08401. Trump, Nicholas L. Ribis, John P. Burke, R. Bruce McKee, Nicholas F. Moles, Larry W. Clark and Walter Kohlross served as either executive officers and/or directors of Taj Associates and its affiliated entities when such parties filed their petition for reorganization under Chapter 11 of the Bankruptcy Code on July 17, 1991. The Second Amended Joint Plan of Reorganization of such parties was confirmed on August 28, 1991, and was declared effective on October 4, 1991. Trump, Nicholas L. Ribis, John P. Burke and Robert M. Pickus served as Executive Committee members, officers and/or directors of TCA and its affiliated entities at the time such parties filed a petition for reorganization under Chapter 11 of the Bankruptcy Code on March 9, 1992. The First Amended Joint Plan of Reorganization of such parties was confirmed on May 5, 1992, and was declared effective on May 29, 1992. Trump, Nicholas L. Ribis and John P. Burke served as either executive officers and/or directors of Plaza Associates and its affiliated entities when such parties filed their petition for reorganization under Chapter 11 of the Bankruptcy Code in March 1992. The First Amended Joint Plan of Reorganization of such parties was confirmed on April 30, 1992, and was declared effective on May 29, 1992. Trump was a partner of Plaza Operating Partners Ltd. when it filed a petition for reorganization under Chapter 11 of the Bankruptcy Code on November 2, 1992. The plan of reorganization for Plaza Operating Partners Ltd. was confirmed on December 11, 1992 and declared effective in January 1993. John P. Burke was Executive Vice President and Chief Administrative Officer of Imperial Corporation of America, a thrift holding company, whose major subsidiary, Imperial Savings, was seized by the Resolution Trust Corporation in February 1990. Subsequently, in February 1990, Imperial filed a petition for reorganization under Chapter 11 of the Bankruptcy Code. Taj Holding does not pay any cash compensation to its executive officers for serving as such and Taj Holding does not offer its executive officers stock- based compensation plans, long-term incentive plans or defined benefit pension plans. The executive officers of Taj Holding, other than Trump, are also employees of Taj Associates and are compensated by Taj Associates. Directors are also compensated for serving on Taj Holding's Board of Directors. See "-- Compensation of Directors" below. Mr. Ribis, as a Class C Director of TM/GP, participates in decisions relating to bonuses paid by Taj Associates, but abstains from decisions relating to his own bonus. The following table sets forth information for each of the last three completed fiscal years regarding compensation paid to or accrued by (i) the President of Taj Holding and (ii) each of the next four highest paid executive officers of Taj Holding and/or Taj Associates, whose salary and bonus exceeded $100,000 for the year ended December 31, 1995, including one additional individual who would have been among the next four highest paid executive officers but for the fact that his employment was terminated in 1995. Compensation accrued during one year and paid in another is recorded under the year of accrual. Information relating to long-term compensation is inapplicable and has therefore been omitted from the table. (1) Mr. Trump performs functions similar to those of a chief executive officer. (2) Represents the dollar value of annual compensation not properly categorized as salary or bonus, including amounts reimbursed for income taxes. Following SEC rules, perquisites and other personal benefits are not included in this table unless the aggregate amount of that compensation is the lesser of either $50,000 or 10% of the total of salary and bonus for such executive officers. (3) The amounts listed represent amounts paid to Trump pursuant to the Taj Services Agreement. See "Certain Transactions--Taj Holding and Affiliates--Taj Services Agreement." Trump is not an employee of Taj Associates and receives no compensation from Taj Associates other than pursuant to the Taj Services Agreement. Mr. Trump is also an executive officer of THCR; the compensation from this entity is not included in this table. See "Management of THCR--Executive Compensation--Summary Compensation Table." (4) Represents vested and unvested contributions made by Taj Associates to the Trump Taj Mahal Retirement Savings Plan. Funds accumulated for an employee under this plan consist of a certain percentage of the employee's compensation plus Taj Associates' employer matching contributions equaling 50% of the participants' contributions, are retained until termination of employment, attainment of age 59 1/2 or financial hardship, at which time the employee may withdraw his or her vested funds. (5) Mr. Ribis devotes approximately one quarter of his professional time to the affairs of Taj Associates, and upon consummation of the Merger Transaction he will devote 75% of his time to the operations of THCR, Plaza Associates and Taj Associates. Mr. Ribis is also an executive officer of THCR and Plaza Associates; the compensation from these entities is not included in this table. See "Management of THCR--Executive Compensation--Summary Compensation Table." (6) Mr. Niglio's employment with Taj Associates commenced on February 6, 1995. (7) Former Vice President of Taj Holding, director of Taj Holding and TM/GP and former Chief Operating Officer of Taj Associates. Mr. Gomes's employment was terminated on October 3, 1995. Taj Associates has an employment agreement with Nicholas L. Ribis (the "Ribis Taj Agreement") pursuant to which Mr. Ribis acts as Chief Executive Officer of Taj Associates. Mr. Ribis received a $250,000 signing bonus. Pursuant to the terms of the Ribis Taj Agreement, in the event that Taj Associates, or any entity which acquires substantially all of Taj Associates, proposes to engage in an offering of common shares to the public, Taj Associates and Mr. Ribis will negotiate new compensation arrangements to include equity participation for Mr. Ribis. Taj Associates may at any time terminate Mr. Ribis's employment for "cause" (as such term is defined in the Ribis Taj Agreement). The Ribis Taj Agreement expires on September 25, 1996. Taj Associates and Mr. Ribis expect to amend the Ribis Taj Agreement, effective as of June 12, 1995, pursuant to which, among other things, Mr. Ribis's annual salary will change from $550,000 (with annual increases of 10% on each anniversary) to $453,750. Mr. Ribis acts as President, Chief Executive Officer and Chief Financial Officer of THCR and THCR Holdings, the Chief Executive Officer of TCA and Plaza Associates, the partnerships that own Trump's Castle and Trump Plaza, and receives additional compensation from such entities. Mr. Ribis devotes approximately one quarter of his professional time to the affairs of Taj Associates. Following the consummation of the Merger Transaction, Mr. Ribis will devote 75% of his professional time to the operations of THCR, Plaza Associates and Taj Associates. See "Management of THCR--Employment Agreements." Taj Associates has an employment agreement with R. Bruce McKee pursuant to which he serves as Senior Vice President, Chief Financial Officer of Taj Associates. The agreement, which expires on September 30, 1997, provides for an annual salary of $175,000, a guaranteed bonus of $25,000 and is terminable by Mr. McKee on each anniversary date of the agreement. Mr. McKee will further be considered for additional bonus compensation at Taj Associates sole discretion. Factors considered by Taj Associates in the awarding of all discretionary bonuses generally are the attainment by Taj Associates of budgeted or forecasted goals and the individual's perceived contribution to the attainment of such goals. Taj Associates has an employment agreement with Larry W. Clark pursuant to which he serves as Executive Vice President, Casino Operations of Taj Associates. The agreement, which expires on November 30, 1997, provides for an annual salary of $300,000 and, in addition, a minimum guaranteed bonus of at least $97,500 per annum. Taj Associates has an employment agreement with Nicholas J. Niglio which was assigned to Taj Associates by TCA on February 6, 1995, pursuant to which he serves as Senior Vice President, Casino Marketing of Taj Associates. The agreement, which expires on December 31, 1996, provides for an annual salary of $250,000 and, an annual bonus at the sole discretion of management of Taj Associates. Mr. Niglio previously served as Executive Vice President of TCA. Taj Associates may terminate the employment agreements of Messrs. Clark, McKee and Niglio in its sole discretion, without cause. If Mr. Clark's employment agreement is terminated, Taj Associates would be obligated to pay Mr. Clark the greater of one year's salary or his salary for the number of months remaining in the agreement, each at his then current salary. If Mr. McKee's employment agreement is terminated, Taj Associates would be obligated to pay Mr. McKee an amount equal to one year's then current salary. If Mr. Niglio's employment agreement is terminated, Taj Associates would be obligated to pay Mr. Niglio the lesser of three month's salary or his salary for the number of months remaining in the agreement, each at his then current salary. Taj Associates entered into a severance agreement with Nicholas F. Moles (the "Moles Agreement") on August 11, 1994. The Moles Agreement provides that upon Mr. Moles' termination other than for "cause" (as defined in the Moles Agreement), loss of his casino key employee license from the CCC or voluntary resignation, Taj Associates will pay Mr. Moles a severance payment equal to the amount of his salary at its then current rate for the period of one year. Taj Associates had an employment agreement with Dennis C. Gomes, pursuant to which Mr. Gomes served as President and Chief Operating Officer of Taj Associates. The agreement, provided for an annual salary of $1,500,000, and annual increases of 10% on each anniversary. Mr. Gomes received a signing bonus of $600,000. On September 19, 1995, pursuant to the terms of the employment agreement, Mr. Gomes terminated his employment agreement as President and Chief Operating Officer of Taj Associates and continued to serve in that position as an employee-at-will. On October 3, 1995, the Board of Directors of TM/GP terminated Mr. Gomes from his position as President and Chief Operating Officer of Taj Associates and Vice President of Taj Holding. On that same date, Trump, the holder of the Taj Holding Class C Common Stock terminated Mr. Gomes as a Class C Director of TM/GP and Taj Holding. Mr. Gomes did not receive any severance compensation in connection with his termination. The directors of Taj Holding are compensated as follows: (i) each Class B Director is paid $60,000 per year plus $4,000 for each meeting of the Board of Directors attended; provided, however, that the total fees received by any Class B Director in any single calendar year may not exceed $90,000 except under unusual circumstances not anticipated to occur; (ii) Trump is not paid any fee for serving as a Class C Director; and (iii) each Class C Director other than Trump is paid a fee of $30,000 per year plus $2,000 for each meeting of the Board of Directors attended (which meeting fee was waived for a portion of 1994 and 1995 for all Class C Directors who are employees of Taj Holding and its affiliates); provided, however, that the total fees received by any Class C Director in any single calendar year may not exceed $45,000, except under unusual circumstances not anticipated to occur. All directors receive reasonable expenses of attendance for each meeting attended. In addition, members of the TM/GP Audit Committee are compensated as follows: each member selected by the Class B Directors receives $2,000 per meeting attended and each member selected by the Class C Directors receives $1,000 per meeting attended. A total of $384,000 and $175,000 in directors' fees and committee fees was paid to the Class B Directors and Class C Directors, respectively, in the fiscal year ended December 31, 1994. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Trump and certain affiliates have engaged in certain related party transactions. See "Certain Transactions." In general, the compensation of executive officers of Taj Associates is determined by the Board of Directors of Taj Holding and TM/GP. No officer or employee of Taj Associates other than Mr. Ribis who serves on the Board of Directors of Taj Holding and TM/GP, participated in the deliberations concerning executive compensation. The SEC requires registrants to disclose the existence of any other corporation in which both (i) an executive officer of the registrant serves on the board of directors and/or compensation committee, and (ii) a director of the registrant serves as an executive officer. Mr. Ribis, an executive officer of Taj Associates, is a member of the Board of Directors of other entities in which members of the Board of Directors of TM/GP, the managing general partner of Taj Associates (namely, Messrs. Trump, Ribis and Burke), are executive officers. Messrs. Trump and Ribis, executive officers of Taj Holding, are members of the Board of Directors of other entities in which members of the Board of Directors of Taj Holding (namely, Messrs. Trump, Ribis and Burke) are executive officers. Mr. Ribis, an executive officer of Taj Funding and TTMI, serves on the Board of Directors of other entities in which the sole Director of Taj Funding and TTMI (namely, Trump) serves as an executive officer. In addition, Trump or entities owned by him receive management or services fees pursuant to fixed formulas provided for in agreements with Taj Associates, Plaza Associates, THCR and TCA, of which Mr. Ribis is a director or a director of the managing general partner. Mr. Ribis serves on the Board of Directors of Taj Holding, which is the 100% beneficial owner of TM/GP, of which Trump is an executive officer. Messrs. Trump and Ribis serve on the Board of Directors of TM/GP, which is the managing general partner of Taj Associates, of which Messrs. Ribis and Burke are executive officers. Trump, however, does not receive any compensation for serving as an executive officer of TM/GP or Taj Holding. Messrs. Trump and Ribis also serve on the Board of Directors of Realty Corp., which leases certain real property to Taj Associates, of which Messrs. Trump and Ribis are executive officers. Messrs. Trump and Ribis, however, do not receive any compensation for serving as executive officers of Realty Corp. Trump is also a director of TTMI, TTMC and Taj Funding; Mr. Ribis serves as an executive officer of one or more of such entities; however, he does not receive any compensation for serving in such capacities. Messrs. Trump and Ribis serve on the Board of Directors of Plaza Funding, Inc., the managing general partner of Plaza Associates, of which Messrs. Trump and Ribis are executive officers. Messrs. Trump and Ribis also serve on the Board of Directors of Plaza Holding, Inc., of which Messrs. Trump, Ribis and Burke are also executive officers. Trump is not compensated by such entities for serving as an executive officer; however, he has entered into a personal services agreement with Plaza Associates and THCR. Messrs. Ribis and Burke are not compensated by the foregoing entities; however, they are compensated by Plaza Associates for their service as executive officers. Trump serves on the Board of Directors of THCR and TC/GP, Inc., of which Messrs. Ribis and Burke are executive officers. Trump is not compensated by such entities for serving as an executive officer; however, a corporation controlled by him has entered into a services agreement with TCA. Messrs. Ribis and Burke are not compensated by the foregoing entities; however, they are compensated by TCA for their service as executive officers. Payments to affiliates in connection with any such transactions are governed by the provisions of the Plaza Mortgage Note Indenture and the Senior Note Indenture, and may also be governed by the provisions of the Taj Note Indenture, which provisions generally require that such transactions be on terms as favorable as would be obtainable from an unaffiliated party, and require the approval of a majority of the independent directors of THCR for certain affiliated transactions. Trump entered into the Trump Executive Agreement, the Contribution Agreement and the License Agreement in June 1995, and is currently the sole limited partner of THCR Holdings. See "Management of THCR--Employment Agreements" and "Business of THCR--Trademark/Licensing." See "Description of the THCR Holdings Partnership Agreement." The only cash compensation paid to Trump in connection with his services to THCR is pursuant to the Trump Executive Agreement, other than payments paid to TPM under the TPM Services Agreement, which payments are currently pledged by TPM to secure lease payments for a Super Puma helicopter that TPM makes available to Plaza Associates. See "--Plaza Associates--TPM Services Agreement." Upon consummation of the June 1995 Offerings, Trump contributed to the capital of Trump Indiana and other jurisdiction subsidiaries payments made by him relating to expenditures for the development of Trump Indiana and other gaming ventures. As of June 12, 1995 these advances totaled approximately $4.4 million. Of these amounts, approximately $3.0 million was used to fund expenses related to the development of Trump Indiana. In order to fund such expenses, THCR Holdings lent to Trump $3.0 million and Trump issued to THCR Holdings a five-year promissory note bearing interest at a fixed rate of prime rate, plus 1%, payable annually. The promissory note will be automatically canceled in the event that at any time during the periods set forth below, the THCR Common Stock trades on the New York Stock Exchange, or any other applicable national exchange or over-the-counter market, at a price per share equal to or greater than the prices set forth below (subject to adjustment in certain circumstances) for any ten trading days during any 15 consecutive trading day period: THCR Holdings has entered into a ten year lease with The Trump-Equitable Fifth Avenue Company, a corporation wholly owned by Trump, dated as of July 1, 1995, for the lease of office space in The Trump Tower in New York City, which THCR Holdings may use for its general executive and administrative offices. The fixed rent is $115,000 per year, paid in monthly installments, for the period from July 1, 1995 to June 30, 2000 and will be $129,250 per year, paid in monthly installments, for the period from July 1, 2000 to June 30, 2005. In addition, THCR Holdings will pay as additional rent a portion of the taxes for each tax year. THCR Holdings has the option to terminate this lease upon ninety days written notice and payment of $32,312.50. In connection with the Merger Transaction, Trump and THCR entered into an agreement, dated January 8, 1996, pursuant to which Trump agreed to take the actions contemplated to be taken by Trump in connection with the Merger Transaction, including to vote, or cause to be voted, all shares of THCR Common Stock and THCR Class B Common Stock beneficially owned by Trump in favor of the approval of the Merger Transaction. THCR agreed to use reasonable efforts to fulfill, and cause to be fulfilled, those obligations owed to Trump in connection with the Merger Transaction. Mr. Ribis, the President, Chief Executive Officer and Chief Financial Officer of THCR, is Counsel to the law firm of Ribis, Graham and Curtin, which serves as New Jersey Counsel to THCR, THCR Holdings and its subsidiaries, Taj Holdings, Taj Associates, and certain of their affiliated entities. Plaza Associates has joint property insurance coverage with TCA, Taj Associates and other entities affiliated with Trump for which the annual premium paid by Plaza Associates was approximately $1.4 million for the twelve months ended May 1996. Plaza Associates leased from Taj Associates certain office facilities located in Pleasantville, New Jersey. In 1993 and 1992, lease payments by Plaza Associates to Taj Associates totaled approximately $30,000 and $138,000, respectively. Such lease terminated on March 19, 1993, and Plaza Associates vacated the premises. Through February 1, 1993, Plaza Associates also leased from Trump approximately 120 parking spaces at Trump Plaza East for approximately $5.50 per parking space per day, with payments under such arrangement for the years ended December 31, 1993 and December 31, 1992 totaling $21,000 and $227,000, respectively. Plaza Associates also leased portions of its warehouse facility located in Egg Harbor Township, New Jersey to TCA until January 31, 1994; lease payments by TCA to Plaza Associates totaled $6,000, $15,000 and $14,000 in 1994, 1993 and 1992, respectively. Seashore Four is the fee owner of a parcel of land constituting a portion of the Plaza Casino Parcel, which it leases to Plaza Associates pursuant to the SFA Lease. Seashore Four was assigned the lessor's interest in the existing SFA Lease in connection with its acquisition of fee title to such parcel from a non-affiliated third party in November 1983. The SFA Lease was entered into by Plaza Associates with such third party on an arm's-length basis. Plaza Associates recorded rental expenses of approximately $788,000, $900,000 and $900,000 in 1995, 1994 and 1993, respectively, concerning rent owed to Seashore Four. Trump Seashore is the fee owner of a parcel of land constituting a portion of the Plaza Casino Parcel, which it leases to Plaza Associates pursuant to the TSA Lease. In July 1988, Trump Seashore exercised a $10 million option to purchase the fee title to such parcel from a non-affiliated third party. In connection therewith, Trump Seashore was assigned the lessors' interest in the Trump Seashore Lease, which interest has, however, been transferred to UST. See "Business of THCR--Properties." Plaza Associates made rental payments to Trump Seashore of approximately $750,000, $1.0 million and $1.0 million in 1995, 1994 and 1993, respectively. Trump World's Fair. In June 1989, Trump Crystal Tower Associates Limited Partnership ("Trump Crystal"), a New Jersey limited partnership wholly owned by Trump, acquired from Elsinore Shore Associates all of the assets constituting the former Atlantis Casino Hotel ("Atlantis"), which is located on The Boardwalk adjacent to the Atlantic City Convention Center on the opposite side from Trump Plaza and is otherwise referred to herein as Trump World's Fair. Prior to such acquisition, all of the Atlantis' gaming operations were discontinued. The facility was renamed the Trump Regency Hotel and, in August 1990, pursuant to a triple net lease with an affiliate of Plaza Associates, leased to Plaza Associates, which operated it solely as a non- casino hotel. During such period of operation, losses attributable to the former Trump Regency Hotel aggregating approximately $14.1 million adversely affected the results of operations of Plaza Associates. Pursuant to the 1992 Plaza Restructuring, Plaza Associates ceased operating the former Trump Regency Hotel as of September 30, 1992. As part of the 1992 Plaza Restructuring, the triple-net lease was terminated and Plaza Associates issued to Chemical Bank ("Chemical"), the assignee of rents payable under such lease, a promissory note in the original principal amount of $17.5 million (the "Regency Note"). At such time, title to the former Trump Regency Hotel was transferred by Trump to ACFH Inc. ("ACFH"), a wholly owned subsidiary of Chemical. From that time until June 12, 1995, the former Trump Regency Hotel was operated on behalf of ACFH as a non-casino hotel by Sovereign Management, a third party unaffiliated with THCR, Trump or their respective affiliates. Pursuant to an agreement between Trump Crystal, and ACFH, Trump Crystal granted ACFH a non-exclusive license to use the "Trump" name in connection with such property. Plaza Associates repaid the Regency Note with a portion of the proceeds from the sale of the Plaza Mortgage Notes and PIK Notes. In December 1993, Trump entered into an option agreement (the "Original Chemical Option Agreement") with Chemical and ACFH. The Original Chemical Option Agreement granted to Trump an option to purchase (i) the former Trump Regency Hotel (including the land, improvements and personal property used in the operation of the hotel) and (ii) certain promissory notes (including a personal promissory note of Trump payable to Chemical for $35.9 million (the "Trump Note")) made by Trump and/or certain of his affiliates and payable to Chemical (the "Chemical Notes") which are secured by certain real estate assets located in New York, unrelated to Plaza Associates, including the Trump Note which was made by Trump on July 20, 1987. As of September 30, 1995, the aggregate amount owed by Trump and his affiliates under the Chemical Notes (none of which constitutes an obligation of Plaza Associates) was approximately $65.8 million. In connection with exercise of the Trump World's Fair Purchase Option, as discussed below, the Trump Note was canceled. The aggregate purchase price payable for the assets subject to the Original Chemical Option Agreement was $80 million. Under the terms of the Original Chemical Option Agreement, $1 million was required to be paid for the option by January 5, 1994. In addition, the Original Chemical Option Agreement provided for an expiration of the option on May 8, 1994, subject to an extension until June 30, 1994 upon payment of an additional $250,000 on or before May 8, 1994. The Original Chemical Option Agreement did not allocate the purchase price among the assets subject to the option or permit the option to be exercised for some, but not all, of such assets. In connection with the execution of the Original Chemical Option Agreement, Plaza Associates was to make the initial $1 million payment, and, in consideration of such payment to be made by Plaza Associates, Trump agreed with Plaza Associates that, if Trump was able to acquire the former Trump Regency Hotel pursuant to the exercise of the option, he would make it available for the sole benefit of Plaza Associates on a basis consistent with Plaza Associates' contractual obligations and requirements. Trump further agreed that Plaza Associates would not be required to pay any additional consideration to Trump in connection with any assignment to Plaza Associates of the option to purchase the former Trump Regency Hotel. On January 5, 1994, Plaza Associates obtained the approval of the CCC to make the $1 million payment, and the payment was made on that date. On June 16, 1994, Trump, Chemical and ACFH amended and restated the Original Chemical Option Agreement (the "First Amended Chemical Option Agreement"). The First Amended Chemical Option Agreement provided for an extension of the expiration of the option through September 30, 1994, upon payment of $250,000. Such payment was made on June 27, 1994. The First Amended Chemical Option Agreement provided for a $60 million option price for the former Trump Regency Hotel and the Trump Note, and a separate $20 million option price for the other Chemical Notes. On August 30, 1994, Trump, Chemical and ACFH entered into an amendment to the First Amended Chemical Option Agreement (the "Second Amended Chemical Option Agreement"). The Second Amended Chemical Option Agreement provided for an extension of the expiration of the option through March 31, 1995 upon the payment of $50,000 a month for the period October through December 1994, and $150,000 a month for the period January through March 1995. Plaza Associates received the approval of the CCC and has made such payments. On March 6, 1995, Trump, Chemical and ACFH entered into an amendment to the Second Amended Chemical Option Agreement (the "Third Amended Chemical Option Agreement") or the Trump World's Fair Purchase Option. On June 12, 1995, Trump exercised the Trump World's Fair Purchase Option for $58,150,000 ($60 million less $1,850,000 in option payments which were available as of that date to offset the original exercise price), and title to Trump World's Fair was transferred via directed deed from ACFH to Plaza Associates. In connection with the exercise of the Trump World's Fair Purchase Option, the Trump Note was canceled. THCR is currently in the process of renovating and integrating Trump World's Fair into Trump Plaza. See "Business of THCR--Trump Plaza--The Trump Plaza Expansion." Trump Plaza East. In 1993, Plaza Associates received the approval of the CCC, subject to certain conditions, for the expansion of its hotel facilities at Trump Plaza East. On June 24, 1993, in connection with the 1993 refinancing of Trump Plaza, (i) Trump transferred title to Trump Plaza East to Missouri Boardwalk, Inc. ("Boardwalk"), a wholly owned subsidiary of Midlantic National Bank ("Midlantic"), in exchange for a reduction in indebtedness to Midlantic in an amount equal to the sum of fair market value of Trump Plaza East and all rent payments made to Boardwalk by Trump under the Trump Plaza East Lease (as defined), (ii) Boardwalk leased Trump Plaza East to Trump (the "Trump Plaza East Lease") for a term of five years, which expires on June 30, 1998, during which time Trump was obligated to pay Boardwalk $260,000 per month in lease payments, and (iii) Plaza Associates acquired the Trump Plaza East Purchase Option. In October 1993, Plaza Associates assumed the Trump Plaza East Lease and related expenses. In addition, Plaza Associates has the Right of First Offer upon any proposed sale of all or any portion of the fee interest in Trump Plaza East during the term of the Trump Plaza East Purchase Option. Pursuant to the Right of First Offer, Plaza Associates has ten days after receiving written notice from the grantor of the proposed sale to commit to exercise the Right of First Offer. If Plaza Associates commits to exercise the Right of First Offer, it has ten days from the date of commitment to deposit $3,000,000 with the grantor, to be credited towards the purchase price or to be retained by the grantor if the closing, through no fault of the grantor, does not occur within 90 days (or, subject to certain conditions, 120 days) of the date of the commitment. If Plaza Associates determines not to timely exercise the Right of First Offer, the grantor thereof may sell Trump Plaza East to a third party, subject, however, to the Trump Plaza East Purchase Option and the lease associated with Trump Plaza East. Trump, individually, also has been granted by such lender the Right of First Offer upon a proposed sale of all or any portion of Trump Plaza East during the term of the Trump Plaza East Purchase Option. Trump has agreed with Plaza Associates that his Right of First Offer will be subject to Plaza Associates' prior exercise of its Right of First Offer (with any decision of Plaza Associates requiring the approval of the independent directors of Plaza Funding, acting as the managing general partner of Plaza Associates). Acquisition of Trump Plaza East by Plaza Associates would under certain circumstances (provided there are no events of default under the Trump Plaza East Lease or the Trump Plaza East Purchase Option and provided that certain other events had not theretofore or do not thereafter occur) discharge Trump's obligation to Midlantic in full. TPM Services Agreement. On June 24, 1993, Plaza Associates and TPM entered into the TPM Services Agreement which amended and restated an earlier services agreement. Pursuant to the TPM Services Agreement, TPM is required to provide to Plaza Associates, from time to time when reasonably requested, consulting services on a non-exclusive basis, relating to marketing, advertising, promotional and other similar and related services (the "TPM Services") with respect to the business and operations of Plaza Associates. In addition, the TPM Services Agreement contains a non-exclusive "license" of the "Trump" name. TPM is not required to devote any prescribed amount of time to the performance of its duties. In consideration for the TPM Services, Plaza Associates pays TPM an annual fee of $1.0 million in equal monthly installments. In addition to such annual fee, Plaza Associates reimburses TPM on a monthly basis for all reasonable out-of-pocket expenses incurred by TPM in performing its obligations under the Trump Plaza Services Agreement. Plaza Associates paid TPM $1,321,000, $1,288,000 and $1,247,000 in 1995, 1994 and 1993, respectively, for the TPM Services. Pursuant to the TPM Services Agreement, Plaza Associates will agree to hold TPM, its officers, directors and employees harmless from and against any loss arising out of or in connection with the performance of the TPM Services and to hold Trump harmless from and against any loss arising out of the license of the "Trump" name. The TPM Services Agreement provides that its term is coextensive with the period during which any Plaza Mortgage Notes remain outstanding. Payments received under the TPM Services Agreement are currently pledged by TPM to secure lease payments for a helicopter that TPM makes available to Plaza Associates. Pending approval by the lessor of the helicopter, it is currently contemplated that the stock of TPM will be transferred by Trump to THCR Holdings, which will in turn assume the lease and related obligations, as well as become entitled to all amounts payable under the TPM Services Agreement. Indemnification Agreements. In addition to the indemnification provisions in THCR's and its subsidiaries' employment agreements (see "Management of THCR--Employment Agreements"), certain former and current Directors of Plaza Funding entered into separate indemnification agreements in May 1992 with Plaza Associates pursuant to which such persons are afforded the full benefits of the indemnification provisions of the partnership agreement governing Plaza Associates. Plaza Associates has also entered into an Indemnification Trust Agreement in November 1992 (the "Trust Agreement") with Midlantic National Bank (the "Indemnification Trustee") pursuant to which the sum of $100,000 was deposited by Plaza Associates with the Indemnification Trustee for the benefit of the Directors of Plaza Funding and certain former Directors of Trump Plaza GP to provide a source for indemnification for such persons if Plaza Associates, Plaza Funding or Trump Plaza GP, as the case may be, fails to immediately honor a demand for indemnification by such persons. The indemnification agreements with the directors of Plaza Funding and Directors of Trump Plaza GP were amended in June 1993 to provide, among other things, that Plaza Associates would maintain directors' and officers' insurance covering such persons during the ten-year term (subject to extension) of the Indemnification Agreements; provided, however, that if such insurance would not be available on a commercially practicable basis, Plaza Associates could, in lieu of obtaining such insurance, annually deposit an amount in the Indemnification Trust Fund equal to $500,000 for the benefit of such directors; provided, however, that deposits relating to the failure to obtain such insurance shall not exceed $2.5 million. On January 8, 1996, as an inducement for Taj Holding, THCR and Merger Sub to enter into the Merger Agreement, Trump agreed to vote, or cause to be voted, all shares of Taj Holding Class C Common Stock beneficially owned by Trump in favor of the approval and adoption of the Merger Agreement. During the fiscal years ended December 31, 1993, 1994 and 1995, Taj Associates reimbursed Taj Holding $1,733,000, $2,171,000 and $1,553,000, respectively, for all amounts necessary to permit TM/GP or Taj Holding (a) to make payments that TM/GP or Taj Holding was required to make pursuant to the terms of the TM/GP Certificate of Incorporation and the Taj Holding Certificate of Incorporation (generally for indemnification of officers and directors), (b) to pay fees to directors (including fees for serving on a committee), (c) to pay all other expenses of TM/GP and Taj Holding and (d) to permit Taj Holding to redeem the Taj Holding Class B Common Stock when required to make such redemption pursuant to the terms of the Taj Holding Certificate of Incorporation. Taj Holding did not engage in any other transactions with its affiliates during the fiscal years ended December 31, 1993, 1994 and 1995. Taj Funding has not engaged in any transactions with its affiliates, except for the loan of funds made to Taj Associates in exchange for an intercompany note secured by a mortgage. Both the note and the mortgage were amended in 1991 pursuant to the 1991 Taj Restructuring. Taj Associates has entered into a lease with The Trump-Equitable Fifth Avenue Co., a corporation wholly owned by Trump, for the lease of office space in The Trump Tower in New York City, which Taj Associates uses as a marketing office. The monthly payments under the lease had been $1,000, and the premises were leased at such rent for four months in 1992, the full twelve months in 1993 and 1994 and eight months in 1995. On September 1, 1995, the lease was renewed for a term of five years with an option for Taj Associates to cancel the lease on September 1 of each year, upon six months' notice and payment of six months' rent. Under the renewed lease, the monthly payments are $2,184. Taj Associates currently leases the Specified Parcels from Realty Corp., consisting of land adjacent to the site of the Taj Mahal, which is being used primarily for a bus terminal, surface parking and the Taj Entertainment Complex, as well as the Steel Pier, and a warehouse complex. During 1993, 1994 and 1995, lease obligations to Realty Corp. for these facilities were approximately $3.3 million per year. Upon consummation of the Merger Transaction, Taj Associates will purchase the Specified Parcels from Realty Corp. See "The Merger Transaction." In April 1991, Taj Associates purchased from Trump's Castle Associates for $1,687,000 two adjacent parcels of land on the Pleasantville-Egg Harbor Township border, constituting approximately 10 acres. The first parcel contains two buildings, certain fleet maintenance facilities and an office building and warehouse facility, portions of which were leased to Trump Plaza Associates. The lease expired in March 1993 and Trump Plaza Associates has vacated. Taj Associates currently leases the space to a commercial tenant. The second parcel is unimproved. In December 1994, Taj Associates entered into a one-year agreement with TCA pursuant to which TCA leases to Taj Associates 300 parking spaces (500 parking spaces during the months of May to September) at a rate of 50 cents per space per day, to be used for employee parking. The agreement expired in December 1995, however, TCA and Taj Associates are currently negotiating an extension of the agreement and have agreed to continue the lease on a month-by-month basis. Taj Associates engages in various transactions with Trump Plaza and Trump's Castle. These transactions are charged at cost or normal selling price in the case of retail items and include certain shared payroll costs as well as complimentary services offered to customers. Expenses incurred by Taj Associates payable to TCA for the years ended December 31, 1993, 1994 and 1995 were approximately $1,100,000, $1,167,000, and $1,056,000, respectively, of which all but $69,000, $30,000, and $148,000, respectively, was paid or offset against amounts owed to Taj Associates by TCA. Expenses incurred by Taj Associates payable to the Plaza Associates for the years ended December 31, 1993, 1994 and 1995 were approximately $83,000, $149,000 and $339,000, respectively, all of which were offset against amounts owed to Taj Associates by Plaza Associates, with exception of $61,000 at December 31, 1995. On October 4, 1991, Taj Associates entered into the Taj Associates-First Fidelity Guarantee to guarantee performance by Realty Corp. of its obligations under the First Fidelity Loan. The Taj Associates-First Fidelity Guarantee is limited to any deficiency in the amount owed under the First Fidelity Loan when due, up to a maximum of $30 million. In connection with the Merger Transaction and the payment of $[50] million and [500,000 shares of THCR Common Stock] to First Fidelity in complete satisfaction of the obligations due under the First Fidelity Loan contemplated thereby, First Fidelity will, among other things, release Taj Associates from the Taj Associates-First Fidelity Guarantee. See "Business of Taj Holding--Certain Indebtedness--First Fidelity Loan/Specified Parcels." During 1992 and prior years, Taj Associates had an arrangement with the Trump Shuttle, Inc. (the "Trump Shuttle"), which at the time was beneficially owned by Trump, for the provision of airline services to Atlantic City on behalf of Taj Associates patrons. During 1992, Taj Associates incurred $29,000 in charges from the Trump Shuttle, all of which was paid. Taj Services Agreement. Taj Associates and Trump have entered into the Taj Services Agreement, which became effective in April 1991, and which provides that Trump will render to Taj Associates marketing, advertising, promotional and related services with respect to the business operations of Taj Associates through December 31, 1999. In consideration for the services to be rendered, Taj Associates pays an annual fee (the "Annual Fee") equal to 1 1/2% of Taj Associates' earnings before interest, taxes and depreciation less capital expenditures for such year, with a minimum base fee of $500,000 per annum. The base fee is payable monthly with the balance due April 15 of the following year. During 1993, 1994 and 1995, Trump earned approximately $1,566,000, $1,353,000 and $1,862,000, respectively, in respect of the Annual Fee, including amounts paid to a third party pursuant to an assignment agreement. In addition to the Annual Fee, Taj Associates reimburses Trump on a monthly basis for all reasonable out-of-pocket expenses up to certain aggregate amounts incurred by Trump in performing his obligations under the Taj Services Agreement. During 1993, 1994 and 1995, Taj Associates reimbursed Trump $232,000, $224,000 and $166,000, respectively, for expenses pursuant to the Taj Services Agreement, of which $127,000, $148,000 and $105,000, respectively, was incurred to an affiliate for air transportation. Taj Associates has agreed to indemnify Trump from and against any licensing fees arising out of his performance of the Taj Services Agreement, and against any liability arising out of his performance of the Taj Services Agreement, other than that due to his gross negligence or willful misconduct. In connection with the Merger, the Taj Services Agreement will be terminated. Indemnification Agreements. In addition to the indemnification provisions in Taj Associates employment agreements (see "Management of Taj Holdings-- Employment Agreements"), the Merger Agreement provides for indemnification of any present or former director, officer, employee or agent of Taj Holding and TM/GP, arising from his services as such, within six years of the Effective Time. See "The Merger Transaction--Indemnification and Insurance." SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF THCR The following table sets forth, as of December 31, 1995 (without giving effect to the transactions contemplated by the Merger Transaction), certain information regarding the beneficial ownership of THCR Common Stock by (i) each of THCR's executive officers, (ii) each director of THCR, (iii) each person who is known to THCR to own beneficially more than 5% of the THCR Common Stock and (iv) all officers and directors of THCR as a group. Such information is based, in part, upon information provided by certain stockholders of THCR. In the case of persons other than members of the officers and directors of THCR, such information is based solely on a review of Schedules 13G filed with the SEC. The above persons have sole voting and investment power, unless otherwise indicated. * Less than 1%. (1) These shares include 6,666,667 shares of THCR Common Stock, into which Trump's limited partnership interest in THCR Holdings is convertible, subject to certain adjustments. See "Description of the THCR Holdings Partnership Agreement." These shares do not include 300 shares of THCR Common Stock held by his wife, Mrs. Marla M. Trump, of which shares Trump disclaims beneficial ownership. Trump is also the beneficial owner of the outstanding shares of the THCR Class B Common Stock (1,000 shares). The THCR Class B Common Stock has voting power equivalent to the voting power of the THCR Common Stock into which Trump's limited partnership interest is convertible. Upon conversion of all or any portion of the THCR Holdings limited partnership interest into shares of THCR Common Stock, the corresponding voting power of the THCR Class B Common Stock will be proportionately diminished. See "Description of THCR Capital Stock." (2) Represents a stock bonus awarded to the President of THCR pursuant to the 1995 Stock Plan. See "Management of THCR--Executive Compensation." These shares do not include 3,081 shares and 2,739 shares held by Mr. Ribis as custodian for his son, Nicholas L. Ribis, Jr., and his daughter, Alexandria Ribis, respectively, of which shares Mr. Ribis disclaims beneficial ownership. (3) Mr. Burke shares voting and dispositive power of 100 of these shares with his wife. The number in the table does not include 100 shares beneficially owned solely by his wife, of which shares Mr. Burke disclaims beneficial ownership. (4) 333 South Hope Street, Los Angeles, California 90071. The Capital Group Companies, Inc. ("Capital Group") has sole dispositive power over these shares and sole voting power over 256,000 of these shares. These shares include 410,000 and 654,000 shares beneficially owned by Capital Research and Management Company ("Capital Research") and Capital Guardian Trust Company ("Capital Guardian"), respectively. Capital Group is the parent holding company of Capital Research and Capital Guardian. Capital Group, Capital Research and Capital Guardian disclaim beneficial ownership of these shares. (5) One Financial Center, 30th Floor, Boston, Massachusetts 02111. State Street Research and Management Company ("State Street") is an investment adviser and disclaims beneficial ownership of these shares. Metropolitan Life Insurance Company, One Madison Avenue, New York, New York 10010, is the parent holding company of State Street. (6) Oppenheimer Tower, World Financial Center, New York, New York 10281. Oppenheimer Group, Inc. ("Oppenheimer") has shared voting and dispositive power over these shares. These shares include 1,029,300 shares beneficially owned by Oppenheimer Capital, an investment adviser, of which Oppenheimer is the parent holding company. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Taj Holding Class A Common Stock and Taj Holding Class B Common Stock. The following tables set forth, as of December 31, 1995 (without giving effect to the Merger Transaction), certain information regarding the beneficial ownership of the Taj Holding Class A Common Stock and Class B Common Stock by each person who is known to Taj Holding to own beneficially more than 5% of Taj Holding Class A Common Stock and Taj Holding Class B Common Stock. Such information is based, in part, upon information provided by certain of the stockholders identified below. Such information is based solely on information provided to Taj Holding by such persons. No directors or executive officers of Taj Holding beneficially own any shares of Taj Holding Class A Common Stock or Taj Holding Class B Common Stock. BENEFICIAL OWNERSHIP OF TAJ HOLDING CLASS A COMMON STOCK The above persons have sole voting and investment power, unless otherwise indicated. (1) 48 Par La Ville Road, Suite 463, Hamilton MH11, Bermuda. (2) One Seaport Plaza, New York, NY 08401. (3) One Post Office Square, Boston, MA 02109. (4) 950 Third Avenue, New York, NY 10022. (5) 512 Fifth Avenue, New York, NY 10022 (6) Party to the Class A Agreement. See "Special Factors--Background to the Merger Transaction." BENEFICIAL OWNERSHIP OF TAJ HOLDING CLASS B COMMON STOCK (1) 120 South LaSalle Street, Chicago, IL 60603. Kemper Financial Services, Inc., a wholly owned subsidiary of Kemper Financial Companies, Inc., serves as an investment advisor to certain mutual funds and various other managed accounts, including those which hold Taj Holding Class B Common Stock. As a result, Kemper Financial Services, Inc. shares with such mutual funds and managed accounts voting and dispositive power over the shares of Taj Holding Class B Common Stock held by those entities. (2) One Post Office Square, Boston, MA 02109. Putnam Investment Management, Inc. serves as an investment advisor to Putnam Funds, and as a result shares with each Putnam Fund voting and dispositive power over the shares of Taj Holding Class B Common Stock held by Putnam Funds. Marsh & McLennan Companies, Inc. and Putnam Investments, Inc. are deemed to control Putnam Investment Management, Inc., and are each therefore deemed to beneficially own Putnam Investment Management, Inc.'s shares of Taj Holding Class B Common Stock reported above. Marsh & McLennan Companies, Inc. is the controlling shareholder of Putnam Investment Management, Inc. Except as otherwise noted above, Taj Holding believes the beneficial holders listed above have sole voting and investment power regarding the shares of Taj Holding Class A Common Stock and Taj Holding Class B Common Stock shown as being beneficially owned by them. Taj Holding Class C Common Stock. Trump, a Class C Director of Taj Holding, owns 100% of the outstanding shares of Taj Holding Class C Common Stock. DESCRIPTION OF THCR CAPITAL STOCK The following summary description of the capital stock of THCR does not purport to be complete and is qualified in its entirety by reference to the THCR Certificate of Incorporation and the THCR By-Laws, copies of which are filed as exhibits to this Registration Statement of which this Proxy Statement-Prospectus is a part. The authorized capital stock of THCR consists of (i) 50,000,000 shares of THCR Common Stock, of which 10,066,667 shares are currently issued and outstanding, (ii) 1,000 shares of THCR Class B Common Stock, all of which are currently issued and outstanding, and (iii) 1,000,000 shares of Preferred Stock, par value $1.00 per share (the "THCR Preferred Stock"), none of which are issued and outstanding. Upon consummation of the Merger Transaction (assuming all of the holders of Taj Holding Class A Common Stock elect Stock Consideration and assuming a price of $ per share of THCR Common Stock as the Market Value in connection with the Merger and as the public offering price in the THCR Stock Offering), there will be shares of THCR Common Stock outstanding. THCR COMMON STOCK AND THCR CLASS B COMMON STOCK Holders of THCR Common Stock are entitled to one vote for each share held on all matters submitted to a vote of stockholders and do not have cumulative voting rights. Subject to the rights of the holders of the THCR Class B Common Stock described below, holders of a majority of the shares of THCR Common Stock entitled to vote in any election of directors and may elect all of the directors standing for election. Holders of THCR Common Stock are entitled to receive ratably such dividends, if any, as may be declared by the THCR Board of Directors out of funds legally available therefor. Upon the liquidation, dissolution or winding up of THCR, the holders of THCR Common Stock and THCR Class B Common Stock will share ratably, out of the assets of THCR legally available for distribution to its stockholders, to the extent of their par value, $.01 per share. After such payment is made, the holders of the THCR Common Stock will be entitled to participate ratably in all of the remaining assets of THCR available for distribution. Holders of THCR Common Stock have no subscription, redemption or conversion rights. Holders of THCR Common Stock have no preemptive rights to subscribe to any additional securities that THCR may issue, nor is the THCR Common Stock subject to calls or assessments by THCR. All the outstanding shares of THCR Common Stock are, and the shares of THCR Common Stock to be issued in connection with the Merger Transaction, when issued and paid for will be, fully paid and non-assessable. The rights, preferences and privileges of holders of THCR Common Stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of THCR Preferred Stock that THCR may designate and issue in the future. Trump is the beneficial owner of all 1000 outstanding shares of THCR Class B Common Stock. The THCR Class B Common Stock votes together with the THCR Common Stock as a single class on all matters submitted to stockholders of THCR for a vote or in respect of which consents are solicited (other than in connection with certain amendments of the THCR Certificate of Incorporation described below). The number of votes represented by the THCR Class B Common Stock held by any holder equals the number of shares of THCR Common Stock issuable to the holder upon the conversion of such holder's partnership interest in THCR Holdings into THCR Common Stock. Upon such conversion, the corresponding voting power of shares of THCR Class B Common Stock (equal in voting power to the number of shares of THCR Common Stock issued upon such conversion) will be proportionately diminished. The THCR Class B Common Stock provides Trump with a voting interest in THCR which is proportionate to his equity interest in THCR Holdings' assets represented by his limited partnership interest. Except for the right to receive par value upon liquidation, the THCR Class B Common Stock has no right to receive any dividend or other distribution in respect of the equity of THCR. In addition, the THCR Certificate of Incorporation provides that the THCR Class B Common Stock is not entitled to a separate class vote on any matters submitted to the stockholders of THCR for their approval, except for any amendment of the terms of the THCR Class B Common Stock, which require (x) the affirmative vote of the THCR Class B Common Stock, voting as a separate class, and (y) the affirmative vote of a majority of the shares of THCR Common Stock held by persons who are not beneficial owners of THCR Class B Common Stock, voting as a separate class. In accordance with the requirements of the Casino Control Act, the Indiana Riverboat Gambling Act and the Mississippi Gaming Control Act, the THCR Certificate of Incorporation provides that all securities of THCR are held subject to the condition that, if a holder thereof is found to be disqualified, such holder shall: (a) dispose of his interest in THCR; (b) not receive any dividends or interest upon any such securities; (c) not exercise, directly or indirectly or through any trustee or nominee, any right conferred by such securities; and (d) not receive any remuneration in any form from the casino license for services rendered or otherwise. The THCR Certificate of Incorporation further provides that THCR may redeem any shares of THCR's capital stock held by any person or entity whose holding of shares may cause the loss or non-reinstatement of a governmental license held by THCR. Such redemption shall be at the lesser of fair market value (as defined in the THCR Certificate of Incorporation), or the purchase price of such capital stock. The THCR Certificate of Incorporation may also contain other provisions required by the gaming laws of other jurisdictions. The Transfer Agent for the THCR Common Stock is Continental Stock Transfer & Trust Company, Jersey City, New Jersey. THCR's Board of Directors may, without further action by THCR's stockholders, issue THCR Preferred Stock in one or more series and fix the rights, preferences, privileges, qualifications, limitations and restrictions of the THCR Preferred Stock including dividend rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of such series. The issuance of THCR Preferred Stock may have the effect of delaying, deferring or preventing a change in control of THCR without further action by the stockholders and may adversely affect the voting and other rights of the holders of THCR Common Stock. At present, THCR has no plans to issue any of the THCR Preferred Stock. PROVISIONS HAVING POSSIBLE ANTI-TAKEOVER EFFECTS The THCR Certificate of Incorporation and the THCR By-Laws contain provisions that could have anti- takeover effects. These provisions are intended to enhance the likelihood of continuity and stability in the composition of the Board of Directors of THCR and in the policies formulated by the Board of Directors of THCR and to discourage certain types of transactions which may involve an actual or threatened change of control of THCR. The provisions are designed to reduce the vulnerability of THCR to an unsolicited proposal for a takeover of THCR that does not contemplate the acquisition of all of its outstanding shares or an unsolicited proposal for the restructuring or sale of all or part of THCR. The provisions are also intended to discourage certain tactics that may be used in proxy fights. The Board of Directors of THCR believes that, as a general rule, such takeover proposals would not be in the best interest of THCR and its stockholders. Set forth below is a description of such provisions in the THCR Certificate of Incorporation and the THCR By-Laws. The Board of Directors of THCR has no current plans to formulate or effect additional measures that could have an anti-takeover effect. The THCR Certificate of Incorporation provides that directors, other than those, if any, elected by the holders of THCR Preferred Stock, can be removed from office only for cause and only by the affirmative vote of the holders of at least 66 2/3% of the combined voting power of the then outstanding shares of capital stock entitled to vote thereon ("THCR Voting Stock"). Pursuant to the By-Laws, newly created directorships resulting from any increase in the authorized number of directors and any vacancies on the Board of Directors of THCR may be filled by the affirmative vote of a majority of the remaining directors. Except as otherwise provided for with respect to the rights of the holders of THCR Preferred Stock, the THCR Certificate of Incorporation provides that the whole Board of Directors of THCR will consist of that number of directors determined from time to time by the Board of Directors of THCR. The THCR By-Laws establish an advance notice procedure with regard to the nomination, other than by or at the direction of the Board of Directors of THCR or a committee thereof, of candidates for election as directors and with regard to certain other matters to be brought before an annual meeting of stockholders of THCR. In general, notice must be received by THCR not later than 10 days after the public announcement of the meeting date and must contain certain specified information concerning the matters to be brought before the meeting and the stockholder submitting the proposal. In addition, the THCR Certificate of Incorporation provides that whenever any vote of THCR Voting Stock is required by law to amend, alter, repeal or rescind any provision thereof, then, in addition to any affirmative vote required by law or any required vote of the holders of THCR Preferred Stock, the affirmative vote of at least a majority of the combined voting power of the then-outstanding shares of THCR Voting Stock and approval by at least a majority of the then-authorized number of directors of THCR is required to amend certain provisions of the THCR Certificate of Incorporation; provided, however, that if any such amendment, alteration, repeal, or rescission (a "THCR Change") relates to those provisions or to removal of directors, such THCR Change must also be approved by the affirmative vote of the holders of at least 66 2/3% of the combined voting power of the then-outstanding shares of THCR Voting Stock, voting together as a single class and, if at the time there exist one or more THCR Related Persons (as defined), such THCR Change must also be approved by the affirmative vote of the holders of at least a majority of the combined voting power of the Disinterested Shares (defined in the THCR Certificate of Incorporation as, to any THCR Related Person, shares of THCR Voting Stock that are beneficially owned and owned of record by stockholders other than such THCR Related Person). A "THCR Related Person" means any person, entity or group which beneficially owns 10% or more of the outstanding voting stock of THCR, provided, however, that Trump and his affiliates are not deemed to be a THCR Related Person. The THCR Certificate of Incorporation provides that the vote(s) required by the immediately preceding provision shall not be required if such THCR Change has been first approved by at least two-thirds of the then- authorized number of directors of THCR and, if at the time there exist one or more THCR Related Persons, by a majority of the THCR Continuing Directors (as defined with respect to any THCR Related Person to be any member of the Board of Directors of THCR who (i) is unaffiliated with and is not the THCR Related Person and (ii) became a member of the Board of Directors of THCR prior to the time that the THCR Related Person became a THCR Related Person, and any successor of a THCR Continuing Director who is recommended to succeed a THCR Continuing Director by a majority of THCR Continuing Directors then on the Board of Directors of THCR). The THCR Certificate of Incorporation provides that the THCR By-Laws may be adopted, altered, amended or repealed by the stockholders of THCR or by a majority vote of the entire Board of Directors of THCR. The THCR Certificate of Incorporation provides that, except as otherwise provided for with respect to the rights of the holders of THCR Preferred Stock, no action that is required or permitted to be taken by the stockholders of THCR at any annual or special meeting of stockholders may be effected by written consent of stockholders in lieu of a meeting of stockholders, unless the action to be effected by written consent of stockholders and the taking of such action by such written consent have expressly been approved in advance by the Board of Directors of THCR and, if such action involves a "business combination" within the meaning of Section 203 of the DGCL, such written consent shall have expressly been approved in advance by the affirmative vote of at least a majority of the THCR Continuing Directors then in office. DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS THCR is subject to the provisions of Section 203 of the DGCL. Section 203 of the DGCL prohibits a publicly held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. A "business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, an "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years did own, 15% of the corporation's voting stock. Neither Trump nor any of his affiliates is deemed to be an "interested stockholder" for purposes of Section 203 of the DGCL. The THCR Certificate of Incorporation contains certain provisions permitted under the DGCL relating to the liability of directors. The provisions eliminate a director's liability for monetary damages for a breach of fiduciary duty, except in certain circumstances involving wrongful acts, such as the breach of a director's duty of loyalty or acts or omissions which involve intentional misconduct or a knowing violation of law. Furthermore, the THCR Certificate of Incorporation and the THCR By-Laws contain provisions to indemnify THCR's directors and officers to the fullest extent permitted by the DGCL, including payment in advance of a final disposition of a director's or officer's expenses and attorneys' fees incurred in defending any action, suit or proceeding. THCR believes that these provisions assist THCR in attracting and retaining qualified individuals to serve as directors. DESCRIPTION OF THE THCR HOLDINGS PARTNERSHIP AGREEMENT The following summary of the Amended and Restated Agreement of Limited Partnership of THCR Holdings (the "THCR Holdings Partnership Agreement"), and the description of certain provisions set forth elsewhere in this Proxy Statement-Prospectus is qualified in its entirety by reference to such Partnership Agreement, which is filed as an exhibit to the Registration Statement of which this Proxy Statement-Prospectus is a part. THCR Holdings was formed in 1995 under the Delaware Revised Uniform Limited Partnership Act, as amended (the "Delaware RULPA"). DISTRIBUTIONS AND ALLOCATIONS OF PROFITS AND LOSSES THCR Holdings makes any required distributions to each partner of THCR Holdings (each, a "Partner") for taxes ("Tax Amounts") in one or more payments from time to time during each year, but in no event later than March 1 of the year immediately following such year, in an aggregate cash sum equal to such Partner's percentage interest in Tax Amounts in respect of such year. In general, Tax Amounts for any year are the product of the highest marginal tax rate applicable to any of the Partners (subject to certain limitations) and THCR Holdings' taxable income for such year. The THCR Holdings Partnership Agreement provides that after making the required tax distributions, additional distributions will be made from time to time as determined by a majority of the Board of Directors of THCR, but in any case pro rata in accordance with the Partners' percentage interests. THCR Holdings' ability to make distributions (including tax distributions) are subject to, among other things, limitations set forth in the Senior Note Indenture. See "Risk Factors--Restrictions on Certain Activities." Profits and losses for tax purposes are generally allocated among the partners in accordance with their percentage interests, subject to compliance with the provisions of Section 704(b) and 704(c) of the Code and the Treasury Regulations thereunder governing special allocations of certain partnership items, including the "ceiling rule" set forth in Treasury Regulations Section 1.704-3 (which are not be subject to cure by special allocation except as specifically provided in the THCR Holdings Partnership Agreement). THCR Holdings has agreed that all expenses of THCR shall, to the maximum extent practicable, be paid directly by THCR Holdings. Any other expenses paid directly by THCR are required to be reimbursed promptly by THCR Holdings and are deemed to be expenses of THCR Holdings. As the sole general partner of THCR Holdings, THCR generally has the exclusive rights, responsibilities and discretion in the management and control of THCR Holdings. The limited partners of THCR Holdings (the "Limited Partners") have no authority, as Limited Partners, to transact business or take any acts on behalf of, or make any decision for, THCR Holdings. Trump, however, has the right to control the management of Plaza Associates. In connection with the Merger Transaction, the THCR Holdings Partnership Agreement will be amended to give Trump the right to control the resolution of tax matters affecting or relating to Taj Associates in respect of periods ending on or prior to the date on which Taj Holding acquired its interest in Taj Associates, including requiring THCR Holdings, Taj Holdings LLC and Taj Associates to adjust the tax basis of assets held by Taj Associates in connection with the resolution of such tax matters to the extent such basis adjustments shall not reduce THCR's share of federal income tax depreciation and cost recovery deductions in respect of assets held by Taj Associates as of the date of the Merger and contributions of the interests in Taj Associates to THCR Holdings and Taj Holdings LLC. The THCR Holdings Partnership Agreement provides that THCR shall not, without the consent of a majority-in-interest of the Limited Partners, undertake actions relating to any of the following during such time as the Limited Partners own more than 10% of the outstanding partnership interests in dissolution of THCR Holdings under the Delaware RULPA, the institution of any proceedings for bankruptcy on behalf of THCR Holdings, the making of a general assignment for the benefit of creditors or the appointment of a custodian, receiver or trustee for all or any part of the assets of THCR Holdings. The THCR Holdings Partnership Agreement provides that THCR may not withdraw as general partner of THCR Holdings, or transfer without the consent of a majority-in-interest of the Limited Partners (other than THCR), so long as the Limited Partners hold at least a 10% interest in THCR Holdings; provided, however, that such consent right shall not apply to a determination by THCR or THCR Holdings to enter into a merger, sale, consolidation, combination or similar transaction. A Limited Partner may transfer all or any portion of his interests in THCR Holdings, provided that (i) THCR including a majority of the Special Committee (as defined) consents to such transfer, which consent may not be unreasonably withheld or delayed, except no such consent is required for (a) a transfer of Partnership interests described below under "Exchange and Registration Rights," (b) a transfer to a Permitted Holder (which term includes the spouse and other descendants of such Limited Partner (including any related trusts controlled by, and established and maintained for the sole benefit of, such Limited Partner or such spouse or descendant) and the estate of any of the foregoing), or (c) a transfer upon foreclosure on an interest of a Limited Partner pursuant to certain permitted liens, and (ii) such transfer does not violate certain other restrictions on transfer contained in the THCR Holdings Partnership Agreement. No transferee is admitted as a substitute Limited Partner of THCR Holdings having the rights of a Limited Partner without the consent of THCR, including a majority of the Special Committee. ADDITIONAL CAPITAL CONTRIBUTIONS; ISSUANCE OF ADDITIONAL PARTNERSHIP INTERESTS No Partner is required under the terms of the THCR Holdings Partnership Agreement to make additional capital contributions to THCR Holdings, except as described below in connection with the issuance of additional partnership interests. The THCR Holdings Partnership Agreement provides that no additional Partnership interests will be issued, except in the case of (i) an additional partnership interest to THCR in exchange for a contribution of value from THCR and (ii) an additional limited partnership interest to Trump or his Permitted Holders in exchange for a contribution of value from Trump or his Permitted Holders (as defined in the THCR Holdings Partnership Agreement), as determined by a majority of the Special Committee. The Special Committee is composed of directors who are not officers or employees of THCR and who are not affiliates of Trump or any of his affiliates. The THCR Holdings Partnership Agreement currently provides that THCR will not issue additional debt or equity securities, unless the proceeds of such issuance are contributed to THCR Holdings and that it will not issue any additional shares of THCR Class B Common Stock, except to Trump or his Permitted Holders. In connection with, and in light of the structure necessary to consummate the Merger Transaction, the THCR Holdings Partnership Agreement will be amended to provide that THCR may contribute to THCR Holdings the indirect interests in Taj Associates that THCR acquires in the Merger rather than contribute the proceeds from the THCR Stock Offering to THCR Holdings. Furthermore, the THCR Holdings Partnership Agreement will be amended to provide that THCR Holdings may issue limited partnership interests to TTMI and TM/GP in exchange for the contribution of their respective 49.995% equity interest in Taj Associate, and to provide that THCR may issue shares of THCR Class B Common Stock to TTMI at such as TTMI becomes a Limited Partner. THCR entered into an exchange and registration rights agreement (the "Exchange Rights Agreement") with Trump, pursuant to which, among other things: (i) Trump and his permitted successors and assigns are able to exchange all or any portion of their interest in THCR Holdings for THCR Common Stock and (ii) a majority of the Special Committee has the right to require any holder of a limited partnership interest (other than Trump and his Permitted Holders) to exchange their Partnership interests for THCR Common Stock. The number of shares of THCR Common Stock issuable upon exchange of limited partnership interests are adjusted from time to time to reflect stock dividends, stock splits, reverse stock splits, reclassifications and recapitalizations. The exchange of limited partnership interests for shares of THCR Common Stock under the Exchange Rights Agreement is subject to (i) the expiration or termination of the applicable waiting period, if any, under the Hart-Scott- Rodino Antitrust Improvements Act of 1976, as amended, and (ii) the satisfaction of certain other conditions contained in the Exchange Rights Agreement. The Exchange Rights Agreement provides that, upon a transfer of limited partnership interests in THCR Holdings, the transferee will obtain the benefits of, and be subject to, all of the provisions of the Exchange Rights Agreement. The Exchange Rights Agreement contains certain registration rights under the Securities Act in favor of the holders of the THCR Common Stock issuable upon the exchange of limited partnership interests. The holders of securities representing a majority of the THCR Common Stock issuable upon the exchange of limited partnership interests shall have the right to require THCR, at THCR's expense (other than with respect to underwriting discounts, commissions and fees attributable to the sale of any such Common Stock), subject to certain limitations, to file two registration statements relating to the resale to the public of all or a portion of their THCR Common Stock. In addition, in the event THCR proposes to register any of its THCR Common Stock pursuant to a registration statement under the Securities Act (other than on Forms S-4 or S-8 or other similar successor forms), such holders may, by giving written notice to THCR, request that THCR, at THCR's expense (other than with respect to underwriting discounts, commissions and fees attributable to the sale of any such THCR Common Stock), include in such registered offering all or any part of their THCR Common Stock. THCR is required to include the securities covered by such notice or notices in such registered offering unless THCR determines for any reason not to proceed with the underlying offering of its equity securities or, in the case of an underwritten offering, if the managing underwriter determines that the amount of THCR Common Stock requested to be included in such registration exceeds the amount which can be sold in such offering without adversely affecting the distribution of the securities being offered. TTMI will be granted registration rights with respect to the shares of THCR Common Stock into which its limited partnership interests will be convertible which are similar to those granted to Trump under the Exchange Rights Agreement (as defined). Pursuant to the THCR Holdings Partnership Agreement, THCR is the tax matters partner of THCR Holdings and, as such, has authority to make tax elections under the Code on behalf of THCR Holdings, subject to certain notice and consultation rights in favor of the Limited Partners. The term of the THCR Holdings Partnership Agreement continues until December 31, 2035, or until sooner dissolved upon (i) the dissolution, bankruptcy or termination of THCR, (ii) the election of THCR and a majority-in-interest of the Limited Partners, (iii) the sale or other disposition of all or substantially all the assets of THCR Holdings (but in the event of such sale or transfer, such time of dissolution may be extended, at the option of THCR, until the receipt of substantially all of the proceeds thereof, or a determination by THCR that no material additional proceeds will likely be received), or (iv) the entry of a decree of judicial dissolution of THCR Holdings pursuant to the provisions of the Delaware RULPA, which decree is final and not subject to approval; provided, however, the Limited Partners may elect to continue THCR Holdings. An election to continue THCR Holdings must be unanimous unless the Delaware RULPA permits such election pursuant to the vote of a lesser percentage in interest of the Limited Partners, in which event such election may be by such lesser percentage in interest as is permitted in the Delaware RULPA, but in no event shall such election be by a vote of less than a majority-in-interest of the Limited Partners. Trump received his limited partnership interest in THCR Holdings in exchange for a contribution of, among other things, all of his beneficial interest in Plaza Associates and all of his other existing interests and rights to gaming activities in both emerging and established jurisdictions, including Trump Indiana, but excluding the Taj Mahal and Trump's Castle. Such contribution was made pursuant to the terms of the Contribution Agreement between Trump and THCR Holdings. Under the Contribution Agreement, Trump agreed to pursue, develop and conduct all new casino and gaming opportunities only on behalf of THCR. Trump further agreed not to engage in certain actions in connection with casino and gaming activities, including, without limitation, casino hotels, and related services and products. For purposes of this grant and without limiting its application with respect to other properties, any hotel with gaming conducted on its premises will be considered a casino hotel and any business or activity engaged in by Trump and located in Nevada, Atlantic City (other than the Taj Mahal (prior to the Merger Transaction) and Trump's Castle) or within one mile of a casino will be presumed to be an activity to which these restrictions will apply. Such a presumption may be rebutted by a vote of the majority of the Special Committee. The agreement to offer new gaming opportunities to THCR is for a term of the later of (i) 20 years, (ii) such time as Trump and his affiliates no longer hold a 15% or greater voting interest in THCR or (iii) such time as Trump ceases to be employed or retained pursuant to an employment, management, consulting or similar services agreement with THCR. Trump may generally continue to engage in business as currently conducted or proposed to be conducted at the Taj Mahal (prior to the Merger Transaction) and Trump's Castle. For as long as Trump owns beneficially 20% or more of the voting power of THCR and no other holder owns more voting power of THCR, or such shorter period ending on the date on which no Plaza Mortgage Notes remain outstanding, to the extent required under the Plaza Mortgage Note Indenture, Trump shall retain the right (x) to designate for election a majority of the Board of Directors of Plaza Funding and its successors and assigns and any other managing general partner of Plaza Associates and (y) to control the management of Plaza Associates. See "Risk Factors--Conflicts of Interest" and "--Control and Involvement of Trump." THCR Holdings indemnifies and hold harmless each Partner and its affiliates, and all officers, directors, employees and agents of such Partner and its affiliates (individually, an "Indemnitee") from and against any and all losses, claims, demands, costs, damages, liabilities, joint and several, expenses of any nature (including attorneys' fees and disbursements), judgments, fines, settlements and other amounts arising from any and all claims, demands, actions, suits or proceedings, civil, criminal, administrative or investigative, in which the Indemnitee may be involved, or threatened to be involved, as a party or otherwise, relating to the operations of THCR Holdings, including, without limitation, liabilities under the Federal and state securities laws, regardless of whether the Indemnitee continues to be a Partner, an affiliate of a Partner, or an officer, director, employee, or agent of a Partner or an affiliate of a Partner at the time any such liability or expense is paid or incurred, but only if the act or omission giving rise to such proceeding does not constitute gross negligence or willful misconduct; provided, however, that such indemnification or agreement to hold harmless, will be recoverable only out of assets of THCR Holdings and not from the Partners. The indemnification provided by the THCR Holdings Partnership Agreement is in addition to any other rights to which an Indemnitee may be entitled under any agreement, as a matter of law or equity, or otherwise, both as to action in the Indemnitee's capacity as a Partner, an affiliate of a Partner, or as an officer, director, employee or agent of a Partner or an affiliate of a Partner and as to any action in another capacity, and will continue, with respect to actions relating to the operations of THCR Holdings, as to an Indemnitee who has ceased to serve in such capacity and will inure to the benefit of the heirs, successors, assigns and administrators of the Indemnitee. No Indemnitee may be denied indemnification in whole or in part under the THCR Holdings Partnership Agreement by reason of the fact that the Indemnitee had an interest in the transaction with respect to which the indemnification applies if the transaction was approved in accordance with the THCR Holdings Partnership Agreement. No officer, employee or agent of THCR Holdings has any liability to THCR Holdings or any of its partners for monetary damages for action taken, or any failure to take any action, in such capacity, with certain exceptions. The THCR Holdings Partnership Agreement provides that it is subject to the provisions of the Casino Control Act and the Indiana Riverboat Gambling Act. The THCR Holdings Partnership Agreement further provides that THCR Holdings may redeem the partnership interest held by any person or entity whose holding of such interest may cause the loss or non-reinstatement of any governmental license or permit of THCR Holdings or any of its subsidiaries. Such redemption will be on the terms set forth in the THCR Holdings Partnership Agreement. The THCR Holdings Partnership Agreement provides that, unless a majority-in- interest of the Limited Partners otherwise consents, all business activities of THCR must be conducted through THCR Holdings or its subsidiaries. THCR Holdings is authorized to enter into transactions with partners or their affiliates, as long as the terms of such transactions are fair and reasonable, and no less favorable to THCR Holdings than would be obtained from an unaffiliated third party. Except for certain technical amendments, the THCR Holdings Partnership Agreement may only be amended by THCR, upon the approval of a majority of the Special Committee with the consent of a majority-in- interest of the Limited Partners. Except for Trump's agreement to conduct all new gaming activities through THCR as described above and under "--Contribution Agreement" and "Management of THCR--Employment Agreements," the THCR Holdings Partnership Agreement provides that any Limited Partner may engage in other business activities outside THCR Holdings, including business activities that directly compete with THCR Holdings; provided, however, that no such other activities discriminate against THCR Holdings. See "Risk Factors--Conflicts of Interest" and "--Control and Involvement of Trump." THCR Holdings has agreed to indemnify Trump in the event of the non-payment by THCR Holdings of certain liabilities assumed by THCR Holdings in connection with its formation. The THCR Holdings Partnership Agreement also provides that no additional compensation shall be paid directly or indirectly to Trump under the Trump Executive Agreement or otherwise, unless approved by the Special Committee. Other than the TPM Services Agreement and notwithstanding the foregoing, THCR (including each of its subsidiaries) may not enter into any management, services, consulting, or similar agreements with Trump or any of his affiliates, except for employment agreements in the ordinary course of business consistent with industry practice and approved by the Special Committee. Upon consummation of the Merger Transaction, holders of Taj Holding Class A Common Stock who elect Stock Consideration will become holders of THCR Common Stock. The following is a summary of material differences between the rights of holders of Taj Holding Class A Common Stock and the rights of holders of THCR Common Stock. As each of Taj Holding and THCR is organized under the laws of Delaware, these differences arise principally from provisions of the charter and by-laws of each of Taj Holding and THCR. The following does not purport to be complete statements of the rights of holders of Taj Holding Class A Common Stock under the Taj Holding Certificate of Incorporation and the Taj Holding By-Laws as compared with the rights of holders of THCR Common Stock under the THCR Certificate of Incorporation and THCR By-Laws. These summaries are qualified in their entirety by reference to the DGCL and governing corporate instruments of Taj Holding and THCR. The terms of THCR's capital stock are described in greater detail under "Description of THCR Capital Stock." Copies of the charter and by-laws for each of Taj Holding and THCR are available for inspection at their respective principal executive offices. In addition, the THCR Certificate of Incorporation and the THCR By-Laws are filed as exhibits to the registration statement to which this Proxy Statement-Prospectus is a part, and copies will be sent to holders of Taj Holding Class A Common Stock upon request. Prior to the redemption of the Bonds (the "Bond Redemption"), the Taj Holding Class A Common Stock has no voting rights, except as otherwise provided by law. After the Bond Redemption, the Taj Holding Class A Common Stock and the Taj Holding Class C Common Stock will each be entitled to one vote per share and will vote on all matters on which stockholders are entitled to vote as a single class. In electing directors, the Taj Holding Certificate of Incorporation provides for cumulative voting rights, that is (i) each holder of Taj Holding Class A Common Stock or Taj Holding Class C Common Stock will have that number of votes that such holder would be entitled to cast for the election of directors with respect to such holder's series of stock multiplied by the number of directors to be elected and (ii) such holder may cast all of such votes for a single nominee. Holders of THCR Common Stock are entitled to one vote for each share held on all matters submitted to a vote of stockholders and do not have cumulative voting rights. Subject to the rights of the holders of THCR Class B Common Stock described below, holders of a majority of the shares of THCR Common Stock entitled to vote in any election of directors may elect all of the directors standing for election. The THCR Certificate of Incorporation provides that THCR Class B Common Stock is not entitled to a separate class vote on any matters submitted to the stockholders of THCR for their approval, except for any amendment of the terms of the THCR Class B Common Stock, which require (x) the affirmative vote of the THCR Class B Common Stock, voting as a separate class, and (y) the affirmative vote of a majority of the shares of THCR Common Stock held by persons who are not beneficial owners of the THCR Class B Common Stock, voting as a separate class. Pursuant to the Taj Holding Certificate of Incorporation, the Board of Directors may issue one or more series of preferred stock with such rights and privileges relating to dividends, redemption, liquidation, conversion and voting as it may determined by resolution; provided, however, that the designation of any class of preferred stock may not limit the voting rights of any class of common stock without the consent of the holders of such class. The THCR Certificate of Incorporation provides that the Board of Directors may, without further action by the stockholders, issue preferred stock in one or more series and fix the rights, preferences, privileges, qualifications, limitations and restrictions of the preferred stock including dividend rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of such series. Accordingly, the issuance of THCR Preferred Stock may have the effect deferring or preventing a change in control of THCR without further action by the stockholders and may adversely affect the voting and other rights of the holders of THCR Common Stock. Special Meetings. The Board of Directors may call a special meeting of stockholders. In addition, the Taj Holding By-Laws provide that special meetings of any class of common stock shall be called by the Secretary upon receipt of a request of at least 10% of the outstanding shares of such class. The THCR Certificate of Incorporation provides that special meetings of stockholders may be called by the Board of Directors or the President and shall be called by the President or the Secretary at the request in writing of a director or a majority of the voting stock issued and outstanding. Actions Without a Meeting. The Taj Holding By-Laws allow for any action required or permitted at any annual or special meeting of stockholders to be taken without a meeting, without prior notice and without a vote, if a consent or consents in writing, setting forth the action to be taken, is signed by the holders of at least majority of each class of outstanding stock entitled to vote thereon. The THCR Certificate of Incorporation, provides that, unless provided for or fixed for a series of preferred stock, no action that is required or permitted to be taken by the stockholders at an annual or special meeting may be effected by written consent in lieu of a meeting, unless the action to be effected by written consent and the taking of such action by written consent have expressly been approved in advance by the Board of Directors, and if such matter involves a "business combination" as defined in Section 203 of the DGCL, such written consent shall have expressly been approved in advance by the affirmative vote of at least a majority of the THCR Continuing Directors. Prior to the Bond Redemption, a merger, consolidation or business combination with or into any other entity must be approved by a majority of the shares of the Taj Holding Class B Common Stock. The Taj Holding Certificate of Incorporation, however, does not afford holders of Taj Holding Class A Common Stock such right, before or after the Bond Redemption. Both Taj Holding and THCR are subject to the provisions of Section 203 of the DGCL. Section 203 prohibits a publicly held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. A "business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, an "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years did own, 15% of the corporation's voting stock. Pursuant to the THCR Certificate of Incorporation, neither Trump nor any of his affiliates is deemed to be an "interested stockholder" for purposes of Section 203 of the DGCL. Holders of Taj Holding Class A Common Stock and holders of THCR Common Stock have no preemptive or appraisal rights, except as provided under the DGCL. The Taj Holding Certificate of Incorporation precludes Trump and his affiliates prior to the Bond Redemption from acquiring beneficial ownership of Taj Holding Class A Common Stock, except to satisfy a warrant given to certain class action plaintiffs in connection with the settlement of their claims. After the Bond Redemption there are no further restrictions on beneficial acquisitions of Taj Holding Class A Common Stock by Trump or its affiliates if all the payments made in connection with the Bonds were made in full. The THCR Certificate of Incorporation does not preclude Trump or his affiliates from acquiring THCR Common Stock. In addition, Trump is the beneficial owner of all 1000 outstanding shares of THCR Class B Common Stock, which votes together with the THCR Common Stock as a single class on all matters submitted to stockholders of THCR for a vote or in respect of which consents are solicited (other than in connection with certain amendments to the terms of the THCR Class B Common Stock described above). The number of votes represented by the THCR Class B Common Stock held by any holder equals the number of shares of THCR Common Stock issuable to the holder upon the conversion of such holder's partnership interest in THCR Holdings into THCR Common Stock. Upon such conversion, the corresponding voting power of shares of THCR Class B Common Stock (equal in voting power to the number of shares of THCR Common Stock issued upon such conversion) will be proportionately diminished. General. The Taj Holding Certificate of Incorporation does not authorize the Board of Directors to change the authorized number of directors and provides that the number of directors shall be nine. Prior to the Bond Redemption, the Board of Directors is divided into two classes, the Taj Holding Class B Directors (elected by the holders of the Taj Holding Class B Common Stock) and the Taj Holding Class C Directors (elected by the holders of Taj Holding Class C Common Stock). After the Bond Redemption, all but one of the Taj Holding Class B Directors shall resign and the Board of Directors shall consist of nine unclassified directors. After the Bond Redemption, the Taj Holding directors will be elected by the holders of Taj Holding Class A Common Stock and Taj Holding Class C Common Stock, voting as a single class. The Taj Holding Certificate of Incorporation further provides that, after the Bond Redemption, directors will be elected by the affirmative vote of a plurality of the votes cast thereon. Except as otherwise provided for with respect to the rights of the holders of THCR Preferred Stock, the THCR Certificate of Incorporation and THCR By- Laws provide that the Board of Directors will consist of that number of directors determined from time to time by it, not to exceed fifteen. In addition, the THCR By-Laws establish an advance notice procedure with regard to the nomination, other than by or at the direction of the Board or a committee thereof, of candidates for election as directors and with regard to certain other matters to be brought before an annual meeting of stockholders. In general, notice must be received by THCR not later than 10 days after the public announcement of the meeting date and must contain certain specified information concerning the matters to be brought before the meeting and the stockholder submitting the proposal. Removal of Directors. The Taj Holding By-Laws provide that a director may be removed from office, with or without cause, by a majority vote of the holders of the class of stock that elected such director. Any vacancies in the Board of Directors as the result of the resignation of a director are filled by the then-remaining directors of the same class. The THCR Certificate of Incorporation provides that directors, other than those, if any, elected by the holders of THCR Preferred Stock, can be removed from office only for cause and only by the affirmative vote of the holders of at least 66 2/3% of the THCR Voting Stock. Pursuant to the THCR By-Laws, newly created directorships resulting from any increase in the authorized number of directors and any vacancies on the Board of Directors may be filled by the affirmative vote of a majority of the remaining directors. INDEMNIFICATION AND LIABILITY OF DIRECTORS AND OFFICERS Both the Taj Holding Certificate of Incorporation and the THCR Certificate of Incorporation provide that each of their officers, directors, employees or agents shall be indemnified to the fullest extent permitted under Delaware law. The charters also provide that directors are not liable to Taj Holding and THCR, respectively, or to each of their stockholders, for monetary damages for breach of fiduciary duty, except if such director (i) is liable under Delaware law or (ii) is liable by reason that such director (a) breached the director's duty of loyalty, (b) did not act in good faith, (c) acted in a manner involving intentional misconduct or a knowing violation of law or (d) derived an improper personal benefit. AMENDMENT OF CERTIFICATE OF INCORPORATION AND BY-LAWS Certificate of Incorporation. Prior to the Bond Redemption, any amendment to the Taj Holding Certificate of Incorporation must be approved by a majority of the holders of Taj Holding Class B Common Stock. Thereafter, any amendment requires a majority vote of the Taj Holding Class A Common Stock and Taj Holding Class C Common Stock voting as a single class. The THCR Certificate of Incorporation provides that whenever any vote of THCR Voting Stock is required by law to amend, alter, repeal or rescind any provision thereof, then, in addition to any affirmative vote required by law or any required vote of the holders of THCR Preferred Stock, the affirmative vote of at least a majority of the combined voting power of the then- outstanding shares of THCR Voting Stock and approval by at least a majority of the then- authorized number of directors is required to amend certain provisions of the THCR Certificate of Incorporation; provided, however, that if a THCR Change relates to those provisions or to removal of directors, such THCR Change must also be approved by the affirmative vote of the holders of at least 66 2/3% of the combined voting power of the then-outstanding shares of THCR Voting Stock, voting together as a single class and, if at the time there exist one or more THCR Related Persons, such THCR Change must also be approved by the affirmative vote of the holders of at least a majority of the combined voting power of the Disinterested Shares. The THCR Certificate of Incorporation further provides that the vote(s) required by the immediately preceding provision shall not be required if such THCR Change has been first approved by at least two-thirds of the then- authorized number of directors of THCR and, if at the time there exist one or more THCR Related Persons, by a majority of the THCR Continuing Directors. By-Laws. Taj Holding By-Laws prohibits the Board of Directors from amending the Taj Holding By-Laws, but provides that the holders of every class of stock of Taj Holding entitled to vote thereon may amend the Taj Holding By-Laws; provided that under certain circumstances prior to the Bond Redemption, the holders of Taj Holding Class B Common Stock have the exclusive power to amend the Taj Holding By-Laws. In addition, the Taj Holding Certificate of Incorporation, provides that prior to the Bond Redemption, any amendment to the By-Laws must be approved by a majority of the holders of Taj Holding Class B Common Stock. The THCR Certificate of Incorporation provides that the THCR By-Laws may be adopted, altered, amended or repealed by the vote of a majority of the stockholders of THCR or by a majority vote of the entire Board. In accordance with the requirements of the Casino Control Act, the Taj Holding Certificate of Incorporation provides that all of its securities are held subject to the condition that, if a holder thereof is found to be disqualified, such holder shall: (a) dispose of his interest in Taj Holding; (b) not receive any dividends or interest upon any such securities; (c) not exercise, directly or indirectly or through any trustee or nominee, any right conferred by such securities; and (d) not receive any remuneration in any form from the casino license for services rendered or otherwise. The Taj Holding Certificate of Incorporation further provides that Taj Holding may redeem any shares of capital stock held by any person or entity whose holding of shares may cause the loss or non-reinstatement of a governmental license held by Taj Holding. The redemption shall be at par value per share thereof. The THCR Certificate of Incorporation has similar provisions, but in addition to any terms required by the Casino Control Act, stockholders are also subject to the Indiana Riverboat Gambling Act and gaming laws of other jurisdictions with authority over the business affairs of THCR. Pursuant to the THCR Certificate of Incorporation, in the case of a mandatory redemption of any shares of capital stock held by any person or entity whose holding of shares may cause the loss or non-reinstatement of a governmental license, the redemption shall be at the lesser of fair market value, as defined in the THCR Certificate of Incorporation, or the purchase price of such capital stock. MARKET PRICE AND DIVIDEND DATA The THCR Common Stock is listed on the NYSE under the symbol "DJT." The initial public offering price of the THCR Common Stock was $14.00 per share. The following table reflects the high and low sales prices of the THCR Common Stock as reported by the NYSE. The reported closing sale price of the THCR Common Stock on the NYSE on January 8, 1996, the last full day of trading prior to the announcement of the Merger Transaction, was $ 21 3/4. As of January 9, 1996 there were approximately 211 holders of record of THCR Common Stock. Trump is the sole beneficial owner of all 1,000 outstanding shares of THCR Class B Common Stock. No established trading market exists for the THCR Class B Common Stock, and no shares of THCR Class B Common Stock have been transferred since their issuance to Trump. The THCR Class B Common Stock has no right to receive any dividend or other distribution with respect to the equity of THCR. THCR has never paid a dividend and does not anticipate paying one in the foreseeable future. The payment of any future dividends will be at the discretion of the THCR Board of Directors and will depend upon, among other things, THCR's, financial condition and capital needs, legal restrictions on the payment of dividends, contractual restrictions in financing agreements and on other factors deemed pertinent by the THCR Board of Directors. See "Risk Factors--Restrictions on Certain Activities." It is the current policy of the THCR Board of Directors to retain earnings, if any, for use in its subsidiaries' operations (except as set forth in the THCR Holdings Partnership Agreement) and THCR otherwise has no current intention of paying dividends to the holders of THCR Common Stock. In addition, the Plaza Mortgage Note Indenture and the Senior Note Indenture contains, and the Taj Mortgage Note Indenture will contain, certain covenants, including, without limitation, covenants with respect to limitations on the payment of dividends, which limitations would limit THCR's ability to obtain funds from THCR Holdings with which to pay dividends. Pursuant to these indentures, there are restrictions on the payment of dividends unless, among other things, (i) no default or event of default has occurred and is continuing under the indenture, (ii) certain entities meet certain consolidated financial ratios and (iii) the total amount of the dividends does not exceed certain amounts specified in the indentures. See "Business of THCR--Certain Indebtedness of THCR" and "Description of the THCR Holdings Partnership Agreement." As of January 9, 1996, the Taj Holding Class A Common Stock was held by 372 holders of record. The Taj Holding Class A Common Stock is not listed on any national securities exchange nor quoted in the over-the-counter market, no established "bid" and "ask" price is available and there is currently no established trading market for the Taj Holding Class A Common Stock. Hamilton Partners, L.P. has informed Taj Holding that on December 28, 1995 it sold all of its 385,736 shares of Taj Holding Class A Common Stock to Prudential Securities, Inc. Taj Holding is not aware of any other recent transfers of Taj Holding Class A Common Stock. Taj Holding has never paid a dividend to its stockholders, and in the event that the Merger Transaction is not consummated, Taj Holding does not anticipate paying a dividend in the foreseeable future. The payment of any future dividends will be determined by the Taj Holding Board of Directors in light of conditions then existing, including, the financial condition of Taj Holding, restrictions in financing agreements, business conditions and other factors. See "Risk Factors--Restrictions on Certain Activities." The ability of Taj Holding to make distributions is restricted by the Bond Indenture, which contains restrictions on the ability of Taj Associates to make distributions to its partners. Each share of Taj Holding Class B Common Stock trades, together with $1,000 principal amount of Bonds, as a Unit. The Taj Holding Class B Common Stock may not trade separately from the Unit. The Unit is traded on the American Stock Exchange ("Amex") under the symbol "TAJA.A." The following table reflects the high and low sales prices of the Units expressed per $100 principal amount of Bonds, as reported by the Amex. The reported closing sale price of the Units (expressed per $100 of principal amount of Bonds) on the Amex on January 8, 1996 the last full day of trading prior to the announcement of the Merger Transaction, was $98. As of January 9, 1996, there were 780,242 Units outstanding (corresponding to 780,242 shares of Taj Holding Class B Common Stock and $780,242,000 aggregate principal amount of Bonds) held by approximately 450 record holders. All the shares of Taj Holding Class C Common Stock are beneficially owned by Trump. No established trading market exists for the Taj Holding Class C Common Stock, and no shares of Taj Holding Class C Common Stock have been transferred since their issuance to Trump. The Taj Holding Certificate of Incorporation provides that holders of Taj Holding Class B Common Stock and Taj Holding Class C Common Stock are not entitled to the payment of dividends. However, if a stock distribution or stock dividend or other reclassification of the Taj Holding Class A Common Stock occurs, an equivalent distribution, stock dividend or other reclassification of the Taj Holding Class C Common Stock will be made such that the total number of issued and outstanding shares of Taj Holding Class C Common Stock is the same as the total number of issued and outstanding shares of Taj Holding Class A Common Stock. CERTAIN FEDERAL INCOME TAX CONSIDERATIONS The Federal income tax consequences of the Merger Transaction are complex. The following summary does not discuss all aspects of United States federal income taxation that may be relevant to a particular holder of Taj Holding Class A Common Stock or holder of Taj Holding Class B Common Stock and Bonds in light of such holder's particular circumstances and income tax situation. Each holder should consult such holder's tax adviser as to the specific tax consequences to the holder of the Merger Transaction, including the application and effect of state, local, foreign and other tax laws. The Merger is anticipated to be a taxable event for holders of Taj Holding Class A Common Stock. A holder will recognize gain or loss equal to the difference between the holder's adjusted basis in the Taj Holding Class A Common Stock and the amount of Merger Consideration received in exchange for such stock. Such gain or loss will be treated as a capital gain or loss if the Taj Holding Class A Common Stock was held as a capital asset and will be a long-term capital gain or loss if the holding period for such stock exceeded one year. If the holder of Taj Holding Class A Common Stock elects to receive Stock Consideration, the holder's initial basis in the THCR Common Stock received will be equal to its fair market value and the holding period in the THCR Common Stock will begin on the day following the date of receipt of the THCR Common Stock. The redemption of the Bonds will be taxable for federal income tax purposes. A holder will recognize gain or loss measured by the difference between the redemption price of the Bonds and the holder's adjusted issue price of the Bonds. Subject to the market discount rules discussed in the next paragraph, such gain or loss will be a capital gain or loss if the Bonds were held as capital assets by the holder and will be a long-term capital gain or loss if the holding period for the Bonds is in excess of one year. Holders who purchased Bonds for a purchase price that was less than the Bonds' stated redemption price at maturity may realize ordinary income upon the redemption of the Bonds. The Internal Revenue Code of 1986, as amended (the "Code"), generally requires holders of "market discount bonds" to treat as ordinary income any gain realized on the disposition of such bonds to the extent of the market discount accrued during the holder's period of ownership (as determined in accordance with the method chosen by the holder under the Code). A "market discount bond" is a debt obligation purchased at or after the original issue at a price below the stated redemption price at maturity. In the case of a bond, such as the Bonds, with original issue discount ("OID"), the stated redemption price at maturity is treated as equal to its adjusted issue price. The accrued market discount generally equals a ratable portion of the bond's market discount determined by the number of days the taxpayer has held the bond at the time of disposition and expressed as a percentage of the number of days from the date of purchase to the bond's maturity date. A holder of a market discount bond may elect to include market discount in income as it accrues and, thus, will avoid recognizing market discount at disposition. To the extent a portion of the redemption price of the Bonds represents accrued and unpaid interest, a holder of a Bond will (i) increase the adjusted issue price of the Bond by the amount of the redemption payment that constitutes accrued OID and (ii) report as ordinary income the portion of the payment, if any, that represents "qualified stated interest," as defined in the Code, in accordance with the holder's method of accounting. REDEMPTION OF THE TAJ HOLDING CLASS B COMMON STOCK The redemption of the Taj Holding Class B Common Stock will be taxable under the Code. Each holder will recognize gain or loss equal to the difference between the amount of the holder's adjusted basis in the Taj Holding Class B Common Stock and the cash redemption amount received for the stock. Such gain or loss will be a capital gain or loss if the stock was held as a capital asset and will be a long-term capital gain or loss if the holding period exceeds one year. Holders of Taj Holding Class A Common Stock and holders of Taj Holding Class B Common Stock and Bonds may be subject to backup withholding at the rate of 31% with respect to reportable payments of (i) interest or OID accrued with respect to the Bonds or (ii) Merger Consideration received in exchange for the Taj Holding Class A Common Stock or the cash proceeds received in connection with the redemption of the Bonds or the Taj Holding Class B Common Stock. A holder will be exempt from backup withholding if the holder is a corporation or comes within certain other exempt categories and, when required, demonstrates that fact, or provides a correct taxpayer identification number, certifies as to no loss of exemption from backup withholding and otherwise complies with the applicable requirements of the backup withholding rules. Amounts paid as backup withholding do not constitute an additional tax and are allowable as a credit against the holder's federal income tax liability. Holders of Taj Holding Class A Common Stock and holders of Taj Holding Class B Common Stock and Bonds should consult their tax advisers as to their qualification for exemption from backup withholding and the procedure for obtaining such an exemption. SPECIAL TAX CONSIDERATIONS FOR FOREIGN SHAREHOLDERS The rules governing United States federal income taxation of non-resident alien individuals, foreign corporations, foreign partnerships and foreign trusts and estates (collectively, "Non-U.S. Shareholders") are complex, and the following discussion is intended only as a summary of such rules. Prospective Non-U.S. Shareholders should consult with their own tax advisers to determine the impact of federal, state and local income tax laws on an investment in THCR, including any reporting requirements, as well as the tax treatment of such an investment under their home country laws. In general, Non-U.S. Shareholders will be subject to regular United States federal income tax with respect to their investment in THCR if such investment is "effectively connected" with the Non-U.S. Shareholder's conduct of a trade or business in the United States. A corporate Non-U.S. Shareholder that receives income or gain from the sale or disposition of THCR Common Stock that is (or is treated as) effectively connected with the conduct of a United States trade or business may also be subject to the branch profits tax under Section 884 of the Code, which is payable in addition to regular United States corporate income tax. The following discussion will apply to Non-U.S. Shareholders whose investment in THCR is not so effectively connected. THCR expects to withhold United States federal income tax, as described below, on the gross amount of any distributions paid to a Non-U.S. Shareholder unless (i) a lower treaty rate applies and the required form evidencing eligibility for that reduced rate is filed with THCR or (ii) the Non-U.S. Shareholder files an IRS Form 4224 with THCR, claiming that the distribution is "effectively connected" income. Generally, dividends paid by THCR will be subject to a United States withholding tax equal to 30% of the gross amount of the distribution unless such tax is reduced or eliminated by an applicable tax treaty. A distribution of cash in excess of THCR's earnings and profits will be treated first as a return of capital that will reduce a Non-U.S. Shareholder's basis in its shares of THCR's stock (but not below zero) and then as gain from the disposition of such shares, the tax treatment of which is described under the rules discussed below with respect to dispositions of shares. A Non-U.S. Shareholder will have to file refund claims to obtain a refund of tax withheld on distributions in excess of the dividend portion of any distribution. A Non-U.S. Shareholder will generally not be subject to United States federal income tax on gain recognized on a sale or other disposition of THCR Common Stock unless (i) as noted above, the gain is effectively connected with the conduct of a trade or business within the United States by the Non-U.S. Shareholder, (ii) in the case of a Non-U.S. Shareholder who is a nonresident alien individual and holds the Common Stock as a capital asset, such holder is present in the United States for 183 or more days in the taxable year and certain other requirements are met or (iii) the Non-U.S. Shareholder is subject to tax under the United States real property holding company rules discussed below. THCR may be, or may subsequently become, a United States real property holding company for United States federal income tax purposes because of its ownership of substantial real estate assets in the United States. If THCR were to be treated as a United States real property holding Company, then a Non- U.S. Shareholder who holds, directly or indirectly, more than 5% of the THCR Common Stock will be subject to United States Federal income taxation on any gain realized from the sale or exchange of such stock, unless an exemption is provided under an applicable treaty. THCR Common Stock owned or treated as owned by an individual who is not a citizen or resident (as specially defined for United States federal estate tax purposes) of the United States at the date of death will be included in such individual's estate for United States federal estate tax purposes, unless an applicable estate tax treaty provides otherwise. INFORMATION REPORTING AND BACKUP WITHHOLDING Under temporary United States Treasury regulations, United States information reporting requirements and backup withholding tax will generally not apply to dividends paid on THCR Common Stock to a Non-U.S. Shareholder at an address outside the United States. Payments by a United States office of a broker of the proceeds of a sale of THCR Common Stock is subject to both backup withholding at a rate of 31% and information reporting unless the holder certifies its Non-U.S. Shareholder status under penalties of perjury or otherwise establishes an exemption. Information reporting requirements (but not backup withholding) will also apply to payments of the proceeds of sales of THCR Common Stock by foreign offices of United States brokers or foreign brokers with certain types of relationships to the United States, unless the broker has documentary evidence in its records that the holder is a Non-U.S. Shareholder and certain other conditions are met, or the holder otherwise establishes an exemption. Any amounts withheld under the backup withholding rules will be refunded or credited against the Non-U.S. Shareholder's United States federal income tax liability, provided that the required information is furnished to the Internal Revenue Service. These information reporting and backup withholding rules are under review by the United States Treasury and their application to THCR Common Stock could be changed by future regulations. Stockholders of THCR wishing to include proposals in the proxy material for the next Annual Meeting of THCR must submit the same in writing so as to be received at the executive offices of THCR on or before , 1996. Such proposals must also meet the other requirements of the rules of the SEC relating to stockholders' proposals and the requirements set forth in the THCR Certificate of Incorporation and THCR By- Laws. Stockholders of Taj Holding wishing to include proposals in the proxy material for the next Annual Meeting of Taj Holding (assuming the Merger is not consummated prior to such meeting, which will not be held if the Merger is consummated prior to the scheduled date for such Annual Meeting) must submit the same in writing so as to be received at the executive offices of Taj Holding on or before , 1996. Such proposals must also meet the other requirements of the rules of the SEC relating to stockholders' proposals and the requirements set forth in the Taj Holding Certificate of Incorporation and Taj Holding By-Laws. Certain legal matters, including certain tax matters, in connection with the securities offered hereby are being passed upon for THCR by Willkie Farr & Gallagher, New York, New York. The statements as to matters of law and legal conclusions concerning New Jersey gaming laws included under the captions "Risk Factors--Strict Regulation by Gaming Authorities," and "Regulatory Matters" (other than the subcaptions "Antitrust Regulations" and "Other Laws and Regulations") have been prepared by Sterns & Weinroth, Trenton, New Jersey, gaming counsel for THCR and Taj Holding. Sterns & Weinroth offers no opinion and does not purport to opine on the application of federal securities laws and regulations or the securities laws and regulations of any state with respect to the securities offered hereby. The statements as to matters of law and legal conclusions concerning Indiana gaming laws included under the captions "Risk Factors--Strict Regulation by Gaming Authorities" and "Regulatory Matters" (other than the subcaptions "Antitrust Regulations" and "Other Laws and Regulations") have been prepared by Tabbert Hahn & Zanetis, P.C., Indianapolis, Indiana, gaming counsel for THCR. Tabbert Hahn & Zanetis, P.C. offers no opinion and does not purport to opine on the application of federal securities laws and regulations or the securities laws and regulations of any state with respect to the securities offered hereby. The audited financial statements of Trump Hotels & Casino Resorts, Inc., Trump Plaza Holding Associates and Trump Plaza Associates, Trump Taj Mahal Associates and Subsidiary, and Taj Mahal Holding Corp. included in this Proxy Statement-Prospectus and elsewhere in the Registration Statement have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their reports with respect thereto, and are included herein in reliance upon the authority of said firm as experts in giving said reports. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Trump Hotels & Casino Resorts, Inc.: We have audited the accompanying balance sheet of Trump Hotels & Casino Resorts, Inc. (a Delaware Corporation) as of March 29, 1995 (parent company only). This balance sheet is the responsibility of the management of Trump Hotels & Casino Resorts, Inc. Our responsibility is to express an opinion on this balance sheet based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the balance sheet is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the balance sheet. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall balance sheet presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the balance sheet referred to above presents fairly, in all material respects, the financial position of Trump Hotels & Casino Resorts, Inc. as of March 29, 1995, in conformity with generally accepted accounting principles. May 5, 1995 (except with respect to the matter discussed in Note 5, as to which the date is TRUMP HOTELS & CASINO RESORTS, INC. The accompanying notes to balance sheet are an integral part of this balance sheet. TRUMP HOTELS & CASINO RESORTS, INC. The accompanying balance sheet is that of Trump Hotels & Casino Resorts, Inc. ("THCR") (parent company only). Trump Hotels & Casino Resorts Holdings, L.P. ("THCR Holdings") is owned 99% by THCR as general partner and 1% by Donald J. Trump ("Trump") as a limited partner and Trump Hotels & Casino Resorts Funding, Inc. ("THCR Funding") is a wholly owned subsidiary of THCR Holdings. THCR was formed on March 29, 1995 to own and operate the Trump Plaza Hotel and Casino ("Trump Plaza"), a luxury casino hotel located on The Boardwalk in Atlantic City, New Jersey, and a riverboat gaming facility currently under development at Buffington Harbor, Indiana (the "Indiana Riverboat"). THCR, through THCR Holdings and its subsidiaries, intends to be the exclusive vehicle through which Trump will engage in new gaming activities in emerging or established gaming jurisdictions. THCR Holdings and THCR Funding were formed on March 29, 1995 to raise funds through the issuance and sale of debt securities for the benefit of Trump Plaza and the Indiana Riverboat. As of March 29, 1995, they had no assets or operations other than their initial capitalization. As of March 29, 1995, all of THCR's common stock (the "THCR Common Stock") was owned by Donald J. Trump and it had no assets or operations other than its initial capitalization and its investment in THCR Holdings. Upon consummation of the proposed public offerings (Note 2), THCR Holdings will beneficially own 100% of Trump Plaza and the Indiana Riverboat, as well as Trump's interests in other gaming jurisdictions. As of March 29, 1995, each of these operations and interests was beneficially owned by Trump. Upon consummation of the proposed public offerings (Note 2), Trump will own an interest in these operations through a limited partnership interest in THCR Holdings as well as THCR's Class B Common Stock (the "THCR Class B Common Stock"). The operating companies that will be owned by THCR and THCR Holdings will have a substantial amount of indebtedness. The ability of these entities to service such debt will be entirely dependent upon their ability to generate cash flow from operations. Other than Trump Plaza, each of the potential gaming operations is in the development stage and has had limited or no site construction. THCR's proposed operations in these jurisdictions are subject to all of the many risks inherent in the establishment of a new business enterprise, including unanticipated construction, permitting, licensing or operating problems associated with the facilities as well as the ability of THCR to market a new venture in a new gaming jurisdiction. In addition, gaming operations in all jurisdictions are subject to strict regulatory licensing and operating controls, as well as commitments for taxes, licensing fees and investment obligations. Failure to maintain or obtain the requisite casino licenses would have a material adverse effect on THCR. For additional information, see the "Risk Factors" section of the Proxy Statement-Prospectus. THCR, THCR Holdings and THCR Funding have filed registration statements for the offering and sale of THCR Common Stock for gross proceeds of $150 million, as well as $140 million of Senior Secured Notes (the "June 1995 Offerings"). The proceeds from the June 1995 Offerings are intended to be used to develop the gaming operations described in Note 1 as well as to repurchase or redeem certain indebtedness of Trump Plaza. In connection with the contribution by Trump of his beneficial ownership in Trump Plaza Funding, Inc. ("Plaza Funding"), Trump Plaza Holding Associates ("Plaza Holding") and Trump Plaza Associates ("Plaza Associates") as well as his investments in other gaming jurisdictions to THCR Holdings, Trump will receive shares of THCR Class B Common Stock. The THCR Class B Common Stock will vote with the THCR Common Stock on all matters submitted to stockholders of THCR for a vote or in respect of which consents are solicited. The number of votes represented by the THCR Class B Common Stock will be equal to the number of shares of THCR Common Stock that could be acquired by Trump and his TRUMP HOTELS & CASINO RESORTS, INC. conversion of interests in THCR Holdings then held by such persons into shares of THCR Common Stock. The THCR Class B Common Stock is intended to provide Trump with a voting interest in THCR which is proportionate to his equity interest in THCR Holdings assets. The THCR Class B Common Stock will have no right to receive any dividend or other distribution in respect of the equity of THCR. In addition, Trump has agreed to waive any state law rights to vote the THCR Class B Common Stock as a class in the event of a merger or sale of substantial assets. In connection with the June 1995 Offerings, the Board of Directors of THCR (the "Board of Directors") will adopt the 1995 Stock Incentive Plan (the "1995 Stock Plan"). Pursuant to the 1995 Stock Plan, directors, employees and consultants of THCR and certain of its subsidiaries and affiliates who have been selected as participants are eligible to receive awards of various forms of equity-based incentive compensation, including stock options, stock appreciation rights, stock bonuses, restricted stock awards, performance units and phantom stock, and awards consisting of combinations of such incentives. The 1995 Stock Plan is administered by a committee appointed by the Board of Directors (the "Stock Incentive Plan Committee"). Subject to the provisions of the 1995 Stock Plan, the Stock Incentive Plan Committee has sole discretionary authority to interpret the 1995 Stock Plan and to determine the type of awards to grant, when, if and to whom awards are granted, the number of shares covered by each award and the terms and conditions of the award. Options granted under the 1995 Stock Plan may be "incentive stock options" ("ISOs"), within the meaning of Section 422 of the Internal Revenue Code, or nonqualified stock options ("NQSOs"). The exercise price of the options is determined by the Stock Incentive Plan Committee when the options are granted, subject to a minimum price in the case of ISOs of the Fair Market Value (as defined in the 1995 Stock Plan) of the THCR Common Stock on the date of grant and a minimum price in the case of NQSOs of the par value of the THCR Common Stock. In the discretion of the Stock Incentive Plan Committee, the option exercise price may be paid in cash or in shares of THCR Common Stock or other property having a fair market value on the date of exercise equal to the option exercise price, or by delivering to THCR a copy of irrevocable instructions to a stockholder to deliver promptly to THCR an amount of sale or loan proceeds sufficient to pay the exercise price. If provided by the Stock Incentive Plan Committee in an underlying stock option agreement, in the event of a Change of Control (as defined in the 1995 Stock Plan), all options subject to such agreement will be fully exercisable. The 1995 Stock Plan permits the Stock Incentive Plan Committee to grant stock appreciation rights ("SARs"). An SAR granted as an alternative or a supplement to a related stock option will entitle its holder to be paid an amount equal to the fair market value of the THCR Common Stock subject to the SAR on the date of exercise of the SAR, less the exercise price of the related stock option or such other price as the Stock Incentive Plan Committee may determine at the time of the grant of the SAR (which may not be less than the lowest price which the Stock Incentive Plan Committee may determine under the 1995 Stock Plan for such stock option). Shares of THCR Common Stock covered by a restricted stock award will be issued to the recipient at the time the award is granted, but will be subject to forfeiture in the event continued employment and/or restrictions and conditions established by the Stock Incentive Plan Committee at the time the award is granted are not satisfied. Unless otherwise determined by the Stock Incentive Plan Committee, a recipient of a restricted stock award will have the same rights as an owner of THCR Common Stock, including the right to receive cash dividends and to vote the shares. A performance unit or phantom stock award will provide for the future payment of cash or the issuance of shares of THCR Common Stock to the TRUMP HOTELS & CASINO RESORTS, INC. employment and/or other performance objectives established by the Stock Incentive Plan Committee at the time of grant are attained. The 1995 Stock Plan also provides for the grant of stock bonus awards, restricted stock awards and performance unit awards, which may be settled in cash, in the discretion of the Stock Incentive Plan Committee and if indicated in the applicable award agreement, on each date on which shares of THCR Common Stock covered by the awards would otherwise have been delivered or become unrestricted, in an amount equal to the fair market value of such shares on such date. THCR has reserved 1,000,000 shares of THCR Common Stock for issuance under the 1995 Stock Plan. In connection with the June 1995 Offerings, the Stock Incentive Plan Committee intends to grant the following awards to Nicholas L. Ribis under the 1995 Stock Plan: (a) a Stock bonus award of 66,667 shares of THCR Common Stock, which will be fully vested when issued, (b) a phantom stock unit award of 66,666 units, entitling Mr. Ribis to receive 66,666 shares of THCR Common Stock two years following such award, subject to certain conditions and (c) an award of NQSOs entitling Mr. Ribis to purchase 133,333 shares of THCR Common Stock, subject to certain conditions (including vesting at a rate of 20% per year over a five-year period). The options will have an exercise price equal to the price at which THCR Common Stock is sold to the public in the Offerings. Trump will serve as the Chairman of the Board of Directors of THCR pursuant to an Executive Agreement to be entered into between Trump and THCR Holdings upon consummation of the June 1995 Offerings (the "Trump Executive Agreement"). In consideration for Trump's services under the Trump Executive Agreement, which has no fixed term, Trump will receive a salary of $1 million per year. Plaza Associates currently has an employment agreement with Nicholas L. Ribis pursuant to which Mr. Ribis acts as Chief Executive Officer of Plaza Associates. The agreement, which expires on September 25, 1996, provides for an annual salary of $550,000 with annual increases of 10% on each anniversary. Mr. Ribis' current annual salary under the agreement is $605,000. Mr. Ribis received a $250,000 signing bonus. THCR Holdings intends to enter into a revised employment agreement with Mr. Ribis to replace the existing agreement, pursuant to which he will agree to serve as chief executive officer of THCR and THCR Holdings. The term of the employment agreement will be for five years and Mr Ribis will be required to devote the majority of his professional time to the affairs of THCR. Mr. Ribis' annual salary will be $907,500. On January 8, 1996, THCR, Taj Mahal Holding Corp. ("Taj Holding") and THCR Merger Corp. ("Merger Sub") entered into the Agreement and Plan of Merger (the "Merger Agreement") pursuant to which Merger Sub will merge with and into Taj Holding (the "Merger"). The Merger Agreement provides that each outstanding share of Class A Common Stock of Taj Holding (the "Taj Holding Class A Common Stock") will be converted into the right to receive, at each holder's election, either (a) $30.00 in cash or (b) that number of shares of THCR Common Stock as shall have a market value equal to $30.00. The Merger Agreement also contemplates the following transactions occurring in connection with the Merger: (a) the consummation of the offering by THCR of up to $140,000,000 of THCR Common Stock (and an amount to be issued pursuant to the underwriters' over- allotment option) (the "THCR Stock Offering") and the offering by Trump Taj Mahal Funding, Inc. ("Taj Funding") of up to $750,000,000 aggregate principal amount of debt securities, the aggregate net proceeds of which will be used, together with available cash of Taj Mahal Associates ("Taj Associates"), to (i) pay cash to those holders of Taj Holding Class A Common Stock electing to receive cash in the Merger, (ii) redeem Taj Funding's outstanding 11.35% Mortgage Bonds, Series A due 1999 (the "Bonds"), (iii) shares of Class B Common Stock, par value $.01 per share, of Taj Holding as required in connection with the redemption of the Bonds pursuant to the Amended and Restated Certificate of Incorporation of Taj Holding, (iv) purchase certain real property adjacent to the Trump Taj Mahal Casino Resort that is currently leased from Trump Taj Mahal Realty Corp., a corporation wholly owned by Trump, and (v) make a payment to Bankers Trust to obtain releases of the liens and guarantees that Bankers Trust has with respect to (b) the contribution by Trump to THCR Holdings and Taj Mahal Holdings LLC ("Taj Holdings LLC"), a subsidiary of THCR Holdings, of all of his direct and indirect ownership interests in Taj Associates; and (c) the contribution by THCR to THCR Holdings and Taj Holdings LLC of all of its indirect ownership interests in Taj Associates acquired in the Merger. Existing and prospective investors should consider among other things, (i) the high leverage and fixed charges of THCR and Taj Holding; (ii) the risk in refinancing and repayment of indebtedness and the need for additional financing (iii) the restrictions imposed on certain activities by certain debt instruments (iv) the recent results of Trump Plaza and the Taj Mahal (v) risks associated with the Trump Plaza Expansion, the Taj Mahal Expansion and the Indiana Riverboat. There can be no assurance that the Trump Plaza Expansion or the Taj Mahal Expansion will be completed or that the Indiana Riverboat or any other gaming venture, will open or that any of THCR's or the Taj Mahal's operations will be successful. See "Risk Factors" included elsewhere in this Proxy Statement-Prospectus for a discussion of these and other factors. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Trump Plaza Holding Associates and Trump Plaza Associates: We have audited the accompanying consolidated balance sheets of Trump Plaza Holding Associates (a New Jersey general partnership) and Trump Plaza Associates (a New Jersey general partnership) as of December 31, 1993 and 1994, and the related consolidated statements of operations, capital (deficit) and cash flows for each of the three years in the period ended December 31, 1994. These consolidated financial statements are the responsibility of the management of Trump Plaza Holding Associates and Trump Plaza Associates. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Trump Plaza Holding Associates and Trump Plaza Associates as of December 31, 1993 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. February 18, 1995 (except with respect to the matters discussed in Note 10, as to which the date TRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES DECEMBER 31, 1993 AND 1994 The accompanying notes to financial statements are an integral part of these consolidated financial statements. TRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES FOR THE YEARS ENDED DECEMBER 31, 1992, 1993 AND 1994 The accompanying notes to financial statements are an integral part of these consolidated financial statements. TRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES CONSOLIDATED STATEMENTS OF CAPITAL (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1992, 1993 AND 1994 The accompanying notes to financial statements are an integral part of these consolidated financial statements. TRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1992, 1993 AND 1994 The accompanying notes to financial statements are an integral part of these consolidated financial statements. The accompanying financial statements include those of Trump Plaza Holding Associates ("Plaza Holding"), a New Jersey general partnership, and its 99% owned subsidiary, Trump Plaza Associates ("Plaza Associates"), a New Jersey general partnership, which owns and operates Trump Plaza Hotel and Casino ("Trump Plaza") located in Atlantic City, New Jersey. Trump Plaza Funding, Inc. ("Plaza Funding"), a New Jersey corporation, owns the remaining 1% interest in Plaza Associates. Plaza Holding's sole source of liquidity is distributions in respect of its interest in Plaza Associates. All significant intercompany balances and transactions have been eliminated in the accompanying consolidated financial statements. The minority interest in Plaza Associates has not been separately reflected in the consolidated financial statements of Plaza Holding since it is not material. Plaza Funding was incorporated on March 14, 1986 and was originally formed solely to raise funds through the issuance and sale of its debt securities for the benefit of Plaza Associates. As part of a Prepackaged Plan of Reorganization under Chapter 11 of the U.S. Bankruptcy Code consummated on May 29, 1992, Plaza Funding became a partner of Plaza Associates and issued approximately three million Stock Units, each comprised of one share of Preferred Stock and one share of Common Stock of Plaza Funding. On June 25, 1993, the Stock Units were redeemed with a portion of the proceeds of Plaza Funding's 10 7/8% Mortgage Notes due 2001 (the "Plaza Mortgage Notes") as well as Plaza Holding's Stock Units. Plaza Holding was formed in February, 1993 for the purpose of raising funds for Plaza Associates. On June 25, 1993, Plaza Holding completed the sale of 12,000 Units (the "Units"), each Unit consisting of $5,000 principal amount of 12 1/2% Pay-In-Kind Notes, due 2003 (the "PIK Notes"), and one PIK Note Warrant (the "PIK Note Warrant") to acquire $1,000 principal amount of PIK Notes. The PIK Notes and the PIK Note Warrants are separately transferable. Plaza Holding has no other assets or business other than its 99% equity interest in Plaza Associates. Plaza Associates was organized in June 1982. Prior to the date of the consummation of the Offerings, Plaza Associates three partners were TP/GP Inc. ("Trump Plaza/GP"), the managing general partner of Plaza Associates, Plaza Funding and Donald J. Trump ("Trump"). On June 25, 1993, Trump contributed his interest in Trump Plaza/GP to Plaza Funding and Trump Plaza/GP merged with and into Plaza Funding. Plaza Funding then became the managing general partner of Plaza Associates. In addition, Trump contributed his interest in Plaza Associates to Plaza Holding, and Plaza Funding and Plaza Holding, each of which are wholly owned by Trump, became the sole partners of Plaza Associates. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES GAMING REVENUES AND PROMOTIONAL ALLOWANCES Gaming revenues represent the net win from gaming activities which is the difference between amounts wagered and amounts won by patrons. The retail value of accommodations, food, beverage and other services provided to customers without charge is included in gross revenue and deducted as promotional allowances. The estimated departmental costs of providing such promotional allowance are included in gaming costs and expenses as follows: During 1992 and 1994, certain Progressive Slot Jackpot Programs were discontinued which resulted in $4,100,000 and $585,000, respectively, of related accruals being taken into income. Inventories of provisions and supplies are carried at the lower of cost (weighted average) or market. Property and equipment is carried at cost and is depreciated on the straight- line method using rates based on the following estimated useful lives: Interest associated with borrowings used to finance construction projects has been capitalized and is being amortized over the estimated useful lives of the assets. Land rights represent the fair value of such rights, at the time of contribution to Plaza Associates by the Trump Plaza Corporation, an affiliate of Plaza Associates. These rights are being amortized over the period of the underlying operating leases which extend through 2078. Plaza Funding, Plaza Holding and Plaza Associates adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"), effective January 1, 1993. Adoption of this new standard did not have a significant impact on the respective statements of financial condition or results of operations. SFAS No. 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method deferred tax liabilities and assets are determined based on the difference between the financial statement and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The accompanying financial statements of Plaza Funding include a provision for Federal income taxes, based on distributions from Plaza Associates relating to Plaza Funding's Preferred Stock which was redeemed on June 25, 1993. Plaza Funding will be reimbursed for such income taxes by Plaza Associates. The accompanying consolidated financial statements of Plaza Holding and Plaza Associates do not include a provision for Federal income taxes since any income or losses allocated to its partners are reportable for Federal income tax purposes by the partners. Under the New Jersey Casino Control Commission regulations, Plaza Associates is required to file a New Jersey corporation business tax return. Accordingly, a provision (benefit) for state income taxes has been reflected in the accompanying consolidated financial statements of Plaza Holding and Plaza Associates. Plaza Associates deferred state income taxes result primarily from differences in the timing of reporting depreciation for tax and financial statement purposes. For purposes of the statements of cash flows, Plaza Funding, Plaza Holding and Plaza Associates consider all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. The following supplemental disclosures are made to the statements of cash flows. Long-term debt consists of the following: PLAZA HOLDING AND PLAZA ASSOCIATES: (A) On June 25, 1993 Plaza Funding issued $330,000,000 principal amount of 10 7/8% Mortgage Notes, due 2001, net of discount of $4,313,000. Net proceeds of the offering were used to redeem all of Plaza Funding's outstanding $225,000,000 principal amount 12% Mortgage Bonds, due 2002 and together with other funds (see (B) Pay-In-Kind Notes) all of Plaza Funding's Stock Units, comprised of $75,000,000 liquidation preference participating cumulative redeemable Preferred Stock with associated shares of Common Stock, to repay $17,500,000 principal amount 9.14% Regency Note due 2003, to make a portion of a distribution to Trump to pay certain personal indebtedness, and to pay transaction expenses. The Plaza Mortgage Notes mature on June 15, 2001 and are redeemable at any time on or after June 15, 1998, at the option of Plaza Funding or Plaza Associates, in whole or in part, at the principal amount plus a premium which declines ratably each year to zero in the year of maturity. The Plaza Mortgage Notes bear interest at the stated rate of 10 7/8% per annum from the date of issuance, payable semi-annually on each June 15 and December 15, commencing December 15, 1993 and are secured by substantially all of Plaza Associates assets. The accompanying consolidated financial statements reflect interest expense at the effective interest rate of 11.12% per annum. The Indenture governing the Plaza Mortgage Notes (the "Mortgage Note Indenture") contains certain covenants limiting the ability of Plaza Associates to incur indebtedness, including indebtedness secured by liens on Trump Plaza. In addition, Plaza Associates may, under certain circumstances, incur up to $25.0 million of indebtedness to finance the expansion of its facilities, which indebtedness may be secured by a lien on the hotel facilities of Plaza Associates ("Trump Plaza East") (see Note 6 Commitments And Contingencies) senior to the liens of one of the Plaza Mortgages (the "Plaza Note Mortgage") and another of the Plaza Mortgages (the "Plaza Guarantee Mortgage") thereon. The Plaza Mortgage Notes represent the senior indebtedness of Plaza Funding. The note from Plaza Associates to Plaza Funding in the same principal amount of the Plaza Mortgage Notes (the "Plaza Associates Note") and the guarantee of the Plaza Mortgage Notes (the "Plaza Guarantee") rank pari passu in right of payment with all existing and future senior indebtedness of Plaza Associates. The Plaza Mortgage Notes, the Plaza Associates Note, the Plaza Note Mortgage, the Plaza Guarantee and the Plaza Guarantee Mortgage are non- recourse to the partners of Plaza Associates, to the shareholders of Plaza Funding and to all other persons and entities (other than Plaza Funding and Plaza Associates), including Trump. Upon an event of default, holders of the Plaza Mortgage Notes would have recourse only to the assets of Plaza Funding and Plaza Associates. (B) On June 25, 1993 Plaza Holding issued $60,000,000 principal amount of 12 1/2% PIK Notes, due 2003, together with PIK Note Warrants to acquire an additional $12,000,000 of PIK Notes at no additional cost. The PIK Note Warrants are exercisable following the earlier of certain triggering events or June 15, 1996. The PIK Notes mature on June 15, 2003 and bear interest at the rate of 12 1/2% per annum from the date of issuance, payable semi-annually on each June 15 and December 15, commencing December 15, 1993. At the option of Plaza Holding, interest is payable in whole or in part, in cash or, in lieu of cash, through the issuance of additional PIK Notes valued at 100% of their principal amount. The ability of Plaza Holding to pay interest in cash on the PIK Notes is entirely dependent on the ability of Plaza Associates to distribute available cash, as defined, to Plaza Holding for such purpose. As of December 31, 1994 Plaza Associates has elected to issue in lieu of cash a total of $11,756,000 in PIK Notes to satisfy its semi-annual PIK Note interest obligation. The PIK Notes are structurally subordinate to Plaza Funding's Mortgage Notes and any other indebtedness of Plaza Associates and are secured by a pledge of Plaza Holding's 99% equity interest in Plaza Associates. The indenture to which the PIK Notes were issued (the "PIK Note Indenture") contains covenants prohibiting Plaza Holding from incurring additional indebtedness and engaging in other activities, and other covenants restricting the activities of Plaza Associates substantially similar to those set forth in the Plaza Mortgage Note Indenture. The PIK Notes and the PIK Note Warrants are non-recourse to the Partners of Plaza Holding, including Trump, and to all other persons and entities (other than Plaza Holding). Upon an event of default, holders of PIK Notes or PIK Note Warrants will have recourse only to the assets of Plaza Holding which consist solely of its equity interest in Plaza Associates. (C) Interest on these notes is payable with interest rates ranging from 10.0% to 11.0%. The notes are due at various dates between 1995 and 1998 and are secured by real property. The aggregate maturities of long-term debt in each of the years subsequent to 1994 are: Plaza Associates leases property (primarily land), certain parking space, and various equipment under operating leases. Rent expense for the years ended December 31, 1992, 1993, and 1994 was $4,361,000, $4,338,000 and $3,613,000, respectively, of which $2,127,000, $2,513,000 and $1,900,000, respectively, relates to affiliates of Plaza Associates. Future minimum lease payments under the noncancelable operating leases are as follows: Certain of these leases contain options to purchase the leased properties at various prices throughout the leased terms. At December 31, 1994, the aggregate option price for these leases was approximately $58,000,000. In October 1993, Plaza Associates assumed the lease of Trump Plaza East to Donald J. Trump ("Trump") (the "Trump Plaza East Lease") and related expenses which are included in the above lease commitment amounts. In connection with the offering and sale of Common Stock of Trump Hotels & Casino Resorts, Inc. ("THCR") for gross proceeds of $150 million and 140 million of Senior Secured Notes (the "June 1995 Offerings"), Plaza Associates acquired a five-year option to purchase Trump Plaza East. See Note 6--"Commitments and Contingencies Future Expansion." (5) EXTRAORDINARY GAIN (LOSS) AND NON-OPERATING EXPENSE The excess of the carrying value of a note obligation over the amount of the settlement payment net of related prepaid expenses in the amount of $4,120,000 has been reported as an extraordinary gain for the year ended December 31, 1993. The extraordinary loss for the year ended December 31, 1992 consists of the effect of stating the PIK Notes and Plaza Funding's Preferred Stock issued at fair value as compared to the carrying value of these securities and the write off of certain deferred financing charges and costs. Non-operating expense in 1992 included $1,462,000 of legal expenses relating to litigation associated with Trump Plaza East. In 1993 and 1994 these costs included $3,873,000 and $4,931,000, respectively, in costs associated with Trump Plaza East (see Note 6--Commitments and Contingencies Future Expansion), net of miscellaneous non-operating credits which amounts included $2,322,000 and $798,000 for 1993 and 1994, respectively, representing real estate taxes applicable for the period prior to June 24, 1993. The operation of an Atlantic City hotel and casino is subject to significant regulatory controls which affect virtually all of its operations. Under the New Jersey Casino Control Act (the "Casino Control Act"), Plaza Associates is required to maintain certain licenses. In April 1993, the New Jersey Casino Control Commission ("CCC") renewed Plaza Associates license to operate Trump Plaza. This license must be renewed in June 1995, is not transferable and will include a review of the financial stability of Plaza Associates. Upon revocation, suspension for more than 120 days, or failure to renew the casino license, the Casino Control Act provides for the mandatory appointment of a conservator to take possession of the hotel and casino's business and property, subject to all valid liens, claims and encumbrances. Plaza Associates, its Partners, certain members of its former Executive Committee, and certain of its employees, have been involved in various legal proceedings. In general, Plaza Associates has agreed to indemnify such persons against any and all losses, claims, damages, expenses (including reasonable costs, disbursements and counsel fees) and liabilities (including amounts paid or incurred in satisfaction of settlements, judgements, fines and penalties ) incurred by them in said legal proceedings. Such persons and entities are vigorously defending the allegations against them and intend to vigorously contest any future proceedings. Various legal proceedings are now pending against Plaza Associates. Plaza Associates considers all such proceedings to be ordinary litigation incident to the character of its business. Plaza Associates believes that the resolution of these claims will not, individually or in the aggregate, have a material adverse effect on its financial condition or results of operations. Plaza Associates is also a party to various administrative proceedings involving allegations that it has violated certain provisions of the Casino Control Act. Plaza Associates believes that the final outcome of these proceedings will not, either individually or in the aggregate, have a material adverse effect on its financial condition, results of operations or on the ability of Plaza Associates to otherwise retain or renew any casino or other licenses required under the Casino Control Act for the operation of Trump Plaza. CASINO REINVESTMENT DEVELOPMENT AUTHORITY OBLIGATIONS Pursuant to the provisions of the Casino Control Act, Plaza Associates, commencing twelve months after the date of opening of Trump Plaza in May 1984, and continuing for a period of twenty-five years thereafter, must either obtain investment tax credits (as defined in the Casino Control Act), in an amount equivalent to 1.25% of its gross casino revenues, or pay an alternative tax of 2.5% of its gross casino revenues, (as defined in the Casino Control Act). Investment tax credits may be obtained by making qualified investments or by the purchase of bonds at below market interest rates from the Casino Reinvestment Development Authority ("CRDA"). Plaza Associates is required to make quarterly deposits with the CRDA based on 1.25% of its gross revenue. For the years ended December 31, 1992, 1993 and 1994, Plaza Associates charged to operations $645,000, $1,047,000 and $838,000, respectively, to give effect to the below market interest rates associated with CRDA bonds that have either been issued or are expected to be issued from funds deposited. In connection with Trump Plaza East (see below), the CRDA has approved the use of up to $1,519,000 in deposits made by Plaza Associates for site improvements. Such deposits are being capitalized as part of property and equipment as funds are appropriated by the CRDA. In accordance with casino industry practice, Plaza Associates extends credit to a limited number of casino patrons, after extensive background checks and investigations of credit worthiness. At December 31, 1994 approximately 28% of Plaza Associates casino receivables (before allowances) were from customers whose primary residence is outside the United States, with no significant concentration in any one foreign country. In 1993, Plaza Associates received the approval of the CCC, subject to certain conditions, for the expansion of Trump Plaza East. On June 24, 1993, Trump transferred title of Trump Plaza East to a lender in exchange for a reduction in indebtedness to such lender in an amount equal to the sum of the fair market value of Trump Plaza East and all rent payments made to such lender by Trump under Trump Plaza East Lease. At that time, the lender leased Trump Plaza East to Trump for a term of five years, which expires on June 30, 1998, during which time Trump is obligated to pay the lender $260,000 per month in lease payments. In October 1993, Plaza Associates assumed the Trump Plaza East Lease and related expenses. On June 25, 1993, Plaza Associates acquired a five-year option to purchase Trump Plaza East (the "Trump Plaza East Purchase Option"). In addition, Plaza Associates has a right of first refusal (the "Right of First Offer") upon any proposed sale of all or any portion of Trump Plaza East during the term of the Trump Plaza East Purchase Option. Until such time as the Trump Plaza East Purchase Option is exercised or expires, Plaza Associates will be obligated, from and after the date it entered into the Trump Plaza East Purchase Option, to pay the net expenses associated with Trump Plaza East. During 1994, Plaza Associates incurred $4.9 million of such expenses. The CCC has required that Plaza Associates exercise the Trump Plaza East Purchase Option or its Right of First Offer no later than July 1, 1995. Plaza Associates has petitioned the CCC to extend such date to July 1, 1996; however, no assurance can be given that such waiver will be granted or that any condition imposed by the CCC would be acceptable to Plaza Associates. If Plaza Associates defaults in making payments due under the Trump Plaza East Purchase Option, Plaza Associates would be liable to the lender for the sum of (a) the present value of all remaining payments to be made by Plaza Associates pursuant to the Trump Plaza East Purchase Option during the term thereof and (b) the cost of demolition of all improvements then located on Trump Plaza East. In order for Plaza Associates to exercise the Trump Plaza East Purchase Option it would be required to pay $27.0 million through June 30, 1995, increasing by $1.0 million annually thereafter until expiration on June 30, 1998. If Plaza Associates is unable to exercise the option, it would be required to expense any capitalized costs associated with Trump Plaza East. As of December 31, 1994, Plaza Associates had capitalized approximately $11.7 million in construction costs related to Trump Plaza East including a $1 million consulting fee paid to Trump (Note 8). Plaza Associates might have to close all or a portion of the expanded casino in order to comply with regulatory requirements, which could have a material adverse effect on the results of operations and financial condition of the Plaza Associates. Plaza Associates ability to acquire Trump Plaza East pursuant to the Trump Plaza East Purchase Option is dependent upon its ability to obtain financing to acquire the property. The ability to incur such indebtedness is restricted by the Plaza Mortgage Note Indenture and the PIK Note Indenture and requires the consent of certain of Trump's personal creditors. Plaza Associates ability to develop Trump Plaza East is dependent upon its ability to use existing cash on hand and generate cash flow from operations sufficient to fund development costs. No assurance can be given that such cash on hand will be available to Plaza Associates for such purposes or that it will be able to generate sufficient cash flow from operations. In addition, exercise of the Trump Plaza East Purchase Option or the Right of First Offer requires the consent of certain of Trump's personal creditors, and there can be no assurance that such consent will be obtained at the time Plaza Associates desires to exercise the Trump Plaza East Purchase Option or such right. The accompanying consolidated financial statements do not include any adjustments that may be necessary should Plaza Associates be unable to exercise the Trump Plaza East Purchase Option. Plaza Associates has a retirement savings plan (the "Plan") for its nonunion employees under Section 401(k) of the Internal Revenue Code. Employees are eligible to contribute up to 15% of their earnings to the Plan and Plaza Associates will match 50% of an eligible employee's contributions up to a maximum of 4% of the employee's earnings. Plaza Associates recorded charges of $699,000, $765,000 and $848,000 for matching contributions for the years ended December 31, 1992, 1993 and 1994, respectively. Plaza Associates provides no other material post-retirement or post- employment benefits. Amounts due to affiliates was $97,000 and $206,000 as of December 31, 1993 and 1994, respectively. Plaza Associates leases warehouse facility space to Trump's Castle Associates. Lease payments of $14,000, $15,000 and $6,000 were received from Trump's Castle Associates in 1992, 1993 and 1994, respectively. Plaza Associates leased office space from Trump Taj Mahal Associates, which terminated on March 19, 1993. Lease payments of $138,000 and $30,000 were paid to Trump Taj Mahal Associates in 1992 and 1993, respectively. Plaza Associates leases two parcels of land under long-term ground leases from Seashore Four Associates and Trump Seashore Associates. In 1992, 1993 and 1994, Plaza Associates paid $900,000, $900,000 and $900,000, respectively, to Seashore Four Associates, and paid $1,000,000, $1,000,000 and $1,000,000 in 1992, 1993 and 1994, respectively, to Trump Seashore Associates. Pursuant to the terms of a Services Agreement with Trump Plaza Management Corp. ("TPM"), a corporation beneficially owned by Donald J. Trump, in consideration for services provided, Plaza Associates pays TPM each year an annual fee of $1.0 million in equal monthly installments, and reimburses TPM on a monthly basis for all reasonable out-of-pocket expenses incurred by TPM in performing its obligations under the Services Agreement, up to certain amounts. Under this Services Agreement, approximately $708,000, $1.2 million and $1.3 million was charged to expense for the years ended December 31, 1992, 1993, and 1994, respectively. In December 1993, Trump entered into an option agreement (the "Original Chemical Option Agreement") with Chemical Bank ("Chemical") and ACFH Inc. ("ACFH") a wholly owned subsidiary of Chemical. The Original Chemical Option Agreement granted to Trump an option to purchase (i) the Trump Regency Hotel (including the land, improvements and personal property used in the operation of the hotel) ("Trump World's Fair") and (ii) certain promissory notes made by Trump and/or certain of his affiliates and payable to Chemical (the "Chemical Notes") which are secured by certain real estate assets located in New York, unrelated to Plaza Associates. The aggregate purchase price payable for the assets subject to the Original Chemical Option Agreement was $60 million. Under the terms of the Original Chemical Option Agreement, $1 million was required to be paid for the option by January 5, 1994. In addition, the Original Chemical Option Agreement provided for an expiration of the option on May 6, 1994, subject to an extension until June 30, 1994 upon payment of an additional $250,000 on or prior to May 6, 1994. The Original Chemical Option Agreement did not allocate the purchase price among the assets subject to the option or permit the option to be exercised for some, but not all of such assets. In connection with the execution of the Original Chemical Option Agreement, Trump agreed with Plaza Associates that, if Trump is able to acquire Trump World's Fair pursuant to the exercise of the option, he would make Trump World's Fair available for the sole benefit of Plaza Associates on a basis consistent with Plaza Associates contractual obligations and requirements. Trump further agreed that Plaza Associates would not be required to pay any additional consideration to Trump in connection with any assignment of the option to purchase Trump World's Fair. On January 5, 1994, Plaza Associates obtained the approval of the CCC to make the $1 million payment, which was made on that date. On June 16, 1994, Trump, Chemical and ACFH entered into, amended and restated the Original Chemical Option Agreement, (the "First Amended Chemical Option Agreement"). The First Amended Chemical Option Agreement provided for an extension of the expiration of the Option through September 30, 1994, upon payment of $250,000. Such payment was made on June 27, 1994. The First Amended Chemical Option Agreement also provided for a $60 million option price for Trump World's Fair and one of the Chemical Notes. On August 30, 1994, Trump, Chemical and ACFH entered into an amendment to the First Amended Chemical Option Agreement (the "Second Amended Chemical Option Agreement"). The Second Amended Chemical Option Agreement provides for an extension of the expiration of the option through March 31, 1995 upon the payment of $50,000 a month for the period October through December 1994, and $150,000 a month for the period January through March 1995. Plaza Associates received the approval of the CCC and has made such payments. As of December 31, 1994, $1,550,000, representing option payments, is included in other assets in the accompanying consolidated balance sheet. If the option is exercised, these amounts are available to offset the $60 million option price. OTHER PAYMENTS TO DONALD J. TRUMP During 1994, Plaza Associates paid to Trump $1,000,000 under a Construction Management Service Agreement. The payment was made for construction management services rendered by Trump with respect to Trump Plaza East. This payment was approved prior to disbursement by the CCC and has been classified in construction in process in the accompanying consolidated balance sheet as of December 31, 1994. During 1994, Plaza Associates also paid Trump a commission of approximately $572,000 for securing a retail lease at Trump Plaza. The commission has been capitalized and is being amortized to expense over the 10-year term of the lease. (9) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of the following financial instruments of Plaza Funding, Plaza Holding and Plaza Associates approximates fair value, as follows: (a) cash and cash equivalents, accrued interest receivables and payables are based on the short term nature of these financial instruments, (b) CRDA bonds and deposits are based on the allowances to give effect to the below market interest rates. The estimated fair values of other financial instruments are as follows: The fair values of the PIK and Mortgage Notes are based on quoted market prices obtained by Plaza Associates from its investment advisor. There are no quoted market prices for other notes payable and a reasonable estimate could not be made without incurring excessive costs. On June 12, 1995 three newly formed entities owned by Trump--Trump Hotels & Casino Resorts, Inc. ("THCR"), Trump Hotels & Casino Resorts Holdings, L.P. ("THCR Holdings") and Trump Hotels & Casino Resorts Funding, Inc.--completed the offering and sale of $155,000,000 of Senior Secured Notes and $140,000,000 of equity, the June 1995 Offerings. In connection with the June 1995 Offerings, Trump contributed all of his beneficial interest in Plaza Associates (consisting of all of the outstanding capital stock of Plaza Funding, a 99% equity interest in Plaza Holding and all of the outstanding capital stock of Trump Plaza Holding, Inc.) to THCR Holdings. Trump also contributed all of his existing interests and rights to new gaming activities in both emerging and established gaming jurisdictions to THCR Holdings. The net proceeds of the June 1995 Offerings were used to repurchase or redeem the PIK Notes and PIK Note Warrants (Note 3), finance the expansion of Trump Plaza (Notes 6 and 8) as well as to fund casino development costs in certain jurisdictions outside of Atlantic City. On January 8, 1996, THCR, Taj Mahal Holding Corp. ("Taj Holding") and THCR Merger Corp. ("Merger Sub") entered into the Agreement and Plan of Merger (the "Merger Agreement") pursuant to which Merger Sub will merge with and into Taj Holding (the "Merger"). The Merger Agreement provides that each outstanding share of Class A Common Stock of Taj Holding ("Taj Holding Class A Common Stock") will be converted into the right to receive, at each holder's election, either (a) $30.00 in cash or (b) that number of shares of Common Stock of THCR ("THCR Common Stock") as shall have a market value equal to $30.00. The Merger Agreement also contemplates the following transactions occurring in connection with the Merger: (a) the consummation of the offering by THCR of up to $140,000,000 of THCR Common Stock (and an amount to be issued pursuant to the underwriters' over- allotment option) (the "THCR Stock Offering") and the offering by Trump Taj Mahal Funding, Inc. ("Taj Funding") of up to $750,000,000 aggregate principal amount of debt securities, the aggregate net proceeds of which will be used, together with available cash of Taj Associates, to (i) pay cash to those holders of Taj Holding Class A Common Stock electing to receive cash in the Merger, (ii) redeem Taj Funding's outstanding 11.35% Mortgage Bonds, Series A due 1999 (the "Bonds"), (iii) redeem the outstanding shares of Class B Common Stock, par value $.01 per share, of Taj Holding as required in connection with the redemption of the Bonds pursuant to the Amended and Restated Certificate of Incorporation of Taj Holding, (iv) purchase certain real property adjacent to the Taj Mahal that is currently leased from Trump Taj Mahal Realty Corp., a corporation wholly owned by Trump, and (v) make a payment to Bankers Trust to obtain releases of the liens and guarantees that Bankers Trust has with (b) the contribution by Trump to THCR Holdings and Taj Mahal Holdings LLC ("Taj Holdings LLC"), a subsidiary of THCR Holdings, of all of his direct and indirect ownership interests in Taj Associates; and (c) the contribution by THCR to THCR Holdings and Taj Holdings LLC of all of its indirect ownership interests in Taj Associates acquired in the Merger. Existing and prospective investors should consider among other things, (i) the high leverage and fixed charges of THCR and Taj Holding; (ii) the risk in refinancing and repayment of indebtedness and the need for additional financing; (iii) the restrictions imposed on certain activities by certain debt instruments; (iv) the recent results of Trump Plaza and the Taj Mahal; (v) risks associated with the Trump Plaza Expansion, the Taj Mahal Expansion and the Indiana Riverboat. There can be no assurance that the Trump Plaza Expansion or the Taj Mahal Expansion will be completed or that the Indiana Riverboat or any other gaming venture, will open or that any of THCR's or the Taj Mahal's operations will be successful. See "Risk Factors" included elsewhere in this Proxy Statement-Prospectus for a discussion of these and other factors. TRUMP HOTELS & CASINO RESORTS, INC. The accompanying notes are an integral part of these condensed consolidated financial statements. TRUMP HOTELS & CASINO RESORTS, INC. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE PERIOD FROM INCEPTION (JUNE 12, 1995) TO SEPTEMBER 30, 1995 (IN THOUSANDS, EXCEPT SHARE DATA) The accompanying notes are an integral part of these condensed consolidated financial statements. TRUMP HOTELS & CASINO RESORTS, INC. CONDENSED CONSOLIDATED STATEMENT OF CAPITAL FOR THE PERIOD FROM INCEPTION (JUNE 12, 1995) TO SEPTEMBER 30, 1995 (IN THOUSANDS EXCEPT SHARE DATA) The accompanying notes are an integral part of these condensed consolidated financial statements. TRUMP HOTELS & CASINO RESORTS, INC. CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE PERIOD FROM INCEPTION (JUNE 12, 1995) TO SEPTEMBER 30, 1995 The accompanying notes are an integral part of these condensed consolidated financial statements. TRUMP HOTELS & CASINO RESORTS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Trump Hotels & Casino Resorts, Inc. ("THCR"), which commenced operations on June 12, 1995, was formed on March 28, 1995 to own and operate the Trump Plaza Hotel and Casino ("Trump Plaza"), a luxury casino hotel located on The Boardwalk in Atlantic City, New Jersey. In addition, THCR, through Trump Indiana, Inc. ("Trump Indiana"), a wholly owned subsidiary of Trump Hotels & Casino Resorts Holdings, L.P. ("THCR Holdings"), is in the process of developing a riverboat gaming facility at Buffington Harbor, Indiana (the "Indiana Riverboat"). THCR, through THCR Holdings and its subsidiaries, will be the exclusive vehicle through which Donald J. Trump ("Trump") will engage in new gaming activities in emerging or established gaming jurisdictions. THCR Holdings and its wholly owned subsidiary, Trump Hotels & Casino Resorts Funding, Inc. ("THCR Funding"), were formed on March 28, 1995 to raise funds through the issuance and sale of debt securities for the benefit of Trump Plaza and Trump Indiana. THCR Holdings is owned approximately 60.2% by THCR, as general partner and approximately 39.8% by Trump, as limited partner. THCR Holdings beneficially owns 100% of Trump Plaza and Trump Indiana, as well as interests in other gaming jurisdictions. All significant intercompany balances and transactions have been eliminated in the accompanying condensed consolidated financial statements. The accompanying condensed financial statements have been prepared without audit. In the opinion of management, all adjustments, consisting of only normal recurring adjustments, necessary to present fairly the financial position, the results of operations and cash flows for the periods presented, have been made. The accompanying condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and note disclosures normally included in financial statements prepared in conformity with generally accepted accounting principles have been condensed or omitted. These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 1994 and Trump Plaza Funding's ("Plaza Funding") and Trump Plaza Associates' ("Plaza Associates") Form 10-Q for the nine months ended September 30, 1995, of Plaza Funding, Trump Plaza Holding Associates ("Plaza Holding") and Plaza Associates each filed with the Securities and Exchange Commission. The accounting policies followed by THCR are substantially the same as those followed by Plaza Funding and Plaza Associates. The casino industry in Atlantic City is seasonal in nature; therefore, results of operations for the period ended September 30, 1995 are not necessarily indicative of the operating results for a full year. On June 12, 1995, THCR completed a public offering of 10,000,000 shares of its common stock, par value $.01 per share (the "THCR Common Stock"), at $14.00 per share (the "June 1995 Stock Offering") for gross proceeds of $140,000,000. Concurrently with the June 1995 Stock Offering, THCR Holdings, together with its subsidiary, THCR Funding, issued 15 1/2% Senior Notes due 2005 (the "Senior Notes") for gross proceeds of $155,000,000 (the "June 1995 Note Offering" and, together with the June 1995 Stock Offering, the "June 1995 Offerings"). THCR contributed the gross proceeds of the June 1995 Stock Offering to THCR Holdings. The net proceeds from the June 1995 Offerings were used for the TRUMP HOTELS & CASINO RESORTS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) and redemption of the 12 1/2% Pay-in-Kind Notes due 2003 ("PIK Notes") of Plaza Holding (including accrued interest payable) of $86,209,000, (b) exercise of an option to purchase the Trump Plaza Regency Hotel ("Trump World's Fair") for $58,150,000, (c) construction costs at a hotel located adjacent to Trump Plaza's existing facility ("Trump Plaza East") for $2,500,000 and (d) construction and land acquisition costs of $23,772,000 for the Indiana Riverboat. The balance of the proceeds will be used for the completion of the construction at Trump Plaza, the Trump Plaza East, the Trump World's Fair and the Indiana Riverboat. Prior to the June 1995 Offerings, Trump was the sole stockholder of THCR and sole beneficial owner of THCR Holdings. Concurrent with the June 1995 Offerings, Trump contributed to THCR Holdings all of his beneficial interest in Plaza Associates, which consisted of all of the outstanding capital stock of Plaza Funding, a 99% equity interest in Plaza Holding and all of the outstanding capital stock of Trump Plaza Holding, Inc. ("Plaza Holding Inc."), which owns the remaining 1% equity interest in Plaza Holding. Trump also contributed all of his existing interests and rights to new gaming activities in both emerging and established gaming jurisdictions, including Trump Indiana but excluding his interests in the Trump Taj Mahal Casino Resort and Trump's Castle Casino Resort (together, the "Other Trump Casinos"), to THCR Holdings. The proceeds of the June 1995 Stock Offering were contributed by THCR to THCR Holdings in exchange for an approximate 60.2% general partnership interest in THCR Holdings. THCR Holdings' partnership agreement provides that all business activities of THCR must be conducted through THCR Holdings or its subsidiary partnerships or corporations. As the sole general partner of THCR Holdings, THCR will have the exclusive rights, responsibilities and discretion in the management and control of THCR Holdings (although Trump has retained certain rights to control the management of Plaza Associates to the extent required by the Mortgage Note Indenture pursuant to which the Plaza Mortgage Notes (as defined) were issued). In exchange for Trump's contributions to THCR Holdings as described above, Trump received an approximately 39.8% limited partnership interest in THCR Holdings. Trump's limited partnership interest in THCR Holdings represents his economic interest in the assets and operations of THCR Holdings. Accordingly, such limited partnership interest is convertible at Trump's option into 6,666,667 shares of THCR Common Stock (subject to certain adjustments) representing approximately 39.8% of the outstanding shares of THCR Common Stock. Trump received shares of Class B Common Stock of THCR, par value $.01 per share (the "THCR Class B Common Stock"). The THCR Class B Common Stock votes together with the Common Stock as a single class on all matters submitted to stockholders of THCR for a vote or in respect of which consents are solicited (other than in connection with certain amendments to THCR's Amended and Restated Certificate of Incorporation). The number of votes represented by the THCR Class B Common Stock held by any holder is equal to the number of shares of THCR Common Stock issuable to the holder upon conversion of such holder's partnership interest in THCR Holdings into THCR Common Stock. Upon such conversion, the corresponding voting power of shares of THCR Class B Common Stock provides Trump with a voting interest in THCR which is proportionate to his equity interest in THCR Holdings' assets represented by his limited partnership interest. Except for the right to receive par value upon liquidation, the THCR Class B Common Stock has no right to receive any dividend or other distribution in respect of the equity of THCR. In addition, Trump has agreed to waive (except as set forth under the Amended and Restated Certificate of Incorporation of THCR) state law rights to vote the THCR Class B Common Stock as a separate class in the event of merger or sale of substantial assets. TRUMP HOTELS & CASINO RESORTS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The accompanying condensed consolidated financial statements of THCR reflect the contributed entities' assets and liabilities on the carryover basis of accounting as of June 12, 1995, the date of such contribution as such entities were under common control. Trump's approximately 39.8% economic interest in THCR Holdings is accounted for as a minority interest in THCR's financial statements. The accompanying statements of operations reflect the operations for the three-month period ended September 30, 1995 and the period from inception through September 30, 1995. THCR did not have any operations from the period of its formation, March 28, 1995, through the date of the Offerings. Federal income taxes are provided based on THCR's income, subject to Federal income tax. Under the New Jersey Casino Control Commission (the "CCC") regulations, Plaza Associates is required to file a New Jersey Corporate Business Tax Return. Accordingly, a provision for state income taxes has been reflected in the accompanying condensed statements of operations of THCR. Earnings per share is based on the weighted average number of shares of common stock and common stock equivalents (including shares to be granted to the President, Chief Executive Officer and Chief Financial Officer of THCR under a phantom stock unit award (see Note 5). The shares of THCR Class B Common Stock owned by Trump have no economic interest and, therefore, are not considered in the calculation of weighted average shares outstanding. On June 12, 1995, THCR Holdings and THCR Funding issued $155,000,000 principal amount of the Senior Notes. The Senior Notes are redeemable in cash at the option of THCR Holdings and THCR Funding, in whole or in part, at any time on or after June 15, 2000 at redemption prices, as defined. The Senior Notes bear interest at the stated rate of 15 1/2% per annum, payable semi- annually in arrears on June 15 and December 15 of each year, commencing December 15, 1995, and are secured by substantially all of the assets of THCR Holdings. Costs associated with the issuance of the debt total approximately $10,151,000. These costs have been deferred and are being amortized over the life of the Senior Notes. On June 25, 1993, Plaza Funding issued $330,000,000 principal amount of 10 7/8% Mortgage Notes due 2001 (the "Plaza Mortgage Notes"), net of discount of $4,313,000. At September 30, 1995, the Plaza Mortgage Notes were $326,543,000, net of discount of $3,457,000. Plaza Associates has other notes payable of $7,212,000 at September 30, 1995, including $2,100,000 in current maturities. Interest on these notes is payable monthly and these notes have various maturity dates. In connection with the June 1995 Offerings, the Board of Directors of THCR (the "Board of Directors") adopted the 1995 Stock Incentive Plan (the "1995 Stock Plan"). Pursuant to the 1995 Stock Plan, directors, TRUMP HOTELS & CASINO RESORTS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) employees and consultants of THCR and certain of its subsidiaries and affiliates who have been selected as participants are eligible to receive awards of various forms of equity-based incentive compensation, including stock options, stock appreciation rights, stock bonuses, restricted stock awards, performance units and phantom stock, and awards consisting of combinations of such incentives. The 1995 Stock Plan is administered by a committee appointed by the Board of Directors (the "Stock Incentive Plan Committee"). Options granted under the 1995 Stock Plan may be incentive stock options ("ISOs"), within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), or nonqualified stock options ("NQSOs"). The vesting, exercisability and exercise price of the options are determined by the Committee when the options are granted, subject to a minimum price, in the case of ISOs, of the Fair Market Value (as defined in the 1995 Stock Plan) of THCR Common Stock on the date of the grant and a minimum price, in the case of NQSOs, of the par value of THCR Common Stock. The 1995 Stock Plan permits the Stock Incentive Plan Committee to grant stock appreciation rights ("SARs") either alone or in connection with an option. An SAR granted as an alternative or a supplement to a related stock option will entitle its holder to be paid an amount equal to the fair market value of THCR Common Stock subject to the SAR on the date of exercise of the SAR, less the exercise price of the related stock option or such other price as the Stock Incentive Plan Committee may determine at the time of the grant of the SAR (which may not be less than the lowest price which the Stock Incentive Plan Committee may determine under the 1995 Stock Plan for such stock option). The 1995 Stock Plan also provides that phantom stock and performance unit awards may be settled in cash, at the discretion of the Stock Incentive Plan Committee and if indicated in the applicable award agreement, on each date on which shares of THCR Common Stock covered by the awards would otherwise have been delivered or become unrestricted, in an amount equal to the fair market value of the shares on such date. Subject to adjustment in the event of changes in the outstanding stock or the capital structure of THCR, THCR has reserved 1,000,000 shares of THCR Common Stock for issuance under the 1995 Stock Plan. In connection with the June 1995 Offerings, the Stock Incentive Plan Committee granted to the President, Chief Executive Officer and Chief Financial Officer of THCR a stock bonus award of 66,667 shares of THCR Common Stock under the 1995 Stock Plan, which was fully vested upon issuance. Compensation expense of approximately $933,000 associated with the stock bonus award is reflected in the accompanying statement of operations of THCR. A phantom stock unit award was also issued to the President, Chief executive Officer and Chief Financial Officer of THCR. This award entitles the President, Chief Executive Officer and Chief Financial Officer of THCR to receive 66,666 shares of THCR Common Stock two years following such award, subject to certain conditions. The compensation expense associated with the phantom stock award is approximately $933,000 and this amount is being amortized over the two-year vesting period and was approximately $189,000 for the period from inception to September 30, 1995. The President, Chief Executive Officer and Chief Financial Officer of THCR also received an award of NQSOs for the purchase of 133,333 shares of THCR Common Stock, subject to certain conditions (including vesting at a rate of 20% per year over a five-year period). The options have an exercise price of $14.00 per share. (6) CERTAIN TRANSACTIONS WITH COMPANY EXECUTIVE Trump serves as the Chairman of the Board of Directors pursuant to an Executive Agreement entered into between Trump, THCR and THCR Holdings (the "Trump Executive Agreement"). In consideration TRUMP HOTELS & CASINO RESORTS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) for Trump's services under the Trump Executive Agreement, Trump receives a salary of $1,000,000 per year, payable in equal monthly installments. Prior to consummation of the June 1995 Offerings, Trump incurred $3,000,000 relating to expenditures for the development of Trump Indiana and other gaming ventures. Concurrently with the June 1995 Offerings, THCR Holdings loaned Trump $3,000,000 and Trump issued to THCR Holdings a five-year promissory note (the "Trump Note") bearing interest at a fixed rate of 10% per annum, payable annually. The Trump Note will be automatically canceled in the event that at any time during the period defined in the Trump Note, the THCR Common Stock trades at a price per share equal to or greater than the prices set forth in the Trump Note (subject to adjustment in certain circumstances). During the period from inception to September 30, 1995, the trading price of the THCR Common Stock did not reach the defined prices. Nicholas L. Ribis ("Ribis"), the President, Chief Executive Officer and Chief Financial Officer of THCR entered into a five-year employment agreement (the "Revised Ribis Agreement") with THCR and THCR Holdings on June 12, 1995. Pursuant to the Revised Ribis Agreement, Ribis shall be employed as the President and Chief Executive Officer of THCR and Chief Executive Officer of THCR Holdings and shall receive a base salary of $907,500, annually. As a condition to the June 1995 Note Offering, THCR Holdings and THCR Funding entered into a Cash Collateral and Disbursement Agreement (the "Cash Collateral Agreement") with First Bank National Association in its respective capacities as Trustee and Disbursement Agent (each as defined therein). The Cash Collateral Agreement called for initial deposits to custodial accounts which are restricted in use for (a) Trump Indiana for the ship and land projects, (b) Trump Plaza construction projects, including the exercise of the option to purchase the Trump World's Fair (the "Trump World's Fair Purchase Option") and construction projects at the Trump Plaza East and the Trump World's Fair and (c) the first two interest payments on the Senior Notes. As of September 30, 1995, $24,225,000 is restricted for the first two interest payments on the Senior Notes and is reflected as Restricted Cash in the accompanying condensed balance sheets. The balance of funds restricted for Trump Indiana, the Trump Plaza East and the Trump World's Fair are approximately $9,725,000, $12,650,000 and $49,375,000, respectively, at September 30, 1995, and are reflected as Cash Restricted for future construction as a non-current asset in the accompanying balance sheets. The operation of an Atlantic City hotel and casino is subject to significant regulatory controls which affect virtually all of its operations. Under the New Jersey Casino Control Act (the "Casino Control Act"), Plaza Associates is required to maintain certain licenses. In June 1995, the New Jersey Casino Control Commission (the "CCC") renewed Plaza Associates' license to operate Trump Plaza. This license must be renewed in June 1999, is not transferable and such renewal of the license will include a review of the financial stability of Plaza Associates. Upon revocation, suspension for more than 120 days or if the CCC fails or refuses to renew such casino license, the Casino Control Act allows for the appointment of a conservator to take possession of the hotel and casino's business and property, subject to all valid liens, claims and encumbrances. TRUMP HOTELS & CASINO RESORTS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) On January 8, 1996, THCR, Taj Holding and THCR Merger Corp. ("Merger Sub") entered into the Agreement and Plan of Merger (the "Merger Agreement") pursuant to which Merger Sub will merge with and into Taj Holding (the "Merger"). The Merger Agreement provides that each outstanding share of Class A Common Stock of Taj Holding ("Taj Holding Class A Common Stock") will be converted into the right to receive, at each holder's election, either (a) $30.00 in cash or (b) that number of shares of THCR Common Stock as shall have a market value equal to $30.00. The Merger Agreement also contemplates the following transactions occurring in connection with the Merger: (a) the consummation of the offering by THCR of up to $140,000,000 of THCR Common Stock (and an amount to be issued pursuant to the underwriters' over- allotment option) (the "THCR Stock Offering") and the offering by Trump Taj Mahal Funding, Inc. ("Taj Funding") of up to $750,000,000 aggregate principal amount of debt securities, the aggregate net proceeds of which will be used, together with available cash of Taj Mahal Associates ("Taj Associates"), to (i) pay cash to those holders of Taj Holding Class A Common Stock electing to receive cash in the Merger, (ii) redeem Trump Taj Mahal Funding, Inc's ("Taj Funding") outstanding 11.35% Mortgage Bonds, Series A due 1999 (the "Bonds"), (iii) redeem the outstanding shares of Class B Common Stock, par value $.01 per share, of Taj Holding as required in connection with the redemption of the Bonds pursuant to the Amended and Restated Certificate of Incorporation of Taj Holding, (iv) purchase (using cash and 500,000 shares of THCR Common Stock) certain real property adjacent to the Trump Taj Mahal Casino Resort that is currently leased from Trump Taj Mahal Realty Corp., a corporation wholly owned by Trump, and (v) make a payment to Bankers Trust to obtain releases of the liens and guarantees that Bankers Trust has with respect to Taj Associates; (b) the contribution by Trump to THCR Holdings and Taj Mahal Holdings LLC ("Taj Holdings LLC"), a subsidiary of THCR Holdings, of all of his direct and indirect ownership interests in Taj Associates; and (c) the contribution by THCR to THCR Holdings and Taj Holdings LLC of all of its indirect ownership interests in Taj Associates acquired in the Merger. TRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES The accompanying notes are an integral part of these condensed consolidated financial statements. TRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1994 AND 1995 The accompanying notes are an integral part of these condensed consolidated financial statements. TRUMP PLAZA HOLDING ASSOCIATES AND CONDENSED CONSOLIDATED STATEMENT OF CAPITAL (DEFICIT) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 The accompanying notes are an integral part of these condensed consolidated financial statements. TRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1994 AND 1995 The accompanying notes are an integral part of these condensed consolidated financial statements. TRUMP PLAZA HOLDING ASSOCIATES AND NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (1) CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The accompanying condensed financial statements include those of Trump Plaza Funding, Inc. ("Plaza Funding"), a New Jersey corporation as well as those of Trump Plaza Holding Associates, ("Plaza Holding") a New Jersey General Partnership, and its 99% owned subsidiary, Trump Plaza Associates, ("Plaza Associates") a New Jersey General Partnership, which owns and operates the Trump Plaza Hotel and Casino located in Atlantic City, New Jersey. Plaza Funding owns the remaining 1% interest in, and is the managing general partner of, Plaza Associates. Plaza Holding's sole source of liquidity is distributions in respect of its interest in Plaza Associates. All significant intercompany balances and transactions have been eliminated in the condensed consolidated financial statements of Plaza Holding. The accompanying condensed financial statements have been prepared by Plaza Funding, Plaza Holding and Plaza Associates without audit. In the opinion of Plaza Funding, Plaza Holding and Plaza Associates, all adjustments, consisting of only normal recurring adjustments, necessary to present fairly the financial position, the results of operations and cash flows for the periods presented, have been made. Certain prior year amounts have been reclassified to conform with the current period presentation. The accompanying condensed financial statements have been prepared by Plaza Funding, Plaza Holding and Plaza Associates pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and note disclosures normally included in financial statements prepared in conformity with generally accepted accounting principles have been condensed or omitted. These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in Plaza Funding's, Plaza Holding's and Plaza Associates' Annual Report on Form 10-K for the year ended December 31, 1994 filed with the Securities and Exchange Commission. The casino industry in Atlantic City is seasonal in nature; therefore, results of operations for the nine months ended September 30, 1995 are not necessarily indicative of the operating results for a full year. On June 12, 1995, Trump Hotels & Casino Resorts, Inc., ("THCR") completed a public offering of 10,000,000 shares of common stock at $14.00 per share (the "June 1995 Stock Offering") for gross proceeds of $140,000,000. Concurrently with the June 1995 Stock Offering, Trump Hotels & Casino Resorts Holdings, L.P. ("THCR Holdings") together with its subsidiary, Trump Hotels & Casino Resorts Funding, Inc. ("THCR Funding") issued 15 1/2% Senior Secured Notes (the "Senior Notes") for gross proceeds of $155,000,000 (the "June 1995 Note Offering" and, together with the June 1995 Stock Offering, the "June 1995 Offerings"). From the proceeds from the June 1995 Stock Offering, THCR contributed approximately $126,848,000 to THCR Holdings. THCR Holdings subsequently contributed $146,859,000 to Plaza Holding. Prior to the June 1995 Offerings, Donald J. Trump ("Trump") was the sole owner of THCR Holdings. Concurrent with the June 1995 Offerings, Trump contributed to THCR Holdings all of his beneficial interest in Plaza Associates (consisting of all of the outstanding capital stock of Plaza Funding, a 99% equity interest in Plaza Holding and all of the outstanding capital stock of Trump Plaza Holding, Inc. ("Plaza Holding, Inc.") which owns the remaining 1% equity interest in Plaza Holding). Trump also contributed to THCR Holdings all of his existing interest and rights to new gaming activities in both emerging and established gaming jurisdictions, including Trump Indiana but excluding his interests in the Trump Taj Mahal Casino Resort and Trump's Castle Casino Resort (together, the "Other Trump Casinos"). TRUMP PLAZA HOLDING ASSOCIATES AND NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Long-term debt consists of the following: (A) On June 25, 1993, Plaza Funding issued $330,000,000 principal amount of 10 7/8% Mortgage Notes, due 2001 (the "Plaza Mortgage Notes"), net of discount of $4,313,000, and loaned the proceeds to Plaza Associates. (B) On June 25, 1993 Plaza Holding issued $60,000,000 principal amount of 12 1/2% Pay-In-Kind Notes, due 2003 (the "PIK Notes"), together with Warrants to acquire an additional $12,000,000 of PIK Notes at no additional cost (the "PIK Note Warrants"). The PIK Note Warrants were exercised prior to June 12, 1995 and the PIK Notes were repurchased and redeemed on June 12, 1995 from the amounts contributed to Plaza Holding by THCR Holdings (See Note 2). Such repurchase and redemption resulted in the recognition of an extraordinary loss of $9,250,000 relating to the redemption and the write- off of unamortized deferred financing costs. The operation of an Atlantic City hotel and casino is subject to significant regulatory controls which affect virtually all of its operations. Under the New Jersey Casino Control Act (the "Casino Control Act") Plaza Associates is required to maintain certain licenses. In June 1995, the New Jersey Casino Control Commission ("CCC") renewed Plaza Associates' license to operate Trump Plaza. This license must be renewed in June 1999, is not transferable, and such renewal of the license will include a review of the financial stability of Plaza Associates. Upon revocation, suspension for more than 120 days, or if the CCC fails or refuses to renew such casino license, the Casino Control Act allows for the appointment of a conservator to take possession of the hotel and casino's business and property, subject to all valid liens, claims and encumbrances. TRUMP PLAZA HOLDING ASSOCIATES AND NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) On June 12, 1995, Trump exercised its option to purchase the Trump Regency ("Trump World's Fair"). The option price of $60,000,000 was funded with $58,150,000 from the capital contributed by THCR Holdings (see Note 2), and $1,850,000 of previous deposits made by Plaza Associates. Plaza Associates received the property via directed deed. On January 8, 1996, THCR, Taj Holding and THCR Merger Corp. ("Merger Sub") entered into the Agreement and Plan of Merger (the "Merger Agreement") pursuant to which Merger Sub will merge with and into Taj Holding (the "Merger"). The Merger Agreement provides that each outstanding share of Class A Common Stock of Taj Holding ("Taj Holding Class A Common Stock") will be converted into the right to receive, at each holder's election, either (a) $30.00 in cash or (b) that number of shares of THCR Common Stock as shall have a market value equal to $30.00. The Merger Agreement also contemplates the following transactions occurring in connection with the Merger: (a) the consummation of the offering by THCR of up to $140,000,000 of THCR Common Stock (and an amount to be issued pursuant to the underwriters' over- allotment option) (the "THCR Stock Offering") and the offering by Trump Taj Mahal Funding, Inc. ("Taj Funding") of up to $750,000,000 aggregate principal amount of debt securities, the aggregate net proceeds of which will be used, together with available cash of Taj Mahal Associates ("Taj Associates"), to (i) pay cash to those holders of Taj Holding Class A Common Stock electing to receive cash in the Merger, (ii) redeem Trump Taj Mahal Funding, Inc's ("Taj Funding") outstanding 11.35% Mortgage Bonds, Series A due 1999 (the "Bonds"), (iii) redeem the outstanding shares of Class B Common Stock, par value $.01 per share, of Taj Holding as required in connection with the redemption of the Bonds pursuant to the Amended and Restated Certificate of Incorporation of Taj Holding, (iv) purchase (using cash and 500,000 shares of THCR Common Stock) certain real property adjacent to the Trump Taj Mahal Casino Resort that is currently leased from Trump Taj Mahal Realty Corp., a corporation wholly owned by Trump, and (v) make a payment to Bankers Trust to obtain releases of the liens and guarantees that Bankers Trust has with respect to Taj Associates; (b) the contribution by Trump to THCR Holdings and Taj Mahal Holdings LLC ("Taj Holdings LLC"), a subsidiary of THCR Holdings, of all of his direct and indirect ownership interests in Taj Associates; and (c) the contribution by THCR to THCR Holdings and Taj Holdings LLC of all of its indirect ownership interests in Taj Associates acquired in the Merger and contributed to THCR by Trump. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Trump Taj Mahal Associates and Subsidiary: We have audited the accompanying consolidated balance sheets of Trump Taj Mahal Associates (a New Jersey general partnership) and Subsidiary as of December 31, 1993 and 1994, and the related consolidated statements of operations, capital (deficit) and cash flows for each of the three years in the period ended December 31, 1994. These consolidated financial statements are the responsibility of Trump Taj Mahal Associates management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Trump Taj Mahal Associates and Subsidiary as of December 31, 1993 and 1994 and the result of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. 10, as to which the date TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY The accompanying notes to financial statements are an integral part of these consolidated financial statements. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY The accompanying notes to financial statements are an integral part of these consolidated financial statements. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CAPITAL (DEFICIT) The accompanying notes to financial statements are an integral part of these consolidated financial statements. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS The accompanying notes to financial statements are an integral part of these consolidated financial statements. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) ORGANIZATION, OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying consolidated financial statements include those of Trump Taj Mahal Associates ("Taj Associates"), and its wholly owned subsidiary, Trump Taj Mahal Funding, Inc. ("Taj Funding"). All significant intercompany balances and transactions have been eliminated in the consolidated financial statements. Taj Associates was formed on June 23, 1988 as a New Jersey limited partnership. Taj Associates was converted to a general partnership in December 1990. The current partners and their respective ownership interests are Trump Taj Mahal, Inc. ("TTMI"), 49.995%, The Trump Taj Mahal Corporation ("TTMC"), .01%, and TM/GP Corporation ("TM/GP"), the managing general partner, and a wholly owned subsidiary of Taj Mahal Holding Corp. ("Taj Holding"), 49.995%. Taj Associates was formed for the purpose of acquiring, constructing and operating the Trump Taj Mahal Casino Resort (the "Taj Mahal"), an Atlantic City hotel, casino and convention center complex. On April 2, 1990, Taj Associates opened the Taj Mahal to the public. Taj Funding was incorporated on June 3, 1988 for the purpose of raising funds through the issuance of its 14% First Mortgage Bonds, Series A, due 1998 (the "Old Bonds"), the proceeds of which were loaned to Taj Associates for construction of the Taj Mahal. During 1991, as a result of a plan of reorganization (the "1991 Taj Restructuring"), the Old Bonds were subsequently exchanged for the Taj Funding's 11.35% Mortgage Bonds, Series A, due 1999 (the "Bonds"). Since Taj Funding has no business operations, its ability to repay the principal and interest on the Bonds is completely dependent on the operations of Taj Associates. Donald J. Trump ("Trump") beneficially owns 50% of Taj Associates and has pledged his total ownership interest as collateral under various debt agreements. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Casino revenues consist of the net win from gaming activities, which is the difference between gaming wins and losses. Revenues from hotel and other services are recognized at the time the related service is performed. Gross revenues includes the retail value of complimentary rooms, food, beverages, and other services furnished to patrons. The retail value of these promotional allowances is deducted from gross revenues to arrive at net revenues. The cost of promotional allowances is charged to operations. Promotional allowances consisted of the following: TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The accompanying financial statements do not include a provision for Federal income taxes of Taj Associates, since any income or losses allocated to the partners are reportable for Federal income tax purposes by the partners. Under the New Jersey Casino Control Commission regulations, Taj Associates is required to file a New Jersey corporation business tax return. Inventories are carried at cost on a weighted average basis. Property and equipment is recorded at cost and is depreciated on the straight-line method over the estimated useful lives of assets. Estimated useful lives range from three to seven years for furniture, fixtures and equipment and 40 years for buildings and building improvements. Leasehold improvements are amortized over the term of the related lease commencing in the period these assets are placed in service. The interest expense associated with borrowings used to fund the purchase and construction of the Taj Mahal has been capitalized and is being amortized over the estimated useful life of the facility. Cash and cash investments include hotel and casino funds, funds on deposit with banks and temporary investments having a maturity of three months or less. Long-term debt consisted of the following at December 31: (a) Taj Funding's Bonds bear interest of 11.35% and are due November 15, 1999. Each Bond, together with one share of Taj Holding's Class B redeemable common stock, par value $.01 per share, trade together as a unit ("Units"), and may not be transferred separately. Interest on the Bonds is due semi-annually on each November 15 and May 15. Interest on the Bonds must be paid in cash on each interest payment date at the rate of 9.375% per annum (the "Mandatory Cash Interest Amount"). In addition to the Mandatory Cash Interest Amount, effective May 15, 1992 and annually thereafter, an additional amount of interest (the "Additional Amount") in cash or additional Bonds or a combination thereof, is payable equal to the difference between 11.35% of the outstanding principal amount of the Bonds and the Mandatory Cash Interest Amount previously paid. To the extent that there is excess available cash TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) flow ("EACF") of Taj Associates, as defined in the related indenture, for the immediately preceding calendar year, Taj Funding will pay the Additional Amount in cash up to 10.28% and the balance thereof may be paid at the option of Taj Funding in cash or additional Units, provided that an equivalent amount of cash is used to purchase or redeem Units. Additional Bonds issued on October 4, 1991 amounted to approximately $7,208,000. For the period from the issuance of the Bonds, October 4, 1991, through December 31, 1992, there was no EACF. Accordingly, Taj Funding paid the Additional Amounts on May 15, 1993 and May 15, 1992 through the issuance of approximately $14,579,000 and $8,844,000, respectively, in additional Bonds. Of the $14,870,000 Additional Amount due May 15, 1994, $2,621,000 was paid in cash and the $12,249,000 balance in Bonds. Of the $15,111,000 Additional Amount due May 15, 1995, Taj Associates expects to satisfy the obligation through the issuance of Bonds. Since Taj Funding has no business operations, its ability to repay the principal and interest on the Bonds is completely dependent on the operations of Taj Associates. The Bonds are guaranteed as to payment of principle and interest by Taj Associates and are collateralized by substantially all Taj Associates property. In accordance with AICPA Statement of Position 90-7, "Financial Reporting By Entities in Reorganization Under the Bankruptcy Code", the Bonds when issued were stated at the present value of amounts to be paid, determined at current interest rates (effective rate of approximately 18%). The effective interest rate of the Bonds was determined based on the trading price of the Bonds for a specific period. Stating the debt at its approximate present value resulted in a reduction of approximately $204,276,000 in the carrying amount of the Bonds. This gain is being offset by increased interest costs over the period of the Bonds to accrete such bonds to their face value at maturity. At December 31, 1994, the unaccreted balance of this discount approximated $153,597,000. The current interest rates of other borrowings approximated their stated interest rates as of the effective date. The accretion amounted to approximately $13,172,000 in 1992, $15,745,000 in 1993 and $18,820,000 in 1994, and is included in interest expense. (b) On November 3, 1989, Taj Associates entered into a loan agreement with National Westminster Bank, U.S.A. (the "NatWest Loan") which provided financing up to $50,000,000 for certain items of furniture, fixtures and equipment installed in the Taj Mahal. The terms of the NatWest Loan were modified in 1991 as part of the 1991 Taj Restructuring. The restructured NatWest Loan bears interest at 9 3/8% per annum. Principal and interest is payable monthly in the fixed amount of $373,000 to be applied first to accrued interest and the balance to the extent available, to principal, through maturity, November 15, 1999. Additionally, on May 15 of each year (May 15, 1992 through May 15, 1999), to the extent principal is still outstanding, NatWest will receive 16.5% of the EACF of the preceding calendar year in excess of the Additional Amount, to be applied first to accrued but unpaid interest, and then to principal. The NatWest Loan is secured by a first priority lien on the furniture, fixtures and equipment acquired with the proceeds of the NatWest Loan plus any after acquired furniture, fixtures and equipment that replaces such property, or of the same type, provided, however, that the NatWest Loan may be subordinated to a lien to secure purchase money financing of such after acquired property up to 50% of the value of such after acquired property. In November 1991, Taj Associates obtained a working capital line of credit in the amount of $25,000,000 with a maturity of five years. In September 1994, Taj Associates extended the maturity to November 1999, in consideration of modifications of the terms of the facility. Interest on advances under the line are at prime plus 3% with a minimum of 0.666 per month. The Agreement provides for a 3/4% annual fee and a 1/2% unused line fee and contains various covenants. During 1993 and 1994, no amounts were outstanding under the line. During 1992, $8,000,000 was drawn under the line and repaid. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Aggregate annual maturities of long-term debt at accreted value are as follows: Taj Associates has engaged in certain transactions with Trump and entities that are wholly or partially owned by Trump. Amounts owed to (receivable from) at December 31 are as follows: (a) Taj Associates has entered into a Services Agreement (the "Services Agreement"), which provides that Trump will render to Taj Associates marketing, advertising, promotional and related services with respect to the business operations of Taj Associates. In consideration for the services to be rendered, Taj Associates will pay an annual fee equal to 1.5% of Taj Associates earnings before interest, taxes and depreciation, as defined, less capital expenditures and partnership distributions for such year, with a minimum base fee of $500,000. The services fee is payable monthly through November 15, 1999, although the agreement provides for earlier termination under certain events. Portions of the fee have been assigned to First Fidelity Bank in connection with the Loan to Realty Corp. which has been guaranteed by Trump. For the years ended December 31, 1992, 1993 and 1994, Taj Associates incurred $1,319,000, $1,566,000 and $1,353,000, respectively, under the Services Agreement. In addition, during 1993 and 1994, Taj Associates reimbursed Mr. Trump $232,000 and $224,000, respectively, for expenses pursuant to the Services Agreement, of which $127,000 and $149,000, respectively, was incurred to an affiliate for air transportation. (b) The term of the lease between Taj Associates and Realty Corp. is through 2023 and provides for base rentals payable by Taj Associates, prior to the time that the NatWest Loan is paid in full, of $2,725,000 per year, plus 3 1/2% of the EACF in excess of the Additional Amount and, upon payment in full of the NatWest loan, increasing to include the payments to which NatWest is otherwise entitled under the amended NatWest Agreement (Note 3). The amended lease was assigned by Realty to First Fidelity Bank ("First Fidelity"). The first $3,300,000 received by First Fidelity each year will be applied to the interest due on the Realty Corp. loan (the "Loan"). Any additional sums paid will also reduce Taj Associates guarantee (see below) and the principal amount of the Loan. The Loan is secured by a first mortgage lien on the underlying parcels owned by Realty Corp. Pursuant to a limited subordinated guarantee Taj Associates will, under certain circumstances, reimburse First Fidelity for any deficiency in the amount owed to First Fidelity upon maturity of the Loan, up to a TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) maximum of $30,000,000, provided that First Fidelity first pursues its first mortgage lien on the parcels, and provided further that the Bonds have been paid in full. Inasmuch as Taj Associates lease payments are Realty Corp's sole source of funds to satisfy the Loan and the amount of the Loan exceeds the estimated fair market value of the land by more than $30,000,000, Taj Associates recorded the present value of the maximum guarantee amount as of October 4, 1991. Discounted at 15%, a reasonable incremental cost of capital, the obligation amounted to approximately $9,103,000. This obligation is being accreted as interest expense over the life of the Bonds and is included in Other Liabilities in the accompanying consolidated balance sheets. The accretion amounted to approximately $1,519,000, $1,763,000, and $2,047,000 for the years ended December 31, 1992, 1993 and 1994, respectively. (c) Taj Associates engages in various transactions with the two other Atlantic City hotel/casinos owned by Trump. These transactions are charged at cost or normal selling price in the case of retail items and include the utilization of fleet maintenance and limousine services, certain shared professional fees and payroll costs as well as complimentary services offered to customers. During 1992, Taj Associates incurred approximately $622,000 and $93,000 of costs for these services from Trump's Castle Casino Resort ("Trump's Castle") and Trump Plaza, respectively. In addition, Taj Associates charged $67,000 and $309,000 to Trump's Castle and Trump Plaza, respectively, for similar services. During 1993, Taj Associates incurred approximately $1,100,000 and $83,000 of costs for these services from Trump's Castle and Trump Plaza, respectively. In addition, Taj Associates charged $256,000 and $255,000 to Trump's Castle and Trump Plaza, respectively, for similar services. During 1994, Taj Associates incurred approximately $1,167,000 and $149,000 of costs for these services from Trump's Castle and Trump Plaza, respectively. In addition, Taj Associates charged $235,000 and $361,000 to Trump's Castle and Trump Plaza, respectively, for similar services. (d) Helicopter Air Services and the Trump Shuttle, Inc. (the "Trump Shuttle") provided aircraft charters and travel services to certain patrons of the Taj Mahal on behalf of Taj Associates. For the years ended December 31, 1992, 1993 and 1994, Taj Associates incurred no charges from Helicopter Air Services. During 1992, Taj Associates incurred charges of $29,000 from Trump Shuttle. The components of other current liabilities at December 31 consisted of the following: TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Taj Associates has entered into employment agreements with certain key employees and lease agreements for land, office and warehouse space under noncancellable operating leases expiring at various dates through 2023. At December 31, 1994, minimum commitments under these arrangements are as follows: Rent expense was approximately $4,942,000, $4,520,000 and $5,027,000 for the years ended December 31, 1992, 1993 and 1994, respectively. Taj Associates leases the pier extending from the Taj Mahal 1,000 feet into the Atlantic Ocean (the "Steel Pier") from Realty Corp. A condition imposed on Taj Associates Coastal Area Facilities Review Act ("CAFRA") permit (which, in turn, is a condition of Taj Associates casino license) initially required that Taj Associates begin construction of certain improvements on the Steel Pier which were to be completed within 18 months of commencement. Taj Associates initially proposed a concept to improve the Steel Pier, the estimated cost of which was $30,000,000. Such concept was approved by the New Jersey Department of Environmental Protection and Energy ("NJDEPE"), the agency which administers CAFRA. In March 1993, Taj Associates obtained a modification of its CAFRA permit providing for the extension of the required commencement and completion dates of the improvements to the Steel Pier for one year based upon an interim use of the Steel Pier for an amusement park. In March 1994 and 1995, Taj Associates received an additional one-year extension of the required commencement and completion dates of the improvements of the Steel Pier based upon the same interim use of the Steel Pier as an amusement park. Effective January 1, 1989, Taj Associates established the Taj Mahal Retirement Savings Plan ("the Benefit Plan") for its employees over 21 years of age who are not covered by a collective bargaining agreement. The Benefit Plan is structured to qualify for favorable tax treatment under Section 401(k) of the Internal Revenue Code and allows eligible participants to contribute up to 15% of their salary (certain limits apply, as defined) to the Benefit Plan with a matching Partnership contribution of 50% of the first 4% of such employee salary contribution. The funds are invested by a Benefit Plan trustee. Taj Associates contributions for the years ended December 31, 1992, 1993 and 1994 were $841,000, $870,000 and $938,000, respectively. Taj Funding and Taj Associates are subject to regulation and licensing by the New Jersey Casino Control Commission (the "CCC"). Taj Associates' casino license must be renewed periodically, is not transferable, is dependent upon the financial stability of Taj Associates and can be revoked at anytime. Upon revocation, suspension for more than 120 days, or failure to renew the casino license due to Taj Associates financial condition or for any other reason, the Casino Control Act (the "Casino Control Act") provides that the CCC may appoint a conservator to take possession of and title to the hotel and casino's TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) subject to all valid liens, claims and encumbrances. On March 22, 1995, the CCC extended Taj Associates' casino license through June 30, 1995 in order to consolidate Taj Associates license renewal proceedings with Trump's Castle and the Taj Mahal (the "Other Trump Casinos"), at which time the CCC will conduct a plenary hearing for renewal of Taj Associates' casino license for a period of up to four years as provided by law. Taj Associates, its partners, certain of its employees and Taj Funding are involved in various legal proceedings incurred in the normal course of business. In the opinion of management of Taj Associates, the expected disposition of these proceedings would not have a material adverse affect on Taj Associates or TTMI's financial condition or results of operations. The Casino Control Act requires Taj Associates to make qualified investments, as defined, in New Jersey, or pay an investment alternative tax to the New Jersey Casino Reinvestment Development Authority ("CRDA"). Commencing in 1991, and for a period of thirty years thereafter, Taj Associates must either obtain investment tax credits, as defined, in an amount equivalent to 1.25% of its gross casino revenues or pay an alternative tax of 2.5% of its gross casino revenues, as defined. Investment tax credits may be obtained by making qualified investments, by depositing funds which may be converted to bonds by the CRDA or by donating previously deposited funds in exchange for future credits against tax liability. Taj Associates intends to satisfy its investment obligation primarily by depositing funds and donations of funds deposited. During 1994, Taj Associates contributed $9,500,000 of previous CRDA deposits, the carrying value of which was $4,750,000. Of the carrying value, $3,250,000 will become a leasehold improvement upon completion of the improvements during 1995, and $1,500,000 was a donation of previously deposited funds, which became a credit utilized in 1994 as a reduction of current year obligations. The deposits and bonds traditionally bear interest at below-market interest rates; accordingly, Taj Associates has reduced its carrying value of the deposits by 50% and charged operations approximately $2,563,000, $2,764,000 and $2,134,000 in 1992, 1993 and 1994, respectively. Taj Associates is required to satisfy its obligations to the CRDA through deposits on a quarterly basis. If such deposits are converted to bonds by the CRDA, such bonds will be accounted for under SFAs No. 115. Taj Associates is obligated to reimburse Taj Holding for its operating expenses which consist of directors and officers liability insurance, board of director fees and expenses, and administrative expenses. Total expenses for the years ended December 31, 1992, 1993 and 1994 approximated $1,825,000, $1,733,000 and $2,171,000, respectively. (7) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of the following financial instruments of Taj Funding and Taj Associates approximates fair value, as follows: (a) cash and cash equivalents and accrued interest payable are based on the short term nature of the financial instruments; and, (b) CRDA deposits are based on the valuation allowances to give effect to the below market interest rates. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The estimated fair values of the other financial instruments are as follows (Note 3): (a) The fair value of the Mortgage Bonds is based on quoted market prices as of December 31, 1993 and 1994. There are no quoted market prices for the Taj Associates-NatWest Loan and other debt and a reasonable estimate of their value could not be made without incurring excessive costs. Financial information relating to Taj Funding as of and for the years ended December 31, 1993 and 1994 is as follows (in thousands): (9) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) On January 8, 1996, Trump Hotels & Casino Resorts Inc. ("THCR"), Taj Holding and THCR Merger Corp. ("Merger Sub") entered into the Agreement and Plan of Merger (the "Merger Agreement") pursuant to which Merger Sub will merge with and into Taj Holding (the "Merger"). The Merger Agreement provides that each outstanding share of Class A Common Stock of Taj Holding ("Taj Holding Class A Common Stock") will be converted into the right to receive, at each holder's election, either (a) $30.00 in cash or (b) that number of shares of Common Stock of THCR ("THCR Common Stock") as shall have a market value equal to $30.00. The Merger Agreement also contemplates the following transactions occurring in connection with the Merger: (a) the consummation of the offering by THCR of up to $140,000,000 of THCR Common Stock (the "THCR Stock Offering") and the offering by Taj Funding of up to $750,000,000 aggregate principal amount of debt securities, the aggregate net proceeds of which will be used, together with available cash of Taj Associates, to (i) pay cash to those holders of Taj Holding Class A Common Stock electing to receive cash in the Merger, (ii) redeem the Bonds, (iii) redeem the outstanding shares of Class B Common Stock, par value $.01 per share, of Taj Holding as required in connection with the redemption of the Bonds pursuant to the Amended and Restated Certificate of Incorporation of Taj Holding, (iv) purchase certain real property adjacent to the Taj Mahal that is currently leased from Realty Corp., a corporation wholly owned by Trump , and (v) make a payment to Bankers Trust to obtain releases of the liens and guarantees that Bankers Trust has with respect to Taj Associates; (b) the contribution by Trump to THCR Holdings and Taj Mahal Holdings LLC ("Taj Holdings LLC"), a subsidiary of Trump Hotels & Casino Resorts Holdings, L.P. ("THCR Holdings"), of all of his direct and indirect ownership interests in Taj Associates; and (c) the contribution by THCR to THCR Holdings and Taj Holdings LLC of all of its indirect ownership interests in Taj Associates acquired in the Merger. Existing and prospective investors should consider among other things, (i) the high leverage and fixed charges of THCR and Taj Holding; (ii) the risk in refinancing and repayment of indebtedness and the need for additional financing (iii) the restrictions imposed on certain activities by certain debt instruments (iv) the recent results of Trump Plaza and the Taj Mahal (v) risks associated with the Trump Plaza Expansion, the Taj Mahal Expansion and the Indiana Riverboat. There can be no assurance that the Trump Plaza Expansion or the Taj Mahal Expansion will be completed or that the Indiana Riverboat or any other gaming venture, will open or that any of THCR's or the Taj Mahal's operations will be successful. See "Risk Factors" included elsewhere in this Proxy Statement-Prospectus for a discussion of these and other factors. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Taj Mahal Holding Corp. We have audited the accompanying consolidated balance sheets of Taj Mahal Holding Corp. (a Delaware corporation) and Subsidiary as of December 31, 1993 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the management of Taj Mahal Holding Corp. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit 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 Taj Mahal Holding Corp. and Subsidiary as of December 31, 1993 and 1994 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. March 22, 1995 (except with respect to the matter discussed in Note 3, as to which the date is January 8, 1996) TAJ MAHAL HOLDING CORP. AND SUBSIDIARY The accompanying notes to financial statements are an integral part of these consolidated financial statements. TAJ MAHAL HOLDING CORP. AND SUBSIDIARY The accompanying notes to financial statements are an integral part of these consolidated financial statements. TAJ MAHAL HOLDING CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY The accompanying notes to financial statements are an integral part of these consolidated financial statements. TAJ MAHAL HOLDING CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS The accompanying notes to the financial statements are an integral part of these consolidated financial statements. TAJ MAHAL HOLDING CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The accompanying consolidated financial statements include those of Taj Mahal Holding Corp. ("Taj Holding") and its wholly owned subsidiary, TM/GP Corporation, ("TM/GP"), the managing general partner of Trump Taj Mahal Associates, a New Jersey general partnership ("Taj Associates") which operates the Trump Taj Mahal Casino Resort. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements. Taj Holding was organized on December 18, 1990 as a Delaware corporation wholly owned by Donald J. Trump ("Trump"). Prior to January 1, 1992, Taj Holding had no activity. As described below, Taj Holding was formed for the purpose of consummating a plan of reorganization (the "1991 Taj Restructuring") involving Taj Associates and Trump Taj Mahal Funding, Inc. ("Taj Funding"), a New Jersey corporation that raised funds for Taj Associates. Prior to the consummation of the 1991 Taj Restructuring, both Taj Associates and Taj Funding were owned by Trump and affiliated entities. Taj Holding and its subsidiary have no business operations other than its investment in Taj Associates. As a result, its ability to pay operating expenses and dividends is completely dependent on the operations of Taj Associates. Upon consummation of the 1991 Taj Restructuring on October 4, 1991, Taj Associates issued to the holders of Taj Funding's 14% First Mortgage Bonds, Series A, Due 1998 (the "Old Bonds"), a general partnership interest representing 49.995% of the equity of Taj Associates. Such holders in turn contributed such partnership interest to Taj Holding. Taj Funding also issued new 11.35% Mortgage Bonds, Series A, Due 1999 ("Bonds") in exchange for the Old Bonds. Each $1,000 principal amount of Bonds trades as a unit with one share of Class B Common Stock (the "Taj Holding Class B Common Stock") of Taj Holding, as described below. TM/GP, which has no other assets, received a 49.995% partnership interest in Taj Associates from Taj Holding. Trump also contributed to Taj Holding a 50% ownership interest in The Trump Taj Mahal Corporation, a Delaware Corporation, which owns a .01% interest in Taj Associates, in exchange for the Class C Common Stock (the "Taj Holding Class C Common Stock"), as described below. At the time of these transfers, Taj Holding issued 1,350,000 shares of its Class A Common Stock (the "Taj Holding Class A Common Stock") and 729,458 shares of the Taj Holding Class B Common Stock to the holders of the Old Bonds and 1,350,000 shares of the Taj Holding Class C Common Stock to Trump. Notwithstanding their par value, the various classes of common stock are recorded at stated value, which represents the value assigned to the shares of Taj Holding which were issued in connection with the consummation of the 1991 Taj Restructuring. In accordance with the terms of the indenture pursuant to which the Bonds were issued (the "Taj Mortgage Note Indenture"), a portion of the interest on the Bonds may be paid in cash or in additional Bonds (the "Additional Amount"). On May 15, 1992, 8,844 units comprised of $8,844,000 of Bonds and 8,844 shares of Taj Holding Class B Common Stock were issued by Taj Funding as payment of the Additional Amount. On May 15, 1993, 14,579 units comprised of Bonds in the aggregate amount of approximately $14,579,000 and 14,579 shares of Taj Holding Class B Common Stock were issued as payment of the Additional Amount. On May 15, 1994, 12,249 units comprised of Bonds in the aggregate principle amount of approximately $12,249,000 and 12,249 shares of Taj Holding Class B Common Stock were issued together with $2,621,000 in cash as payment of the Additional Amount. Currently, the holders of Taj Holding Class B Common Stock are entitled to elect four of the nine members of Taj Holding's Board of Directors and Trump, as holder of Taj Holding Class C Common Stock, is entitled to elect the remaining five directors. The Taj Holding Class A Common Stock has no voting TAJ MAHAL HOLDING CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) during the time any of Taj Holding Class B Common Stock is outstanding. However, upon Taj Holding's liquidation, all three classes of Taj Holding's common stock share ratably in the assets of Taj Holding to the extent of their par value, with the Taj Holding Class A Common Stock entitled to the residual. The Taj Holding Class B Common Stock must be redeemed at a price of $.50 per share when the Bonds, with which they were issued, are paid, redeemed or purchased and canceled. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Taj Holding accounts for its investment in Taj Associates using the equity method of accounting. Under this method, Taj Holding reports as equity income 50% of Taj Associates' earnings, if any, from October 4, 1991. In addition, the difference between Taj Holding's equity in the underlying identifiable assets of Taj Associates as of October 4, 1991 ($91,703,000) and the cost basis of its investment in Taj Associates is being amortized into income over 40 years. For the period from October 4, 1991 to December 31, 1994, Taj Associates incurred a net loss of $109,851,000. Taj Holding's equity in this loss ($54,926,000) less amortization of the difference between the underlying identifiable assets of Taj Associates and the cost basis of its investment in Taj Associates, for the period from October 4, 1991 to December 31, 1994, $7,451,000, will not be reflected in Taj Holding's financial statements until such time as Taj Associates generates earnings sufficient to offset the accumulated net loss. Taj Holding is not committed to providing future financial support to Taj Associates. Taj Holding will record Federal income taxes based on its allocable share of Taj Associates' earnings. The payment of any such taxes will be reimbursed by Taj Associates. Under New Jersey Casino Control Commission regulations, Taj Associates is required to file a consolidated New Jersey corporation business tax return and pay all state taxes attributable to its earnings. Expenses of Taj Holding consist of directors and officers liability insurance, board of director fees and expenses, and administrative expenses. Taj Holding is entitled to full reimbursement of such expenses by Taj Associates . Total expenses for the years ended December 31, 1994, 1993 and 1992 approximated $2,171,000, $1,733,000 and $1,825,000, respectively, all of which were reimbursed by Taj Associates. As the redemption of the Class B Common Stock is outside of the control of Taj Holding, the Class B Common Stock is not shown as a component of Stockholders' Equity. Accretion of the Class B Common Stock to redemption value and the value of the additional Class B Common Stock issued in connection with the additional Bonds (Note 1) are not material. For the calculation of net loss per share, Class A Stock was used since it is the only Class of participating stock. Net loss per share is determined by dividing the net loss by the weighted average number of shares of Class A Stock outstanding. TAJ MAHAL HOLDING CORP. AND TM/GP CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) On January 8, 1996, Trump Hotels & Casino Resorts, Inc. ("THCR"), Taj Holding and THCR Merger Corp. ("Merger Sub") entered into the Agreement and Plan of Merger (the "Merger Agreement") pursuant to which Merger Sub will merge with and into Taj Holding (the "Merger"). The Merger Agreement provides that each outstanding share of Taj Holding Class A Common Stock will be converted into the right to receive, at each holder's election, either (a) $30.00 in cash or (b) that number of shares of Common Stock of THCR ("THCR Common Stock") as shall have a market value equal to $30.00. The Merger Agreement also contemplates the following transactions occurring in connection with the Merger: (a) the consummation of the offering by THCR of up to $140,000,000 of THCR Common Stock (the "THCR Stock Offering") and the offering by Taj Funding of $750,000,000 aggregate principal amount of debt securities, the aggregate net proceeds of which will be used, together with available cash of Taj Associates, to (i) pay cash to those holders of Taj Holding Class A Common Stock electing to receive cash in the Merger, (ii) redeem the Bonds, (iii) redeem the outstanding shares of Taj Holding Class B Common Stock as required in connection with the redemption of the Bonds pursuant to the Amended and Restated Certificate of Incorporation of Taj Holding, (iv) purchase certain real property adjacent to the Trump Taj Mahal Casino Resort that is currently leased from Trump Taj Mahal Realty Corp., a corporation wholly owned by Trump, and (v) make a payment to Bankers Trust to obtain releases of the liens and guarantees that Bankers Trust has with respect to (b) the contribution by Trump to THCR Holdings and Taj Mahal Holdings LLC ("Taj Holdings LLC"), a subsidiary of Trump Hotels & Casino Resorts Holdings, L.P. ("THCR Holdings"), of all of his direct and indirect ownership interests in Taj Associates; and (c) the contribution by THCR to THCR Holdings and Taj Holdings LLC of all of its indirect ownership interests in Taj Associates acquired in the Merger. Existing and prospective investors should consider among other things, (i) the high leverage and fixed charges of THCR and Taj Holding; (ii) the risk in refinancing and repayment of indebtedness and the need for additional financing; (iii) the restrictions imposed on certain activities by certain debt instruments; (iv) the recent results of Trump Plaza and the Taj Mahal; (v) risks associated with the Trump Plaza Expansion, the Taj Mahal Expansion and the Indiana Riverboat. There can be no assurance that the Trump Plaza Expansion or the Taj Mahal Expansion will be completed or that the Indiana Riverboat or any other gaming venture, will open or that any of THCR's or the Taj Mahal's operations will be successful. See "Risk Factors" included elsewhere in this Proxy Statement-Prospectus for a discussion of these and other factors. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY The accompanying notes to financial statements are an integral part of these condensed consolidated financial statements. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS The accompanying notes to financial statements are an integral part of these condensed consolidated financial statements. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENT OF CAPITAL (DEFICIT) The accompanying notes to financial statements are an integral part of these condensed consolidated financial statements. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS The accompanying notes to financial statements are an integral part of these condensed consolidated financial statements. TRUMP TAJ MAHAL ASSOCIATES AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The accompanying consolidated financial statements include those of Trump Taj Mahal Associates ("Taj Associates"), and its wholly owned subsidiary, Trump Taj Mahal Funding, Inc. ("Taj Funding"). All significant intercompany balances and transactions have been eliminated in the consolidated financial statements. Taj Associates was formed on June 23, 1988, as a New Jersey limited partnership. Taj Associates was converted to a general partnership in December, 1990. The current partners and their respective ownership interests are Trump Taj Mahal, Inc. ("TTMI"), 49.995%, The Trump Taj Mahal Corporation ("TTMC"), .01%, and TM/GP Corporation ("TM/GP"), the managing general partner, and a wholly owned subsidiary of Taj Mahal Holding Corp. ("Taj Holding"), 49.995%. The accompanying financial statements have been prepared by Taj Associates and Taj Funding without audit. In the opinion of Taj Associates and Taj Funding, all adjustments, consisting of only normal recurring adjustments, necessary to present fairly the financial position, results of operations and changes in cash flows for the periods presented, have been made. The accompanying financial statements have been prepared by Taj Associates and Taj Funding pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Accordingly, certain information and note disclosures normally included in financial statements prepared in conformity with generally accepted accounting principles have been condensed or omitted. These financial statements should be read in conjunction with the financial statements and notes thereto included in Taj Associates and Taj Funding's December 31, 1994 Annual Report on Form 10-K. Donald J. Trump ("Trump") beneficially owns 50% of Taj Associates and has pledged his total ownership interest as collateral under various debt agreements. The casino industry in Atlantic City is seasonal in nature. Therefore, results of operations for the three and nine months ended September 30, 1995 and 1994 are not necessarily indicative of the operating results for a full year. Long term debt consists of bank debt and outstanding bonds. Taj Funding's first bonds bear interest at the rate of 11.35% and are due November 15, 1999 (the "Bonds"). Each $1,000 principal amount of Bonds, together with one share of Class B Common Stock of Taj Holding ("Taj Holding Class B Common Stock"), trade together as a Unit, and may not be transferred separately. Interest on the Bonds is due semi-annually on each November 15 and May 15. Interest on the Bonds must be paid in cash on each interest payment date at the rate of 9.375% per annum (the "Mandatory Cash Interest Amount"). In addition to the Mandatory Cash Interest Amount, effective May 15, 1992 and annually thereafter, an additional amount of interest (the "Additional Amount") in cash or additional Bonds or a combination thereof, is payable equal to the difference between 11.35% of the outstanding principal amount of the Bonds and the Mandatory Cash Interest Amount previously paid. To the extent that there is excess available cash flow ("EACF") of Taj Associates, as defined in the Indenture governing the Bonds, for the immediately preceding calendar year, Taj Funding will pay the Additional Amount in cash up to 10.28% and the balance thereof may be paid at the option of Taj Funding in cash or additional Units, provided that an equivalent amount of cash is used to purchase or redeem Units. Additional Bonds issued on October 4, 1991 amounted to approximately $7,208,000. For the period from the issuance of the Bonds, October 4, 1991 through December 31, 1992, there was no EACF. Accordingly, Taj Funding paid the Additional Amounts on May 15, 1993 and May 15, 1992 through the issuance of TRUMP TAJ MAHAL ASSOCIATES, AND SUBSIDIARY NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED) approximately $14,579,000 and $8,844,000, respectively, in additional Bonds. Of the $14,870,000 Additional Amount due May 15, 1994, $2,621,000 was paid in cash and the $12,249,000 balance in Bonds. Of the $15,112,000 Additional Amount due May 15, 1995, Taj Funding satisfied the entire obligation through the issuance of Bonds. Since Taj Funding has no business operations, its ability to repay the principal and interest on the Bonds is completely dependent on the operations of Taj Associates. The Bonds are guaranteed as to payment of principle and interest by Taj Associates and are collateralized by substantially all Taj Associates' property. In accordance with AICPA Statement of Position 90-7, "Financial Reporting By Entities in Reorganization Under the Bankruptcy Code", the Bonds when issued were stated at the present value of amounts to be paid, determined at current interest rates (effective rate of approximately 18%). The effective interest rate of the Bonds was determined based on the trading price of the Bonds for a specific period. Stating the debt at its approximate present value resulted in a reduction of approximately $204,276,000 in the carrying amount of the Bonds. This gain is being offset by increased interest costs over the period of the Bonds to accrete such Bonds to their face value at maturity. At September 30, 1995, the unaccreted balance of this discount was approximately $137,108,000. The current interest rates of other borrowings approximated their stated interest rates as of the effective date. Taj Associates also has a loan agreement (the "NatWest Loan") with National Westminster Bank, U.S.A. ("NatWest") which provided financing up to $50,000,000 for certain items of furniture, fixtures and equipment installed in the Trump Taj Mahal Casino Resort. The NatWest Loan bears interest at 9 3/8% per annum. Principal and interest is payable monthly in the fixed amount of $373,000 to be applied first to accrued interest and the balance to the extent available, to principal, through maturity, November 15, 1999. Additionally, on May 15 of each year while principal is still outstanding, NatWest will receive 16.5% of the EACF of the preceding calendar year in excess of the Additional Amount, to be applied first to accrued but unpaid interest, and then to principal. The NatWest Loan is secured by a first priority lien on the furniture, fixtures and equipment acquired with the proceeds of the NatWest Loan plus any after acquired furniture, fixtures and equipment that replaces such property, or of the same type, provided however, that the NatWest Loan may be subordinated to a lien to secure purchase money financing of such after acquired property up to 50% of the value of such after acquired property. In November 1991,Taj Associates obtained a working capital line of credit in the amount of $25,000,000 with a maturity of five years. In September 1994, Taj Associates extended the maturity to November 1999, in consideration for modifications of the terms of the facility. Interest on advances under the line are at prime plus 3% with a minimum of 7% per annum. The agreement provides for a 3/4% annual fee and a 1/2% unused line fee and contains various covenants. During 1995 and 1994, no amounts were outstanding under the line. Taj Funding and Taj Associates are subject to regulation and licensing by the New Jersey Casino Control Commission (the "CCC"). The Taj Associates' casino license must be renewed periodically, is not transferable, is dependent upon the financial stability of the Partnership and can be revoked at anytime. Upon revocation, suspension for more than 120 days, or failure to renew the casino license due to Taj Associates' financial condition or for any other reason, the Casino Control Act (the "Casino Control Act") provides that the CCC may appoint a conservator to take possession of and title to the hotel and casino's business and property, subject to all valid liens, claims and encumbrances. On June 22, 1995, the CCC renewed Taj Associates casino license for four years, through March 31, 1999. TRUMP TAJ MAHAL ASSOCIATES, AND SUBSIDIARY NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED) Taj Associates, its Partners, certain of its employees and Taj Funding are involved in various legal proceedings incurred in the normal course of business. In the opinion of management of Taj Associates, the expected disposition of these proceedings would not have a material adverse effect on the Taj Associates' or Taj Funding's financial condition or results of operations. Taj Associates is obligated to reimburse Taj Holding for its operating expenses which consist of directors and officers liability insurance, board of director fees and expenses, and administrative expenses. Total expenses for the nine months ended September 30, 1995 and 1994 approximated $1,205,000 and $1,710,000, respectively. (6) FINANCIAL INFORMATION TAJ FUNDING Financial information relating to Taj Funding is as follows (in thousands): On January 8, 1996, THCR, Taj Holding and THCR Merger Corp. ("Merger Sub") entered into the Agreement and Plan of Merger (the "Merger Agreement") pursuant to which Merger Sub will merge with and into Taj Holding (the "Merger"). The Merger Agreement provides that each outstanding share of Taj Holding Class A Common Stock will be converted into the right to receive, at each holder's election, either (a) $30.00 in cash or (b) that number of shares of THCR Common Stock or shall have a market value equal to $30.00. The Merger Agreement also contemplates the following transactions occurring in connection with the Merger: (a) the consummation of the offering by THCR of up to $140,000,000 of THCR Common Stock (the "THCR Stock Offering") and the offering by Taj Funding of up to $750,000,000 aggregate principal amount of debt securities, the aggregate net proceeds of which will be used, together with available cash of Taj Associates, to (i) pay cash to those holders of Taj Holding Class A TRUMP TAJ MAHAL ASSOCIATES, AND TRUMP TAJ MAHAL FUNDING, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED) receive cash in the Merger, (ii) redeem the Bonds, (iii) redeem the outstanding shares of Taj Holding Class B Common Stock as required in connection with the redemption of the Bonds pursuant to the Amended and Restated Certificate of Incorporation of Taj Holding, (iv) purchase certain real property adjacent to the Taj Mahal that is currently leased from Trump Taj Mahal Realty Corp., a corporation wholly owned by Trump, and (v) make a payment to Bankers Trust to obtain releases of the liens and guarantees that Bankers Trust has with respect to Taj Associates; (b) the contribution by Trump to THCR Holdings and Taj Mahal Holdings LLC ("Taj Holdings LLC"), a subsidiary of Trump Hotels & Casino Resorts Holdings, L.P. ("THCR Holdings"), of all of his direct and indirect ownership interests in Taj Associates; and (c) the contribution by THCR to THCR Holdings and Taj Holdings LLC of all of its indirect ownership interests in Taj Associates acquired in the Merger. TAJ MAHAL HOLDING CORP. AND SUBSIDIARY The accompanying notes to financial statements are an integral part of these condensed consolidated financial statements. TAJ MAHAL HOLDING CORP. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS The accompanying notes to financial statements are an integral part of these condensed consolidated financial statements. TAJ MAHAL HOLDING CORP. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY The accompanying notes to financial statements are an integral part of these condensed consolidated financial statements. TAJ MAHAL HOLDING CORP. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS The accompanying notes to financial statements are an integral part of these condensed consolidated financial statements. TAJ MAHAL HOLDING CORP. AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The accompanying consolidated financial statements include those of Taj Mahal Holding Corp. ("Taj Holding") and its wholly owned subsidiary, TM/GP Corporation ("TM/GP"), the managing general partner of Trump Taj Mahal Associates, a New Jersey general partnership ("Taj Associates") which operates the Trump Taj Mahal Casino Resort (the "Taj Mahal"). All significant intercompany balances and transactions have been eliminated in the consolidated financial statements. Taj Holding was organized on December 18, 1990 as a Delaware corporation wholly owned by Donald J. Trump ("Trump"). Prior to January 1, 1992, Taj Holding had no activity. As described below, Taj Holding was formed for the purpose of consummating a plan of reorganization (the "1991 Taj Restructuring") involving Taj Associates and Trump Taj Mahal Funding, Inc. ("Taj Funding"), a New Jersey corporation which restructured the indebtedness of Taj Associates. Prior to the 1991 Taj Restructuring, both Taj Associates and Taj Funding were owned by Trump and affiliated entities. Taj Holding and its subsidiaries have no business operations other than their investment in Taj Associates. As a result, their ability to pay operating expenses and dividends is completely dependent on the operations of Taj Associates. Upon consummation of the 1991 Taj Restructuring on October 4, 1991, the Taj Associates issued to the holders of Taj Funding's 14% First Mortgage Bonds, Series A, Due 1998 (the "Old Bonds"), a general partnership interest representing 49.995% of the equity of Taj Associates. Such holders in turn contributed such partnership interest to Taj Holding. Taj Funding also issued new 11.35% Mortgage Bonds, Series A, Due 1999 (the "Bonds") in exchange for the Old Bonds. Each $1,000 principal amount of Bonds trades as a unit with one share of Class B Common Stock (the "Taj Holding Class B Common Stock") of Taj Holding, as described below. TM/GP, which has no other assets, received a 49.995% partnership interest in Taj Associates from Taj Holding. Trump also contributed to Taj Holding a 50% ownership interest in The Trump Taj Mahal Corporation, a Delaware corporation, which owns a .01% interest in the Partnership, in exchange for the Class C Common Stock (the "Taj Holding Class C Common Stock"), as described below. At the time of these transfers, Taj Holding issued 1,350,000 shares of its Class A Common Stock (the "Taj Holding Class A Common Stock") and 729,458 shares of its Taj Holding Class B Common Stock to the holders of the Old Bonds and 1,350,000 shares of its Taj Holding Class C Common Stock to Trump. Notwithstanding their par value, the various classes of common stock are recorded at stated value, which represents the value assigned to the shares of Taj Holding which were issued in connection with the 1991 Taj Restructuring . In accordance with the terms of the indenture pursuant to which the Bonds were issued, a portion of the interest on the Bonds may be paid in cash or in additional Bonds (the "Additional Amount"). On May 15, 1992, 8,844 units comprised of Bonds in the aggregate amount of $8,844,000 and 8,844 shares of Taj Holding Class B Common Stock were issued by Taj Funding as payment of the Additional Amount. On May 15, 1993, 14,579 units comprised of Bonds in the aggregate amount of approximately $14,579,000 and 14,579 shares of Taj Holding Class B Common Stock were issued as payment of the Additional Amount. On May 15, 1994, 12,249 units comprised of Bonds in the aggregate principal amount of approximately $12,249,000 and 12,249 shares of Taj Holding Class B Common Stock were issued together with $2,621,000 in cash as payment of the Additional Amount. On May 15, 1995, 15,112 units comprised of Bonds in the aggregate principal amount of approximately $15,112,000 and 15,112 shares of Taj Holding Class B Common Stock were issued as payment of the Additional Amount. TAJ MAHAL HOLDING CORP. AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Currently, the holders of the Taj Holding Class B Common Stock are entitled to elect four of the nine members of Taj Holding's Board of Directors and Trump, as holder of the Taj Holding Class C Common Stock is entitled to elect the remaining five directors. The Taj Holding Class A Common Stock has no voting rights during the time any of the Taj Holding Class B Common Stock is outstanding. However, upon Taj Holding's liquidation, all three classes of Taj Holding's common stock share ratably in the assets of Taj Holding to the extent of their par value, with the Taj Holding Class A Common Stock entitled to the residual. The Taj Holding Class B Common Stock must be redeemed at a price of $.50 per share when the Bonds, with which they were issued, are paid, redeemed or purchased and canceled. The accompanying financial statements have been prepared by Taj Holding without audit. In the opinion of Taj Holding, all adjustments, consisting of only normal recurring adjustments, necessary to present fairly the financial position, results of operations and changes in cash flows for the periods presented, have been made. The accompanying financial statements have been prepared by Taj Holding pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Accordingly, certain information and note disclosures normally included in financial statements prepared in conformity with generally accepted accounting principles have been condensed or omitted. These financial statements should be read in conjunction with the financial statements and notes thereto included in Taj Holding's December 31, 1994 Annual Report on Form 10-K. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Taj Holding accounts for its investment in Taj Associates using the equity method of accounting. Under this method, Taj Holding reports as equity income 50% of Taj Associates' earnings, if any, from October 4, 1991. In addition, the difference between Taj Holding's equity in the underlying identifiable assets of the Taj Associates as of October 4, 1991 ($91,703,000) and the cost basis of its investment in Taj Associates is being amortized into income over 40 years. For the period from October 4, 1991 to September 30, 1995, Taj Associates incurred a net loss of $123,559,000. Taj Holding's equity in this loss ($61,779,500) less amortization of the difference between the underlying identifiable assets of Taj Associates and the cost basis of its investment in Taj Associates, for the period from October 4, 1991 to September 30, 1995, (9,170,000), will not be reflected in Taj Holding's financial statements until such time as Taj Associate generates earnings sufficient to offset the accumulated net loss. Taj Holding will record Federal income taxes based on its allocable share of Taj Associates earnings. The payment of any such taxes will be reimbursed by Taj Associates. Under New Jersey Casino Control Commission regulations, Taj Associates is required to file a consolidated New Jersey corporation business tax return and pay all state taxes attributable to its earnings. Expenses of Taj Holding consist of directors and officers liability insurance, board of director fees and expenses, and administrative expenses. Taj Holding is entitled to full reimbursement of such expense by Taj TAJ MAHAL HOLDING CORP. AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Associates. Total expenses for the nine months ended September 30, 1995 and 1994 approximated $1,205,000 and $1,710,000, respectively, all of which were reimbursed by Taj Associates. For the calculation of net loss per share, Taj Holding Class A Common Stock was used since it is the only class of participating stock. Net loss per share is determined by dividing the net loss by the weighted average number of shares of Taj Holding Class A Common Stock outstanding. On January 8, 1996, THCR, Taj Holding and THCR Merger Corp. ("Merger Sub") entered into the Agreement and Plan of Merger (the "Merger Agreement") pursuant to which Merger Sub will merge with and into Taj Holding (the "Merger"). The Merger Agreement provides that each outstanding share of Taj Holding Class A Common Stock will be converted into the right to receive, at each holder's election, either (a) $30.00 in cash or (b) that number of shares of THCR Common Stock as shall have a market value equal to $30.00. The Merger Agreement also contemplates the following transactions occurring in connection with the Merger: (a) the consummation of the offering by THCR of up to $140,000,000 of THCR Common Stock (the "THCR Stock Offering") and the offering by Taj Funding of up to $750,000,000 aggregate principal amount of debt securities, the aggregate net proceeds of which will be used, together with available cash of Taj Associates, to (i) pay cash to those holders of Taj Holding Class A Common Stock electing to receive cash in the Merger, (ii) redeem the Bonds, (iii) redeem the outstanding shares of Taj Holding Class B Common Stock as required in connection with the redemption of the Bonds pursuant to the Amended and Restated Certificate of Incorporation of Taj Holding, (iv) purchase certain real property adjacent to the Taj Mahal that is currently leased from Trump Taj Mahal Realty Corp., a corporation wholly owned by Trump, make a payment to Bankers Trust to obtain releases of the liens and guarantees that Bankers Trust has with respect to Taj Associates; (b) the contribution by Trump to THCR Holdings and Taj Mahal Holdings LLC ("Taj Holdings LLC"), a subsidiary of Trump Hotels & Casino Resorts Holdings, Inc. ("THCR Holdings"), of all of his direct and indirect ownership interests in Taj Associates; and (c) the contribution by THCR to THCR Holdings and Taj Holdings LLC of all of its indirect ownership interests in Taj Associates acquired in the Merger. AGREEMENT AND PLAN OF MERGER TRUMP HOTELS & CASINO RESORTS, INC. DATED AS OF JANUARY 8, 1996 * The Table of Contents is not part of this Merger Agreement. AGREEMENT AND PLAN OF MERGER AGREEMENT AND PLAN OF MERGER, dated as of January 8, 1996 (the "Merger Agreement"), by and among TRUMP HOTELS & CASINO RESORTS, INC., a Delaware corporation ("THCR"), TAJ MAHAL HOLDING CORP., a Delaware corporation ("Taj Holding"), and THCR MERGER CORP., a Delaware corporation and a wholly owned subsidiary of THCR ("Merger Sub"). WHEREAS, Taj Holding and certain of its affiliates and THCR and certain of its affiliates desire to effect the Merger Transaction, which includes (a) the merger of Merger Sub with and into Taj Holding upon the terms and subject to the conditions set forth herein (the "Merger"); (b) consummation of the offering by THCR (the "THCR Offering") of up to $140,000,000 of Common Stock of THCR, par value $.01 per share ("THCR Common Stock"), and the offering by Trump Taj Mahal Funding, Inc. ("Taj Funding") or its affiliate of up to $750,000,000 aggregate principal amount of debt securities (the "Taj Funding Offering"), the aggregate net proceeds of which will be used, together with available cash of Trump Taj Mahal Associates ("Taj Associates"), to, among other things, (i) pay cash, pursuant to this Merger Agreement, to those holders of Class A Common Stock of Taj Holding, par value $.01 per share (the "Taj Holding Class A Common Stock"), electing to receive cash in the Merger, (ii) redeem (the "Bond Redemption") Taj Funding's outstanding 11.35% Mortgage Bonds, Series A due 1999 (the "Bonds"), (iii) redeem the outstanding shares of Class B Common Stock of Taj Holding, par value $.01 per share (the "Taj Holding Class B Common Stock"), as required in connection with the Bond Redemption, (iv) purchase certain real property (collectively, the "Specified Parcels") that is currently leased by Taj Associates, the owner and operator of the Trump Taj Mahal Casino Resort (the "Taj Mahal"), from Trump Taj Mahal Realty Corp. ("Realty Corp."), a corporation wholly owned by Donald J. Trump ("Trump"), and (v) make a payment to Bankers Trust Company ("Bankers Trust") to obtain releases of the Liens (defined below) and guarantees that Bankers Trust has with respect to Taj Associates; (c) the contribution by Trump to Trump Hotels & Casino Resorts Holdings, L.P., a subsidiary of THCR ("THCR Holdings"), and Taj Mahal Holdings LLC ("Taj Holdings LLC") of all of his direct and indirect ownership interests in Taj Associates; and (d) the contribution by THCR to THCR Holdings and Taj Holdings LLC of all its indirect ownership interests in Taj Associates acquired in the Merger; WHEREAS, THCR and Trump have agreed that (a) in exchange for their contributions to THCR Holdings and Taj Holdings LLC, THCR's and Trump's beneficial equity interests in THCR Holdings will be adjusted pursuant to the terms of the Amended and Restated Agreement of Limited Partnership of THCR Holdings (the "Partnership Agreement"), and (b) as part of the Merger Transaction, THCR will issue to Trump a warrant to purchase 1.8 million shares of THCR Common Stock, one-third of which may be purchased on or prior to (i) the third anniversary of the issuance of the warrant at $30 per share, (ii) the fourth anniversary of the issuance of the warrant at $35 per share and (iii) the fifth anniversary of the issuance of the warrant at $40 per share (the Merger and the related transactions discussed above are collectively referred to as the "Merger Transaction"); WHEREAS, pursuant to the Class A Voting Agreement (defined below), the holders of approximately 52% of the outstanding shares of Taj Holding Class A Common Stock have agreed to vote in favor of the Merger; WHEREAS, pursuant to the Trump THCR Voting Agreement (defined below) Trump has agreed to vote all of the shares in THCR beneficially owned by him in favor of the Merger Transaction, and pursuant to the Trump Taj Voting Agreement (defined below) Trump has agreed to vote all of the shares beneficially owned by him in Taj Holding in favor of the Merger Agreement; WHEREAS, the THCR Special Committee of the Board of Directors of THCR (defined below), and the Taj Holding Class B Directors (defined below) and the Board of Directors of Taj Holding, have received the DLJ Fairness Opinion and the Rothschild Fairness Opinion (each defined below), respectively; WHEREAS, the THCR Special Committee and the Board of Directors of THCR have determined that the Merger Transaction is consistent with and in furtherance of the long-term business strategy of THCR; WHEREAS, the Taj Holding Class B Directors and the Board of Directors of Taj Holding have determined that the Merger is consistent with and in furtherance of the long-term business strategy of Taj Holding; WHEREAS, the THCR Special Committee and the Board of Directors of THCR have determined that the Merger Transaction is fair to, and in the best interests WHEREAS, the Taj Holding Class B Directors and the Board of Directors of Taj Holding based on, among other things, the advice of the financial advisor to Taj Holding and existence of the Class A Voting Agreement (defined below), have determined that the Merger is fair to, and in the best interests of, Taj Holding and the holders of Taj Holding Class A Common Stock; WHEREAS, the THCR Special Committee and the Board of Directors of THCR have approved the Merger Transaction and this Merger Agreement; WHEREAS, the Taj Holding Class B Directors and the Board of Directors of Taj Holding have approved the Merger and this Merger Agreement; and WHEREAS, the Board of Directors of Merger Sub has approved this Merger Agreement and THCR, as the sole stockholder of Merger Sub, has approved and adopted this Merger Agreement. NOW THEREFORE, in consideration of the foregoing and the mutual representations, warranties, covenants and agreements contained herein, the parties hereto agree as follows: Section 1.01. Definitions. As used in this Merger Agreement, the following terms shall have the respective meanings set forth below (terms defined in the singular shall have the same meanings when used in the plural and vice versa): "Acquisition Proposal" with respect to any Person shall mean any proposed (i) merger, consolidation, share exchange or similar transaction involving such Person or a Subsidiary of such Person, as a result of which the consolidated assets of such Person and its Subsidiaries taken as a whole, increase or decrease by 25% or more, (ii) sale, lease or other disposition directly or indirectly (other than by merger, consolidation, share exchange or similar transaction) of assets of such Person or its Subsidiaries representing 25% or more of the consolidated assets of such Person and its Subsidiaries, (iii) issue, sale, or other disposition (other than by merger, consolidation, share exchange or similar transaction) of securities (or options, rights or warrants to purchase, or securities convertible into, such securities) representing 25% or more of the voting power of such Person or (iv) transaction in which any Person shall acquire beneficial ownership, or the right to acquire beneficial ownership or any "group" (as such term is defined under the Exchange Act) shall have been formed which beneficially owns or has the right to acquire beneficial ownership of 25% or more of the outstanding common stock of such Person (other than Persons or groups having such beneficial ownership as of the date hereof). "Bankers Trust" shall have the meaning set forth in the Recitals. "Bond Indenture" shall mean the Amended and Restated Indenture, dated as of October 4, 1991, among Taj Funding, as issuer, Taj Associates, as guarantor, and First Bank National Association, as trustee, relating to the issuance of the Bonds. "Bond Redemption" shall have the meaning set forth in the Recitals. "Bonds" shall have the meaning set forth in the Recitals. "Cash Consideration" shall have the meaning set forth in Section 2.02. "Certificate of Merger" shall have the meaning set forth in Section 2.01. "Class A Voting Agreement" means the letter agreement, dated as of October 6, 1995, among Taj Holding, Taj Associates, Taj Funding, Putnam Investment Management, Hamilton Partners, L.P., Prudential Securities, Grace Brothers Ltd., SC Fundamental Value Fund, L.P. and SC Fundamental Value BVI Ltd., relating to the voting of shares of Taj Holding Class A Common Stock, as such agreement may be amended from time to time. "Closing" shall have the meaning set forth in Section 2.01. "Confidential Information" shall mean all information about a party hereto, whether furnished before or after the date hereof, and regardless of the manner in which it is furnished, together with all analyses, compilations, studies, summaries, extracts or other documents, which contain or otherwise reflect such information. Confidential Information shall not include information which the recipient can clearly demonstrate falls within any of the following categories: (i) information which has come within the public domain through no fault or action of the recipient or its affiliates (including, without limitation, all information contained in publicly available documents filed with the SEC); (ii) information which was known to the recipient on a non-confidential basis prior to its disclosure by a party hereto; or (iii) information which becomes available to the recipient on a non-confidential basis from any third party, the disclosure of which to, or the receipt of which by, the recipient, to the knowledge of the recipient after due inquiry, does not violate any contractual or legal obligation said third party has to the disclosing party or any other Person with respect to such information. "Current D&O Premium" shall mean an amount not greater than 150% of the premium paid by Taj Holding (on an annualized basis) for directors' and officers' liability insurance during the period from January 1, 1996 to the Effective Time. "Debt S-1" shall have the meaning set forth in Section 3.15. "DGCL" shall mean the Delaware General Corporation Law. "Disclosing Party" shall mean any party to this Merger Agreement that discloses or provides Confidential Information to any other party to this Merger Agreement. "Dissenting Shares" shall have the meaning set forth in Section 2.12. "DLJ" shall have the meaning set forth in Section 4.06. "DLJ Fairness Opinion" shall have the meaning set forth in Section 4.06. "Effective Time" shall have the meaning set forth in Section 2.01. "Election Deadline" shall have the meaning set forth in Section 2.07. "Election Form" shall have the meaning set forth in Section 2.07. "Equity S-1" shall have the meaning set forth in Section 3.16. "Exchange Act" shall mean the Securities Exchange Act of 1934 and the rules and regulations promulgated thereunder. "Exchange Agent" shall have the meaning set forth in Section 2.06. "Exchange Agreement" shall mean the Exchange and Registration Rights Agreement, dated as of June 12, 1995, between THCR and Trump. "Exchange Fund" shall have the meaning set forth in Section 2.08. "First Fidelity" shall mean First Fidelity Bank, N.A. "Gaming Authority" shall mean the New Jersey Casino Control Commission, the New Jersey Division of Gaming Enforcement, the Indiana Gaming Commission, the Mississippi Gaming Commission and the Mississippi State Tax Commission or any other governmental agency which regulates gaming in a jurisdiction in which either THCR or its Subsidiaries or Taj Holding or its Subsidiaries conducts gaming activities. "Gaming Laws" shall mean any laws, rules, regulations or ordinances governing gaming activities and any administrative rules or regulations promulgated thereunder, and any other corresponding statutes, rules and regulations. "HSR Act" shall mean the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. "Joint Proxy Statement" shall mean the joint proxy statement of Taj Holding and THCR with respect to the Taj Holding Meeting and the THCR Meeting. "Lien" shall mean any mortgage, charge, pledge, lien (statutory or otherwise), privilege, security interest, hypothecation, or other encumbrance upon or with respect to any property of any kind, real or personal, movable or immovable, now owned or hereafter acquired. "Market Value" shall mean the average of the high and low per share sales prices of the THCR Common Stock during the fifteen trading days immediately preceding the Effective Time or, if THCR and Taj Holding mutually agree, during any such other period as agreed under the Class A Voting Agreement. "Merger" shall have the meaning set forth in Recitals. "Merger Agreement" shall have the meaning set forth in the Preamble. "Merger Consideration" shall have the meaning set forth in Section 2.02. "Merger Sub" shall have the meaning set forth in the Preamble. "Merger Sub Common Stock" shall mean the Common Stock, par value $.01 per share, of Merger Sub. "Merger Sub Material Adverse Effect" shall mean a material adverse effect with respect to the business, results of operations, properties, operations or financial condition of Merger Sub. "Merger Transaction" shall have the meaning set forth in the Recitals. "NYSE" shall mean the New York Stock Exchange. "Partnership Agreement" shall have the meaning set forth in the Recitals. "Permitted Investments" shall have the meaning set forth in Section 2.08. "Person" shall mean any individual, partnership, corporation, trust, association, limited liability company, governmental agency or any other entity. "Realty Corp." shall have the meaning set forth in the Recitals. "Receiving Party" shall mean any party to this Merger Agreement that receives or obtains Confidential Information from a Disclosing Party. "Rothschild" shall have the meaning set forth in Section 3.06. "Rothschild Fairness Opinion" shall have the meaning set forth in Section 3.06. "SEC" shall mean the United States Securities and Exchange Commission. "Securities Act" shall mean the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. "Special Counsel" shall mean Andrews & Kurth L.L.P., special counsel to the Taj Holding Class B Directors. "Specified Parcels" shall have the meaning set forth in the Recitals. "Stock Consideration" shall have the meaning set forth in Section 2.02. "Subsidiary" shall mean, with respect to any Person, any other Person in which such first Person, directly or indirectly, owns, controls or has the power to vote at least 50% of the outstanding securities generally entitled to vote upon the election of directors. For the purposes of this Merger Agreement the term "Subsidiary" shall also include, with respect to Taj Holding, Taj Associates and, with respect to THCR, THCR Holdings, Trump Plaza Holding Associates and Trump Plaza Associates. "Surviving Corporation" shall mean the surviving corporation in the Merger. "Taj Associates" shall have the meaning set forth in the Recitals. "Taj Funding" shall have the meaning set forth in the Recitals. "Taj Funding Offering" shall have the meaning set forth in the Recitals. "Taj Holding" shall have the meaning set forth in the Preamble. "Taj Holding Certificates" shall have the meaning set forth in Section 2.08. "Taj Holding Class A Common Stock" shall have the meaning set forth in the Recitals. "Taj Holding Class B Common Stock" shall have the meaning set forth in the Recitals. "Taj Holding Class C Common Stock" shall mean the Class C Common Stock, par value $.01 per share, of Taj Holding. "Taj Holding Class B Directors" shall mean the Class B Directors of Taj Holding. "Taj Holding Class C Directors" shall mean the Class C Directors of Taj Holding. "Taj Holding Indemnified Parties" shall have the meaning set forth in Section 7.04. "Taj Holding Material Adverse Effect" shall mean a material adverse effect with respect to the business, results of operations, properties, operations or financial condition of Taj Holding and its Subsidiaries, taken as a whole. "Taj Holding Meeting" shall have the meaning set forth in Section 6.03. "Taj Holding SEC Reports" shall have the meaning set forth in Section 3.04. "Taj Holdings LLC" shall have the meaning set forth in the Recitals. "Taj Mahal" shall have the meaning set forth in the Recitals. "THCR" shall have the meaning set forth in the Preamble. "THCR Certificates" shall have the meaning set forth in Section 2.08. "THCR Class B Common Stock" shall mean the Class B Common Stock, par value $.01 per share, of THCR. "THCR Common Stock" shall have the meaning set forth in the Recitals. "THCR Dividends" shall have the meaning set forth in Section 2.08. "THCR Holdings" shall have the meaning set forth in the Recitals. "THCR Material Adverse Effect" shall mean a material adverse effect with respect to the business, results of operations, properties, operations or financial condition of THCR and its Subsidiaries, taken as a whole. "THCR Meeting" shall have the meaning set forth in Section 7.03. "THCR Offering" shall have the meaning set forth in the Recitals. "THCR Registration Statement" shall mean the Registration Statement on Form S-4 of THCR to be filed with the SEC in connection with the Merger, including the Prospectus with respect to the THCR Common Stock included therein. "THCR SEC Reports" shall have the meaning set forth in Section 4.04. "THCR Special Committee" shall mean the Special Committee of the Board of Directors of THCR. "TM/GP" shall mean TM/GP Corporation, a wholly owned subsidiary of Taj Holding. "TM/GP Class B Common Stock" shall mean the Class B Common Stock of TM/GP, par value $.01 per share. "Trump" shall have the meaning set forth in the Recitals. "Trump Taj Voting Agreement" shall have the meaning set forth in Section 3.06. "Trump THCR Voting Agreement" shall have the meaning set forth in Section 4.06. "TTMI Note" shall mean the promissory note from Trump Taj Mahal, Inc. to Trump, dated October 4, 1991. Section 2.01. The Merger. (a) Upon the terms and subject to the conditions of this Merger Agreement, at the Effective Time, Merger Sub shall be merged with and into Taj Holding in accordance with the DGCL, whereupon the separate existence of Merger Sub shall cease, and Taj Holding shall be the Surviving Corporation. (b) Unless this Merger Agreement shall have been terminated and the transactions herein contemplated shall have been abandoned pursuant to Section 10.01 and subject to the satisfaction or, if permissible, waiver of the conditions set forth in Article IX, the closing of the Merger (the "Closing") shall take place as promptly as practicable (and in any event within two business days) after satisfaction or waiver of the conditions set forth in Article IX, at the offices of Willkie Farr & Gallagher, 153 East 53rd Street, New York, New York, unless another date, time or place is agreed to in writing by the parties hereto. (c) At the Closing, (i) Taj Holding will deliver to THCR and Merger Sub the opinion referred to in Section 6.04 and the various certificates, instruments and documents referred to in Section 9.03, (ii) THCR and Merger Sub will deliver to Taj Holding the various certificates, instruments and documents referred to in Section 9.02 and (iii) THCR will deliver to the Exchange Agent the Merger Consideration. (d) As soon as practicable after the Closing, Taj Holding and Merger Sub will file, or cause to be filed, with the Secretary of State of the State of Delaware, a certificate of merger for the Merger in accordance with the provisions of the DGCL (the "Certificate of Merger"). The Merger shall become effective at the time such filing is accepted for filing by the Secretary of State of the State of Delaware or at such other time as set forth in the Certificate of Merger (the "Effective Time"). (e) From and after the Effective Time, the Surviving Corporation, shall have all the rights, privileges, powers and franchises and be subject to all of the restrictions, disabilities and duties of Taj Holding and Merger Sub, all as provided under the DGCL. Section 2.02. Conversion of Outstanding Shares; Redemption. (a) At the Effective Time: (i) each share of Taj Holding Class A Common Stock outstanding immediately prior to the Effective Time shall, except as otherwise provided in this Section, be converted into and represent the right to receive, at the holder's election, either (x) $30.00 in cash (the "Cash Consideration") or (y) that number of fully paid and nonassessable shares of THCR Common Stock determined by dividing $30.00 by the Market Value (the "Stock Consideration" and together with the Cash Consideration, the "Merger (ii) all shares of Taj Holding Class C Common Stock outstanding immediately prior to the Effective Time shall be canceled; and (iii) each share of Merger Sub Common Stock outstanding immediately prior to the Effective Time shall be converted into and represent the right to receive one fully paid and nonassessable share of Common Stock, par value $0.01 per share, of the Surviving Corporation. (b) Immediately prior to the Effective Time, Taj Holding shall cause each share of Taj Holding Class B Common Stock outstanding immediately prior to such time to be redeemed at $.50 per share in accordance with the provisions of the certificate of incorporation of Taj Holding and the Bond Indenture. (c) Each share of Taj Holding Class A Common Stock held by Taj Holding as treasury stock immediately prior to the Effective Time or owned by any direct or indirect Subsidiary of Taj Holding immediately prior to the Effective Time shall be canceled, and no conversion or payment shall be made with respect thereto. Section 2.03. Certificate of Incorporation. The certificate of incorporation of Merger Sub in effect at the Effective Time shall be the certificate of incorporation of the Surviving Corporation, until amended in accordance with the DGCL, except that Article Second thereof shall be amended to read as follows: "The name of the Corporation is Taj Mahal Holding Corp." Section 2.04. By-laws. The by-laws of Merger Sub in effect at the Effective Time shall be the by-laws of the Surviving Corporation, until amended in accordance with the DGCL and the certificate of incorporation of the Surviving Corporation. Section 2.05. Directors and Officers. From and after the Effective Time, until successors are duly elected or appointed in accordance with the DGCL and the Surviving Corporation's certificate of incorporation and by-laws, (a) the directors of Merger Sub at the Effective Time shall be the directors of the Surviving Corporation and (b) the officers of Taj Holding at the Effective Time shall be the officers of the Surviving Corporation. Section 2.06. Exchange Agent. Prior to the Effective Time, THCR and Taj Holding shall designate Continental Stock Transfer & Trust Company, or another mutually acceptable bank or trust company, to act as exchange agent for the Merger (the "Exchange Agent"). Section 2.07. Election Procedures. (a) Taj Holding shall, or shall cause the Exchange Agent to, send an election form (the "Election Form") in form satisfactory to THCR, to each holder of Taj Holding Class A Common Stock together with the Joint Proxy Statement. Each Election Form shall permit each holder of Taj Holding Class A Common Stock (or the beneficial owner through appropriate and customary documentation and instructions) to elect to receive either the Stock Consideration or the Cash Consideration. (b) Any holder of Taj Holding Class A Common Stock who wishes to receive Cash Consideration must send the Election Form properly completed to the Exchange Agent at the address set forth in the Election Form on or before 5:00 p.m. on the business day prior to the Taj Holding Meeting or at any other time and date as Taj Holding and THCR may mutually agree (the "Election Deadline"). (c) Holders of the Taj Holding Class A Common Stock who (i) fail to complete properly the Election Form, (ii) fail to send the Election Form to the Exchange Agent prior to the Election Deadline or (iii) make no election, shall be deemed to have elected to receive the Stock Consideration. (d) Taj Holding shall use its best efforts to make available one or more Election Forms as may be reasonably requested by all Persons who become holders (or beneficial owners) of Taj Holding Class A Common Stock between the record date established for purposes of the Taj Holding Stockholder Meeting and the Election Deadline. (e) Any Election Form may be revoked prior to the Election Deadline by submitting a new Election Form to the Exchange Agent. In addition, all Election Forms shall automatically be deemed revoked if the Exchange Agent is notified in writing by Taj Holding and THCR that the Merger has been abandoned or this Merger Agreement has been terminated. (f) Subject to the terms of this Merger Agreement, the determination of the Exchange Agent shall be binding and conclusive as to whether or not the Election Form has been properly or timely submitted or revoked. Neither the Exchange Agent, Taj Holding, THCR nor Merger Sub shall be under any obligation to notify any Person of any defect in an Election Form or the revocation thereof. Section 2.08. Taj Holding Class A Common Stock Exchange Procedures. (a) As soon as practicable after the Effective Time, THCR shall instruct the Exchange Agent to mail to each holder of a certificate or certificates evidencing shares of Taj Holding Class A Common Stock (other than Dissenting Shares) (the "Taj Holding Certificates") (i) a letter of transmittal (which shall specify that delivery shall be effected, and risk of loss and title to the Taj Holding Certificates shall pass, only upon proper delivery of such Taj Holding Certificates to the Exchange Agent) and (ii) instructions to effect the surrender of the Taj Holding Certificates in exchange for Merger Consideration. Each holder of Taj Holding Class A Common Stock, upon surrender to the Exchange Agent of such holder's Taj Holding Certificates with the letter of transmittal, duly executed, and such other customary documents as may be required pursuant to such instructions, shall be given the amount to which such holder is entitled, pursuant to this Merger Agreement, of (i) certificates evidencing shares of THCR Common Stock (the "THCR Certificates") as payment of the Stock Consideration, (ii) cash as payment of the Cash Consideration (without any interest accrued thereon), (iii) dividends or distributions declared or made on the THCR Common Stock after the Effective Time and payable between the Effective Time and the time of such surrender (the "THCR Dividends") and/or (iv) cash for payment of fractional shares of THCR Common Stock. Until so surrendered, each Taj Holding Certificate shall after the Effective Time represent for all purposes only the right to receive THCR Certificates or cash, as the case may be. After the Effective Time, there shall be no further registration of transfers of Taj Holding Class A Common Stock. THCR shall establish reasonable procedures for the delivery of THCR Certificates or cash, as the case may be, to holders of Taj Holding Class A Common Stock whose Taj Holding Certificates have been lost, destroyed or mutilated. (b) At the Closing, THCR shall deposit in trust with the Exchange Agent, for the benefit of the holders of Taj Holding Class A Common Stock, the appropriate amount to which such holders are entitled, pursuant to this Merger Agreement, of THCR Certificates for payment of the Stock Consideration, cash for payment of the Cash Consideration, THCR Dividends, if any, and cash for payment of fractional shares of THCR Common Stock (collectively, the "Exchange Fund"). The Exchange Agent shall, pursuant to irrevocable instructions, make the payments to the holders of Taj Holding Class A Common Stock as set forth in this Merger Agreement. The Exchange Agent shall not be entitled to vote or exercise any rights of ownership with respect to the THCR Common Stock held by it from time to time hereunder, except that it shall hold all THCR Dividends paid or distributed for the accounts of the Persons entitled thereto. (c) If any delivery of the Merger Consideration is to be made to a Person other than the registered holder of the Taj Holding Certificates surrendered in exchange therefor, it shall be a condition to such delivery that the Taj Holding Certificate so surrendered shall be properly endorsed or be otherwise in proper form for transfer and that the Person requesting such delivery shall (i) pay to the Exchange Agent any transfer or other taxes required as a result of delivery to a Person other than the registered holder or (ii) establish to the satisfaction of the Exchange Agent that such tax has been paid or is not payable. (d) Any portion of the Exchange Fund that remains undistributed to the holders of the Taj Holding Class A Common Stock for 180 days after the Effective Time shall be delivered to THCR upon demand. Any holder of Taj Holding Class A Common Stock who has not therefore complied with this Article within 180 days after the Effective Time shall have no further claim upon the Exchange Agent and shall thereafter look only to THCR for conversion or payment, as the case may be, of the Merger Consideration, THCR Dividends and fractional shares of THCR Common Stock. (e) If a Taj Holding Certificate has not been surrendered prior to the date on which any receipt of Merger Consideration, THCR Dividends or cash for payment of fractional shares of THCR Common Stock would otherwise escheat to or become the property of any governmental agency, such Taj Holding Certificate shall, to the extent permitted by applicable law, be deemed to be canceled and no money or other property will be due to the holder thereof. (f) The Exchange Agent shall invest cash in the Exchange Fund, as directed by THCR, on a daily basis, provided that all such investments shall be in obligations of or guaranteed by the United States of America with remaining maturities not exceeding 180 days, in commercial paper obligations receiving the highest rating from either Moody's Investors Services, Inc. or Standard & Poor's Corporation, or in certificates of deposit or banker's acceptances of commercial banks with capital exceeding $500 million (collectively, "Permitted Investments"). The maturities of Permitted Investments shall be such as to permit the Exchange Agent to make prompt payment to former stockholders of Taj Holding entitled thereto as contemplated by this Section. THCR shall promptly replenish the Exchange Fund to the extent of any losses incurred as a result of Permitted Investments. Any interest and other income resulting from such investments shall be paid to THCR. If for any reason (including losses) the Exchange Fund is inadequate to pay the amounts to which holders of Taj Holding Class A Common Stock shall be entitled under this Merger Agreement, THCR shall in any event be liable for payment thereof. The Exchange Fund shall not be used for any purpose not specifically provided for in this Merger Agreement. Section 2.09. Dividends; Liability. No THCR Dividend will be paid to Persons entitled to receive certificates representing THCR Common Stock pursuant to this Merger Agreement until such Persons surrender their Taj Holding Certificates. Upon such surrender, THCR Dividends shall be paid to the Person in whose name the THCR Certificate shall be issued. In no event shall the Person entitled to receive such dividends or distributions be entitled to receive interest on such dividends or distributions. Notwithstanding the foregoing, neither the Exchange Agent nor any party hereto shall be liable to a holder of Taj Holding Class A Common Stock for any shares of THCR Common Stock or dividends or distributions thereon delivered to a governmental agency pursuant to any applicable escheat or similar laws. Section 2.10. No Further Rights for Holders Electing Cash Consideration. Holders of Taj Holding Class A Common Stock who elect to receive the Cash Consideration or who shall receive cash for payment of fractional shares of THCR Common Stock shall, upon properly surrendering their Taj Holding Certificates, be deemed to have been paid in full satisfaction of all rights pertaining to the shares or fractions thereof exchanged for cash theretofore. Section 2.11. No Fractional Shares. No fractional shares of THCR Common Stock will be issued in connection with the Merger. In lieu of any fractional shares, each holder of Taj Holding Class A Common Stock who would otherwise have been entitled to a fractional share of THCR Common Stock upon surrender of Taj Holding Certificates for exchange will be paid cash (without interest) in an amount equal to the Market Value of such fractional shares. As soon as practicable after the determination of the amount of cash to be paid to former holders of Taj Holding Class A Common Stock in lieu of any fractional shares, the Exchange Agent will make available such amounts to such former holders. Section 2.12. Dissenting Shares. (a) Notwithstanding any other provision of this Merger Agreement to the contrary, shares of Taj Holding Class A Common Stock that are outstanding immediately prior to the Effective Time and which are held by holders who shall have not voted in favor of the Merger or consented thereto in writing and who shall have demanded properly in writing appraisal for such shares in accordance with Section 262 of the DGCL and who shall not have withdrawn such demand or otherwise have forfeited appraisal rights (collectively, the "Dissenting Shares") shall not be converted into or represent the right to receive the Merger Consideration. Such holders shall be entitled to receive payment of the appraised value of such shares, except that all Dissenting Shares held by holders who shall have failed to perfect or who effectively shall have withdrawn or lost their rights to appraisal of such shares under such Section 262 shall thereupon be deemed to have been converted into and to have become exchangeable, as of the Effective Time, for the right to receive, without any interest thereon, the Stock Consideration, upon surrender of the Taj Holding Certificates evidencing such shares. (b) Taj Holding shall give THCR (i) prompt notice of any demands for appraisal received by Taj Holding, withdrawals of such demands, and any other instruments served pursuant to the DGCL and received by Taj Holding and (ii) the opportunity to direct all negotiations and proceedings with respect to demands for appraisal under the DGCL. Taj Holding shall not, except with the prior written consent of THCR, make any payment with respect to any demands for appraisal, or offer to settle, or settle, any such demands. REPRESENTATIONS AND WARRANTIES OF TAJ HOLDING Taj Holding represents and warrants to THCR and Merger Sub that: Section 3.01. Corporate Organization. Taj Holding is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and has all requisite corporate power and authority to own its properties and assets and to conduct its businesses as now conducted. Taj Holding is duly qualified and in good standing in each jurisdiction in which the property owned, leased or operated by it makes such qualification necessary, except where the failure to be so qualified and in good standing would not be reasonably expected to have a Taj Holding Material Adverse Effect. Section 3.02. Capitalization. The authorized capital stock of Taj Holding consists of (i) 1,000,000 shares of Preferred Stock, par value $1.00 per share, (ii) 10,000,000 shares of Taj Holding Class A Common Stock, (iii) 860,000 shares of Taj Holding Class B Common Stock and (iv) 10,000,000 shares of Taj Holding Class C Common Stock. 1,350,000, 780,242 and 1,350,000 shares of Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock, respectively, are issued and outstanding. The outstanding shares of Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock have been duly authorized and validly issued and are fully paid, nonassessable and free of preemptive rights. The outstanding shares of Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock are the sole outstanding capital stock of Taj Holding. There are no options, warrants or other rights to purchase debt or equity securities of Taj Holding outstanding. Section 3.03. Subsidiaries. Each Subsidiary of Taj Holding (i) is a corporation or other legal entity duly organized, validly existing and (if applicable) in good standing under the laws of the jurisdiction of its organization and has the full power and authority to own its properties and conduct its business and operations as currently conducted, except where the failure to be duly organized, validly existing or in good standing does not have, and would not be reasonably expected to have, a Taj Holding Material Adverse Effect, and (ii) is duly qualified and in good standing in each jurisdiction in which the property owned, leased or operated by it or the nature of the business conducted by it makes such qualification necessary, except where the failure to be so qualified does not have and would not be reasonably expected to have a Taj Holding Material Adverse Effect. Section 3.04. Financial Statements; SEC Reports. Taj Holding has previously furnished THCR and Merger Sub with true and complete copies of the Taj Holding and Taj Associates (i) Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as filed with the SEC, (ii) Quarterly Reports on Form 10-Q for the quarters ended March 31, 1995, June 30, 1995, and September 30, 1995, as filed with the SEC, (iii) proxy statements related to all meetings of stockholders (whether annual or special) since January 1, 1995 and prior to the date hereof and (iv) all other reports or registration statements filed with the SEC since January 1, 1995 (clauses (i) through (iv) being referred to herein collectively as the "Taj Holding SEC Reports"). As of their respective filing dates, the Taj Holding SEC Reports complied in all material respects with the requirements of the Securities Act or the Exchange Act, as the case may be. As of their respective dates, the Taj Holding SEC Reports, including, without limitation, any financial statements included therein, did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. The audited consolidated financial statements and unaudited interim financial statements included in the Taj Holding SEC Reports comply as to form in all material respects with applicable accounting requirements and with the published rules and regulations of the SEC with respect thereto, have been prepared in accordance with generally accepted accounting principles applied on a basis consistent with prior periods (except as may be indicated therein or in the notes thereto), present fairly the financial position of the entities to which they relate as of the dates thereof and the results of their operations and cash flows for the periods presented therein subject, in the case of the unaudited interim financial statements, to normal year-end audit adjustments, any other adjustments described therein and the fact that certain information and notes have been condensed or omitted in accordance with the Exchange Act, and are, in all material respects, in accordance with the books of account and records of Taj Holding. Section 3.05. Absence of Certain Changes or Events. Except as described in the Taj Holding SEC Reports, during the period since September 30, 1995, (i) the business of Taj Holding and its Subsidiaries has been conducted only in the ordinary course, consistent with past practice, (ii) neither Taj Holding nor any of its Subsidiaries has entered into any material transaction other than in the ordinary course, consistent with past practice, and (iii) there has not been any event or change that has had a Taj Holding Material Adverse Effect. Section 3.06. Authorization and Validity of Agreements; Opinion of Financial Advisor. (a) Taj Holding has the corporate power to enter into this Merger Agreement and to carry out its obligations hereunder and, subject to the approval of the holders of the Taj Holding Class B Common Stock and the Taj Holding Class C Common Stock, each voting as a separate class, has the corporate power to consummate the Merger and the other transactions contemplated by this Merger Agreement to be performed by Taj Holding. The execution and delivery of this Merger Agreement, the performance of Taj Holding's obligations hereunder and the consummation of the Merger and the other transactions contemplated by this Merger Agreement to be performed by Taj Holding have been duly authorized by all necessary corporate action by the Taj Holding Class B Directors and the Board of Directors of Taj Holding. Rothschild Inc. ("Rothschild") has delivered to the Taj Holding Class B Directors and to the Board of Directors of Taj Holding its opinion, dated January 8, 1996 (the "Rothschild Fairness Opinion"), that the consideration to be received by the holders of the Taj Holding Class A Common Stock in connection with the Merger Transaction is fair, from a financial point of view, to the holders of the Taj Holding Class A Common Stock. The Taj Holding Class B Directors and the Board of Directors of Taj Holding have unanimously approved the terms of the Merger and the other transactions contemplated by this Merger Agreement to be performed by Taj Holding (subject to, in the case of the Taj Funding Offering, the negotiation of the terms relating thereto) and this Merger Agreement. This Merger Agreement has been duly executed and delivered by Taj Holding and constitutes the valid and binding obligation of Taj Holding enforceable against Taj Holding in accordance with its terms, except (i) to the extent that enforceability may be limited by applicable bankruptcy, insolvency, reorganization or other laws affecting the enforcement of creditors' rights generally, and (ii) that the availability of equitable remedies, including specific performance, is subject to the discretion of the court before which any proceeding therefor may be brought. (b) The Class B Directors of TM/GP and the entire board of directors of TM/GP have unanimously approved the terms of all the transactions relating to the Merger to the extent they contemplate action by TM/GP or Taj Associates. The Taj Holding Class B Directors have caused, pursuant to the certificate of incorporation of Taj Holding, all the shares of TM/GP Class B Common Stock to approve the terms of all the transactions relating to the Merger to the extent they contemplate action by TM/GP or Taj Associates. The Taj Holding Class B Directors and Taj Holding Class C Directors have caused, pursuant to the certificate of incorporation of Taj Holding, Taj Holding to approve, as the sole shareholder of TM/GP, the terms all the transactions relating to the Merger to the extent they contemplate action by TM/GP or Taj Associates. (c) Except for the approvals referred to in this Section, no other corporate proceedings on the part of Taj Holding are necessary to authorize this Merger Agreement and the transactions contemplated hereby to be performed by it (subject to, in the case of the Taj Funding Offering, the negotiation of the terms relating thereto); provided, however, that pursuant to Section 9.01 hereof, this Merger Agreement must also be approved and adopted by a majority of the outstanding shares of the Taj Holding Class A Common Stock, voting as a separate class. (d) Trump, the beneficial owner of all the outstanding shares of Taj Holding Class C Common Stock, has agreed to vote all of such shares in favor of the Merger pursuant to a voting agreement (the "Trump Taj Voting Agreement"), a copy of which has been delivered to each of the parties hereto. Section 3.07. No Conflict or Violation. The execution, delivery and performance by Taj Holding of this Merger Agreement, the consummation of the Merger, the Bond Redemption and the Taj Funding Offering do not and will not violate or conflict with any provision of the charter documents or by-laws of Taj Holding or its Subsidiaries and do not and will not violate any provision of law, or any order, judgment or decree of any court or other governmental or regulatory authority, nor violate or result in a breach of or constitute (with due notice or lapse of time or both) a default under any contract, lease, loan agreement, mortgage, security agreement, trust indenture or other agreement or instrument to which Taj Holding or its Subsidiaries are a party or by which they are bound or to which their respective properties or assets are subject, nor result in the creation or imposition of any lien, charge or encumbrance of any kind whatsoever upon any of the properties or assets of Taj Holding or its Subsidiaries, nor adversely affect or result in the cancellation, modification, revocation or suspension of any of the licenses, franchises, permits, authorizations or approvals issued or granted to Taj Holding or its Subsidiaries by the United States, any state or local government, any foreign national or local government, or any department, agency, board, commission, bureau or instrumentality of any of the foregoing, except as would not be reasonably expected to have a Taj Holding Material Adverse Effect or as would not prevent consummation of the transactions contemplated by this Merger Agreement. Section 3.08. Consents and Approvals. The execution, delivery and performance of this Merger Agreement by Taj Holding do not and will not require any material consent, waiver, authorization or approval of any governmental or regulatory authority, domestic or foreign, or of any other Person, and no material declaration or notification to, or filing or registration with, or permit of, any governmental or regulatory authority, except as it (i) may be required in connection or compliance with applicable provisions of the DGCL, the Exchange Act, the Securities Act, the HSR Act, blue sky or other state securities laws or Gaming Laws, (ii) would not be reasonably expected to have a Taj Holding Material Adverse Effect, (iii) would not prevent consummation of the transactions contemplated by this Merger Agreement or (iv) is otherwise contemplated in this Merger Agreement. Section 3.09. Litigation. Except as disclosed in the Taj Holding SEC Reports, there are no actions, suits, investigations or proceedings (adjudicatory, rulemaking or otherwise) pending or, to the knowledge of Taj Holding, threatened against Taj Holding or any of its Subsidiaries, or any property of Taj Holding or any such Subsidiary in any court or before any arbitrator of any kind or before or by any governmental or regulatory authority, domestic or foreign, except actions, suits, investigations or proceedings which, individually or in the aggregate, do not have and would not be reasonably expected to result in a Taj Holding Material Adverse Effect. Section 3.10. Taxes. Taj Holding and its Subsidiaries have filed all federal, state, county, local and foreign tax returns required to be filed by them, and have paid all taxes shown to be due thereon, other than taxes appropriate reserves for which have been made in the financial statements of Taj Holding and its Subsidiaries (and, to the extent material, such reserves have been accurately described to THCR). There are no assessments or adjustments that have been asserted in writing against Taj Holding or its Subsidiaries for any period for which Taj Holding has not made appropriate reserves in its financial statements. Section 3.11. Contracts and Leases. The Taj Holding SEC Reports contain a complete listing of all material contracts, leases, agreements or understandings, whether written or oral, required to be described therein or filed as exhibits thereto pursuant to the Exchange Act. Each of such contracts, leases, agreements and understandings is in full force and effect and (i) none of Taj Holding or its Subsidiaries or, to Taj Holding's best knowledge, any other party thereto, has breached or is in default thereunder, (ii) no event has occurred which, with the passage of time or the giving of notice would constitute such a breach or default, (iii) no claim of material default thereunder has, to Taj Holding's best knowledge, been asserted or threatened and (iv) none of Taj Holding or its Subsidiaries or, to Taj Holding's best knowledge, any other party thereto is seeking the renegotiation thereof or substitute performance thereunder, except where such breach or default, or attempted renegotiation or substitute performance, individually or in the aggregate, does not have and would not be reasonably expected to have a Taj Holding Material Adverse Effect. Section 3.12. Joint Proxy Statement. None of the information supplied or to be supplied by Taj Holding for inclusion or incorporation by reference in the THCR Registration Statement, the Joint Proxy Statement or the Schedule 13E-3 to be filed by Taj Holding and others in connection with the Merger Transaction, will at the time it becomes effective (in the case of the THCR Registration Statement) or it is mailed (in the case of the Joint Proxy Statement) contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading. If at any time prior to the Effective Time any event with respect to Taj Holding, its officers and directors or any of its Subsidiaries should occur which is required to be described in an amendment of, or a supplement to, such registration statement or proxy statement, Taj Holding shall notify THCR thereof. Section 3.13. Takeover Provisions Inapplicable. As of the date hereof and at all times on or prior to the Effective Time, Section 203 of the DGCL, is, and shall be, inapplicable to the Merger and the other transactions contemplated by the Merger Transaction. Section 3.14. Brokerage/Finder's Fees. Except for Rothschild, no broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission in connection with the Merger based upon arrangements made by or on behalf of Taj Holding or its Subsidiaries, and the fees and commissions payable to Rothschild, as contemplated by this Section, will be paid in full by Taj Holding. Taj Holding hereby indemnifies THCR and Merger Sub for any fees owing as a result of a breach of this Section. Section 3.15. Bond Redemption; Taj Funding Offering. Taj Holding, Taj Associates and Taj Funding have the right under the Bond Indenture to effect the Bond Redemption. The Boards of Directors of Taj Holding and Taj Funding have authorized, subject to the consummation of the Merger and the other elements of the Merger Transaction, (a) the Bond Redemption and (b) the filing of a registration statement on Form S-1 with the SEC relating to the Taj Funding Offering (the "Debt S-1") and, subject to the negotiation of the terms relating thereto, the Taj Funding Offering. Section 3.16. THCR Offering. None of the information supplied by Taj Holding with respect to Taj Holding and its Subsidiaries for inclusion in the registration statement on Form S-1 to be filed by THCR with the SEC relating to the THCR Offering (the "Equity S-1") will, at the time the Equity S-1 becomes effective under the Securities Act, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading. If any time prior to the Effective Time any event with respect to Taj Holding, its officers and directors or any of its Subsidiaries should occur which is required to be described in an amendment to or supplement to such registration statement, Taj Holding shall immediately notify THCR thereof. REPRESENTATIONS AND WARRANTIES OF THCR THCR represents and warrants to Taj Holding that: Section 4.01. Corporate Organization. THCR is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and has all requisite corporate power and authority to own its properties and assets and to conduct its businesses as now conducted. THCR is duly qualified and in good standing in each jurisdiction in which the property owned, leased or operated by it makes such qualification necessary, except where the failure to be so qualified and in good standing would not be reasonably expected to have a THCR Material Adverse Effect. Section 4.02. Capitalization. The authorized capital stock of THCR consists of 50,000,000 shares of THCR Common Stock, 1,000 shares of THCR Class B Common Stock and 1,000,000 shares of Preferred Stock, par value $1.00 per share. 10,066,667 and 1,000 shares of the THCR Common Stock and the THCR Class B Common Stock, respectively, are issued and outstanding. All outstanding shares of THCR Class B Common Stock are owned by Trump. The outstanding shares of THCR Common Stock and THCR Class B Common Stock have been duly authorized and validly issued and are fully paid, nonassessable and free of preemptive rights. The outstanding shares of the THCR Common Stock and the THCR Class B Common Stock are the sole outstanding capital stock of THCR. THCR is the sole general partner of THCR Holdings, and, as of December 31, 1995, THCR held a 60% general partnership interest in THCR Holdings. As of December 31, 1995, Trump's 40% limited partnership interest in THCR Holdings was convertible, at Trump's option, into 6,666,667 shares of THCR Common Stock (subject to certain adjustments set forth in the Exchange Agreement). The shares of THCR Common Stock to be issued to holders of Taj Holding Class A Common Stock in connection with the Merger have been duly authorized and, when issued and delivered to such holders as provided in this Merger Agreement, will be validly issued, fully paid and non-assessable, and the issuance of such shares of THCR Common Stock will not be subject to any preemptive or similar rights. Section 4.03. Subsidiaries. Each Subsidiary of THCR (i) is a corporation or other legal entity duly organized, validly existing and (if applicable) in good standing under the laws of the jurisdiction of its organization and has the full power and authority to own its properties and conduct its business and operations as currently conducted, except where the failure to be duly organized, validly existing or in good standing does not have, and would not be reasonably expected to have, a THCR Material Adverse Effect, and (ii) is duly qualified and in good standing in each jurisdiction in which the property owned, leased or operated by it or the nature of the business conducted by it makes such qualification necessary, except where the failure to be so qualified does not have and would not be reasonably expected to have a THCR Material Adverse Effect. Section 4.04. Financial Statements; SEC Reports. THCR has previously furnished Taj Holding with true and complete copies of the THCR (i) Registration Statement on Form S-1 (File No. 33-90784), as filed with the SEC, (ii) Quarterly Reports on Form 10-Q for the quarters ended June 30, 1995 and September 30, 1995, as filed with the SEC, and (iii) all other reports or registration statements filed with the SEC since June 7, 1995 (clauses (i) through (iii) being referred to herein collectively as the "THCR SEC respective filing dates, the THCR SEC Reports, including, without limitation, any financial statements included therein, did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. The audited consolidated financial statements and unaudited interim financial statements included in the THCR SEC Reports comply as to form in all material respects with applicable accounting requirements and with the published rules and regulations of the SEC with respect thereto, have been prepared in accordance with generally accepted accounting principles applied on a basis consistent with prior periods (except as may be indicated therein or in the notes thereto), present fairly the financial position of the entities to which they relate as of the dates thereof and the results of their operations and cash flows for the periods presented therein subject, in the case of the unaudited interim financial statements, to normal year-end audit adjustments, any other adjustments described therein and the fact that certain information and notes have been condensed or omitted in accordance with the Exchange Act, and are, in all material respects, in accordance with the books of account and records of THCR. Section 4.05. Absence of Certain Changes or Events. Except as described in the THCR SEC Reports, during the period since September 30, 1995, (i) the business of THCR and its Subsidiaries has been conducted only in the ordinary course, consistent with past practice, (ii) neither THCR nor any of its Subsidiaries has entered into any material transaction other than in the ordinary course, consistent with past practice, and (iii) there has not been any change or event that has had a THCR Material Adverse Effect. Section 4.06. Authorization and Validity of Agreements; Opinion of Financial Advisor. (a) THCR has the corporate power to enter into this Merger Agreement and to carry out its obligations hereunder and, subject to the approval by the affirmative vote of a majority of the outstanding shares of THCR Common Stock and THCR Class B Common Stock, voting as a single class, has the power to consummate the Merger and the other transactions contemplated by this Merger Agreement to be performed by THCR. The execution and delivery of this Merger Agreement, the performance of THCR's obligations hereunder and the consummation of the Merger have been duly authorized by all necessary corporate action by the THCR Special Committee and the Board of Directors of THCR. Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") has delivered to the THCR Special Committee its opinion, dated January 8, 1996 (the "DLJ Fairness Opinion"), that the aggregate consideration to be paid by THCR pursuant to the transactions contemplated by this Merger Agreement, is fair, from a financial point of view, to THCR. The THCR Special Committee and the Board of Directors of THCR have unanimously approved the terms of the Merger Transaction and this Merger Agreement. This Merger Agreement has been duly executed and delivered by THCR and constitutes the valid and binding obligation of THCR enforceable against THCR in accordance with its terms, except (i) to the extent that enforceability may be limited by applicable bankruptcy, insolvency, reorganization or other laws affecting the enforcement of creditors' rights generally, and (ii) that the availability of equitable remedies, including specific performance, is subject to the discretion of the court before which any proceeding therefor may be brought. (b) Except for the approval of the Merger Transaction by the holders of THCR Common Stock and THCR Class B Common Stock as described in this Section and in Section 9.01 hereof (which approval shall constitute adoption of this Merger Agreement) and the required amendment to the Partnership Agreement, no other corporate proceedings on the part of THCR are necessary to authorize the Merger Transaction. (c) Trump, the beneficial owner of all the outstanding shares of THCR Class B Common Stock, has agreed to vote all of such shares and any shares of THCR Common Stock that he beneficially owns in favor of the Merger Transaction pursuant to a voting agreement (the "Trump THCR Voting Agreement"), a copy of which has been delivered to each of the parties hereto. Section 4.07. No Conflict or Violation. The execution, delivery and performance by THCR of this Merger Agreement, the consummation of the Merger and the other elements of the Merger Transaction, including, without limitation, the THCR Offering, do not, and will not violate or conflict with any provision of the charter documents or by-laws of THCR or its Subsidiaries and do not and will not violate any provision of law, or any order, judgment or decree of any court or other governmental or regulatory authority, nor result in a breach of or constitute (with due notice or lapse of time or both) a default under any contract, lease, loan agreement, mortgage, security agreement, trust indenture or other agreement or instrument to which THCR or its Subsidiaries are a party or by which they are bound or to which their respective properties or assets are subject, nor result in the creation or imposition of any lien, charge or encumbrance of any kind whatsoever upon any of the properties or assets of THCR or its Subsidiaries, nor adversely affect or result in the cancellation, modification, revocation or suspension of any of the licenses, franchises, permits, authorizations or approvals issued or granted to THCR or its Subsidiaries by the United States, any state or local government, any foreign national or local government, or any department, agency, board, commission, bureau or instrumentality of any of the foregoing, except as would not be reasonably expected to have a THCR Material Adverse Effect or as would not prevent consummation of the transactions contemplated by this Merger Agreement. Section 4.08. Consents and Approvals. The execution, delivery and performance of this Merger Agreement by THCR and Merger Sub do not and will not require any material consent, waiver, authorization or approval of any governmental or regulatory authority, domestic or foreign, or of any other Person, and no material declaration or notification to, or filing or registration with, or permit of, any governmental or regulatory authority, except as it (i) may be required in connection or compliance with applicable provisions of the DGCL, the Exchange Act, the Securities Act, the HSR Act, blue sky or other state securities laws or Gaming Laws, (ii) would not be reasonably expected to have a THCR Material Adverse Effect, (iii) would not prevent consummation of the transactions contemplated by this Merger Agreement or the payment of the Merger Consideration following consummation of the Merger or (iv) is otherwise contemplated in this Merger Agreement. Section 4.09. Litigation. Except as disclosed in the THCR SEC Reports, there are no actions, suits, investigations or proceedings (adjudicatory, rulemaking or otherwise) pending or, to the knowledge of THCR, threatened against THCR or any of its Subsidiaries, or any property of THCR or any such Subsidiary in any court or before any arbitrator of any kind or before or by any governmental or regulatory authority, domestic or foreign, except actions, suits, investigations or proceedings which, individually or in the aggregate, do not have and would not be reasonably expected to result in a THCR Material Adverse Effect. Section 4.10. Taxes. THCR and its Subsidiaries have filed all federal, state, county, local and foreign tax returns required to be filed by them, and have paid all taxes shown to be due thereon, other than taxes appropriate reserves for which have been made in the financial statements of THCR and its Subsidiaries (and, to the extent material, such reserves have been accurately described to Taj Holding). There are no assessments or adjustments that have been asserted in writing against THCR or its Subsidiaries for any period for which THCR has not made appropriate reserves in its financial statements. Section 4.11. Contracts and Leases. The THCR SEC Reports contain a complete listing of all material contracts, leases, agreements or understandings, whether written or oral, required to be described therein or filed as exhibits thereto pursuant to the Exchange Act. Each of such contracts, leases, agreements and understandings is in full force and effect and (i) none of THCR or its Subsidiaries or, to THCR's best knowledge, any other party thereto, has breached or is in default thereunder, (ii) no event has occurred which, with the passage of time or the giving of notice would constitute such a breach or default, (iii) no claim of material default thereunder has, to THCR's best knowledge, been asserted or threatened and (iv) none of THCR or its Subsidiaries or, to THCR's best knowledge, any other party thereto is seeking the renegotiation thereof or substitute performance thereunder, except where such breach or default, or attempted renegotiation or substitute performance, individually or in the aggregate, does not have and would not be reasonably expected to have a THCR Material Adverse Effect. Section 4.12. THCR Registration Statement. None of the information supplied or to be supplied by THCR with respect to THCR and its Subsidiaries for inclusion or incorporation by reference in the THCR Registration Statement and the Joint Proxy Statement will at the time it becomes effective (in the case of the THCR Registration Statement) or it is mailed (in the case of the Joint Proxy Statement) contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading. If at any time prior to the Effective Time any event with respect to THCR, its officers and directors or any of its Subsidiaries should occur which is required to be described in an amendment of, or a supplement to, such registration statement or proxy statement, THCR shall notify Taj Holding thereof. Section 4.13. Takeover Provisions Inapplicable. As of the date hereof and at all times on or prior to the Effective Time, Section 203 of the DGCL, is, and shall be, inapplicable to the Merger and the other transactions contemplated by the Merger Transaction. Section 4.14. Brokerage/Finder's Fees. Except for DLJ, no broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission in connection with the Merger based upon arrangements made by or on behalf of THCR or its Subsidiaries, and the fees and commissions payable to DLJ, as contemplated by this Section, will be paid in full by THCR. THCR indemnifies Taj Holding for any fees owing as a result of a breach of this Section. Section 4.15. Taj Funding Offering. None of the information supplied by THCR with respect to THCR and its Subsidiaries for inclusion in the Debt S-1 will, at the time the Debt S-1 becomes effective under the Securities Act, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading. If any time prior to the Effective Time any event with respect to THCR, its officers and directors or any of its Subsidiaries should occur which is required to be described in an amendment to, or supplement to, such registration statement, THCR shall immediately notify Taj Holding thereof. REPRESENTATIONS AND WARRANTIES OF MERGER SUB Merger Sub represents and warrants to Taj Holding that: Section 5.01. Corporate Organization; Subsidiaries. Merger Sub is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and has all requisite corporate power and authority to own its properties and assets and to conduct its businesses as now conducted. Merger Sub is duly qualified and in good standing in each jurisdiction in which the property owned, leased or operated by it makes such qualification necessary, except where the failure to be so qualified and in good standing would not be reasonably expected to have a Merger Sub Material Adverse Effect. Merger Sub has no Subsidiaries. Section 5.02. Capitalization. The authorized capital stock of Merger Sub consists of 1,000 shares of Merger Sub Common Stock, 100 of which are issued and outstanding. THCR is the owner of all the outstanding shares of the Merger Sub Common Stock. The outstanding shares of Merger Sub Common Stock have been duly authorized and validly issued and are fully paid, nonassessable and free of preemptive rights. The Merger Sub Common Stock is the sole outstanding capital stock of Merger Sub. Section 5.03. Authorization and Validity of Agreements. Merger Sub has the corporate power to enter into this Merger Agreement and to carry out its obligations hereunder and has the power to consummate the Merger. The execution and delivery of this Merger Agreement, the performance of Merger Sub's obligations hereunder and the consummation of the Merger have been duly authorized by all necessary corporate action by the Board of Directors of Merger Sub and by THCR as the sole holder of Merger Sub Common Stock. This Merger Agreement has been duly executed and delivered by Merger Sub and constitutes the valid and binding obligation of Merger Sub enforceable against Merger Sub in accordance with its terms, except (i) to the extent that enforceability may be limited by applicable bankruptcy, insolvency, reorganization or other laws affecting the enforcement of creditors' rights generally, and (ii) that the availability of equitable remedies, including specific performance, is subject to the discretion of the court before which any proceeding therefor may be brought. No other corporate proceedings on the part of Merger Sub are necessary to authorize this Merger Agreement and the transactions contemplated hereby. Section 6.01. Conduct Pending the Merger. From and after the date of this Merger Agreement and until the Effective Time, Taj Holding shall, and shall cause each of its Subsidiaries to, conduct its business solely in the ordinary course consistent with past practice and, without the prior written consent of THCR, Taj Holding shall not, and shall cause each of its Subsidiaries not to, except as required or permitted pursuant to the terms hereof or as contemplated in the Taj Holding SEC Reports filed through the date hereof or by the terms of the Merger Transaction: (i) make any material change in the conduct of its businesses and operations or enter into any transaction, other than in the ordinary course of business consistent with past practice, or make any investment other than a Permitted Investment (as such term is defined in the Bond (ii) make any change in its certificate of incorporation or by-laws, issue any additional shares of capital stock or equity securities, grant any option, warrant or right to acquire any capital stock or equity securities, issue any security convertible into or exchangeable for its capital stock, alter in any material respect the terms of any of its outstanding securities, or make any change in its outstanding shares of capital stock or in its capitalization, whether by reason of a reclassification, recapitalization, stock split or combination, exchange or readjustment of shares, stock dividend or otherwise; (iii) incur, assume or guarantee any indebtedness for borrowed money, issue any notes, bonds, debentures or other corporate securities or grant any option, warrant or right to purchase any thereof; (iv) make any sale, assignment, transfer, abandonment or other conveyance of any of its assets or any part thereof, except in the ordinary course of business consistent with past practices; (v) subject any of its assets, or any part thereof, to any lien or suffer such to be imposed other than such liens as may arise in the ordinary course of business consistent with past practice or by operation of law; (vi) redeem, retire, purchase or otherwise acquire, directly or indirectly, any shares of its capital stock or declare, set aside or pay any dividends or other distribution in respect of such shares; (vii) increase the compensation payable or to become payable to its executive officers or employees, except for increases in the ordinary course of business in accordance with past practices, or grant any severance or termination pay to, or enter into any employment or severance agreement (other than in the ordinary course of business) with, any director or executive officer, or establish, adopt, enter into or amend in any material respect or take action to accelerate any rights or benefits under any collective bargaining, bonus, profit sharing, thrift, compensation, stock option, restricted stock, pension, retirement, deferred compensation, employment, termination, severance or other plan, agreement, trust fund, policy or arrangement for the benefit of any director, (viii) take any other action that would cause any of the representations and warranties made in this Merger Agreement not to remain true and (ix) commit itself to do any of the foregoing. Section 6.02. Joint Proxy Statement. As promptly as reasonably practicable after the execution of this Merger Agreement, Taj Holding and THCR shall prepare and file with the SEC the preliminary Joint Proxy Statement, which will be included within the THCR Registration Statement. As promptly as reasonably practicable after comments are received from the SEC with respect to the THCR Registration Statement and after the satisfactory response thereto by Taj Holding and THCR, Taj Holding and THCR shall file with the SEC the definitive Joint Proxy Statement and any amendment to the THCR Registration Statement and shall use all reasonable efforts to cause the THCR Registration Statement to become effective as soon thereafter as it is reasonably practicable. Promptly thereafter, Taj Holding shall distribute the Joint Proxy Statement and related proxy card and the Election Form to its stockholders. Section 6.03. Stockholders Meeting. Taj Holding shall take all action necessary, in accordance with applicable law and its certificate of incorporation and by-laws, to convene a special meeting of the holders of the Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock (the "Taj Holding Meeting") as promptly as practicable for the purpose of approving and adopting this Merger Agreement. Subject to its fiduciary duties, as advised by Special Counsel, the Board of Directors of Taj Holding will recommend that holders of Taj Holding Class A Common Stock, Taj Holding Class B Common Stock and Taj Holding Class C Common Stock vote in favor of this Merger Agreement at the Taj Holding Meeting. Section 6.04. Compliance with the Securities Act. At the Closing, Taj Holding shall cause to be delivered to THCR a certificate (satisfactory to counsel for THCR) of the general counsel of Taj Associates identifying all holders of Taj Holding Class A Common Stock who were, to the best of his knowledge and after being advised by outside counsel, affiliates (for purposes of Rule 145 under the Securities Act) of Taj Holding at the time of the Taj Holding Meeting. Section 6.05. No Solicitation. (a) Subject to the fiduciary duties of the Board of Directors of Taj Holding, as advised by Special Counsel, neither Taj Holding nor any of its Subsidiaries shall, directly or indirectly, take (nor shall Taj Holding authorize or permit its Subsidiaries, officers, directors, employees, representatives, investment bankers, attorneys, accountants or other agents or affiliates, to take) any action (i) to knowingly encourage, solicit or initiate the submission of any Acquisition Proposal, (ii) to enter into any agreement with respect to any Acquisition Proposal or (iii) to participate in any way in discussions or negotiations with, or furnish any information to, any Person in connection with, or take any other action to facilitate any inquiries or the making of any proposal that constitutes, or may reasonably be expected to lead to, any Acquisition Proposal. Taj Holding will promptly communicate to the other parties hereto any solicitation by or of Taj Holding and the terms of any proposal or inquiry, including the identity of the Person and its affiliates making the same, that it may receive in respect of any such transaction, or of any such information requested from it or of any such negotiations or discussions being sought to be initiated with it. (b) Notwithstanding paragraph (a) above, Taj Holding may, directly or indirectly, furnish information and access, in each case in response to unsolicited requests therefor, to any Person pursuant to appropriate confidentiality agreements, and may participate in discussions and negotiate with such Person concerning any Acquisition Proposal involving Taj Holding or any direct or indirect Subsidiary of Taj Holding, if the Taj Holding Class B Directors by a majority vote determine in their good faith judgment that such action is appropriate in furtherance of the best interests of stockholders. Section 6.06. Dividend Prohibition. From the date of this Merger Agreement through the Effective Time, Taj Holding shall not, and shall cause its Subsidiaries not to, pay or declare any dividend or make any distribution with respect to any of their equity interests except as contemplated in connection with the Merger Transaction. Section 6.07. Letters of Accountants. Taj Holding shall use its reasonable best efforts to cause to be delivered to THCR "comfort letters" of Arthur Andersen LLP, Taj Holding's independent public accountants, dated and delivered the date on which the THCR Registration Statement shall become effective and as of the Effective Time, and addressed to THCR, in form and substance reasonably satisfactory to THCR and reasonably customary in scope and substance for letters delivered by independent public accountants in connection with transactions such as those contemplated by this Merger Agreement. Section 7.01. Conduct Pending the Merger. From and after the date of this Merger Agreement and until the Effective Time, THCR shall, and shall cause each of its Subsidiaries to, conduct its business solely in the ordinary course consistent with past practice and, without the prior written consent of Taj Holding, THCR shall not, and shall cause each of its Subsidiaries not to, except as required or permitted pursuant to the terms hereof or as contemplated in the THCR SEC Reports filed through the date hereof or by the terms of the Merger Transaction: (i) make any material change in the conduct of its businesses and operations or enter into any transaction other than in the ordinary course of business consistent with past practice; (ii) make any change in its certificate of incorporation or by-laws, or make any material change in its outstanding shares of capital stock or in its capitalization, whether by reason of a reclassification, recapitalization, stock split or combination, exchange or readjustment of shares, stock dividend or otherwise; (iii) take any other action that would cause any of the representations and warranties made in this Merger Agreement not to remain true and (iv) commit itself to do any of the foregoing. Section 7.02. Joint Proxy Statement. As promptly as reasonably practicable after the execution of this Merger Agreement, THCR and Taj Holding shall prepare and THCR shall file with the SEC the THCR Registration Statement, which shall include the preliminary Joint Proxy Statement and the preliminary prospectus with respect to the THCR Common Stock to be issued in connection with the Merger. As promptly as reasonably practicable after comments are received from the SEC with respect to the THCR Registration Statement and after the satisfactory response thereto by THCR and Taj Holding, THCR and Taj Holding shall file with the SEC the definitive Joint Proxy Statement and THCR shall file with the SEC any amendment to the THCR Registration Statement and shall use all reasonable efforts to cause the THCR Registration Statement to become effective as soon thereafter as it is reasonably practicable. Promptly thereafter, THCR shall distribute the Joint Proxy Statement and related proxy card to its stockholders. Section 7.03. Stockholders Meeting. (a) THCR shall take all action necessary, in accordance with applicable law and its certificate of incorporation and by-laws, to convene a special meeting of the holders of the THCR Common Stock and the THCR Class B Common Stock (the "THCR Meeting") as promptly as practicable for the purpose of approving the Merger Transaction. Subject to its fiduciary duties, as advised by outside counsel, the Board of Directors of THCR will recommend that holders of THCR Common Stock vote in favor of and adopt the Merger Transaction (which approval will constitute adoption of this Merger Agreement) at the THCR Meeting. (b) THCR, as the sole stockholder of Merger Sub, has consented to the adoption of this Merger Agreement by Merger Sub and agrees that such consent shall be deemed for all purposes as a vote duly adopted at a meeting of the stockholders of Merger Sub held for such purpose. Section 7.04. Indemnification and Insurance. (a) For a period of six years from the Effective Time, each of the Surviving Corporation and TM/GP shall, and THCR shall cause the Surviving Corporation and TM/GP to, provide to the former officers and directors of Taj Holding (the "Taj Holding Indemnified Parties") indemnification as set forth in the certificate of incorporation and by-laws of THCR as in effect as of the date hereof. THCR agrees, and shall cause the Surviving Corporation and TM/GP to agree, that until six years from the Effective Time, unless otherwise required by law, the certificate of incorporation and by-laws of the Surviving Corporation and TM/GP shall not be amended, repealed or modified to reduce or limit the rights of indemnity afforded to the present and former directors, officers and employees of Taj Holding and TM/GP (including, without limitation, with respect to the transactions contemplated by this Merger Agreement), or the ability of the Surviving Corporation or TM/GP to indemnify them, nor to hinder, delay or make more difficult the exercise of such rights of indemnity or the ability to indemnify. (b) Should any claim or claims be made against any present or former director, officer, employee or agent of Taj Holding or TM/GP, arising from his services as such, within six years of the Effective Time, the provisions of this Section with respect to indemnification and the certificate of incorporation and the by-laws of the Surviving Corporation and TM/GP shall continue in effect until the final disposition of all such claims. (c) In the event the Surviving Corporation or TM/GP or any of their respective successors or assigns (i) consolidates with or merges into any other Person and shall not be the continuing or surviving corporation or entity of such consolidation or merger or (ii) transfers all or substantially all of its properties and assets to any Person, then and in each such case, proper provision shall be made so that the successors and assigns of the Surviving Corporation or TM/GP, as the case may be, shall assume all of its obligations set forth in this Section. (d) For a period of six years after the Effective Time, the Surviving Corporation and TM/GP shall, and THCR shall cause the Surviving Corporation and TM/GP to, purchase and maintain in effect directors' and officers' liability insurance policies covering the Taj Holding Indemnified Parties on terms no less favorable than the terms of the current insurance policies coverage. Notwithstanding the foregoing, if the directors' and officers' liability insurance referred to in this paragraph is unavailable for the Current D&O Premium, the Surviving Corporation and TM/GP shall obtain as much insurance as can be obtained for a premium not in excess (on an annualized basis) of the Current D&O Premium. (e) In the event any claim is made against present or former directors, officers or employees of Taj Holding or TM/GP that is covered or potentially covered by insurance, THCR agrees that it shall, and shall cause the Surviving Corporation and TM/GP to, do nothing that would forfeit, jeopardize, restrict or limit the insurance coverage available for that claim until the final disposition of that claim unless otherwise required by law or their respective certificate of incorporation or by-laws. (f) This Section 7.04 is intended to be for the benefit of, and shall be enforceable by, the Taj Holding Indemnified Parties, their heirs and personal representatives and shall be binding on THCR, the Surviving Corporation and TM/GP and their respective successors and assigns. Section 7.05. Letters of Accountants. THCR shall use its reasonable best efforts to cause to be delivered to Taj Holding "comfort letters" of Arthur Andersen LLP, THCR's independent public accountants, dated and delivered the date on which the THCR Registration Statement shall become effective and as of the Effective Time, and addressed to Taj Holding, in form and substance reasonably satisfactory to Taj Holding and reasonably customary in scope and substance for letters delivered by independent public accountants in connection with transactions such as those contemplated by this Merger Agreement. Section 8.01. Stock Exchange Listing. THCR shall, prior to the Effective Time, use its best efforts to list on the NYSE, subject to official notice of issuance, the THCR Common Stock to be issued pursuant to the Merger. Section 8.02. Additional Agreements; Consents and Permits. Subject to the terms and conditions herein provided, each of the parties hereto agrees to use all reasonable efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable under applicable laws and regulations to consummate and make effective the transactions contemplated by this Merger Agreement, including using all reasonable efforts to obtain all necessary waivers, consents and approvals, to effect all necessary registrations and filings (including, but not limited to, filings with all applicable governmental agencies) and to lift any injunction or other legal bar to the transactions contemplated by this Merger Agreement (and, in such case, to proceed with the transactions contemplated by this Merger Agreement as expeditiously as possible), subject, however, to the appropriate vote of the respective stockholders or stockholder, as the case may be, of Taj Holding, THCR and Merger Sub. Section 8.03. Registration of Securities. Each of the parties hereto shall use its reasonable efforts to prepare promptly and file with the SEC, shall furnish such information required to be included in, and shall cooperate in the preparation of, such registration statements under the Securities Act and Schedules 13E under the Exchange Act, and to cause such registration statements to be declared effective, as applicable, as shall be required to finance the Merger Transaction and to register the shares of THCR Common Stock issuable pursuant to the terms of this Merger Agreement. Each of the parties hereto shall use its reasonable efforts to cause such registration statements and schedules to comply as to form in all material respects with the provisions of the Securities Act and the Exchange Act, respectively. Section 8.04. Access to Information; Confidentiality. (a) Each of the parties hereto shall afford to the other parties hereto and to their accountants, counsel and other representatives full access during normal business hours (and at such other times as the parties may mutually agree) throughout the period until the Effective Time to all of its properties, books, contracts, commitments, records and personnel and, during such period, each shall furnish promptly to the others (i) a copy of each report, schedule and other document filed or received by it pursuant to the requirements of federal or state securities laws or Gaming Laws, and (ii) all other information concerning its business, properties and personnel, both past and present, as such party may reasonably request. (b) A Receiving Party shall (i) keep confidential and not disclose or reveal to any Person, other than those employed by the Receiving Party or acting on the Receiving Party's behalf and directly participating in the performance of such party's obligations under this Merger Agreement, all Confidential Information, (ii) cause their respective affiliates and the directors, officers, employees, agents, advisors and controlled or controlling Persons of such party and its affiliates to observe the terms of this Section and to keep confidential and not disclose or reveal to any Person all Confidential Information, and (iii) not use Confidential Information for any purpose other than in connection with the transactions contemplated by this Merger Agreement and in a manner approved by the Disclosing Party. (c) In the event that a Receiving Party is requested or required by interrogatories, requests for information or documents, subpoena, civil investigative demand or similar process or required (as advised in writing by its outside counsel) to disclose any of the Confidential Information, the Receiving Party shall provide the Disclosing Party with prompt written notice so that it may seek a protective order or other appropriate remedy. In the event such protection or other remedy is not obtained, the Receiving party may disclose such Confidential Information pursuant to such interrogatories, requests for information or documents, subpoena, civil investigative demand or similar process or other law; provided, however, that the Receiving Party shall exercise best efforts to obtain assurance that confidential treatment will be accorded to such Confidential Information. (d) Without prejudice to the rights and remedies otherwise available to a Disclosing Party, a Disclosing Party shall be entitled to equitable relief by way of injunction if the Receiving Party or any of the Receiving Party's affiliates and the directors, officers, employees, agents, advisors and controlled or controlling Persons of such Receiving Party and its affiliates breach or threaten to breach any of the provisions of this Section. Section 8.05. Notification of Certain Matters. Taj Holding, THCR and Merger Sub shall give prompt notice to each other of: (i) any notice or other communication from any Person alleging that the consent of such Person is or may be required in connection with the transactions contemplated by this Merger Agreement; (ii) any notice or other communication from any governmental or regulatory agency or authority in connection with the transactions contemplated by this Merger Agreement; (iii) any action, suit, claim, investigation or proceeding commenced or, to its knowledge, threatened against, relating to or involving or otherwise affecting Taj Holding, THCR or any of their Subsidiaries, which is reasonably likely to (A) have a Taj Holding Material Adverse Effect, THCR Material Adverse Effect or Merger Sub Material Adverse Effect, as the case may be, or (B) prevent the consummation of the transactions contemplated by this Merger Agreement or cause any of such transactions to be rescinded (iv) the occurrence, or failure to occur, of any event or change in circumstances where such occurrence or failure to occur would be likely to cause any representation or warranty contained in this Merger Agreement to be untrue or inaccurate in any material respect at any time from the date hereof to the Effective Time; and (v) any material failure of such party to comply with or satisfy any covenant, condition or agreement to be complied with or satisfied by it hereunder; provided, however, that no such notification shall affect the representations or warranties of the parties or the conditions to the obligations of the parties hereunder. Section 8.06. HSR Act. The Parties shall use their best efforts to file or cause to be filed as soon as practicable notifications under the HSR Act in connection with the Merger, and to respond as promptly as practicable to any inquiries received from the Federal Trade Commission and the Antitrust Division of the Department of Justice for additional information or documentation and to respond as promptly as practicable to all inquiries and requests received from any State Attorney General or other governmental authority in connection with antitrust matters. Section 8.07. Bond Redemption. Taj Holding shall take all necessary actions to cause the Bond Redemption to occur immediately after the Effective Time. Section 9.01. Conditions to the Obligations of Each Party. The respective obligations of Taj Holding, THCR and Merger Sub to consummate the transactions contemplated by this Merger Agreement are subject to the fulfillment at or prior to the Effective Time of each of the following conditions, any or all of which may be waived in whole or in part, to the extent permitted by applicable law: (i) this Merger Agreement shall have been duly approved and adopted by the affirmative vote of a majority of the outstanding shares of the Taj Holding Class B Common Stock and Taj Holding Class C Common Stock, each voting as a separate class, in accordance with the DGCL and the certificate of incorporation of Taj Holding; (ii) this Merger Agreement shall have been duly approved and adopted by the affirmative vote of a majority of the outstanding shares of Taj Holding Class A Common Stock, voting as a separate class; (iii) the Merger Transaction shall have been duly approved and adopted by the affirmative vote of a majority of the outstanding shares of THCR Common Stock and THCR Class B Common Stock, voting as a single class, in accordance with the DGCL and the certificate of incorporation of THCR; (iv) the Merger Transaction shall have been duly approved by the affirmative vote of a majority of the outstanding shares of THCR Common Stock (excluding officers and directors of THCR and their affiliates), voting as a separate class; (v) all filings required to be made prior to the Effective Time with, and all consents, approvals, permits and authorizations required to be obtained prior to the Effective Time from, governmental and regulatory authorities (including, without limitation, Gaming Authorities) in connection with the execution and delivery of this Merger Agreement and the consummation of the transactions contemplated hereby by Taj Holding, THCR and Merger Sub shall have been made or obtained (as the case may be) without restrictions, except where the failure to obtain such consents, approvals, permits and authorizations could not be reasonably be expected to have a Taj Holding Material Adverse Effect or a THCR Material Adverse Effect (assuming the (vi) no court or governmental or regulatory authority of competent jurisdiction (including, without limitation, Gaming Authorities) shall have enacted, issued, promulgated, enforced or entered any statute, rule, regulation, judgment, decree, injunction or other order (whether temporary, or taken any action that prohibits the consummation of the transactions contemplated by this Merger Agreement; provided, however, that the parties invoking this condition shall use their best efforts to have any such judgment, decree, injunction or order vacated; (vii) the shares of THCR Common Stock to be issued pursuant to the Merger shall have been approved for listing on the NYSE, subject to official (viii) the waiting period applicable to the consummation of the Merger under the HSR Act shall have expired or been terminated. Section 9.02. Conditions to the Obligation of Taj Holding. The obligation of Taj Holding to consummate the transactions contemplated by this Merger Agreement is subject to the fulfillment at or prior to the Effective Time of each of the following conditions, any or all of which may be waived in whole or in part by Taj Holding to the extent permitted by applicable law: (i) the Taj Funding Offering shall have been consummated on terms reasonably acceptable to Taj Holding; (ii) the consent of certain of Taj Associates' creditors necessary to consummate the Merger Transaction shall have been obtained; (iii) Taj Holding LLC or any other Person to which part or all of the assets of Taj Holding or any of its Subsidiaries has been or will be transferred shall have assumed (without releasing the Surviving Corporation or TM/GP) the indemnification and other obligations of the Surviving Corporation and TM/GP set forth in Section 7.04 hereof; (iv) each of THCR and Merger Sub shall have performed in all material respects all of its respective obligations hereunder required to be performed by them at or prior to the Effective Time; (v) each of the representations and warranties of each of THCR and Merger Sub contained in this Merger Agreement and in any certificate or other writing delivered by THCR and Merger Sub pursuant hereto shall be true in all material respects at and as of the Effective Time, as if made at and as of such time (except to the extent it relates to a particular date); and (vi) Taj Holding shall have received a certificate from THCR and Merger Sub, signed by an executive officer of THCR and Merger Sub, respectively, to the effect set forth in clauses (iv) and (v) of this Section. Section 9.03. Conditions to the Obligations of THCR and Merger Sub. The obligation of each of THCR and Merger Sub to consummate the transactions contemplated by this Merger Agreement is subject to the fulfillment at or prior to the Effective Time of each of the following conditions, any or all of which may be waived in whole or in part by THCR to the extent permitted by applicable law: (i) the Market Value of the THCR Common Stock shall be $20 or more; (ii) the THCR Offering and the Taj Funding Offering shall have been consummated on terms acceptable to THCR; (iii) the purchase of the Specified Parcels shall have been consummated on terms acceptable to THCR, the obligations relating to the outstanding indebtedness of Realty Corp. to First Fidelity shall have been satisfied and the releases of the Liens and guarantees relating to such indebtedness (iv) the payment to Bankers Trust of $10 million, contemplated as part of the Merger Transaction, shall have been made and the releases of the Liens and guarantees that Bankers Trust has with respect to Taj Associates (including Trump's direct and indirect ownership interest therein) and with respect to the TTMI Note shall have been obtained; (v) Trump shall have contributed, or caused to be contributed, to THCR Holdings and Taj Holdings LLC all of his direct and indirect ownership interests in Taj Associates on terms acceptable to THCR; (vi) the number of shares of Taj Holding Class A Common Stock for which written demand for appraisal has been properly made pursuant Section 262 of the DGCL shall have not exceeded 5% of the total number of shares of Taj Holding Class A Common Stock outstanding immediately prior to the Effective (vii) the THCR Registration Statement shall have been declared effective and no stop order suspending effectiveness shall have been issued, no action, suit, proceeding or investigation by the SEC to suspend the effectiveness thereof shall have been initiated and be continuing, and all necessary approvals under blue sky or other state securities laws, the Securities Act or the Exchange Act relating to the issuance or trading of the THCR Common Stock shall have been received; (viii) the consent of certain of Trump's creditors necessary to consummate the Merger Transaction shall have been obtained; (ix) Taj Holding shall have performed in all material respects all of its obligations hereunder required to be performed by it at or prior to the (x) each of the representations and warranties of Taj Holding contained in this Merger Agreement and in any certificate or other writing delivered by Taj Holding pursuant hereto shall be true in all material respects at and as of the Effective Time, as if made at and as of such time (except to the extent it relates to a particular date); and (xi) THCR and Merger Sub shall have received a certificate signed by an executive officer of Taj Holding to the effect set forth in clauses (ix) and (x) of this Section. Section 10.01. Termination. This Merger Agreement may be terminated and the Merger may be abandoned at any time prior to the Effective Time (whether before or after approval of this Merger Agreement by the respective stockholders of Taj Holding or THCR): (i) by joint written consent of Taj Holding and THCR; (ii) by Taj Holding if any of the conditions specified in Sections 9.01 or 9.02 have not been satisfied or waived by Taj Holding at such time as such condition is no longer capable of satisfaction; (iii) by THCR and Merger Sub if any of the conditions specified in Sections 9.01 or 9.03 have not been satisfied or waived by THCR and Merger Sub at such time as such condition is no longer capable of satisfaction; (iv) by Taj Holding, acting through the Taj Holding Class B Directors, if the Taj Holding Class B Directors shall have withdrawn or modified their approval or recommendation of this Merger Agreement or the Merger in order to permit Taj Holding to execute an agreement to effect an Acquisition Proposal determined by the Taj Holding Class B Directors to be more favorable to the Taj Holding stockholders than the transactions (v) by either party if the Merger has not been consummated on or before June 30, 1996; provided, however, that a party may not terminate this Merger Agreement pursuant to this clause if the failure of such party to fulfill any of its obligations under this Merger Agreement shall have been the reason that the Merger shall not have been consummated on or before said date. Section 10.02. Effect of Termination. In the event of termination of this Merger Agreement pursuant this Article, this Merger Agreement shall forthwith terminate and (except for the willful breach of this Merger Agreement by any party hereto) there shall be no liability on the part of any party hereto; provided, however, that Sections 3.14, 4.14, 8.04(b), (c) and (d), 10.02, 11.05, 11.06, 11.07, 11.09, 11.11 and 11.13 shall survive the termination of this Merger Agreement. Section 11.01. Notices. All notices, requests and other communications to any party hereunder shall be in writing (including facsimile or similar writing) and shall be given: (i) if to Taj Holding to: Atlantic City, New Jersey 08401 Attention: Nicholas F. Moles, Esq. New York, New York 10017 Attention: Emanuel S. Cherney, Esq. (ii) if to THCR or Merger Sub to: Trump Hotels & Casino Resorts, Inc. Mississippi Avenue and The Boardwalk Atlantic City, New Jersey 08401 Attention: Robert M. Pickus, Esq. New York, New York 10022 Attention: Daniel D. Rubino, Esq. or such other address or facsimile number as such party may hereafter specify by notice to the other parties hereto. Each such notice, request or other communication shall be effective (i) if given by facsimile, when such facsimile is transmitted to the facsimile number specified in this Section and the appropriate confirmation is provided, (ii) if given via United States mail, three days after such notice is deposited in the mail in a postage pre- paid envelope or (iii) if given by any other means, when delivered at the address specified in this Section. Section 11.02. Survival. None of the representations, warranties, agreements or covenants contained herein shall survive the Effective Time, except for the agreements contained in Articles I and II, Sections 3.14, 4.14, 7.04, 8.02, 8.04(b), (c) and (d), 11.02, 11.05, 11.06, 11.07, 11.09, 11.11, 11.13 and the last sentence of Section 11.03. Section 11.03. Amendment. Any provision of this Merger Agreement may be amended by the parties hereto by action of each of their respective Boards of Directors, at any time prior to the Effective Time; provided, however, that any such amendment made after the adoption of this Merger Agreement by the stockholders of Taj Holding or THCR shall not, without further approval of such stockholders (i) alter or change the amount, kind or manner of payment of the Merger Consideration, (ii) alter or change any term of the certificate of incorporation of the Surviving Corporation (except as otherwise provided in this Merger Agreement) or (iii) change any other terms or conditions of this Merger Agreement, if any of such changes, alone or in the aggregate, would materially and adversely affect the stockholders of Taj Holding or THCR. Any amendment to this Merger Agreement shall be in writing signed by all the parties hereto. Section 11.04. Waiver. At any time prior to the Effective Time, Taj Holding, THCR and Merger Sub may, unless otherwise set forth in this Merger Agreement, (i) extend the time for the performance of any agreement of the other party or parties hereto, (ii) waive any accuracy in the representations and warranties contained herein or in any document delivered pursuant hereto or (iii) waive compliance with any agreement or condition of the other party or parties hereto contained herein. Any agreement on the part of any party to any such extension or waiver shall be effective only if set forth in a writing signed on behalf of such party and delivered to the other party or parties. No failure or delay by any party in exercising any right, power or privilege hereunder shall operate as a waiver thereof nor shall any single or partial exercise thereof preclude any other right, power or privilege. Section 11.05. Successors and Assigns. The provisions of this Merger Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns; provided, however, that no party may assign or otherwise transfer any of its rights under this Merger Agreement without the consent of each of the other parties hereto. Section 11.06. Governing Law. Except to the extent set forth in Section 11.07 or in the DGCL, this Merger Agreement shall be construed in accordance with and governed by the internal laws of the State of New York without regard to principles of conflict of laws. Section 11.07. Gaming Laws. Each of the provisions of this Merger Agreement is subject to and shall be enforced in compliance with the Gaming Laws. Section 11.08. Integration. This Merger Agreement embodies the entire agreement and understanding among the parties hereto and supersedes all prior agreements and understandings relating to the subject matter hereof. Section 11.09. Third Party Beneficiaries. This Merger Agreement (including the documents and instruments referred to herein) is not intended to confer upon any other Person any rights or remedies hereunder; provided, however, the Taj Holding Indemnified Parties shall be third party beneficiaries of Section 7.04 hereof. Section 11.10. Specific Performance. The parties hereto agree that irreparable damage would occur in the event that any of the provisions of this Merger Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches of this Merger Agreement and to enforce specifically the terms and provisions hereof in any court of the United States or any state having jurisdiction, this being in addition to any other remedy to which they are entitled at law or in equity. Section 11.11. Remedies Cumulative. All rights, powers and remedies provided under this Merger Agreement otherwise available at law or in equity shall be cumulative and not alternative, and the exercise or beginning of any thereof by any party shall not preclude the simultaneous or later exercise of any other such right, power or remedy by such party. Section 11.12. Publicity. So long as this Merger Agreement is in effect, each of the parties agrees to consult with each other in issuing any press release or otherwise making any public statement with respect to the Merger, and none of them shall issue any press release or make any public statement prior to such consultation, except as may be required by law or by obligations pursuant to any listing agreement with any national securities exchange. The commencement of litigation relating to this Merger Agreement or any proceedings in connection therewith shall not be deemed a violation of this Section. Section 11.13. Fees and Expenses. Whether or not the Merger is consummated, all costs and expenses incurred in connection with this Merger Agreement and the transactions contemplated hereby shall be paid equally by Taj Holding and THCR; provided, however, that all costs and expenses incurred in connection with (i) printing, filing and distributing the Equity S-1 and (ii) any filings pursuant to Section 8.06 hereof, shall be borne solely by THCR. Section 11.14. Headings; Counterparts; Effectiveness. The headings contained in this Merger Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Merger Agreement. This Merger Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Merger Agreement shall become effective when each party hereto shall have received counterparts hereof signed by the other parties hereto. IN WITNESS WHEREOF, the parties hereto have caused this Merger Agreement to be duly executed by their respective authorized officers as of the day and year first above written. of Trump Taj Mahal Associates TRUMP HOTELS & CASINO RESORTS, INC. Title: President and Chief Executive Title: President and Chief Executive the Board of Directors of Trump Hotels & Casino Resorts, Inc. You have requested our opinion as to the fairness from a financial point of view to Trump Hotels & Casino Resorts, Inc. (the "Company") of the aggregate consideration to be paid by the Company pursuant to the transactions contemplated by the Agreement and Plan of Merger to be dated as of January 8, 1996, among the Company, THCR Merger Corp. and Taj Mahal Holding Corp. ("Taj Holding") (the "Agreement"). Unless otherwise defined herein, all capitalized terms used herein shall have the meanings ascribed to them in the Agreement. We have assumed, with your consent, that both the consideration to be paid and the consideration to be received by the Company pursuant to the transactions contemplated by the Agreement is as set forth in this paragraph. Not more than 4,550,000 (less the Reduced Amount (as defined below)) shares of common stock, $0.01 par value per share (the "Common Stock") of the Company (or equivalents of such shares) will be issued by the Company (excluding any shares of Common Stock issued pursuant to the THCR Offering), warrants (the "Warrants") to purchase not more than 600,000, 600,000 and 600,000 shares of Common Stock at exercise prices not less than $30.00, $35.00 and $40.00 per share, respectively, and which will have a maturity of three, four and five years, respectively, will be issued by the Company, and not more than $60 million in cash plus the Cash Consideration will be expended (exclusive of any transaction fees and expenses). For purposes of this letter, the Reduced Amount shall be equal to a number of shares of Common Stock determined by dividing (a) the Cash Consideration received by the holders of the Taj Holding Class A Common Stock in the transactions contemplated by the Agreement by (b) $20.00. Upon consummation of the transactions contemplated by the Agreement, (i) the Company will receive additional general partnership interests in Trump Hotels & Casino Resorts Holdings, L.P. ("THCR Holdings") for contributing or causing its subsidiaries to contribute its total direct and indirect beneficial ownership of Taj Associates to THCR Holdings in an amount calculated pursuant to the Amended and Restated Agreement of Limited Partnership of THCR Holdings, (ii) THCR Holdings will be the beneficial owner of 100% of the outstanding equity of Taj Associates free and clear of any liens and encumbrances, (iii) immediately after giving effect to the transactions contemplated by the Agreement, the Company will own the Specified Parcels free and clear of any liens and encumbrances and the lease between Taj Associates and Trump Realty Corp. relating to the Specified Parcels shall terminate and Taj Associates shall no longer be obligated to make any payments to Trump Realty Corp. and/or First Fidelity on account of such Specified Parcels and (iv) the Services Agreement dated as of April 1, 1991 by and between Taj Associates and Donald J. Trump will be terminated. We have assumed, with your consent, that Taj Holding LLC, TTMC, Taj Associates and Taj Funding will not have more than $800 million of net indebtedness (i.e., aggregate face value of outstanding indebtedness (including accrued cash interest and non-cash interest) less available cash (excluding reasonable and customary amounts of cash or restricted cash)) collectively on their balance prior to the consummation of the transactions contemplated by the Agreement. We have also assumed, with your consent, that for the purposes of this opinion, the price of the Common Stock will be no less than $20.00 per share (before deducting any underwriting discounts or commissions). In arriving at our opinion, we have reviewed the Agreement and the Proxy Statement in draft form included in the draft Form S-4 registration statement as proposed to be filed with the Securities and Exchange Commission, both dated as of January 5, 1995. We also have reviewed financial and other information that was publicly available or furnished to us by or on behalf of the Company and Taj Associates including information provided during discussions with their respective managements. Included in the information provided to us during discussions with the respective managements were certain financial projections of Taj Associates for the periods beginning the quarter ending December 31, 1995 and ending the fiscal year ending December 31, 2000 prepared by the management of Taj Associates and certain financial projections of the Company for the periods beginning the quarter ending December 31, 1995 and ending the fiscal year ending December 31, 1997 prepared by the management of the Company. In addition, we have compared certain financial and securities data of the Company and Taj Associates with various other companies whose securities are traded in public markets, reviewed prices and premiums paid in other business combinations and conducted such other financial studies, analyses and investigations as we deemed appropriate for purposes of this opinion. In rendering our opinion, we have relied upon and assumed the accuracy, and completeness of all of the financial and other information that was available to us from public sources, that was provided to us by or on behalf of the Company and Taj Associates or their respective representatives, or that was otherwise reviewed by us. In particular, we have relied upon the estimates of the management of the Company of the operating synergies achievable as a result of the Merger and upon our discussion of such synergies with the management of Taj Associates. With respect to the financial projections supplied to us, we have assumed, with your consent, that they have been reasonably prepared on the basis reflecting the best currently available estimates and judgments of the management of the Company and Taj Associates as to the future operating and financial performance of the Company and Taj Associates. We have not assumed any responsibility for making any independent evaluation or appraisal of the Specified Parcels or Taj Associates' assets or liabilities or for making any independent verification of any of the information reviewed by us. We have relied as to all legal matters on advice of counsel to the Company. Our opinion is necessarily based on economic, market, financial and other conditions as they exist on, and on the information made available to us as of, the date of this letter. It should be understood that, although subsequent developments may affect this opinion, we do not have any obligation to update, revise or reaffirm this opinion. We are expressing no opinion herein as to the fairness of the allocation of the aggregate consideration to be paid by the Company among the parties receiving such consideration. Additionally, we are expressing no opinion herein as to the prices at which the Company's common stock will actually trade at any time, including the Effective Time. Our opinion does not constitute a recommendation to any shareholder as to how such shareholder should vote on the proposed transaction. Finally, our opinion does not address the underlying business decision of the Company to consummate the transactions contemplated by the Agreement. Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ"), as part of its investment banking services, is regularly engaged in the valuation of businesses and securities in connection with mergers, acquisitions, underwritings, sales and distributions of listed and unlisted securities, private placements and valuations for estate, corporate and other purposes. DLJ has performed investment banking and other services for the Company, Taj Holding and other Trump affiliated businesses in the past and has been compensated for such services. During 1990-1992, DLJ served as a financial advisor to Trump in connection with refinancings at the Trump Plaza and Trump Taj Mahal casinos in Atlantic City. In June 1995, DLJ served as lead manager in connection with a concurrent $140 million IPO and $155 million Senior Secured Note offering for the Company. DLJ has been retained with respect to other transactions related to entities controlled by Donald Trump. DLJ has been retained to act as lead manager in connection with the issuance and sale by the Company (including its subsidiaries) of any debt securities or any equity securities (including the THCR Offering) related to or contemplated by the acquisition of Taj Associates. DLJ has also been retained to act as the financial advisor to the Company in connection with the acquisition of Taj Associates, including rendering this opinion. The Company has paid or has agreed to pay, as applicable, DLJ fees in connection with the performance of these services. Please note that DLJ is a full service securities firm engaged in securities trading and brokerage activities, as well as providing investment banking and financial advisory services. In the ordinary course of our trading and brokerage activities, DLJ or its affiliates may at any time hold long or short positions, and may trade or otherwise effect transactions, for our own account or the accounts of customers, in debt or equity securities of the Company, Taj Associates or their affiliates. We recognize our responsibility for compliance with federal laws in connection with any such activities. Based upon, and subject to, the foregoing and such other factors as we deem relevant, we are of the opinion that the aggregate consideration to be paid by the Company pursuant to the transactions contemplated by the Agreement (as described herein), is fair to the Company from a financial point of view. Mississippi Avenue and The Boardwalk Atlantic City, New Jersey 08401 You have requested our opinion (the "Opinion") as to the fairness, from a financial point of view, to the holders of Class A Common Stock ("Class A Shareholders") of Taj Mahal Holding Corp. ("Taj Holding") of the consideration to be received by the Class A Shareholders, pursuant to the Agreement and Plan of Merger, dated as of January 8, 1996 (the "Merger Agreement"), among Trump Hotels & Casino Resorts, Inc. ("THCR"), Taj Holding and a wholly-owned subsidiary of THCR, in connection with the Merger Transaction (as defined below). The Merger Agreement, in addition to addressing other potential related transactions, provides that each outstanding share of Taj Holding's Class A Common Stock will be converted into a right to receive, at each Class A Shareholder's election, either (a) $30.00 in cash or (b) shares of Common Stock of THCR ("THCR Common Stock") having a Market Value (as such term is defined in the Merger Agreement) of $30.00. The merger ("Merger") and the other related transactions contemplated to be consummated in connection with the Merger, as more fully described in the Merger Agreement and the Registration Statement on Form S-4 (draft dated January 5, 1996) to be filed with respect to the Merger, are hereinafter referred to as the "Merger Transaction". In formulating the Opinion, we considered: (i) the terms and conditions of the Merger Transaction as set forth in the Merger Agreement; (ii) certain publicly available information relating to Taj Holding and THCR; (iii) financial and business information including financial projections, provided by Taj Holding and THCR and their respective representatives both orally and in writing; (iv) discussions with Taj Holding's and THCR's managements regarding Taj Holding's and THCR's businesses, respectively; (v) analyses utilizing several different methodologies relating to Taj Holding and THCR; (vi) historical market prices and trading volumes of THCR Common Stock and certain other gaming companies; (vii) that the Merger Transaction is contingent upon the consummation of other related transactions contemplated by the Merger Agreement; (viii) publicly available information regarding certain other gaming companies and transactions we deemed relevant; and (ix) other factors and information we deemed appropriate. We have (i) relied upon, without independent verification (which it was agreed was beyond the scope of our assignment), the accuracy and completeness, in all material respects, of all financial and other information publicly available and/or furnished to us orally or in writing by Taj Holding and THCR or their respective representatives and (ii) neither made an independent appraisal or evaluation of the assets of Taj Holding nor received any such appraisal or evaluation other than the appraisal of Trump Taj Mahal Casino Resort prepared by Appraisal Group International ("AGI") for Trump Taj Mahal Associates in March 1994 and AGI's appraisal, dated December 1995, regarding various parcels of land owned by Trump Taj Mahal Realty Corp. In addition, it was agreed we were not asked to, and do not, express any opinion as to whether another transaction with THCR, or its affiliates or any other entity, might provide more favorable terms to the Class A Shareholders than the Merger Transaction. With respect to financial forecasts, we understand from Taj Holding and THCR that they have been reasonably prepared on bases reflecting the best currently available estimates and judgments of the future financial performance of Taj Holding and THCR. We have acted as financial advisor to the Board of Directors of Taj Holding (including the Directors elected by the holders of Class B Common Stock of Taj Holding) for the purpose of rendering a written Opinion and shall receive a fee for such service. In February 1995, we were retained, together with BT Securities Corporation, to act as financial advisor to Taj Holding and certain of its affiliates in connection with a proposed restructuring pursuant to which we received a fee. Said retention has been terminated. In addition, we have previously acted as financial advisor to a committee of bondholders of Trump Taj Mahal Funding, Inc. in connection with a restructuring transaction in 1991 and, during the preceding two years, have performed investment banking and other financial advisory services for entities affiliated with Donald J. Trump for which customary compensation was received. Based on and subject to the foregoing and other factors we deemed relevant, it is our Opinion as of the date hereof that the consideration in the form of either cash or THCR Common Stock to be received by the Class A Shareholders, at each Class A Shareholder's election, in connection with the Merger Transaction, is fair, from a financial point of view, to the Class A Shareholders. SECTION 262 OF THE GENERAL CORPORATION LAW OF THE STATE OF DELAWARE APPRAISAL RIGHTS. (a) Any stockholder of a corporation of this State who holds shares of stock on the date of the making of a demand pursuant to subsection (d) of this section with respect to such shares, who continuously holds such shares through the effective date of the merger or consolidation, who has otherwise complied with subsection (d) of this section and who has neither voted in favor of the merger or consolidation nor consented thereto in writing pursuant to (S)228 of this title shall be entitled to an appraisal by the Court of Chancery of the fair value of his shares of stock under the circumstances described in subsections (b) and (c) of this section. As used in this section, the word "stockholder" means a holder of record of stock in a stock corporation and also a member of record of a nonstock corporation; the words "stock" and "share" mean and include what is ordinarily meant by those words and also membership or membership interest of a member of a nonstock corporation; and the words "depository receipt" mean a receipt or other instrument issued by a depository representing an interest in one or more shares, or fractions thereof, solely of stock of a corporation, which stock is deposited with the depository. (b) Appraisal rights shall be available for the shares of any class or series of stock of a constituent corporation in a merger or consolidation to be effected pursuant to (S)251,252,254,257,258,263 or 264 of this title: (1) Provided, however, that no appraisal rights under this section shall be available for the shares of any class or series of stock, which stock, or depository receipts in respect thereof, at the record date fixed to determine the stockholders entitled to receive notice of and to vote at the meeting of stockholders to act upon the agreement of merger or consolidation, were either (i) listed on a national securities exchange or designated as a national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc. or (ii) held of record by more than 2,000 holders; and further provided that no appraisal rights shall be available for any shares of stock of the constituent corporation surviving a merger if the merger did not require for its approval the vote of the holders of the surviving corporation as provided in /1/ subsections (f) or (g) of (S)251 of this title. (2) Notwithstanding paragraph (1) of this subsection, appraisal rights under this section shall be available for the shares of any class or series of stock of a constituent corporation if the holders thereof are required by the terms of an agreement of merger or consolidation pursuant to (S)(S)251, 252, 254, 257, 258, 263 and 264 of this title to accept for such stock anything except: a. Shares of stock of the corporation surviving or resulting from such merger or consolidation, or depository receipts in respect b. Shares of stock of any other corporation, or depository receipts in respect thereof, which shares of stock or depository receipts at the effective date of the merger or consolidation will be either listed on a national securities exchange or designated as a national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc. or held of record by more than c. Cash in lieu of fractional shares or fractional depository receipts described in the foregoing subparagraphs a. and b. of this d. Any combination of the shares of stock, depository receipts and cash in lieu of fractional shares or fractional depository receipts described in the foregoing subparagraphs a., b. and c. of this paragraph. (3) In the event all of the stock of a subsidiary Delaware corporation party to a merger effected under (S)253 of this title is not owned by the parent corporation immediately prior to the merger, appraisal rights shall be available for the shares of the subsidiary Delaware corporation. (c) Any corporation may provide in its certificate of incorporation that appraisal rights under this section shall be available for the shares of any class or series of its stock as a result of an amendment to its certificate of incorporation, any merger or consolidation in which the corporation is a constituent corporation or the sale of all or substantially all of the assets of the corporation. If the certificate of incorporation contains such a provision, the procedures of this section, including those set forth in subsections (d) and (e) of this section, shall apply as nearly as is practicable. (d) Appraisal rights shall be perfected as follows: (1) If a proposed merger or consolidation for which appraisal rights are provided under this section is to be submitted for approval at a meeting of stockholders, the corporation, not less than 20 days prior to the meeting, shall notify each of its stockholders who was such on the record date for such meeting with respect to shares for which appraisal rights are available pursuant to subsections (b) or (c) hereof that appraisal rights are available for any or all of the shares of the constituent corporations, and shall include in such notice a copy of this section. Each stockholder electing to demand the appraisal of his shares shall deliver to the corporation, before the taking of the vote on the merger or consolidation, a written demand for appraisal of his shares. Such demand will be sufficient if it reasonably informs the corporation of the identity of the stockholder and that the stockholder intends thereby to demand the appraisal of his shares. A proxy or vote against the merger or consolidation shall not constitute such a demand. A stockholder electing to take such action must do so by a separate written demand as herein provided. Within 10 days after the effective date of such merger or consolidation, the surviving or resulting corporation shall notify each stockholder of each constituent corporation who has complied with this subsection and has not voted in favor of or consented to the merger or consolidation of the date that the merger or consolidation has become (2) If the merger or consolidation was approved pursuant to (S)288 or 253 of this title, the surviving or resulting corporation, either before the effective date of the merger or consolidation or within 10 days thereafter, shall notify each of the stockholders entitled to appraisal rights of the effective date of the merger or consolidation and that appraisal rights are available for any or all of the shares of the constituent corporation, and shall include in such notice a copy of this section. The notice shall be sent by certified or registered mail, return receipt requested, addressed to the stockholder at his address as it appears on the records of the corporation. Any stockholder entitled to appraisal rights may, within 20 days after the date of mailing of the notice, demand in writing from the surviving or resulting corporation the appraisal of his shares. Such demand will be sufficient if it reasonably informs the corporation of the identity of the stockholder and that the stockholder intends thereby to demand the appraisal of his shares. (e) Within 120 days after the effective date of the merger or consolidation, the surviving or resulting corporation or any stockholder who has complied with subsections (a) and (d) hereof and who is otherwise entitled to appraisal rights, may file a petition in the Court of Chancery demanding a determination of the value of the stock of all such stockholders. Notwithstanding the foregoing, at any time within 60 days after the effective date of the merger or consolidation, any stockholder shall have the right to withdraw his demand for appraisal and to accept the terms offered upon the merger or consolidation. Within 120 days after the effective date of the merger or consolidation, any stockholder who has complied with the requirements of subsection (a) and (d) hereof, upon written request, shall be entitled to receive from the corporation surviving the merger or resulting from the consolidation a statement setting forth the aggregate number of shares not voted in favor of the merger or consolidation and with respect to which demands for appraisal have been received and the aggregate number of holders of such shares. Such written statement shall be mailed to the stockholder within 10 days after his written request for such a statement is received by the surviving or resulting corporation or within 10 days after expiration of the period for delivery of demands for appraisal under subsection (d) hereof, whichever is later. (f) Upon the filing of any such petition by a stockholder, service of a copy thereof shall be made upon the surviving or resulting corporation, which shall within 20 days after such service file in the office of the Register in Chancery in which the petition was filed a duly verified list containing the names and addresses of all stockholders who have demanded payment for their shares and with whom agreements as to the value of their shares have not been reached by the surviving or resulting corporation. If the petition shall be filed by the surviving or resulting corporation, the petition shall be accompanied by such a duly verified list. The Register in Chancery, if so ordered by the Court, shall give notice of the time and place fixed for the hearing of such petition by registered or certified mail to the surviving or resulting corporation and to the stockholders shown on the list at the addresses therin stated. Such notice shall also be given by 1 or more publications at least 1 week before the day of the hearing, in a newspaper of general circulation published in the City of Wilmington, Delaware or such publication as the Court deems advisable. The forms of the notices by mail and by publication shall be approved by the Court, and the costs thereof shall be borne by the surviving or resulting corporation. (g) At the hearing on such petition, the Court shall determine the stockholders who have complied with this section and who have become entitled to appraisal rights. The Court may require the stockholders who have demanded an appraisal for their shares and who hold stock represented by certificates to submit their certificates of stock to the Register in Chancery for notation thereon of the pendency of the appraisal proceedings; and if any stockholder fails to comply with such direction, the Court may dismiss the proceedings as to such stockholder. (h) After determining the stockholders entitled to an appraisal, the Court shall appraise the shares, determining their fair value exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation, together with a fair rate of interest, if any, to be paid upon the amount determined to be the fair value. In determining such fair value, the Court shall take into account all relevant factors. In determining the fair rate of interest, the Court may consider all relevant factors, including the rate of interest which the surviving or resulting corporation would have had to pay to borrow money during the pendency of the proceeding. Upon application by the surviving or resulting corporation or by any stockholder entitled to participate in the appraisal proceeding, the Court may, in its discretion, permit discovery or other pretrial proceedings and may proceed to trial upon the appraisal prior to the final determination of the stockholder entitled to an appraisal. Any stockholder whose name appears on the list filed by the surviving or resulting corporation pursuant to subsection (f) of this section and who has submitted his certificates of stock to the Register in Chancery, if such is required, may participate fully in all proceedings until it is finally determined that he is not entitled to appraisal rights under this section. (i) The Court shall direct the payment of the fair value of the shares, together with interest, if any, by the surviving or resulting corporation to the stockholders entitled thereto. Interest may be simple or compound, as the Court may direct. Payment shall be so made to each such stockholder, in the case of holders of uncertificated stock forthwith, and the case of holders of shares represented by certificates upon the surrender to the corporation of the certificates representing such stock. The Court's decree may be enforced as other decrees in the Court of Chancery may be enforced, whether such surviving or resulting corporation be a corporation of this State or of any state. (j) The costs of the proceeding may be determined by the Court and taxed upon the parties as the Court deems equitable in the circumstances. Upon application of a stockholder, the Court may order all or a portion of the expenses incurred by any stockholder in connection with the appraisal proceeding, including, without limitation, reasonable attorney's fees and the fees and expenses of experts, to be charged pro rata against the value of all the shares entitled to an appraisal. (k) From and after the effective date of the merger or consolidation, no stockholder who has demanded his appraisal rights as provided in subsection (d) of this section shall be entitled to vote such stock for any purpose or to receive payment of dividends or other distributions on the stock (except dividends or other distributions payable to stockholders of record at a date which is prior to the effective date of the merger or consolidation); provided, however, that if no petition for an appraisal shall be filed within the time provided in subsection (e) of this section, or if such stockholder shall deliver to the surviving or resulting corporation a written withdrawal of his demand for an appraisal and an acceptance of the merger or consolidation, either within 60 days after the effective date of the merger or consolidation as provided in subsection (e) of this section or thereafter with written approval of the corporation, then the right of such stockholder to an appraisal shall cease. Notwithstanding the foregoing, no appraisal proceeding in the Court of Chancery shall be dismissed as to any stockholder without the approval of the Court, and such approval may be conditioned upon such terms as the Court deems just. (l) The shares of the surviving or resulting corporation to which the shares of such objecting stockholders would have been converted had they assented to the merger or consolidation shall have the status of authorized and unissued shares of the surviving or resulting corporation.	SC 13E3	EX-99.17.(D)	1996-01-12T00:00:00	1996-01-11T17:58:48
0000897101-96-000008	0000897101-96-000008_0000.txt	[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES For the quarter ended November 30, 1995 (State of incorporation) (IRS Employer ID No.) 21340 Hayes Avenue, Lakeville, MN 55044-0430 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (612) 469-4981 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. As of December 31, 1995 the Company had 6,701,424 shares of common stock outstanding. REPORT ON FORM 10-Q FOR THE QUARTER ENDED NOVEMBER 30,1995 ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) PAGE CONSOLIDATED STATEMENTS OF FINANCIAL POSITION ....... 3 CONSOLIDATED STATEMENTS OF EARNINGS.................. 4 CONSOLIDATED STATEMENTS OF CASH FLOWS................ 5 CONSOLIDATED NOTES TO FINANCIAL STATEMENTS........... 6 ITEM 2. MANAGEMENT'S DISCUSSION AND AND RESULTS OF OPERATIONS............................ 7 ITEM 1. LEGAL PROCEEDINGS.......................................... 9 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K........................... 9 PART I - FINANCIAL INFORMATION GRIST MILL CO. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL POSITION CASH AND CASH EQUIVALENTS $ 1,396 $ 3,271 ACCOUNTS RECEIVABLE, LESS ALLOWANCES 6,428 6,045 LAND AND BUILDING 11,220 11,145 MACHINERY AND EQUIPMENT 40,072 36,245 LESS ACCUMULATED DEPRECIATION (24,463) (22,371) DRAFTS PAYABLE $ 1,640 $ 984 ACCRUED COMPENSATION AND COMMISSIONS 1,542 1,863 ACCRUED MARKETING EXPENSES 1,261 796 OTHER ACCRUED EXPENSES 702 1,144 CURRENT MATURITIES OF LONG-TERM DEBT 1,620 1,708 DEFERRED INCOME TAXES 1,290 1,370 ADDITIONAL PAID-IN CAPITAL 9,211 9,022 SEE NOTES TO FINANCIAL STATEMENTS GRIST MILL CO. AND SUBSIDIARY (UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) SEE NOTES TO FINANCIAL STATEMENTS GRIST MILL CO. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS CASH FLOWS FROM OPERATING ACTIVITIES: NET EARNINGS $ 1,955 $ 1,893 NON-CASH ITEMS INCLUDED IN EARNINGS: DEPRECIATION AND AMORTIZATION 2,367 2,202 CHANGES IN OPERATING ASSETS AND LIABILITIES: NET CASH PROVIDED BY (USED IN) CASH FLOWS FROM INVESTING ACTIVITIES: PROCEEDS FROM: SHORT TERM INVESTMENTS, NET 3,039 4,294 PAYMENTS FOR: PROPERTY AND EQUIPMENT (3,902) (2,710) NET CASH PROVIDED BY (USED IN) CASH FLOWS FROM FINANCING ACTIVITIES: PROCEEDS FROM: EXERCISE OF STOCK OPTIONS, INCLUDING RELATED TAX BENEFITS 193 25 PAYMENTS FOR: LONG-TERM DEBT OBLIGATIONS (837) (2,324) PURCHASE AND RETIREMENT OF TREASURY STOCK (2,820) NET CASH PROVIDED BY (USED IN) DECREASE IN CASH AND CASH EQUIVALENTS (1,875) (2,336) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 3,271 3,310 CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,396 $ 974 SEE NOTES TO FINANCIAL STATEMENTS GRIST MILL CO. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. Condensed Consolidated Financial Statements The accompanying unaudited interim financial statements have been prepared in accordance with the instructions for Form 10-Q and do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended May 31, 1995. In the opinion of management, all adjustments necessary for a fair presentation of such interim consolidated financial statements have been included. All such adjustments are of a normal recurring nature. ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND Net sales for the second quarter of fiscal 1996 were $21.5 million, or an increase of 22% over 1995 second quarter sales of $17.6 million. For the six months ended November 30, 1995 the Company had sales of $44.6 million, compared to $35.1 million for the same period a year ago. Earnings for the quarter were $747,000, or $.11 per share compared to net earnings of $775,000, or $.11 per share in the comparable quarter a year ago. For the six month period ended November 30, 1995, the Company earned $2.0 million or $.28 per share compared to net earnings of $1.9 million or $.27 per share during the same period a year ago. Sales of core grocery products were up 25% for the quarter over the same quarter a year ago. This growth was generated by the Company's ready-to-eat cereal and wholesome snack bar products. Year to date ready-to-eat cereal sales have increased 68% over the prior year. Over the past year, the Company has added several new ready-to-eat cereal customers. The number of product offerings has also increased over the last year, allowing existing customers to purchase more of their store brand ready-to-eat cereal offerings from the Company. In the wholesome snack bar category, the Company has built a broad customer base for its fruit-filled cereal bar that was introduced early in the previous fiscal year. Contract manufacturing sales were also higher for the quarter and first six months of the current year than they were for the same periods a year ago. However, sales in the current quarter were lower than in recent quarters because of reduced demand from the Company's largest contract customer. There are no guaranteed minimum production requirements associated with manufacturing for this customer. The Company does expect, however, that it will have significant sales to this customer in the coming quarters. The gross profit margin for the first six months of the year was 26%, versus 30% during the same period a year ago. The decline is partially attributable to start up costs related to the Company's new ready-to-eat cereal products. While improvement in the operating efficiencies for ready-to-eat cereal products is expected, the Company expects that the improvement will occur gradually over future quarters. Another factor contributing to the decline in the Company's gross profit margin was lower pricing for the Company's contract manufacturing products. Additionally, a higher proportion of Company sales were generated by contract manufacturing, which historically has lower gross profit margins. Selling and delivery expenses for the first six months of the year totaled $6.1 million, or 13.6% of net sales, compared to $5.0 million, or 14.3% of net sales during the first six months of last year. This is primarily due to higher contract manufacturing sales which do not have significant selling and delivery expenses associated with them. General, administrative, and product development costs were $2.3 million, or 5.1% of net sales for the first six months of the year, compared to $2.3 million, or 6.6% of net sales for the same period of last year. Resources directed at new product development have declined from a year ago as the emphasis has shifted to increasing production efficiencies on new products. Offsetting this decline was an increase in litigation costs related to a lawsuit, which was settled during the current quarter. (See Part II, Other Information, Item 1. Legal Proceedings). Year to date net interest expense totaled $136,000 compared to $253,000 for the first six months of last year. Scheduled payments on the Company's unsecured senior notes resulted in lower average levels of debt for the year when compared to a year ago. The effective tax rate was 36% for the first half of fiscal 1996 compared to 35.5% for the first half of fiscal 1995. Lower levels of tax exempt investment income during the current year resulted in the increase in the tax rate. Since May 31, 1995 the Company's key liquidity ratios have not changed significantly. Working capital has decreased from $10.0 million to $9.2 million, and the current ratio went from 2.0 to 1.9. Net cash used in operations was $435,000 during the first half of the current fiscal year compared to cash provided by operations of $1.8 million in the first half of the previous fiscal year. The growth in the Company's business has increased working capital funding needs primarily due to increased ready-to-eat cereal inventories. Cash used in investing activities was $1.5 million for the first half of the fiscal year, compared to cash provided of $1.2 million in the first half of last year. Equipment additions were primarily for ready-to-eat cereal manufacturing equipment and upgrading one of the company's snack bar manufacturing lines. Proceeds and payments for financing activities offset each other for the first half of the fiscal year. During the previous year's six month period the Company made a prepayment on long-term debt and completed a capital stock acquisition program. The Company renewed its $4.0 million line of credit during the quarter. There were no borrowings under this line during the first half of the year. PART II - OTHER INFORMATION In its Annual Report on Form 10-K for the fiscal year ended May 31, 1995, the Company reported under Item 3 Legal Proceedings that The Kellogg Company had filed a complaint against the Company alleging breach of contract and misappropriation of trade secrets. This litigation was settled during the quarter. Neither party admitted any wrongdoing. The terms of the settlement did not have a material adverse impact on the Company's financial statements. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K Exhibit 4 - $4,000,000 Revolving credit agreement dated October 24, 1995. Exhibit 10 - Amendment Number 6 to the Grist Mill Co. Non-Qualified Exhibit 11 - Computation of Earnings Per Share Exhibit 27 - Financial Data Schedule (B) Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended November 30, 1995. Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: January 12, 1996 By: Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: January 12, 1996 By: /s/ Daniel J. Kinsella INDEX OF EXHIBITS TO QUARTERLY REPORT ON FORM 10-Q FOR QUARTER ENDED NOVEMBER 30, 1995 Exhibit 4 $4,000,000 Revolving credit agreement dated October 24, 1995 Exhibit 10 Amendment Number 6 to the Grist Mill Non-Qualified Stock Option Exhibit 11 Computation of Earnings Per Share Exhibit 27 Financial Data Schedule	10-Q	10-Q	1996-01-12T00:00:00	1996-01-12T13:44:52
0000201533-96-000009	0000201533-96-000009_0001.txt	<DESCRIPTION>CREDIT AGREEMENT DATED NOV 21, 1995 Dated as of November 21, 1995, ARTICLE I DEFINITIONS AND ACCOUNTING TERMS SECTION 1.01. Certain Defined Terms . . . . . . . . . . . . . . . 2 SECTION 1.02. Computation of Time Periods . . . . . . . . . . . . 21 SECTION 1.03. Accounting Terms . . . . . . . . . . . . . . . . . . 21 SECTION 2.01. The Commitments . . . . . . . . . . . . . . . . . . 21 SECTION 2.02. Fees . . . . . . . . . . . . . . . . . . . . . . . . 21 SECTION 2.03. Reduction of the Commitments . . . . . . . . . . . . 24 SECTION 2.04. Computations of Outstandings . . . . . . . . . . . . 24 SECTION 2.05. Extension of Termination Date . . . . . . . . . . . 24 SECTION 3.01. Advances . . . . . . . . . . . . . . . . . . . . . . 25 SECTION 3.02. Conversion of Advances . . . . . . . . . . . . . . . 27 SECTION 3.03. Interest Periods . . . . . . . . . . . . . . . . . . 27 SECTION 3.04. Other Terms Relating to the Making and Conversion of Advances . . . . . . . . . . . . . . 28 SECTION 3.05. Repayment of Advances . . . . . . . . . . . . . . . 31 ARTICLE IV LETTERS OF CREDIT SECTION 4.01. LC Banks . . . . . . . . . . . . . . . . . . . . . . 32 SECTION 4.02. Letters of Credit . . . . . . . . . . . . . . . . . 32 SECTION 4.03. LC Bank Fees . . . . . . . . . . . . . . . . . . . . 33 SECTION 4.04. Reimbursement to LC Banks . . . . . . . . . . . . . 33 SECTION 4.05. Obligations Absolute . . . . . . . . . . . . . . . . 34 SECTION 4.06. Liability of LC Banks and the Lenders . . . . . . . 35 ARTICLE V PAYMENTS, COMPUTATIONS ANDYIELD PROTECTION SECTION 5.01. Payments and Computations . . . . . . . . . . . . . 36 SECTION 5.02. Interest Rate Determination . . . . . . . . . . . . 38 SECTION 5.03. Prepayments . . . . . . . . . . . . . . . . . . . . 38 SECTION 5.04. Yield Protection . . . . . . . . . . . . . . . . . . 39 SECTION 5.05. Sharing of Payments, Etc. . . . . . . . . . . . . . 41 SECTION 5.06. Taxes . . . . . . . . . . . . . . . . . . . . . . . 42 SECTION 6.01. Conditions Precedent to the Initial Extension of Credit . . . . . . . . . . . . . . . . . . . . . . 44 SECTION 6.02. Conditions Precedent to Each Extension of Credit . . 46 SECTION 6.03. Conditions Precedent to Certain Extensions of Credit . . . . . . . . . . . . . . . . . . . . . . 47 SECTION 6.04. Reliance on Certificates . . . . . . . . . . . . . . 48 ARTICLE VII REPRESENTATIONS AND WARRANTIES SECTION 7.01. Representations and Warranties of the Borrower . . . 48 ARTICLE VIII COVENANTS OF THE BORROWER SECTION 8.01. Affirmative Covenants . . . . . . . . . . . . . . . 52 SECTION 8.02. Negative Covenants . . . . . . . . . . . . . . . . . 55 SECTION 8.03. Reporting Obligations . . . . . . . . . . . . . . . 61 SECTION 9.01. Events of Default . . . . . . . . . . . . . . . . . 65 SECTION 9.02. Remedies . . . . . . . . . . . . . . . . . . . . . . 67 SECTION 10.01. Authorization and Action . . . . . . . . . . . . . 68 SECTION 10.02. Agents' Reliance, Etc. . . . . . . . . . . . . . . 69 SECTION 10.03. Citibank, Union Bank and Affiliates . . . . . . . . 69 SECTION 10.04. Lender Credit Decision . . . . . . . . . . . . . . 69 SECTION 10.05. Indemnification . . . . . . . . . . . . . . . . . . 70 SECTION 10.06. Successor Agents . . . . . . . . . . . . . . . . . 70 SECTION 11.01. Amendments, Etc. . . . . . . . . . . . . . . . . . 71 SECTION 11.02. Notices, Etc. . . . . . . . . . . . . . . . . . . . 72 SECTION 11.03. No Waiver of Remedies . . . . . . . . . . . . . . . 72 SECTION 11.04. Costs, Expenses and Indemnification . . . . . . . . 72 SECTION 11.05. Right of Set-off . . . . . . . . . . . . . . . . . 74 SECTION 11.06. Binding Effect . . . . . . . . . . . . . . . . . . 75 SECTION 11.07. Assignments and Participation . . . . . . . . . . . 75 SECTION 11.08. Confidentiality . . . . . . . . . . . . . . . . . . 79 SECTION 11.09. Waiver of Jury Trial . . . . . . . . . . . . . . . 80 SECTION 11.10. Governing Law . . . . . . . . . . . . . . . . . . . 80 SECTION 11.11. Relation of the Parties; No Beneficiary . . . . . . 81 SECTION 11.12. Existing Banks' Waiver, Acknowledgment and Release . . . . . . . . . . . . . . . . . . . 81 SECTION 11.13. Execution in Counterparts . . . . . . . . . . . . . 81 SECTION 11.14. Survival of Agreement . . . . . . . . . . . . . . 81 EXHIBIT A - Form of Note EXHIBIT B - Form of Notice of Borrowing EXHIBIT C - Form of Notice of Conversion EXHIBIT D - Form of Cash Collateral Agreement EXHIBIT E - Form of Opinion of Denise M. Sturdy, Esq., Counsel of the EXHIBIT F - Form of Opinion of King & Spalding, counsel to the Agents EXHIBIT G - Form of Compliance Schedule EXHIBIT H - Form of Lender Assignment SCHEDULE I Applicable Lending Offices Dated as of November 21, 1995 THIS CREDIT AGREEMENT is made by and among: (i) CMS Energy Corporation, a Michigan corporation (the (ii) the banks (the "Banks") listed on the signature pages hereof and the other Lenders (as hereinafter defined) from time to time party hereto, (iii) Citibank, N.A. ("Citibank") and Union Bank ("Union Bank"), as co-administrative agents (individually a "Co-Agent" and collectively, the "Co-Agents") for the Lenders hereunder, (iv) Citibank, as documentation agent (the "Documentation Agent") for the Lenders hereunder, (v) Union Bank, as operational agent (the "Operational Agent") for the Lenders hereunder, and (vi) Bank of America Illinois, BZW Division of Barclays Bank PLC, The Chase Manhattan Bank, N.A., The First National Bank of Boston and The First National Bank of Chicago, as co-managers (individually, the "Co-Manager" and, collectively, the "Co-Managers"). The Borrower has requested the Banks to provide the credit facilities hereinafter described in the amounts and on the terms and conditions set forth herein. The Banks have so agreed on the terms and conditions set forth herein, and the Agents have agreed to act as agents for the Lenders on such terms and conditions. The parties hereto acknowledge and agree that neither Consumers (as hereinafter defined) nor any of its Subsidiaries (as hereinafter defined) will be a party to, or will in any way be bound by any provision of, this Agreement or any other Loan Document (as hereinafter defined), and that no Loan Document will be enforceable against Consumers or any of its Subsidiaries or their respective assets. Accordingly, the parties hereto agree as follows: SECTION 1.01. Certain Defined Terms. As used in this Agreement, the following terms shall have the following meanings (such meanings to be applicable to the singular and plural forms of the terms defined): "Advance" means an Advance by a Lender to the Borrower pursuant to Section 3.01 (or deemed made pursuant to Section 4.04(d)), and refers to a Base Rate Advance or a Eurodollar Rate Advance (each of which shall be a "Type" of Advance). All Advances by a Lender of the same Type, having the same Interest Period and made or Converted on the same day shall be deemed to be a single Advance by such Lender until repaid or next Converted. "Affiliate" means, with respect to any Person, any other Person directly or indirectly controlling (including but not limited to all directors and officers of such Person), controlled by, or under direct or indirect common control with such Person. A Person shall be deemed to control another entity if such Person possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of such entity, whether through the ownership of voting securities, by contract, or otherwise. "Agent" means, as the context may require, the Co-Agents, the Operational Agent or the Documentation Agent; and "Agents" means any or all of the foregoing. "Alternate Base Rate" means a fluctuating interest rate per annum equal at all times to the highest of: (a)the rate of interest announced publicly by Union Bank in Los Angeles, California, from time to time, as the Union (b)1/2 of one percent per annum above the latest three-week moving average of secondary market morning offering rates in the United States for three-month certificates of deposit of major United States money market banks, such three-week moving average being determined weekly by the Operational Agent on the basis of such rates reported by certificate of deposit dealers to and published by the Federal Reserve Bank of New York or, if such publication shall be suspended or terminated, on the basis of quotations for such rates received by the Operational Agent from three New York certificate of deposit dealers of recognized standing selected by the Operational Agent, in either case adjusted to the nearest 1/4 of one percent or, if there is no nearest 1/4 of one percent, to the next higher 1/4 of one percent; and (c)1/2 of one percent per annum above the Federal Funds Rate. Each change in the Alternate Base Rate shall take effect concurrently with any change in such base rate, moving average, or Federal Funds Rate. "Applicable Lending Office" means, with respect to each Lender, (i) such Lender's Domestic Lending Office, in the case of a Base Rate Advance, and (ii) such Lender's Eurodollar Lending Office, in the case of a Eurodollar Rate Advance. "Applicable Margin" means, on any date of determination, (i) for a Base Rate Advance, 0.00% per annum, and (ii) for a Eurodollar Rate Advance, 1.25% per annum. Notwithstanding the foregoing, (i) each of the foregoing Applicable Margins shall be increased by 0.50% per annum in the event that, and at all times during which, the Senior Notes shall be rated BB- (or its equivalent) or lower by (A) any three of S&P, Fitch, Moody's and D&P, or (B) both S&P and Moody's, and (ii) the foregoing Applicable Margin applicable to Eurodollar Rate Advances shall be decreased by 0.25% per annum in the event that, and at all times during which, the Senior Notes shall be rated BBB- (or its equivalent) or higher by (x) any three of S&P, Fitch, Moody's and D&P, or (y) both S&P and Moody's. The Applicable Margins shall be increased or decreased in accordance with this definition upon any change in the applicable ratings, and such increased or decreased Applicable Margins shall be effective from the date of announcement of any such new ratings. The Borrower agrees to notify the Operational Agent promptly after each change in any rating of the Senior Notes. For purposes of this definition only, if the Senior Notes shall no longer be outstanding or shall no longer be rated by any three of S&P, Fitch, Moody's and D&P or by both Moody's and S&P, "Senior Notes" shall mean such other senior unsecured Debt of the Borrower that is both outstanding and so rated. In the event that no Senior Notes are outstanding and so rated, the Applicable Margins will be such amount or amounts as may be mutually agreed by the Borrower and all the Lenders. (i)in the case of each Base Rate Advance, a rate per annum equal at all times to the sum of the Alternate Base Rate in effect from time to time plus the Applicable Margin in effect from time to time; and (ii)in the case of each Eurodollar Rate Advance comprising part of the same Borrowing, a rate per annum during each Interest Period equal at all times to the sum of the Eurodollar Rate for such Interest Period plus the Applicable Margin in effect from time to time during such Interest Period. "Available Commitment" means, for each Lender on any day, the unused portion of such Lender's Commitment, computed after giving effect to all Extensions of Credit or prepayments to be made on such day and the application of proceeds therefrom. "Available Commitments" means the aggregate of the Lenders' Available Commitments hereunder. "Base Rate Advance" means an Advance that bears interest as provided in Section 3.05(b)(i). "Borrowing" means a borrowing consisting of Advances of the same Type, having the same Interest Period and made or Converted on the same day by the Lenders, ratably in accordance with their respective Percentages. Any Borrowing consisting of Advances of a particular Type may be referred to as being a Borrowing of such "Type". All Advances of the same Type, having the same Interest Period and made or Converted on the same day shall be deemed a single Borrowing hereunder until repaid or next Converted. "Business Day" means a day of the year on which banks are not required or authorized to close in New York City, Los Angeles, California and Detroit, Michigan, and, if the applicable Business Day relates to any Eurodollar Rate Advance, on which dealings are carried on in the London interbank market. "Cash Collateral Agreement" means the Cash Collateral Agreement, dated as of the date hereof, between the Borrower and the Operational Agent, for the benefit of the Lenders, substantially in the form of Exhibit D. "Cash Dividend Income" means, for any period, the amount of all cash dividends received by the Borrower from its Subsidiaries during such period that are paid out of the net income (without giving effect to any extraordinary gains in excess of $5,000,000) of such Subsidiaries during such period; provided, however, that for the fiscal year ending December 31, 1995, "Cash Dividend Income" shall also include an amount equivalent to 80% of Consumers' consolidated net income for such year to the extent that such consolidated net income has not been paid in cash dividends by Consumers to the Borrower. "Closing Date" means the date upon which each of the conditions precedent enumerated in Section 6.01 has been fulfilled to the satisfaction of the Lenders, the Co-Agents and the Borrower. All transactions contemplated by the Closing Date shall take place on or before November 21, 1995, at the offices of King & Spalding, 120 West 45th Street, New York, New York 10036, at 10:00 A.M., or such other time as the parties hereto may mutually agree. "Commitment" means, for each Lender, the obligation of such Lender to make Advances to the Borrower and to participate in Extensions of Credit resulting from the issuance (or extension, modification or amendment) of any Letter of Credit in an aggregate amount no greater than the amount set forth opposite such Lender's name on the signature pages hereof or, if such Lender has entered into one or more Lender Assignments, set forth for such Lender in the Register maintained by the Documentation Agent pursuant to Section 11.07(c), in each such case as such amount may be reduced from time to time pursuant to Section 2.03. "Commitments" means the total of the Lenders' Commitments hereunder. The Commitments shall in no event exceed $450,000,000 million. "Confidential Information" has the meaning assigned to that term in Section 11.08. "Consolidated Capital" means, at any date of determination, the sum of (a) Consolidated Debt, (b) consolidated equity of the common stockholders of the Borrower and the Consolidated Subsidiaries, (c) consolidated equity of the preference stockholders of the Borrower and the Consolidated Subsidiaries, and (d) consolidated equity of the preferred stockholders of the Borrower and the Consolidated Subsidiaries, in the case of clauses (b) through (d) above, determined at such date in accordance with GAAP; provided, however, that Consolidated Capital shall include Project Finance Equity of the Borrower and the Consolidated Subsidiaries in any Consolidated Subsidiary only to the extent of the Borrower's Ownership Interest in such Consolidated Subsidiary. "Consolidated Debt" means, without duplication, at any date of determination, the sum of the aggregate Debt of the Borrower plus the aggregate debt (as such term is construed in accordance with GAAP) of the Consolidated Subsidiaries, provided, however, that Consolidated Debt shall not include any Support Obligation described in clause (iv) or (v) of the definition thereof if such Support Obligation or the primary obligation so supported is not fixed or conclusively determined or is not otherwise reasonably quantifiable as of the date of determination; provided, further, that for purposes of this definition only, Debt of the Borrower shall (a) include only 50% of the aggregate principal amount of Subordinated Debt and Preferred Securities described in clause (b) of the definition thereof, subject to a maximum exclusion of $100,000,000 in the aggregate, and (b) not include Subordinated Debt or Preferred Securities if such Subordinated Debt or Preferred Securities, as the case may be, is mandatorily convertible into common stock of the Borrower upon terms and conditions satisfactory to the Majority Lenders; and provided, further, that for purposes of this definition only, debt of any Consolidated Subsidiary shall include Project Finance Debt of such Consolidated Subsidiary only to the extent of the Borrower's Ownership Interest in such Consolidated Subsidiary. "Consolidated Subsidiary" means any Subsidiary whose accounts are or are required to be consolidated with the accounts of the Borrower in accordance with GAAP. "Consumers" means Consumers Power Company, a Michigan corporation, all of whose common stock is on the date hereof owned by the Borrower. "Consumers Dividend Restriction" means any restriction enacted or imposed after October 1, 1992 upon the ability of Consumers to pay cash dividends to the Borrower in respect of Consumers' capital stock, whether such restriction is imposed by statute, regulation, decisions or rulings by the Michigan Public Service Commission or the Federal Energy Regulatory Commission (or any successor agency or agencies), final judgments of any court of competent jurisdiction, indentures, agreements, contracts or restrictions to which Consumers is a party or by which it is bound or otherwise; provided, that no restriction on such dividends existing on October 1, 1992 shall be a Consumers Dividend Restriction at any time. "Conversion", "Convert" or "Converted" refers to a conversion of Advances of one Type into Advances of another Type, or to the selection of a new, or the renewal of the same, Interest Period for Advances, as the case may be, pursuant to Section 3.02. "D&P" means Duff & Phelps, Inc. or any successor thereto. "Debt" means, for any Person, without duplication, any and all indebtedness, liabilities and other monetary obligations of such Person (whether for principal, interest, fees, costs, expenses or otherwise, and whether contingent or otherwise) (i) for borrowed money or evidenced by bonds, debentures, notes or other similar instruments, (ii) to pay the deferred purchase price of property or services (except trade accounts payable arising in the ordinary course of business which are not overdue), (iii) as lessee under leases which shall have been or should be, in accordance with GAAP, recorded as capital leases, (iv) under reimbursement or similar agreements with respect to letters of credit issued thereunder, (v) under any interest rate swap, "cap", "collar" or other hedging agreements; provided, however, for purposes of the calculation of Debt for this clause (v) only, the actual amount of Debt of such Person shall be determined on a net basis to the extent such agreements permit such amounts to be calculated on a net basis, (vi) to pay rent or other amounts under leases entered into in connection with sale and leaseback transactions involving assets of such Person being sold in connection therewith, (vii) arising from any accumulated funding deficiency (as defined in Section 412(a) of the Internal Revenue Code of 1986, as amended) for a Plan, and (viii) arising from (A) direct or indirect guaranties in respect of, and obligations to purchase or otherwise acquire, or otherwise to warrant or hold harmless, pursuant to a legally binding agreement, a creditor against loss in respect of, Debt of others referred to in clauses (i) through (vii) above and (B) other guaranty or similar financial obligations in respect of the performance of others, including, without limitation, Support Obligations. "Default Rate" means a rate per annum equal at all times to the higher of (i) 2% per annum above the higher, from time to time, of (A) the Applicable Rate for Eurodollar Rate Advances immediately prior to such Default Rate becoming applicable and (B) the Applicable Rate in effect from time to time for Base Rate Advances, and (ii) the highest rate per annum payable pursuant to the Indenture with respect to any principal amount of the Senior Notes that is not paid when due. "Dividend Coverage Ratio" means, at any date, the ratio of (i) Pro Forma Dividend Amounts to (ii) Issuer Interest Expense, as such terms are defined in the Indenture as in effect on the date hereof. "Dollars" and the sign "$" each means lawful money of the United States. "Domestic Lending Office" means, with respect to any Lender, the office or affiliate of such Lender specified as its "Domestic Lending Office" opposite its name on Schedule I hereto or in the Lender Assignment pursuant to which it became a Lender, or such other office or affiliate of such Lender as such Lender may from time to time specify in writing to the Borrower and the Operational Agent. "Eligible Assignee" means (a) a commercial bank or trust company organized under the laws of the United States, or any State thereof; (b) a commercial bank organized under the laws of any other country that is a member of the OECD, or a political subdivision of any such country, provided that such bank is acting through a branch or agency located in the United States; (c) the central bank of any country that is a member of the OECD; and (d) any other commercial bank or other financial institution engaged generally in the business of extending credit or purchasing debt instruments; provided, however, that (A) any such Person shall also (i) have outstanding unsecured indebtedness that is rated A- or better by S&P or A3 or better by Moody's (or an equivalent rating by another nationally-recognized credit rating agency of similar standing if neither of such corporations is then in the business of rating unsecured indebtedness of entities engaged in such businesses) or (ii) have combined capital and surplus (as established in its most recent report of condition to its primary regulator) of not less than $250,000,000 (or its equivalent in foreign currency), (B) any Person described in clause (b), (c), or (d) above, shall, on the date on which it is to become a Lender hereunder, (1) be entitled to receive payments hereunder without deduction or withholding of any United States Federal income taxes (as contemplated by Section 5.06) and (2) not be incurring any losses, costs or expenses of the type for which such Person could demand payment under Section 5.04(a) or (d) (except to the extent that, in the absence of the making of an assignment to such Person, the assigning Lender would have incurred an equal or greater amount of such losses, costs or expenses and such losses, costs or expenses would have been payable by the Borrower to such assigning Lender hereunder), (C) any Person described in clauses (a), (b), (c) and (d) above, which is not a Lender shall, in addition, be acceptable to any LC Bank based upon its then-existing credit criteria and (D) any Person described in clause (d) above shall, in addition, be acceptable to the Co-Agents. "Enterprises" means CMS Enterprises Company, a Michigan corporation, all of whose common stock is on the date hereof owned by the Borrower. "Enterprises Significant Subsidiary" means Nomeco, CMS Generation Co., CMS Gas Transmission and Storage Company and any other direct subsidiary of Enterprises having a net worth in excess of $50 million. "Equity Distributions" shall mean, for any period, the aggregate amount of cash received by the Borrower from its Subsidiaries during such period that are paid out of proceeds from the sale of common equity of Subsidiaries of the Borrower. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time. "ERISA Affiliate" means, with respect to any Person, any trade or business (whether or not incorporated) that is a "commonly controlled entity" within the meaning of the regulations under Section 414 of the Internal Revenue Code of 1986, as amended. "Eurocurrency Liabilities" has the meaning assigned to that term in Regulation D of the Board of Governors of the Federal Reserve System, as in effect from time to time. "Eurodollar Lending Office" means, with respect to any Lender, the office or affiliate of such Lender specified as its "Eurodollar Lending Office" opposite its name on Schedule I hereto or in the Lender Assignment pursuant to which it became a Lender (or, if no such office or affiliate is specified, its Domestic Lending Office), or such other office or affiliate of such Lender as such Lender may from time to time specify in writing to the Borrower and the Operational Agent. "Eurodollar Rate" means, for each Interest Period for each Eurodollar Rate Advance made as part of the same Borrowing, an interest rate per annum equal to the average (rounded upward to the nearest whole multiple of 1/16 of 1% per annum, if such average is not such a multiple) of the rate per annum at which deposits in U.S. dollars are offered by the principal office of each of the Reference Banks in London, England to prime banks in the London interbank market at 11:00 A.M. (London time) two Business Days before the first day of such Interest Period in an amount substantially equal to such Reference Bank's Eurodollar Rate Advance made as part of such Borrowing and for a period equal to such Interest Period. The Eurodollar Rate for the Interest Period for each Eurodollar Rate Advance made as part of the same Borrowing shall be determined by the Operational Agent on the basis of applicable rates furnished to and received by the Operational Agent from the Reference Banks two Business Days before the first day of such Interest Period, subject, however, to the provisions of Sections 3.04(c) and 5.02. "Eurodollar Rate Advance" means an Advance that bears interest as provided in Section 3.05(b)(ii). "Eurodollar Reserve Percentage" of any Lender for each Interest Period for each Eurodollar Rate Advance means the reserve percentage applicable during such Interest Period (or if more than one such percentage shall be so applicable, the daily average of such percentages for those days in such Interest Period during which any such percentage shall be so applicable) under Regulation D or other regulations issued from time to time by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including, without limitation, any emergency, supplemental or other marginal reserve requirement) for such Lender with respect to liabilities or assets consisting of or including Eurocurrency Liabilities having a term equal to such Interest Period. "Event of Default" has the meaning specified in Section 9.01. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Existing Agreement" means the Credit Agreement, dated as of July 29, 1994, among the Borrower, the lenders named therein, the Co-Agents, the Documentation Agent and the Operational Agent. "Existing Banks" means the Banks party to the Existing Agreement. "Existing Letters of Credit" means, (i) the irrevocable standby letter of credit, dated April 29, 1994, issued by The Bank of Tokyo, Ltd. in favor of New York State Electric & Gas Corporation, bearing letter of credit number 165-LCS-916840, and (ii) the irrevocable standby letter of credit, dated December 8, 1994, issued by The Bank of Tokyo, Ltd., in favor of Banco Latino Americano de Exportaciones, S.A., bearing letter of credit number 165-LCS-917216. The Existing Letters of Credit shall each constitute a Letter of Credit hereunder. "Extension of Credit" means (i) the making of a Borrowing (including, without limitation, any Conversion), (ii) the issuance of a Letter of Credit, or (iii) the amendment of any Letter of Credit having the effect of extending the stated termination date thereof, increasing the LC Outstandings thereunder, or otherwise altering any of the material terms or conditions thereof. "Federal Funds Rate" means, for any period, a fluctuating interest rate per annum equal for each day during such period to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations for such day on such transactions received by the Operational Agent from three Federal funds brokers of recognized standing selected by the Operational Agent. "Fee Letter" has the meaning assigned to that term in Section 2.02(d). "Fitch" means Fitch's Investors Services or any successor thereto. "GAAP" has the meaning assigned to that term in Section 1.03. "Governmental Approval" means any authorization, consent, approval, license, permit, certificate, exemption of, or filing or registration with, any governmental authority or other legal or regulatory body, required in connection with either (i) the execution, delivery, or performance of any Loan Document by the Borrower, (ii) the grant and perfection of any Lien contemplated by the Cash Collateral Agreement or (iii) the exercise by any Agent (on behalf of the Lenders) of any right or remedy provided for under the Cash Collateral Agreement. "Hazardous Substance" means any waste, substance, or material identified as hazardous, dangerous or toxic by any office, agency, department, commission, board, bureau, or instrumentality of the United States or of the State or locality in which the same is located having or exercising jurisdiction over such waste, substance or material. "Indemnified Person" has the meaning assigned to that term in Section 11.04(b). "Indenture" means that certain Indenture, dated as of September 15, 1992, between the Borrower and the Trustee, as supplemented by the First Supplemental Indenture, dated as of October 1, 1992, and the Second Supplemental Indenture, dated as of October 1, 1992, as said Indenture may be further amended or otherwise modified from time to time in accordance with its terms. "Interest Period" has the meaning assigned to that term in Section 3.03. "LC Bank" means a Lender or other financial institution designated by the Borrower, and acceptable to the Documentation Agent and the Operational Agent, in accordance with Section 4.01(a), as the issuer of a Letter of Credit pursuant to an LC Bank Agreement. It is understood and agreed that each Lender shall be deemed to be acceptable to the Documentation Agent and the Operational Agent for such purposes. As of the date hereof, the Borrower has designated Union Bank, The Bank of Tokyo, Ltd. and The Chase Manhattan Bank, N.A. as LC Banks, and the Agents have accepted such designees pursuant to Section 4.01. "LC Bank Agreement" means an agreement between an LC Bank and the Borrower, in form and substance satisfactory to the Documentation Agent and the Operational Agent, providing for the issuance of one or more Letters of Credit, in form and substance satisfactory to the Documentation Agent and the Operational Agent, in support of a general corporate activity of the Borrower. "LC Payment Notice" has the meaning assigned to that term in Section 4.04(b). "LC Outstandings" means, for any Letter of Credit on any date of determination, the maximum amount available to be drawn under such Letter of Credit (assuming the satisfaction of all conditions for drawing enumerated therein). "Lender Assignment" means an assignment and agreement entered into by a Lender and an Eligible Assignee, and accepted by the Documentation Agent, in substantially the form of Exhibit H. "Lenders" means the Banks listed on the signature pages hereof, each Eligible Assignee that shall become a party hereto pursuant to Section 11.07 and, if and to the extent so provided in Section 4.04(c), each LC Bank. "Letter of Credit" means a letter of credit issued by an LC Bank pursuant to Section 4.02, as such letter of credit may from time to time be amended, modified or extended in accordance with the terms of this Agreement and the LC Bank Agreement to which it relates. "Lien" has the meaning assigned to that term in Section 8.02(a). "Loan Documents" means this Agreement, the Notes, the Fee Letter, the Cash Collateral Agreement, the LC Bank Agreement(s) and all other agreements, instruments and documents now or hereafter executed and/or delivered pursuant hereto or thereto. "Majority Lenders" means, on any date of determination, Lenders that, collectively, on such date (i) have Percentages in the aggregate of at least 66-2/3% and (ii) if the Commitments have been terminated, hold at least 66-2/3% of the then aggregate unpaid principal amount of the Advances owing to Lenders. Any determination of those Lenders constituting the Majority Lenders shall be made by the Co-Agents and shall be conclusive and binding on all parties absent manifest error. "Measurement Quarter" has the meaning assigned to that term in Section 8.01(j). "Moody's" means Moody's Investors Service, Inc. or any successor thereto. "Net Worth" means, with respect to any Person, the excess of such Person's total assets over its total liabilities, total assets and total liabilities each to be determined in accordance with GAAP consistently applied, excluding, however, from the determination of total assets (i) goodwill, organizational expenses, research and development expenses, trademarks, trade names, copyrights, patents, patent applications, licenses and rights in any thereof, and other similar intangibles, (ii) cash held in a sinking or other analogous fund established for the purpose of redemption, retirement or prepayment of capital stock or Debt, and (iii) any items not included in clauses (i) or (ii) above, that are treated as intangibles in conformity with GAAP. "Nomeco" means NOMECO Oil & Gas Co., a Michigan corporation, all of whose capital stock is on the date hereof owned by Enterprises. "Note" means a promissory note of the Borrower payable to the order of a Lender, in substantially the form of Exhibit A. "Noteholders" means, collectively, the owners of record from time to time of the Senior Notes. "Notice of Borrowing" has the meaning assigned to that term in Section 3.01(a). "OECD" means the Organization for Economic Cooperation and Development. "Ownership Interest" of the Borrower in any Consolidated Subsidiary means, at any date of determination, the percentage determined by dividing (i) the aggregate amount of Project Finance Equity in such Consolidated Subsidiary owned or controlled, directly or indirectly, by the Borrower and any other Consolidated Subsidiary on such date, by (ii) the aggregate amount of Project Finance Equity in such Consolidated Subsidiary owned or controlled, directly or indirectly, by all Persons (including the Borrower and the Consolidated Subsidiaries) on such date. Notwithstanding anything to the contrary set forth above, if the "Ownership Interest," calculated as set forth above, is 50% or less, such percentage shall be deemed to equal 0%. "PBGC" means the Pension Benefit Guaranty Corporation (or any successor entity) established under ERISA. "Percentage" means, for any Lender on any date of determination, the percentage obtained by dividing such Lender's Commitment on such day by the total of the Commitments on such date, and multiplying the quotient so obtained by 100%. "Permitted Investments" means each of the following so long as no such Permitted Investment shall have a final maturity later than six months from the date of investment therein: (i)direct obligations of the United States, or of any agency thereof, or obligations guaranteed as to principal and interest by the United States or any agency thereof; (ii)certificates of deposit or bankers' acceptances issued, or time deposits held, or investment contracts guaranteed, by any Lender, any nationally-recognized securities dealer or any other commercial bank, trust company, savings and loan association or savings bank organized under the laws of the United States, or any State thereof, or of any other country which is a member of the OECD, or a political subdivision of any such country, and in each case having outstanding unsecured indebtedness that (on the date of acquisition thereof) is rated AA- or better by S&P or Aa3 or better by Moody's (or an equivalent rating by another nationally-recognized credit rating agency of similar standing if neither of such corporations is then in the business of (iii)obligations with any Lender, any other bank or trust company described in clause (ii), above, or any nationally- recognized securities dealer, in respect of the repurchase of obligations of the type described in clause (i), above, provided that such repurchase obligations shall be fully secured by obligations of the type described in said clause (i) and the possession of such obligations shall be transferred to, and segregated from other obligations owned by, such Lender, such other bank or trust company or such (iv)commercial paper rated (on the date of acquisition thereof) A-1 or P-1 or better by S&P or Moody's, respectively (or an equivalent rating by another nationally-recognized credit rating agency of similar standing if neither of such corporations is then in the business of rating commercial (v)any eurodollar certificate of deposit issued by any Lender or any other commercial bank, trust company, savings and loan association or savings bank organized under the laws of the United States, or any State thereof, or of any country which is a member of the OECD, or a political subdivision of any such country, and in each case having outstanding unsecured indebtedness that (on the date of acquisition thereof) is rated AA- or better by S&P or Aa3 or better by Moody's (or an equivalent rating by another nationally- recognized credit rating agency of similar standing if neither of such corporations is then in the business of rating unsecured bank indebtedness). "Person" means an individual, partnership, corporation (including a business trust), joint stock company, trust, unincorporated association, joint venture or other entity, or a government or any political subdivision or agency thereof. "Plan" means, with respect to any Person, an employee benefit plan (other than a Multiemployer Plan) maintained for employees of such Person or any ERISA Affiliate of such Person and covered by Title IV of ERISA. "Plan Termination Event" means, with respect to any Person, (i) a Reportable Event described in Section 4043 of ERISA and the regulations issued thereunder (other than a Reportable Event not subject to the provision for 30-day notice to the PBGC under such regulations), or (ii) the withdrawal of such Person or any of its ERISA Affiliates from a Plan during a plan year in which it was a "substantial employer" as defined in Section 4001(a)(2) of ERISA, or (iii) the filing of a notice of intent to terminate a Plan or the treatment of a Plan under Section 4041 of ERISA, or (iv) the institution of proceedings to terminate a Plan by the PBGC, or (v) any other event or condition which is reasonably likely to constitute grounds under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Plan. "Preferred Securities" means (a) any preferred securities issued by a financing entity (i.e., partnership, trust, limited liability company) used exclusively to raise capital for the Borrower, where such financing transaction and preferred securities have the following characteristics: (i)the financing entity lends substantially all of the proceeds from the issuance of the preferred securities to the Borrower in exchange for Subordinated Debt, which preferred securities contain terms providing for the deferral of interest payments corresponding to provisions providing for the deferral of interest payments on the Subordinated Debt; (ii)the Borrower makes periodic interest payments on the Subordinated Debt, which interest payments are in turn used by the financing entity to make corresponding payments to the holders of the preferred securities; and (b) any other preferred securities issued by the Borrower, provided that (A) the Borrower requests such preferred securities be treated as "preferred securities" for the purpose of clause (a) of the second proviso of Consolidated Debt and (B) such preferred securities are on terms and conditions satisfactory to the Majority Lenders. "Project Finance Debt" means Debt of any Person that is non- recourse to such Person (unless such Person is a special-purpose entity) and any Affiliate of such Person, other than with respect to the interest of the holder of such Debt in the collateral, if any, securing such Debt. "Project Finance Equity" means, at any date of determination, consolidated equity of the common, preference and preferred stockholders of the Borrower and the Consolidated Subsidiaries relating to any obligor with respect to Project Finance Debt. "Recipient" has the meaning assigned to that term in Section 11.08. "Reference Banks" means Citibank, Union Bank and Bank of America Illinois, or any additional or substitute Lenders as may be selected from time to time to act as Reference Banks hereunder by the Operational Agent, the Majority Lenders and the Borrower. "Register" has the meaning specified in Section 11.07(c). "Request for Issuance" has the meaning assigned to that term in Section 4.02(a). "Required Lenders" means, on any date of determination, Lenders that, collectively, on such date (i) hold at least 51% of the then aggregate unpaid principal amount of the Advances owing to Lenders and (ii) if no Advances are then outstanding, have Percentages in the aggregate of at least 51%. Any determination of those Lenders constituting the Required Lenders shall be made by the Co-Agents and shall be conclusive and binding on all parties absent manifest error. "Restricted Subsidiary" means (i) Enterprises and (ii) any other Subsidiary of the Borrower (other than Consumers and its Subsidiaries) that, on a consolidated basis with any of its Subsidiaries as of any date of determination, accounts for more than 10% of the consolidated assets of the Borrower and its Consolidated Subsidiaries. "S&P" means Standard & Poor's Rating Group or any successor thereto. "Senior Note Debt" means, collectively, all principal indebtedness of the Borrower to the Noteholders now or hereafter existing under the Senior Notes, together with interest and premiums, if any, thereon and other amounts payable in respect thereof or in connection therewith in accordance with the terms of the Senior Notes or the Indenture. "Senior Notes" means the Series A Senior Deferred Coupon Notes Due 1997 and the Series B Senior Deferred Coupon Notes Due 1999 issued by the Borrower pursuant to the Indenture. "Subordinated Debt" means, for any Person, unsecured Debt of such Person (i) issued in exchange for the proceeds of Preferred Securities and (ii) subordinated to the rights of the Lenders hereunder and under the Notes on terms and conditions satisfactory to the Majority Lenders, including, without limitation, (A) terms providing for the deferral of interest payments on such Debt corresponding to provisions providing for the deferral of interest payments on the Preferred Securities and (B) the maturity thereof. "Subsidiary" means, with respect to any Person, any corporation or unincorporated entity of which more than 50% of the outstanding capital stock (or comparable interest) having ordinary voting power (irrespective of whether at the time capital stock (or comparable interest) of any other class or classes of such corporation or entity shall or might have voting power upon the occurrence of any contingency) is at the time directly or indirectly owned by said Person (whether directly or through one or more other Subsidiaries). In the case of an unincorporated entity, a Person shall be deemed to have more than 50% of interests having ordinary voting power only if such Person's vote in respect of such interests comprises more than 50% of the total voting power of all such interests in the unincorporated entity. "Support Obligations" means, for any Person, without duplication, any financial obligation, contingent or otherwise, of such Person guaranteeing or otherwise supporting any Debt or other obligation of any other Person in any manner, whether directly or indirectly, and including, without limitation, any obligation of such Person, direct or indirect, (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Debt or to purchase (or to advance or supply funds for the purchase of) any security for the payment of such Debt, (ii) to purchase property, securities or services for the purpose of assuring the owner of such Debt of the payment of such Debt, (iii) to maintain working capital, equity capital, available cash or other financial statement condition of the primary obligor so as to enable the primary obligor to pay such Debt, (iv) to provide equity capital under or in respect of equity subscription arrangements (to the extent that such obligation to provide equity capital does not otherwise constitute Debt), or (v) to perform, or arrange for the performance of, any non-monetary obligations or non-funded debt payment obligations of the primary obligor. "Tax Sharing Agreement" means the Agreement for the Allocation of Income Tax Liabilities and Benefits, dated as of January 1, 1990, by and among the Borrower, each of the members of the Consolidated Group (as defined therein), and each of the corporations that become members of the Consolidated Group. "Termination Date" means the earlier to occur of (i) June 30, 1998 or such later date to which the Termination Date is extended in accordance with Section 2.05 and (ii) the date of termination or reduction in whole of the Commitments pursuant to Section 2.03 or 9.02. "Trustee" has the meaning assigned to that term in the Indenture. "Type" has the meaning assigned to such term (i) in the definition of "Advance" when used in such context and (ii) in the definition of "Borrowing" when used in such context. "Unmatured Default" means an event that, with the giving of notice or lapse of time or both, would constitute an Event of Default. SECTION 1.02. Computation of Time Periods. Unless otherwise indicated, each reference in this Agreement to a specific time of day is a reference to New York City time. In the computation of periods of time under this Agreement, any period of a specified number of days or months shall be computed by including the first day or month occurring during such period and excluding the last such day or month. In the case of a period of time "from" a specified date "to" or "until" a later specified date, the word "from" means "from and including" and the words "to" and "until" each means "to but excluding". SECTION 1.03. Accounting Terms. All accounting terms not specifically defined herein shall be construed in accordance with generally accepted accounting principles consistent with those applied in the preparation of the financial statements referred to in Section 7.01(e) ("GAAP"). SECTION 2.01. The Commitments. Each Lender severally agrees, on the terms and conditions hereinafter set forth, to make Advances to the Borrower and to participate in the issuance of Letters of Credit (and the LC Outstandings thereunder) during the period from the Closing Date until the Termination Date in an aggregate outstanding amount not to exceed on any day such Lender's Available Commitment (after giving effect to all Extensions of Credit to be made on such day and the application of the proceeds thereof). Within the limits hereinafter set forth, the Borrower may request Extensions of Credit hereunder, prepay Advances, or reduce or cancel Letters of Credit, and use the resulting increase in the Available Commitments for further Extensions of Credit in accordance with the terms hereof. SECTION 2.02. Fees. (a) The Borrower agrees to pay to the Operational Agent for the account of each Lender a commitment fee on the average daily amount of such Lender's Available Commitment at the rate of 0.375% per annum, from the date hereof, in the case of each Bank, and from the effective date specified in the Lender Assignment pursuant to which it became a Lender, in the case of each other Lender, until the Termination Date, payable quarterly in arrears on the last day of each January, April, July and October, commencing the first such date to occur following the date hereof, and on the Termination Date. (b) The Borrower agrees to pay to the Operational Agent for the account of each Bank a participation fee equal to .075% of such Bank's Commitment, such fee to be payable on the Closing Date. (c) The Borrower agrees to pay to the Operational Agent for the account of each Lender a commission on the average daily aggregate amount of the LC Outstandings from the date hereof until the Termination Date at a rate per annum equal to the Applicable Margin with respect to Eurodollar Rate Advances from time to time, payable quarterly in arrears on the last day of each January, April, July and October, commencing on January 31, 1996, and on the Termination Date; provided, however, that with respect to Letters of Credit that support only performance obligations of the Borrower or any of its Subsidiaries, such commission shall be at a rate per annum equal to 50% of the Applicable Margin with respect to Eurodollar Rate Advances from time to time. The determination (the "Initial Determination") of whether a particular Letter of Credit supports only performance obligations of the Borrower or any of its Subsidiaries shall be made by the Co-Agents prior to the issuance of such Letter of Credit, and the foregoing Letter of Credit commission shall, subject to clauses (i) and (ii) below, be payable in accordance with such Initial Determination. The Documentation Agent shall promptly give notice of the Initial Determination to the Borrower and each Lender. If the Initial Determination of the Co-Agents is that, for capital requirements purposes, such Letter of Credit supports only performance obligations of the Borrower or any of its Subsidiaries, then each Lender shall, within 90 days after its receipt of notice of the Initial Determination from the Documentation Agent, provide written notice to the Documentation Agent stating whether it concurs with and approves the Initial Determination. The failure of any Lender to so respond within such 90-day period shall be deemed to constitute an approval by such Lender of the Initial Determination. If the Majority Lenders do not concur with and approve the Initial Determination within such period, (i) the Borrower shall pay to the Operational Agent for the account of each Lender an amount equal to the excess, if any, of (A) the Letter of Credit commission that would have been payable by the Borrower pursuant to the first sentence of this subsection (c) (without giving effect to the proviso thereto) with respect to such Letter of Credit over (B) the actual Letter of Credit commission paid by the Borrower pursuant to this subsection (c) with respect to such Letter of Credit, such amount to be payable immediately upon the Borrower's receipt of notice from the Documentation Agent stating that the Majority Lenders failed to concur with and approve the Initial Determination, and (ii) the Letter of Credit commission payable by the Borrower with respect to such Letter of Credit shall be at the rate specified in the first sentence of this subsection (c) (without giving effect to the proviso thereto). If the Initial Determination of the Co- Agents is that, for capital requirements purposes, a particular Letter of Credit supports only financial obligations of the Borrower or any of its Subsidiaries and, within 30 days after the Documentation Agent gives notice of such Initial Determination to the Borrower and each Lender, the Co-Agents determine that such Letter of Credit in fact supports only performance obligations of the Borrower or any of its Subsidiaries, the Documentation Agent shall promptly notify the Borrower and each Lender of such determination (the "Final Determination") and each Lender shall, within 90 days after its receipt of notice of the Final Determination from the Documentation Agent, provide written notice to the Documentation Agent stating whether it concurs with and approves the Final Determination. The failure of any Lender to so respond within such 90-day period shall be deemed to constitute an approval by such Lender of the Final Determination. If the Majority Lenders concur with and approve the Final Determination within such period, (1) an amount equal to the excess, if any, of (x) the actual Letter of Credit commission paid by the Borrower pursuant to this subsection (c) with respect to such Letter of Credit over (y) the Letter of Credit commission that would have been payable by the Borrower pursuant to the proviso to the first sentence of this subsection (c) with respect to such Letter of Credit, shall be set off and deducted by the Borrower from all subsequent Letter of Credit commissions payable pursuant to this subsection (c) until such amount has been set off and deducted in full, and (2) the Letter of Credit commission payable by the Borrower with respect to such Letter of Credit shall be at the rate specified in the proviso to the first sentence of this subsection (c). In connection with the Lenders' review of each Initial Determination and Final Determination, the Borrower shall provide to each Lender all supporting information regarding the applicable Letter of Credit and such other information as any Lender, through the Documentation Agent, may reasonably request. (d) In addition to the fees provided for in subsections (a), (b) and (c) above, the Borrower shall pay to the Operational Agent, for the account of the Co-Agents, such other fees as are provided for in that certain letter agreement between the Borrower and the Co-Agents (the "Fee Letter") entered into separately herefrom and dated the date hereof. SECTION 2.03. Reduction of the Commitments. (a) The Borrower may, upon at least five Business Days' notice to each Co-Agent, terminate in whole or reduce ratably in part the unused portions of the Commitments; provided that any such partial reduction shall be in the aggregate amount of $10,000,000 or an integral multiple of $1,000,000 in excess thereof. (b) On each date that the Borrower repurchases Senior Notes from any Noteholder as the result of a Change in Control (as defined in the Indenture), the Commitments of the Lenders shall automatically be ratably reduced by an amount equal in the aggregate to the product of (i) the Commitments on such date (after giving effect to all Extensions of Credit to be made on such date and the application of the proceeds thereof) and (ii) the percentage obtained by dividing (A) the aggregate principal amount of such Senior Notes being repurchased by (B) the aggregate principal amount of the Senior Note Debt then outstanding. SECTION 2.04. Computations of Outstandings. Whenever reference is made in this Agreement to the principal amount outstanding on any date under this Agreement, such reference shall refer to the sum of (i) the aggregate principal amount of all Advances outstanding on such date plus (ii) the aggregate LC Outstandings of all Letters of Credit outstanding on such date, in each case after giving effect to all Extensions of Credit to be made on such date and the application of the proceeds thereof. At no time shall the principal amount outstanding under this Agreement exceed the aggregate amount of the Commitments. References to the unused portion of the Commitments shall refer to the excess, if any, of the Commitments over the principal amount outstanding hereunder; and references to the unused portion of any Lender's Commitment shall refer to such Lender's Percentage of the unused Commitments. SECTION 2.05. Extension of Termination Date. At least 30 but not more than 90 days prior to each anniversary of the date of the Closing Date (but in any event no later than 60 days prior to the then-scheduled Termination Date), the Borrower may, by delivering a written notice to such effect to the Operational Agent (each such request being irrevocable), request that each Lender consent to a one-year extension of the Termination Date. Upon receipt of any such notice, the Operational Agent shall promptly communicate such request to the Lenders. Within 30 days following the giving of such notice by the Borrower, the Lenders shall indicate to the Operational Agent whether the Borrower's request to so extend the then-scheduled Termination Date is acceptable to the Lenders (and, if so, the conditions, if any, relating to such acceptance), it being understood that the unanimous written consent of the Lenders shall be required to effect any such request, that the determination by each Lender will be in its sole and absolute discretion and that the failure of any Lender to so respond within such period shall be deemed to constitute a refusal by such Lender to consent to such request (with the result being that such request is denied). The Operational Agent shall promptly notify the Borrower and the Lenders of the result of such request, and if such request shall have been consented to by all of the Lenders, the Termination Date shall be extended to the first anniversary of the then- scheduled Termination Date; provided, however, that the Termination Date shall be so extended notwithstanding the existence of one or more Lenders (the "Nonextending Lenders") that have elected not to extend (or failed to notify the Operational Agent of its (or their) consent to extend) if (i) such Nonextending Lender(s) has (or have) been replaced in the full amount of its (or their) Commitment(s) pursuant to Section 11.07(g) and (ii) no Event of Default or Unmatured Default shall then have occurred and be continuing. If a Nonextending Lender is not so replaced pursuant to Section 11.07(g), the Commitments of all of the Lenders shall automatically terminate on the then-scheduled Termination Date. SECTION 3.01. Advances.(a) The Borrower may request a Borrowing (other than a Conversion) by delivering a notice (a "Notice of Borrowing") to the Operational Agent no later than 12:00 noon (New York City time) on the fourth Business Day or, in the case of Base Rate Advances, on the first Business Day, prior to the date of the proposed Borrowing. The Operational Agent shall give each Lender prompt notice of each Notice of Borrowing. Each Notice of Borrowing shall be in substantially the form of Exhibit B and shall specify the requested (i) date of such Borrowing, (ii) Type of Advances to be made in connection with such Borrowing and (iii) Interest Period, if any, for such Advances. Each proposed Borrowing shall conform to the requirements of Sections 3.03 and 3.04. (b) Each Lender shall, before 12:00 noon (New York City time) on the date of such Borrowing, make available for the account of its Applicable Lending Office to the Operational Agent at the Operational Agent's address referred to in Section 11.02, in same day funds, such Lender's Percentage of such Borrowing. After the Operational Agent's receipt of such funds and upon fulfillment of the applicable conditions set forth in Article VI, the Operational Agent will make such funds available to the Borrower at the Operational Agent's aforesaid address; provided, however, that the proceeds of the initial Extension of Credit shall be applied first directly by the Operational Agent on the Closing Date to the prepayment in full of all outstanding principal, accrued interest and other amounts then owing under the Existing Agreement, and then, to the extent the proceeds of such initial Extension of Credit exceed the amount necessary to prepay in full all outstanding principal, accrued interest and other amounts then owing under the Existing Credit Agreement, to the Borrower at the Operational Agent's aforesaid address for general corporate purposes. Notwithstanding the foregoing, unless the Operational Agent shall have received notice from a Lender prior to the date of any Borrowing that such Lender will not make available to the Operational Agent such Lender's Percentage of such Borrowing, the Operational Agent may assume that such Lender has made such Percentage available to the Operational Agent on the date of such Borrowing in accordance with the first sentence of this subsection (b), and the Operational Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. (c) If and to the extent that any Lender (a "non-performing Lender") shall not have made available to the Operational Agent, in accordance with subsection (b) above, such Lender's Percentage of any Borrowing, the non-performing Lender and the Borrower severally agree to repay to the Operational Agent forthwith on demand corresponding amounts, together with interest thereon for each day from the date such amount is made available to the Borrower until the date such amount is repaid to the Operational Agent, at (i) in the case of the Borrower, the interest rate applicable at the time to Advances made in connection with such Borrowing and (ii) in the case of such Lender, the Federal Funds Rate. Within the limits of each Lender's Available Commitment hereunder and subject to the other terms and conditions set forth in this Agreement for the making of Advances, the Borrower may request (and the Lenders shall honor) one or more additional Borrowings from the performing Lenders to fund such repayment to the Operational Agent. If a non-performing Lender shall repay to the Operational Agent such corresponding amount in full (with interest as above provided), (x) the Operational Agent shall apply such corresponding amount and interest to the repayment to the Operational Agent (or repayment of Advances made to fund such repayment to the Operational Agent), and shall make any remainder available to the Borrower and (y) such amount so repaid shall be deemed to constitute such Lender's Advance, made as part of such Borrowing for purposes of this Agreement as if funded concurrently with the other Advances made as part of such Borrowing, and such Lender shall forthwith cease to be deemed a non-performing Lender; if and so long as such non-performing Lender shall not repay such amount, and unless and until an Eligible Assignee shall have assumed and performed the obligations of such non-performing Lender, all computations by the Operational Agent of Percentages, Commitments and payments hereunder shall be made without regard to the Commitments, or outstanding Advances, of such non-performing Lender, and any amounts paid to the Operational Agent for the account of such non-performing Lender shall be held by the Operational Agent in trust for such non-performing Lender in a non-interest-bearing special purpose account. Nothing herein shall in any way limit, waive or otherwise reduce any claims that any party hereto may have against any non-performing Lender. The failure of any Lender to make the Advance to be made by it as part of any Borrowing shall not relieve any other Lender of its obligation, if any, hereunder to make its Advance on the date of such Borrowing, but no Lender shall be responsible for the failure of any other Lender to make the Advance to be made by such other Lender on the date of any Borrowing. SECTION 3.02. Conversion of Advances. The Borrower may from time to time Convert any Advance (or portion thereof) of any Type to one or more Advances of the same or any other Type by delivering a notice of such Conversion (a "Notice of Conversion") to the Operational Agent no later than 12:00 noon (New York City time) on (x) the fourth Business Day prior to the date of any proposed Conversion into a Eurodollar Rate Advance and (y) the first Business Day prior to the date of any proposed Conversion into a Base Rate Advance. The Operational Agent shall give each Lender prompt notice of each Notice of Conversion. Each Notice of Conversion shall be in substantially the form of Exhibit C and shall specify the requested (i) date of such Conversion, (ii) Type of, and Interest Period, if any, applicable to, the Advances (or portions thereof) proposed to be Converted, (iii) Type of Advances to which such Advances (or portions thereof) are proposed to be Converted, (iv) initial Interest Period, if any, to be applicable to the Advances resulting from such Conversion and (v) aggregate amount of Advances (or portions thereof) proposed to be Converted. Each proposed Conversion shall be subject to the provisions of Sections 3.03 and 3.04. SECTION 3.03. Interest Periods. The period between the date of each Eurodollar Rate Advance and the date of payment in full of such Advance shall be divided into successive periods of months or days ("Interest Periods") for purposes of computing interest applicable thereto. The initial Interest Period for each such Advance shall begin on the day such Advance is made, and each subsequent Interest Period shall begin on the last day of the immediately preceding Interest Period for such Advance. The duration of each Interest Period shall be 1, 2, 3, or 6 months, as the Borrower may, in accordance with Section 3.01 or 3.02, select; provided, however, that: (i) the Borrower may not select any Interest Period that ends after the Termination Date; and (ii)whenever the last day of any Interest Period would otherwise occur on a day other than a Business Day, the last day of such Interest Period shall occur on the next succeeding Business Day, provided that if such extension would cause the last day of such Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the next preceding Business Day. SECTION 3.04. Other Terms Relating to the Making and Conversion of Advances. (a) Notwithstanding anything in Section 3.01 or 3.02 to the contrary: (i) each Borrowing (other than a Borrowing deemed made under Section 4.04(d)) shall be in an aggregate amount not less than $10,000,000, or an integral multiple of $1,000,000 in excess thereof (or such lesser amount as shall be equal to the total amount of the Available Commitments on such date, after giving effect to all other Extensions of Credit to be made on such date), and shall consist of Advances of the same Type, having the same Interest Period and made or Converted on the same day by the Lenders ratably according to their respective Percentages; provided, however, that the initial Borrowing shall be in an aggregate amount sufficient to repay in full all outstanding principal, accrued interest and other amounts owing under the Existing Agreement as of the Closing Date; (ii)the Borrower may request that more than one Borrowing be made on the same day; (iii)at no time shall more than ten different Borrowings comprising Eurodollar Rate Advances be outstanding hereunder; (iv)no Eurodollar Rate Advance may be Converted on a date other than the last day of the Interest Period applicable to such Advance unless the corresponding amounts, if any, payable to the Lenders pursuant to Section 5.04(c) are paid contemporaneously (v) if the Borrower shall either fail to give a timely Notice of Conversion pursuant to Section 3.02 in respect of any Advances or fail, in any Notice of Conversion that has been timely given, to select the duration of any Interest Period for Advances to be Converted into Eurodollar Rate Advances in accordance with Section 3.03, such Advances shall, on the last day of the then existing Interest Period therefor, automatically Convert into, or remain as, as the case may be, Base Rate Advances; and (vi)if, on the date of any proposed Conversion, any Event of Default or Unmatured Default shall have occurred and be continuing, all Advances then outstanding shall, on such date, automatically Convert into, or remain as, as the case may be, Base Rate Advances; provided, however, that with respect to any Unmatured Default that occurs and is continuing as a result of the failure of the Borrower to comply with the ratio set forth in Section 8.01(j), any such Advances may be Converted into Eurodollar Rate Advances with an Interest Period not to exceed three months in duration. (b) If any Lender shall notify the Operational Agent that the introduction of or any change in or in the interpretation of any law or regulation makes it unlawful, or that any central bank or other governmental authority asserts that it is unlawful, for such Lender or its Applicable Lending Office to perform its obligations hereunder to make, or to fund or maintain, Eurodollar Rate Advances hereunder, (i) the obligation of such Lender to make, or to Convert Advances into, Eurodollar Rate Advances for such Borrowing or any subsequent Borrowing from such Lender shall be forthwith suspended until the earlier to occur of the date upon which (A) such Lender shall cease to be a party hereto and (B) it is no longer unlawful for such Lender to make, fund or maintain Eurodollar Rate Advances, and (ii) if the maintenance of Eurodollar Rate Advances then outstanding through the last day of the Interest Period therefor would cause such Lender to be in violation of such law, regulation or assertion, the Borrower shall either prepay or Convert all Eurodollar Rate Advances from such Lender within five days after such notice. Promptly upon becoming aware that the circumstances that caused such Lender to deliver such notice no longer exist, such Lender shall deliver notice thereof to the Operational Agent (but the failure to do so shall impose no liability upon such Lender). Promptly upon receipt of such notice from such Lender (or upon such Lender's assigning all of its Commitments, Advances, participation and other rights and obligations hereunder to an Eligible Assignee), the Operational Agent shall deliver notice thereof to the Borrower and the Lenders and such suspension shall terminate. (c) If (i) only one, or none, of the Reference Banks furnishes timely information to the Operational Agent for determining the Eurodollar Rate for Eurodollar Rate Advances to be made in connection with any proposed Borrowing or (ii) the Majority Lenders shall, at least one Business Day before the date of any requested Borrowing, notify the Operational Agent that the Eurodollar Rate for Eurodollar Rate Advances to be made in connection with such Borrowing will not adequately reflect the cost to such Majority Lenders of making, funding or maintaining their respective Eurodollar Rate Advances for such Borrowing, the right of the Borrower to select Eurodollar Rate Advances for such Borrowing and any subsequent Borrowing shall be suspended until the Operational Agent shall notify the Borrower and the Lenders that the circumstances causing such suspension no longer exist, and each Advance to be made or Converted in connection with such Borrowing shall be a Base Rate Advance. (d) If any Lender shall have delivered a notice to the Operational Agent described in Section 3.04(b), or shall become a non- performing Lender under Section 3.01(c) or Section 4.04(c), and if and so long as such Lender shall not have withdrawn such notice or corrected such non-performance in accordance with said Section 3.04(b), Section 3.01(c) or Section 4.04(c), the Borrower or the Co-Agents may demand that such Lender assign in accordance with Section 11.07, to one or more Eligible Assignees designated by the Borrower or the Co-Agents, all (but not less than all) of such Lender's Commitment, Advances, participation and other rights and obligations hereunder; provided that any such demand by the Borrower during the continuance of an Event of Default or Unmatured Default shall be ineffective without the consent of the Majority Lenders. If, within 30 days following any such demand by the Co-Agents or the Borrower, any such Eligible Assignee so designated shall fail to consummate such assignment on terms reasonably satisfactory to such Lender, or the Borrower and the Co-Agents shall have failed to designate any such Eligible Assignee, then such demand by the Borrower or the Co- Agents shall become ineffective, it being understood for purposes of this provision that such assignment shall be conclusively deemed to be on terms reasonably satisfactory to such Lender, and such Lender shall be compelled to consummate such assignment forthwith, if such Eligible Assignee (i) shall agree to such assignment in substantially the form of the Lender Assignment attached hereto as Exhibit I and (ii) shall tender payment to such Lender in an amount equal to the full outstanding dollar amount accrued in favor of such Lender hereunder (as computed in accordance with the records of the Operational Agent). (e) Each Notice of Borrowing and Notice of Conversion shall be irrevocable and binding on the Borrower. In the case of any Borrowing which the related Notice of Borrowing or Notice of Conversion specifies is to be comprised of Eurodollar Rate Advances, the Borrower shall indemnify each Lender against any loss, cost or expense incurred by such Lender as a result of any failure to fulfill, on or before the date specified in such Notice of Borrowing or Notice of Conversion for such Borrowing, the applicable conditions (if any) set forth in this Article III (other than failure pursuant to the provisions of Section 3.04(b) or (c) hereof) or in Article VI, including, without limitation, any such loss (including loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund the Advance to be made by such Lender when such Advance, as a result of such failure, is not made on such date. SECTION 3.05. Repayment of Advances. (a) Principal. The Borrower shall repay the principal amount of the Advances on the Termination Date. (b) Interest. The Borrower shall pay interest on the unpaid principal amount of each Advance owing to each Lender from the date of such Advance until such principal amount shall be paid in full, at the Applicable Rate for such Advance (except as otherwise provided in this subsection (b)), payable as follows: (i) Base Rate Advances. If such Advance is a Base Rate Advance, interest thereon shall be payable quarterly in arrears on the last day of each January, April, July and October, on the date of any Conversion of such Base Rate Advance and on the date such Base Rate Advance shall become due and payable or shall otherwise be paid in full; provided that any amount of principal that is not paid when due (whether at stated maturity, by acceleration or otherwise) shall bear interest, from the date on which such amount is due until such amount is paid in full, payable on demand, at a rate per annum equal at all times to the Default Rate. (ii)Eurodollar Rate Advances. If such Advance is a Eurodollar Rate Advance, interest thereon shall be payable on the last day of such Interest Period and, if the Interest Period for such Advance has a duration of more than three months, on that day of each third month during such Interest Period that corresponds to the first day of such Interest Period (or, if any such month does not have a corresponding day, then on the last day of such month); provided that any amount of principal that is not paid when due (whether at stated maturity, by acceleration or otherwise) shall bear interest, from the date on which such amount is due until such amount is paid in full, payable on demand, at a rate per annum equal at all times to the Default Rate. SECTION 4.01. LC Banks. Subject to the terms and conditions hereof, the Borrower may from time to time identify and arrange for one or more financial institutions to act as LC Banks hereunder. Any such designation by the Borrower shall be notified to the Documentation Agent and the Operational Agent at least five Business Days prior to the first date upon which the Borrower proposes that such LC Bank issue its first Letter of Credit, so as to provide adequate time for such proposed LC Bank to be approved by such Agents hereunder. In that regard, the Borrower agrees to use its best efforts to so identify and arrange for Lenders to serve in such capacity, provided that nothing contained herein shall be deemed to require any Lender to agree to act as an LC Bank, if it does not so desire. Within two Business Days following the receipt of any such designation of a proposed LC Bank (other than any Lender so designated), the Documentation Agent and the Operational Agent shall notify the Borrower as to whether such designee is acceptable to such Agents. SECTION 4.02. Letters of Credit. (a) Each Letter of Credit shall be issued (or the stated maturity thereof extended or terms thereof modified or amended) on not less than three Business Days' prior written notice thereof to the Operational Agent (which shall promptly distribute copies thereof to the Lenders) and the relevant LC Bank. Each such notice (a "Request for Issuance") shall specify (i) the date (which shall be a Business Day) of issuance of such Letter of Credit (or the date of effectiveness of such extension, modification or amendment) and the stated expiry date thereof (which shall be no later than the Termination Date), (ii) the proposed stated amount of such Letter of Credit (which shall not be less than $500,000) and (iii) such other information as shall demonstrate compliance of such Letter of Credit with the requirements specified therefor in this Agreement and the relevant LC Bank Agreement. Each Request for Issuance shall be irrevocable unless modified or rescinded by the Borrower not less than two days prior to the proposed date of issuance (or effectiveness) specified therein. Not later than 12:00 noon (New York City time) on the proposed date of issuance (or effectiveness) specified in such Request for Issuance, and upon fulfillment of the applicable conditions precedent and the other requirements set forth herein and in the relevant LC Bank Agreement, such LC Bank shall issue (or extend, amend or modify) such Letter of Credit and provide notice and a copy thereof to the Operational Agent, which shall promptly furnish copies thereof to the Lenders. (b) Each Lender severally agrees with such LC Bank to participate in the Extension of Credit resulting from the issuance (or extension, modification or amendment) of such Letter of Credit, in the manner and the amount provided in Section 4.04(b), and the issuance of such Letter of Credit shall be deemed to be a confirmation by such LC Bank and each Lender of such participation in such amount. SECTION 4.03. LC Bank Fees. The Borrower shall pay directly to each LC Bank the letter of credit fees, if any, specified to be paid pursuant to the terms of the LC Bank Agreement to which such LC Bank is a party at the times, and in the manner, specified in such LC Bank Agreement. SECTION 4.04. Reimbursement to LC Banks. (a) The Borrower hereby agrees to pay to the Operational Agent for the account of each LC Bank, on demand made by such LC Bank to the Borrower and the Operational Agent, on and after each date on which such LC Bank shall pay any amount under the Letter of Credit issued by such LC Bank, a sum equal to the amount so paid plus interest on such amount from the date so paid by such LC Bank until repayment to such LC Bank in full at a fluctuating interest rate per annum equal at all times to the interest rate hereunder for Base Rate Advances. (b) If any LC Bank shall not have been reimbursed in full for any payment made by such LC Bank under the Letter of Credit issued by such LC Bank on the date of such payment, such LC Bank shall give the Operational Agent and each Lender prompt notice thereof (an "LC Payment Notice") no later than 12:00 noon (New York City time) on the Business Day immediately succeeding the date of such payment by such LC Bank. Each Lender severally agrees to purchase a participation in the reimbursement obligation of the Borrower to such LC Bank under subsection (a) above, by paying to the Operational Agent for the account of such LC Bank an amount equal to such Lender's Percentage of such unreimbursed amount paid by such LC Bank, plus interest on such amount at a rate per annum equal to the Federal Funds Rate from the date of such payment by such LC Bank to the date of payment to such LC Bank by such Lender. Each such payment by a Lender shall be made not later than 3:00 P.M. (New York City time) on the later to occur of (i) the Business Day immediately following the date of such payment by such LC Bank and (ii) the Business Day on which such Lender shall have received an LC Payment Notice from such LC Bank. Each Lender's obligation to make each such payment to the Operational Agent for the account of such LC Bank shall be several and shall not be affected by the occurrence or continuance of an Unmatured Default or Event of Default or the failure of any other Lender to make any payment under this Section 4.04. Each Lender further agrees that each such payment shall be made without any offset, abatement, withholding or reduction whatsoever. (c) The failure of any Lender to make any payment to the Operational Agent for the account of an LC Bank in accordance with subsection (b) above, shall not relieve any other Lender of its obligation to make payment, but no Lender shall be responsible for the failure of any other Lender. If any Lender (a "non-performing Lender") shall fail to make any payment to the Operational Agent for the account of an LC Bank in accordance with subsection (b) above, within five Business Days after the LC Payment Notice relating thereto, then, for so long as such failure shall continue, such LC Bank shall be deemed, for purposes of Section 5.05 and Article IX hereof and the Cash Collateral Agreement, to be a Lender hereunder owed an Advance in an amount equal to the outstanding principal amount due and payable by such Lender to the Operational Agent for the account of such LC Bank pursuant to subsection (b) above. (d) Each participation purchased by a Lender under subsection (b) above, shall constitute a Base Rate Advance deemed made by such Lender to the Borrower on the date of such payment by the relevant LC Bank under the Letter of Credit issued by such LC Bank (irrespective of the Borrower's noncompliance, if any, with the conditions precedent for Advances hereunder); and all such payments by the Lenders in respect of any one such payment by such LC Bank shall constitute a single Borrowing hereunder. SECTION 4.05. Obligations Absolute. The payment obligations of each Lender under Section 4.04(b) and of the Borrower under this Agreement in respect of any payment under any Letter of Credit and any Advance made under Section 4.04(d) shall be unconditional and irrevocable, and shall be paid strictly in accordance with the terms of this Agreement under all circumstances, including, without limitation, the following circumstances: (i) any lack of validity or enforceability of any Loan Document or any other agreement or instrument relating thereto or to such Letter of Credit; (ii)any amendment or waiver of, or any consent to departure from, all or any of the Loan Documents; (iii)the existence of any claim, set-off, defense or other right which the Borrower may have at any time against any beneficiary, or any transferee, of such Letter of Credit (or any Persons for whom any such beneficiary or any such transferee may be acting), any LC Bank, or any other Person, whether in connection with this Agreement, the transactions contemplated herein or by such Letter of Credit, or any unrelated transaction; (iv)any statement or any other document presented under such Letter of Credit proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect; (v) payment in good faith by any LC Bank under the Letter of Credit issued by such LC Bank against presentation of a draft or certificate which does not comply with the terms of such Letter of (vi)any other circumstance or happening whatsoever, whether or not similar to any of the foregoing. SECTION 4.06. Liability of LC Banks and the Lenders. The Borrower assumes all risks of the acts and omissions of any beneficiary or transferee of any Letter of Credit. Neither the LC Bank that has issued such Letter of Credit, the Lenders nor any of their respective officers, directors, employees, agents or Affiliates shall be liable or responsible for (a) the use that may be made of such Letter of Credit or any acts or omissions of any beneficiary or transferee thereof in connection therewith; (b) the validity, sufficiency or genuineness of documents, or of any endorsement thereon, even if such documents should prove to be in any or all respects invalid, insufficient, fraudulent or forged; (c) payment by such LC Bank against presentation of documents that do not comply with the terms of such Letter of Credit, including failure of any documents to bear any reference or adequate reference to such Letter of Credit; or (d) any other circumstances whatsoever in making or failing to make payment under such Letter of Credit, except that the Borrower shall have the right to bring suit against such LC Bank, and such LC Bank shall be liable to the Borrower and any Lender, to the extent of any direct, as opposed to consequential, damages suffered by the Borrower or such Lender which the Borrower or such Lender proves were caused by such LC Bank's wilful misconduct or gross negligence, including such LC Bank's wilful failure to make timely payment under such Letter of Credit following the presentation to it by the beneficiary thereof of a draft and accompanying certificate(s) which strictly comply with the terms and conditions of such Letter of Credit. In furtherance and not in limitation of the foregoing, any LC Bank may accept sight drafts and accompanying certificates presented under the Letter of Credit issued by such LC Bank that appear on their face to be in order, without responsibility for further investigation, regardless of any notice or information to the contrary. Notwithstanding the foregoing, no Lender shall be obligated to indemnify the Borrower for damages caused by any LC Bank's wilful misconduct or gross negligence, and the obligation of the Borrower to reimburse the Lenders hereunder shall be absolute and unconditional, notwithstanding the gross negligence or wilful misconduct of any LC Bank. SECTION 5.01. Payments and Computations. (a) The Borrower shall make each payment hereunder and under the other Loan Documents not later than 11:00 A.M. (New York City time) on the day when due in U.S. Dollars to the Operational Agent at its address referred to in Section 11.02 in same day funds; any payment received after 2:00 P.M. (New York City time) shall be deemed to have been received at the start of business on the next succeeding Business Day, unless the Operational Agent shall have received from, or on behalf of, the Borrower a Federal Reserve reference number with respect to such payment before 3:00 P.M. (New York City time). The Operational Agent will promptly thereafter cause to be distributed like funds relating to the payment of principal, interest, fees or other amounts payable to the Lenders, to the respective Lenders to which the same are payable, for the account of their respective Applicable Lending Offices, in each case to be applied in accordance with the terms of this Agreement. If and to the extent that any distribution of any payment from the Borrower required to be made to any Lender pursuant to the preceding sentence shall not be made in full by the Operational Agent on the date such payment was received by the Operational Agent, the Operational Agent shall pay to such Lender, upon demand, interest on the unpaid amount of such distribution, at a rate per annum equal to the Federal Funds Rate, from the date of such payment by the Borrower to the Operational Agent to the date of payment in full by the Operational Agent to such Lender of such unpaid amount. Upon the Operational Agent's acceptance of a Lender Assignment and recording of the information contained therein in the Register pursuant to Section 11.07, from and after the effective date specified in such Lender Assignment, the Operational Agent shall make all payments hereunder and under the Notes in respect of the interest assigned thereby to the Lender assignee thereunder, and the parties to such Lender Assignment shall make all appropriate adjustments in such payments for periods prior to such effective date directly between themselves. (b) The Borrower hereby authorizes the Operational Agent, each Lender and each LC Bank, if and to the extent payment owed to the Operational Agent, such Lender or such LC Bank, as the case may be, is not made when due hereunder (or, in the case of a Lender, under the Note held by such Lender), to charge from time to time against any or all of the Borrower's accounts with the Operational Agent, such Lender or such LC Bank, as the case may be, any amount so due. (c) All computations of interest based on the Alternate Base Rate and of fees payable pursuant to Section 2.02(a) shall be made by the Operational Agent on the basis of a year of 365 or 366 days, as the case may be. All other computations of interest and fees hereunder (including computations of interest based on the Eurodollar Rate and the Federal Funds Rate) shall be made by the Operational Agent on the basis of a year of 360 days. In each such case, such computation shall be made for the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest or fees are payable. Each such determination by the Operational Agent or a Lender shall be conclusive and binding for all purposes, absent manifest error. (d) Whenever any payment hereunder or under any other Loan Document shall be stated to be due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of payment of interest and fees hereunder; provided, however, that if such extension would cause payment of interest on or principal of Eurodollar Rate Advances to be made in the next following calendar month, such payment shall be made on the next preceding Business Day and such reduction of time shall in such case be included in the computation of payment of interest hereunder. (e) Unless the Operational Agent shall have received notice from the Borrower prior to the date on which any payment is due to the Lenders hereunder that the Borrower will not make such payment in full, the Operational Agent may assume that the Borrower has made such payment in full to the Operational Agent on such date, and the Operational Agent may, in reliance upon such assumption, cause to be distributed to each Lender on such due date an amount equal to the amount then due such Lender. If and to the extent the Borrower shall not have so made such payment in full to the Operational Agent, such Lender shall repay to the Operational Agent forthwith on demand such amount distributed to such Lender, together with interest thereon, for each day from the date such amount is distributed to such Lender until the date such Lender repays such amount to the Operational Agent, at the Federal Funds Rate. (f) Any amount payable by the Borrower hereunder or under any of the Notes that is not paid when due (whether at stated maturity, by acceleration or otherwise) shall (to the fullest extent permitted by law) bear interest, from the date when due until paid in full, at a rate per annum equal at all times to the Default Rate payable on demand. SECTION 5.02. Interest Rate Determination. (a) Each Reference Bank agrees to furnish to the Operational Agent timely information for the purpose of determining the Eurodollar Rate for each Interest Period. If any one or more of the Reference Banks shall not furnish such timely information to the Operational Agent for the purpose of determining any such interest rate, the Operational Agent shall determine such interest rate on the basis of timely information furnished by the remaining Reference Banks, subject to Section 3.04(c). (b) The Operational Agent shall give prompt notice to the Borrower and the Lenders of the applicable interest rate determined by the Operational Agent for purposes of Section 3.05(b)(i) or (ii), and the Eurodollar Rate, if any, furnished by each Reference Bank for the purpose of determining the applicable interest rate under Section 3.05(b)(ii). SECTION 5.03. Prepayments. The Borrower shall have no right to prepay any principal amount of any Advances other than as provided in subsections (a) and (b) below. (a) The Borrower may, upon at least five Business Days' notice to the Operational Agent stating the proposed date and aggregate principal amount of the prepayment, and if such notice is given, the Borrower shall, prepay the outstanding principal amounts of Advances made as part of the same Borrowing, in whole or ratably in part, together with (i) accrued interest to the date of such prepayment on the principal amount prepaid and (ii) in the case of Eurodollar Rate Advances, any amount payable to the Lenders pursuant to Section 5.04(c); provided, however, that each partial prepayment shall be in an aggregate principal amount of not less than $10,000,000 or an integral multiple of $1,000,000 in excess thereof. (b) On the date of any termination or optional or mandatory reduction of the Commitments pursuant to Section 2.03, the Borrower shall pay or prepay so much of the principal amount outstanding under this Agreement as shall be necessary in order that such aggregate principal amount outstanding will not exceed the Commitments following such termination or reduction, together with (i) accrued interest to the date of such prepayment on the principal amount repaid and (ii) in the case of prepayments of Eurodollar Rate Advances, any amount payable to the Lenders pursuant to Section 5.04(c). Any prepayments required by this subsection (b) shall be applied to outstanding Base Rate Advances up to the full amount thereof before they are applied, first, to outstanding Eurodollar Rate Advances and, second, as cash collateral, pursuant to the Cash Collateral Agreement, to secure LC Outstandings. SECTION 5.04. Yield Protection. (a) Increased Costs. If, due to either (i) the introduction of or any change in or in the interpretation of any law or regulation after the date hereof, or (ii) the compliance with any guideline or request from any central bank or other governmental authority (whether or not having the force of law) issued or made after the date hereof, there shall be reasonably incurred any increase in (A) the cost to any Lender of agreeing to make or making, funding or maintaining Eurodollar Rate Advances, or of participating in the issuance, maintenance or funding of any Letter of Credit, or (B) the cost to any LC Bank of issuing or maintaining any Letter of Credit, then the Borrower shall from time to time, upon demand by such Lender or LC Bank, as the case may be (with a copy of such demand to the Operational Agent), pay to the Operational Agent for the account of such Lender or LC Bank, as the case may be, additional amounts sufficient to compensate such Lender or LC Bank, as the case may be, for such increased cost. A certificate as to the amount of such increased cost and giving a reasonable explanation thereof, submitted to the Borrower and the Operational Agent by such Lender or such LC Bank, as the case may be, shall constitute such demand and shall be conclusive and binding for all purposes, absent manifest error. (b) Eurodollar Reserves. The Borrower shall pay to the Operational Agent for the account of each Lender, so long as such Lender shall be required under regulations of the Board of Governors of the Federal Reserve System to maintain reserves with respect to liabilities or assets consisting of or including Eurocurrency Liabilities, additional interest on the unpaid principal amount of each Eurodollar Rate Advance of such Lender, from the date of such Advance until such principal amount is paid in full, at an interest rate per annum equal at all times to the remainder obtained by subtracting (i) the Eurodollar Rate for the Interest Period for such Advance from (ii) the rate obtained by dividing such Eurodollar Rate by a percentage equal to 100% minus the Eurodollar Reserve Percentage of such Lender for such Interest Period, payable on each date on which interest is payable on such Advance. Such additional interest shall be determined by such Lender and notified to the Borrower and the Operational Agent. A certificate as to the amount of such additional interest, submitted to the Borrower and the Operational Agent by such Lender, shall be conclusive and binding for all purposes, absent manifest error. (c) Breakage. If, due to any prepayment pursuant to Section 5.03, an acceleration of maturity of the Advances pursuant to Section 9.02, or any other reason, any Lender receives payments of principal of any Eurodollar Rate Advance other than on the last day of the Interest Period relating to such Advance, or if the Borrower shall Convert any Eurodollar Rate Advances on any day other than the last day of the Interest Period therefor, the Borrower shall, promptly after demand by such Lender (with a copy of such demand to the Operational Agent), pay to the Operational Agent for the account of such Lender any amounts required to compensate such Lender for additional losses, costs, or expenses (including anticipated lost profits) that such Lender may reasonably incur as a result of such payment or Conversion, including, without limitation, any loss, cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund or maintain such Advance. For purposes of this subsection (c), a certificate setting forth the amount of such additional losses, costs, or expenses and giving a reasonable explanation thereof, submitted to the Borrower and the Operational Agent by such Lender, shall constitute such demand and shall be conclusive and binding for all purposes, absent manifest error. (d) Capital. If any Lender or LC Bank determines that (i) compliance with any law or regulation or any guideline or request from any central bank or other governmental authority (whether or not having the force of law) affects or would affect the amount of capital required or expected to be maintained by such Lender or LC Bank, whether directly, or indirectly as a result of commitments of any corporation controlling such Lender or LC Bank (but without duplication), and (ii) the amount of such capital is increased by or based upon (1) the existence of such Lender's or LC Bank's commitment to lend or issue or participate in any Letter of Credit hereunder, or (2) the participation in or issuance or maintenance of any Letter of Credit or Advance and (3) other similar such commitments, then, upon demand by such Lender or LC Bank, the Borrower shall immediately pay to the Operational Agent for the account of such Lender or LC Bank from time to time as specified by such Lender or LC Bank additional amounts sufficient to compensate such Lender or LC Bank in the light of such circumstances, to the extent that such Lender or LC Bank reasonably determines such increase in capital to be allocable to the transactions contemplated hereby. A certificate as to such amounts and giving a reasonable explanation thereof (to the extent permitted by law), submitted to the Borrower and the Operational Agent by such Lender or LC Bank, shall be conclusive and binding for all purposes, absent manifest error. (e) Notices. Each Lender hereby agrees to use its best efforts to notify the Borrower of the occurrence of any event referred to in subsection (a), (b), (c) or (d) of this Section 5.04 promptly after becoming aware of the occurrence thereof. The failure of any Lender to provide such notice or to make demand for payment under said subsection shall not constitute a waiver of such Lender's rights hereunder; provided that, notwithstanding any provision to the contrary contained in this Section 5.04, the Borrower shall not be required to reimburse any Lender for any amounts or costs incurred under (i) subsection (a), (c) or (d) above, more than 90 days prior to the date that such Lender notifies the Borrower in writing thereof, and (ii) subsection (b) above, more than 180 days prior to the date that such Lender notifies the Borrower in writing thereof, in each case unless, and to the extent that, any such amounts or costs so incurred shall relate to the retroactive application of any event notified to the Borrower which entitles such Lender to such compensation. If any Lender shall subsequently determine that any amount demanded and collected under this Section 5.04 was done so in error, such Lender will promptly return such amount to the Borrower. (f) Survival of Obligations. Subject to subsection (e) above, the Borrower's obligations under this Section 5.04 shall survive the repayment of all other amounts owing to the Lenders, the Agents and the LC Banks under the Loan Documents and the termination of the Commitments. If and to the extent that the obligations of the Borrower under this Section 5.04 are unenforceable for any reason, the Borrower agrees to make the maximum contribution to the payment and satisfaction thereof which is permissible under applicable law. SECTION 5.05. Sharing of Payments, Etc. If any Lender shall obtain any payment (whether voluntary, involuntary, through the exercise of any right of set-off, or otherwise) on account of the Advances owing to it (other than pursuant to Section 5.04) in excess of its ratable share of payments obtained by all the Lenders on account of the Advances of such Lenders, such Lender shall forthwith purchase from the other Lenders such participation in the Advances owing to them as shall be necessary to cause such purchasing Lender to share the excess payment ratably with each of them; provided, however, that if all or any portion of such excess payment is thereafter recovered from such purchasing Lender, such purchase from each Lender shall be rescinded and such Lender shall repay to the purchasing Lender the purchase price to the extent of such recovery together with an amount equal to such Lender's ratable share (according to the proportion of (i) the amount of such Lender's required repayment to (ii) the total amount so recovered from the purchasing Lender) of any interest or other amount paid or payable by the purchasing Lender in respect of the total amount so recovered. The Borrower agrees that any Lender so purchasing a participation from another Lender pursuant to this Section 5.05 may, to the fullest extent permitted by law, exercise all its rights of payment (including the right of set-off) with respect to such participation as fully as if such Lender were the direct creditor of the Borrower in the amount of such participation. Notwithstanding the foregoing, if any Lender shall obtain any such excess payment involuntarily, such Lender may, in lieu of purchasing participations from the other Lenders in accordance with this Section 5.05, on the date of receipt of such excess payment, return such excess payment to the Operational Agent for distribution in accordance with Section 5.01(a). SECTION 5.06. Taxes. (a) All payments by the Borrower hereunder and under the other Loan Documents shall be made in accordance with Section 5.01, free and clear of and without deduction for all present or future taxes, levies, imposts, deductions, charges or withholdings, and all liabilities with respect thereto, excluding, in the case of each Lender, each LC Bank and each Agent, taxes imposed on its overall net income, and franchise taxes imposed on it by the jurisdiction under the laws of which such Lender, LC Bank or Agent (as the case may be) is organized or any political subdivision thereof and, in the case of each Lender, taxes imposed on its overall net income, and franchise taxes imposed on it by the jurisdiction of such Lender's Applicable Lending Office or any political subdivision thereof (all such non-excluded taxes, levies, imposts, deductions, charges, withholdings and liabilities being hereinafter referred to as "Taxes"). If the Borrower shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder or under any other Loan Document to any Lender, LC Bank or Agent, (i) the sum payable shall be increased as may be necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section 5.06) such Lender, LC Bank or Agent (as the case may be) receives an amount equal to the sum it would have received had no such deductions been made, (ii) the Borrower shall make such deductions and (iii) the Borrower shall pay the full amount deducted to the relevant taxation authority or other authority in accordance with applicable law. (b) In addition, the Borrower agrees to pay any present or future stamp or documentary taxes or any other excise or property taxes, charges or similar levies that arise from any payment made hereunder or under any other Loan Document or from the execution, delivery or registration of, or otherwise with respect to, this Agreement or any other Loan Document (hereinafter referred to as "Other Taxes"). (c) The Borrower will indemnify each Lender, LC Bank and Agent for the full amount of Taxes and Other Taxes (including, without limitation, any Taxes and any Other Taxes imposed by any jurisdiction on amounts payable under this Section 5.06) paid by such Lender, LC Bank or Agent (as the case may be) and any liability (including penalties, interest and expenses) arising therefrom or with respect thereto, whether or not such Taxes or Other Taxes were correctly or legally asserted. This indemnification shall be made within 30 days from the date such Lender, LC Bank or Agent (as the case may be) makes written demand therefor; provided, that such Lender, LC Bank or Agent (as the case may be) shall not be entitled to demand payment under this Section 5.06 for an amount if such demand is not made within one year following the date upon which such Lender, LC Bank or Agent (as the case may be) shall have been required to pay such amount. (d) Within 30 days after the date of any payment of Taxes, the Borrower will furnish to the Documentation Agent, at its address referred to in Section 11.02, the original or a certified copy of a receipt evidencing payment thereof. (e) Each Bank represents and warrants that either (i) it is organized under the laws of a jurisdiction within the United States or (ii) it has delivered to the Borrower or the Operational Agent duly completed copies of such form or forms prescribed by the United States Internal Revenue Service indicating that such Bank is entitled to receive payments without deduction or withholding of any United States federal income taxes, as permitted by the Internal Revenue Code of 1986, as amended. Each other Lender agrees that, on or prior to the date upon which it shall become a party hereto, and upon the reasonable request from time to time of the Borrower or the Operational Agent, such Lender will deliver to the Borrower and the Operational Agent either (A) a statement that it is organized under the laws of a jurisdiction within the United States or (B) duly completed copies of such form or forms as may from time to time be prescribed by the United States Internal Revenue Service, indicating that such Lender is entitled to receive payments without deduction or withholding of any United States federal income taxes, as permitted by the Internal Revenue Code of 1986, as amended. Each Bank that has delivered, and each other Lender that hereafter delivers, to the Borrower and the Operational Agent the form or forms referred to in the two preceding sentences further undertakes to deliver to the Borrower and the Operational Agent further copies of such form or forms, or successor applicable form or forms, as the case may be, as and when any previous form filed by it hereunder shall expire or shall become incomplete or inaccurate in any respect. Each Lender represents and warrants that each such form supplied by it to the Operational Agent and the Borrower pursuant to this subsection (e), and not superseded by another form supplied by it, is or will be, as the case may be, complete and accurate. SECTION 6.01. Conditions Precedent to the Initial Extension of Credit. The obligation of each Lender to make its initial Extension of Credit is subject to the fulfillment of the following conditions precedent: (a) The Documentation Agent shall have received, on or before the day of the initial Extension of Credit, the following, each dated such day (except where specified otherwise below), in form and substance satisfactory to each Lender (except where otherwise specified below) and (except for the Notes) in sufficient copies for each Lender: (i) Certified copies of the resolutions of the Board of Directors, or of the Executive Committee of the Board of Directors, of the Borrower authorizing the Borrower to enter into this Agreement, the Notes and the other Loan Documents to which it is, or is to be, a party, and of all documents evidencing other necessary corporate action and governmental approvals, if any, with respect to this Agreement, the Notes and such Loan Documents. (ii)A certificate of the Secretary or an Assistant Secretary of the Borrower certifying the names, true signatures and incumbency of (A) the officers of the Borrower authorized to sign this Agreement, the Notes and the other Loan Documents to which it is, or is to be, a party, and the other documents to be delivered hereunder and thereunder and (B) the representatives of the Borrower authorized to sign notices to be provided under this Agreement and the other Loan Documents to which it is, or is to be, a party, which representatives shall be acceptable to the Co- Agents. (iii)Copies of the Certificate of Incorporation (or comparable charter document) and by-laws of the Borrower, together with all amendments thereto, certified by the Secretary or an Assistant Secretary of the Borrower. (iv)An irrevocable notice from the Borrower requesting termination of the "Commitments" under the Existing Agreement effective automatically on such date upon the satisfaction (or waiver) of the other conditions precedent set forth in this Section 6.01. (v) A Note, payable to the order of each Lender then party hereto, duly executed by the Borrower. (vi)The Cash Collateral Agreement duly executed by the Borrower together with evidence of the completion of all other actions as may be necessary or, in the opinion of the Co-Agents and counsel for the Co-Agents, desirable to perfect the security interests and liens created thereby. (vii)The Fee Letter, duly executed by the Borrower. (viii)A certified copy of Schedule II hereto, in form and substance reasonably satisfactory to the Co-Agents setting forth: (A)all Project Finance Debt of the Consolidated Subsidiaries, together with the Borrower's Ownership Interest in each such Consolidated Subsidiary; and (B)debt (as such term is construed in accordance with GAAP) of Enterprises as of the Closing Date. (A)Denise M. Sturdy, Esq., Assistant General Counsel of the Borrower, in substantially the form of Exhibit E and as to such other matters as the Majority Lenders, through the Documentation Agent, may reasonably request; and (B)King & Spalding, counsel to the Agents, in substantially the form of Exhibit F and as to such other matters as the Majority Lenders, through the Documentation Agent, may reasonably request. (x) Letters from each LC Bank (as defined in the Existing Agreement) confirming that the participation obligations of each Existing Bank has been terminated with respect to each Existing Letter of Credit. (b) The Existing Credit Agreement has been (or will have been, upon the first Extension of Credit and the application of the proceeds thereof) paid in full, the commitments thereunder terminated and all letters of credit issued thereunder either canceled or replaced. (c) The following statements shall be true and the Documentation Agent shall have received a certificate of a duly authorized officer of the Borrower, dated the Closing Date and in sufficient copies for each Lender stating that: (i) the representations and warranties set forth in Section 7.01 of this Agreement are true and correct on and as of the Closing Date as though made on and as of such date, and (ii)no event has occurred and is continuing that constitutes an Unmatured Default or an Event of Default. (d) The Borrower shall have paid all fees under or referenced in Section 2.02 hereof, to the extent then due and payable; and SECTION 6.02. Conditions Precedent to Each Extension of Credit. The obligation of each Lender or LC Bank, as the case may be, to make an Extension of Credit (including the initial Extension of Credit) shall be subject to the further conditions precedent that, on the date of such Extension of Credit and after giving effect thereto: (a) the following statements shall be true (and each of the giving of the applicable notice or request with respect thereto and the making of such Extension of Credit without prior correction by the Borrower shall (to the extent that such correction has been previously consented to by the Lenders and the LC Banks) constitute a representation and warranty by the Borrower that, on the date of such Extension of Credit, such statements are true): (i)the representations and warranties contained in Section 7.01 of this Agreement (other than those contained in subsections (e)(ii) and (f) thereof) and in Section 7 of the Cash Collateral Agreement are correct on and as of the date of such Extension of Credit, before and after giving effect to such Extension of Credit and to the application of the proceeds thereof, as though made on and as of such date; and (ii)no Event of Default has occurred and is continuing, or would result from such Extension of Credit or the application of the proceeds thereof; and (b) the Documentation Agent shall have received such other approvals, opinions and documents as any Lender or LC Bank, through the Documentation Agent, may reasonably request as to the legality, validity, binding effect or enforceability of the Loan Documents or the financial condition, results of operations, properties or business of the Borrower and its Consolidated Subsidiaries. SECTION 6.03. Conditions Precedent to Certain Extensions of Credit. The obligation of each Lender or LC Bank, as the case may be, to make an Extension of Credit (including the initial Extension of Credit) that would (after giving effect to all Extensions of Credit on such date and the application of proceeds thereof) increase the principal amount outstanding hereunder, or to make an Extension of Credit of the type described in clause (ii) or (iii) of the definition thereof (except any amendment of a Letter of Credit the sole effects of which are to extend the stated termination date thereof and/or to make nonmaterial modifications thereto), shall be subject to the further conditions precedent that, on the date of such Extension of Credit and after giving effect thereto: (a) the following statements shall be true (and each of the giving of the applicable notice or request with respect thereto and the making of such Extension of Credit without prior correction by the Borrower shall (to the extent that such correction has been previously consented to by the Lenders and the LC Banks) constitute a representation and warranty by the Borrower that, on the date of such Extension of Credit, such statements are true): (i) the representations and warranties contained in subsections (e)(ii) and (f) of Section 7.01 of this Agreement are correct on and as of the date of such Extension of Credit, before and after giving effect to such Extension of Credit and to the application of the proceeds thereof, as though made on and as of (ii)no Unmatured Default has occurred and is continuing, or would result from such Extension of Credit or the application of (b) the Documentation Agent shall have received such other approvals, opinions and documents as any Lender or LC Bank, through the Documentation Agent, may reasonably request. SECTION 6.04. Reliance on Certificates. The Lenders, the LC Banks and each Agent shall be entitled to rely conclusively upon the certificates delivered from time to time by officers of the Borrower as to the names, incumbency, authority and signatures of the respective persons named therein until such time as the Documentation Agent may receive a replacement certificate, in form acceptable to the Documentation Agent, from an officer of such Person identified to the Documentation Agent as having authority to deliver such certificate, setting forth the names and true signatures of the officers and other representatives of such Person thereafter authorized to act on behalf of such Person. SECTION 7.01. Representations and Warranties of the Borrower. The Borrower represents and warrants as follows: (a) Each of the Borrower, Consumers and each of the Restricted Subsidiaries is a corporation duly organized, validly existing and in good standing under the laws of the state of its incorporation and is duly qualified to do business in, and is in good standing in, all other jurisdictions where the nature of its business or the nature of property owned or used by it makes such qualification necessary. (b) The execution, delivery and performance by the Borrower of each Loan Document to which it is or will be a party (i) are within the Borrower's corporate powers, (ii) have been duly authorized by all necessary corporate action and (iii) do not and will not (A) require any consent or approval of the stockholders of the Borrower, (B) violate any provision of the charter or by-laws of the Borrower or of law, (C) violate any legal restriction binding on or affecting the Borrower, (D) result in a breach of, or constitute a default under, any indenture or loan or credit agreement or any other agreement, lease or instrument to which the Borrower is a party or by which it or its properties may be bound or affected, or (E) result in or require the creation of any Lien (other than pursuant to the Loan Documents) upon or with respect to any of its properties. (c) No Governmental Approval is required. (d) This Agreement is, and each other Loan Document to which the Borrower will be a party when executed and delivered hereunder will be, legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with their respective terms; subject to the qualification, however, that the enforcement of the rights and remedies herein and therein is subject to bankruptcy and other similar laws of general application affecting rights and remedies of creditors and the application of general principles of equity (regardless of whether considered in a proceeding in equity or at law). (e) (i) The consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as at December 31, 1994, and the related consolidated statements of income, retained earnings and cash flows of the Borrower and its Consolidated Subsidiaries for the fiscal year then ended, together with the report thereon of Arthur Andersen & Co. included in the Borrower's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, and the unaudited consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as at September 30, 1995, and the related unaudited consolidated statements of income, retained earnings and cash flows for the nine-month period then ended, copies of each of which have been furnished to each Lender, fairly present (subject, in the case of such balance sheets and statements of income for the nine months ended September 30, 1995, to year-end adjustments) the financial condition of the Borrower and its Consolidated Subsidiaries as at such dates and the results of operations of the Borrower and its Consolidated Subsidiaries for the periods ended on such dates, all in accordance with generally accepted accounting principles consistently applied; (ii) since December 31, 1994, except as disclosed in the Borrower's Quarterly Report on Form 10-Q for the period ended September 30, 1995, there has been no material adverse change in the business, financial condition or results of operations of the Borrower and its Subsidiaries, considered as a whole, or in the Borrower's ability to perform its obligations under this Agreement or any other Loan Document to which it is or will be a party; and (iii) the Borrower has no material liabilities or obligations except as reflected in the foregoing financial statements and in Schedule II hereto, as evidenced by the Loan Documents and as may be incurred, in accordance with the terms of this Agreement, in the ordinary course of business (as presently conducted) following the date of this Agreement. (f) Except as disclosed in the Borrower's Quarterly Report on Form 10-Q for the period ended September 30, 1995, there are no pending or threatened actions, suits or proceedings against or, to the knowledge of the Borrower, affecting the Borrower or any of its Subsidiaries or the properties of the Borrower or any of its Subsidiaries before any court, governmental agency or arbitrator, that would, if adversely determined, reasonably be expected to materially adversely affect the financial condition, properties, business or operations of the Borrower and it Subsidiaries, considered as a whole, or affect the legality, validity or enforceability of this Agreement or any other Loan Document. (g) All insurance required by Section 8.01(b) is in full force and effect. (h) No Plan Termination Event has occurred nor is reasonably expected to occur with respect to any Plan of the Borrower or any of its ERISA Affiliates which would result in a material liability to the Borrower, except as disclosed and consented to by the Majority Lenders in writing from time to time. Since the date of the most recent Schedule B (Actuarial Information) to the annual report of the Borrower (Form 5500 Series), if any, there has been no material adverse change in the funding status of the Plans referred therein and no "prohibited transaction" has occurred with respect thereto which is reasonably expected to result in a material liability to the Borrower. Neither the Borrower nor any of its ERISA Affiliates has incurred nor reasonably expects to incur any material withdrawal liability under ERISA to any Multiemployer Plan, except as disclosed and consented to by the Majority Lenders in writing from time to time. (i) No fire, explosion, accident, strike, lockout or other labor dispute, drought, storm, hail, earthquake, embargo, act of God or of the public enemy or other casualty (except for any such circumstance, if any, which is covered by insurance which coverage has been confirmed and not disputed by the relevant insurer) affecting the properties, business or operations of the Borrower, Consumers or any Restricted Subsidiary has occurred that could reasonably be expected to have a material adverse effect on the business, financial condition or results of operations of (A) the Borrower and its Subsidiaries, considered as a whole, or (B) Consumers and its Subsidiaries, considered as a whole. (j) The Borrower and its Subsidiaries have filed all tax returns (Federal, state and local) required to be filed and paid all taxes shown thereon to be due, including interest and penalties, or, to the extent the Borrower or any of its Subsidiaries is contesting in good faith an assertion of liability based on such returns, has provided adequate reserves for payment thereof in accordance with GAAP. (k) No extraordinary judicial, regulatory or other legal constraints exist which limit or restrict Consumers' ability to declare or pay cash dividends with respect to its capital stock. (l) The Borrower owns 100% of the outstanding shares of common stock of Enterprises. (m) The Borrower owns not less than 80% of the outstanding shares of common stock of Consumers. (n) The CMS Energy Corporation 1995-1999 Financial Forecast, dated August 21, 1995 (the "Projections"), copies of which have been distributed to the Banks, is based upon assumptions that the Borrower believed were reasonable at the time the Projections were delivered, and all other financial information previously delivered by the Borrower to the Co-Agents are true and correct in all material respects as at the dates and for the periods indicated therein. (o) The executed and delivered Cash Collateral Agreement creates a valid, perfected, first priority Lien in the Collateral (other than the "Account", as such term is defined therein) described therein, subject only to Liens permitted by Section 8.02(a), and all filings and other actions necessary to perfect and protect such security interests have been taken. (p) The Borrower is not engaged in the business of extending credit for the purpose of buying or carrying margin stock (within the meaning of Regulation U issued by the Board of Governors of the Federal Reserve System), and no proceeds of any Advance or any drawing under any Letter of Credit will be used to buy or carry any margin stock or to extend credit to others for the purpose of buying or carrying any margin stock. (q) The Borrower is not an investment company (within the meaning of the Investment Company Act of 1940, as amended). (r) No proceeds of any Extension of Credit or any drawing under any Letter of Credit will be used to acquire any equity security of a class that is registered pursuant to Section 12 of the Exchange Act. (s) Following application of the proceeds of each Extension of Credit, not more than 25 percent of the value of the assets of the Borrower and its Subsidiaries on a consolidated basis will be margin stock (within the meaning of Regulation U issued by the Board of Governors of the Federal Reserve System). SECTION 8.01. Affirmative Covenants. So long as any Note shall remain unpaid, any Letter of Credit shall remain outstanding or any Lender shall have any Commitment: (a) Payment of Taxes, Etc. The Borrower shall pay and discharge, and each of its Subsidiaries shall pay and discharge, before the same shall become delinquent, all taxes, assessments and governmental charges, royalties or levies imposed upon it or upon its property except, in the case of taxes, to the extent the Borrower or any Subsidiary, as the case may be, is contesting the same in good faith and by appropriate proceedings and has set aside adequate reserves for the payment thereof in accordance with GAAP. (b) Maintenance of Insurance. The Borrower shall maintain, and each of its Restricted Subsidiaries and Consumers shall maintain, insurance covering the Borrower, each of its Restricted Subsidiaries, Consumers and their respective properties in effect at all times in such amounts and covering such risks as is usually carried by companies engaged in similar businesses and owning similar properties in the same general geographical area in which the Borrower, its Restricted Subsidiaries and Consumers operates, either with reputable insurance companies or, in whole or in part, by establishing reserves of one or more insurance funds, either alone or with other corporations or associations. (c) Preservation of Existence, Etc. The Borrower shall preserve and maintain, and each of its Restricted Subsidiaries and Consumers shall preserve and maintain, its corporate existence, material rights (statutory and otherwise) and franchises, and take such other action as may be necessary or advisable to preserve and maintain its right to conduct its business in the states where it shall be conducting its business. (d) Compliance with Laws, Etc. The Borrower shall comply, and each of its Restricted Subsidiaries and Consumers shall comply, in all material respects with the requirements of all applicable laws, rules, regulations and orders of any governmental authority, including without limitation any such laws, rules, regulations and orders relating to zoning, environmental protection, use and disposal of Hazardous Substances, land use, construction and building restrictions, and employee safety and health matters relating to business operations. (e) Inspection Rights. Subject to the requirements of laws or regulations applicable to the Borrower or its Subsidiaries, as the case may be, and in effect at the time, at any time and from time to time upon reasonable notice, the Borrower shall permit (i) the Co-Agents and their respective agents and representatives to examine and make copies of and abstracts from the records and books of account of, and the properties of, the Borrower or any of its Subsidiaries and (ii) the Co-Agents, each of the Lenders, and their respective agents and representatives to discuss the affairs, finances and accounts of the Borrower and its Subsidiaries with the Borrower and its Subsidiaries and their respective officers, directors and accountants, in each case, to the extent that any out-of- pocket expenses are incurred in connection therewith at such time as no Event of Default or Unmatured Default shall have occurred and be continuing, at the expense of the Co-Agents, each of the Lenders, or their respective agents and representatives, as the case may be. (f) Keeping of Books. The Borrower shall keep, and each of its Subsidiaries shall keep, proper records and books of account, in which full and correct entries shall be made of all financial transactions of the Borrower and its Subsidiaries and the assets and business of the Borrower and its Subsidiaries, in accordance with GAAP. (g) Maintenance of Properties, Etc. The Borrower shall maintain, and each of its Restricted Subsidiaries shall maintain, in substantial conformity with all laws and material contractual obligations, good and marketable title to all of its properties which are used or useful in the conduct of its business; provided, however, that the foregoing shall not restrict the sale of any asset of the Borrower or any Restricted Subsidiary to the extent not prohibited by Section 8.02(i). In addition, the Borrower shall preserve, maintain, develop, and operate, and each of its Subsidiaries shall preserve, maintain, develop and operate, in substantial conformity with all laws and material contractual obligations, all of its material properties which are used or useful in the conduct of its business in good working order and condition, ordinary wear and tear excepted. (h) Use of Proceeds. The Borrower shall apply the proceeds of the initial Extension of Credit, to the extent necessary, to the repayment in full and termination of all outstanding obligations under the Existing Agreement, whether for principal, interest, fees, or otherwise (and, in furtherance thereof, the Borrower hereby expressly and irrevocably authorizes the Operational Agent to so apply such proceeds to such repayment), and use all subsequent Extensions of Credit for general corporate purposes (subject to the terms and conditions of this Agreement). (i) Consolidated Leverage Ratio. The Borrower shall maintain at all times a ratio of Consolidated Debt to Consolidated Capital of not more than the amount set forth below during each corresponding period set forth below: Closing Date through 9/30/96 .70:1.0 (j) Cash Dividend Coverage Ratio. The Borrower shall maintain, as of the last day of each fiscal quarter (in each case, the "Measurement Quarter"), a ratio of (i) the sum of (A) Cash Dividend Income for the immediately preceding four-fiscal-quarter period ending on the last day of the fiscal quarter immediately preceding such Measurement Quarter, plus (B) 25% of the amount of Equity Distributions received by the Borrower during such period but in no event in excess of $10,000,000, plus (C) all amounts received by the Borrower from its Subsidiaries and Affiliates during such period constituting reimbursement of interest expense (including commitment, guaranty and letter of credit fees) paid by the Borrower on behalf of any such Subsidiary or Affiliate to (ii) interest expense (including commitment, guaranty and letter of credit fees) accrued by the Borrower in respect of all Debt during such period of (1) not less than 2.1 to 1.0 for each such period from the Closing Date until (and including) the fiscal quarter ending December 31, 1998 and (2) not less than 2.0 to 1.0 thereafter; provided, that the Borrower shall be deemed not to be in breach of the foregoing covenant if, during the Measurement Quarter, it has a) permanently reduced the Commitments and the principal amount outstanding under this Agreement and the Notes such that the amount determined pursuant to clause (ii) above, when recalculated on a pro forma basis assuming that the amount of such reduced Commitments and principal amount outstanding under this Agreement and the Notes were in effect at all times during such four-fiscal-quarter period, would result in the Borrower being in compliance with such ratio, and/or b) increased Cash Dividend Income during such Measurement Quarter such that the ratio of (x) Cash Dividend Income for the four-fiscal- quarter period ending on the last day of the Measurement Quarter to (y) the amount determined pursuant to clause (ii) above (as recalculated pursuant to clause a) above), equals or exceeds (1) 2.1 to 1.0 for each such period from the Closing Date until (and including) the fiscal quarter ending December 31, 1998 and (2) 2.0 to 1.0 thereafter; and provided further, that until the Borrower so reduces such Commitments and principal amount outstanding under this Agreement and the Notes and/or increases Cash Dividend Income during such Measurement Quarter, the Borrower may not request any additional Extensions of Credit (other than Conversions). (k) Refinancing of Senior Note Debt. In connection with any refinancings of the Senior Note Debt, the Borrower shall cause the maturity thereof to be no sooner than the earlier to occur of (i) the third anniversary of the date of any such refinancing and (ii) the then- scheduled maturity date of the Senior Notes being refinanced. (l) Further Assurances. The Borrower shall promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary or that any Lender through the Documentation Agent may reasonably request in order to give effect to the transactions contemplated by this Agreement and the other Loan Documents. In addition, the Borrower will use all reasonable efforts to duly obtain or make Governmental Approvals required from time to time on or prior to such date as the same may become legally required. SECTION 8.02. Negative Covenants. So long as any Note shall remain unpaid, any Letter of Credit shall remain outstanding or any Lender shall have any Commitment, the Borrower shall not, without the written consent of the Majority Lenders: (a) Liens, Etc. Create, incur, assume or suffer to exist, or permit any of its Restricted Subsidiaries to create, incur, assume or suffer to exist, any lien, security interest, or other charge or encumbrance (including the lien or retained security title of a conditional vendor) of any kind, or any other type of arrangement intended or having the effect of conferring upon a creditor a preferential interest upon or with respect to any of its properties of any character (including, without limitation, capital stock of Consumers, Enterprises, Nomeco and any of the Borrower's other directly-owned Subsidiaries and accounts) (any of the foregoing being referred to herein as a "Lien"), whether now owned or hereafter acquired, or sign or file, or permit any of its Restricted Subsidiaries to sign or file, under the Uniform Commercial Code of any jurisdiction a financing statement which names the Borrower or any Restricted Subsidiary as debtor, sign, or permit any of its Restricted Subsidiaries to sign, any security agreement authorizing any secured party thereunder to file such financing statement, or assign, or permit any of its Restricted Subsidiaries to assign, accounts, excluding, however, from the operation of the foregoing restrictions the Liens created under the Loan Documents and the following: (i) Liens for taxes, assessments or governmental charges or levies to the extent not past due; (ii)cash pledges or deposits to secure (A) obligations under workmen's compensation laws or similar legislation, (B) public or statutory obligations of the Borrower or any of its Restricted Subsidiaries, or (C) Support Obligations of the Borrower; provided that the aggregate amount of pledges or deposits securing such Support Obligations shall not exceed $30 million at any one time (iii)Liens imposed by law, such as materialmen's, mechanics', carriers', workmen's and repairmen's liens and other similar Liens arising in the ordinary course of business securing obligations which are not overdue or which have been fully bonded and are being contested in good faith; and (iv)purchase money Liens or purchase money security interests upon or in property acquired or held by the Borrower or any of its Restricted Subsidiaries in the ordinary course of business to secure the purchase price of such property or to secure indebtedness incurred solely for the purpose of financing the acquisition of any such property to be subject to such Liens or security interests, or Liens or security interests existing on any such property at the time of acquisition, or extensions, renewals or replacements of any of the foregoing for the same or a lesser amount, provided that no such Lien or security interest shall extend to or cover any property other than the property being acquired and no such extension, renewal or replacement shall extend to or cover property not theretofore subject to the Lien or security interest being extended, renewed or replaced, and provided, further, that the aggregate principal amount of the Debt at any one time outstanding secured by Liens permitted by this clause (iv) shall not exceed $10,000,000. (b) Enterprises Debt. Permit Enterprises to create, incur, assume or suffer to exist any debt (as such term is construed in accordance with GAAP) other than: (i) debt arising by reason of the endorsement of negotiable instruments for deposit or collection or similar transactions in the ordinary course of Enterprises' business; (ii)in the form of indemnities in respect of unfiled mechanics' liens and Liens affecting Enterprises' properties permitted under Section 8.02(a)(iii); and (iii)other debt of Enterprises outstanding on the Closing Date set forth on Schedule II hereto; (c) Lease Obligations. Create, incur, assume or suffer to exist, or permit any of its Restricted Subsidiaries to create, incur, assume or suffer to exist, any obligations as lessee for the rental or hire of real or personal property of any kind under leases or agreements to lease (other than leases which constitute Debt) having an original term of one year or more which would cause the aggregate direct or contingent liabilities of the Borrower and its Restricted Subsidiaries in respect of all such obligations payable in any period of 12 consecutive calendar months to exceed $10,000,000. (d) Investments in Other Persons. Upon the occurrence and during the continuance of an Event of Default or an Unmatured Default (other than an Unmatured Default that occurs and is continuing prior to the last day of any Measurement Quarter resulting from the failure of the Borrower to comply with the ratio set forth in Section 8.01(j)), make, or permit any of its Restricted Subsidiaries to make, any loan or advance to any Person or purchase or otherwise acquire any capital stock, obligations or other securities of, make any capital contribution to, or otherwise invest in, any Person, other than Permitted Investments. (e) Restricted Payments. Declare or pay, or permit any of its Restricted Subsidiaries to declare or pay, directly or indirectly, any dividend, payment or other distribution of assets, properties, cash, rights, obligations or securities on account of any share of any class of capital stock of the Borrower or any of its Restricted Subsidiaries (other than (1) stock splits and dividends payable solely in nonconvertible equity securities of the Borrower and (2) distributions made to the Borrower or a Restricted Subsidiary), or purchase, redeem, retire, or otherwise acquire for value, or permit any of its Restricted Subsidiaries to purchase, redeem, retire, or otherwise acquire for value, any shares of any class of capital stock of the Borrower or any of its Restricted Subsidiaries or any warrants, rights, or options to acquire any such shares, now or hereafter outstanding, or make, or permit any of its Restricted Subsidiaries to make, any distribution of assets to any of its shareholders (other than distributions to the Borrower or a Restricted Subsidiary) (any such dividend, payment, distribution, purchase, redemption, retirement or acquisition being hereinafter referred to as a "Restricted Payment"), unless (i) no Unmatured Default or Event of Default has occurred and is continuing or would occur as a result of such Restricted Payment, and (ii) after giving effect thereto, the aggregate amount of all such Restricted Payments made since September 30, 1993 shall not have exceeded the sum of (A) $120,000,000, (B) 100% of Consolidated Net Income (as defined in the Indenture in effect on the date hereof) accrued during the period (treated as one accounting period) from September 30, 1993 to the end of the most recent fiscal quarter of the Borrower ending at least 45 days prior to the date of such Restricted Payment (or, in case such amount shall be a deficit, minus 100% of such deficit), and (C) the aggregate Net Proceeds (as defined in the Indenture in effect on the date hereof) received by the Borrower from any issuance or sale of, or contribution with respect to, its capital stock subsequent to September 30, 1993; provided, however, that the foregoing shall not prohibit (1) any purchase or redemption of capital stock of the Borrower made by exchange for, or out of the proceeds of the substantially concurrent sale of, capital stock of the Borrower (other than Redeemable Stock or Exchangeable Stock (as such terms are defined in the Indenture in effect on the date hereof)), provided that such purchase or redemption shall be excluded from the calculation of the amount of Restricted Payments permitted by this subsection (e); (2) dividends or other distributions paid in respect of any class of the Borrower's capital stock issued in respect of the acquisition of any business or assets by the Borrower or a Restricted Subsidiary where the dividends or other distributions with respect to such capital stock are payable solely from the net earnings of such business or assets; (3) dividends paid within 60 days after the date of declaration thereof if at such date of declaration such dividend would have complied with this subsection (e), provided that at the time of payment of such dividend, no Unmatured Default or Event of Default shall have occurred and be continuing (or result therefrom), and provided further that such dividends shall be included (without duplication) in the calculation of the amount of Restricted Payments permitted by this subsection (e); or (4) payments made by the Borrower or any Restricted Subsidiary pursuant to the Tax Sharing Agreement. For purposes of this subsection (e), the amount of any Restricted Payment not in the form of cash shall be the fair market value of such Restricted Payment as determined in good faith by the Board of Directors of the Borrower, provided that if the value of the non-cash portion of such Restricted Payment as determined by the Borrower's Board of Directors is in excess of $25 million, such value shall be based on an opinion from a nationally-recognized firm acceptable to the Co-Agents experienced in the appraisal of similar types of property or transactions. (f) Compliance with ERISA. (i) Permit to exist any "accumulated funding deficiency" (as defined in Section 412(a) of the Internal Revenue Code of 1986), (ii) terminate, or permit any ERISA Affiliate to terminate, any Plan so as to result in any material (in the opinion of the Majority Lenders) liability of the Borrower, any Restricted Subsidiary or Consumers to the PBGC, or (iii) permit to exist any occurrence of any Reportable Event (as defined in Title IV of ERISA), or any other event or condition, which presents a material (in the opinion of the Majority Lenders) risk of such a termination by the PBGC of any Plan and such a material liability to the Borrower, any Restricted Subsidiary or Consumers. (g) Transactions with Affiliates. Enter into, or permit any of its Subsidiaries to enter into, any transaction with any of its Affiliates unless such transaction is on terms no less favorable to the Borrower or such Subsidiary than if the transaction had been negotiated in good faith on an arm's-length basis with a non-Affiliate. (h) Mergers, Etc. Merge with or into or consolidate with or into, or permit any of its Restricted Subsidiaries, Consumers or Nomeco to merge with or into or consolidate with or into, any other Person, except that (1) any Restricted Subsidiary (other than Enterprises) may merge into any other Restricted Subsidiary; (2) Nomeco may merge with or into Enterprises or the Borrower; (3) Nomeco may merge with or into any other Person, provided that, in connection with such merger, Enterprises shall have received fair consideration (as determined by the Board of Directors of Enterprises or the Borrower); (4) any Restricted Subsidiary may merge with or into the Borrower, and the Borrower may merge with any other Person, provided that, immediately after giving effect to any such merger, (A) no event shall occur and be continuing which constitutes an Unmatured Default or an Event of Default, (B) the Borrower is the surviving corporation, and (C) the Borrower shall not be liable with respect to any Debt or allow its property to be subject to any Lien which it could not become liable with respect to or allow its property to become subject to under this Agreement or any other Loan Document on the date of such transaction; (5) Consumers may merge with any other Person, provided that, immediately after giving effect thereto, (w) no event shall occur and be continuing which constitutes an Unmatured Default or an Event of Default, (x) Consumers is the surviving corporation, (y) the Borrower shall continue to own not less than 80% of the outstanding shares of common stock of Consumers and (z) Consumers' Net Worth shall be equal to or greater than its Net Worth immediately prior to such merger; and (6) any Person (other than the Borrower and its Affiliates) may merge with or into Enterprises, provided that, immediately after giving effect thereto, (A) no event shall occur and be continuing which constitutes an Unmatured Default or an Event of Default, (B) Enterprises is the surviving corporation, (C) Enterprises' Net Worth shall be equal to or greater than its Net Worth immediately prior to such merger and (D) Enterprises shall not be liable with respect to any Debt or allow its property to be subject to any Lien which it could not become liable with respect to or allow its property to become subject to under this Agreement or any other Loan Document on the date of such transaction; provided, that after giving effect to any merger described in clause (2), (3), or (5) above, the Borrower shall be in compliance with Section 8.01(i). (i) Sales, Etc., of Assets. Sell, lease, transfer, assign, or otherwise dispose of all or any substantial part of its assets, or permit any of its Restricted Subsidiaries to sell, lease, transfer, or otherwise dispose of all or any substantial part of its assets, except to give effect to a transaction permitted by subsection (h) above or subsection (j) below. (j) Maintenance of Ownership of Subsidiaries. Sell, transfer, assign or otherwise dispose of any shares of capital stock of any of its Restricted Subsidiaries or Consumers (other than preferred or preference stock of Consumers) or any warrants, rights or options to acquire such capital stock, or permit any Restricted Subsidiary or Consumers to issue, sell, transfer, assign or otherwise dispose of any shares of its capital stock (other than preferred or preference stock of Consumers) or the capital stock of any other Restricted Subsidiary or any warrants, rights or options to acquire such capital stock, except to give effect to a transaction permitted by subsection (h) above; provided, however, that (i) the Borrower may sell, transfer, assign or otherwise dispose of not more than 20% of the common stock of Consumers, provided that after giving effect to such transaction the Borrower shall be in compliance with Section 8.01(i) and (ii) Enterprises may, and the Borrower may permit Enterprises to, sell, transfer, assign or otherwise dispose of not more than 49% of the common stock of any Enterprises Significant Subsidiary, provided that after giving effect to such transaction the Borrower shall be in compliance with Section 8.01(i). (k) Amendment of Tax Sharing Agreement. Directly or indirectly, amend, modify, supplement, waive compliance with, seek a waiver under, or assent to noncompliance with, any term, provision or condition of the Tax Sharing Agreement if the effect of such amendment, modification, supplement, waiver or assent is to (i) reduce materially any amounts otherwise payable to, or increase materially any amounts otherwise owing or payable by, the Borrower thereunder, or (ii) change materially the timing of any payments made by or to the Borrower thereunder. SECTION 8.03. Reporting Obligations. So long as any Note shall remain unpaid, any Letter of Credit shall remain outstanding or any Lender shall have any Commitment, the Borrower will, unless the Majority Lenders shall otherwise consent in writing, furnish to each Lender, the following: (a) as soon as possible and in any event within five days after the Borrower knows or should have reason to know of the occurrence of each Unmatured Default or Event of Default continuing on the date of such statement, a statement of the chief financial officer or chief accounting officer of the Borrower setting forth details of such Unmatured Default or Event of Default and the action that the Borrower proposes to take with (b) as soon as available and in any event within 60 days after the end of each of the first three quarters of each fiscal year of the Borrower, a consolidated balance sheet of the Borrower and its Subsidiaries as at the end of such quarter and consolidated statements of income and retained earnings and of cash flows of the Borrower and its Subsidiaries for the period commencing at the end of the previous fiscal year and ending with the end of such quarter (which requirement shall be deemed satisfied by the delivery of the Borrower's quarterly report on Form 10-Q for such quarter), all in reasonable detail and duly certified (subject to year-end audit adjustments) by the chief financial officer or chief accounting officer of the Borrower as having been prepared in accordance with GAAP, together with (A) a schedule (substantially in the form of Exhibit G appropriately completed) of (1) the computations used by the Borrower in determining compliance with the covenants contained in Sections 8.01(i) and 8.01(j) and, after the enactment of any Consumers Dividend Restriction, the ratio set forth in Section 9.01(k), (2) all Project Finance Debt of the Consolidated Subsidiaries, together with the Borrower's Ownership Interest in each such Consolidated Subsidiary and (3) all Support Obligations of the Borrower of the types described in clauses (iv) and (v) of the definition of Support Obligations (whether or not each such Support Obligation or the primary obligation so supported is fixed, conclusively determined or reasonably quantifiable) to the extent such Support Obligations have not been previously disclosed as "Consolidated Debt" pursuant to clause (1) above, and (B) a certificate of said officer stating that no Unmatured Default or Event of Default has occurred and is continuing or, if an Unmatured Default or Event of Default has occurred and is continuing, a statement as to the nature thereof and the action that the Borrower proposes to take with respect thereto; (c) as soon as available and in any event within 120 days after the end of each fiscal year of the Borrower and its Subsidiaries, a copy of the Annual Report on Form 10-K (or any successor form) for the Borrower and its Subsidiaries for such year, including therein a consolidated balance sheet of the Borrower and its Subsidiaries as of the end of such fiscal year and consolidated statements of income and retained earnings and of cash flows of the Borrower and its Subsidiaries for such fiscal year, accompanied by a report thereon of Arthur Andersen & Co. or another nationally-recognized independent public accounting firm, together with a schedule in form satisfactory to the Majority Lenders of (A) the computations used by such accounting firm in determining, as of the end such fiscal year, compliance with the covenants contained in Sections 8.01(i) and 8.01(j) and, after the enactment of any Consumers Dividend Restriction, the ratio set forth in Section 9.01(k), (B) all Project Finance Debt of the Consolidated Subsidiaries, together with the Borrower's Ownership Interest in each such Consolidated Subsidiary and (C) all Support Obligations of the Borrower of the types described in clauses (iv) and (v) of the definition of Support Obligations (whether or not each such Support Obligation or the primary obligation so supported is fixed, conclusively determined or reasonably quantifiable) to the extent such Support Obligations have not been previously disclosed as "Consolidated Debt" pursuant to clause (A) (d) as soon as available and in any event within 60 days after the end of each of the first three quarters of each fiscal year of the Borrower, a balance sheet of the Borrower as at the end of such quarter and statements of income and retained earnings and of cash flows of the Borrower for the period commencing at the end of the previous fiscal year and ending with the end of such quarter, all in reasonable detail and duly certified (subject to year-end audit adjustments) by the chief financial officer or chief accounting officer of the Borrower as having been prepared in (e) as soon as available and in any event within 120 days after the end of each fiscal year of the Borrower, a balance sheet of the Borrower as at the end of such fiscal year and statements of income and retained earnings and of cash flows of the Borrower for such fiscal year, all in reasonable detail and duly certified (subject to year-end audit adjustments) by the chief financial officer or chief accounting officer of the Borrower as having been prepared in accordance with GAAP; (f) as soon as possible and in any event (A) within 30 days after the Borrower knows or has reason to know that any Plan Termination Event described in clause (i) of the definition of Plan Termination Event with respect to any Plan of the Borrower or any ERISA Affiliate of the Borrower has occurred and could reasonably be expected to result in a material liability to the Borrower and (B) within 10 days after the Borrower knows or has reason to know that any other Plan Termination Event with respect to any Plan of the Borrower or any ERISA Affiliate of the Borrower has occurred and could reasonably be expected to result in a material liability to the Borrower, a statement of the chief financial officer or chief accounting officer of the Borrower describing such Plan Termination Event and the action, if any, which the Borrower proposes to take with respect thereto; (g) promptly after receipt thereof by the Borrower or any of its ERISA Affiliates from the PBGC copies of each notice received by the Borrower or any such ERISA Affiliate of the PBGC's intention to terminate any Plan or to have a trustee appointed to (h) promptly and in any event within 30 days after the filing thereof with the Internal Revenue Service, copies of each Schedule B (Actuarial Information) to the annual report (Form 5500 Series) with respect to each Plan (if any) to which the Borrower is a (i) promptly after receipt thereof by the Borrower or any of its ERISA Affiliates from a Multiemployer Plan sponsor, a copy of each notice received by the Borrower or any of its ERISA Affiliates concerning the imposition or amount of withdrawal liability in an aggregate principal amount of at least $250,000 pursuant to Section 4202 of ERISA in respect of which the Borrower is reasonably expected to be liable; (j) promptly after the Borrower becomes aware of the occurrence thereof, notice of all actions, suits, proceedings or other events of the type described in Section 7.01(f); (k) promptly after the sending or filing thereof, copies of all proxy statements, financial statements and reports which the Borrower sends to its public security holders (if any), copies of all regular, periodic and special reports which the Borrower files with the Securities and Exchange Commission or any governmental authority which may be substituted therefor, or with any national securities exchange, pursuant to the Exchange Act, and copies of all final prospectuses with respect to any securities issued or to be issued by the Borrower or any of its Subsidiaries; (l) as soon as possible and in any event within five days after the occurrence of any material default under any material agreement to which the Borrower or any of its Subsidiaries is a party, which default would materially adversely affect the financial condition, business, results of operations or property of the Borrower and its Subsidiaries, considered as a whole, any of which is continuing on the date of such certificate, a certificate of the chief financial officer of the Borrower setting forth the details of such material default and the action which the Borrower or any such Subsidiary proposes to take with respect (m) promptly after requested, such other information respecting the business, properties, condition or operations, financial or otherwise, of the Borrower and its Subsidiaries as any Agent or the Majority Lenders may from time to time reasonably request in writing. SECTION 9.01. Events of Default. If any of the following events (each an "Event of Default") shall occur and be continuing, the Co-Agents and the Lenders shall be entitled to exercise the remedies set forth in Section 9.02: (a) The Borrower shall fail to pay (i) any principal of any Note when due or (ii) any interest thereon within two Business Days after such interest shall have become due; or (b) Any representation or warranty made by or on behalf of the Borrower in any Loan Document or certificate or other writing delivered pursuant thereto shall prove to have been incorrect in any material respect when made or deemed made; or (c) The Borrower or any of its Subsidiaries shall fail to perform or observe any term or covenant on its part to be performed or observed contained in Section 8.01(c), (h), (i) or (j) or in Section 8.02 hereof (and the Borrower, each Lender and each Agent hereby agrees that an Event of Default under this subsection (c) shall be given effect as if the defaulting Subsidiary were a party to this Agreement); or (d) The Borrower or any of its Subsidiaries shall fail to perform or observe any other term or covenant on its part to be performed or observed contained in any Loan Document and any such failure shall remain unremedied, after written notice thereof shall have been given to the Borrower by the Documentation Agent, for a period of 10 Business Days (and the Borrower, each Lender and each Agent hereby agrees that an Event of Default under this subsection (d) shall be given effect as if the defaulting Subsidiary were a party to this Agreement); or (e) The Borrower, any Restricted Subsidiary or Consumers shall fail to pay any of its Debt (including any interest or premium thereon but excluding Debt evidenced by the Notes) (i) aggregating, in the case of the Borrower and each Restricted Subsidiary, $6,000,000 or more or, in the case of Consumers, $25,000,000 or more, or (ii) arising under the Indenture or any Senior Note, when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) and such failure shall continue after the applicable grace period, if any, specified in any agreement or instrument relating to such Debt; or any other default under any agreement or instrument relating to any such Debt, or any other event, shall occur and shall continue after the applicable grace period, if any, specified in such agreement or instrument, if the effect of such default or event is to accelerate, or to permit the acceleration of, the maturity of such Debt; or any such Debt shall be declared to be due and payable, or required to be prepaid (other than by a regularly scheduled required prepayment) prior to the stated maturity thereof; unless in each such case the obligee under or holder of such Debt shall have waived in writing such circumstance so that such circumstance is no longer continuing; or (f) (i) The Borrower, any Restricted Subsidiary or Consumers shall generally not pay its debts as such debts become due, or shall admit in writing its inability to pay its debts generally, or shall make an assignment for the benefit of creditors; or (ii) any proceeding shall be instituted by or against the Borrower, any Restricted Subsidiary or Consumers seeking to adjudicate it a bankrupt or insolvent, or seeking liquidation, winding up, reorganization, arrangement, adjustment, protection, relief, or composition of its debts under any law relating to bankruptcy, insolvency, or reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, or other similar official for it or for any substantial part of its property and, in the case of a proceeding instituted against the Borrower, either such proceeding shall remain undismissed or unstayed for a period of 60 days or any of the actions sought in such proceeding (including without limitation the entry of an order for relief against the Borrower, a Restricted Subsidiary or Consumers or the appointment of a receiver, trustee, custodian or other similar official for the Borrower, such Restricted Subsidiary or Consumers or any of its property) shall occur; or (iii) the Borrower, any Restricted Subsidiary or Consumers shall take any corporate or other action to authorize any of the actions set forth above in this subsection (f); or (g) Any judgment or order for the payment of money in excess of $6,000,000 shall be rendered against the Borrower or its properties and either (i) enforcement proceedings shall have been commenced by any creditor upon such judgment or order or (ii) there shall be any period of 30 consecutive days during which a stay of enforcement of such judgment or order, by reason of a pending appeal or otherwise, shall not be in effect; (h) Any material provision of any Loan Document, after execution hereof or delivery thereof under Article VI, shall for any reason other than the express terms hereof or thereof cease to be valid and binding on any party thereto; or the Borrower shall so assert in (i) The Cash Collateral Agreement after delivery under Article VI hereof shall for any reason, except to the extent permitted by the terms thereof or due to any failure by any Agent to take any action on its part to be performed under applicable law in order to maintain such perfection, ceases to create a valid and perfected first priority Lien (to the extent purported to be granted by the Cash Collateral Agreement) in any of the Collateral described therein; or (j) At any time any LC Bank shall have been served with or otherwise subjected to a court order, injunction, or other process or decree issued or granted at the instance of the Borrower restraining or seeking to restrain such LC Bank from paying any amount under any Letter of Credit issued by it and either (i) there has been a drawing under such Letter of Credit which such LC Bank would otherwise be obligated to pay or (ii) the stated expiration date or any reduction of the stated amount of such Letter of Credit has occurred but the right of the beneficiary to draw thereunder has been extended in connection with the pendency of the related court action or proceeding; or (k) There shall be imposed or enacted any Consumers Dividend Restriction, the result of which is that the Dividend Coverage Ratio shall be less than 1.15 to 1.0 at any time after the imposition of such Consumers Dividend Restriction. SECTION 9.02. Remedies. If any Event of Default has occurred and is continuing, then the Co-Agents shall at the request, or may with the consent, of the Required Lenders, upon notice to the Borrower (i) declare the Commitments and the obligation of each Lender to make or Convert Advances (other than Advances under Section 4.04 hereof) and of any LC Bank to issue a Letter of Credit to be terminated, whereupon the same shall forthwith terminate, (ii) declare the Notes, all interest thereon and all other amounts payable under this Agreement and the other Loan Documents to be forthwith due and payable, whereupon the Notes, all such interest and all such amounts shall become and be forthwith due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by the Borrower, (iii) provide from the proceeds of any Collateral (as defined in the Cash Collateral Agreement) for cash collateralization of LC Outstandings, and (iv) exercise in respect of any and all collateral, in addition to the other rights and remedies provided for herein and in the Cash Collateral Agreement or otherwise available to the Co-Agents or the Lenders, all the rights and remedies of a secured party on default under the Uniform Commercial Code in effect in the State of New York and in effect in any other jurisdiction in which collateral is located at that time; provided, however, that in the event of an actual or deemed entry of an order for relief with respect to the Borrower under the Federal Bankruptcy Code, (A) the Commitments and the obligation of each Lender to make Advances and of any LC Bank to issue any Letter of Credit shall automatically be terminated and (B) the Notes, all such interest and all such amounts shall automatically become and be due and payable, without presentment, demand, protest or any notice of any kind, all of which are hereby expressly waived by the Borrower. Notwithstanding anything to the contrary contained herein, no notice given or declaration made by the Co-Agents pursuant to this Section 9.02 shall affect (i) the obligation of any LC Bank to make any payment under any Letter of Credit issued by such LC Bank in accordance with the terms of such Letter of Credit or (ii) the participatory interest of each Lender in each such payment. SECTION 10.01. Authorization and Action. Each Lender and LC Bank hereby appoints and authorizes each of the Agents to take such action as agent on its behalf and to exercise such powers under this Agreement as are delegated to such Agents by the terms hereof, together with such powers as are reasonably incidental thereto. The Operational Agent is hereby expressly authorized on behalf of each Lender and each LC Bank, without hereby limiting any implied authority, to receive on behalf of each of the Lenders any payment of principal of, or interest on, the Notes and all other amounts accrued thereunder or hereunder paid to the Operational Agent, and promptly to distribute in accordance with Section 5.01(a) to each Lender its proper share of all payments so received. Each Agent is hereby expressly authorized on behalf of each Lender and each LC Bank, without hereby limiting any implied authority, to distribute to each Lender copies of all notices, agreements and other materials as provided for in this Agreement and any other Loan Document received by such Agent. As to any matters not expressly provided for by this Agreement (including, without limitation, enforcement or collection of the Notes), the Agents shall not be required to exercise any discretion or take any action, but shall be required to act or to refrain from acting (and shall be fully protected in so acting or refraining from acting) upon the instructions of the Majority Lenders, and such instructions shall be binding upon all Lenders, all LC Banks and all holders of Notes; provided, however, that the Agents shall not be required to take any action that exposes any Agent to personal liability or that is contrary to this Agreement or applicable law. Each Agent agrees to give to each Lender prompt notice of each notice given to it by the Borrower pursuant to the terms of this Agreement. SECTION 10.02. Agents' Reliance, Etc. Neither any Agent nor any of its directors, officers, agents or employees shall be liable for any action taken or omitted to be taken by it or them under or in connection with any Loan Document, except for its or their own gross negligence or wilful misconduct. Without limitation of the generality of the foregoing: (i) each Agent may treat the payee of any Note as the holder thereof until the Documentation Agent receives and accepts a Lender Assignment entered into by the Lender which is the payee of such Note, as assignor, and an Eligible Assignee, as assignee, as provided in Section 11.07; (ii) each Agent may consult with legal counsel (including counsel for the Borrower), independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken in good faith by it in accordance with the advice of such counsel, accountants or experts; (iii) the Agents make no warranty or representation to any Lender and shall not be responsible to any Lender for any statements, warranties or representations made in or in connection with any Loan Document; (iv) no Agent shall have any duty to ascertain or to inquire as to the performance or observance of any of the terms, covenants or conditions of any Loan Document on the part of the Borrower or to inspect any property (including the books and records) of the Borrower; (v) no Agent shall be responsible to any Lender for the due execution, legality, validity, enforceability, genuineness, sufficiency or value of any Loan Document; and (vi) no Agent shall incur liability under or in respect of any Loan Document by acting upon any notice, consent, certificate or other instrument or writing (which may be by telegram, cable, telex, telecopy or other teletransmission) believed by it to be genuine and signed or sent by the proper party or parties. SECTION 10.03. Citibank, Union Bank and Affiliates. With respect to its Commitment and the Note issued to it, each of Citibank and Union Bank shall have the same rights and powers under this Agreement as any other Lender and may exercise the same as though it were not an Agent; and the term "Lender" or "Lenders" shall, unless otherwise expressly indicated, include Citibank and Union Bank each in its individual capacity. Citibank and Union Bank and their respective Affiliates may accept deposits from, lend money to, act as trustee under indentures of, and generally engage in any kind of business with, the Borrower, any of its Subsidiaries, its Affiliates and any Person who may do business with or own securities of the Borrower or any such Subsidiary or Affiliate, all as if Citibank and Union Bank were not an Agent and without any duty to account therefor to the Lenders. SECTION 10.04. Lender Credit Decision. Each Lender acknowledges that it has, independently and without reliance upon the Agents or any other Lender and based on the financial information referred to in Section 7.01(e) and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon the Agents or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement. SECTION 10.05. Indemnification. The Lenders agree to indemnify the Agents (to the extent not reimbursed by the Borrower), ratably according to the respective principal amounts of the Notes then held by each of them (or if no Notes are at the time outstanding or if any Notes are held by Persons which are not Lenders, ratably according to the respective Percentages of the Lenders), from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, incurred by, or asserted against the Agents in any way relating to or arising out of this Agreement or any action taken or omitted by the Agents under this Agreement, provided that no Lender shall be liable for any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements resulting from the Agents' gross negligence or willful misconduct. Without limitation of the foregoing, each Lender agrees to reimburse the Agents promptly upon demand for its ratable share of any out-of-pocket expenses (including counsel fees) incurred by the Agents in connection with the preparation, execution, delivery, administration, modification, amendment or enforcement (whether through negotiations, legal proceedings or otherwise) of, or legal advice in respect of rights or responsibilities under, this Agreement to the extent that the Agents are entitled to reimbursement for such expenses pursuant to Section 11.04 but are not reimbursed for such expenses by the Borrower. SECTION 10.06. Successor Agents. Each Agent may resign at any time by giving written notice thereof to the Lenders and the Borrower and may be removed at any time with or without cause by the Majority Lenders, with any such resignation or removal to become effective only upon the appointment of a successor Agent in such capacity, pursuant to this Section 10.06. Upon any such resignation or removal, the Majority Lenders shall have the right to appoint a successor Agent in such capacity which shall be a Lender or another commercial bank or trust company reasonably acceptable to the Borrower organized under the laws of the United States, or of any State thereof. If no successor Agent shall have been so appointed by the Majority Lenders, and shall have accepted such appointment, within 30 days after the retiring Agent's giving of notice of resignation or the Majority Lenders' removal of the retiring Agent, then the retiring Agent may, on behalf of the Lenders, appoint a successor Agent in such capacity, which shall be a Lender or shall be another commercial bank or trust company organized under the laws of the United States or of any State thereof reasonably acceptable to the Borrower. Upon the acceptance of any appointment as an Agent hereunder by a successor Agent and the execution and delivery by the Borrower and the successor Agent of an agreement relating to the fees to be paid to the successor Agent under Section 2.02(d) hereof in connection with its acting as an Agent hereunder, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent and the retiring Agent shall be discharged from its duties and obligations under this Agreement. After any retiring Agent's resignation or removal hereunder as an Agent, the provisions of this Article X shall inure to its benefit as to any actions taken or omitted to be taken by it while it was an Agent in such capacity under this Agreement. SECTION 11.01. Amendments, Etc. No amendment or waiver of any provision of any Loan Document, nor consent to any departure by the Borrower therefrom, shall in any event be effective unless the same shall be in writing and signed by the Majority Lenders, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given; provided, however, that no amendment, waiver or consent shall, unless in writing and signed by all the Lenders, do any of the following: (i) waive, modify or eliminate any of the conditions specified in Article VI, (ii) increase the Commitments of the Lenders that may be maintained hereunder or subject the Lenders to any additional obligations, (iii) reduce the principal of, or interest on, the Notes, any Applicable Margin or any fees or other amounts payable hereunder (other than fees payable to the Operational Agent pursuant to Section 2.02(d)), (iv) postpone any date fixed for any payment of principal of, or interest on, the Notes or any fees or other amounts payable hereunder (other than fees payable to the Operational Agent pursuant to Section 2.02(d)), (v) change the percentage of the Commitments or of the aggregate unpaid principal amount of the Notes, or the number of Lenders which shall be required for the Lenders or any of them to take any action hereunder, (vi) amend any Loan Document in a manner intended to prefer one or more Lenders over any other Lenders, (vii) amend Section 2.03(b) or this Section 11.01, or (viii) release any collateral or change any provision of the Cash Collateral Agreement providing for the release of collateral; and provided, further, that no amendment, waiver or consent shall, unless in writing and signed by each Agent in addition to the Lenders required above to take such action, affect the rights or duties of any Agent under this Agreement or any Note. Any request from the Borrower for any amendment, waiver or consent under this Section 11.01 shall be addressed to the Documentation Agent. SECTION 11.02. Notices, Etc. All notices and other communications provided for hereunder and under the other Loan Documents shall be in writing (including telegraphic, facsimile, telex or cable communication) and mailed, telegraphed, telecopied, telexed, cabled or delivered, (i) if to the Borrower, at its address at Fairlane Plaza South, 330 Town Center Drive, Suite 1100, Dearborn, Michigan 48126, Attention: Denise M. Sturdy, Esq., Assistant General Counsel, with a copy to Doris F. Galvin, Vice President and Treasurer, 212 West Michigan Avenue, Jackson, Michigan 49201; (ii) if to any Bank, at its Domestic Lending Office specified opposite its name on Schedule I hereto; (iii) if to any LC Bank, at its address specified in the LC Bank Agreement to which it is a party; (iv) if to any Lender other than a Bank, at its Domestic Lending Office specified in the Lender Assignment pursuant to which it became a Lender; (v) if to the Operational Agent, at its address at 445 South Figueroa Street, 15th Floor, Los Angeles, California 90071, Attention: Utilities Department Head; and (vi) if to the Documentation Agent, at its address at 399 Park Avenue, New York, New York 10043, Attention: Utilities Department Head; or, as to each party, at such other address as shall be designated by such party in a written notice to the other parties. All such notices and communications shall, when mailed, telegraphed, telecopied, telexed or cabled, be effective five days after when deposited in the mails, or when delivered to the telegraph company, telecopied, confirmed by telex answerback or delivered to the cable company, respectively, except that notices and communications to any Agent pursuant to Article II, III, or X shall not be effective until received by such Agent. SECTION 11.03. No Waiver of Remedies. No failure on the part of the Borrower, any Lender, any LC Bank or any Agent to exercise, and no delay in exercising, any right hereunder or under any Note shall operate as a waiver thereof; nor shall any single or partial exercise of any such right preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law. SECTION 11.04. Costs, Expenses and Indemnification. (a) The Borrower agrees to (i) reimburse on demand all reasonable costs and expenses of each Agent (including, without limitation, reasonable fees and expenses of counsel to the Agents) in connection with (A) the preparation, negotiation, execution and delivery of the Loan Documents and (B) the care and custody of any and all collateral, and any proposed modification, amendment, or consent relating to any Loan Document, and (ii) to pay on demand all reasonable costs and expenses of each Agent and, on and after the date upon which the Notes become or are declared to be due and payable pursuant to Section 9.02 or an Event of Default specified in Section 9.01(a) shall have occurred and be continuing, each Lender (including, without limitation, reasonable fees and expenses of counsel to the Agents, special Michigan counsel to the Lenders and, from and after such date, counsel for each Lender (including the allocated costs and expenses of in- house counsel)) in connection with the enforcement (whether through negotiations, legal proceedings or otherwise) of this Agreement, the Notes and the other documents to be delivered hereunder. (b) The Borrower hereby agrees to indemnify and hold each Lender, each Agent, each LC Bank and their respective officers, directors, employees, professional advisors and affiliates (each, an "Indemnified Person") harmless from and against any and all claims, damages, losses, liabilities, costs or expenses (including reasonable attorney's fees and expenses, whether or not such Indemnified Person is named as a party to any proceeding or is otherwise subjected to judicial or legal process arising from any such proceeding) which any of them may incur or which may be claimed against any of them by any Person: (i) by reason of or in connection with the execution, delivery or performance of any of the Loan Documents or any transaction contemplated thereby, or the use by the Borrower of the proceeds of any Extension of Credit; (ii)in connection with any documentary taxes, assessments or charges made by any governmental authority by reason of the execution and delivery of any of the Loan Documents; or (iii)in connection with or resulting from the utilization, storage, disposal, treatment, generation, transportation, release or ownership of any Hazardous Substance (i) at, upon or under any property of the Borrower or any of its Affiliates or (ii) by or on behalf of the Borrower or any of its Affiliates at any time and in provided, however, that nothing contained in this subsection (b) shall constitute a relinquishment or waiver of the Borrower's rights to any independent claim that the Borrower may have against any Indemnified Person for such Indemnified Person's gross negligence or wilful misconduct, but no Lender shall be liable for any such conduct on the part of any Agent or any other Lender, and no Agent shall be liable for any such conduct on the part of any Lender. (c) The Borrower's other obligations under this Section 11.04 shall survive the repayment of all amounts owing to the Lenders, the LC Banks and the Agents under the Loan Documents and the termination of the Commitments. If and to the extent that the obligations of the Borrower under this Section 11.04 are unenforceable for any reason, the Borrower agrees to make the maximum contribution to the payment and satisfaction thereof which is permissible under applicable law. SECTION 11.05. Right of Set-off. (a) Upon (i) the occurrence and during the continuance of any Event of Default and (ii) the making of the request or the granting of the consent specified by Section 9.02 to authorize the Co-Agents to declare the Notes due and payable pursuant to the provisions of Section 9.02, each Lender and LC Bank is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by such Lender or LC Bank to or for the credit or the account of the Borrower, against any and all of the obligations of the Borrower now or hereafter existing under this Agreement and the Note held by such Lender or the LC Bank Agreement to which such LC Bank is a party, as the case may be, irrespective of whether or not such Lender or LC Bank shall have made any demand under this Agreement or such Note or such LC Bank Agreement and although such obligations may be unmatured. Each Lender and LC Bank agrees to notify promptly the Borrower after any such set-off and application made by such Lender or LC Bank, provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of each Lender and LC Bank under this Section 11.05 are in addition to other rights and remedies (including, without limitation, other rights of set-off) which such Lender and LC Bank may have. (b) The Borrower agrees that it shall have no right of off-set, deduction or counterclaim in respect of its obligations hereunder, and that the obligations of the Lenders hereunder are several and not joint. Nothing contained herein shall constitute a relinquishment or waiver of the Borrower's rights to any independent claim that the Borrower may have against any Agent or any Lender for such Agent's or such Lender's, as the case may be, gross negligence or wilful misconduct, but no Lender shall be liable for any such conduct on the part of any Agent or any other Lender, and no Agent shall be liable for any such conduct on the part of any Lender. SECTION 11.06. Binding Effect. This Agreement shall become effective when it shall have been executed by the Borrower and the Agents and when the Documentation Agent shall have been notified by each Bank that such Bank has executed it and thereafter shall be binding upon and inure to the benefit of the Borrower, the Agents and each Lender and their respective successors and assigns, except that the Borrower shall not have the right to assign its rights hereunder or any interest herein without the prior written consent of the Lenders. SECTION 11.07. Assignments and Participation. (a) Each Lender may, with the consent of the Borrower (such consent not to be unreasonably withheld or delayed), assign to one or more banks or other entities all or a portion of its rights and obligations under this Agreement and the other Loan Documents (including, without limitation, all or a portion of its Commitment, the Advances owing to it and the Note or Notes held by it); provided, however, that (i) each such assignment shall be of a constant, and not a varying, percentage of all of the assigning Lender's rights and obligations under this Agreement, (ii) the amount of the Commitment of the assigning Lender being assigned pursuant to each such assignment (determined as of the date of the Lender Assignment with respect to such assignment) shall in no event be less than the lesser of the amount of such Lender's Commitment and $10,000,000 and shall be an integral multiple of $5,000,000, (iii) each such assignment shall be to an Eligible Assignee, and (iv) the parties to each such assignment shall execute and deliver to the Documentation Agent (with a copy to the Operational Agent), for its acceptance and recording in the Register, a Lender Assignment, together with any Note or Notes subject to such assignment and a processing and recordation fee of $2,500; and provided further, however, that the consent of the Borrower shall not be required for any assignments by a Lender to any of its Affiliates or to any other Lender or any of its Affiliates. Upon such execution, delivery, acceptance and recording, from and after the effective date specified in each Lender Assignment, which effective date shall be at least five Business Days after the execution thereof, (A) the assignee thereunder shall be a party hereto and, to the extent that rights and obligations hereunder have been assigned to it pursuant to such Lender Assignment, have the rights and obligations of a Lender hereunder and (B) the Lender assignor thereunder shall, to the extent that rights and obligations hereunder have been assigned by it to an Eligible Assignee pursuant to such Lender Assignment, relinquish its rights and be released from its obligations under this Agreement (and, in the case of a Lender Assignment covering all or the remaining portion of an assigning Lender's rights and obligations under this Agreement, such Lender shall cease to be a party hereto); provided, however, that the limitation set forth in clause (iii), above, shall not apply if an Event of Default shall have occurred and be continuing and the Co-Agents shall have declared all Advances to be immediately due and payable hereunder. The Documentation Agent agrees to give prompt notice to the Lenders and the Borrower of any assignment or participation of its rights and obligations as a Bank hereunder. Notwithstanding anything to the contrary contained in this Agreement, any Lender may at any time assign all or any portion of the Advances owing to it to any Affiliate of such Lender. The assigning Lender shall promptly notify the Borrower of any such assignment. No such assignment, other than to an Eligible Assignee, shall release the assigning Lender from its obligations hereunder. (b) By executing and delivering a Lender Assignment, the Lender assignor thereunder and the assignee thereunder confirm to and agree with each other and the other parties hereto as follows: (i) other than as provided in such Lender Assignment, such assigning Lender makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with any Loan Document or the execution, legality, validity, enforceability, genuineness, sufficiency or value of any Loan Document or any other instrument or document furnished pursuant thereto; (ii) such assigning Lender makes no representation or warranty and assumes no responsibility with respect to the financial condition of the Borrower or the performance or observance by the Borrower of any of its obligations under any Loan Document or any other instrument or document furnished pursuant thereto; (iii) such assignee confirms that it has received a copy of each Loan Document, together with copies of the financial statements referred to in Section 7.01(e) and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into such Lender Assignment; (iv) such assignee will, independently and without reliance upon the Agents, such assigning Lender or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Loan Documents; (v) such assignee confirms that it is an Eligible Assignee (unless an Event of Default shall have occurred and be continuing and the Co-Agents shall have declared all Advances to be immediately due and payable hereunder, in which case no such confirmation is necessary); (vi) such assignee appoints and authorizes each Agent to take such action as agent on its behalf and to exercise such powers under the Loan Documents as are delegated to each Agent by the terms thereof, together with such powers as are reasonably incidental thereto; and (vii) such assignee agrees that it will perform in accordance with their terms all of the obligations which by the terms of the Loan Documents are required to be performed by it as a Lender. (c) The Documentation Agent shall maintain at its address referred to in Section 11.02 a copy of each Lender Assignment delivered to and accepted by it and a register for the recordation of the names and addresses of the Lenders and the Commitment of, and principal amount of the Advances owing to, each Lender from time to time (the "Register"). The entries in the Register shall be conclusive and binding for all purposes, absent manifest error, and the Borrower, the Agents and the Lenders may treat each Person whose name is recorded in the Register as a Lender hereunder for all purposes of this Agreement. The Register shall be available for inspection by the Borrower or any Lender at any reasonable time and from time to time upon reasonable prior notice. (d) Upon its receipt of a Lender Assignment executed by an assigning Lender and an assignee representing that it is an Eligible Assignee, together with any Note or Notes subject to such assignment, the Documentation Agent shall, if such Lender Assignment has been completed and is in substantially the form of Exhibit H, (i) accept such Lender Assignment, (ii) record the information contained therein in the Register and (iii) give prompt notice thereof to the Borrower. Within five Business Days after its receipt of such notice, the Borrower, at its own expense, shall execute and deliver to the Documentation Agent in exchange for the surrendered Note or Notes a new Note to the order of such Eligible Assignee in an amount equal to the Commitment assumed by it pursuant to such Lender Assignment and, if the assigning Lender has retained a Commitment hereunder, a new Note to the order of the assigning Lender in an amount equal to the Commitment retained by it hereunder. Such new Note or Notes shall be in an aggregate principal amount equal to the aggregate principal amount of such surrendered Note or Notes, shall be dated the effective date of such Lender Assignment and shall otherwise be in substantially the form of Exhibit A. (e) Each Lender may sell participations to one or more banks or other entities in or to all or a portion of its rights and obligations under the Loan Documents (including, without limitation, all or a portion of its Commitment, the Advances owing to it and the Note or Notes held by it); provided, however, that (i) such Lender's obligations under this Agreement (including, without limitation, its Commitment to the Borrower hereunder) shall remain unchanged, (ii) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, (iii) such Lender shall remain the holder of any such Note for all purposes of this Agreement, and (iv) the Borrower, the Agents and the other Lenders shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under this Agreement. (f) Any Lender may, in connection with any assignment or participation or proposed assignment or participation pursuant to this Section 11.07, disclose to the assignee or participant or proposed assignee or participant, any information relating to the Borrower furnished to such Lender by or on behalf of the Borrower; provided that, prior to any such disclosure, the assignee or participant or proposed assignee or participant shall agree, in accordance with the terms of Section 11.08, to preserve the confidentiality of any Confidential Information received by it from such Lender. (g) If any Lender (or any bank or other entity to which such Lender has sold a participation) shall (i) make any demand for payment under Section 5.04(a) or (d), or (ii) determine not to extend the Termination Date in response to any request by the Borrower pursuant to Section 2.05, then (A) in the case of any demand made under clause (i) above, within 30 days after any such demand (if, but only if, such demanded payment has been made by the Borrower) or notice, and (B) in the case of the occurrence of the event described in clause (ii) above, within 20 days after such occurrence, the Borrower may, with the approval of the Agents (which approval shall not be unreasonably withheld) and provided that no Event of Default or Unmatured Default shall then have occurred and be continuing, demand that such Lender assign in accordance with this Section 11.07 to one or more Eligible Assignees designated by the Borrower all (but not less than all) of such Lender's Commitment and the Advances owing to it within the period ending on the later to occur of (x) the last day in the period described in clause (A) or (B) above, as applicable, and (y) the last day of the longest of the then current Interest Periods for such Advances. If any such Eligible Assignee designated by the Borrower shall fail to consummate such assignment on terms acceptable to such Lender, or if the Borrower shall fail to designate any such Eligible Assignees for all or part of such Lender's Commitment or Advances, then such demand by the Borrower shall become ineffective; it being understood for purposes of this subsection (g) that such assignment shall be conclusively deemed to be on terms acceptable to such Lender, and such Lender shall be compelled to consummate such assignment to an Eligible Assignee designated by the Borrower, if such Eligible Assignee (1) shall agree to such assignment by entering into a Lender Assignment with such Lender and (2) shall offer compensation to such Lender in an amount equal to all amounts then owing by the Borrower to such Lender hereunder and under the Note made by the Borrower to such Lender, whether for principal, interest, fees, costs or expenses (other than the demanded payment referred to in clause (i) above, and payable by the Borrower as a condition to the Borrower's right to demand such assignment) or otherwise. In addition, in the case of any amount demanded for payment by any Lender (or such a participant) pursuant to Section 5.04(a) or (d), the Borrower may, in the case of any such Lender, with the approval of the Agents (which approval shall not be unreasonably withheld) and provided that no Event of Default or Unmatured Default shall then have occurred and be continuing, terminate all (but not less than all) such Lender's Commitment and prepay all (but not less than all) such Lender's Advances not so assigned, together with all interest accrued thereon to the date of such prepayment and all fees, costs and expenses and other amounts then owing by the Borrower to such Lender hereunder and under the Note made by the Borrower to such Lender, at any time from and after such later occurring day in accordance with Sections 2.03 and 5.03 hereof (but without the requirement stated therein for ratable treatment of the other Lenders), if and only if, after giving effect to such termination and prepayment, the sum of the aggregate principal amount of the Advances of all Lenders then outstanding does not exceed the then remaining Commitments of the Lenders. Notwithstanding anything set forth above in this subsection (g) to the contrary, the Borrower shall not be entitled to compel the assignment by any Lender demanding payment under Section 5.04(a) of its Commitment and Advances or terminate and prepay the Commitment and Advances of such Lender if, prior to or promptly following any such demand by the Borrower, such Lender shall have changed or shall change, as the case may be, its Applicable Lending Office for its Eurodollar Rate Advances so as to eliminate the further incurrence of such increased cost. In furtherance of the foregoing, any such Lender demanding payment or giving notice as provided above agrees to use reasonable efforts to so change its Applicable Lending Office if, to do so, would not result in the incurrence by such Lender of additional costs or expenses which it deems material or, in the sole judgment of such Lender, be inadvisable for regulatory, competitive or internal management reasons. (h) Anything in this Section 11.07 to the contrary notwithstanding, any Lender may assign and pledge all or any portion of its Commitment and the Advances owing to it to any Federal Reserve Bank (and its transferees) as collateral security pursuant to Regulation A of the Board of Governors of the Federal Reserve System and any Operating Circular issued by such Federal Reserve Bank. No such assignment shall release the assigning Lender from its obligations hereunder. SECTION 11.08. Confidentiality. In connection with the negotiation and administration of this Agreement and the other Loan Documents, the Borrower has furnished and will from time to time furnish to the Agents and the Lenders (each, a "Recipient") written information which is identified to the Recipient when delivered as confidential (such information, other than any such information which (i) was publicly available, or otherwise known to the Recipient, at the time of disclosure, (ii) subsequently becomes publicly available other than through any act or omission by the Recipient or (iii) otherwise subsequently becomes known to the Recipient other than through a Person whom the Recipient knows to be acting in violation of his or its obligations to the Borrower, being hereinafter referred to as "Confidential Information"). The Recipient will not knowingly disclose any such Confidential Information to any third party (other than to those persons who have a confidential relationship with the Recipient), and will take all reasonable steps to restrict access to such information in a manner designed to maintain the confidential nature of such information, in each case until such time as the same ceases to be Confidential Information or as the Borrower may otherwise instruct. It is understood, however, that the foregoing will not restrict the Recipient's ability to freely exchange such Confidential Information with prospective participants in or assignees of the Recipient's position herein, but the Recipient's ability to so exchange Confidential Information shall be conditioned upon any such prospective participant's entering into an agreement as to confidentiality similar to this Section 11.08. It is further understood that the foregoing will not prohibit the disclosure of any or all Confidential Information if and to the extent that such disclosure may be required (i) by a regulatory agency or otherwise in connection with an examination of the Recipient's records by appropriate authorities, (ii) pursuant to court order, subpoena or other legal process or (iii) otherwise, as required by law; in the event of any required disclosure under clause (ii) or (iii), above, the Recipient agrees to use reasonable efforts to inform the Borrower as promptly as practicable to the extent not prohibited by law. SECTION 11.09. Waiver of Jury Trial. THE BORROWER, THE AGENTS, THE CO-MANAGER, THE LC BANKS AND THE LENDERS EACH HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT, OR ANY OTHER INSTRUMENT OR DOCUMENT DELIVERED HEREUNDER OR THEREUNDER. SECTION 11.10. Governing Law. This Agreement and the Notes shall be governed by, and construed in accordance with, the laws of the State of New York. The Borrower, the Lenders, the LC Banks, the Co-Manager and the Agents each (i) irrevocably submits to the jurisdiction of any New York State court or Federal court sitting in New York City in any action arising out of any Loan Document, (ii) agrees that all claims in such action may be decided in such court, (iii) waives, to the fullest extent it may effectively do so, the defense of an inconvenient forum and (iv) consents to the service of process by mail. A final judgment in any such action shall be conclusive and may be enforced in other jurisdictions. Nothing herein shall affect the right of any party to serve legal process in any manner permitted by law or affect its right to bring any action in any other court. SECTION 11.11. Relation of the Parties; No Beneficiary. No term, provision or requirement, whether express or implied, of any Loan Document, or actions taken or to be taken by any party thereunder, shall be construed to create a partnership, association, or joint venture between such parties or any of them. No term or provision of the Loan Documents shall be construed to confer a benefit upon, or grant a right or privilege to, any Person other than the parties hereto. SECTION 11.12. Existing Banks' Waiver, Acknowledgment and Release. The Existing Banks hereby waive compliance by the Borrower with the requirement contained in Section 5.03(b) of the Existing Agreement for the Borrower to provide, upon the termination in full of the "Commitments" under the Existing Agreement on the date hereof, cash collateral to secure LC Outstandings with respect to the Existing Letters of Credit. The Lenders and each LC Bank acknowledge and agree that each Existing Letter of Credit shall constitute a Letter of Credit for all purposes under this Agreement. In addition, the Existing Banks hereby release their Lien on all of the Collateral (as defined in the Existing Agreement) and direct the Documentation Agent to return all such Collateral to the Borrower. SECTION 11.13. Execution in Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same Agreement. SECTION 11.14. Survival of Agreement. All covenants, agreements, representations and warranties made herein and in the certificates pursuant hereto shall be considered to have been relied upon by the Agents and the Lenders and shall survive the making by the Lenders of the Extensions of Credit and the execution and delivery to the Lenders of the Notes evidencing the Extensions of Credit and shall continue in full force and effect so long as any Note or any amount due hereunder is outstanding and unpaid or any Commitment of any Lender has not been terminated. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written. By /s/ A. M. Wright as Co-Agent, Documentation Agent and Bank as Co-Agent, Operational Agent and Bank By /s/ John M. Edmonston $25,000,000 BANK OF AMERICA ILLINOIS, By /s/ Felipi A. Gomez By /s/ Sydney G. Dennis $25,000,000 THE FIRST NATIONAL BANK OF BOSTON, as Co-Manager and Bank By /s/ Richard A. Low $25,000,000 THE FIRST NATIONAL BANK OF CHICAGO, as Co-Manager and Bank $25,000,000 THE CHASE MANHATTAN BANK, N.A., as Co-Manager and Bank By /s/ Thomas L. Casey By /s/ Catherine M. Oniffrey $20,000,000 THE MITSUBISHI TRUST AND BANKING By /s/ S. C. Schumacher $20,000,000 TORONTO DOMINION (TEXAS), INC. By /s/ Howard H. Turner By /s/ Joel W. Peterson $15,000,000 CREDIT LYONNAIS CHICAGO BRANCH Title: Vice President and Group Head $15,000,000 THE FUJI BANK, LIMITED By /s/ Peter L. Chinnici By /s/ Mark S. Aben $15,000,000 THE SANWA BANK LIMITED, By /s/ Richard H. Ault $15,000,000 NATIONAL WESTMINSTER BANK PLC By /s/ Marilyn A. Windsor By /s/ Marilyn A. Windsor By /s/ Albert H. Tune Title: Vice President and Manager By /s/ Petrus J. Mare $15,000,000 THE BANK OF NEW YORK $15,000,000 THE SUMITOMO BANK, LTD., Credit Agreement, dated as of November 21, 1995 among CMS Energy Corporation, the Banks named therein, Citibank, N.A. and Union Bank, as Co-Agents Name of Bank Domestic Lending Office Eurodollar Lending Office Citibank, N.A. 399 Park Avenue, 4th Floor - same - New York, New York 10043 Union Bank 445 South Figueroa Street - same - Illinois 200 West Jackson Boulevard - same - Barclays Bank PLC 222 Broadway, 11th Floor - same - New York, New York 10038 Bank of Boston 100 Federal Street - same - Bank of Chicago One First National Bank Plaza - same - Attention: Mr. Michael K. Murphy Bank, N.A. 1 Chase Manhattan Plaza, 3rd Floor- same - New York, New York 10081 Bank of Scotland 565 Fifth Avenue, 1st Floor - same - New York, New York 10017 Aktiengesellschaft 590 Madison Avenue - same - New York, New York 10022 and Banking Corp- 801 S. Figueroa Street, Suite 500- same - ation/Los Angeles Los Angeles, California 90017 NationsBank, N.A. Utility Finance Division - same - (Texas), Inc. Houston Agency - same - Bank of Montreal 115 South LaSalle Street, 12th Floor- same - CIBC Inc. 2727 Paces Ferry Road - same - Chicago Branch 227 West Monroe Street, #3800 - same - Limited 225 West Wacker Drive, Suite 2000- same - Bank 124 West Allegan Street - same - Ltd. 10 South Wacker Drive, 31st Floor- same - Bank Plc/National c/o 175 Water Street - same - Westminster Bank New York, New York 10038 Plc, Nassau Branch Attention: Gary Tenner York 1 Wall Street, 19th Floor - same - New York, New York 10286 Ltd., Chicago 223 South Wacker Drive, Suite 7117- same - Societe Generale 181 West Madison, Suite 3400 - same - As of November 21, 1995 Jackson Pipeline Company Partnership Debt $ 5,378,948 Centrales Termica's Mendoza Debt $23,048,968 Debt (according to GAAP) of Enterprises -0- FOR VALUE RECEIVED, the undersigned, CMS ENERGY CORPORATION, a Michigan corporation (the "Borrower"), HEREBY PROMISES TO PAY to the order of ____________________________ (the "Lender") for the account of its Applicable Lending Office (as defined in the Credit Agreement referred to below) the principal sum of U.S.$[amount of the Lender's Commitment in figures] or, if less, the aggregate principal amount of all Advances (as defined below) made by the Lender to the Borrower pursuant to the Credit Agreement outstanding on the Termination Date (as defined in the Credit Agreement). The Borrower promises to pay interest on the unpaid principal amount of each Advance from the date of such Advance until such principal amount is paid in full, at such interest rates, and payable at such times, as are specified in the Credit Agreement. Both principal and interest are payable in lawful money of the United States of America to Union Bank, as Operational Agent, at its offices at 445 South Figueroa Street, 15th Floor, Los Angeles, California 90071, in same day funds. Each Advance made by the Lender to the Borrower pursuant to the Credit Agreement, and all payments made on account of the principal amount thereof, shall be recorded by the Lender and, prior to any transfer hereof, endorsed on the grid attached hereto which is part of this Promissory Note, provided that the failure to so record any Advance or any payment on account thereof shall not affect the payment obligations of the Borrower hereunder or under the Credit Agreement. This Promissory Note is one of the Notes referred to in, and is entitled to the benefits of, the Credit Agreement, dated as of November __, 1995 (as amended, modified or supplemented from time to time, the "Credit Agreement", the terms defined therein and not otherwise defined herein being used herein as therein defined), among the Borrower, the Lender and certain other Lenders parties thereto, the Co-Agents, the Documentation Agent and the Operational Agent, and the Loan Documents referred to therein and entered into pursuant thereto. The Credit Agreement, among other things, (i) provides for the making of advances (the "Advances") by the Lender to the Borrower from time to time in an aggregate amount not to exceed the U.S. dollar amount first above mentioned, the indebtedness of the Borrower resulting from each such Advance being evidenced by this Promissory Note, and (ii) contains provisions for acceleration of the maturity hereof upon the happening of certain stated events and also for prepayments on account of principal hereof prior to the maturity hereof upon the terms and conditions therein specified. ADVANCES AND PAYMENTS OF PRINCIPAL Amount of Paid or Principal Notation Date Advance Prepaid Balance Made By FORM OF NOTICE OF BORROWING Agent for the Lenders parties The undersigned, CMS Energy Corporation, refers to the Credit Agreement, dated as of November ____, 1995 (as amended, modified or supplemented from time to time, the "Credit Agreement", the terms defined therein and not otherwise defined herein being used herein as therein defined), among the Borrower, the Lenders named therein, the Co-Agents, the Documentation Agent and the Operational Agent, and hereby gives you notice, irrevocably, pursuant to Section 3.01 of the Credit Agreement that the undersigned hereby requests a Borrowing under the Credit Agreement, and in that connection sets forth below the information relating to such Borrowing (the "Proposed Borrowing") as required by Section 3.01(a) of the Credit Agreement: (i) The Business Day of the Proposed Borrowing is ______________, 19__. (ii) The Type of Advances comprising the Proposed Borrowing is [Base Rate Advances] [Eurodollar Rate Advances]. (iii) The aggregate amount of the Proposed Borrowing is $ . 1[(iv) The initial Interest Period for each Advance made as part of the Proposed Borrowing is ____ months.] The undersigned hereby acknowledges that the delivery of this Notice of Borrowing shall constitute a representation and warranty by the Borrower that, on the date of the Proposed Borrowing, the statements contained in Sections 6.02(a) and 6.03(a) of the Credit Agreement are true. 1 To be included for a Proposed Borrowing comprised of Eurodollar Rate Advances. FORM OF NOTICE OF CONVERSION Agent for the Lenders parties The undersigned, CMS Energy Corporation, refers to the Credit Agreement, dated as of November ____, 1995 (as amended, modified or supplemented from time to time, the "Credit Agreement", the terms defined therein and not otherwise defined herein being used herein as therein defined), among the Borrower, the Lenders named therein, the Co-Agents, the Documentation Agent and the Operational Agent, and hereby gives you notice, irrevocably, pursuant to Section 3.02 of the Credit Agreement that the undersigned hereby requests a Conversion under the Credit Agreement, and in that connection sets forth below the information relating to such Conversion (the "Proposed Conversion") as required by Section 3.02 of the Credit Agreement: (iii) The Business Day of the Proposed Conversion is ______________. (iv) The Type of Advances comprising the Proposed Conversion is [Base Rate Advances] [Eurodollar Rate Advances]. (v) The aggregate amount of the Proposed Conversion is $__________. (vi) The Type of Advances to which such Advances are proposed to be Converted is [Base Rate Advances] [Eurodollar Rate Advances]. (vii) The Interest Period for each Advance made as part of the Proposed Conversion is ____ month(s).1 The undersigned hereby certifies that the Borrower's request for the Proposed Conversion is made in compliance with Sections 3.02, 3.03 and 3.04 of the Credit Agreement. The undersigned hereby acknowledges that the delivery of this Notice of Conversion shall constitute a representation and warranty by the Borrower that, on the date of the Proposed Conversion, [(i)] the statements contained in Section 6.02(a) of the Credit Agreement are true and [(ii) no Unmatured Default [(other than an Unmatured Default resulting from the failure of the Borrower to comply with the ratio set forth in Section 8.01(j) of the Credit Agreement)]2 has 1 Delete for Base Rate Advances 2 Include only if an Unmatured Default has occurred and is continuing as the result of the failure of the Borrower to comply with the ratio set forth in Section 8.01(j) of the Credit Agreement. In such case, a Conversion into Eurodollar Rate Advances with an Interest Period not to exceed three months in duration is permitted pursuant to Section 3.04(a)(vi) of the Credit Agreement. 3 Delete if Conversion is into Base Rate Advances. FORM OF CASH COLLATERAL AGREEMENT CASH COLLATERAL AGREEMENT, dated as of November 21, 1995, made by CMS ENERGY CORPORATION, a Michigan corporation (the "Pledgor"), to Union Bank ("Union Bank"), as operational agent (the "Operational Agent") for the lenders (the "Lenders") parties to the Credit Agreement (as hereinafter defined). (1) Citibank, N.A. and Union Bank, as Co-Agents, and the Lenders have entered into a Credit Agreement, dated as of November 21, 1995 (said Agreement as it may hereafter be amended or otherwise modified from time to time, being the "Credit Agreement", the terms defined therein and not otherwise defined herein being used herein as therein defined), with the Pledgor. (2) Pursuant to Section 5.03(b) of the Credit Agreement, any prepayments required by such subsection are to be applied to outstanding Base Rate Advances up to the full amount thereof before they are applied, first, to outstanding Eurodollar Rate Advances and, second, as cash collateral, pursuant to this Agreement, to secure LC Outstandings. (3) The cash collateral referenced in preliminary statement (2), above, shall be deposited by the Operational Agent in a special non-interest-bearing cash collateral account (the "Account") with the Operational Agent at its office at 445 South Figueroa Street, 15th Floor, Los Angeles, California 90071, Account No. 2200412004 (or at such other office of the Operational Agent as the Operational Agent may, from time to time, notify the Pledgor), in the name of the Pledgor but under the sole control and dominion of the Operational Agent and subject to the terms of this Agreement. NOW THEREFORE, in consideration of the premises and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Pledgor hereby agrees with the Operational Agent for its benefit and the ratable benefit of the Lenders as follows: SECTION 1. Pledge and Assignment. The Pledgor hereby pledges and assigns to the Operational Agent for its benefit and the ratable benefit of the Lenders, and grants to the Operational Agent for its benefit and the ratable benefit of the Lenders a security interest in, the following collateral (the "Collateral"): (i) the Account, all funds held therein and all certificates and instruments, if any, from time to time representing or evidencing the (ii) all Investments (as hereinafter defined) from time to time, and all certificates and instruments, if any, from time to time representing or evidencing the Investments; (iii) all notes, certificates of deposit, deposit accounts, checks and other instruments from time to time hereafter delivered to or otherwise possessed by the Operational Agent for or on behalf of the Pledgor in substitution for or in addition to any or all of the then (iv) all interest, dividends, cash, instruments and other property from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the then existing (v) all proceeds of any and all of the foregoing Collateral. SECTION 2. Security for Obligations. This Agreement secures the payment of all reimbursement obligations of the Pledgor now or hereafter existing with respect to LC Outstandings, and all obligations of the Pledgor now or hereafter existing under this Agreement (all such obligations of the Pledgor being the "Obligations"). Without limiting the generality of the foregoing, this Agreement secures the payment of all amounts which constitute part of the Obligations and would be owed by the Pledgor to the Operational Agent or the Lenders under the Credit Agreement and the Notes but for the fact that they are unenforceable or not allowable due to of the existence of a bankruptcy, reorganization or similar proceeding involving the Pledgor. SECTION 3. Delivery of Collateral. All certificates or instruments, if any, representing or evidencing the Collateral shall be delivered to and held by or on behalf of the Operational Agent pursuant hereto and shall be in suitable form for transfer by delivery, or shall be accompanied by duly executed instruments of transfer or assignment in blank, all in form and substance satisfactory to the Operational Agent. The Operational Agent shall have the right, at any time upon the occurrence and during the continuance of an Event of Default or an Unmatured Default, in its discretion and without notice to the Pledgor, to transfer to or to register in the name of the Operational Agent or any of its nominees any or all of the Collateral. In addition, the Operational Agent shall have the right at any time to exchange certificates or instruments representing or evidencing Collateral for certificates or instruments of smaller or larger denominations. SECTION 4. Maintaining the Account. So long as any Lender has any Commitment or any Note shall remain unpaid: (a) The Pledgor will maintain the Account with the Operational Agent. (b) It shall be a term and condition of the Account, notwithstanding any term or condition to the contrary in any other agreement relating to the Account and except as otherwise provided by the provisions of Section 6 and Section 13, that no amount (including interest on the Account, if any) shall be paid or released to or for the account of, or withdrawn by or for the account of, the Pledgor or any other Person (other than the Operational Agent and the Lenders) from the Account. The Account shall be subject to such applicable laws, and such applicable regulations of the Board of Governors of the Federal Reserve System and of any other appropriate banking or governmental authority, as may now or hereafter be in effect. SECTION 5. Investing of Amounts in the Account. If requested by the Pledgor, the Operational Agent will, subject to the provisions of Section 6 and Section 13, from time to time (a) invest amounts on deposit in the Account in such Permitted Investments as the Pledgor may select and the Operational Agent may approve and (b) invest interest paid on the Permitted Investments referred to in clause (a) above, and reinvest other proceeds of any such Permitted Investments which may mature or be sold, in each case in such Permitted Investments as the Pledgor may select and the Operational Agent may approve (the Permitted Investments referred to in clauses (a) and (b) above, being collectively "Investments"). Interest and proceeds that are not invested or reinvested in Investments as provided above shall be deposited and held in the Account. SECTION 6. Release of Amounts. So long as no Event of Default or Unmatured Default shall have occurred and be continuing, the Operational Agent will pay and release to the Pledgor or at its order, upon the request of the Pledgor, (a) amounts of credit balance of the Account and of principal of any other Collateral when matured or sold to the extent that (i) the sum of the credit balance of the Account plus the aggregate outstanding principal amount of all other Collateral exceeds (ii) the aggregate amount of LC Outstandings in respect of all Letters of Credit and all other amounts owing by the Pledgor hereunder, (b) all amounts in the Account if the Commitments exceed the aggregate amount of LC Outstandings in respect of all Letters of Credit and all other amounts owing by the Pledgor hereunder and (c) all interest and earnings on the Investments deposited and held in the Account. SECTION 7. Representations and Warranties. The Pledgor represents and warrants as follows: (a) The Pledgor is the legal and beneficial owner of the Collateral free and clear of any lien, security interest, option or other charge or encumbrance except for the security interest created by this Agreement. (b) The pledge and assignment of the Collateral pursuant to this Agreement creates a valid and perfected first priority security interest in the Collateral, securing the payment of the Obligations. (c) No consent of any other Person and no authorization, approval, or other action by, and no notice to or filing with, any governmental authority or regulatory body is required (i) for the pledge and assignment by the Pledgor of the Collateral pursuant to this Agreement or for the execution, delivery or performance of this Agreement by the Pledgor, (ii) for the perfection or maintenance of the security interest created hereby (including the first priority nature of such security interest) or (iii) for the exercise by the Operational Agent of its rights and remedies hereunder. (d) There are no conditions precedent to the effectiveness of this Agreement that have not been satisfied or waived. (e) The Pledgor has, independently and without reliance upon the Operational Agent or any Lender and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. SECTION 8. Further Assurances. The Pledgor agrees that at any time and from time to time, at the expense of the Pledgor, the Pledgor will promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary or desirable, or that the Operational Agent may reasonably request, in order to perfect and protect any security interest granted or purported to be granted hereby or to enable the Operational Agent to exercise and enforce its rights and remedies hereunder with respect to any Collateral. SECTION 9. Transfers and Other Liens. The Pledgor agrees that it will not (i) sell, assign (by operation of law or otherwise) or otherwise dispose of, or grant any option with respect to, any of the Collateral, or (ii) create or permit to exist any lien, security interest, option or other charge or encumbrance upon or with respect to any of the Collateral, except for the security interest under this Agreement. SECTION 10. Operational Agent Appointed Attorney-in-Fact. The Pledgor hereby appoints the Operational Agent the Pledgor's attorney-in-fact, with full authority in the place and stead of the Pledgor and in the name of the Pledgor or otherwise, from time to time upon the occurrence and during the continuance of an Event of Default or Unmatured Default or otherwise to the extent that the Operational Agent shall reasonably deem any action to be necessary in order to maintain its security interest in the Collateral, in the Operational Agent's discretion, to take any action and to execute any instrument which the Operational Agent may deem necessary or advisable to accomplish the purposes of this Agreement, including, without limitation, to receive, indorse and collect all instruments made payable to the Pledgor representing any interest payment, dividend or other distribution in respect of the Collateral or any part thereof and to give full discharge for the same. SECTION 11. Operational Agent May Perform. If the Pledgor fails to perform any agreement contained herein, the Operational Agent may itself perform, or cause performance of, such agreement, and the expenses of the Operational Agent incurred in connection therewith shall be payable by the Pledgor under Section 14. SECTION 12. The Operational Agent's Duties. The powers conferred on the Operational Agent hereunder are solely to protect its interest in the Collateral and shall not impose any duty upon it to exercise any such powers. Except for the safe custody of any Collateral in its possession and the accounting for moneys actually received by it hereunder, the Operational Agent shall have no duty as to any Collateral, as to ascertaining or taking action with respect to calls, conversions, exchanges, maturities, tenders or other matters relative to any Collateral, whether or not the Operational Agent or any Lender has or is deemed to have knowledge of such matters, or as to the taking of any necessary steps to preserve rights against any parties or any other rights pertaining to any Collateral. The Operational Agent shall be deemed to have exercised reasonable care in the custody and preservation of any Collateral in its possession if such Collateral is accorded treatment substantially equal to that which the Operational Agent accords its own property. SECTION 13. Remedies upon Default. If any Event of Default shall have occurred and be continuing: (a) The Operational Agent may, without notice to the Pledgor except as required by law and at any time or from time to time, charge, set-off and otherwise apply all or any part of the Account against the Obligations or any part thereof. (b) The Operational Agent may also exercise in respect of the Collateral, in addition to other rights and remedies provided for herein or otherwise available to it, all the rights and remedies of a secured party on default under the Uniform Commercial Code in effect in the State of New York at that time (the "Code") (whether or not the Code applies to the affected Collateral), and may also, without notice except as specified below, sell the Collateral or any part thereof in one or more parcels at public or private sale, at any of the Operational Agent's offices or elsewhere, for cash, on credit or for future delivery, and upon such other terms as the Operational Agent may deem commercially reasonable. The Pledgor agrees that, to the extent notice of sale shall be required by law, at least ten days' notice to the Pledgor of the time and place of any public sale or the time after which any private sale is to be made shall constitute reasonable notification. The Operational Agent shall not be obligated to make any sale of Collateral regardless of notice of sale having been given. The Operational Agent may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned. (c) Any cash held by the Operational Agent as Collateral and all cash proceeds received by the Operational Agent in respect of any sale of, collection from, or other realization upon all or any part of the Collateral may, in the discretion of the Operational Agent, be held by the Operational Agent as collateral for, and/or then or at any time thereafter be applied (after payment of any amounts payable to the Operational Agent pursuant to Section 14) in whole or in part by the Operational Agent for the ratable benefit of the Lenders against, all or any part of the Obligations in such order as the Operational Agent shall elect. Any surplus of such cash or cash proceeds held by the Operational Agent and remaining after payment in full of all the Obligations shall be paid over to the Pledgor or to whomsoever may be lawfully entitled to receive such surplus. SECTION 14. Expenses. The Pledgor will upon demand pay to the Operational Agent the amount of any and all reasonable expenses, including the reasonable fees and expenses of its counsel and of any experts and agents, which the Operational Agent may incur in connection with (i) the administration of this Agreement, (ii) the custody or preservation of, or the sale of, collection from, or other realization upon, any of the Collateral, (iii) the exercise or enforcement of any of the rights of the Operational Agent or the Lenders hereunder or (iv) the failure by the Pledgor to perform or observe any of the provisions hereof. SECTION 15. Amendments, Etc. No amendment or waiver of any provision of this Agreement, and no consent to any departure by the Pledgor herefrom shall in any event be effective unless the same shall be in writing and signed by the Operational Agent, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. SECTION 16. Addresses for Notices. All notices and other communications provided for hereunder shall be in writing (including telegraphic, facsimile, telex or cable communication) and mailed, telegraphed, telecopied, telexed, cabled or delivered, if to the Pledgor, at its address at Fairlane Plaza South, 330 Town Center Drive, Suite 1100, Dearborn, Michigan 48126, Attention: Denise M. Sturdy, Esq., with a copy to Doris F. Galvin, Vice President and Treasurer, 212 West Michigan Avenue, Jackson, Michigan 49201, and if to the Operational Agent, at its address specified in the Credit Agreement, or, as to either party, at such other address as shall be designated by such party in a written notice to the other party. All such notices and communications shall, when mailed, telegraphed, telecopied, telexed or cabled, be effective five days after when deposited in the mails, or when delivered to the telegraph company, telecopied, confirmed by telex answerback or delivered to the cable company, respectively. SECTION 17. Continuing Security Interest; Assignments under Credit Agreement. This Agreement shall create a continuing security interest in the Collateral and shall (i) remain in full force and effect until the later of (x) the payment in full of the Obligations and all other amounts payable under this Agreement and (y) the expiration or termination of the Commitments, (ii) be binding upon the Pledgor, its successors and assigns, and (iii) inure to the benefit of, and be enforceable by, the Operational Agent, the Lenders and their respective successors, transferees and assigns. Without limiting the generality of the foregoing clause (iii), any Lender may assign or otherwise transfer all or any portion of its rights and obligations under the Credit Agreement (including, without limitation, all or any portion of its Commitment, the Advances owing to it and any Note held by it) to any other Person, and such other Person shall thereupon become vested with all the benefits in respect thereof granted to such Lender herein or otherwise, subject, however, to the provisions of Article X (concerning the Agents) and Section 11.07 of the Credit Agreement. Upon the later of the payment in full of the Obligations and all other amounts payable under this Agreement and the expiration or termination of the Commitments, the security interest granted hereby shall terminate and all rights to the Collateral shall revert to the Pledgor. Upon any such termination, the Operational Agent will, at the Pledgor's expense, return to the Pledgor such of the Collateral as shall not have been sold or otherwise applied pursuant to the terms hereof and execute and deliver to the Pledgor such documents as the Pledgor shall reasonably request to evidence such termination. SECTION 18. Governing Law; Terms. This Agreement shall be governed by and construed in accordance with the laws of the State of New York, except to the extent that perfection of the security interest hereunder, or remedies hereunder, in respect of any particular Collateral are governed by the laws of a jurisdiction other than the State of New York. Unless otherwise defined herein or in the Credit Agreement, terms defined in Article 9 of the Code are used herein as therein defined. IN WITNESS WHEREOF, the Pledgor has caused this Agreement to be duly executed and delivered by its officer thereunto duly authorized as of the date first above written. UNION BANK, as Operational Agent OF COUNSEL FOR THE BORROWER To each of the Lenders parties to the Credit Agreement referred to below, and to Citibank, N.A. and Union Bank, as Agents under the Credit This letter is furnished to you pursuant to Section 6.01(a)(ix)(A) of the Credit Agreement, dated as of November 21, 1995 (the "Credit Agreement"), among CMS Energy Corporation (the "Borrower"), the Banks parties thereto and the other Lenders from time to time parties thereto, Citibank, N.A. and Union Bank, as Co-Agents, Citibank, N.A., as Documentation Agent, and Union Bank, as Operational Agent. Capitalized terms not defined herein have the meanings ascribed thereto in the Credit Agreement and the other Loan Documents (as defined in the Credit Agreement). I am Assistant General Counsel of the Borrower and I, or an attorney or attorneys under my general supervision, have represented the Borrower in connection with the preparation, execution and delivery of, and the initial Extension of Credit made under, the Credit Agreement and other Loan Documents. In that capacity, I, or an attorney or attorneys under my general supervision, have examined: (c) The Cash Collateral Agreement; (d) The Articles of Incorporation of the Borrower and all amendments thereto (the "Charter") and (e) The by-laws of the Borrower and all amendments thereto (the "By-laws"). In addition, I, or an attorney or attorneys under my general supervision, have examined the originals, or copies certified to my satisfaction, of such other corporate records of the Borrower, certificates of public officials and of officers of the Borrower, and agreements, instruments and other documents, as I have deemed necessary as a basis for the opinions expressed below. As to various questions of fact material to such opinions, I have, when relevant facts were not independently established by me, relied upon the representations of officers of the Borrower in the Loan Documents, and upon certificates of the Borrower or their respective officers or of public officials. I have assumed (i) the due execution and delivery, pursuant to due authorization, of each document referred to in clauses (a) through (c) above by all parties to such document (other than the Borrower), (ii) the authenticity of all such documents submitted to us as originals, (ii) the genuineness of all signatures (other than those of the Borrower), and (iv) the conformity to the originals of all such documents submitted to us as copies. Based upon the foregoing and upon such investigation as we have deemed necessary, I am of the following opinion: 1. The Borrower is a corporation duly organized, validly existing and in good standing under the laws of the State of Michigan. 2. The execution, delivery and performance by the Borrower of the Credit Agreement, the Notes and the other Loan Documents to which it is, or is to be, a party, are within the corporate power and authority of the Borrower, have been duly authorized by all necessary corporate action, and do not contravene (a) the Charter or the By-laws, (a) any provision of applicable law or (b) any legal or contractual restriction binding on the Borrower or its properties; and such execution, delivery and performance do not result in or require the creation or imposition of any mortgage, deed of trust, pledge, or Lien upon or with respect to any of its properties (other than under the Cash Collateral Agreement). The Credit Agreement, the Notes and the Cash Collateral Agreement have been duly executed and delivered on behalf of the Borrower. 3. Except as disclosed in the Borrower's Quarterly Report on Form 10-Q for the period ended September 30, 1995, there are no pending or threatened actions or proceedings against the Borrower or its properties before any court, governmental agency or arbitrator, that could, if adversely determined, reasonably be expected to materially adversely affect the financial condition, properties, business or operations of the Borrower, the legality, validity or enforceability of the Credit Agreement or any other Loan Document to which the Borrower is, or is to be, a party, or the validity, enforceability, perfection or priority of any Lien purported to be granted by or under the Cash Collateral Agreement to which the Borrower is, or is to be, a party. 4. No authorization or approval or other action by, and no notice to or filing with, any Michigan governmental authority or regulatory body (including, without limitation, the Michigan Public Service Commission) is required for (b) the valid execution, delivery and performance by the Borrower of the Credit Agreement and the other Loan Documents to which it is, or is to be, a party or (c) the creation of any Lien purported to be granted or created pursuant to the Cash Collateral Agreement. 5. In any action or proceeding arising out of or relating to the Credit Agreement, the Notes or any other Loan Document to which the Borrower is, or is to be, a party in any Michigan state court or any Federal court sitting in the State of Michigan, such court would recognize and give effect to the provisions of the Credit Agreement, the Notes or any other Loan Document, as the case may be, wherein the parties thereto agree that the Credit Agreement, the Notes or such other Loan Document, as the case may be, shall be governed by, and construed in accordance with, the laws of the State of New York, except in the case of those provisions set forth in the Credit Agreement, the Notes and the other Loan Documents the enforcement of which would contravene a fundamental policy of the State of Michigan. In the course of our review of the Credit Agreement, the Notes and the other Loan Documents, nothing has come to my attention to indicate that any of such provisions would do so. The opinions expressed herein are limited to the laws of the State of Michigan and the Federal laws of the United States of America. I consent to the reliance on this opinion by King & Spalding in their opinion to you of even date herewith delivered pursuant to Section 6.01(a)(ix)(B) of the Credit Agreement. Except as otherwise specified herein, this opinion is being delivered solely for the benefit of the parties to whom it is addressed. Accordingly, it may not be quoted, filed with any governmental authority or otherwise circulated or utilized for any other purpose without my prior written consent. FORM OF OPINION OF COUNSEL TO THE AGENTS To the Banks listed on Schedule A hereto, and to Citibank, N.A. and We have acted as special New York counsel to Citibank, N.A. and Union Bank, individually and as Agents, in connection with the execution and delivery of, and the making of the initial Extension of Credit on this date under, the Credit Agreement, dated as of November 21, 1995 (the "Credit Agreement"), among CMS Energy Corporation, the Banks parties thereto and the other Lenders from time to time parties thereto, and Citibank, N.A. and Union Bank, as Co-Agents. Terms defined in the Credit Agreement are used herein as therein defined. In this connection, we have examined the following documents: 1. a counterpart of the Credit Agreement, executed by the 2. the Notes to the order of each Bank; and 3. the other documents furnished to the Agents pursuant to Section 6.01(a) of the Credit Agreement, including (without limitation) the opinion (the "Opinion") of Denise M. Sturdy, Esq., Assistant General Counsel of the Borrower. In our examination of the documents referred to above, we have assumed the authenticity of all such documents submitted to us as originals, the genuineness of all signatures, the due authority of the parties executing such documents and the conformity to the originals of all such documents submitted to us as copies. We have further assumed that you have evaluated, and are satisfied with, the creditworthiness of the Borrower and the business and financial terms evidenced by the Loan Documents. We have relied, as to factual matters, on the documents we have examined. To the extent that our opinions expressed below involve conclusions as to matters governed by law other than the law of the State of New York, we have relied upon the Opinion and have assumed without independent investigation the correctness of the matters set forth therein, our opinions expressed below being subject to the assumptions, qualifications and limitations set forth in the Opinion. Based upon and subject to the foregoing, and subject to the qualifications set forth below, we are of the following opinion: 1. The Credit Agreement, the Notes and the other Loan Documents are, and upon their completion, execution and delivery in accordance with the terms of the Credit Agreement, Notes and the other Loan Documents will be, the legal, valid and binding obligations of the Borrower, enforceable against the Borrower in accordance with their respective terms. 2. The Cash Collateral Agreement will, upon the deposit of cash with the Operational Agent pursuant thereto, create a valid security interest in the Collateral (as defined therein, but excluding the Account (as defined therein) and any other type of Collateral that is not subject to Article 9 of the UCC) securing payment of the Obligations (as defined therein). Our opinion is subject to the following qualifications: (a) The enforceability of the Borrower's obligations under the Credit Agreement, the Notes and the other Loan Documents is subject to the effect of any applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium or similar law affecting creditors' rights generally. (b) The enforceability of the Borrower's obligations under the Credit Agreement, the Notes and the other Loan Documents is subject to the effect of general principles of equity, including (without limitation) concepts of materiality, reasonableness, good faith and fair dealing (regardless of whether considered in a proceeding in equity or at law). Such principles of equity are of general application, and, in applying such principles, a court, among other things, might not allow a contracting party to exercise remedies in respect of a default deemed immaterial, or might decline to order an obligor to perform covenants. (c) We note further that, in addition to the application of equitable principles described above, courts have imposed an obligation on contracting parties to act reasonably and in good faith in the exercise of their contractual rights and remedies, and may also apply public policy considerations in limiting the right of parties seeking to obtain indemnification under circumstances where the conduct of such parties is determined to have constituted negligence. (d) We express no opinion herein as to (i) Section 10.05 of the Credit Agreement, (ii) the enforceability of provisions purporting to grant to a party conclusive rights of determination, (iii) the availability of specific performance or other equitable remedies, (iv) the enforceability of rights to indemnity under federal or state securities laws or (v) the enforceability of waivers by parties of their respective rights and remedies under law. (e) With respect to the opinions set forth in paragraph 2 above, we have assumed that the Borrower has not granted or permitted, nor does there otherwise exist, any execution or attachment on any of the Collateral or any other Lien therein or thereon which does not require steps for perfection under the UCC of any jurisdiction to be enforceable against third parties. Further, with respect to any Collateral constituting "securities" within the meaning of Article 8 of the UCC, a security interest in such Collateral is enforceable and can attach only if such security is transferred to the Operational Agent or a person designated by the Operational Agent pursuant to a provision of Section 8-313(1) of the UCC. (f) We express no opinion herein as to: (i) the Borrower's rights in or title to any Collateral, or the authenticity or enforceability thereof; (ii) the perfection or priority of any security interests. (g) Our opinions expressed above are limited to the law of the State of New York, and we do not express any opinion herein concerning any other law. The foregoing opinion is solely for your benefit and may not be relied upon by any other person or entity, other than any Person that may become a Lender under the Credit Agreement after the date hereof. IN DETERMINING COMPLIANCE WITH COVENANTS CONTAINED IN SECTIONS 8.01(i) AND 8.01(j) (Capitalized terms used herein and not otherwise defined shall have the meanings ascribed thereto in the Credit Agreement dated as of November 21, 1995, among CMS Energy Corporation, the banks named therein, and Citibank, N.A. and Union Bank, as Co-Agents) I. SECTION 8.01(i) (Consolidated Leverage Ratio) (a) Debt of the Borrower (See worksheet set forth on Schedule I hereto) $_______ (b)1 Aggregate debt (as such term is construed in accordance with GAAP) of the Consolidated Subsidiaries $_______ (a) Total Consolidated Debt (See (i) above) $_______ (b)2 Consolidated equity of the common stockholders of the Borrower and the 1 To the extent included, Project Finance Debt of any Consolidated Subsidiary shall be included only to the extent of the Borrower's Ownership Interest in such Consolidated Subsidiary. 2 To the extent included in (b), (c) or (d) above, Project Finance Equity of the Borrower and the Consolidated Subsidiaries in any Consolidated Subsidiary should be included only to the extent of the Borrower's Ownership Interest in each such Consolidated Subsidiary. (c)2 Consolidated equity of the preference stockholders of the Borrower and the (d)2 Consolidated equity of the preferred stockholders of the Borrower and the (iii) Consolidated Leverage Ratio (i/ii) ____ Maximum Ratio - Section 8.01(i) ____ II. SECTION 8.01(j) (Cash Dividend Coverage Ratio) (a) Cash Dividend Income $_______ (b) 25% of Equity Distributions (not to exceed $10,000,000) $_______ (c) All amounts received by the and letter of credit fees) paid by the Borrower on behalf of any such Subsidiary or Affiliate $_______ Total Cash Dividend Income $_______ (ii) Interest expense (including commitment, guaranty and letter of credit fees) accrued by the Borrower in respect of all Debt $_______ Maximum Ratio - Section 8.01(j) ____ III. SECTION Project Finance Debt3 3 Set forth all Project Finance Debt of any Consolidated Subsidiary and the Borrower's Ownership Interest in such Consolidated Subsidiary. 4 Set forth all Support Obligations of the Borrower of the types described in clauses (iv) and (v) of the definition of Support Obligations (whether or not each such Support Obligation or the primary obligation so supported is fixed, conclusively determined or reasonably quantifiable) unless such Support Obligation is previously disclosed as "Consolidated Debt" pursuant to Section I or II above. Computation of Aggregate Debt of the Borrower Aggregate Debt of the Borrower (without duplication) any and all indebtedness, liabilities and other monetary obligations of the Borrower (whether for principal, interest, fees, costs, expenses or otherwise, and (i) for borrowed money or evidenced by bonds, debentures, notes or other (ii) to pay the deferred purchase price of property or services (except trade accounts payable arising in the ordinary course of business which (iii) as lessee under leases which shall have been or should be, in accordance with GAAP, recorded as capital leases $_______ (iv) under reimbursement or similar agreements with respect to letters of (v) under any interest rate swap, "cap", "collar" or other hedging agreements; provided, however, for purposes of the calculation of Debt for this clause only, the actual amount of Debt of the Borrower shall be determined on a net basis to the extent such agreements permit such amounts to be calculated on 1 Debt of the Borrower shall (a) include only 50% of the aggregate principal amount of Subordinated Debt and Preferred Securities described in clause (b) of the definition of Preferred Securities, subject to a maximum exclusion of $100,000,000 in the aggregate, and (b) not include Subordinated Debt or Preferred Securities if such Subordinated Debt or Preferred Securities, as the case may be, is mandatorily convertible into common stock of the Borrower upon terms and conditions satisfactory to the Majority Lenders. (vi) to pay rent or other amounts under leases entered into in connection with sale and leaseback transactions involving assets of the Borrower being sold in connection (vii) arising from any accumulated funding deficiency (as defined in Section 412(a) of the Internal Revenue Code of 1986, as amended) for a Plan $_______ (viii) direct or indirect guaranties in respect of, and obligations to purchase or otherwise acquire, or otherwise to warrant or hold harmless, pursuant to a legally binding agreement, a creditor against loss in respect of, Debt of others referred to in clauses (i) through (vii) above $_______ (ix) other guaranty or similar financial obligations in respect of the performance of others, including, without limitation, any financial obligation, contingent or otherwise, of the Borrower guaranteeing or otherwise supporting any Debt or other obligation of any other Person in any manner, whether directly or indirectly, and including, without limitation, any obligation of such Person, direct or indirect $_______ (A) to purchase or pay (or advance or supply funds for the purchase or payment of) such Debt or to purchase (or to advance or supply funds for the purchase of) any security for the payment of such (B) to purchase property, securities or services for the purpose of assuring the owner of such Debt of the payment of such Debt $_______ (C) to maintain working capital, equity capital, available cash or other financial statement condition of the primary obligor so as to enable the primary obligor to pay such Debt $_______ (D)2 to provide equity capital under or in respect of equity subscription arrangements (to the extent that such obligation to provide equity capital does not otherwise constitute (E)2 to perform, or arrange for the payment obligations of the primary Total of Debt of the Borrower $_______ 2 For purposes of this clause do not include Support Obligations if such Support Obligation or the primary obligation so supported is not fixed or conclusively determined or is not otherwise reasonably quantifiable as of the date of determination. Reference is made to the Credit Agreement, dated as of November ____, 1995 (said Agreement, as it may hereafter be amended or otherwise modified from time to time, being the "Credit Agreement", the terms defined therein and not otherwise defined herein being used herein as therein defined), among the Borrower, the Lenders, the Co-Agents, the Documentation Agent and the Operational Agent. Pursuant to the Credit Agreement, ________________________________ (the "Assignor") has committed to make advances ("Advances") to the Borrower, which Advances are evidenced by a promissory note (the "Note") issued by the Borrower to the Assignor. The Assignor and ____________________________________ (the "Assignee") agree as follows: 1. The Assignor hereby sells and assigns to the Assignee, and the Assignee hereby purchases and assumes from the Assignor, that interest in and to all of the Assignor's rights and obligations under the Credit Agreement as of the date hereof which represents the percentage interest specified on Schedule 1 of all outstanding rights and obligations under the Credit Agreement (the "Assigned Interest"), including, without limitation, such interest in the Assignor's Commitment, the Advances owing to the Assignor and the Note held by the Assignor. After giving effect to such sale and assignment, the Assignee's Commitment and the amount of the Advances owing to the Assignee will be as set forth in Section 2 of Schedule 1. The effective date of this sale and assignment shall be the date specified in Section 3 of Schedule 1 hereto (the "Effective Date"). 2. On _______________, 19__, the Assignee will pay to the Assignor, in same day funds, at such address and account as the Assignor shall advise the Assignee, $___________, and the sale and assignment contemplated hereby shall thereupon become effective as of the Effective Date. From and after the Effective Date, the Assignor agrees that the Assignee shall be entitled to all rights, powers and privileges of the Assignor under the Credit Agreement and the Note to the extent of the Assigned Interest, including without limitation (i) the right to receive all payments in respect of the Assigned Interest for the period from and after the Effective Date, whether on account of principal, interest, fees, indemnities in respect of claims arising after the Effective Date, increased costs, additional amounts or otherwise, (ii) the right to vote and to instruct the Agents under the Credit Agreement according to its Percentage based on the Assigned Interest, (iii) the right to set-off and to appropriate and apply deposits of the Borrower as set forth in the Credit Agreement and (iv) the right to receive notices, requests, demands and other communications. The Assignor agrees that it will promptly remit to the Assignee any amount received by it in respect of the Assigned Interest (whether from the Borrower, any Agent or otherwise) in the same funds in which such amount is received by the Assignor. 3. The Assignor (i) represents and warrants that it is the legal and beneficial owner of the interest being assigned by it hereunder and that such interest is free and clear of any adverse claim; (ii) makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with the Credit Agreement or the execution, legality, validity, enforceability, genuineness, sufficiency or value of the Credit Agreement or any other instrument or document furnished pursuant thereto; and (iii) makes no representation or warranty and assumes no responsibility with respect to the financial condition of the Borrower or the performance or observance by the Borrower of any of its obligations under the Credit Agreement or any other instrument or document furnished pursuant thereto. Except as specified in this Section 3, the assignment of the Assigned Interest contemplated hereby shall be without recourse to the Assignor. 4. The Assignee (i) confirms that it has received a copy of the Credit Agreement, together with copies of the financial statements referred to in Section 7.01(e)(i) thereof and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into this Assignment and purchase the Assigned Interest, (ii) agrees that it will, independently and without reliance upon the Assignor and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Credit Agreement, (iii) confirms that it satisfies the requirements of an Eligible Assignee, (iv) appoints and authorizes each Agent to take such action as agent on its behalf and to exercise such powers under the Loan Documents as are delegated to each Agent by the terms thereof, together with such powers as are reasonably incidental thereto and (v) agrees that it will perform in accordance with their terms all of the obligations which by the terms of the Loan Documents are required to be performed by it as a Lender. 5. This Assignment may be executed in any number of counterparts and by different parties in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute but one and the same instrument. 6. This Assignment shall be governed by, and construed in accordance with, the laws of the State of New York. IN WITNESS WHEREOF, the parties hereto have caused this Assignment to be executed by their respective officers thereunto duly authorized, as of the date first above written, such execution being made on Schedule 1 hereto. Advances owing to the Assignee: $______ (1) Consent of the Borrower is required for all assignments except for any assignment by a Lender to any of its Affiliates or to any other Lender or any of its Affiliates.	POS AM	EX-4	1996-01-12T00:00:00	1996-01-12T15:11:58
0000950115-96-000013	0000950115-96-000013_0016.txt	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE For the fiscal year ended: September 30, 1995 Commission File (Exact name of registrant as specified in its charter) (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1403 Foulk Road, Suite 102 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (302) 479-0281 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.001 per share 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 ___ The aggregate market value of the registrant's voting stock held by nonaffiliates (based upon the closing price of $9.875) on December 1, 1995, was approximately $33,900,000. As of December 1, 1995, there were 6,126,250 shares of Common Stock, par value $.001 per share, outstanding. 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 statements incorporated by reference in Part III of this Form 10-K or any amendment to this Portions of the Proxy Statement for the Annual Meeting of Stockholders to be held in 1996 are incorporated by reference into Part III. The index to Exhibits begins on page 27. PCI Services, Inc. (the "Company") provides integrated packaging services to meet the diverse and changing packaging needs of its pharmaceutical customers in the United States and Europe. The packaging of a pharmaceutical product is an integral part of its efficacy, safety and consumer acceptance. While many pharmaceutical companies package certain products at their own facilities, many regularly utilize independent packagers for other products and special circumstances. Some manufacturers also use independent packagers to provide additional packaging capacity for peaks in demand, and some manufacturers do not package their products, using independent packagers for all of their packaging needs. The pharmaceutical industry is affected by global concerns relating to health care reform, the regulatory climate, environmental protection and general economic conditions. The Company is unable to determine the effect, if any, changes in the pharmaceutical industry may have on pharmaceutical packagers. The market for pharmaceutical packaging services has benefited from increased competition in the pharmaceutical industry, particularly for over-the-counter products, increased use of "unit-dose" packaging and changes in regulatory practices. The Company provides a wide range of packaging services to its pharmaceutical customers. By offering a single source of integrated packaging services, the Company can assist a pharmaceutical manufacturer in enhancing quality and uniformity, reducing waste through increased production efficiency, and obtaining faster delivery by reducing multiple vendor involvement. The customer can select the full range of packaging services or may select only those which meet its needs for a particular product. The Company packages pharmaceutical products in the form of tablets, capsules, powders, ointments, lotions and liquids. The packaging services offered by the Company include blister packaging, bottle filling, strip packaging, pouching, capsule filling and cold-forming, as well as tamper-evident and child-resistant features. Blister packaging consists of a blister affixed to a rigid or semi-rigid backing material, through which an individual dose is expelled. Bottle filling uses high speed equipment which fills glass or plastic bottles with pharmaceutical products, and then adds cotton, safety seals, caps and labels in one production line. Strip packaging is often used for products that require extra protection from moisture, light and tampering and generally consists of higher density materials produced in a perforated strip of packages. Pouching, which is similar to strip packaging, is often used for larger volume packages filled with powders or liquids, but can also be used as a unit-dose package for tablets or capsules, and consists of a flexible packaging material (plastic, foil, paper or synthetic materials) which is formed, filled and sealed. Capsule filling consists of hard gelatin capsules which are filled with pharmaceutical products in the form of powders, granules, pellets or tablets. Cold-forming uses laminated foil, which is formed, filled and heat-sealed, and is generally used for products requiring extra protection from moisture. Tamper-evident and child-resistant features may take the form of blister, shrink-wrap, over-wrap or other packaging. Additional packaging services provided by the Company include the production of folding cartons, thermoformed components, and the printing of product inserts. Folding cartons are printed, die cut and glued boxes ready for machine or hand filling with blisters, bottles or other pharmaceutical packages. Thermoformed components consist of vacuum formed plastic trays and display components. The Company provides production services from layout and design through full color printing, die cutting, folding and gluing. The Company's services include the design, printing and folding of inserts, containing important dosage and other information, for the customer to add to its pharmaceutical packages or for the Company to include as part of its other packaging services. The Company markets its services primarily through the development of relationships with senior managers within the purchasing, manufacturing, quality assurance, marketing and package development departments of pharmaceutical companies. These relationships are fostered and maintained by the Company's senior management and sales force, as well as by representatives from the Company's manufacturing and quality assurance operations. The Company's existing customers, as well as potential new accounts, are contacted on a regular basis by the Company's senior management and sales force. In general, pharmaceutical packaging services are provided by the Company to its customers on an as-needed basis. The Company also has single source relationships, in which the pharmaceutical manufacturer relies principally on the Company to fulfill particular needs. A single source relationship can increase volume predictability and decrease production setup time and costs, resulting in increased operating efficiencies for the Company. In addition, single sourcing can help streamline the customer's purchasing operations, reduce its inventory, warehousing and personnel expenses and increase vendor reliability, quality assurance and responsiveness. For the fiscal years ended September 30, 1995, 1994 and 1993, divisions or affiliates of Johnson & Johnson accounted for an aggregate of 24%, 21% and 22%, respectively, of net revenue. The Company maintains separate relationships with each of these divisions or affiliates and believes that purchasing decisions are made on an independent basis. The Company believes that competition for pharmaceutical packaging services is based primarily on quality, the variety of packaging services available, customer service, responsiveness and price. The Company competes with several companies that provide many types of packaging services, and a large number of companies that provide one or a few types of packaging services. The Company currently competes with companies that are larger and have greater financial and other resources. The Company believes that while there are a large number of independent providers of one or more pharmaceutical packaging services, only a few, such as the Company, offer a broad range of services. In order to compete successfully, the Company believes an independent packager must have expertise in the packaging services required, satisfy the high quality standards of pharmaceutical companies and the U.S. Food and Drug Administration ("FDA"), and respond to the diverse and changing needs of the pharmaceutical industry, all at competitive prices. Government Regulation and Quality Assurance The Company's domestic pharmaceutical packaging operations are required to be, and the Company believes that such operations are, conducted pursuant to the current Good Manufacturing Practices standards of the FDA. The Company is registered with the FDA as a pharmaceutical packager and its pharmaceutical packaging facilities undergo general FDA inspections every two years. In addition, certain of the Company's facilities are subject to limited inspections from time to time in connection with the Company being designated in new drug applications by pharmaceutical companies as a potential independent packager. The purpose of the inspections is to review the Company's capability to package the new drug in question. Only those companies designated in an approved new drug application may provide packaging services with respect to such new drug. While the Company does not conduct an independent analysis of the products provided by its customers for packaging, rigorous controls are maintained to account for product utilization. The Company is also subject to various rules and regulations administered by the Drug Enforcement Administration division of the United States Department of Health and Human Services and other federal, state and local agencies. In addition, the Company's facilities are inspected periodically by the Company's customers as part of their quality assurance process, with the frequency of inspections varying by customer and packaging service. The Company's operations in Germany are subject to state and local certification requirements, including compliance with the current Good Manufacturing Practices adopted by the European Community. The Company's facility in Germany is also subject to periodic regulatory and customer inspections. The Company has approximately 1,300 employees engaged in executive, sales, technical and administrative functions and production. Certain of the Company's employees at certain of the domestic facilities are represented by unions pursuant to contracts expiring in 2000. As is customary in Germany, certain terms and conditions of employment for the Company's employees in that country are regulated by national union contracts. The number of persons employed by the Company fluctuates depending upon the volume of business. The Company was incorporated on September 20, 1991 under the laws of the State of Delaware. Prior to its initial public offering in January 1992, the Company had been a wholly-owned subsidiary of MEDIQ Incorporated ("MEDIQ"). MEDIQ, a 47% owner of the Company, is currently exploring alternative ways to maximize MEDIQ's shareholder value. MEDIQ has announced its intention to pursue the realization of the value of its investment in the Company. Financial Information About Foreign and Domestic Operations Financial information about foreign and domestic operations is discussed in Note J to the Consolidated Financial Statements included elsewhere herein. The Company operates the following principal facilities (which are leased unless otherwise indicated): (2) Anticipated to be operational early 1996. The Company's facilities in New Jersey, Germany, Puerto Rico and Virginia also contain regional administrative and sales offices. The Company is constructing a new pharmaceutical packaging facility in Schorndorf, Germany to replace the Company's facility in Waiblingen, Germany, the lease on which expires in April 1996. The Company believes that its facilities are well maintained and in good operating condition, and that such facilities will be adequate for all of the Company's reasonably foreseeable requirements. The Company may, from time to time, become involved in various legal proceedings incidental to its business, some of which may be covered by insurance. The Company knows of no litigation, either pending or threatened, which is likely to have a material adverse effect on the Company. The Company has never been subject to any product liability claims. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the quarter ended September 30, 1995. ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED The following table sets forth, for the periods indicated, the high and low prices for the common stock as reported by NASDAQ. Fiscal year ended September 30, 1995: First Quarter $ 7.000 $ 5.500 Fiscal year ended September 30, 1994: First Quarter $11.750 $ 8.750 The Company believes there are approximately 1,500 holders of common stock, including shares held in street name by brokers. The Company did not declare any dividends on its common stock in the fiscal years ended September 30, 1995, 1994 and 1993. Pursuant to a lending arrangement, there are restrictions on the amount of dividends which may be paid, the most restrictive of which limits cash dividends to no more than 50% of net income during any year. Any future determination to pay cash dividends will be at the discretion of the Board of Directors, and will be dependent upon the Company's financial condition, results of operations, capital requirements and such other factors as the Board of Directors deem relevant. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data presented below has been derived from the audited financial statements of the Company. This data is qualified in its entirety by reference to, and should be read in conjunction with, Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements included elsewhere herein. See Notes to Selected Consolidated Financial Data on following page. Notes to Selected Consolidated Financial Data (1) In December 1992, the Company issued 660,000 shares of common stock to acquire Allpack Industrielle Lohnverpackung GmbH ("Allpack"). (2) Management fees - MEDIQ represented primarily an allocation of MEDIQ's overhead and its costs to provide senior management, financial, legal, accounting and risk management services to the Company. In connection with the Company's initial public offering, certain relationships with MEDIQ were restructured. Effective October 1, 1991, the Company entered into a services agreement pursuant to which the Company obtains certain legal, accounting, tax and risk management services from MEDIQ. Costs for such services were $100,000 for each of the fiscal years 1995, 1994, 1993 and 1992, and are included in selling, general and administrative expenses. The Company believes that the terms of the services agreement and MEDIQ's charges for such services are on terms no less favorable than those that could be obtained from unaffiliated third parties for comparable services. (3) In August 1994, the Company repurchased the 660,000 shares of common stock which had been issued in connection with the acquisition of Allpack. (4) In February 1992, the Company completed its initial public offering consisting of 3,306,250 shares of common stock at a price of $10 per share. The Company utilized a portion of the proceeds to repay amounts outstanding to MEDIQ, to purchase equipment under capital lease arrangements and to retire certain term loan obligations. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS The following discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto, contained elsewhere herein. The Company's pharmaceutical packaging services are generally provided on an as-needed basis. As a result, revenue per customer and profit margins per order can vary significantly from year to year and quarter to quarter. Results for any particular quarter are not necessarily indicative of results for any subsequent quarter or related fiscal year. Effective October 1, 1994, the Company sold its 70% interest in KR-Verpackung GmbH ("KR") of Muggensturm, Germany and its manufacturing facility, to the management of KR for $5,201,000, including the assumption of debt of $4,379,000. The sale of KR and the manufacturing facility resulted in a pretax loss of $23,000. Revenues from KR were $6,700,000 and $5,852,000, for 1994 and 1993, respectively, and net income was $152,000 and $203,000, respectively. The following table sets forth for the periods indicated the percentage relationship that items in the Consolidated Statements of Operations bear to net revenue. Net revenue 100.0% 100.0% 100.0% Cost of goods sold 78.3 79.3 78.1 Gross profit 21.7 20.7 21.9 Selling, general and administrative expenses 12.8 13.4 12.9 Interest and other (income) expense 1.5 1.1 .9 Income before income tax expense 7.4 6.2 8.1 Income tax expense 3.1 1.8 2.6 Net income 4.3% 4.4% 5.5% Fiscal Year 1995 Compared to Fiscal Year 1994 Net revenue was $129,785,000, an increase of $8,608,000, or 7.1%, over prior year net revenue of $121,177,000, which included revenues from KR of $6,700,000. This increase was primarily attributable to the introduction by customers of several new pharmaceutical products, as well as revenues from the Company's new pharmaceutical insert/outsert manufacturing facility in New Jersey, which commenced production in April 1994, and increased demand for packaging services from the Company's facilities in Puerto Rico. Gross profit was 21.7% of net revenue, as compared to 20.7% in 1994. This increase was attributable to changes in product mix and improved results from the Company's foreign operations, which had been adversely affected in the prior year as a result of a decision by a major European customer to discontinue a packaging contract with the Company in order to perform the packaging in its own facilities. The Company has mitigated this loss by obtaining additional foreign business, including the return of a portion of the discontinued contract. Gross profit for 1995 was also affected by decreased contributions from the Company's facilities in Puerto Rico as a result of competitive pressures. Selling, general and administrative expenses were $16,613,000, as compared to $16,249,000 in 1994. As a percentage of net revenue, selling, general and administrative expenses decreased to 12.8%, as compared to 13.4% in the prior year as a result of the allocation of these costs over higher net revenues. Interest expense was $1,838,000, as compared to $1,527,000 in 1994. This increase was primarily attributable to debt incurred in the fourth quarter of 1994 in connection with the purchase of shares of the Company's common stock, partially offset by the elimination of interest expense related to the mortgage on KR's manufacturing facility. Capitalized interest expense related to new facilities in Philadelphia, Pennsylvania and Schorndorf, Germany was $318,000 in 1995. The Company's effective income tax rate increased to 42.2%, as compared to 28.8% in 1994 principally as a result of lower earnings from operations in Puerto Rico combined with growth of the Company's other operations. The Revenue Reconciliation Act of 1993 limits Section 936 tax credits applicable to operations in Puerto Rico. These limitations did not adversely impact, nor are they anticipated to adversely impact, the Company's effective income tax rate. Fiscal Year 1994 Compared to Fiscal Year 1993 Net revenue was $121,177,000, an increase of $9,905,000, or 8.9%, as compared to 1993. The increase was primarily attributable to increased volume to existing customers and an expanded customer base. Strong demand for contract packaging, carton manufacturing and insert manufacturing services continued to generate new business. Gross profit increased to $25,085,000, representing a gross margin on net revenue of 20.7%, as compared to 21.9% in 1993. The gross margin decrease was caused by domestic product mix and a lower profit contribution from the Company's foreign operations. Foreign gross profit margins were adversely affected in 1994 as a result of a decision by a major European customer to discontinue a packaging contract with the Company in order to perform the packaging in its own facilities. Customer decisions to move packaging into the customers' facilities are a normal occurrence in the pharmaceutical packaging industry. While the Company mitigated this loss by obtaining additional foreign business, including the return of a portion of the discontinued contract, these operations did not return to profitability until the fourth quarter of 1994. Gross margins were also adversely affected by costs associated with the Company's new pharmaceutical insert manufacturing plant in New Jersey, which commenced production in April 1994. Selling, general and administrative expenses were $16,249,000, an increase of $1,915,000, or 13.4%, as compared to 1993 expenses of $14,334,000. As a percentage of net revenue, selling, general and administrative expenses increased to 13.4% from 12.9% in 1993, primarily attributable to costs associated with increased sales and marketing expenses. Interest expense increased to $1,527,000, as compared to $1,269,000 in 1993. This increase resulted primarily from debt assumed in connection with the acquisition of the Company's Virginia facility in January 1993 and debt incurred in connection with the purchase of an operating facility in April 1993 which had previously been leased. The Company's effective income tax rate decreased to 28.8% in 1994 as compared to 31.6% in 1993 as a result of higher earnings from operations in Puerto Rico. At September 30, 1995, the Company had working capital of $12,180,000 including cash and cash equivalents of $3,619,000. Net cash provided by operations was $11,400,000 for 1995, which was comparable to 1994. Net cash provided by operations for 1995 was adversely affected by increased accounts receivable attributable to increased revenues and the elimination of a discount policy. In addition, inventories increased in the fourth quarter of 1995 in anticipation of increased business in the first quarter of fiscal 1996. Investing activities for 1995 consisted principally of capital expenditures of $23,777,000, of which approximately $8,100,000 was attributable to building improvements for the Company's new pharmaceutical packaging facility in Philadelphia, Pennsylvania and $8,500,000 was attributable to the purchase of land and construction costs for a new pharmaceutical packaging facility in Schorndorf, Germany, with the remainder attributable to equipment purchases. The Schorndorf facility, which is scheduled to open in January 1996, will replace the Company's facility in Waiblingen, Germany, which is leased through April 1996. The Company anticipates capital expenditures in 1996 of approximately $8,000,000 for equipment and $7,000,000 for the Schorndorf facility. Investing activities also included proceeds from the sale of assets, including KR, of $1,141,000 and the payment of $533,000 representing the final installment of the contingent consideration related to the 1992 acquisition of a business in Puerto Rico. Financing activities for 1995 included debt repayments of $3,754,000 and borrowings of $16,317,000, of which approximately $8,600,000 related to the new packaging facility in Philadelphia and $5,500,000 related to the new facility in Schorndorf. In addition, the Company purchased an aggregate of 55,000 shares of its common stock for $382,000 pursuant to a stock buy-back program, initiated by the Company's Board of Directors in fiscal 1994. The program allows for the purchase of 245,000 additional shares of common stock from time to time in the open market or through private transactions. During 1995, the Company entered into agreements with a bank and state and municipal authorities to finance building improvements and equipment for the new facility in Philadelphia. The bank financing includes a mortgage of $3,800,000 payable in monthly installments over 15 years with interest at the prime rate plus .25% and state and municipal financing of approximately $5,000,000, including $4,000,000 payable over 15 years with interest at 2%, $500,000 payable over 15 years with interest at 5.25% and $500,000 payable over 7 years with interest at 2%. In addition, the Company entered into a $13,000,000 mortgage with a bank in Germany to finance the construction of the new packaging facility in Schorndorf, Germany. The financing bears interest at the rate of 7.73% for the first five years, and, thereafter, at a rate to be negotiated. Interest only is payable for the first two years, and then principal and interest is payable monthly until maturity in 2014. At September 30, 1995, $5,478,000 was outstanding under this facility. At September 30, 1995, the Company had approximately $2,000,000 available under its lines of credit. Management believes that working capital, anticipated funds to be generated from future operations and available credit facilities will be sufficient to meet anticipated operating and capital needs. Depending upon the future growth of the business, additional financing may be required. Effective December 1, 1995, the Company exercised its option to repurchase shares of preferred stock of Tri-Line, a subsidiary of the Company, issued in connection with the acquisition in 1992. The purchase price was $900,000, representing the book value of such shares (which were included in other liabilities in the Company's Consolidated Balance Sheets), and was funded out of working capital. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA Consolidated Statements of Operations - Three Years Ended September 30, 1995 14 Consolidated Balance Sheets - September 30, 1995 and 1994 15 Consolidated Statements of Stockholders' Equity - Three Years Ended September 30, 1995 16 Consolidated Statements of Cash Flows - Three Years Ended September 30, 1995 17 Notes to Consolidated Financial Statements 18 Board of Directors and Stockholders PCI Services, Inc. We have audited the accompanying consolidated balance sheets of PCI Services, Inc. and subsidiaries as of September 30, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended September 30, 1995. Our audits also include the financial statement schedule listed in the index at Item 14. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PCI Services, Inc. and subsidiaries as of September 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. PCI SERVICES, INC. AND SUBSIDIARIES See notes to consolidated financial statements. PCI SERVICES, INC. AND SUBSIDIARIES See notes to consolidated financial statements. PCI SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY See notes to consolidated financial statements. PCI SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS See notes to consolidated financial statements. Note A - Summary of Significant Accounting Policies Principles of Consolidation - The consolidated financial statements include the accounts of PCI Services, Inc. and its subsidiaries (the "Company"). In consolidation, all significant intercompany transactions and balances have been eliminated. Cash Equivalents - Cash equivalents include all unrestricted, liquid investments purchased with maturities of three months or less. Inventories - Inventories are stated at the lower of cost (first-in, first-out method) or market. Property, Plant and Equipment - Property, plant and equipment are stated at cost. Capital leases are recorded at the lower of fair market value or the present value of future lease payments. The Company provides for depreciation and amortization on a straight-line basis as follows: Buildings 25 to 30 years Building improvements 15 to 30 years Machinery, equipment, furniture and fixtures 5 to 10 years Goodwill - The purchase price in excess of net assets acquired is amortized on a straight-line basis over forty years. Carrying Value of Long-Term Assets - The Company evaluates the carrying value of long-term assets, including goodwill, based upon current and anticipated net income and/or undiscounted cash flows and recognizes an impairment when it is probable that such estimated future net income and/or cash flows will be less than the carrying value of the asset. Measurement of the amount of impairment, if any, is based upon the difference between carrying value and fair value. Foreign Currency Translation - In accordance with Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation," the consolidated financial statements of the Company's German subsidiary, Allpack Industrielle Lohnverpackung GmbH ("Allpack"), are translated from deutschemarks to U.S. dollars using the exchange rate at the balance sheet date for assets and liabilities, and the weighted average exchange rate during the period for results of operations and cash flows. The related translation adjustment is included as a separate component of stockholders' equity. Revenue Recognition - The Company recognizes revenue on specific orders when they are shipped. In certain situations, based on individual agreements with customers, revenue is recognized when the packaging services are completed, and delivery is deferred at the customer's request. Income Taxes - Effective October 1, 1993, the Company adopted the provisions of SFAS No. 109, "Accounting for Income Taxes", which supersedes SFAS No. 96. The Company adopted SFAS No. 96 in fiscal 1990. The effect of the adoption of SFAS No. 109 was not significant for the year ended September 30, 1994. Note A - Summary of Significant Accounting Policies (Continued) Earnings Per Share - Earnings per share computations are based upon the weighted average number of common shares outstanding. Outstanding stock options have been excluded from the calculation of weighted average shares outstanding, since the dilutive effect is less than 3%. Reclassifications - Certain items in the prior years' financial statements have been reclassified to conform with the 1995 presentation. Note B - Sale of KR - Verpackung GmbH Effective October 1, 1994, the Company sold its 70% interest in KR-Verpackung GmbH ("KR") of Muggensturm, Germany and its manufacturing facility, to the management of KR for $5,201,000, including the assumption of debt of $4,379,000. The net assets of KR and the manufacturing facility were classified as "Assets Held For Sale" in the accompanying balance sheet as of September 30, 1994. The sale of KR and the manufacturing facility resulted in a pretax loss of $23,000. Revenues from KR were $6,700,000 and $5,852,000, for 1994 and 1993, respectively, and net income was $152,000 and $203,000, respectively. Raw materials $ 6,894,000 $5,077,000 Work in process 1,000,000 1,760,000 Note D - Property, Plant and Equipment Land $ 4,161,000 $ 1,388,000 Building and improvements 26,819,000 12,289,000 Machinery, equipment, furniture and fixtures 58,750,000 49,684,000 Equipment under capital lease 1,341,000 3,667,000 Less: accumulated depreciation and amortization 29,170,000 22,883,000 Depreciation and amortization expense related to property, plant and equipment for fiscal years 1995, 1994 and 1993 was $6,538,000, $5,037,000 and $4,472,000, respectively. Note E - Notes Payable to Financial Institutions At September 30, 1995, the Company had $1,010,000 available under unsecured lines of credit with a financial institution with $2,005,000 outstanding bearing interest at rates ranging from 3.56% to 5.35%. The average amount outstanding in fiscal year 1995 was $1,624,000 and the weighted average interest rate computed on the monthly outstanding balance was 4.7%. Note F - Long-Term Debt Maturities of long-term debt are as follows: In 1995, the Company entered into agreements with a bank and state and municipal authorities to finance building improvements and equipment for the new packaging facility in Philadelphia, Pennsylvania. The bank financing included a mortgage of $3,800,000 payable over 15 years with interest at the prime rate plus .25% and state and municipal financing of approximately $5,000,000 of term loans and a mortgage, with $4,000,000 payable over 15 years with interest at 2%, $500,000 payable over 15 years with interest at 5.25% and $500,000 payable over 7 years with interest at 2%. In February 1995, the Company entered into a $13,000,000 mortgage with a bank in Germany to finance the construction of the new packaging facility in Schorndorf, Germany. The financing bears interest at the rate of 7.73% for the first five years, and at a rate to be negotiated for the remainder of the term. Interest only is payable for the first two years, and then principal and interest is payable monthly until maturity in 2014. At September 30, 1995, $5,478,000 was outstanding under this facility. Note F - Long-Term Debt (Continued) In August 1994, the Company entered into an agreement with a commercial lender for a revolving credit facility and two term notes of $7,500,000 and $983,000. The revolving credit facility has been extended to March 31, 1997 and bears interest, at the Company's option, at the prime rate or LIBOR plus 2%. Draws under this facility for equipment purchases aggregating $1,000,000 or more are converted to term notes, payable over a maximum of 60 months. At September 30, 1995, $3,000,000 was outstanding under this facility, with $1,000,000 available for additional borrowing. The $7,500,000 term note is payable monthly through August 1999 with interest at the prime rate plus .25%. The $983,000 term note is payable monthly through May 1999 plus interest at the prime rate. The revolving credit facility and certain term loans and mortgages require the maintenance of specific balance sheet and operating ratios and impose other financial and dividend limitations. The most restrictive of these provisions limits cash dividends to no more than 50% of net income in any one year. At September 30, 1995, the Company either complied with or obtained the necessary waivers from its lenders regarding these ratios and limitations. The net carrying value of assets pledged as collateral under long-term debt agreements was approximately $79,000,000 as of September 30, 1995. Note G - Commitments and Contingencies Leases - The Company leases certain manufacturing and warehouse facilities and equipment. Rental expense for operating leases was $1,497,000, $1,452,000 and $1,286,000 for fiscal years 1995, 1994 and 1993, respectively. At September 30, 1995 equipment under capitalized lease obligations was $1,341,000, less accumulated amortization of $787,000. Future minimum payments under capital leases and noncancelable operating leases are as follows: 1996 $ 86,000 $ 830,000 2000 and thereafter -- 33,000 Total minimum lease payments 91,000 $1,454,000 Present value of minimum lease payments $ 89,000 Letters of Credit - As of September 30, 1995, the Company had outstanding letters of credit of $2,657,000, which secure the Company's obligations under insurance programs. Note H - Income Taxes Income tax expense consisted of the following: The differences between the provision for income taxes and income taxes computed using the U.S. federal income tax rate were as follows: Note H - Income Taxes (Continued) Significant components of deferred tax assets and liabilities were as follows: Depreciation expense $ 3,293,000 $ 3,079,000 Deferred acquisition costs 194,000 179,000 Amortization of goodwill 375,000 161,000 Foreign net operating losses 627,000 770,000 State net operating losses 277,000 317,000 Net deferred tax liability $ 1,517,000 $ 1,633,000 Under the provisions of SFAS No. 96, the deferred tax provision for fiscal year 1993 of $638,000 resulted principally from depreciation of $432,000 and the net tax effect of the German net operating loss of $597,000, partially offset by insurance accruals of $271,000. At September 30, 1995, the Company had state net operating loss carryforwards of approximately $5,200,000, expiring through 2009, and German net operating loss carryforwards of $1,600,000, which can be carried forward indefinitely. At September 30, 1995 and 1994, the balance of undistributed earnings of foreign subsidiaries was $587,000 and $747,000, respectively. It is presumed that ultimately these earnings will be distributed to the Company. The tax effect of this presumption was evaluated by assuming that these earning were remitted to the Company in the period in which they were earned and that the Company received the benefit of all available tax planning alternatives and available tax credits and deductions. Note I - Selected Quarterly Financial Data (Unaudited) Selected quarterly financial data for fiscal years 1995 and 1994 is as follows: Note J - Geographic Segment Data The Company operates in the United States (including Puerto Rico) and Europe. The following table presents operating results for fiscal years 1995 and 1994 and identifiable assets of the Company as of September 30, 1995 and 1994, by geographic area. Note K - Related Party Transactions MEDIQ - The Board of Directors of MEDIQ Incorporated ("MEDIQ"), a 47% owner of the Company, is currently exploring alternative ways to maximize MEDIQ's shareholder value. MEDIQ has announced its intention to pursue the realization of the value of its investment in the Company. PCI/Virginia - Effective October 1, 1991, the Company transferred by dividend to MEDIQ all of the capital stock of PCI/Virginia, resulting in a reduction of stockholders' equity of $1,996,000. In January 1993, the Company exercised its purchase option and acquired PCI/Virginia from MEDIQ for aggregate consideration equal to MEDIQ's net book value of approximately $2,300,000. In addition, MEDIQ assigned to the Company a purchase option to acquire the real estate leased by PCI/Virginia, in consideration for which the Company reimbursed MEDIQ for a $1,010,000 deposit previously made on the purchase. For the periods in which PCI/Virginia was owned by MEDIQ, the Company provided senior management services to PCI/Virginia and recognized management fee income of $97,000 for 1993. Pennsauken Facility - Effective February 25, 1994, the asset and related mortgage obligation related to the Pennsauken, New Jersey facility were transferred from MEDIQ to the Company. Prior to such date, in anticipation of this transfer, the asset, the related mortgage obligation and all costs related to the ownership and operation of the facility, were reflected in the Company's financial statements. Insurance - The Company obtains certain insurance coverages through insurance programs administered by MEDIQ, including worker's compensation coverage through June 1, 1992. Insurance expense related to such insurance programs was $322,000, $681,000 and $471,000 for fiscal years 1995, 1994 and 1993, respectively. Services Agreement - The Company obtains certain legal, accounting, tax and risk management services from MEDIQ. Costs for such services were $100,000 for each of the fiscal years 1995, 1994 and 1993, and are included in selling, general and administrative expenses. The Company believes that the terms of the services agreement and MEDIQ's charges for such services are on terms no less favorable than those that could be obtained from unaffiliated third parties for comparable services. Inventory Purchases - The Company purchases certain packaging materials from a company owned by one of its directors, totalling $1,782,000, $1,486,000 and $1,073,000 for fiscal years 1995, 1994 and 1993, respectively. Amounts due to this company were $238,000 and $168,000 as of September 30, 1995 and 1994, respectively. Pledge of Stock - A portion of the shares of the Company's stock owned by MEDIQ secures certain MEDIQ indebtedness. Note L - Major Customers Divisions or affiliates of Johnson & Johnson accounted for an aggregate of 24%, 21% and 22%, of net revenue for fiscal years 1995, 1994 and 1993, respectively. Note M - Stock Option Plan In September 1991, the Company's Board of Directors adopted a stock option plan under which 600,000 shares have been reserved for stock options. These options may be granted to directors, officers and key employees of the Company and its subsidiaries. No option may be granted under the plan for a term in excess of ten years from the date of grant. As of September 30, 1995, 408,000 stock options were exercisable under the plan. The stock option prices listed below represent the fair market value at dates of grant. A summary of stock option activity for fiscal years 1995 and 1994 follows: September 30, 1993 415,000 $10.00 - 12.25 Granted 45,000 10.00 - 10.75 September 30, 1994 455,000 $10.00 - 10.75 September 30, 1995 480,000 $ 6.50 - 10.75 Note N - Employee Benefit Plans The Company maintains and administers a money purchase pension plan and a profit sharing plan for substantially all of its employees other than those covered by collective bargaining agreements or compensated solely on a commission basis. The benefits accruing under these plans are funded by contributions made by the Company and earnings thereon. Under the money purchase pension plan, the Company contributes in each year an amount equal to 4% of each participant's earnings up to the Social Security taxable wage tax base for the year and an additional amount equal to 8% of each participant's earnings in excess of the taxable wage base. Under the profit sharing plan, the Company contributes an annual amount determined at the discretion of the Company's Board of Directors. The Company also participates in multi-employer plans which provide defined benefits to employees covered by collective bargaining agreements. Expenses related to these plans were as follows: Note O - Subsequent Event Effective December 1, 1995, the Company exercised its option to repurchase shares of preferred stock of Tri-Line, a subsidiary of the Company, issued in connection with the acquisition in 1992. The purchase price was $900,000, representing the book value of such shares (which were included in other liabilities in the Company's Consolidated Balance Sheets). The information required to be included herein has been incorporated herein by reference to the Registrant's proxy statement relating to the Annual Meeting of Stockholders scheduled to be held in 1996. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) (1) The response to this portion of Item 14 is submitted as a separate section of this report commencing on page 12. (a) (2) Financial Statement Schedules Schedule II Valuation and qualifying accounts and reserves Other schedules are omitted because of the absence of conditions under which they are required. (a) (3) Exhibits. The exhibits are listed on the Index to Exhibits appearing below. (b) Reports on Form 8-K: No reports on Form 8-K were filed during the fourth quarter of fiscal 1995. (c) Exhibits (numbered in accordance with Item 601 of Regulation S-K). Pursuant to requirements of Section 13 of 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. Dated: December 11, 1995 PCI SERVICES, INC. Vice President and Chief Financial Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, which include at least a majority of the Board of Directors on behalf of the Registrant and in the capacities and on the dates indicated. /s/ Bernard J. Korman Chairman of the Board December 11, 1995 Bernard J. Korman of Directors /s/ Richard S. Sauter Vice Chairman of the December 11, 1995 Richard S. Sauter Board of Directors and /s/ Lawrence Chimerine Director December 11, 1995 /s/ Herbert Lotman Director December 11, 1995 /s/ Robert Purcell Director December 11, 1995 /s/ Theodore H. Seidenberg Director December 11, 1995 PCI SERVICES, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993 (1) Represents accounts directly written-off net of recoveries	10-K405	EX-99.1	1996-01-12T00:00:00	1996-01-12T11:57:13
0000950156-96-000036	0000950156-96-000036_0000.txt	File Nos. 2-91556 and 811-4052 (Members of the Landmark(SM) Family of Funds) This Prospectus describes two diversified money market mutual funds in the Landmark Family of Funds: Landmark Cash Reserves and Landmark U.S. Treasury Reserves. Each Fund has its own investment objectives and policies. Landmark Cash Reserves offers both Class A and Class B shares. Citibank, N.A. is the investment adviser. UNLIKE OTHER MUTUAL FUNDS WHICH DIRECTLY ACQUIRE AND MANAGE THEIR OWN PORTFOLIOS OF SECURITIES, LANDMARK CASH RESERVES AND LANDMARK U.S. TREASURY RESERVES SEEK THEIR INVESTMENT OBJECTIVES BY INVESTING ALL OF THEIR INVESTABLE ASSETS IN CASH RESERVES PORTFOLIO AND U.S. TREASURY RESERVES PORTFOLIO, RESPECTIVELY (EACH CALLED A "PORTFOLIO"). EACH PORTFOLIO HAS THE SAME INVESTMENT OBJECTIVES AND POLICIES AS ITS CORRESPONDING FUND. SEE "SPECIAL INFORMATION CONCERNING INVESTMENT STRUCTURE" ON PAGE 9. INVESTMENTS IN THE FUNDS ARE NEITHER INSURED NOR GUARANTEED BY THE U.S. GOVERNMENT. EACH FUND ATTEMPTS TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE; HOWEVER, THERE CAN BE NO ASSURANCE THAT EITHER FUND WILL BE ABLE TO DO SO. PROSPECTIVE INVESTORS SHOULD ALSO BE AWARE THAT SHARES OF THE FUNDS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, CITIBANK, N.A. OR ANY OF ITS AFFILIATES, ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER AGENCY, AND INVOLVE INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL AMOUNT INVESTED. This Prospectus concisely sets forth information about the Funds that a prospective investor should know before investing. A Statement of Additional Information dated January 2, 1996 (and incorporated by reference in this Prospectus) has been filed with the Securities and Exchange Commission. Copies of the Statement of Additional Information may be obtained without charge, and further inquiries about the Funds may be made, by contacting the investor's shareholder servicing agent (see inside back cover for address and phone number). Condensed Financial Information ........................................ 6 Net Income and Distributions ...........................................14 Appendix -- Permitted Investments and THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. INVESTORS SHOULD READ THIS PROSPECTUS AND RETAIN IT FOR FUTURE REFERENCE. See the body of the Prospectus for more information on the topics discussed in this summary. THE FUNDS: This Prospectus describes two money market mutual funds: Landmark Cash Reserves and Landmark U.S. Treasury Reserves. Each Fund has its own investment objectives and policies. Each Fund seeks its objectives by investing its investable assets in a Portfolio having the same investment objectives and policies as that Fund. There can be no assurance that either Fund will achieve its objectives. INVESTMENT OBJECTIVES AND POLICIES: LANDMARK CASH RESERVES. To provide its shareholders with liquidity and as high a level of current income as is consistent with the preservation of capital. Through Cash Reserves Portfolio, the Fund invests in U.S. dollar-denominated money market obligations with maturities of 397 days or less issued by U.S. and non-U.S. issuers. LANDMARK U.S. TREASURY RESERVES. To provide its shareholders with liquidity and as high a level of current income from U.S. Government obligations as is consistent with the preservation of capital. Through U.S. Treasury Reserves Portfolio, the Fund invests in obligations issued by the U.S. Government with maturities of 397 days or less. INVESTMENT ADVISER AND DISTRIBUTOR: Citibank, N.A., ("Citibank" or the "Adviser"), a wholly-owned subsidiary of Citicorp, is the investment adviser of each Portfolio. Citibank and its affiliates manage more than $73 billion in assets worldwide. The Landmark Funds Broker-Dealer Services, Inc. ("LFBDS" or the "Distributor") is the distributor of shares of each Fund. See "Management." PURCHASES AND REDEMPTIONS: Customers of Shareholder Servicing Agents may purchase and redeem shares of the Funds on any Business Day. See "Purchases" and "Redemptions." PRICING: LANDMARK CASH RESERVES. Investors may select Class A or Class B shares, with different expense levels and sales charges (if made available by the investors' Shareholder Servicing Agents). Class A shares are offered at net asset value (normally $1.00 per share), without a sales load, and are subject to a distribution fee at the annual rate of 0.10% (0.06% after anticipated waivers) of the average daily net assets represented by the Class A shares. Class B shares are offered at net asset value (normally $1.00 per share), and investors pay a contingent deferred sales charge not to exceed 5% of the lesser of the shares' net asset value at redemption or their original purchase price if the shares are redeemed within six years of the date of purchase. Class B shares are subject to a distribution fee at the annual rate of 0.75% of the average daily net assets represented by the Class B shares. Class B shares automatically convert into Class A shares approximately eight years after purchase. Class B shares may only be purchased by exchange of Class B shares of another Landmark Fund. See "Classes of Shares," "Purchases," "Redemptions" and "Management -- Distribution Arrangements." LANDMARK U.S. TREASURY RESERVES. Shares of the Fund are purchased and redeemed at net asset value (normally $1.00 per share), without a sales load or redemption fees. While there are no sales loads, shares of the Fund are subject to a distribution fee at the annual rate of 0.10% (0.00% after anticipated waivers) of the average daily net assets of the Fund. See "Purchases" and "Management -- Distribution Arrangements." EXCHANGES: Shares may be exchanged for shares of most other Landmark Funds. See "Exchanges." DIVIDENDS: Declared daily and distributed monthly. Shares begin accruing dividends on the day they are purchased. See "Net Income and Distributions." REINVESTMENT: Dividends may be received either in cash or in Fund shares at net asset value, subject to the policies of a shareholder's Shareholder Servicing Agent. See "Net Income and Distributions." WHO SHOULD INVEST: Each Fund is designed for investors seeking liquidity, preservation of capital and current income, and for whom growth of capital is not a consideration. Landmark Cash Reserves is also designed for investors seeking a convenient means of accumulating an interest in a professionally managed, diversified portfolio consisting of short-term U.S. dollar- denominated money market obligations issued by U.S. and non-U.S. issuers. Landmark U.S. Treasury Reserves is designed for investors seeking a convenient means of accumulating an interest in a professionally managed, diversified portfolio consisting of short-term U.S. Government obligations. See "Investment Information." RISK FACTORS: There can be no assurance that either Fund or its corresponding Portfolio will achieve its investment objectives. In addition, while each Fund intends to maintain a stable net asset value of $1.00 per share, there can be no assurance that either Fund will be able to do so. Investments in high quality, short-term instruments may, in many circumstances, result in a lower yield than would be available from investments with a lower quality or a longer term. Investors in Cash Reserves should be able to assume the special risks of investing in non-U.S. securities, which include possible adverse political, social and economic developments abroad, differing regulations to which non- U.S. issuers are subject and different characteristics of non-U.S. economies and markets. In addition, the prices of securities of non-U.S. issuers may be more volatile than those of comparable U.S. issuers. Certain investment practices also may entail special risks. Prospective investors should read "Risk Considerations" for more information about risk factors. The following table summarizes estimated shareholder transaction and annual operating expenses for each Fund and for its corresponding Portfolio.* Each Fund invests all of its investable assets in its corresponding Portfolio. The Trustees of each Fund believe that the aggregate per share expenses of that Fund and its corresponding Portfolio will be less than or approximately equal to the expenses that the Fund would incur if the assets of the Fund were invested directly in the types of securities held by its Portfolio. For more information on costs and expenses, see "Management" -- page 15 and "General Information-Expenses" -- page 20. The Example assumes that all dividends are reinvested, and expenses are based on each Fund's fiscal year ended August 31, 1995, after waivers and reimbursements. If waivers and reimbursements were not in place, the amounts in the example would be $11, $34, $60 and $133 for Landmark Cash Reserves -- Class A, $68, $85, $116 and $213 for Landmark Cash Reserves -- Class B (assuming complete redemption at the end of each period) and $11, $33, $58 and $129 for Landmark U.S. Treasury Reserves. The assumption of a 5% annual return is required by the Securities and Exchange Commission for all mutual funds, and is not a prediction of either Fund's future performance. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OF EITHER FUND. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. The following tables provide condensed financial information about the Funds for the periods indicated. This information should be read in conjunction with the financial statements appearing in each Fund's Annual Report to Shareholders, which are incorporated by reference in the Statement of Additional Information. The financial statements and notes, as well as the table below, covering periods through August 31, 1995 have been audited by Price Waterhouse LLP (for the fiscal years ended August 31, 1995 and August 31, 1994) and Deloitte & Touche LLP (for periods prior to the fiscal year ended August 31, 1994), independent accountants, on behalf of Cash Reserves, and by Deloitte & Touche LLP on behalf of U.S. Treasury Reserves. The accountants' reports are included in the applicable Fund's Annual Report. Copies of the Annual Reports may be obtained without charge from an investor's Shareholder Servicing Agent (see inside of back cover for address and phone number). INVESTMENT OBJECTIVES: The investment objective of CASH RESERVES is to provide its shareholders with liquidity and as high a level of current income as is consistent with the preservation of capital. The investment objective of U.S. TREASURY RESERVES is to provide its shareholders with liquidity and as high a level of current income from U.S. Government obligations as is consistent with the preservation of capital. The investment objective of each Fund may be changed by its Trustees without approval by that Fund's shareholders, but shareholders will be given written notice at least 30 days before any change is implemented. Of course, there can be no assurance that either Fund will achieve its investment objective. INVESTMENT POLICIES: CASH RESERVES seeks its objective by investing all of its investable assets in Cash Reserves Portfolio. Cash Reserves Portfolio seeks the same objective as the Fund by investing in high quality U.S. dollar- denominated money market instruments. These instruments include short-term obligations of the U.S. Government and repurchase agreements covering these obligations, bank obligations (such as certificates of deposit, bankers' acceptances and fixed time deposits) of U.S. and non-U.S. banks and obligations issued or guaranteed by the governments of Western Europe, Scandinavia, Australia, Japan and Canada. The U.S. Government obligations in which the Portfolio invests include U.S. Treasury bills, notes and bonds, and instruments issued by U.S. Government agencies or instrumentalities. Some obligations of U.S. Government agencies and instrumentalities are supported by the "full faith and credit" of the United States, others by the right of the issuer to borrow from the U.S. Treasury and others only by the credit of the agency or instrumentality. For more information regarding the Portfolio's permitted investments and investment practices, see the Appendix -- Permitted Investments and Investment Practices on page 20. U.S. TREASURY RESERVES seeks its objective by investing all of its investable assets in U.S. Treasury Reserves Portfolio. U.S. Treasury Reserves Portfolio seeks the same objective as the Fund by investing in U.S. Treasury bills, notes and bonds, and instruments issued by U.S. Government agencies or instrumentalities which are supported by the "full faith and credit" of the United States. U.S. Treasury Reserves Portfolio will not enter into repurchase agreements. For more information regarding the Portfolio's permitted investments and investment practices, see the Appendix -- Permitted Investments and Investment Practices on page 20. ALTHOUGH THE PORTFOLIO INVESTS IN U.S. GOVERNMENT OBLIGATIONS, NEITHER AN INVESTMENT IN THE FUND NOR AN INVESTMENT IN THE PORTFOLIO IS INSURED OR GUARANTEED BY THE U.S. GOVERNMENT. $1.00 NET ASSET VALUE. Each Fund employs specific investment policies and procedures designed to maintain a constant net asset value of $1.00 per share. There can be no assurance, however, that a constant net asset value will be maintained on a continuing basis. See "Net Income and Distributions." MATURITY AND QUALITY. All of the Portfolios' investments mature or are deemed to mature within 397 days from the date of acquisition, and the average maturity of the investments held by each Portfolio (on a dollar-weighted basis) is 90 days or less. All of the Portfolios' investments are in high quality securities which have been determined by the Adviser to present minimal credit risks. To meet a Portfolio's high quality standards a security must be rated in the highest rating category for short-term obligations by at least two nationally recognized statistical rating organizations (each, an "NRSRO") assigning a rating to the security or issuer or, if only one NRSRO assigns a rating, that NRSRO or, in the case of an investment which is not rated, of comparable quality as determined by the Adviser. Investments in high quality, short-term instruments may, in many circumstances, result in a lower yield than would be available from investments in instruments with a lower quality or a longer term. PERMITTED INVESTMENTS. For more information regarding permitted investments and investment practices, see the Appendix -- Permitted Investments and Investment Practices on page 20. The Funds will not necessarily invest or engage in each of the investments and investment practices in the Appendix but reserve the right to do so. INVESTMENT RESTRICTIONS. The Statement of Additional Information contains a list of specific investment restrictions which govern the investment policies of the Funds and the Portfolios. Certain of these specific restrictions may not be changed without shareholder approval. Except as otherwise indicated, the Funds' and Portfolios' investment objectives and policies may be changed without shareholder approval. If a percentage or rating restriction (other than a restriction as to borrowing) is adhered to at the time an investment is made, a later change in percentage or rating resulting from changes in the Portfolios' securities will not be a violation of policy. BROKERAGE TRANSACTIONS. The primary consideration in placing the Portfolios' security transactions with broker-dealers for execution is to obtain and maintain the availability of execution at the most favorable prices and in the most effective manner possible. The risks of investing in each Fund vary depending upon the nature of the securities held, and the investment practices employed, on its behalf. Certain of these risks are described below. "CONCENTRATION" IN BANK OBLIGATIONS. Cash Reserves Portfolio invests at least 25% of its assets, and may invest up to 100% of its assets, in bank obligations. This concentration policy is fundamental, and may not be changed without the consent of the Portfolio's investors. Banks are subject to extensive governmental regulation which may limit both the amounts and types of loans and other financial commitments which may be made and interest rates and fees which may be charged. The profitability of this industry is largely dependent upon the availability and cost of capital funds for the purpose of financing lending operations under prevailing money market conditions. Also, general economic conditions play an important part in the operation of this industry and exposure to credit losses arising from possible financial difficulties of borrowers might affect a bank's ability to meet its obligations. NON-U.S. SECURITIES. Investors in Cash Reserves should be aware that investments in non-U.S. securities involve risks relating to political, social and economic developments abroad, as well as risks resulting from the differences between the regulations to which U.S. and non-U.S. issuers and markets are subject. These risks may include expropriation, confiscatory taxation, withholding taxes on dividends and interest, limitations on the use or transfer of Portfolio assets and political or social instability. In addition, non-U.S. companies may not be subject to accounting standards or governmental supervision comparable to U.S. companies, and there may be less public information about their operations. Non-U.S. markets may be less liquid and more volatile than U.S. markets, and may offer less protection to investors such as the Portfolio. INVESTMENT PRACTICES. Certain of the investment practices employed for the Portfolios may entail certain risks. See the Appendix -- Permitted Investments and Investment Practices on page 20. SPECIAL INFORMATION CONCERNING INVESTMENT STRUCTURE: Unlike other mutual funds which directly acquire and manage their own portfolio securities, each Fund seeks its investment objective by investing all of its investable assets in its corresponding Portfolio, a registered investment company. Each Portfolio has the same investment objective and policies as its corresponding Fund. In addition to selling beneficial interests to a Fund, a Portfolio may sell beneficial interests to other mutual funds, collective investment vehicles, or institutional investors. Such investors will invest in the Portfolio on the same terms and conditions and will pay a proportionate share of the Portfolio's expenses. However, the other investors investing in the Portfolio are not required to sell their shares at the same public offering price as the Fund due to variations in sales commissions and other operating expenses. Therefore, investors in a Fund should be aware that these differences may result in differences in returns experienced by investors in the different funds that invest in that Portfolio. Such differences in returns are also present in other mutual fund structures. Information concerning other holders of interests in the Portfolios is available from the Funds' distributor, LFBDS, at the address and telephone number indicated on the back cover of this Prospectus. The investment objective of each Fund may be changed by its Trustees without the approval of the Fund's shareholders, but not without written notice thereof to shareholders at least 30 days prior to implementing the change. If there is a change in a Fund's investment objective, shareholders should consider whether the Fund remains an appropriate investment in light of their then current financial positions and needs. The investment objective of each Portfolio may also be changed without the approval of the investors in the Portfolio, but not without written notice thereof to the investors in the Portfolio (and, if a Fund is then invested in the Portfolio, notice to Fund shareholders) at least 30 days prior to implementing the change. There can, of course, be no assurance that the investment objective of either a Fund or its Portfolio will be achieved. See "Investment Objective, Policies and Restrictions -- Investment Restrictions" in the Statement of Additional Information for a description of the fundamental policies of each Fund and its Portfolio that cannot be changed without approval by the holders of a "majority of the outstanding voting securities" (as defined in the Investment Company Act of 1940 (the "1940 Act")) of the Fund or Portfolio. Except as stated otherwise, all investment guidelines, policies and restrictions described herein and in the Statement of Additional Information are non- fundamental. Certain changes in a Portfolio's investment objective, policies or restrictions or a failure by a Fund's shareholders to approve a change in the Portfolio's investment objective or restrictions, may preclude the Fund from investing its investable assets in the Portfolio or require the Fund to withdraw its interest in the Portfolio. Any such withdrawal could result in an "in-kind" distribution of securities (as opposed to a cash distribution) from the Portfolio which may or may not be readily marketable. If securities are distributed, the Fund could incur brokerage, tax or other charges in converting the securities to cash. The in kind distribution may result in the Fund having a less diversified portfolio of investments or adversely affect the liquidity of the Fund. Notwithstanding the above, there are other means for meeting shareholder redemption requests, such as borrowing. The absence of substantial experience with this investment structure could have an adverse effect on an investment in the Funds. Smaller funds investing in a Portfolio may be materially affected by the actions of larger funds investing in the Portfolio. For example, if a large fund withdraws from the Portfolio, the remaining funds may subsequently experience higher pro rata operating expenses, thereby producing lower returns. Additionally, because the Portfolio would become smaller, it may become less diversified, resulting in increased portfolio risk; however, these possibilities exist for traditionally structured funds which have large or institutional investors who may withdraw from a fund. Also, funds with a greater pro rata ownership in the Portfolio could have effective voting control of the operations of the Portfolio. If a Fund is requested to vote on matters pertaining to its Portfolio (other than a vote by the Fund to continue the operation of the Portfolio upon the withdrawal of another investor in the Portfolio), the Fund will hold a meeting of its shareholders and will cast all of its votes proportionately as instructed by such shareholders. The Fund will vote the shares held by Fund shareholders who do not give voting instructions in the same proportion as the shares of Fund shareholders who do give voting instructions. Shareholders of the Fund who do not vote will have no effect on the outcome of such matters. Each Fund may withdraw its investment from its Portfolio at any time, if the Fund's Board of Trustees determines that it is in the best interest of the Fund to do so. Upon any such withdrawal, the Board of Trustees would consider what action might be taken, including the investment of all of the investable assets of the Fund in another pooled investment entity having the same investment objective as the Fund or the retaining of an investment adviser to manage the Fund's assets in accordance with the investment policies described above. In the event the Fund's Trustees were unable to find a substitute investment company in which to invest the Fund's assets or were unable to secure directly the services of an investment adviser, the Trustees would determine the best course of action. For a description of the management of the Portfolios, see "Management" -- page 15. For descriptions of the expenses of the Portfolios, see "Management" and "General Information -- Expenses" -- page 20. For a description of the investment objectives, policies and restrictions of the Portfolios, see "Investment Information" -- page 8. Net asset value per share of each Fund is determined each day the New York Stock Exchange is open for trading (a "Business Day"). This determination is made once each day as of 3:00 p.m., Eastern time, for Cash Reserves, and 12:00 noon, Eastern time, for U.S. Treasury Reserves, by adding the market value of all securities and other assets of a Fund (including its interest in its Portfolio), then subtracting the liabilities charged to the Fund, and then dividing the result by the number of outstanding shares of the Fund. Net asset value is calculated separately for Class A and Class B shares of Cash Reserves. The amortized cost method of valuing Portfolio securities is used in order to stabilize the net asset value of shares of each Fund at $1.00; however, there can be no assurance that a Fund's net asset value will always remain at $1.00 per share. The net asset value per share is effective for orders received and accepted by the Distributor prior to its calculation. The amortized cost method involves valuing a security at its cost and thereafter assuming a constant amortization to maturity of any discount or premium. Although the amortized cost method provides certainty in valuation, it may result in periods during which the stated value of a security is higher or lower than the price the Portfolio would receive if the security were sold. DIFFERENCES BETWEEN THE CLASSES: Cash Reserves offers two classes of shares to investors, Class A and Class B shares, which represent interests in the same mutual fund. The primary distinctions between these classes lie in the contingent deferred sales charge applicable to Class B shares and in the classes' ongoing expenses, including asset-based sales charges in the form of distribution fees. Each class has distinct advantages and disadvantages for different investors, and investors may choose the class that best suits their circumstances and objectives. CLASS B SHARES MAY ONLY BE PURCHASED BY EXCHANGE OF CLASS B SHARES OF ANOTHER LANDMARK FUND. U.S. Treasury Reserves offers a single class of shares to investors. SALES CHARGES. Class A shares are sold at net asset value, without a sales load. Class B shares are sold with no initial sales charge, but a contingent deferred sales charge (up to 5% of the lesser of the shares' net asset value at redemption or the original purchase price) applies to redemptions made within six years of purchase. The contingent deferred sales charge may be waived upon redemption of certain Class B shares. See "Purchases" below. ONGOING ANNUAL EXPENSES. Class A shares pay an annual 12b-1 distribution fee of 0.10% (0.06% after anticipated waivers) of average daily net assets. Class B shares pay an annual 12b-1 distribution fee of 0.75% of average daily net assets. Annual 12b-1 distribution fees are a form of asset-based sales charge. An investor should consider both ongoing annual expenses and any contingent deferred sales charges in estimating the costs of investing in the different classes of Fund shares over various time periods. CONVERSION OF CLASS B SHARES: A shareholder's Class B shares in Cash Reserves will automatically convert to Class A shares in Cash Reserves approximately eight years after the date of issuance, together with a pro rata portion of all Class B shares representing dividends and other distributions paid in additional Class B shares. The conversion will be effected at the relative net asset values per share of the two classes on the first Business Day of the month in which the eighth anniversary of the issuance of the Class B shares occurs. If a shareholder effects one or more exchanges among Class B shares of the Landmark Funds during the eight-year period, the holding periods for the shares so exchanged will be counted toward the eight-year period. The conversion of Class B shares to Class A shares is subject to the continuing availability of a ruling from the Internal Revenue Service or an opinion of counsel that such conversion will not constitute a taxable event for federal tax purposes. There can be no assurance that such ruling or opinion will be available, and the conversion of Class B shares to Class A shares will not occur if such ruling or opinion is not available. In that event, Class B shares would continue to be subject to higher expenses than Class A shares for an indefinite period. OTHER INFORMATION: See "Purchases," "Redemptions" and "Management -- Distribution Arrangements" for a more complete description of the contingent deferred sales charges applicable to Class B shares of Cash Reserves, and distribution fees for both classes of shares of Cash Reserves. Cash Reserves offers two classes of shares, Class A and B shares, with different expense levels and sales charges. See "Classes of Shares" above for more information. U.S. Treasury Reserves offers one class of shares. WHEN PLACING PURCHASE ORDERS FOR CASH RESERVES, INVESTORS SHOULD SPECIFY WHETHER THE ORDER IS FOR CLASS A OR CLASS B SHARES. ALL SHARE PURCHASE ORDERS THAT FAIL TO SPECIFY A CLASS AUTOMATICALLY WILL BE INVESTED IN CLASS A SHARES. CLASS B SHARES MAY ONLY BE PURCHASED BY EXCHANGE OF CLASS B SHARES OF ANOTHER LANDMARK FUND. Shares of the Funds are offered continuously and may be purchased on any Business Day without a sales load at the shares' net asset value (normally $1.00 per share) next determined after an order is transmitted to and accepted by the Distributor. Shares may be purchased either through a securities broker which has a sales agreement with the Distributor or through a bank or other financial institution which has an agency agreement with the Distributor. Shares of the Funds are being offered exclusively to customers of a Shareholder Servicing Agent (i.e., a financial institution, such as a federal or state-chartered bank, trust company, savings and loan association or savings bank, or a securities broker, that has entered into a shareholder servicing agreement concerning a Fund). An investor's Shareholder Servicing Agent may not make available both classes of shares of Cash Reserves. Each Fund and the Distributor reserve the right to reject any purchase order and to suspend the offering of Fund shares for a period of time. While there is no sales load imposed on shares of the Funds, the Distributor receives fees from each Fund pursuant to a Distribution Plan. See "Management -- Distribution Arrangements." In addition, Class B shares may be subject to a contingent deferred sales charge upon redemption. Each shareholder's account is established and maintained by his or her Shareholder Servicing Agent, which will be the shareholder of record of the Fund. Each Shareholder Servicing Agent may establish its own terms, conditions and charges with respect to services it offers to its customers. Charges for these services may include fixed annual fees and account maintenance fees. The effect of any such fees will be to reduce the net return on the investment of customers of that Shareholder Servicing Agent. Shareholder Servicing Agents will not transmit purchase orders to the Distributor until they have received the purchase price in federal or other immediately available funds. If Fund shares are purchased by check, there will be a delay (usually not longer than two business days) in transmitting the purchase order until the check is converted into federal funds. PURCHASING CLASS A SHARES: Class A shares of Cash Reserves may be purchased at their next determined net asset value (normally $1.00 per share), without a sales load. PURCHASING CLASS B SHARES: CONTINGENT DEFERRED SALES CHARGE -- CLASS B SHARES. Class B shares of Cash Reserves may be purchased at their next determined net asset value (normally $1.00 per share), without a sales load, but only by exchange of Class B shares of another Landmark Fund. A contingent deferred sales charge, however, is imposed upon certain redemptions of Class B shares. Class B shares that are redeemed will not be subject to a contingent deferred sales charge to the extent that the value of such shares represents (i) capital appreciation of Fund assets, (ii) reinvestment of dividends or capital gain distributions or (iii) shares redeemed more than six years after their purchase. Otherwise, redemptions of Class B shares purchased through an exchange of another Landmark Fund will be subject to a contingent deferred sales charge. Upon redemption, the applicable contingent deferred sales charge will be calculated as if no exchange had taken place and the investor were redeeming shares of that fund. The amount of the contingent deferred sales charge will depend on the number of years since the investor has invested and the dollar amount being redeemed. When determining the amount of the contingent deferred sales charge, the Fund will use the contingent deferred sales charge schedule of any fund from which the investor has exchanged shares that would result in the investor paying the highest contingent deferred sales charge. An investor should consult the prospectus of the fund from which shares were exchanged to determine the applicable contingent deferred sales charge. In determining the applicability and rate of any contingent deferred sales charge, it will be assumed that a redemption is made first of Class B shares representing the reinvestment of dividends and capital gains distributions followed by Class B shares held by the shareholder for the longest period of time. The holding period of Class B shares will be calculated from the date that the Class B shares were initially acquired in one of the other Landmark Funds, and Class B shares being redeemed will be considered to represent, as applicable, capital appreciation or dividend and capital gains distribution reinvestments in such other funds. This will result in any contingent deferred sales charge being imposed at the lowest possible rate. For federal income tax purposes, the amount of the contingent deferred sales charge will reduce the gain or increase the loss, as the case may be, on the amount realized on redemption. Any contingent deferred sales charges will be paid to the Distributor. SALES CHARGE WAIVERS -- CLASS B SHARES. The contingent deferred sales charge will be waived for exchanges. In addition, the contingent deferred sales charge will be waived for a total or partial redemption made within one year of the death of the shareholder. This waiver is available where the deceased shareholder is either the sole shareholder or owns the shares with his or her spouse as a joint tenant with right of survivorship, and applies only to redemption of shares held at the time of death. The contingent deferred sales charge also will be waived in connection with: (i) a lump sum or other distribution in the case of an Individual Retirement Account ("IRA"), a self-employed individual retirement plan (so-called "Keogh Plan") or a custodian account under Section 403(b) of the Code, in each case following attainment of age 59 1/2, (ii) a total or partial redemption resulting from any distribution following retirement in the case of a tax-qualified retirement plan, and (iii) a redemption resulting from a tax-free return of an excess contribution to an IRA. Contingent deferred sales charge waivers will be granted subject to confirmation by a shareholder's Shareholder Servicing Agent of the shareholder's status or holdings, as the case may be. Securities dealers and other financial institutions may receive different compensation with respect to sales of Class A and Class B shares. Shares of each Fund may be exchanged for shares of other Landmark Funds that are made available by a shareholder's Shareholder Servicing Agent, or may be acquired through an exchange of shares of those funds. No initial sales charge is imposed on shares being acquired through an exchange unless the shares being acquired are subject to a sales charge that is greater than the current sales charge of the Fund (in which case an initial sales charge will be imposed at a rate equal to the difference). No contingent deferred sales charge is imposed on Class B shares of Cash Reserves being disposed of though an exchange; however, contingent deferred sales charges may apply to redemptions of Class B shares of other Landmark Funds disposed of or acquired through an exchange. In general, shares of a particular class may be exchanged only for shares of another fund of the same class. Investors should note that Class A shares of Cash Reserves may not be exchanged for Class A shares of another fund without a sales charge, but may be exchanged for shares of certain other Landmark money market funds without a sales charge. Shareholders must place exchange orders through their Shareholder Servicing Agents, and may do so by telephone if their account applications so permit. For more information on telephone transactions see "Redemptions." All exchanges will be effected based on the relative net asset values per share next determined after the exchange order is received by the Distributor. See "Valuation of Shares." Shares of the Funds may be exchanged only after payment in federal funds for the shares has been made. This exchange privilege may be modified or terminated at any time, upon at least 60 days' notice when such notice is required by SEC rules, and is available only in those jurisdictions where such exchanges legally may be made. See the Statement of Additional Information for further details. Before making any exchange, shareholders should contact their Shareholder Servicing Agents to obtain more information and prospectuses of the Landmark Funds to be acquired through the exchange. Fund shares may be redeemed at their net asset value (normally $1.00 per share) next determined after a redemption request in proper form is received by a shareholder's Shareholder Servicing Agent (subject to any applicable contingent deferred sales charge for Class B shares of Cash Reserves). Shares of U.S. Treasury Reserves and Class A shares of Cash Reserves may be redeemed without a sales charge. Shareholders may redeem shares of a Fund only by authorizing their Shareholder Servicing Agents to redeem such shares on their behalf through the Distributor. If a redeeming shareholder owns shares of more than one class, Class A shares will be redeemed first unless the shareholder specifically requests otherwise. REDEMPTIONS BY MAIL. Shareholders may redeem Fund shares by sending written instructions in proper form (as determined by a shareholder's Shareholder Servicing Agent) to their Shareholder Servicing Agents. Shareholders are responsible for ensuring that a request for redemption is in proper form. REDEMPTIONS BY TELEPHONE. Shareholders may redeem or exchange Fund shares by telephone, if their account applications so permit, by calling their Shareholder Servicing Agents. During periods of drastic economic or market changes or severe weather or other emergencies, shareholders may experience difficulties implementing a telephone exchange or redemption. In such an event, another method of instruction, such as a written request sent via an overnight delivery service, should be considered. The Funds and each Shareholder Servicing Agent will employ reasonable procedures to confirm that instructions communicated by telephone are genuine. These procedures may include recording of the telephone instructions and verification of a caller's identity by asking for the shareholder's name, address, telephone number, Social Security number, and account number. If these or other reasonable procedures are not followed, the Fund or the Shareholder Servicing Agent may be liable for any losses to a shareholder due to unauthorized or fraudulent instructions. Otherwise, the shareholder will bear all risk of loss relating to a redemption or exchange by telephone. PAYMENT OF REDEMPTIONS. The proceeds of a redemption are paid in federal funds normally on the Business Day the redemption is effected, but in any event within seven days. If a shareholder requests redemption of shares which were purchased recently, a Fund may delay payment until it is assured that good payment has been received. In the case of purchases by check, this can take up to ten days. See "Determination of Net Asset Value" in the Statement of Additional Information regarding the Funds' right to pay the redemption price in kind with securities (instead of cash). Questions about redemption requirements should be referred to the shareholder's Shareholder Servicing Agent. The right of any shareholder to receive payment with respect to any redemption may be suspended or the payment of the redemption price postponed during any period in which the New York Stock Exchange is closed (other than weekends or holidays) or trading on the Exchange is restricted or if an emergency exists. The net income of each Fund is determined each Business Day (and on such other days as is necessary in order to comply with the 1940 Act). This determination is made once during each such day as of 3:00 p.m., Eastern time, for Cash Reserves and 12:00 noon, Eastern time, for U.S. Treasury Reserves. All the net income of each Fund is declared as a dividend to shareholders of record at the time of such determination. Shares begin accruing dividends on the day they are purchased, and accrue dividends up to and including the day prior to redemption. Dividends are distributed monthly on or prior to the last Business Day of each month. Unless a shareholder elects to receive dividends in cash (subject to the policies of the shareholder's Shareholder Servicing Agent), dividends are distributed in the form of full and fractional additional shares of the applicable Fund at the rate of one share of the Fund for each one dollar of dividend income. Since the net income of each Fund is declared as a dividend each time the net income of the Fund is determined, the net asset value per share of each Fund is expected to remain at $1.00 per share immediately after each such determination and dividend declaration. Any increase in the value of a shareholder's investment in a Fund, representing the reinvestment of dividend income, is reflected by an increase in the number of shares of the Fund in the shareholder's account. It is expected that each Fund will have a positive net income at the time of each determination thereof. If for any reason a Fund's net income is a negative amount, which could occur, for instance, upon default by an issuer of a portfolio security, the Fund would first offset the negative amount with respect to each shareholder account from the dividends declared during the month with respect to those accounts. If and to the extent that negative net income exceeds declared dividends at the end of the month, the Fund would reduce the number of outstanding Fund shares by treating each shareholder as having contributed to the capital of the Fund that number of full and fractional shares in the shareholder's account which represents the shareholder's share of the amount of such excess. Each shareholder would be deemed to have agreed to such contribution in these circumstances by investment in a Fund. TRUSTEES AND OFFICERS: Each Fund is supervised by the Board of Trustees of Landmark Funds III. Each Portfolio is supervised by its own Board of Trustees. In each case, a majority of the Trustees are not affiliated with the Adviser. In addition, a majority of the disinterested Trustees of the Funds are different from a majority of the disinterested Trustees of their corresponding Portfolios. More information on the Trustees and officers of the Funds and the Portfolios appears under "Management" in the Statement of Additional Information. INVESTMENT ADVISER: CITIBANK. Each Fund draws on the strength and experience of Citibank. Citibank offers a wide range of banking and investment services to customers across the United States and throughout the world, and has been managing money since 1822. Its portfolio managers are responsible for investing in money market, equity and fixed income securities. Citibank and its affiliates manage more than $73 billion in assets worldwide, including the Landmark Funds and Portfolios. Citibank is a wholly-owned subsidiary of Citicorp. Citibank manages the assets of each Portfolio pursuant to separate investment advisory agreements ("Advisory Agreements"). Subject to policies set by the Portfolios' Trustees, Citibank makes investment decisions for the Portfolios. ADVISORY FEES. For its services under the Advisory Agreements, the Adviser receives investment advisory fees, which are accrued daily and paid monthly, of 0.15% of each Portfolio's average daily net assets on an annualized basis for the Portfolio's then-current fiscal year. The Adviser has voluntarily agreed to waive a portion of its investment advisory fee. For the fiscal year ended August 31, 1995, the investment advisory fees payable to Citibank were as follows: for Cash Reserves Portfolio, $4,097,854, of which $2,306,161 was voluntarily waived (after waiver, 0.06% of the Portfolio's average daily net assets for that fiscal year); and for U.S. Treasury Reserves Portfolio, $1,148,418, of which $753,105 was voluntarily waived (after waiver, 0.05% of the Portfolio's average daily net assets for that fiscal year). BANKING RELATIONSHIPS. Citibank and its affiliates may have deposit, loan and other relationships with the issuers of securities purchased on behalf of the Portfolios, including outstanding loans to such issuers which may be repaid in whole or in part with the proceeds of securities so purchased. Citibank has informed the Funds and the Portfolios that, in making its investment decisions, it does not obtain or use material inside information in the possession of any division or department of Citibank or in the possession of any affiliate of Citibank. BANK REGULATORY MATTERS. The Glass-Steagall Act prohibits certain financial institutions, such as Citibank, from underwriting securities of open-end investment companies, such as the Funds or the Portfolios. Citibank believes that its services under the Advisory Agreements and the activities performed by it or its affiliates as Shareholder Servicing Agents and sub- administrator are not underwriting and are consistent with the Glass-Steagall Act and other relevant federal and state laws. However, there is no controlling precedent regarding the performance of the combination of investment advisory, shareholder servicing and sub-administrative activities by banks. State laws on this issue may differ from applicable federal law and banks and financial institutions may be required to register as dealers pursuant to state securities laws. Changes in either federal or state statutes or regulations, or in their interpretations, could prevent Citibank or its affiliates from continuing to perform these services. If Citibank or its affiliates were to be prevented from acting as the Adviser, sub-administrator or a Shareholder Servicing Agent, the affected Funds or Portfolios would seek alternative means for obtaining these services. The Funds do not expect that shareholders would suffer any adverse financial consequences as a result of any such occurrence. ADMINISTRATIVE SERVICES PLANS: The Funds and Portfolios have administrative services plans ("Administrative Services Plans") which provide that the applicable Fund or Portfolio may obtain the services of an administrator, a transfer agent, a custodian, a fund accountant, and, in the case of the Funds, one or more Shareholder Servicing Agents, and may enter into agreements providing for the payment of fees for such services. Under the Funds' Administrative Services Plan, the total of the fees paid to each Fund's Administrator and Shareholder Servicing Agents and the distribution fee paid to the Distributor (other than fees paid with respect to Class B shares of Cash Reserves and other than any fee concerning electronic or other media advertising) may not exceed 0.70% of a Fund's average daily net assets on an annualized basis for the Fund's then-current fiscal year. Within this overall limitation, individual fees may vary. Under each Portfolio's Administrative Services Plan, fees paid to the Portfolio's Administrator may not exceed 0.05% of the Portfolio's average daily net assets on an annualized basis for the Portfolio's then-current fiscal year. See "Administrators," "Shareholder Servicing Agents" and "Transfer Agent, Custodian and Fund Accountant." ADMINISTRATORS: LFBDS provides certain administrative services to the Funds and U.S. Treasury Reserves Portfolio, and Signature Financial Group (Cayman), Ltd., either directly or through a wholly-owned subsidiary ("SFG"), provides certain administrative services to Cash Reserves Portfolio, in each case under administrative services agreements. These administrative services include providing general office facilities, supervising the overall administration of the Funds and Portfolios, and providing persons satisfactory to the Boards of Trustees to serve as Trustees and officers of the Funds and Portfolios. These Trustees and officers may be directors, officers or employees of LFBDS, SFG or their affiliates. For these services, the Administrators receive fees accrued daily and paid monthly of 0.35% of the average daily net assets of each Fund and 0.05% of the assets of each Portfolio, in each case on an annualized basis for the Fund's or the Portfolio's then-current fiscal year. However, each of the Administrators may voluntarily agree to waive a portion of the fees payable to it. LFBDS and SFG are wholly-owned subsidiaries of Signature Financial Group, Inc. "Landmark" is a service mark of LFBDS. SUB-ADMINISTRATOR: Pursuant to sub-administrative services agreements, Citibank performs such sub-administrative duties for the Funds and Portfolios as from time to time are agreed upon by Citibank and LFBDS or SFG. Citibank's compensation as sub-administrator is paid by LFBDS or SFG. SHAREHOLDER SERVICING AGENTS: The Funds have entered into separate shareholder servicing agreements with each Shareholder Servicing Agent pursuant to which that Shareholder Servicing Agent provides shareholder services, including answering customer inquiries, assisting in processing purchase, exchange and redemption transactions and furnishing Fund communications to shareholders. For these services, each Shareholder Servicing Agent receives a fee from each Fund at an annual rate of 0.25% of the average daily net assets of the Fund represented by shares owned by investors for whom such Shareholder Servicing Agent maintains a servicing relationship. Some Shareholder Servicing Agents may impose certain conditions on their customers in addition to or different from those imposed by the Funds, such as requiring a minimum initial investment or charging their customers a direct fee for their services. Each Shareholder Servicing Agent has agreed to transmit to its customers who are shareholders of a Fund appropriate prior written disclosure of any fees that it may charge them directly and to provide written notice at least 30 days prior to imposition of any transaction fees. TRANSFER AGENT, CUSTODIAN AND FUND ACCOUNTANT: State Street Bank and Trust Company (or its affiliate State Street Canada, Inc.) acts as transfer agent and dividend disbursing agent for each Fund. State Street (or its affiliate State Street Canada, Inc.) acts as the custodian of each Fund's and each Portfolio's assets. Securities held for a Portfolio may be held by a sub- custodian bank approved by the Portfolio's Trustees. State Street also provides fund accounting services to the Funds and the Portfolios and calculates the daily net asset value for the Funds and the Portfolios. DISTRIBUTION ARRANGEMENTS: LFBDS is the distributor of each Fund's shares and also serves as distributor for each of the other Landmark Funds and as a Shareholder Servicing Agent for certain investors. LFBDS receives distribution fees from the Funds pursuant to Distribution Plans adopted in accordance with Rule 12b-1 under the 1940 Act, and also collects any contingent deferred sales charges imposed on redemptions of Class B shares of Cash Reserves. In those states where LFBDS is not a registered broker-dealer, shares of the Funds are sold through Signature Broker-Dealer Services, Inc., as dealer. Under a single plan of distribution for U.S. Treasury Reserves and the Class A shares of Cash Reserves and a separate plan of distribution for the Class B shares of Cash Reserves (collectively "Plans"), the Funds pay the Distributor a fee at an annual rate not to exceed 0.10% of the average daily net assets of U.S. Treasury Reserves, 0.10% of the average daily net assets of Cash Reserves represented by Class A shares and 0.75% of the average daily net assets of Cash Reserves represented by Class B shares. However, the Distributor has agreed to waive a portion of these fees on a month-to-month basis for U.S. Treasury Reserves and for the Class A shares of Cash Reserves. The Plan for U.S. Treasury Reserves and the Class A shares of Cash Reserves also permits the Funds to pay the Distributor an additional fee (not to exceed 0.10% of the average daily net assets of the applicable shares) in anticipation of or as reimbursement for print or electronic media advertising expenses incurred in connection with the sale of the shares. The Funds did not pay anything under this provision during their fiscal years ended August 31, 1995 and do not anticipate doing so during the current fiscal year. The Plan for Class B shares of Cash Reserves also provides that Cash Reserves may pay the Distributor a monthly service fee at an annual rate not to exceed 0.25% of the average daily net assets represented by the Class B shares. However, Cash Reserves has not entered into any agreement to pay any such service fee to the Distributor. If such an agreement is entered into in the current fiscal year, it will not provide for the payment of a service fee in excess of 0.10% of the average daily net assets represented by the Class B shares. The Distributor uses the distribution fees under the Plans to offset each Fund's marketing costs attributable to such classes, such as preparation of sales literature, advertising, and printing and distributing prospectuses and other shareholder materials to prospective investors. In addition, the Distributor may use the distribution fees to pay costs related to distribution activities, including employee salaries, bonuses and other overhead expenses. The Funds and the Distributor provide to the Trustees quarterly a written report of amounts expended pursuant to the Plans and the purposes for which the expenditures were made. From time to time LFBDS may make payments for distribution and/or shareholder servicing activities out of its past profits or any other services available to it. During the period they are in effect, the Plans and related distribution agreements ("Distribution Agreements") obligate the Funds to pay distribution fees to LFBDS as compensation for its distribution activities, not as reimbursement for specific expenses incurred. Thus, even if LFBDS's expenses exceed its distribution fees for any Fund, the Fund will not be obligated to pay more than those fees and, if LFBDS's expenses are less than such fees, it will retain its full fees and realize a profit. Each Fund will pay the distribution fees to LFBDS until either the applicable Plan or Distribution Agreement is terminated or not renewed. In that event, LFBDS's expenses in excess of distribution fees received or accrued through the termination date will be LFBDS's sole responsibility and not obligations of the Fund. In their annual consideration of the continuation of the Plans, the Trustees of Cash Reserves will review each Plan and LFBDS's expenses for each class separately. Each class of shares of Cash Reserves has exclusive voting rights with respect to the Plan for that class. This discussion of taxes is for general information only. Investors should consult their own tax advisers about their particular situations. Each Fund intends to meet requirements of the Internal Revenue Code applicable to regulated investment companies so that it will not be liable for any federal income or excise taxes. Shareholders are required to pay federal income tax on any dividends and other distributions received. Generally, distributions from a Fund's net investment income and short-term capital gains will be taxed as ordinary income. Distributions from long-term net capital gains will be taxed as such regardless of how long the shares of a Fund have been held. Dividends and distributions are treated in the same manner for federal tax purposes whether they are paid in cash or as additional shares. Distributions derived from interest on U.S. Government obligations may be exempt from state and local taxes in certain states. Early each year, each Fund will notify its shareholders of the amount and tax status of distributions paid to shareholders for the preceding year. The account application asks each new shareholder to certify that the shareholder's Social Security or taxpayer identification number is correct and that the shareholder is not subject to 31% backup withholding for failing to report income to the IRS. A Fund may be required to withhold (and pay over to the IRS for the shareholder's credit) 31% of certain distributions paid to shareholders who fail to provide this information or otherwise violate IRS regulations. Investors should consult their own tax advisers regarding the status of their accounts under state and local laws. Fund performance may be quoted in advertising, shareholder reports and other communications in terms of yield, effective yield, tax equivalent yield, total rate of return or tax equivalent total rate of return. All performance information is historical and is not intended to indicate future performance. Yields and total rates of return fluctuate in response to market conditions and other factors. Each Fund may provide its period and average annualized "total rates of return" and U.S. Treasury Reserves may also provide "tax equivalent total rates of return." The "total rate of return" refers to the change in the value of an investment in the Fund over a stated period and is compounded to include the value of any shares purchased with any dividends or capital gains declared during such period. Period total rates of return may be "annualized." An "annualized" total rate of return assumes that the period total rate of return is generated over a one-year period. The "tax equivalent total rate of return" refers to the total rate of return that a fully taxable money market fund would have to generate in order to produce an after-tax total rate of return equivalent to that of U.S. Treasury Reserves. The use of a tax equivalent total rate of return allows investors to compare the total rates of return of U.S. Treasury Reserves, the dividends from which may be exempt from state personal income taxes, with the total rates of return of funds the dividends from which are not so tax exempt. Each Fund may provide annualized "yield" and "effective yield" quotations, and U.S. Treasury Reserves may also provide "tax equivalent yield" quotations. The "yield" of a Fund refers to the income generated by an investment in the Fund over a seven-day period (which period is stated in any such advertisement or communication). This income is then annualized; that is, the amount of income generated by the investment over that period is assumed to be generated each week over a 365-day period and is shown as a percentage of the investment. The "effective yield" is calculated similarly, but when annualized the income earned by the investment during that seven-day period is assumed to be reinvested. The effective yield is slightly higher than the yield because of the compounding effect of this assumed reinvestment. The "tax equivalent yield" refers to the yield that a fully taxable money market fund would have to generate in order to produce an after-tax yield equivalent to that of U.S. Treasury Reserves. The use of a tax equivalent yield allows investors to compare the yield of U.S. Treasury Reserves, the dividends from which may be exempt from state personal income tax, with yields of funds the dividends from which are not so tax exempt. A Fund may also provide yield, effective yield and tax equivalent yield quotations for longer periods. Cash Reserves will include performance data for both classes of Fund shares in any advertisements, reports or communications including Fund performance data. Of course, any fees charged by a shareholder's Shareholder Servicing Agent will reduce that shareholder's net return on his or her investment. See the Statement of Additional Information for more information concerning the calculation of yield and total rate of return quotations for the Funds. ORGANIZATION: Each Fund is a diversified series of Landmark Funds III. Landmark Funds III, which was known as "Landmark Cash Reserves" until its name changed effective January 17, 1991, is a Massachusetts business trust which was organized on June 28, 1985; it also is an open-end management investment company registered under the 1940 Act. Under the 1940 Act, a diversified series or diversified investment company must invest at least 75% of its assets in cash and cash items, U.S. Government securities, investment company securities and other securities limited as to any one issuer to not more than 5% of the total assets of the investment company and not more than 10% of the voting securities of the issuer. Under Massachusetts law, shareholders of a business trust may, under certain circumstances, be held personally liable as partners for the trust's obligations. However, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which both inadequate insurance existed and the trust itself was unable to meet its obligations. Each Portfolio is a separate trust organized under the laws of the State of New York. The Declaration of Trust of each Portfolio provides that a Fund and other entities investing in a Portfolio are each liable for all obligations of that Portfolio. However, it is not expected that the liabilities of a Portfolio would ever exceed its assets. VOTING AND OTHER RIGHTS: Landmark Funds III (the "Trust") may issue an unlimited number of shares, may create new series of shares and may divide shares in each series into classes. Each share of each Fund gives the shareholder one vote in Trustee elections and other matters submitted to shareholders for vote. All shares of each series of the Trust have equal voting rights except that, in matters affecting only a particular Fund or class, only shares of that particular Fund or class are entitled to vote. At any meeting of shareholders of a Fund, a Shareholder Servicing Agent may vote any shares of which it is the holder of record and for which it does not receive voting instructions proportionately in accordance with instructions it receives for all other shares of which that Shareholder Servicing Agent is the holder of record. The Trust's activities are supervised by the Trust's Board of Trustees. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will usually be sought only for changes in a Fund's or Portfolio's fundamental investment restrictions and for the election of Trustees under certain circumstances. Trustees may be removed by shareholders under certain circumstances. Each share of each Fund is entitled to participate equally in dividends and other distributions and the proceeds of any liquidation of that Fund. CERTIFICATES: The Funds' Transfer Agent maintains a share register for shareholders of record, i.e., Shareholder Servicing Agents. Share certificates are not issued. RETIREMENT PLANS: Investors may be able to establish new accounts in a Fund under one of several tax-sheltered plans. Such plans include IRAs, Keogh or Corporate Profit-Sharing and Money-Purchase Plans, 403(b) Custodian Accounts, and certain other qualified pension and profit-sharing plans. Investors should consult with their Shareholder Servicing Agents and tax and retirement advisers. EXPENSES: For the fiscal year ended August 31, 1995, total operating expenses of the Funds, after allocating to each Fund its share of its Portfolio's expenses and after giving effect to fee waivers or reimbursements, were as follows: for Cash Reserves -- Class A, 0.69% of the Fund's average daily net assets for that fiscal year; and for U.S. Treasury Reserves, 0.70% of the Fund's average daily net assets for that fiscal year. All fee waivers and reimbursements are voluntary and may be reduced or terminated at any time. The Statement of Additional Information dated the date hereof contains more detailed information about the Funds and the Portfolios, including information related to (i) investment policies and restrictions, (ii) the Trustees, officers, Adviser and Administrators, (iii) securities transactions, (iv) the Funds' shares, including rights and liabilities of shareholders, (v) the method used to calculate performance information, (vi) programs for the purchase of shares, and (vii) the determination of net asset value. No person has been authorized to give any information or make any representations not contained in this Prospectus in connection with the offering made by this Prospectus and, if given or made, such information or representations must not be relied upon as having been authorized by the Funds or their distributor. This Prospectus does not constitute an offering by the Funds or their distributor in any jurisdiction in which such offering may not lawfully be made. TREASURY RECEIPTS. Each Portfolio may invest in Treasury Receipts, which are unmatured interest coupons of U.S. Treasury bonds and notes which have been separated and resold in a custodial receipt program administered by the U.S. Treasury. COMMERCIAL PAPER. Cash Reserves Portfolio may invest in commercial paper, which is unsecured debt of corporations usually maturing in 270 days or less from its date of issuance. ASSET-BACKED SECURITIES. Cash Reserves Portfolio may invest in asset- backed securities, which represent fractional interests in underlying pools of assets, such as car installment loans or credit card receivables. The rate of return on asset-backed securities may be affected by prepayment of the underlying loans or receivables. Reinvestment of principal may occur at higher or lower rates than the original yield. REPURCHASE AGREEMENTS. Cash Reserves Portfolio may enter into repurchase agreements. Repurchase agreements are transactions in which an institution sells the Portfolio a security at one price, subject to the Portfolio's obligation to resell and the selling institution's obligation to repurchase that security at a higher price normally within a seven day period. There may be delays and risks of loss if the seller is unable to meet its obligation to repurchase. LENDING OF PORTFOLIO SECURITIES. Consistent with applicable regulatory requirements and in order to generate additional income, each Portfolio may lend its portfolio securities to broker-dealers and other institutional borrowers. Such loans must be callable at any time and continuously secured by collateral (cash or U.S. Government securities) in an amount not less than the market value, determined daily, of the securities loaned. It is intended that the value of securities loaned by a Portfolio would not exceed 33 1/3% of the Portfolio's net assets. In the event of the bankruptcy of the other party to a securities loan or a repurchase agreement, the Portfolio could experience delays in recovering either the securities lent or cash. To the extent that, in the meantime, the value of the securities lent have increased or the value of the securities purchased have decreased, the Portfolio could experience a loss. PRIVATE PLACEMENTS AND ILLIQUID INVESTMENTS. Each Portfolio may invest up to 10% of its net assets in securities for which there is no readily available market. These illiquid securities may include privately placed restricted securities for which no institutional market exists. The absence of a trading market can make it difficult to ascertain a market value for illiquid investments. Disposing of illiquid investments may involve time-consuming negotiation and legal expenses, and it may be difficult or impossible for the Portfolio to sell them promptly at an acceptable price. FOR CITIBANK NEW YORK RETAIL BANKING AND BUSINESS AND PROFESSIONAL CUSTOMERS: Citibank, N.A. 450 West 33rd Street, New York, NY 10001 (212) 564-3456 or (800) 846-5300 P.O. Box 5130, New York, NY 10126-5130 Call Your Citigold Executive, or in NY or CT (800) 285-1701, or for all other states (800) 285-1707 FOR CITIBANK PRIVATE BANKING CLIENTS: Citibank, N.A. 153 East 53rd Street, New York, NY 10043 Call Your Citibank Private Banking Account Officer, Registered Representative or (212) 559-5959 FOR CITIBANK GLOBAL ASSET MANAGEMENT CLIENTS: Citibank, N.A. 153 East 53rd Street, New York, NY 10043 FOR CITIBANK NORTH AMERICAN INVESTOR SERVICES CLIENTS: Citibank, N.A. 111 Wall Street, New York, NY 10043 Call Your Account Manager or (212) 657-9100 FOR CITICORP INVESTMENT SERVICES CUSTOMERS: One Court Square, Long Island City, NY11120 Call Your Investment Consultant or (800) 846-5200 (212) 736-8170 in New York City New York Tax Free Reserves National Tax Free Income Fund New York Tax Free Income Fund Emerging Asian Markets Equity Fund C. Oscar Morong, Jr., Chairman Affiliated Person of Administrator and Distributor 153 East 53rd Street, New York, NY 10043 The Landmark Funds Broker-Dealer Services, Inc. 6 St. James Avenue, Boston, MA 02116 State Street Bank and Trust Company 225 Franklin Street, Boston, MA 02110 160 Federal Street, Boston, MA02110 (FOR LANDMARK U.S. TREASURY RESERVES) 125 Summer Street, Boston, MA 02110 150 Federal Street, Boston, MA 02110 MM/P/96/RB Printed on Recycled Paper [Recycle Symbol] (Members of the LandmarkSM Family of Funds) Landmark Cash Reserves ("Cash Reserves") and Landmark U.S. Treasury Reserves ("U.S. Treasury Reserves" and together with Cash Reserves, the "Funds") are each separate series of Landmark Funds III (the "Trust"). The address and telephone number of the Trust are 6 St. James Avenue, Boston, Massachusetts 02116, (617) 423-1679. The Trust invests all of the investable assets of Cash Reserves and U.S. Treasury Reserves in, respectively, Cash Reserves Portfolio and U.S. Treasury Reserves Portfolio (the "Portfolios"). The address of Cash Reserves Portfolio is Elizabethan Square, George Town, Grand Cayman, British West Indies. The address and telephone number of U.S. Treasury Reserves Portfolio are 6 St. James Avenue, Boston, Massachusetts 02116, (617) 423-1679. FUND SHARES ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, CITIBANK, N.A. OR ANY OF ITS AFFILIATES, ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER AGENCY, AND INVOLVE INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL AMOUNT INVESTED. Determination of Net Asset Value 16 Description of Shares, Voting Rights Certain Additional Tax Matters 31 This Statement of Additional Information sets forth information which may be of interest to investors but which is not necessarily included in the Funds' Prospectus, dated January 2, 1996. This Statement of Additional Information should be read in conjunction with the Prospectus, a copy of which may be obtained by an investor without charge by contacting the Funds' Distributor (see back cover for address and phone number). THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS AND IS AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE INVESTORS ONLY IF PRECEDED OR ACCOMPANIED BY AN EFFECTIVE PROSPECTUS. The Trust is a no-load, diversified, open-end management investment company which was organized as a business trust under the laws of the Commonwealth of Massachusetts on June 28, 1985 and is the successor to the business of The Landmark Funds Cash Reserves, Inc., which was incorporated under the laws of the State of Maryland in 1984. The Trust was known as "Landmark Cash Reserves" until its name was changed effective February 1, 1991. All references in this Statement of Additional Information to the Trust's activities are intended to include those of the Trust and its predecessor, unless the context indicates otherwise. Shares of the Trust are divided into two separate series, Cash Reserves and U.S. Treasury Reserves, which are described in this Statement of Additional Information. References in this Statement of Additional Information to the Prospectus are to the Prospectus, dated January 2, 1996, of the Funds by which shares of the Funds are offered. Each of the Funds is a type of mutual fund commonly referred to as a "money market fund." The net asset value of each of the Funds' shares is expected to remain constant at $1.00, although there can be no assurance that this will be so on a continuing basis. (See "Determination of Net Asset Value.") The Trust seeks the investment objectives of the Funds by investing all the investable assets of Cash Reserves and U.S. Treasury Reserves in, respectively, Cash Reserves Portfolio and U.S. Treasury Reserves Portfolio. Each of the Portfolios is a diversified open-end management investment company. Each Portfolio has the same investment objectives and policies as its corresponding Fund. Citibank, N.A. ("Citibank" or the "Adviser") is the investment adviser to each of the Portfolios. The Adviser manages the investments of each Portfolio from day to day in accordance with the investment objectives and policies of that Portfolio. The selection of investments for each Portfolio, and the way they are managed, depend on the conditions and trends in the economy and the financial marketplaces. The Landmark Funds Broker-Dealer Services, Inc. ("LFBDS") supervises the overall administration of the Trust and U.S. Treasury Reserves Portfolio. Signature Financial Group (Cayman), Ltd., either directly or through its wholly-owned subsidiary ("SFG"), supervises the overall administration of Cash Reserves Portfolio. The Boards of Trustees of the Trust and the Portfolios provide broad supervision over the affairs of the Trust and of the Portfolios, respectively. Shares of each Fund are continuously sold by LFBDS, the Funds' distributor (the "Distributor"), only to investors who are customers of a financial institution, such as a federal or state-chartered bank, trust company, savings and loan association or savings bank, or a securities broker, that has entered into a shareholder servicing agreement with the Trust with respect to that Fund (collectively, "Shareholder Servicing Agents"). Although shares of the Funds are sold without a sales load, LFBDS may receive fees from the Funds pursuant to a Distribution Plan adopted in accordance with Rule 12b-1 under the Investment Company Act of 1940, as amended (the "1940 Act"). 2. INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS The investment objectives of CASH RESERVES are to provide shareholders of the Fund with liquidity and as high a level of current income as is consistent with the preservation of capital. The investment objectives of U.S. TREASURY RESERVES are to provide shareholders of the Fund with liquidity and as high a level of current income from U.S. Government obligations as is consistent with the preservation of capital. The investment objectives of each of the Funds may be changed without approval by the Fund's shareholders. Of course, there can be no assurance that either Fund will achieve its investment objectives. The Trust seeks the investment objectives of the Funds by investing all of the investable assets of Cash Reserves and U.S. Treasury Reserves in, respectively, Cash Reserves Portfolio and U.S. Treasury Reserves Portfolio, each of which has the same investment objectives and policies as its corresponding Fund. The Prospectus contains a discussion of the various types of securities in which each Portfolio may invest and the risks involved in such investments. The following supplements the information contained in the Prospectus concerning the investment objectives, policies and techniques of each Fund and each Portfolio. Since the investment characteristics of each Fund will correspond directly to those of the Portfolio in which it invests, the following is a supplementary discussion with respect to each Portfolio. The Trust may withdraw the investment of either Fund from its corresponding Portfolio at any time, if the Board of Trustees of the Trust determines that it is in the best interests of the Fund to do so. Upon any such withdrawal, a Fund's assets would be invested in accordance with the investment policies described below with respect to its corresponding Portfolio. Except for the concentration policy of Cash Reserves with respect to bank obligations described in paragraph (1) below, which is fundamental and may not be changed without the approval of Cash Reserves' shareholders, the approval of a Fund's shareholders would not be required to change any of that Fund's investment policies. Likewise, except for the concentration policy of Cash Reserves Portfolio with respect to bank obligations described in paragraph (1) below, which is fundamental and may not be changed without the approval of Cash Reserves Portfolio's investors, the approval of the investors in a Portfolio would not be required to change that Portfolio's investment objectives or any of that Portfolio's investment policies discussed below, including those concerning securities transactions. Cash Reserves Portfolio seeks its investment objective through investments limited to the following types of high quality U.S. dollar-denominated money market instruments. All investments by Cash Reserves Portfolio mature or are deemed to mature within 397 days from the date of acquisition and the average maturity of the investments held by the Portfolio (on a dollar-weighted basis) is 90 days or less. All investments by the Portfolio are in "high quality" securities (i.e., securities rated in the highest rating category for short-term obligations by at least two nationally recognized statistical rating organizations (each, an "NRSRO") assigning a rating to the security or issuer or, if only one NRSRO assigns a rating, that NRSRO or, in the case of an investment which is not rated, of comparable quality as determined by the Adviser) and are determined by the Adviser to present minimal credit risks. Investments in high quality, short term instruments may, in many circumstances, result in a lower yield than would be available from investments in instruments with a lower quality or a longer term. Under the 1940 Act, Cash Reserves and Cash Reserves Portfolio are each classified as "diversified", although in the case of Cash Reserves, all of its investable assets are invested in the Portfolio. A "diversified investment company" must invest at least 75% of its assets in cash and cash items, U.S. Government securities, investment company securities (e.g., interests in the Portfolio) and other securities limited as to any one issuer to not more than 5% of the total assets of the investment company and not more than 10% of the voting securities of the issuer. (1) Bank obligations -- Cash Reserves Portfolio invests at least 25% of its investable assets, and may invest up to 100% of its assets, in bank obligations. These obligations include, but are not limited to, negotiable certificates of deposit, bankers' acceptances and fixed time deposits. Cash Reserves Portfolio limits its investments in U.S. bank obligations (including their non-U.S. branches) to banks having total assets in excess of $1 billion and which are subject to regulation by an agency of the U.S. Government. The Portfolio may also invest in certificates of deposit issued by banks the deposits in which are insured by the Federal Deposit Insurance Corporation ("FDIC"), through either the Bank Insurance Fund or the Savings Association Insurance Fund, having total assets of less than $1 billion, provided that the Portfolio at no time owns more than $100,000 principal amount of certificates of deposit (or any higher principal amount which in the future may be fully insured by FDIC insurance) of any one of those issuers. Fixed time deposits are obligations which are payable at a stated maturity date and bear a fixed rate of interest. Generally, fixed time deposits may be withdrawn on demand by the Portfolio, but they may be subject to early withdrawal penalties which vary depending upon market conditions and the remaining maturity of the obligation. Although fixed time deposits do not have a market, there are no contractual restrictions on the Portfolio's right to transfer a beneficial interest in the deposit to a third party. This concentration policy is fundamental and may not be changed without the approval of the investors in Cash Reserves Portfolio. U.S. banks organized under federal law are supervised and examined by the Comptroller of the Currency and are required to be members of the Federal Reserve System and to be insured by the FDIC. U.S. banks organized under state law are supervised and examined by state banking authorities and are members of the Federal Reserve System only if they elect to join. However, state banks which are insured by the FDIC are subject to federal examination and to a substantial body of federal law and regulation. As a result of federal and state laws and regulations, U.S. branches of U.S. banks, among other things, are generally required to maintain specified levels of reserves, and are subject to other supervision and regulation designed to promote financial soundness. Cash Reserves Portfolio limits its investments in non-U.S. bank obligations (i.e., obligations of non-U.S. branches and subsidiaries of U.S. banks, and U.S. and non-U.S. branches of non-U.S. banks) to U.S. dollar-denominated obligations of banks which at the time of investment are branches or subsidiaries of U.S. banks which meet the criteria in the preceding paragraphs or are branches of non-U.S. banks which (i) have more than $10 billion, or the equivalent in other currencies, in total assets; (ii) in terms of assets are among the 75 largest non-U.S. banks in the world; (iii) have branches or agencies in the United States; and (iv) in the opinion of the Adviser, are of an investment quality comparable with obligations of U.S. banks which may be purchased by the Portfolio. These obligations may be general obligations of the parent bank, in addition to the issuing branch or subsidiary, but the parent bank's obligations may be limited by the terms of the specific obligation or by governmental regulation. The Portfolio also limits its investments in non-U.S. bank obligations to banks, branches and subsidiaries located in Western Europe (United Kingdom, France, Germany, Belgium, the Netherlands, Italy, Switzerland), Scandinavia (Denmark, Norway, Sweden), Australia, Japan, the Cayman Islands, the Bahamas and Canada. Cash Reserves Portfolio does not purchase any bank obligation of the Adviser or an affiliate of the Adviser. Since Cash Reserves Portfolio may hold obligations of non-U.S. branches and subsidiaries of U.S. banks, and U.S. and non-U.S. branches of non-U.S. banks, an investment in Cash Reserves involves certain additional risks. Such investment risks include future political and economic developments, the possible imposition of non-U.S. withholding taxes on interest income payable on such obligations held by the Portfolio, the possible seizure or nationalization of non-U.S. deposits and the possible establishment of exchange controls or other non-U.S. governmental laws or restrictions applicable to the payment of the principal of and interest on certificates of deposit or time deposits that might affect adversely such payment on such obligations held by the Portfolio. In addition, there may be less publicly-available information about a non-U.S. branch or subsidiary of a U.S. bank or a U.S. or non-U.S. branch of a non-U.S. bank than about a U.S. bank and such branches and subsidiaries may not be subject to the same or similar regulatory requirements that apply to U.S. banks, such as mandatory reserve requirements, loan limitations and accounting, auditing and financial record-keeping standards and requirements. The provisions of federal law governing the establishment and operation of U.S. branches do not apply to non-U.S. branches of U.S. banks. However, Cash Reserves Portfolio may purchase obligations only of those non-U.S. branches of U.S. banks which were established with the approval of the Board of Governors of the Federal Reserve System (the "Board of Governors"). As a result of such approval, these branches are subject to examination by the Board of Governors and the Comptroller of the Currency. In addition, such non-U.S. branches of U.S. banks are subject to the supervision of the U.S. bank and creditors of the non-U.S. branch are considered general creditors of the U.S. bank subject to whatever defenses may be available under the governing non-U.S. law and to the terms of the specific obligation. Nonetheless, Cash Reserves Portfolio generally will be subject to whatever risk may exist that the non-U.S. country may impose restrictions on payment of certificates of deposit or time deposits. U.S. branches of non-U.S. banks are subject to the laws of the state in which the branch is located or to the laws of the United States. Such branches are therefore subject to many of the regulations, including reserve requirements, to which U.S. banks are subject. In addition, Cash Reserves Portfolio may purchase obligations only of those U.S. branches of non-U.S. banks which are located in states which impose the additional requirement that the branch pledge to a designated bank within the state an amount of its assets equal to 5% of its total liabilities. Non-U.S. banks in whose obligations Cash Reserves Portfolio may invest may not be subject to the laws and regulations referred to in the preceding two paragraphs. (2) Obligations of, or guaranteed by, non-U.S. governments. Cash Reserves Portfolio limits its investments in non-U.S. government obligations to obligations issued or guaranteed by the governments of Western Europe (United Kingdom, France, Germany, Belgium, the Netherlands, Italy, Switzerland), Scandinavia (Denmark, Norway, Sweden), Australia, Japan and Canada. Generally, such obligations may be subject to the additional risks described in paragraph 1 above in connection with the purchase of non-U.S. bank obligations. (3) Commercial paper rated Prime-1 by Moody's Investors Service, Inc. ("Moody's") or A-1 by Standard & Poor's Ratings Group ("Standard & Poor's") or, if not rated, determined to be of comparable quality by the Adviser, such as unrated commercial paper issued by corporations having an outstanding unsecured debt issue currently rated Aaa by Moody's or AAA by Standard & Poor's. (4) Obligations of, or guaranteed by, the U.S. Government, its agencies or instrumentalities. These include issues of the U.S. Treasury, such as bills, certificates of indebtedness, notes and bonds, and issues of agencies and instrumentalities established under the authority of an Act of Congress. Some of the latter category of obligations are supported by the full faith and credit of the United States, others are supported by the right of the issuer to borrow from the U.S. Treasury, and still others are supported only by the credit of the agency or instrumentality. Examples of each of the three types of obligations described in the preceding sentence are (i) obligations guaranteed by the Export-Import Bank of the United States, (ii) obligations of the Federal Home Loan Mortgage Corporation, and (iii) obligations of the Student Loan Marketing Association, respectively. (5) Repurchase agreements, providing for resale within 397 days or less, covering obligations of, or guaranteed by, the U.S. Government, its agencies or instrumentalities which may have maturities in excess of 397 days. A repurchase agreement arises when a buyer purchases an obligation and simultaneously agrees with the vendor to resell the obligation to the vendor at an agreed-upon price and time, which is usually not more than seven days from the date of purchase. The resale price of a repurchase agreement is greater than the purchase price, reflecting an agreed-upon market rate which is effective for the period of time the buyer's funds are invested in the obligation and which is not related to the coupon rate on the purchased obligation. Obligations serving as collateral for each repurchase agreement are delivered to the Portfolio's custodian either physically or in book entry form and the collateral is marked to the market daily to ensure that each repurchase agreement is fully collateralized at all times. A buyer of a repurchase agreement runs a risk of loss if, at the time of default by the issuer, the value of the collateral securing the agreement is less than the price paid for the repurchase agreement. If the vendor of a repurchase agreement becomes bankrupt, Cash Reserves Portfolio might be delayed, or may incur costs or possible losses of principal and income, in selling the collateral. The Portfolio may enter into repurchase agreements only with a vendor which is a member bank of the Federal Reserve System or which is a "primary dealer" (as designated by the Federal Reserve Bank of New York) in U.S. Government obligations. The Portfolio will not enter into any repurchase agreements with the Adviser or an affiliate of the Adviser. The restrictions and procedures described above which govern the Portfolio's investment in repurchase agreements are designed to minimize the Portfolio's risk of losses in making those investments. (6) Asset-backed securities, which may include securities such as Certificates for Automobile Receivables ("CARS") and Credit Card Receivable Securities ("CARDS"), as well as other asset-backed securities that may be developed in the future. CARS represent fractional interests in pools of car installment loans, and CARDS represent fractional interests in pools of revolving credit card receivables. The rate of return on asset-backed securities may be affected by early prepayment of principal on the underlying loans or receivables. Prepayment rates vary widely and may be affected by changes in market interest rates. It is not possible to accurately predict the average life of a particular pool of loans or receivables. Reinvestment of principal may occur at higher or lower rates than the original yield. Therefore, the actual maturity and realized yield on asset-backed securities will vary based upon the prepayment experience of the underlying pool of loans or receivables. (See "Asset-Backed Cash Reserves Portfolio does not purchase securities which the Portfolio believes, at the time of purchase, will be subject to exchange controls or non-U.S. withholding taxes; however, there can be no assurance that such laws may not become applicable to certain of the Portfolio's investments. In the event exchange controls or non-U.S. withholding taxes are imposed with respect to any of the Portfolio's investments, the effect may be to reduce the income received by the Portfolio on such investments. As set forth above, Cash Reserves Portfolio may purchase asset-backed securities that represent fractional interests in pools of retail installment loans, both secured (such as Certificates for Automobile Receivables) and unsecured, or leases or revolving credit receivables, both secured and unsecured (such as Credit Card Receivable Securities). These assets are generally held by a trust and payments of principal and interest or interest only are passed through monthly or quarterly to certificate holders and may be guaranteed up to certain amounts by letters of credit issued by a financial institution affiliated or unaffiliated with the trustee or originator of the trust. Underlying automobile sales contracts, leases or credit card receivables are subject to prepayment, which may reduce the overall return to certificate holders. Nevertheless, principal repayment rates tend not to vary much with interest rates and the short-term nature of the underlying loans, leases or receivables tends to dampen the impact of any change in the prepayment level. Certificate holders may also experience delays in payment on the certificates if the full amounts due on underlying loans, leases or receivables are not realized by the Portfolio because of unanticipated legal or administrative costs of enforcing the contracts or because of depreciation or damage to the collateral (usually automobiles) securing certain contracts, or other factors. If consistent with its investment objectives and policies, Cash Reserves Portfolio may invest in other asset-backed securities that may be developed in the future. Consistent with applicable regulatory requirements and in order to generate income, each of the Portfolios may lend its securities to broker-dealers and other institutional borrowers. Such loans will usually be made only to member banks of the U.S. Federal Reserve System and to member firms of the New York Stock Exchange ("NYSE") (and subsidiaries thereof). Loans of securities would be secured continuously by collateral in cash, cash equivalents, or U.S. Treasury obligations maintained on a current basis at an amount at least equal to the market value of the securities loaned. The cash collateral would be invested in high quality short-term instruments. A Portfolio would have the right to call a loan and obtain the securities loaned at any time on customary industry settlement notice (which will not usually exceed five days). During the existence of a loan, a Portfolio would continue to receive the equivalent of the interest or dividends paid by the issuer on the securities loaned and would also receive compensation based on investment of the collateral. The Portfolio would not, however, have the right to vote any securities having voting rights during the existence of the loan, but would call the loan in anticipation of an important vote to be taken among holders of the securities or of the giving or withholding of their consent on a material matter affecting the investment. As with other extensions of credit, there are risks of delay in recovery or even loss of rights in the collateral should the borrower fail financially. However, the loans would be made only to entities deemed by the Adviser to be of good standing, and when, in the judgment of the Adviser, the consideration which can be earned currently from loans of this type justifies the attendant risk. If the Adviser determines to make loans, it is not intended that the value of the securities loaned by a Portfolio would exceed 33 1/3% of the value of its net assets. U.S. Treasury Reserves Portfolio seeks its investment objective by investing in obligations of, or guaranteed by, the U.S. Government, its agencies or instrumentalities including issues of the U.S. Treasury, such as bills, certificates of indebtedness, notes and bonds, and issues of agencies and instrumentalities established under the authority of an Act of Congress which are supported by the full faith and credit of the United States. U.S. Treasury Reserves Portfolio will not enter into repurchase agreements. The Trust, on behalf of the Funds, and the Portfolios have each adopted the following policies which may not be changed without approval by holders of a "majority of the outstanding shares" of the applicable Fund or Portfolio, which as used in this Statement of Additional Information means the vote of the lesser of (i) 67% or more of the outstanding voting securities of the Fund or Portfolio present at a meeting, if the holders of more than 50% of the outstanding "voting securities" of the Fund or Portfolio are present or represented by proxy, or (ii) more than 50% of the outstanding "voting securities" of the Fund or the Portfolio. The term "voting securities" as used in this paragraph has the same meaning as in the 1940 Act. Whenever the Trust is requested to vote on a change in the investment restrictions of a Portfolio (or, in the case of Cash Reserves Portfolio, its concentration policy described in paragraph (1) under "Investment Policies"), the Trust will hold a meeting of the corresponding Fund's shareholders and will cast its vote as instructed by the shareholders. Each Fund will vote the shares held by its shareholders who do not give voting instructions in the same proportion as the shares of that Fund's shareholders who do give voting instructions. Shareholders of the Funds who do not vote will have no effect on the outcome of these matters. The Trust, on behalf of Cash Reserves, may not: (1) Invest in equity securities (e.g., common stock, preferred stock, options, warrants, puts, calls), voting securities, restricted securities, corporate debt securities (e.g., bonds, debentures) other than those bank securities and commercial paper referred to under "Investment Policies", local or state government securities (e.g., municipal bonds, state bonds), commodities or commodity contracts, real estate, or securities of other investment companies, except that the Trust may invest all or a portion of the Fund's assets in a diversified, open-end management investment company with substantially the same investment objective, policies and restrictions as the Fund. The Trust, on behalf of the Fund, will not sell securities short, write put or call options, engage in underwriting, or invest in companies for the purpose of exercising control. The Trust, on behalf of the Fund, will not make loans to other persons except that it may acquire debt securities as discussed under "Investment Policies". (2) Purchase securities or obligations of any one issuer (other than securities issued by the U.S. Government, its agencies and instrumentalities and repurchase agreements covering such securities) if immediately after such purchase more than 5% of the value of its assets would be invested in that issuer except that the Trust may invest all or a portion of the Fund's assets in a diversified, open-end management investment company with substantially the same investment objective, policies and restrictions as the Fund. (3) Borrow money except from banks as a temporary measure for extraordinary or emergency purposes (not for leveraging) or in order to meet unexpectedly heavy redemption requests in an amount not exceeding 15% of the value of the Fund's assets and will not purchase any securities at any time when the Fund's total outstanding borrowings from banks exceed 5% of the Fund's gross assets. The Trust, on behalf of the Fund, will not pledge its assets except to secure borrowings. While the Trust, on behalf of the Fund, may borrow from its Custodian for the foregoing purposes, any borrowing from the Custodian will be on terms no less favorable to the Fund than those offered by the Custodian to comparable borrowers and on terms which the Trust believes are not less favorable than those readily obtainable elsewhere. (4) Concentrate the Fund's investments in any particular industry, but if it is deemed appropriate to the achievement of the Fund's investment objective, up to 25% of the assets of the Fund (taken at market value at the time of each investment) may be invested in any one industry, provided that, if the Trust withdraws the Fund's investment from an open-end management investment company with substantially the same investment objective, policies and restrictions as the Fund, it will invest at least 25%, and may invest up to 100%, of the assets of the Fund in bank obligations; and provided, further, that nothing in this Investment Restriction is intended to affect the Trust's ability to invest 100% of the Fund's assets in a diversified, open-end management investment company with substantially the same investment objective, policies and restrictions as the Fund. (5) There is no limitation on investing in securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities, or repurchase agreements covering those securities, except that the Trust, on behalf of the Fund, will not acquire securities that are not readily marketable or repurchase agreements calling for resale within more than 7 days if, as a result thereof, more than 10% of the value of its net assets would be invested in such securities. The Trust, on behalf of the Fund, may not invest in fixed time deposits maturing in more than seven calendar days, and fixed time deposits maturing from two business days through seven calendar days may not exceed 10% of the Fund's net assets. Cash Reserves Portfolio may not: (1) borrow money, except that as a temporary measure for extraordinary or emergency purposes the Portfolio may borrow from banks in an amount not to exceed 1/3 of the value of the net assets of the Portfolio, including the amount borrowed (moreover, the Portfolio may not purchase any securities at any time at which borrowings exceed 5% of its total assets (taken at market value))(it is intended that the Portfolio would borrow money only from banks and only to accommodate requests for the withdrawal of all or a portion of a beneficial interest in the Portfolio while effecting an orderly liquidation of securities); for additional related restrictions, see clause (i) under the caption "State and (2) purchase any security or evidence of interest therein on margin, except that the Portfolio may obtain such short term credit as may be necessary for the clearance of purchases and sales of securities; (3) underwrite securities issued by other persons, except insofar as the Portfolio may technically be deemed an underwriter under the Securities Act of 1933 in selling a security; (4) make loans to other persons except (a) through the lending of securities held by the Portfolio, but not in excess of 33 1/3% of the Portfolio's net assets, (b) through the use of fixed time deposits or repurchase agreements or the purchase of short term obligations, or (c) by purchasing all or a portion of an issue of debt securities of types commonly distributed privately to financial institutions; for purposes of this paragraph 4 the purchase of short term commercial paper or a portion of an issue of debt securities which are part of an issue to the public shall not be considered the making of a loan; for additional related restrictions, see clause (x) under the caption "State and Federal Restrictions" below; (5) purchase or sell real estate (including limited partnership interests but excluding securities secured by real estate or interests therein), interests in oil, gas or mineral leases, commodities or commodity contracts in the ordinary course of business (the Portfolio reserves the freedom of action to hold and to sell real estate acquired as a result of the ownership of securities (6) concentrate its investments in any particular industry, but if it is deemed appropriate for the achievement of its investment objective, up to 25% of the assets of the Portfolio (taken at market value at the time of each investment) may be invested in any one industry, except that the Portfolio will invest at least 25% of its assets and may invest up to 100% of its assets in (7) issue any senior security (as that term is defined in the 1940 Act) if such issuance is specifically prohibited by the 1940 Act or the rules and regulations promulgated thereunder, except as appropriate to evidence a debt incurred without violating Investment Restriction (1) above. Neither the Trust, on behalf of U.S. Treasury Reserves, nor U.S. Treasury Portfolio may: (1) borrow money, except that as a temporary measure for extraordinary or emergency purposes either the Trust or the Portfolio may borrow from banks in an amount not to exceed 1/3 of the value of the net assets of the Fund or the Portfolio, respectively, including the amount borrowed (moreover, neither the Trust (on behalf of the Fund) nor the Portfolio may purchase any securities at any time at which borrowings exceed 5% of the total assets of the Fund or the Portfolio, respectively (taken in each case at market value)) (it is intended that the Fund and the Portfolio would borrow money only from banks and only to accommodate requests for the repurchase of shares of the Fund or the withdrawal of all or a portion of a beneficial interest in the Portfolio while effecting an orderly liquidation of securities); for additional related restrictions, see clause (i) under the caption "State and Federal Restrictions" below; (2) purchase any security or evidence of interest therein on margin, except that either the Trust, on behalf of the Fund, or the Portfolio may obtain such short term credit as may be necessary for the clearance of purchases and (3) underwrite securities issued by other persons, except that all the assets of the Fund may be invested in the Portfolio and except insofar as either the Trust or the Portfolio may technically be deemed an underwriter under the Securities Act of 1933 in selling a security; (4) make loans to other persons except (a) through the lending of securities held by either the Fund or the Portfolio, but not in excess of 33 1/3% of the Fund's or the Portfolio's net assets, as the case may be, (b) through the use of repurchase agreements or the purchase of short term obligations, or (c) by purchasing all or a portion of an issue of debt securities of types commonly distributed privately to financial institutions; for purposes of this paragraph 4 the purchase of a portion of an issue of debt securities which is part of an issue to the public shall not be considered the making of a loan; for additional related restrictions, see clause (x) under the caption "State and Federal Restrictions" below; (5) purchase or sell real estate (including limited partnership interests but excluding securities secured by real estate or interests therein), interests in oil, gas or mineral leases, commodities or commodity contracts in the ordinary course of business (the Fund and the Portfolio reserve the freedom of action to hold and to sell real estate acquired as a result of the ownership of securities by the Fund or the Portfolio); (6) concentrate its investments in any particular industry; provided, that nothing in this Investment Restriction is intended to affect the ability to invest 100% of the Fund's assets in the Portfolio; or (7) issue any senior security (as that term is defined in the 1940 Act) if such issuance is specifically prohibited by the 1940 Act or the rules and regulations promulgated thereunder, except as appropriate to evidence a debt incurred without violating Investment Restriction (1) above. In order to comply with certain state and federal statutes and regulatory policies, neither the Trust, on behalf of either of the Funds, nor the corresponding Portfolio will as a matter of operating policy: (i) borrow money for any purpose in excess of 10% of the total assets of the Fund or Portfolio (taken in each case at cost), (ii) pledge, mortgage or hypothecate for any purpose in excess of 10% of the net assets of the Fund or Portfolio (taken in each case at market value), (iii) sell any security which it does not own unless by virtue of its ownership of other securities it has at the time of sale a right to obtain securities, without payment of further consideration, equivalent in kind and amount to the securities sold; and provided, that if such right is conditional the sale is made upon the same conditions, (iv) invest for the purpose of exercising control or management, except that all of the assets of the Fund may be invested in the corresponding (v) purchase securities issued by any registered investment company, except that all of the assets of the Fund may be invested in the corresponding Portfolio and except by purchase in the open market where no commission or profit to a sponsor or dealer results from such purchase other than the customary broker's commission, and except when such purchase, though not made in the open market, is part of a plan of merger or consolidation; provided, however, that the Trust (on behalf of the Fund) and the Portfolio will not purchase the securities of any registered investment company if such purchase at the time thereof would cause more than 10% of the total assets of the Fund or the Portfolio (taken in each case at the greater of cost or market value) to be invested in the securities of such issuers or would cause more than 3% of the outstanding voting securities of any such issuer to be held by the Portfolio; and provided, further, that the Portfolios shall not purchase securities issued by any open-end investment company, (vi) taken together with any investments described in clause (x) below, invest more than 10% of the net assets of the Fund or the Portfolio in securities that are not readily marketable, including debt securities for which there is no established market (and, in the case of Cash Reserves and Cash Reserves Portfolio, repurchase agreements maturing in more than seven days), except that all the assets of the Fund may be invested in the corresponding (vii) purchase securities of any issuer if such purchase at the time thereof would cause it to hold more than 10% of any class of securities of such issuer, for which purposes all indebtedness of an issuer shall be deemed a single class, except that all the assets of the Fund may be invested in the (viii) purchase or retain any securities issued by an issuer any of whose officers, directors, trustees or security holders is an officer or Trustee of the Trust or the Portfolio, or is an officer or director of the Adviser, if after the purchase of the securities of such issuer by the Trust, on behalf of the Fund, or a Portfolio, one or more of such persons owns beneficially more than 1/2 of 1% of the shares or securities, or both, all taken at market value, of such issuer, and such persons owning more than 1/2 of 1% of such shares or securities together own beneficially more than 5% of such shares or securities, or both, all taken at market value, (ix) write, purchase or sell any put or call option or any combination (x) taken together with any investments described in clause (vi) above, invest in securities which are subject to legal or contractual restrictions on resale (other than, in the case of Cash Reserves and Cash Reserves Portfolio, repurchase agreements and fixed time deposits maturing in not more than seven days) if, as a result thereof, more than 10% of the net assets of the Fund or Portfolio (in each case taken at market value), would be so invested (including, in the case of Cash Reserves and Cash Reserves Portfolio, repurchase agreements maturing in more than seven days), except that all the assets of the Fund may be (xi) purchase securities of any issuer if such purchase at the time thereof would cause more than 10% of the voting securities of such issuer to be held by the Fund or Portfolio, except that all the assets of the Fund may be invested in a corresponding Portfolio, or (xii) make short sales of securities or maintain a short position, unless at all times when a short position is open it owns an equal amount of such securities or securities convertible into or exchangeable, without payment of any further consideration, for securities of the same issue as, and equal in amount to, the securities sold short, and unless not more than 10% of the net assets of the Fund or Portfolio, respectively (in each case taken at market value), is held as collateral for such sales at any one time. (The Portfolios do not presently intend to make such sales.) These policies are not fundamental and may be changed by the Trust with respect to either of the Funds without approval by the Fund's shareholders or by either of the Portfolios without the approval by the corresponding Fund or its other investors, in each case in response to changes in the various state and federal requirements. If a percentage restriction or a rating restriction (other than a restriction as to borrowing) on investment or utilization of assets set forth above or referred to in the Prospectus is adhered to at the time an investment is made or assets are so utilized, a later change in percentage resulting from changes in the value of the securities held by a Fund or a Portfolio or a later change in the rating of a security held by a Fund or a Portfolio is not considered a violation of policy. Any current yield quotation of a Fund which is used in such a manner as to be subject to the provisions of Rule 482(d) under the Securities Act of 1933, as amended, consists of an annualized historical yield, carried at least to the nearest hundredth of one percent, based on a specific seven calendar day period and is calculated by dividing the net change in the value of an account having a balance of one share at the beginning of the period by the value of the account at the beginning of the period and multiplying the quotient by 365/7. For this purpose the net change in account value would reflect the value of additional shares purchased with dividends declared on the original share and dividends declared on both the original share and any such additional shares, but would not reflect any realized gains or losses as a result of the Fund's investment in the Portfolio or any unrealized appreciation or depreciation on portfolio securities. In addition, any effective yield quotation of a Fund so used shall be calculated by compounding the current yield quotation for such period by multiplying such quotation by 7/365, adding 1 to the product, raising the sum to a power equal to 365/7, and subtracting 1 from the result. Any tax equivalent yield quotation of a Fund is calculated as follows: If the entire current yield quotation for such period is tax-exempt, the tax equivalent yield will be the current yield quotation divided by 1 minus a stated income tax rate or rates. If a portion of the current yield quotation is not tax-exempt, the tax equivalent yield will be the sum of (a) that portion of the yield which is tax-exempt divided by 1 minus a stated income tax rate or rates and (b) the portion of the yield which is not tax-exempt. A total rate of return quotation for a Fund is calculated for any period by (a) dividing (i) the sum of the net asset value per share on the last day of the period and the net asset value per share on the last day of the period of shares purchasable with dividends and capital gains distributions declared during such period with respect to a share held at the beginning of such period and with respect to shares purchased with such dividends and capital gains distributions, by (ii) the public offering price on the first day of such period, and (b) subtracting 1 from the result. Any annualized total rate of return quotation is calculated by (x) adding 1 to the period total rate of return quotation calculated above, (y) raising such sum to a power which is equal to 365 divided by the number of days in such period, and (z) subtracting 1 from the result. Any tax equivalent total rate of return quotation of a Fund is calculated as follows: If the entire current total rate of return quotation for such period is tax-exempt, the tax equivalent total rate of return will be the current total rate of return quotation divided by 1 minus a stated income tax rate or rates. If a portion of the current total rate of return quotation is not tax-exempt, the tax equivalent total rate of return will be the sum of (a) that portion of the total rate of return which is tax-exempt divided by 1 minus a stated income tax rate or rates and (b) the portion of the total rate of return which is not tax-exempt. Set forth below is total rate of return information, assuming that dividends and capital gains distributions, if any, were reinvested, for the Funds for the periods indicated, at the beginning of which periods no sales charges were applicable to purchases of shares of the Funds. The annualized yield of Cash Reserves for the seven-day period ended August 31, 1995 was 5.37%. The effective compound annualized yield of Cash Reserves for such period was 5.52%. The annualized yield of U.S. Treasury Reserves for the seven-day period ended August 31, 1995 was 4.86%, the effective compound annualized yield of U.S. Treasury Reserves for such period was 4.98% and the annualized tax equivalent yield of U.S. Treasury Reserves for such period was 5.53% (assuming a combined state and local tax rate of 12.051% for New York City residents). 4. DETERMINATION OF NET ASSET VALUE The net asset value of each share of each class of Cash Reserves is determined on each day on which the NYSE is open for trading. This determination is made once during each such day as of 3:00 p.m., Eastern time, by dividing the value of Cash Reserves' net assets attributable to a class (i.e., the value of the Fund's investment in Cash Reserves Portfolio and other assets attributable to the class less the Fund's liabilities attributable to the class, including expenses payable or accrued) by the number of shares of that class outstanding at the time the determination is made. The net asset value of each share of U.S. Treasury Reserves is determined on each day on which the NYSE is open for trading. This determination is made once during each such day as of 12:00 noon, Eastern time, by dividing the value of the Fund's net assets (i.e., the value of its investment in U.S. Treasury Reserves Portfolio and other assets less its liabilities, including expenses payable or accrued) by the number of shares of the Fund outstanding at the time the determination is made. As of the date of this Statement of Additional Information, the NYSE is open for trading every weekday except for the following holidays (or the days on which they are observed): New Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. It is anticipated that the net asset value of each share of each Fund will remain constant at $1.00 and, although no assurance can be given that they will be able to do so on a continuing basis, as described below, the Funds and Portfolios employ specific investment policies and procedures to accomplish this result. The value of a Portfolio's net assets (i.e., the value of its securities and other assets less its liabilities, including expenses payable or accrued) is determined at the same time and on the same days as the net asset value per share of the corresponding Fund is determined. The net asset value of a Fund's investment in the corresponding Portfolio is equal to the Fund's pro rata share of the total investment of the Fund and of other investors in the Portfolio less the Fund's pro rata share of the Portfolio's liabilities. The securities held by a Fund or Portfolio are valued at their amortized cost. Amortized cost valuation involves valuing an instrument at its cost and thereafter assuming a constant amortization to maturity of any discount or premium. If fluctuating interest rates cause the market value of the securities held by the Fund or Portfolio to deviate more than 1/2 of 1% from their value determined on the basis of amortized cost, the Fund or Portfolio's Board of Trustees will consider whether any action should be initiated, as described in the following paragraph. Although the amortized cost method provides certainty in valuation, it may result in periods during which the stated value of an instrument is higher or lower than the price the Fund or Portfolio would receive if the instrument were sold. Pursuant to the rules of the Securities and Exchange Commission ("SEC"), the Trust's and the Portfolios' Boards of Trustees have established procedures to stabilize the value of the Funds' and Portfolios' net assets within 1/2 of 1% of the value determined on the basis of amortized cost. These procedures include a review of the extent of any such deviation of net asset value, based on available market rates. Should that deviation exceed 1/2 of 1% for a Fund or a Portfolio, the Trust's or Portfolio's Board of Trustees will consider whether any action should be initiated to eliminate or reduce material dilution or other unfair results to investors in the Fund or Portfolio. Such action may include withdrawal in kind, selling securities prior to maturity and utilizing a net asset value as determined by using available market quotations. The Funds and Portfolios maintain a dollar-weighted average maturity of 90 days or less, do not purchase any instrument with a remaining maturity greater than 397 days or (in the case of Cash Reserves and Cash Reserves Portfolio) subject to a repurchase agreement having a duration of greater than 397 days, limit their investments, including repurchase agreements, to those U.S. dollar-denominated instruments that are determined by the Adviser to present minimal credit risks and comply with certain reporting and recordkeeping procedures. The Trust and Portfolios also have established procedures to ensure that securities purchased by the Funds and Portfolios meet high quality criteria. (See "Investment Objectives, Policies and Restrictions -- Investment Subject to compliance with applicable regulations, the Trust and the Portfolios have each reserved the right to pay the redemption price of shares of the Funds or beneficial interests in the Portfolios, either totally or partially, by a distribution in kind of readily marketable securities (instead of cash). The securities so distributed would be valued at the same amount as that assigned to them in calculating the net asset value for the shares or beneficial interests being sold. If a holder of shares or beneficial interests received a distribution in kind, such holder could incur brokerage or other charges in converting the securities to cash. The Trust or the Portfolios may suspend the right of redemption or postpone the date of payment for shares of a Fund or beneficial interests in a Portfolio more than seven days during any period when (a) trading in the markets the Fund or Portfolio normally utilizes is restricted, or an emergency, as defined by the rules and regulations of the SEC, exists making disposal of the Fund's or Portfolio's investments or determination of its net asset value not reasonably practicable; (b) the NYSE is closed (other than customary weekend and holiday closings); or (c) the SEC has by order permitted such suspension. The Trustees and officers of the Trust and the Portfolios, their ages and their principal occupations during the past five years are set forth below. Their titles may have varied during that period. Asterisks indicate that those Trustees and officers are "interested persons" (as defined in the 1940 Act) of the Trust or a Portfolio. Unless otherwise indicated below, the address of each Trustee and officer is 6 St. James Avenue, Boston, Massachusetts. The address of Cash Reserves Portfolio is Elizabethan Square, George Town, Grand Cayman, British West Indies. The address of U.S. Treasury Reserves Portfolio is 6 St. James Avenue, Boston, Massachusetts. H. B. ALVORD; 73 -- Treasurer - Tax Collector, County of Los Angeles (retired, March, 1984); Trustee, The 59 Wall Street Trust and The 59 Wall Street Fund, Inc. (Registered Investment Companies). His address is P.O. Box 1812, Pebble Beach, California. PHILIP W. COOLIDGE; 44 -- President of the Trust and the Portfolios; Chairman, Chief Executive Officer and President, Signature Financial Group, Inc. and The Landmark Funds Broker-Dealer Services, Inc. (since December, 1988). C. OSCAR MORONG, JR.; 60 -- Chairman of the Board of Trustees of the Trust; Managing Director, Morong Capital Management (since February, 1993); Senior Vice President and Investment Manager, CREF Investments, Teachers Insurance & Annuity Association (retired January, 1993). His address is 1385 Outlook Drive West, Mountainside, New Jersey. E. KIRBY WARREN; 61 -- Professor of Management, Graduate School of Business, Columbia University (since 1987). His address is Columbia University, Graduate School of Business, 725 Uris Hall, New York, New York. ELLIOTT J. BERV; 52 -- Chairman and Director, Catalyst, Inc. (Management Consultants) (since August, 1992); President, Chief Operating Officer and Director, Deven International, Inc. (International Consultants) (June, 1991 to July, 1992); President and Director, Elliott J. Berv & Associates (Management Consultants) (since May, 1984). His address is 15 Stornoway Drive, Cumberland Foreside, Maine. PHILIP W. COOLIDGE; 44* -- President of the Trust and the Portfolios; Chairman, Chief Executive Officer and President, Signature Financial Group, Inc. and The Landmark Funds Broker-Dealer Services, Inc. (since December, 1988). MARK T. FINN; 52 -- President and Director, Delta Financial, Inc. (since June, 1983); Chairman of the Board and Chief Executive Officer, FX 500 Ltd. (Commodity Trading Advisory Firm) (since April, 1990); Director, Vantage Consulting Group, Inc. (since October, 1988). His address is 3500 Pacific Avenue, P.O. Box 539, Virginia Beach, Virginia. WALTER E. ROBB, III; 69 -- President, Benchmark Advisors, Inc. (Corporate Financial Advisors) (since 1989); Trustee of certain registered investment companies in the MFS Family of Funds. His address is 35 Farm Road, Sherborn, Massachusetts. OFFICERS OF THE TRUST AND PORTFOLIOS PHILIP W. COOLIDGE; 44* -- President of the Trust and the Portfolios; Chairman, Chief Executive Officer and President, Signature Financial Group, Inc., and The Landmark Funds Broker-Dealer Services, Inc. (since December, 1988). DAVID G. DANIELSON; 30* -- Assistant Treasurer of the Trust and the Portfolios; Assistant Manager, Signature Financial Group, Inc. since May 1991; Graduate Student, Northeastern University from April 1990 to March 1991. JOHN R. ELDER; 47* -- Treasurer of the Trust and the Portfolios; Vice President, Signature Financial Group, Inc. (since April 1995); Treasurer, Phoenix Family of Mutual Funds (Phoenix Home Life Mutual Insurance Company) (from 1983 to March 1995). LINDA T. GIBSON; 30* -- Assistant Secretary of the Trust and the Portfolios; Legal Counsel, Signature Financial Group, Inc. (since June 1991); law student, Boston University School of Law (from September 1989 to May 1992); Product Manager, Signature Financial Group, Inc. (January 1989 to September 1989). SUSAN JAKUBOSKI; 31* -- Vice President, Assistant Treasurer and Assistant Secretary of Cash Reserves Portfolio and Assistant Secretary of the Trust (since August, 1994); Manager, Signature Financial Group (Cayman) Ltd. (since August, 1994); Senior Fund Administrator, Signature Financial Group, Inc. (since August, 1994); Assistant Treasurer, Signature Broker-Dealer Services, Inc. (since September, 1994); Fund Compliance Administrator, Concord Financial Group (November, 1990 to August, 1994); Senior Fund Accountant, Neuberger & Berman Management, Inc. (from February, 1988 to November, 1990); Customer Service Representative, I.B.J. Schroder (prior to 1988). Her address is Elizabethan Square, George Town, Grand Cayman, Cayman Islands, BWI. JAMES S. LELKO; 30* -- Assistant Treasurer of the Trust and the Portfolios; Assistant Manager, Signature Financial Group, Inc. since January 1993; Senior Tax Compliance Accountant, Putnam Companies since prior to December 1992. THOMAS M. LENZ; 37* -- Secretary of the Trust and the Portfolios; Vice President and Associate General Counsel, Signature Financial Group, Inc. (since November 1989); Attorney, Ropes & Gray (September 1984 to November 1989). MOLLY S. MUGLER; 44* -- Assistant Secretary of the Trust and the Portfolios; Legal Counsel and Assistant Secretary, Signature Financial Group, Inc. (since December, 1988); Assistant Secretary, The Landmark Funds Broker-Dealer Services, Inc. (since December, 1988). BARBARA M. O'DETTE; 36* -- Assistant Treasurer of the Trust and the Portfolios; Assistant Treasurer, Signature Financial Group, Inc. and The Landmark Funds Broker-Dealer Services, Inc. (since December, 1988). ANDRES E. SALDANA; 33* -- Assistant Secretary of the Trust and the Portfolios; Legal Counsel and Assistant Secretary, Signature Financial Group, Inc. since November 1992; Attorney, Ropes & Gray from September 1990 to November 1992. DANIEL E. SHEA; 33* -- Assistant Treasurer of the Trust and the Portfolios; Assistant Manager of Fund Administration, Signature Financial Group, Inc. since November 1993; Supervisor and Senior Technical Advisor, Putnam Investments since prior to 1990. The Trustees and officers of the Trust and the Portfolios also hold comparable positions with certain other funds for which LFBDS or an affiliate serves as the distributor or administrator. As of December 15, 1995, all Trustees and officers as a group owned less than 1% of each Fund's outstanding shares. As of the same date, more than 95% of the outstanding shares of each Fund were held of record by Citibank, N.A. or an affiliate, as a Shareholder Servicing Agent of the Funds, for the accounts of their respective clients. The Declaration of Trust of each of the Trust and the Portfolios provides that the Trust or such Portfolio, as the case may be, will indemnify its Trustees and officers against liabilities and expenses incurred in connection with litigation in which they may be involved because of their offices with the Trust or such Portfolio, as the case may be, unless, as to liability to the Trust or such Portfolio or its respective investors, it is finally adjudicated that they engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in their offices, or unless with respect to any other matter it is finally adjudicated that they did not act in good faith in the reasonable belief that their actions were in the best interests of the Trust or such Portfolio, as the case may be. In the case of settlement, such indemnification will not be provided unless it has been determined by a court or other body approving the settlement or other disposition, or by a reasonable determination, based upon a review of readily available facts, by vote of a majority of disinterested Trustees of the Trust or such Portfolio, or in a written opinion of independent counsel, that such officers or Trustees have not engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of their duties. Citibank manages the assets of each Portfolio pursuant to separate investment advisory agreements (the "Advisory Agreements"). Subject to such policies as the Board of Trustees of the Portfolio may determine, the Adviser manages the securities of each Portfolio and makes investment decisions for each Portfolio. The Adviser furnishes at its own expense all services, facilities and personnel necessary in connection with managing each Portfolio's investments and effecting securities transactions for each Portfolio. Each of the Advisory Agreements will continue in effect as long as such continuance is specifically approved at least annually by the Board of Trustees of the applicable Portfolio or by a vote of a majority of the outstanding voting securities of the applicable Portfolio, and, in either case, by a majority of the Trustees of the applicable Portfolio who are not parties to such Advisory Agreement or interested persons of any such party, at a meeting called for the purpose of voting on the Advisory Agreements. Each of the Advisory Agreements provides that the Adviser may render services to others. Each Advisory Agreement is terminable without penalty on not more than 60 days' nor less than 30 days' written notice by the applicable Portfolio when authorized either by a vote of a majority of the outstanding voting securities of the applicable Portfolio or by a vote of a majority of the Board of Trustees of the applicable Portfolio, or by the Adviser on not more than 60 days' nor less than 30 days' written notice, and will automatically terminate in the event of its assignment. Each Advisory Agreement provides that neither the Adviser nor its personnel shall be liable for any error of judgment or mistake of law or for any loss arising out of any investment or for any act or omission in the execution of security transactions for the applicable Portfolio, except for willful misfeasance, bad faith or gross negligence or reckless disregard of its or their obligations and duties under the Advisory Agreement. The Prospectus contains a description of the fees payable to the Adviser for services under the Advisory Agreements. Cash Reserves Portfolio: For the fiscal years ended August 31, 1993, 1994 and 1995, the fees paid to Citibank under the Advisory Agreement were $2,108,642, $1,806,314 and $4,097,854, respectively (of which $943,419 and $2,306,161 were voluntarily waived for the years ended August 31, 1994 and 1995, respectively). U.S. Treasury Reserves Portfolio: For the fiscal year ended December 31, 1992 and the eight-month period ended August 31, 1993, the fees paid to Citibank under the Advisory Agreement were $933,117 and $570,108, respectively. For the fiscal years ended August 31, 1994 and 1995, the fees payable to Citibank under the Advisory Agreement were $850,924 and $1,148,418 (of which $506,109 and $753,105 were voluntarily waived). Pursuant to Administrative Services Agreements (the "Administrative Services Agreements"), LFBDS provides the Trust and U.S. Treasury Reserves Portfolio, and SFG provides Cash Reserves Portfolio, with general office facilities, and LFBDS supervises the overall administration of the Trust and U.S. Treasury Reserves Portfolio and SFG supervises the overall administration of Cash Reserves Portfolio, including, among other responsibilities, the negotiation of contracts and fees with, and the monitoring of performance and billings of, the independent contractors and agents of the Trust and the Portfolios; the preparation and filing of all documents required for compliance by the Trust and the Portfolios with applicable laws and regulations; and arranging for the maintenance of books and records of the Trust and the Portfolios. LFBDS and SFG provide persons satisfactory to the Board of Trustees of the Trust and the Portfolios to serve as Trustees and officers of the Trust and the Portfolios. Such Trustees and officers may be directors, officers or employees of LFBDS, SFG or their affiliates. The Prospectus contains a description of the fees payable to LFBDS and SFG under the Administrative Services Agreements. Cash Reserves: For the fiscal years ended August 31, 1993, 1994 and 1995, the fees paid or payable to LFBDS from the Fund under the Administrative Services Agreement and a prior administrative services agreement with the Trust were $701,335, $1,146,206 and $1,566,336 (of which $14,759 and $52,077 were voluntarily waived in 1993 and 1994). For the fiscal years ended August 31, 1993, the fee paid or payable to LFBDS under a prior administrative services agreement with Cash Reserves Portfolio was $702,881 (of which $596,227 was voluntarily waived). For the fiscal years ended August 31, 1994 and 1995, the fees paid or payable to SFG under the Administrative Services Agreement with Cash Reserves Portfolio were $602,105 and $1,365,951 (all of which were voluntarily waived). U.S. Treasury Reserves: For the fiscal year ended December 31, 1992, the fee paid to LFBDS from the Fund under a prior administrative services agreement with the Trust was $246,286. For the eight-month period ended August 31, 1993 and for the fiscal years ended August 31, 1994 and 1995, the fees paid to LFBDS from the Fund under the Administrative Services Agreement with the Trust were $302,379 (of which $34,314 was voluntarily waived), $577,750 (of which $49,087 was voluntarily waived), and $561,420 (none of which was waived). For the fiscal year ended December 31, 1992, the fee payable to LFBDS under the Administrative Services Agreement with the Portfolio was $311,039 (of which $72,119 was voluntarily waived). For the fiscal year ended December 31, 1992, the eight-month period ended August 31, 1993 and for the fiscal years ended August 31, 1994 and 1995, the fees payable to LFBDS under the Administrative Services Agreement with the Portfolio were $311,039 (of which $72,119 was voluntarily waived), $190,036 (all of which was voluntarily waived), $283,642 (all of which was voluntarily waived) and $382,806 (all of which was voluntarily waived). The Administrative Services Agreement with the Trust acknowledges that the names "Landmark" and "Landmark Funds" are the property of LFBDS and provides that if LFBDS ceases to serve as the administrator of the Trust, the Trust and the Funds will change their respective names so as to delete the word "Landmark" or the words "Landmark Funds". The Administrative Services Agreement with the Trust also provides that LFBDS may render administrative services to others and may permit other investment companies in addition to the Trust to use the word "Landmark" or the words "Landmark Funds" in their names. The Administrative Services Agreement with the Trust continues in effect as to a Fund if such continuance is specifically approved at least annually by the Trust's Board of Trustees or by a vote of a majority of the outstanding voting securities of such Fund and, in either case, by a majority of the Trustees of the Trust who are not interested parties of the Trust or LFBDS. The Administrative Services Agreement with the Trust terminates automatically if it is assigned and may be terminated as to a Fund by the Trust without penalty by vote of a majority of the outstanding voting securities of the Fund or by either party on not more than 60 days' nor less than 30 days' written notice. The Administrative Services Agreement with the Trust also provides that neither LFBDS nor its personnel shall be liable for any error of judgment or mistake of law or for any act or omission in the administration or management of the Trust, except for willful misfeasance, bad faith or gross negligence in the performance of its or their duties or by reason of reckless disregard of its or their obligations and duties under the Administrative Services Agreement. LFBDS has agreed to reimburse the Funds for their operating expenses (exclusive of interest, taxes, brokerage, and extraordinary expenses) which in any year exceed the limits prescribed by any state in which the Funds' shares are qualified for sale. The expenses incurred by the Funds for distribution purposes pursuant to the Trust's Distribution Plans are included within such operating expenses only to the extent required by any state in which the Funds' shares are qualified for sale. The Trust may elect not to qualify the Funds' shares for sale in every state. The Trust believes that currently the most restrictive expense ratio limitation imposed by any state is 2 1/2% of the first $30 million of a Fund's average net assets for its then-current fiscal year, 2% of the next $70 million of such assets, and 1 1/2% of such assets in excess of $100 million. For the purpose of this obligation to reimburse expenses, the Funds' annual expenses are estimated and accrued daily, and any appropriate estimated payments will be made by LFBDS. Subject to the obligation of LFBDS to reimburse the Funds for their excess expenses as described above, the Trust has, under its Administrative Services Agreement, confirmed its obligation for payment of all other expenses of the Funds. The Administrative Services Agreements with the Portfolios provide that LFBDS or SFG, as the case may be, may render administrative services to others. The Administrative Services Agreement with each of the Portfolios terminates automatically if it is assigned and may be terminated without penalty by a vote of a majority of the outstanding voting securities of the Portfolio or by either party on not more than 60 days' nor less than 30 days' written notice. The Administrative Services Agreement with each of the Portfolios also provides that neither LFBDS or SFG, as the case may be, nor its personnel shall be liable for any error of judgment or mistake of law or for any act or omission in the administration or management of the Portfolio, except for willful misfeasance, bad faith or gross negligence in the performance of its or their duties or by reason of reckless disregard of its or their obligations and duties under the Administrative Services Agreement. LFBDS and SFG are wholly-owned subsidiaries of Signature Financial Group, Inc. Pursuant to Sub-Administrative Services Agreements (the "Sub-Administrative Agreements"), Citibank performs such sub-administrative duties for the Trust and the Portfolios as are from time to time agreed upon by Citibank and, as the case may be, LFBDS or SFG. Citibank's sub-administrative duties may include providing equipment and clerical personnel necessary for maintaining the organization of the Trust and the Portfolios, participation in preparation of documents required for compliance by the Trust and the Portfolios with applicable laws and regulations, preparation of certain documents in connection with meetings of Trustees and shareholders of the Trust and Portfolios, and other functions which would otherwise be performed by LFBDS as set forth above. For performing such sub-administrative services, Citibank receives such compensation as is from time to time agreed upon by Citibank and, as the case may be, LFBDS or SFG not in excess of the amount paid to LFBDS or SFG for its services under the applicable Administrative Services Agreement. All such compensation is paid by LFBDS or SFG, as the case may be. The Trust has adopted Distribution Plans (the "Distribution Plans") on behalf of itself and the Funds in accordance with Rule 12b-1 under the 1940 Act after having concluded that there is a reasonable likelihood that the Distribution Plans will benefit the Funds and their shareholders. Cash Reserves has both Class A Shares and Class B Shares. U.S. Treasury Reserves has a single class of shares. The Distribution Plan with respect to the Class A shares of Cash Reserves and the shares of U.S. Treasury Reserves provides that the Trust shall pay a distribution fee to the Distributor at an annual rate not to exceed 0.10% the average daily net assets of U.S. Treasury Reserves and of the average daily net assets represented by the Class A shares of Cash Reserves (exclusive of any advertising expenses incurred by the Distributor in connection with the sale of shares of each Fund). The Distribution Plan with respect to Class B shares of Cash Reserves provides that the Fund will pay the Distributor a distribution fee at annual rate not to exceed 0.75% of the average daily net assets represented by the Class B shares. The Distributor may use all or any portion of such fee to pay for Fund expenses of printing prospectuses and reports used for sales purposes, expenses of the preparation and printing of sales literature and other distribution-related expenses. The Distribution Plan with respect to the Class A shares of Cash Reserves and the shares of U.S. Treasury Reserves also permits each Fund to pay the Distributor an additional fee (not to exceed 0.10% per annum of the average daily net assets of U.S. Treasury Reserves and of the average daily net assets represented by the Class A shares of Cash Reserves) in anticipation of, or as reimbursement for, print or electronic media advertising expenses incurred in connection with the sale of Class A shares of Cash Reserves and shares of U.S. Treasury Reserves. The Distribution Plan for Class B shares of Cash Reserves also provides that Cash Reserves may pay the Distributor a monthly service fee at an annual rate not to exceed 0.25% of the average daily net assets represented by the Class B shares. However, Cash Reserves has not entered into any agreement to pay any such service fee to the Distributor. No payments under the Distribution Plans are made to Shareholder Servicing Agents although Shareholder Servicing Agents receive payments under the Administrative Services Plan referred to below. Each Distribution Plan continues in effect if such continuance is specifically approved at least annually by a vote of both a majority of the Trust's Trustees and a majority of the Trust's Trustees who are not "interested persons" of the Trust and who have no direct or indirect financial interest in the operation of the Distribution Plans or in any agreement related to the Plans ("Qualified Trustees"). Each Distribution Plan requires that the Trust and the Distributor shall provide to the Board of Trustees, and the Board of Trustees shall review, at least quarterly, a written report of the amounts expended (and the purposes therefor) under the Distribution Plan. Each Distribution Plan further provides that the selection and nomination of the Qualified Trustees is committed to the discretion of the disinterested Trustees (as defined in the 1940 Act) then in office. The Distribution Plans may be terminated with respect to any Fund at any time by a vote of a majority of the Trust's Qualified Trustees or by a vote of a majority of the outstanding voting securities of the Fund. The Distribution Plans may not be amended to increase materially the amount of a Fund's permitted expenses thereunder without the approval of a majority of the outstanding voting securities of that Fund and may not be materially amended in any case without a vote of the majority of both the Trustees and the Qualified Trustees. The Distributor will preserve copies of any plan, agreement or report made pursuant to each Distribution Plan for a period of not less than six years from the date of the Plan, and for the first two years the Distributor will preserve such copies in an easily accessible place. As contemplated by the Distribution Plans, LFBDS acts as the agent of the Funds in connection with the offering of shares of the Funds pursuant to Distribution Agreements (the "Distribution Agreements"). After the prospectus and periodic reports have been prepared, set in type and mailed to existing shareholders, the Distributor pays for the printing and distribution of copies of the prospectuses and periodic reports which are used in connection with the offering of shares of the each of the Funds to prospective investors. The Prospectus contains a description of fees payable to the Distributor under the Distribution Agreements. Cash Reserves: For the fiscal years ended August 31, 1993, 1994 and 1995, the fees paid from the Fund to the Distributor under the Distribution Agreement were $233,778, $229,241 and $313,267, respectively, of which no portion was applicable to print or electronic media advertising. U.S. Treasury Reserves: For the eight-month period ended August 31, 1993 and for the fiscal years ended August 31, 1994 and 1995, the fees paid from the Fund to the Distributor under the Distribution Agreement were $100,793, $115,550 and $112,284 (of which $3,435, $10,186 and $7,800 were voluntarily waived, respectively, and none of which was applicable to print or electronic media advertising). SHAREHOLDER SERVICING AGENTS, TRANSFER AGENT AND CUSTODIAN The Trust has adopted an Administrative Services Plan (the "Administrative Plan") which provides that the Trust may obtain the services of an administrator, a transfer agent, a custodian and one or more Shareholder Servicing Agents, and may enter into agreements providing for the payment of fees for such services. Under the Administrative Plan, the total of the fees paid to the Administrator and Shareholder Servicing Agents from each Fund and the distribution fee paid to the Distributor from each Fund (other than fees paid with respect to Class B shares and other than any fee concerning electronic or other media advertising) may not exceed 0.70% of that Fund's average daily net assets on an annualized basis for the Fund's then-current fiscal year. Within this overall limitation, individual fees may vary. The Administrative Plan continues in effect if such continuance is specifically approved at least annually by a vote of both a majority of the Trust's Trustees and a majority of the Trust's Trustees who are not "interested persons" of the Trust and who have no direct or indirect financial interest in the operation of the Administrative Plan or in any agreement related to such Plan ("Qualified Trustees"). The Administrative Plan requires that at least quarterly the Trust provide to the Trust's Board of Trustees and the Trust's Board of Trustees review a written report of the amounts expended (and the purposes therefor) under the Administrative Plan. The Administrative Plan may be terminated with respect to a Fund at any time by a vote of a majority of the Trust's Qualified Trustees or by a vote of a majority of the outstanding voting securities of the Fund. The Administrative Plan may not be amended to increase materially the amount of a Fund's permitted expenses thereunder without the approval of a majority of the outstanding voting securities of the Fund and may not be materially amended in any case without a vote of the majority of both the Trust's Trustees and the Trust's Qualified Trustees. The Trust has entered into a shareholder servicing agreement (a "Servicing Agreement") with each Shareholder Servicing Agent and a Transfer Agency and Service Agreement and a Custodian Agreement with State Street Bank and Trust Company ("State Street") pursuant to which State Street (or its affiliate State Street Canada, Inc.) acts as transfer agent and custodian for the Trust. For additional information, including a description of fees paid to the Shareholder Servicing Agents under the Servicing Agreements, see "Shareholder Servicing Agents" and "Transfer Agent, Custodian and Fund Accountant" in the Prospectus. For the fiscal years ended August 31, 1994 and 1995, aggregate fees payable from Cash Reserves to Shareholder Servicing Agents under the Servicing Agreement were $1,833,930 and $2,506,138, respectively (of which $687,723 and $939,802, respectively, were voluntarily waived). For the fiscal years ended August 31, 1994 and 1995, aggregate fees payable from U.S. Treasury Reserves to Shareholder Servicing Agents under the Servicing Agreement were $924,400 and $898,272, respectively (of which $346,650 and $336,852, respectively, were voluntarily waived). The Portfolios have also adopted Administrative Services Plans (the "Portfolio Administrative Plans") which provide that the Portfolios may obtain the services of an administrator, a transfer agent and a custodian, and may enter into agreements providing for the payment of fees for such services. Under the Portfolio Administrative Plans, the administrative services fee payable to either LFBDS or SFG, as the case may be, may not exceed 0.05% of a Portfolio's average daily net assets on an annualized basis for its then-current fiscal year. Each Portfolio Administrative Plan continues in effect if such continuance is specifically approved at least annually by a vote of both a majority of the applicable Portfolio's Trustees and a majority of the Portfolio's Trustees who are not "interested persons" of the Portfolio and who have no direct or indirect financial interest in the operation of the Portfolio Administrative Plan or in any agreement related to such Plan ("Qualified Trustees"). Each Portfolio Administrative Plan requires that the applicable Portfolio provide to its Board of Trustees and the Board of Trustees review, at least quarterly, a written report of the amounts expended (and the purposes therefor) under the Portfolio Administrative Plan. Each Portfolio Administrative Plan may be terminated at any time by a vote of a majority of the Portfolio's Qualified Trustees or by a vote of a majority of the outstanding voting securities of the applicable Portfolio. Neither Portfolio Administrative Plan may be amended to increase materially the amount of permitted expenses thereunder without the approval of a majority of the outstanding voting securities of the applicable Portfolio and may not be materially amended in any case without a vote of the majority of both the Portfolio's Trustees and the Portfolio's Qualified Trustees. Each Portfolio has entered into a Transfer Agency and Service Agreement and a Custodian Agreement with State Street pursuant to which State Street (or its affiliate State Street Canada, Inc.) acts as transfer agent and custodian and performs fund accounting services for the Portfolios. The Portfolios' purchases and sales of portfolio securities usually are principal transactions. Portfolio securities are normally purchased directly from the issuer or from an underwriter or market maker for the securities. There usually are no brokerage commissions paid for such purchases. The Portfolios do not anticipate paying brokerage commissions. Any transaction for which a Portfolio pays a brokerage commission will be effected at the best price and execution available. Purchases from underwriters of portfolio securities include a commission or concession paid by the issuer to the underwriter, and purchases from dealers serving as market makers include the spread between the bid and asked price. Allocation of transactions, including their frequency, to various dealers is determined by the Adviser in its best judgment and in a manner deemed to be in the best interest of investors in the applicable Portfolio rather than by any formula. The primary consideration is prompt execution of orders in an effective manner at the most favorable price. Investment decisions for each Portfolio will be made independently from those for any other account, series or investment company that is or may in the future become managed by the Adviser or its affiliates. If, however, a Portfolio and other investment companies, series or accounts managed by the Adviser are contemporaneously engaged in the purchase or sale of the same security, the transactions may be averaged as to price and allocated equitably to each account. In some cases, this policy might adversely affect the price paid or received by the Portfolio or the size of the position obtainable for the Portfolio. In addition, when purchases or sales of the same security for a Portfolio and for other investment companies or series managed by the Adviser occur contemporaneously, the purchase or sale orders may be aggregated in order to obtain any price advantages available to large denomination purchases or sales. No portfolio transactions are executed with the Adviser, or with any affiliate of the Adviser, acting either as principal or as broker. 7. DESCRIPTION OF SHARES, VOTING RIGHTS AND LIABILITIES The Trust's Declaration of Trust permits the Trust's Board of Trustees to issue an unlimited number of full and fractional Shares of Beneficial Interest (without par value) of each series and to divide or combine the shares of any series into a greater or lesser number of shares of that series without thereby changing the proportionate beneficial interests in that series. Currently, the Funds are the only two series of shares of the Trust, one of which, Cash Reserves, is divided into two classes. Each share of each class of Cash Reserves represents an equal proportionate interest in the Fund with each other share of that class. Each share of U.S. Treasury Reserves represents an equal proportionate interest in the Fund with each other share of U.S. Treasury Reserves. Upon liquidation or dissolution of a Fund, the Fund's shareholders are entitled to share pro rata in the Fund's net assets available for distribution to its shareholders. The Trust reserves the right to create and issue additional series and classes of shares. Shares of each series participate equally in the earnings, dividends and distribution of net assets of the particular series upon the liquidation or dissolution (except for any differences among classes of shares in a series). Shares of each series are entitled to vote separately to approve advisory agreements or changes in investment policy, but shares of all series may vote together in the election or selection of Trustees and accountants for the Trust. In matters affecting only a particular Fund or class, only shares of that particular Fund or class are entitled to vote. Shareholders are entitled to one vote for each share held on matters on which they are entitled to vote. Shareholders in the Trust do not have cumulative voting rights, and shareholders owning more than 50% of the outstanding shares of the Trust may elect all of the Trustees of the Trust if they choose to do so and in such event the other shareholders in the Trust would not be able to elect any Trustee. The Trust is not required and has no current intention to hold annual meetings of shareholders but the Trust will hold special meetings of a Fund's shareholders when in the judgment of the Trust's Trustees it is necessary or desirable to submit matters for a shareholder vote. Shareholders have under certain circumstances (e.g., upon application and submission of certain specified documents to the Trustees by a specified number of shareholders) the right to communicate with other shareholders in connection with requesting a meeting of shareholders for the purpose of removing one or more Trustees. Shareholders also have the right to remove one or more Trustees without a meeting by a declaration in writing by a specified number of shareholders. No material amendment may be made to the Trust's Declaration of Trust without the affirmative vote of the holders of a majority of its outstanding shares. The Trust's Declaration of Trust provides that, at any meeting of shareholders of the Trust or of any series of the Trust, a Shareholder Servicing Agent may vote any shares of which it is the holder of record and for which it does not receive voting instructions proportionately in accordance with the instructions it receives for all other shares of which it is the holder of record. Shares have no preference, pre-emptive, conversion or similar rights. Shares, when issued, are fully paid and non-assessable, except as set forth below. The Trust may enter into a merger or consolidation, or sell all or substantially all of its assets (or all or substantially all of the assets belonging to any series of the Trust), if approved by the vote of the holders of two-thirds of the Trust's outstanding shares voting as a single class, or of the affected series of the Trust, as the case may be, except that if the Trustees of the Trust recommend such sale of assets, merger or consolidation, the approval by vote of the holders of a majority of the Trust's or the affected series' outstanding shares would be sufficient. The Trust or any series of the Trust, as the case may be, may be terminated (i) by a vote of a majority of the outstanding voting securities of the Trust or the affected series or (ii) by the Trustees by written notice to the shareholders of the Trust or the affected series. If not so terminated, the Trust will continue indefinitely. Share certificates will not be issued. The Trust is an entity of the type commonly known as a "Massachusetts business trust". Under Massachusetts law, shareholders of such a business trust may, under certain circumstances, be held personally liable as partners for its obligations and liabilities. However, the Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations of the Trust and provides for indemnification and reimbursement of expenses out of Trust property for any shareholder held personally liable for the obligations of the Trust. The Declaration of Trust also provides that the Trust shall maintain appropriate insurance (e.g., fidelity bonding and errors and omissions insurance) for the protection of the Trust, its shareholders, Trustees, officers, employees and agents covering possible tort and other liabilities. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which both inadequate insurance existed and the Trust itself was unable to meet its obligations. The Trust's Declaration of Trust further provides that obligations of the Trust are not binding upon the Trustees individually but only upon the property of the Trust and that the Trustees will not be liable for any action or failure to act, but nothing in the Declaration of Trust protects a Trustee against any liability to which he or she would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his or her office. Each Portfolio is organized as a trust under the laws of the State of New York. Each Portfolio's Declaration of Trust provides that investors in the Portfolio (e.g., other investment companies (including the corresponding Fund), insurance company separate accounts and common and commingled trust funds) are each liable for all obligations of the Portfolio. However, the risk of a Fund incurring financial loss on account of such liability is limited to circumstances in which both inadequate insurance existed and the applicable Portfolio itself was unable to meet its obligations. It is not expected that the liabilities of either Portfolio would ever exceed its assets. Each investor in a Portfolio, including the corresponding Fund, may add to or reduce its investment in the Portfolio on each business day. At 3:00 p.m., Eastern time, for Cash Reserves Portfolio, and 12:00 noon, Eastern time, for U.S. Treasury Reserves Portfolio, on each such business day, the value of each investor's interest in the Portfolio is determined by multiplying the net asset value of the Portfolio by the percentage representing that investor's share of the aggregate beneficial interests in the Portfolio effective for that day. Any additions or withdrawals, which are to be effected on that day, are then effected. The investor's percentage of the aggregate beneficial interests in the Portfolio is then re-computed as the percentage equal to the fraction (i) the numerator of which is the value of such investor's investment in the Portfolio as of 3:00 p.m. Eastern time, for Cash Reserves Portfolio, and 12:00 noon, Eastern time, for U. S. Treasury Reserves Portfolio, on such day plus or minus, as the case may be, the amount of any additions to or withdrawals from the investor's investment in the Portfolio effected on such day, and (ii) the denominator of which is the aggregate net asset value of the Portfolio as of 3:00 p.m., Eastern time, for Cash Reserves Portfolio, and 12:00 noon, Eastern time, for U.S. Treasury Reserves Portfolio, on such day plus or minus, as the case may be, the amount of the net additions to or withdrawals from the aggregate investments in the Portfolio by all investors in the Portfolio. The percentage so determined is then applied to determine the value of the investor's interest in the Portfolio as of 3:00 p.m., Eastern time, for Cash Reserves Portfolio, and 12:00 noon, Eastern time, for U.S. Treasury Reserves Portfolio, on the following business day of the Portfolio. 8. CERTAIN ADDITIONAL TAX MATTERS Each of the Funds has elected to be treated and intends to qualify each year as a "regulated investment company" under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), by meeting all applicable requirements of Subchapter M, including requirements as to the nature of the Fund's gross income, the amount of Fund distributions and the composition and holding period of the Fund's portfolio assets. Provided all such requirements are met and all of a Fund's net investment income and realized capital gains are distributed to shareholders in accordance with the timing requirements imposed by the Code, no federal income or excise taxes will be required to be paid by the Fund. If a Fund should fail to qualify as a regulated investment company for any year, the Fund would incur a regular corporate federal income tax upon its taxable income and Fund distributions would generally be taxable as ordinary dividend income to shareholders. Each of the Portfolios believes that it will not be required to pay any federal income or excise taxes. Investment income received by Cash Reserves from non-U.S. investments may be subject to foreign income taxes withheld at the source; Cash Reserves does not expect to be able to pass through to shareholders any foreign tax credits with respect to those foreign taxes. The United States has entered into tax treaties with many foreign countries that may entitle Cash Reserves to a reduced rate of tax or an exemption from tax on these investments. It is not possible to determine Cash Reserves' effective rate of foreign tax in advance since that rate depends upon the proportion of the Cash Reserves Portfolio's assets ultimately invested within various countries. Because each Fund expects to earn primarily interest income, it is expected that no Fund distributions will qualify for the dividends-received deduction for corporations. 9. INDEPENDENT ACCOUNTANTS AND FINANCIAL STATEMENTS Price Waterhouse LLP and Price Waterhouse are the independent and chartered accountants for Cash Reserves and Cash Reserves Portfolio, respectively, providing audit services and assistance and consultation with respect to the preparation of filings with the SEC. Deloitte & Touche LLP were the independent certified public accountants for Cash Reserves and Cash Reserves Portfolio through December 31, 1993. The selection of Price Waterhouse LLP and Price Waterhouse was based on management's decision with respect to certain areas of expertise and service capabilities. There was no disagreement between the Fund, the Portfolio and Deloitte & Touche LLP with respect to the accounting and audit services provided by such firm. Deloitte & Touche LLP are the independent certified public accountants for U.S. Treasury Reserves and U.S. Treasury Reserves Portfolio, providing audit services and assistance and consultation with respect to the preparation of filings with the SEC. The audited financial statements of Cash Reserves (Statement of Assets and Liabilities at August 31, 1995, Statement of Operations for the year ended August 31, 1995, Statement of Changes in Net Assets for the years ended August 31, 1995 and August 31, 1994, Financial Highlights for each of the years in the five-year period ended August 31, 1995, Notes to Financial Statements and Independent Auditors' Report) and of Cash Reserves Portfolio (Portfolio of Investments at August 31, 1995, Statement of Assets and Liabilities at August 31, 1995, Statement of Operations for the year ended August 31, 1995, Statement of Changes in Net Assets for the years ended August 31, 1995 and August 31, 1994, Financial Highlights for each of the years in the five-year period ended August 31, 1995, Notes to Financial Statements and Independent Auditors' Report), each of which is included in the Annual Report to Shareholders of Cash Reserves, are incorporated by reference into this Statement of Additional Information and have been so incorporated in reliance upon the reports of Price Waterhouse LLP and Price Waterhouse (for the fiscal years ended August 31, 1995 and 1994) and Deloitte & Touche LLP (for periods prior to the fiscal year ended August 31, 1994). The audited financial statements of U.S. Treasury Reserves (Statement of Assets and Liabilities at August 31, 1995, Statement of Operations for the year ended August 31, 1995, Statement of Changes in Net Assets for the years ended August 31, 1995 and 1994, Financial Highlights for each of the years in the two-year period ended August 31, 1995, the eight months ended August 31, 1993, the year ended December 31, 1992 and the period from May 3, 1991 (commencement of operations) to December 31, 1991, and the Notes to Financial Statements and Independent Auditors' Report) and of U.S. Treasury Reserves Portfolio (Portfolio of Investments at August 31, 1995, Statement of Assets and Liabilities at August 31, 1995, Statement of Operations for the year ended August 31, 1995, Statement of Changes in Net Assets for the years ended August 31, 1995 and 1994, and the Financial Highlights for the years ended August 31, 1995 and 1994, the eight months ended August 31, 1993, the year ended December 31, 1992 and the period from March 1, 1991 (commencement of operations) to December 31, 1991, the Notes to Financial Statements and Independent Auditors' Report), each of which is included in the Annual Report to Shareholders of U.S. Treasury Reserves, are incorporated by reference into this Statement of Additional Information and have been so incorporated in reliance upon the report of Deloitte & Touche LLP, independent certified public accountants, as experts in accounting and auditing. A copy of each of the Annual Reports accompanies this Statement of Additional Information. FOR CITIBANK NEW YORK RETAIL BANKING AND BUSINESS AND PROFESSIONAL CUSTOMERS: Citibank, N.A. 450 West 33rd Street, New York, NY 10001 (212) 564-3456 or (800) 846-5300 P.O. Box 5130, New York, NY 10126-5130 Call Your Citigold Executive or in NY or CT (800) 285-1701, or for all other states, (800) 285-1707 153 East 53rd Street, New York, NY 10043 Call Your Citibank Private Banking Account Officer, Registered Representative or (212) 559-5959 FOR CITIBANK GLOBAL ASSET MANAGEMENT CLIENTS: Citibank, N.A. 153 East 53rd Street, New York, NY l0043 FOR NORTH AMERICAN INVESTOR SERVICES CLIENTS: Citibank, N.A. 111 Wall Street, New York, NY 10043 Call Your Account Manager or (212) 657-9100 FOR CITICORP INVESTMENT SERVICES CUSTOMERS: One Court Square, Long Island City, NY 11120 Call Your Investment Consultant or (800) 846-5200 (212) 736-8170 in New York City C. Oscar Morong, Jr., Chairman *Affiliated Person of Administrator and Distributor 153 East 53rd Street, New York, NY 10043 The Landmark Funds Broker-Dealer Services, Inc. 6 St. James Avenue, Boston, MA 02116 State Street Bank and Trust Company 225 Franklin Street, Boston, MA 02110 160 Federal Street, Boston, MA 02110 125 Summer Street, Boston, MA 02110 150 Federal Street, Boston, MA 02110	497	497	1996-01-12T00:00:00	1996-01-12T10:01:44
0000891020-96-000021	0000891020-96-000021_0002.txt	<DESCRIPTION>STOCK OPTION AGREEMENT DATED 1/10/96 STOCK OPTION AGREEMENT, dated as of January 10, 1996 (the "Agreement"), by and between Central Bancorporation, a Washington corporation ("Issuer"), and InterWest Bancorp, Inc., a Washington corporation ("Grantee"). WHEREAS, Grantee and Issuer have entered into an Agreement and Plan of Mergers dated as of January 10, 1996 (the "Plan"), providing for, among other things, the merger of Issuer with and into Grantee, with Grantee as the WHEREAS, as a condition and inducement to Grantee's execution of the Plan, Grantee has required that Issuer agree, and Issuer has agreed, to grant Grantee the Option (as defined below); NOW, THEREFORE, in consideration of the foregoing and the respective representations, warranties, covenants and agreements set forth herein and in the Plan, and intending to be legally bound hereby, Issuer and Grantee agree as follows: 1. DEFINED TERMS. Capitalized terms which are used but not defined herein shall have the meanings ascribed to such terms in the Plan. 2. GRANT OF OPTION. Subject to the terms and conditions set forth herein, Issuer hereby grants to Grantee an irrevocable option (the "Option") to purchase up to 201,898 shares (as adjusted as set forth herein, the "Option Shares", which shall include the Option Shares before and after any transfer of such Option Shares) of common stock, par value $1.67 per share ("Issuer Common Stock"), of Issuer at a purchase price per Option Share (the "Purchase Price") equal to $26.00. (a) Provided that (i) Grantee or Holder (as defined below), as applicable, shall not be in material breach of the agreements or covenants contained in this Agreement or the Plan, and (ii) no preliminary or permanent injunction or other order against the delivery of shares covered by the Option issued by any court of competent jurisdiction in the United States shall be in effect, the Holder may exercise the Option, in whole or in part, at any time and from time to time following the occurrence of a Purchase Event (as hereinafter defined); PROVIDED that the Option shall terminate and be of no further force and effect upon the earliest to occur of (A) the Effective Date, (B) termination of the Plan by Issuer in accordance with the terms thereof prior to the occurrence of a Purchase Event or a Preliminary Purchase Event (as hereinafter defined) (an "Issuer Termination"), (C) 15 months after the termination of the Plan by Issuer in accordance with the terms thereof other than pursuant to an Issuer Termination, and (D) 15 months after the termination of the Plan by Grantee in accordance with the terms thereof; PROVIDED, HOWEVER, that any purchase of shares upon exercise of the Option shall be subject to compliance with applicable law, including, without limitation, the Bank Holding Company Act of 1956, as amended (the "BHC Act"). The term "Holder" shall mean the holder or holders of the Option from time to time, and which initially is Grantee. (b) As used herein, a "Purchase Event" means any of the following events: (i) Without Grantee's prior written consent, Issuer shall have authorized, recommended, publicly proposed or publicly announced an intention to authorize, recommend or propose, or entered into an agreement with any person (other than Grantee or any subsidiary of Grantee) to effect an Acquisition Transaction. As used herein, the term "Acquisition Transaction" shall mean (A) a merger, consolidation or similar transaction involving Issuer or any of its significant subsidiaries, (B) the disposition, by sale, lease, exchange or otherwise, of assets or deposits of Issuer or any of its significant either case 20% or more of the consolidated assets or deposits of Issuer and its subsidiaries, or (C) the issuance, sale or other disposition of (including by way of merger, consolidation, share exchange or any similar transaction) securities representing 20% or more of the voting power of Issuer or any of its significant subsidiaries other than the issuance of Issuer Common Stock upon the exercise of outstanding options or the conversion of outstanding convertible securities of Issuer; or (ii) any person (other than Grantee or any subsidiary of Grantee) shall have acquired beneficial ownership (as such term is defined in Rule 13d-3 promulgated under the Exchange Act) of or the right to acquire beneficial ownership of, or any "group" (as such term is defined under the Exchange Act) shall have been formed which beneficially owns or has the right to acquire beneficial ownership of, 15% or more (or if such person or group is the beneficial owner of 15% or more on the date hereof, such person or group acquires an additional 5% or more) of the voting power of Issuer or any of its significant subsidiaries. (c) As used herein, a "Preliminary Purchase Event" means any of the following events: (i) any person (other than Grantee or any subsidiary of Grantee) shall have commenced (as such term is defined in Rule 14d-2 under the Exchange Act) or shall have filed a registration statement under the Securities Act with respect to, a tender offer or exchange offer to purchase any shares of Issuer Common Stock such that, upon consummation of such offer, such person would own or control 20% or more of the then outstanding shares of Issuer Common Stock (such an offer being referred to herein as a "Tender Offer" or an "Exchange (ii) the holders of Issuer Common Stock shall not have approved the Plan at the Meeting, the Meeting shall not have been held or shall have been canceled prior to termination of the Plan, or Issuer's Board of Directors shall have withdrawn or modified in a manner adverse to Grantee the recommendation of Issuer's Board of Directors with respect to the Plan, in each case after it shall have been publicly announced that any person (other than Grantee or any subsidiary of Grantee) shall have (A) made a proposal to engage in an Acquisition Transaction, or (B) commenced a Tender Offer or filed a registration statement under the Securities Act with respect to an (iii) any person, other than Grantee or any subsidiary of Grantee, shall have made a bona fide proposal to Issuer or its stockholders by public announcement, or written communication that is or becomes the subject of public disclosure, to engage in an (iv) after a bona fide proposal is made by a third party to Issuer or its stockholders to engage in an Acquisition Transaction, Issuer shall have breached any covenant or obligation contained in the Plan and such breach would entitle Grantee to terminate the Plan under Section 7.1(b) thereof (without regard to the cure period provided for therein unless such cure is promptly effected without jeopardizing consummation of the Mergers pursuant to the terms of the Plan); or (v) any person, other than Grantee or any subsidiary of Grantee, other than in connection with a transaction to which Grantee has given its prior written consent, shall have filed an application or notice with the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"), or other federal or state bank regulatory authority, for approval to engage in an Acquisition Transaction. As used in this Agreement, "person" shall have the meaning specified in Sections 3(a)(9) and 13(d)(3) of the Exchange Act. (d) Issuer shall notify Grantee promptly in writing of the occurrence of any Preliminary Purchase Event or Purchase Event (in either case, a "Triggering Event"), it being understood that the giving of such notice by Issuer shall not be a condition to the right of Holder to exercise the Option. (e) In the event Holder wishes to exercise the Option, it shall send to Issuer a written notice (the date of which being herein referred to as the "Notice Date") specifying (i) the total number of Option Shares it intends to purchase pursuant to such exercise, and (ii) a place and date not earlier than three business days nor later than 15 business days from the Notice Date for the closing (the "Closing") of such purchase (the "Closing Date"); PROVIDED, HOWEVER, if any required application for listing such shares on the NASDAQ National Market System has not been approved by the date so specified, such date shall be extended for a period not to exceed 21 days from the Notice Date. If prior notification to or approval of the Federal Reserve Board or any other regulatory authority is required in connection with such purchase, Issuer shall cooperate with the Holder in the filing of the required notice of application for approval and the obtaining of such approval and the Closing shall occur immediately following such regulatory approvals (and any mandatory waiting periods). Any exercise of the Option shall be deemed to occur on the Notice Date relating thereto. 4. PAYMENT AND DELIVERY OF CERTIFICATES. (a) On each Closing Date, Holder shall (i) pay to Issuer, in immediately available funds by wire transfer to a bank account designated by Issuer, an amount equal to the Purchase Price multiplied by the number of Option Shares to be purchased on such Closing Date, and (ii) present and surrender this Agreement to the Issuer at the address of the Issuer specified in subsection (f) of Section 11 hereof. (b) At each Closing, simultaneously with the delivery of immediately available funds and surrender of this Agreement as provided in subsection (a) of this Section 4, (i) Issuer shall deliver to Holder (A) a certificate or certificates representing the Option Shares to be purchased at such Closing, which Option Shares shall be free and clear of all liens, claims, charges and encumbrances of any kind whatsoever and subject to no preemptive rights, and (B) if the Option is exercised in part only, an executed new agreement with the same terms as this Agreement evidencing the right to purchase the balance of the shares of Issuer Common Stock purchasable hereunder, and (ii) Holder shall deliver to Issuer a letter agreeing that Holder shall not offer to sell or otherwise dispose of such Option Shares in violation of applicable federal and state law or of the provisions of this Agreement. (c) In addition to any other legend that is required by applicable law, certificates for the Option Shares delivered at each Closing shall be endorsed with a restrictive legend which shall read substantially as follows: THE TRANSFER OF THE STOCK REPRESENTED BY THIS CERTIFICATE IS SUBJECT TO RESTRICTIONS ARISING UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND PURSUANT TO THE TERMS OF A STOCK OPTION AGREEMENT DATED AS OF ___________ __, 1996. A COPY OF SUCH AGREEMENT WILL BE PROVIDED TO THE HOLDER HEREOF WITHOUT CHARGE UPON RECEIPT BY THE ISSUER OF A WRITTEN REQUEST THEREFOR. It is understood and agreed that the above legend shall be removed by delivery of substitute certificate(s) without such legend if Holder shall have delivered to Issuer a copy of a letter from the staff of the SEC, or an opinion of counsel in form and substance reasonably satisfactory to Issuer and its counsel, to the effect that such legend is not required for purposes of the Securities Act. (d) Upon the giving by Holder to Issuer of the written notice of exercise of the Option provided for under subsection (e) of Section 3 hereof, the tender of the applicable purchase price in immediately available funds and the tender of this Agreement to Issuer, Holder shall be deemed to be the holder of record of the shares of Issuer Common Stock issuable upon such exercise, notwithstanding that the stock transfer books of Issuer shall then be closed or that certificates representing such shares of Issuer Common Stock shall not then be actually delivered to Holder. Issuer shall pay all expenses, and any and all United States federal, state, and local taxes and other charges that may be payable in connection with the preparation, issuance and delivery of stock certificates under this Section in the name of Holder or its assignee, transferee, or designee. (e) Issuer agrees (i) that it shall at all times maintain, free from preemptive rights, sufficient authorized but unissued or treasury shares of Issuer Common Stock so that the Option may be exercised without additional authorization of Issuer Common Stock after giving effect to all other options, warrants, convertible securities and other rights to purchase Issuer Common Stock, (ii) that it will not, by charter amendment or through reorganization, consolidation, merger, dissolution or sale of assets, or by any other voluntary act, avoid or seek to avoid the observance or performance of any of the covenants, stipulations or conditions to be observed or performed hereunder by Issuer, (iii) promptly to take all action as may from time to time be required (including (A) complying with all premerger notification, reporting and waiting period requirements specified in 15 U.S.C. Section 18a and regulations promulgated thereunder and (B) in the event, under the BHC Act, or the Change in Bank Control Act of 1978, as amended, or a state banking law, prior approval of or notice to the Federal Reserve Board or to any state regulatory authority is necessary before the Option may be exercised, cooperating fully with Holder in preparing such applications or notices and providing such information to the Federal Reserve Board or such state regulatory authority as they may require) in order to permit Holder to exercise the Option and Issuer duly and effectively to issue shares of the Issuer Common Stock pursuant hereto, and (iv) promptly to take all action provided herein to protect the rights of Holder against dilution. 5. REPRESENTATIONS AND WARRANTIES OF ISSUER. Issuer hereby represents and warrants to Grantee (and Holder, if different than Grantee) as follows: (a) Due Authorization. Issuer has all requisite corporate power and authority to enter into this Agreement and, subject to any approvals or consents referred to herein, to consummate the transactions contemplated hereby. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by all necessary corporate action on the part of Issuer. This Agreement has been duly executed and delivered by Issuer. (b) Authorized Stock. Issuer has taken all necessary corporate and other action to authorize and reserve and to permit it to issue, and, at all times from the date hereof until the obligation to deliver Issuer Common Stock upon the exercise of the Option terminates, will have reserved for issuance, upon exercise of the Option, the number of shares of Issuer Common Stock necessary for Holder to exercise the Option, and Issuer will take all necessary corporate action to authorize and reserve for issuance all additional shares of Issuer Common Stock or other securities which may be issued pursuant to Section 7 upon exercise of the Option. The shares of Issuer Common Stock to be issued upon due exercise of the Option, including all additional shares of Issuer Common Stock or other securities which may be issuable pursuant to Section 7, upon issuance pursuant hereto, shall be duly and validly issued, fully paid and nonassessable, and shall be delivered free and clear of all liens, claims, charges and encumbrances of any kind or nature whatsoever, including any preemptive rights of any stockholder of Issuer. 6. REPRESENTATIONS AND WARRANTIES OF GRANTEE. Grantee hereby represents and warrants to Issuer that: (a) Due Authorization. Grantee has all requisite corporate power and authority to enter into this Agreement and, subject to any approvals or consents referred to herein, to consummate the transactions contemplated hereby. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by all necessary corporate action on the part of Grantee. This Agreement has been duly executed and delivered by Grantee. (b) Purchase not for Distribution. This Option is not being, and any Option Shares or other securities acquired by Grantee upon exercise of the Option will not be, acquired with a view to the public distribution thereof and will not be transferred or otherwise disposed of except in a transaction registered or exempt from registration under the Securities Act. 7. ADJUSTMENT UPON CHANGES IN ISSUER CAPITALIZATION, ETC. (a) In the event of any change in Issuer Common Stock by reason of a stock dividend, stock split, split-up, recapitalization, combination, exchange of shares or similar transaction, the type and number of shares or securities subject to the Option, and the Purchase Price therefor, shall be adjusted appropriately, and proper provision shall be made in the agreements governing such transaction so that Holder shall receive, upon exercise of the Option, the number and class of shares or other securities or property that Holder would have received in respect of Issuer Common Stock if the Option had been exercised immediately prior to such event, or the record date therefor, as applicable. If any additional shares of Issuer Common Stock are issued after the date of this Agreement (other than pursuant to an event described in the first sentence of this subsection (a), upon exercise of any option to purchase Issuer Common Stock outstanding on the date hereof or upon conversion into Issuer Common Stock of any convertible security of Issuer outstanding on the date hereof), the number of shares of Issuer Common Stock subject to the Option shall be adjusted so that, after such issuance, it, together with any shares of Issuer Common Stock previously issued pursuant hereto, equals 19.9% of the number of shares of Issuer Common Stock then issued and outstanding, without giving effect to any shares subject to or issued pursuant to the Option. No provision of this Section 7 shall be deemed to affect or change, or constitute authorization for any violation of, any of the covenants or representations in the Plan. (b) In the event that Issuer shall enter in an agreement (i) to consolidate with or merge into any person, other than Grantee or one of its subsidiaries, and shall not be the continuing or surviving corporation of such consolidation or merger, (ii) to permit any person, other than Grantee or one of its subsidiaries, to merge into Issuer and Issuer shall be the continuing or surviving corporation, but, in connection with such merger, the then outstanding shares of Issuer Common Stock shall be changed into or exchanged for stock or other securities of Issuer or any other person or cash or any other property or the outstanding shares of Issuer Common Stock immediately prior to such merger shall after such merger represent less than 50% of the outstanding shares and share equivalents of the merged company, or (iii) to sell or otherwise transfer all or substantially all of its assets to any person, other than Grantee or one of its subsidiaries, then, and in each such case, the agreement governing such transaction shall make proper provisions so that the Option shall, upon the consummation of any such transaction and upon the terms and conditions set forth herein, be converted into, or exchanged for, an option (the "Substitute Option"), at the election of Holder, of either (x) the Acquiring Corporation (as hereinafter defined), (y) any person that controls the Acquiring Corporation, or (z) in the case of a merger described in clause (ii), Issuer (such person being referred to as "Substitute Option Issuer"). (c) The Substitute Option shall have the same terms as the Option, provided, that, if the terms of the Substitute Option cannot, for legal reasons, be the same as the Option, such terms shall be as similar as possible and in no event less advantageous to Holder. Substitute Option Issuer shall also enter into an agreement with Holder in substantially the same form as this Agreement, which shall be applicable to the Substitute Option. (d) The Substitute Option shall be exercisable for such number of shares of Substitute Common Stock (as hereinafter defined) as is equal to the Assigned Value (as hereinafter defined) multiplied by the number of shares of Issuer Common Stock for which the Option was theretofore exercisable, divided by the Average Price (as hereinafter defined). The exercise price of Substitute Option per share of Substitute Common Stock (the "Substitute Option Price") shall then be equal to the Option Price multiplied by a fraction in which the numerator is the number of shares of Issuer Common Stock for which the Option was theretofore exercisable and the denominator is the number of shares of the Substitute Common Stock for which the Substitute Option is exercisable. (e) The following terms have the meanings indicated: (1) "Acquiring Corporation" shall mean (i) the continuing or surviving corporation of a consolidation or merger with Issuer (if other than Issuer), (ii) Issuer in a merger in which Issuer is the continuing or surviving person, or (iii) the transferee of all or substantially all of Issuer's assets (or a substantial part of the assets of its subsidiaries taken as a whole). (2) "Substitute Common Stock" shall mean the common stock issued by Substitute Option Issuer upon exercise of the Substitute Option. (3) "Assigned Value" shall mean the highest of (x) the price per share of Issuer Common Stock at which a Tender Offer or an Exchange Offer therefor has been made, (y) the price per share of Issuer Common Stock to be paid by any third party pursuant to an agreement with Issuer, and (z) the highest per share closing price for shares of Issuer Common Stock within the six-month period immediately preceding the consolidation, merger, or sale in question. In the event that a Tender Offer or an Exchange Offer is made for Issuer Common Stock or an agreement is entered into for a merger or consolidation involving consideration other than cash, the value of the securities or other property issuable or deliverable in exchange for Issuer Common Stock shall be determined by a nationally recognized investment banking firm selected by Holder or Owner, as the case may be (and if there are both a Holder and an Owner, the Holder). (4) "Average Price" shall mean the average closing price per share of Substitute Common Stock for the one year immediately preceding the consolidation, merger, or sale in question, but in no event higher than the closing price of the shares of Substitute Common Stock on the day preceding such consolidation, merger or sale; provided that if Issuer is the issuer of the Substitute Option, the Average Price shall be computed with respect to a share of common stock issued by Issuer, the person merging into Issuer or by any company which controls such person, as Holder may elect. (f) In no event, pursuant to any of the foregoing paragraphs, shall the Substitute Option be exercisable for more than 19.9% of the aggregate of the shares of Substitute Common Stock outstanding prior to exercise of the Substitute Option. In the event that the Substitute Option would be exercisable for more than 19.9% of the aggregate of the shares of Substitute Common Stock but for the limitation in the first sentence of this subsection (f), Substitute Option Issuer shall make a cash payment to Holder equal to the excess of (i) the value of the Substitute Option without giving effect to the limitation in the first sentence of this subsection (f) over (ii) the value of the Substitute Option after giving effect to the limitation in the first sentence of this subsection (f). This difference in value shall be determined by a nationally-recognized investment banking firm selected by Holder. (g) Issuer shall not enter into any transaction described in subsection (b) of this Section 7 unless the Acquiring Corporation and any person that controls the Acquiring Corporation assume in writing all the obligations of Issuer hereunder and take all other actions that may be necessary so that the provisions of this Section 7 are given full force and effect (including, without limitation, any action that may be necessary so that the holders of the other shares of common stock issued by Substitute Option Issuer are not entitled to exercise any rights by reason of the issuance or exercise of the Substitute Option and the shares of Substitute Common Stock are otherwise in no way distinguishable from or have lesser economic value (other than any dimunition in value resulting from the fact that the Substitute Common Stock are restricted securities, as defined in Rule 144 under the Securities Act) than other shares of common stock issued by Substitute Option Issuer). (a) Demand Registration Rights. Issuer shall, subject to the conditions of subparagraph (c) below, if requested by any Holder or Owner, as applicable, including Grantee and any permitted transferee ("Selling Shareholder"), as expeditiously as possible prepare and file a registration statement under the Securities Act if such registration is necessary in order to permit the sale or other disposition of any or all shares of Issuer Common Stock or other securities that have been acquired by or are issuable to the Selling Shareholder upon exercise of the Option in accordance with the intended method of sale or other disposition stated by the Selling Shareholder in such request, including without limitation a "shelf" registration statement under Rule 415 under the Securities Act or any successor provision, and Issuer shall use its best efforts to qualify such shares or other securities for sale under any applicable state securities laws. Grantee shall have the right to demand no more than two registrations pursuant to this paragraph. If requested by Grantee in connection with any such registration, Issuer and Grantee shall provide each other with representatives, warranties, indemnities and other agreements customarily given in connection with such registration. If requested by Grantee in connection with any such registration, Issuer and Grantee shall become party to any underwriting agreement relating to the sale of the Option Shares, but only to the extent of obligating themselves in respect of representations, warranties, indemnities and other agreement customarily included in such underwriting agreements. (b) Additional Registration Rights. If Issuer at any time after the exercise of the Option proposes to register any shares of Issuer Common Stock under the Securities Act in connection with an underwritten public offering of such Issuer Common Stock, Issuer will promptly give written notice to the Selling Shareholders of its intention to do so and, upon the written request of any Selling Shareholder given within 30 days after receipt of any such notice (which request shall specify the number of shares of Issuer Common Stock intended to be included in such underwritten public offering by the Selling Shareholder), Issuer will cause all such shares for which a Selling Shareholder requests participation in such registration, to be so registered and included in such underwritten public offering; PROVIDED, HOWEVER, that Issuer may elect to not cause any such shares to be so registered (i) if the underwriters in good faith object for valid business reasons, or (ii) in the case of a registration solely to implement an employee benefit plan or a registration filed on Form S-4; PROVIDED, FURTHER, HOWEVER, that such election pursuant to (i) may only be made two times. If some but not all the shares of Issuer Common Stock, with respect to which Issuer shall have received requests for registration pursuant to this subsection (b) shall be excluded from such registration, Issuer shall make appropriate allocation of shares to be registered among the Selling Shareholders desiring to register their shares pro rata in the proportion that the number of shares requested to be registered by each such Selling Shareholder bears to the total number of shares requested to be registered by all such Selling Shareholders then desiring to have Issuer Common Stock registered for sale. (c) Conditions to Required Registration. Issuer shall use all reasonable efforts to cause each registration statement referred to in subparagraph (a) above to become effective and to obtain all consents or waivers of other parties which are required therefor and to keep such registration statement effective, PROVIDED, HOWEVER, that Issuer may delay any registration of Option Shares required pursuant to subparagraph (a) above for a period not exceeding 180 days provided Issuer shall in good faith determine that any such registration would adversely affect an offering or contemplated offering of other securities by Issuer, and Issuer shall not be required to register Option Shares under the Securities Act pursuant to subsection (a) above: (i) prior to the earliest of (a) termination of the Plan pursuant to Article VII thereof, (b) failure to obtain the requisite stockholder approval pursuant to Section 6.1.(A) of the Plan, and (c) a Purchase Event or a (ii) on more than one occasion during any calendar year; (iii) within 90 days after the effective date of a registration referred to in subsection (b) above pursuant to which the Selling Shareholder or Selling Shareholders concerned were afforded the opportunity to register such shares under the Securities Act and such shares were registered as (iv) unless a request therefor is made to Issuer by Selling Shareholders that hold at least 25% or more of the aggregate number of Option Shares (including shares of Issuer Common Stock issuable upon exercise of the Option) then outstanding. In addition to the foregoing, Issuer shall not be required to maintain the effectiveness of any registration statement after the expiration of nine months from the effective date of such registration statement. Issuer shall use all reasonable efforts to make any filings, and take all steps, under all applicable state securities laws to the extent necessary to permit the sale or other disposition of the Option Shares so registered in accordance with the intended method of distribution for such shares, PROVIDED, HOWEVER, that Issuer shall not be required to consent to general jurisdiction or qualify to do business in any state where it is not otherwise required to so consent to such jurisdiction or to so qualify to do business. (d) Expenses. Except where applicable state law prohibits such payments, Issuer will pay all expenses (including without limitation registration fees, qualification fees, blue sky fees and expenses (including the fees and expenses of counsel), legal expenses, including the reasonable fees and expenses of one counsel to the holders whose Option Shares are being registered, printing expenses and the costs of special audits or "cold comfort" letters, expenses of underwriters, excluding discounts and commissions but including liability insurance if Issuer so desires or the underwriters so require, and the reasonable fees and expenses of any necessary special experts) in connection with each registration pursuant to subsection (a) or (b) above (including the related offerings and sales by holders of Option Shares) and all other qualifications, notifications or exemptions pursuant to subsection (a) or (b) above. (e) Miscellaneous Reporting. Issuer shall comply with all reporting requirements and will do all such other things as may be necessary to permit the expeditious sale at any time of any Option Shares by the Selling Shareholders thereof in accordance with and to the extent permitted by any rule or regulation promulgated by the SEC from time to time, including, without limitation, Rule 144A. Issuer shall at its expense provide the Selling Shareholders with any information necessary in connection with the completion and filing of any reports or forms required to be filed by them under the Securities Act or the Exchange Act, or required pursuant to any state securities laws or the rules of any stock exchange. (f) Issuer Taxes. Issuer will pay all stamp taxes in connection with the issuance and the sale of the Option Shares and in connection with the exercise of the Option, and will save the Selling Shareholders harmless, without limitation as to time, against any and all liabilities, with respect to all such taxes. 9. QUOTATION; LISTING. If Issuer Common Stock or any other securities to be acquired in connection with the exercise of the Option are then authorized for quotation or trading or listing on the NASDAQ National Market or any securities exchange, Issuer, upon the request of Holder, will promptly file an application, if required, to authorize for quotation or trading or listing the shares of Issuer Common Stock or other securities to be acquired upon exercise of the Option on the NASDAQ National Market or such other securities exchange and will use its best efforts to obtain approval, if required, of such quotation or listing as soon as practicable. 10. DIVISION OF OPTION. This Agreement (and the Option granted hereby) are exchangeable, without expense, at the option of Holder, upon presentation and surrender of this Agreement at the principal office of Issuer for other Agreements providing for Options of different denominations entitling the holder thereof to purchase in the aggregate the same number of shares of Issuer Common Stock purchasable hereunder. The terms "Agreement" and "Option" as used herein include any other Agreements and related Options for which this Agreement (and the Option granted hereby) may be exchanged. Upon receipt by Issuer of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Agreement, and (in the case of loss, theft or destruction) of reasonably satisfactory indemnification, and upon surrender and cancellation of this Agreement, if mutilated, Issuer will execute and deliver a new Agreement of like tenor and date. Any such new Agreement executed and delivered shall constitute an additional contractual obligation on the part of Issuer, whether or not the Agreement so lost, stolen, destroyed or mutilated shall at any time be enforceable by anyone. (a) Expenses. Each of the parties hereto shall bear and pay all costs and expenses incurred by it or on its behalf in connection with the transactions contemplated hereunder, including fees and expenses of its own financial consultants, investment bankers, accountants and counsel. (b) Waiver and Amendment. Any provision of this Agreement may be waived at any time by the party that is entitled to the benefits of such provision. This Agreement may not be modified, amended, altered or supplemented except upon the execution and delivery of a written agreement executed by the parties hereto. (c) Entire Agreement: no Third-party Beneficiary; Severability. This Agreement, together with the Plan and the other documents and instruments referred to herein and therein, between Grantee and Issuer (a) constitutes the entire agreement and supersedes all prior agreements and understandings, both written and oral, between the parties with respect to the subject matter hereof and (b) is not intended to confer upon any person other than the parties hereto (other than any transferees of the Option Shares or any permitted transferee of this Agreement pursuant to subsection (h) of this Section 14) any rights or remedies hereunder. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction or a federal or state regulatory agency to be invalid, void or unenforceable, the remainder of the terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. If for any reason such court or regulatory agency determines that the Option does not permit Holder or Owner to acquire, or does not require Issuer to repurchase, the full number of shares of Issuer Common Stock as provided in Section 3 (as adjusted pursuant to Section 7), it is the express intention of Issuer to allow Holder or Owner to acquire or to require Issuer to repurchase such lesser number of shares as may be permissible without any amendment or modification hereof. (d) Governing Law. This Agreement shall be governed and construed in accordance with the laws of the State of Washington without regard to any applicable conflicts of law rules. (e) Descriptive Headings. The descriptive headings contained herein are for convenience of reference only and shall not affect in any way the meaning or interpretation of this Agreement. (f) Notices. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally, telecopied (with confirmation) or mailed by registered or certified mail (return receipt requested) to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): if to Grantee: InterWest Bancorp, Inc. with a copy to: Edward C. Beeksma Zylstra, Beeksma, Waller and Skinner and to: John F. Breyer, Jr. if to Issuer to: Central Bancorporation with a copy to: Stephen M. Klein (g) Counterparts. This Agreement and any amendments hereto may be executed in two counterparts, each of which shall be considered one and the same agreement and shall become effective when both counterparts have been signed, it being understood that both parties need not sign the same counterpart. (h) Assignment. Neither this Agreement nor any of the rights, interests or obligations hereunder or under the Option shall be assigned by any of the parties hereto (whether by operation of law or otherwise) without the prior written consent of the other party, except that Holder may assign this Agreement to a wholly-owned subsidiary of Holder and Holder may assign its rights hereunder in whole or in part after the occurrence of a Purchase Event. Subject to the preceding sentence, this Agreement shall be binding upon, inure to the benefit of and be enforceable by the parties and their respective successors and assigns. (i) Further Assurances. In the event of any exercise of the Option by the Holder, Issuer and the Holder shall execute and deliver all other documents and instruments and take all other action that may be reasonably necessary in order to consummate the transactions provided for by such exercise. (j) Specific Performance. The parties hereto agree that this Agreement may be enforced by either party through specific performance, injunctive relief and other equitable relief. Both parties further agree to waive any requirement for the securing or posting of any bond in connection with the obtaining of any such equitable relief and that this provision is without prejudice to any other rights that the parties hereto may have for any failure to perform this Agreement. IN WITNESS WHEREOF, Issuer and Grantee have caused this Stock Option Agreement to be signed by their respective officers thereunto duly authorized, all as of the day and year first written above.	8-K	EX-10	1996-01-12T00:00:00	1996-01-12T14:34:35
0000950117-96-000032	0000950117-96-000032_0001.txt	The undersigned (the "Underwriters") understand that Eli Lilly and Company, an Indiana corporation (the "Company"), proposes to issue and sell (i) $200,000,000 aggregate principal amount of 6.57% Notes Due 2016 (the "20-Year Notes") and (ii) $300,000,000 aggregate principal amount of 6.77% Notes Due 2036 (the "40-Year Notes" and, together with the 20-Year Notes, the "Notes"). Subject to the terms and conditions set forth or incorporated by reference herein, the Company hereby agrees to sell and the Underwriters agree to purchase, severally and not jointly, the principal amount of the 20-Year Notes set forth below opposite their names at a purchase price of 99.125% of the principal amount thereof and the principal amount of the 40-Year Notes set forth below opposite their names at a purchase price of 99.125% of the principal amount thereof, plus, in each case, accrued interest from January 1, 1996 to the date of payment and delivery: The Underwriters will pay for the Notes upon delivery thereof at the office of Morgan Stanley & Co. Incorporated at 10:00 a.m. (New York time) on January 10, 1996 or at such other time, not later than 5:00 p.m. (New York time) on January 17, 1996, as shall be designated by the Underwriters. The time and date of such payment and delivery are hereinafter referred to as the Closing Date. The Notes shall have the respective terms set forth in the Prospectus dated June 1, 1995 and the Prospectus Supplement dated January 5, 1996, including the following: Maturity Date: January 1, 2016 (20-Year Notes) January 1, 2036 (40-Year Notes) Interest Rate: 6.57% per annum (20-Year Notes) 6.77% per annum (40-Year Notes) Redemption Provisions: The Notes will be redeemable in whole or in part at the option of the Company at any time at a redemption price equal to the greater of (i) 100% of their principal amount or (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted to the date of redemption on a semiannual basis (assuming a 360-day year consisting of twelve 30-day months) at the Treasury Yield (as defined in the Prospectus Supplement) plus in each case accrued interest to Interest Payment Dates: January 1 and July 1 commencing July 1, 1996 (interest accrues from Form and Denomination: Notes will be issued in the form of global securities in the aggregate for the 20-Year Notes and $300,000,000 for the 40-Year Notes Price to Public: 100% (20-Year Notes) All provisions contained in the document entitled Eli Lilly and Company Underwriting Agreement Standard Provisions (Debt Securities) dated March 18, 1993, a copy of which is attached hereto, are herein incorporated by reference in their entirety and shall be deemed to be a part of this Agreement to the same extent as if such provisions had been set forth in full herein, except that (i) if any term defined in such document is otherwise defined herein, the definition set forth herein shall control, (ii) all references in such document to a type of security that is not a Note shall not be deemed to be a part of this Agreement, (iii) all references in such document to the "Manager" shall be deemed to refer to the Underwriters, (iv) the several obligations of the Underwriters are subject to the additional condition that the Notes shall have been approved for listing on the New York Stock Exchange subject to official notice of issuance and (v) the opinion referred to in Section 4(c) shall be delivered by Daniel P. Carmichael, Esq., Deputy General Counsel of the Company. Please confirm your agreement by having an authorized officer sign a copy of this Agreement in the space set forth below. MORGAN STANLEY & CO. INCORPORATED GOLDMAN, SACHS & CO. J.P. MORGAN SECURITIES INC. By: MORGAN STANLEY & CO. INCORPORATED By: /s/ Edwin W. Miller Title: Vice President and Treasurer	8-K	EX-1	1996-01-12T00:00:00	1996-01-12T15:10:21
0000950147-96-000008	0000950147-96-000008_0000.txt	[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1994 (Exact name of registrant as specified in its charter) (State or other jurisdiction of (I.R.S. Employer Identification No.) Belgravia, London, England SW1X 9HX (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (4471) 823-1032 29 Love Lane, Pandon Quays, Quayside, Newcastle-Upon-Tyne, NE1 3DW England (Former name, former address and former fiscal year, if changed since last Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common stock, $.01 par value 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. 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 statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock held by nonaffiliates of the Registrant as of April 7, 1995 was -0-. The number of shares of the Registrant's $.01 par value common stock outstanding as of April 7, 1995 was 24,999,236. Original Theatrical Operations. Registrant was incorporated on April 3, 1980 under the name "Little Prince Productions, Ltd." ("LPP") pursuant to the laws of the State of New York for the purpose of exploiting certain ancillary and subsidiary rights to the literary work entitled "The Little Prince" by Antoine de Saint-Exupery (the "Work") and to engage in various other aspects of the theatrical production business. From its inception through November 16, 1992, LPP's business activities were limited to theatrical production projects, in various areas of the entertainment industry, of properties which included but were not limited to the Work, which was assigned to LPP by its founder and then president, A. Joseph Tandet in 1980. In October 1980, LPP completed and closed a public offering of its common stock with the sale of 750,000 shares which yielded net proceeds in the amount of approximately $1,250,000. The funds raised from LPP's initial public offering were used to mount a Broadway musical production based upon the Work. Reverse Acquisition-Tyne River Properties. On November 16, 1992 (the "Acquisition Date"), Registrant acquired and became the successor to Tyne River Properties, plc, an English company ("TRP") through a "Reverse Acquisition" pursuant to which the shareholders of TRP acquired an aggregate of 11,899,236 common shares of Registrant (the "Acquisition Shares"), comprising, upon issuance, approximately 85% of the issued and outstanding common stock of Registrant, in exchange for all of the issued and outstanding capital stock of TRP. As a part of the Reverse Acquisition, as at November 16, 1992, Registrant's theatrical operations and assets were transferred and assigned to its wholly owned subsidiary, LPPL Corp. to be continued therein under the direction of A. Joseph Tandet, resigned his position as president of LPP and was appointed president of LPPL Corp., and Peter N. Chapman who was also appointed as an executive officer and director of LPPL Corp. As a further consequence of the Reverse Acquisition, on February 4, 1993 Registrant changed its fiscal year end from March 31 to December 31 to coincide with the fiscal year end of TRP. Hereinafter, unless context necessarily requires otherwise, "LPP" shall refer to Little Prince Productions, Ltd. from its inception until the Acquisition Date and to LPPL Corp. a wholly owned subsidiary of Little Prince Productions, Ltd. after the Acquisition Date; "TRP" shall refer to Tyne River Properties, plc, and its wholly owned subsidiaries, collectively, before and after the Acquisition Date; and "Registrant" shall refer to Little Prince Productions, Ltd. before the Acquisition Date and to Little Prince Productions, Ltd. and its wholly owned subsidiaries, LPPL Corp. and TRP, collectively, from the Acquisition Date until March 29, 1994. Overview. Following the Acquisition Date, Registrant's business activities were intended to be conducted in three separate segments, with TRP's proposed real estate acquisition and investment operations constituting Registrant's principal business and the theatrical production operations of LPP constituting a smaller, but continuing area of operations. Certain real estate development projects and operations, owned and conducted by TRP at the Acquisition Date were intended to constitute a third segment which was to be phased out as promptly as practicable through the completion and/or disposition of all such projects. Through and until March 29, 1994 Registrant conducted or attempted to initiate operations in these three segments, in accordance with such intentions by: (a) obtain financing, through public or private sales of its equity securities, for its proposed real estate acquisition and investment business; (b) endeavoring to complete and/or dispose of its real estate development projects on favorable terms; and (c) continue its operations in the field of theatrical production through its wholly owned subsidiary LPPL Corp. Ultimately, however, Registrant was unable to raise any financing with which to commence its proposed real estate investment business. In addition, Registrant was forced by unforeseen circumstances to divest itself of all of its real estate development projects, and to enter into certain transactions, referred to below as a "Second Reorganization" which involved the issuance of a major block of stock to Riparian Securities, Ltd. ("RSL") and a change in management, all of which events and transactions are discussed below. Discontinued Real Estate Development Projects-Sale of TRP. TRP was, from its inception in 1987 through March 29, 1994, engaged in the acquisition and development of property in the Newcastle-Upon-Tyne area in England. It conducted its business directly and indirectly through its operating subsidiaries, Exchange Buildings Limited ("EBL"), Pandon Developments Limited ("PDL"), and Selective Construction plc ("SCP"). Its development sites included the Pandon and Exchange building sites in central Newcastle-Upon-Tyne and a parcel of land adjacent to a car assembly plant approximately five miles south of Newcastle-Upon- Tyne. Towards the end of 1993, TRP began to encounter a severe cash flow problem which accelerated from that point in a swift and unanticipated manner leading TRP insolvent by early 1994. Such cash flow problems were caused and exacerbated by a number of factors, including, but not limited to, a severe economic recession in the UK, which had a significant adverse effect on the UK real estate property markets, significant drains on TRP's limited cash resources, the cessation of rental revenues from a major property owned by TRP, the refusal of TRP's major lending bank to extend further credit, and the unexpected demand by a major creditor of TRP for payment in full of a major outstanding liability, and the completely unanticipated actions taken by such creditor in issuing a petition to the Court to dissolve TRP's wholly owned subsidiary, Exchange Buildings, Limited ("EBL") and to liquidate its assets. These events and circumstances eventually led to Registrant's sale of TRP in March 1994, at a significant loss, and the discontinuation by Registrant of its involvement in real estate development projects, as described below. On March 29, 1994, Registrant sold all of the issued and outstanding stock of TRP to Bravecorp Limited ("Bravecorp"), a U.K. company wholly owned by Riparian Investments Limited ("RIL") and formed specifically for the purpose of purchasing TRP. RIL is a company affiliated with Riparian Securities Limited ("RSL") through common ownership and management (RIL and RSL, as well as their controlling persons, will sometimes be referred to herein, collectively, as the "Riparian Group"). The background of this transaction was as follows: Towards the end of 1993, TRP began to encounter severe cash flow problems which accelerated from that point in a swift and unanticipated manner leaving TRP insolvent by early 1994. This was a result of a number of circumstances including, but not limited to, one of the most severe economic recessions experienced in the UK since World War II. Although, TRP's management continued to believe, through most of 1993, that economic conditions would improve. This was not the case, and the property market generally continued to be adversely affected. During 1993, however, based upon management's belief that economic conditions would improve, TRP continued to move forward on its real estate development projects. One of such projects, the Exchange Building, is a listed (historical landmark), 150 year-old, 5-story brick building, was a major piece of real estate which TRP's management believed had enormous potential for development. Substantial expenditures had been made on the Exchange Building project prior to 1993, but considerable additional expenditures would have been required to bring this project to its full economic potential. Work on the Exchange Building had began in 1990 and before the end of 1992, TRP had obtained all permits required for the renovation of the property into 75,000 square feet of commercial office space. By the end of 1993, TRP had completed the complex legal and commercial negotiations which had been required to remove all of tenants from the building. This project was funded for over four years by Barclays Bank, which continued to extend credit to TRP until December of 1993. During 1993, however, TRP had begun to encounter severe cash flow problems which made it increasingly difficult to service the Barclays Bank debt. TRP's cash flow problems were caused and exacerbated by a number of factors. First, the economic recession cut badly into TRP's ability to reach projected sales goals for apartments which had been completed in another development project, "Pandon Development." The disappointing sales at the Pandon Development were the direct result of the downturn in the real estate market which had resulted from the economic recession noted above. Cash flow problems were further compounded by the drain on TRP's limited cash resources caused by the necessity to pay substantial settlement fees in order to get tenants to vacate the Exchange Building. Further, work on the renovation of that property which, if completed, might have enabled TRP to generate some income, was greatly curtailed, if not stopped entirely, because of TRP's inability to pay the contractors and professionals who would have been retained for such purposes. Moreover, because of poor general economic conditions in the area, TRP was unable to prelet any space in the planned renovation and was therefore further disabled from obtaining financing for the project. In addition, TRP's income was severely diminished as a result of the cessation of rental revenues which followed the removal of tenants from the Exchange Building. As a result of the foregoing cash flow problems, by early 1994 TRP began actively pursuing the negotiation of a joint venture agreement with terms that would have enabled it to meet its obligations in full. At about the same time, Barclays Bank indicated that they would like repayment of their loan, but that they would be reasonably flexible as to when repayment had to be made, as long as TRP took steps to sell the Exchange Building or make alternate plans to repay the Barclays debt. Management believed that with Barclays Bank remaining flexible as to the time of payment, TRP would be able to realize a reasonable return on the Exchange Building. Plans were made to seek one or more partners for a joint venture which would fund and complete the renovations of the building, allowing TRP to at least share in the revenues to be derived from the completed project. Also at the same time, Vaux Breweries ("Vaux"), a former tenant in the Exchange Building, demanded payment of a (pound)35,000 settlement fee from TRP. This liability had arisen out of a settlement agreement which TRP had entered into for the purpose of getting Vaux to agree to vacate its facilities in the Exchange Building. Barclays Bank rejected TRP's request for a loan of (pound)35,000 to pay this liability. Thereupon TRP's management engaged in negotiations with Vaux aimed at getting Vaux to agree to delay payment until TRP was able to liquidate the Exchange Building on favorable terms. Vaux refused to agree to such delay and, instead, issued a petition to the Court to dissolve Exchange Buildings, Limited ("EBL") (the wholly owned subsidiary of TRP which help ownership of the Exchange Building) and liquidate its assets. This step was roughly equivalent to Vaux's bringing a petition for involuntary bankruptcy under Chapter VII of the U.S. Bankruptcy Code. As a direct result of the actions taken by Vaux, Barclays Bank was constrained to demand immediate payment in full of all moneys owned to it by EBL, which at that time equaled (pound)489,000, (or approximately $724,000). Thus, the Vaux petition effectively made it impossible for TRP to negotiate either a joint venture agreement for the renovation of the Exchange Building or a sale of the Exchange Building under favorable, or even reasonable, circumstances. It was clear that the combination of the foregoing circumstances was inevitably going to result in a forced sale of the Exchange Building at a price substantially lower than TRP's previous valuation of that property. As a direct result of the foregoing circumstances it was necessary to reduce the value at which the Exchange Building was included in the accounts of Registrant by $970,000 to reflect its much reduced value on the basis of the requirement for a forced sale. This reduction in the asset value of the Exchange Building attributed to TRP having a negative net worth of approximately (pound)199,000 by early 1994. TRP's financial condition was further worsened by a diminishment in the value of its two other development projects, the property known as the Padon Development and a parcel of twenty acres of undeveloped land with one two-story brick farmhouse situated thereon, located near a major highway (the "A19 Property"). With respect to the Padon Development, as noted above, the general downturn in the real estate market throughout the UK made it extremely difficult to sell the apartments into which the Padon Development had been convened. Moreover, became of TRP's overall poor financial condition, it was forced to remit any net proceeds, from such sales as it was able to effect, to creditors. The A19 Property was also revalued downward during fiscal 1993 in the amount of $120,000. This was the direct result of the refusal of a planning permission for a parcel of property adjacent to the A19 Property, owned by unrelated persons. To the best knowledge of TRP's management, it was assured before 1994 that the adjacent property was to be the site of a new football stadium. Unfortunately, however, unexpected opposition to construction of such a facility at that site, from an unrelated party, prevented the issuance of a permit for such purpose. Appeals to the local planning commission were brought by the football club and the final, adverse decision was not handed down until March of 1994. As a result of the foregoing, by March 29, 1994, the value of the A19 Property had been significantly diminished from TRP's original estimate thereof. Commencing in January of 1994, the Riparian Group had begun to explore the feasibility of acquiring a major stock position in, and management control of, Registrant. They were interested in a publicly traded corporation because they believed it would be an effective vehicle for the effectuation of their proposed business plan. For a discussion of the Riparian Group's proposed business plan, reference is made to the subtopic, "Proposed Business Plan of RSL" of this Item 1. In the interest of such potential affiliation with Registrant, the Riparian Group agreed with TRP, to use its best efforts to protect Little Prince Productions Ltd. from the anticipated adverse effects of the dissolution of TRP's subsidiaries, and the liquidation of properties held thereby, under the unfavorable conditions then obtaining. Thereupon, the Riparian Group formed Bravecorp for the purpose of purchasing TRP. The sale was effected on March 29, 1994 for the nominal consideration of (pound)1. At the time of the sale, TRP had a negative net worth of approximately (pound)199,000. The sale therefore resulted in the improvement of Registrant's net worth in a like amount. The events which followed confirmed the expectations of all the parties, to wit: On April 15, 1994, Barclays Bank, foreclosed on EBL and took legal possession of the Exchange Building. On April 18, 1994, Bravecorp sold EBL to Lacebury Limited, a firm which specializes in dealing with insolvent companies, for a price of (pound)2. On April 26, 1994, Bravecorp sold all of the remaining assets of TRP, except for PDL (and the Pandon Development owned by PDL) to Lacebury Limited for a price of (pound)2. At approximately the same point in time, Bravecorp sold PDL for the same nominal sum to Gracelord Limited ("Gracelord"). Neither Lacebury nor Gracelord is affiliated with Registrant, the Riparian Group, or any affiliate of Registrant or the Riparian Group. In connection with their services in respect of the foregoing transactions and dealing with outstanding creditors and the appointment of company receivers and liquidators, Bravecorp incurred unreimbursed expenses of approximately (pound)3,525 (approximately $5,000). At the time of Bravecorp's purchase of TRP, the Riparian Group was not affiliated with Registrant and all of the foregoing transactions were made at arm's-length. In September of 1994, RSL acquired approximately 25% of Registrant's issued and outstanding common stock by way new issuances and transfers of shares from certain of Registrant's past and present officers and directors. In connection therewith, certain members of Registrant's management, who were associated with TRP, resigned and in their place, members of RSL's management were appointed as officers and directors of Registrant (see the discussion, below, under the caption "RSL Agreement"). Proposed, But Uninstituted, TRP Real Estate Investment Business. Commencing in or about 1993, TRP endeavored to change the principal thrust of its operations from the real estate development operations discussed above to the real estate investment business. In an effort to further such purpose, TRP participated in the Reverse Acquisition so as to gain access to the U.S. public capital markets as a means of raising financing for the acquisition of real estate properties through the sale of equity interests in Registrant. However, TRP was never able to raise any funds through private or public sales of Registrant's securities and, as a result, was never able to institute its proposed real estate investment business. Lack of Working Capital-Second Reorganization. As noted above, after the Reverse Acquisition, Registrant was not able to raise any funds through private or public sales of its securities, or otherwise, TRP was therefore unable to institute its real estate investment business plan and the lack of available working capital resulted in Registrant's overall inability to conduct operations in any of its three proposed business segments during 1993 or subsequently thereto, except on a minimal level. On August 22, 1994, in an effort to improve Registrant's business prospects, Registrant and certain members of its then current management entered into an agreement with Riparian Securities, Ltd ("RSL") whereby, among other things, RSL became the owner of approximately 25% of Registrant's issued and outstanding common stock and RSL designees were appointed as officers and directors of Registrant. (For a discussion of the transactions involving RSL, reference is made to the subtopic "Subsequent Events-RSL Agreement," of this Item 1.) As of the date hereof, RSL has not yet instituted its business plan and Registrant has had no active business operations other than theatrical operations which have remained minimal. (For information respecting RSL's proposed business plan, reference is made to the discussion, included below, under the caption "Proposed Business Plan of RSL" of this Item 1.) RSL Agreement. On August 22, 1994, Registrant entered into an agreement (the "RSL Agreement") with RSL. RSL is a company incorporated and registered in England (Company No. 2855251). Its registered office is located at 40 Lowndes Street, Belgravia, London, SW1X 9HX, England. RSL is engaged in the business of real estate investment and management, principally in the area encompassing London and the Southwest of England. The RSL Agreement principally provided for: (a) a loan by RSL to Registrant of GB(pound)25,000, to be used to satisfy financial, tax and regulatory obligations of Registrant; (b) the sale by Registrant to RSL of 3,250,000 shares of original issue common stock of Registrant at a price of $.01 per share in conjunction with the sale by Peter N. Chapman and William J. Peacock to RSL of an aggregate of an additional 2,990,402 shares for the nominal price of $.0001 per share; (c) the resignation of four of the five then present directors of Registrant, pursuant to which Terence G. Galgey, William J. Peacock, A. Joseph Tandet, and Carl Kuehner resigned as directors of Registrant, which resignations became effective as of October 1, 1994; (d) the replacement of the resigning directors by two designees of RSL, Adrian P. Kirby and Christopher N.C. Jones, and the reduction in the size of the board from five to three persons; and (e) the resignations of Messrs. Galgey, Peacock, Tandet, and Kuekner as officers of Registrant, which resignations became effective as of October 1, 1994. The closing of the RSL Agreement took place on September 9, 1994. The newly constituted board of directors took office on October 1, 1994, ten days after a Notice to Shareholders, prepared in accordance with Rule 14f-1 of the Securities and Exchange Act of 1934, as amended (the "34 Act") was mailed to Registrant's shareholders. Thereafter, Adrian P. Kirby was appointed as Chairman and Chief Executive Officer of Registrant and Christopher N.C. Jones was appointed as its Executive Vice President. Prior to their taking office, neither Mr. Kirby nor Mr. Jones held any offices, employments, directorships or other affiliations with Registrant. Peter N. Chapman continued to hold the positions of Secretary, Treasurer and a Director of Registrant. On February 15, 1995, Mr. Jones was removed for cause by the remaining members of the board and Robert D. Evans was appointed to fill the vacancies created by Mr. Jones's removal. Proposed Business Plan of RSL. RSL originally entered into the RSL Agreement with the intention of arranging for Registrant to acquire, within six months, sufficient investment properties and related business activities to enable Registrant to satisfy the minimum financial criteria for inclusion in the National Association of Securities Dealers, Inc. Automated Quotation System ("NASDAQ"). Such acquisitions were intended to consist of commercial properties, located in the London area, preferably untenanted or under tenanted, the values of which could be enhanced by Registrant though the installation of suitable tenants obtained for such properties by Registrant. Registrant intended to effect such acquisitions through the issuance of large blocks of equity shares of Registrant. Although Registrant's initial estimate of the time when such plan could be put into effect has been extended, its basic intentions with respect to the business of Registrant have not changed, except insofar as it has been expanded to encompass the potential acquisition of service or manufacturing businesses, as well as commercial real estate properties for equity in Registrant. However, in order to make acquisitions of any such properties or businesses, in exchange for issuances of stock in Registrant, a meeting of Registrant's shareholders must be called for the purpose of, among other things, increasing the amount of authorized capital stock. Such a meeting cannot be called, however, until all of Registrant's past and currently due annual reports on Forms 10-K and quarterly reports on Forms 10-Q are prepared and filed with the Securities and Exchange Commission. Registrant is currently in the process of doing so and has filed this Report in correction with such efforts. If undertaken, an equity financing may result in significant dilution to Registrant's current shareholders and may also cause further changes in the control of Registrant and its management. RSL has not, as of the date hereof, located any commercial properties or service or manufacturing businesses for potential acquisition and has no present understanding, arrangement, or contractual commitment respecting, any specific property or business. Registrant's management, however, continues to believe that opportunities exist both in the United States and United Kingdom for investment in the foregoing areas of business and property and is actively investigating potential investment opportunities. It is the intention of management that Registrant's existing and proposed business activities continue to be conducted in separate segments. While at present Registrant's theatrical production activities, which are extremely limited in nature, represent the only active pan of Registrant's activities, it is intended that these activities will, in due course, as investment opportunities are secured, constitute a less significant part of Registrant's overall business. Management's current acquisition strategy involves the possibility of acquiring, in exchange for equity in Registrant, existing businesses which management believes will offer the opportunity of sound sustainable earnings with the potential for growth. Registrant does not intend to seek investments which involve a high degree of dependence on specialized skills or market conditions or which will be at risk from rapid changes in market conditions or from technological Change. All potential acquisitions will be analyzed in depth by the executive officers of Registrant. Advice from independent advisors will be sought as deemed appropriate by the executive officers. In evaluating potential investments, Registrant will consider, among other factors: (a) the current anticipated cash flows and their ability to meet operational needs and provide a competitive market return on the equity invested; (b) the potential for capital appreciation; (c) the geographical area and location of the business and/or property; (d) the ability to increase cash flow through a capable management; (e) the capability of existing management; (f) the market positions and relative strengths of the business related to its competitors; (g) the general economic growth and tax and regulatory environment of the communities in which the business operates; and (h) the prospects for liquidity, through sale, financing or refinancing. Registrant further intends to keep debt to conservative levels relative to equity with regard to both mature investments and new acquisitions. Registrant plans to raise funds by selling equity securities in Registrant in public or private transactions. The stockholders of Registrant do not and will not have any preemptive rights with respect to any such issues of Registrant's equity securities. Moreover, there can be no assurance that Registrant will be able to raise any funds through the sale of such securities. Registrant's directors may determine in the future that a change from Registrant's current investment strategies and policies is in the best interest of Registrant and its stockholders Stockholder approval will not be necessary for a change in Registrant's investment policies. Although no change in Registrant's investment policies is currently anticipated, should the directors deem it advisable, charges will be made. Alternative methods of financing, which could be adopted by the board of directors in the future, could include short, intermediate or long-term borrowings, on secured or unsecured basis. Such borrowings could be in the form of bank borrowings, including unsecured borrowings or borrowings secured on Registrant's then existing assets and/or assets being acquired with borrowed funds. Borrowings could also be made by Registrant by way of Registrant's issuance, in public or private transactions, of senior or subordinated notes or debentures, including notes or debentures convertible into shares of Registrant's common stock. Registrant may also combine any of the above financing methods. The ability of Registrant to finance the acquisition of investments through the issuance of Registrant's equity securities may result in the dilution of the book value of the shares of common stock held by Registrant's then current stockholders. Furthermore, the issuance by Registrant of senior or subordinated notes or debentures to finance any such acquisitions would result in the creation of creditors of Registrant having rights which are senior to those of the holders of Registrant's common stock. In some cases, borrowings may be made pursuant to loan agreements or indentures containing restrictive covenants or other limitations on Registrant's other operations. The bylaws of Registrant do not require the directors to review Registrant's investment policies at any specific intervals, to determine whether such policies are being followed or whether they are in the best interests of the stockholders of Registrant. Settlements with Officers and Directors. On or about November 16, 1992, Registrant's newly appointed officers, Terence G. Galgey, William J. Peacock, Peter N. Chapman, Carl J. Kuehner, and A. Joseph Tandet entered into employment or service agreements with Registrant (the "Executive Officer Compensation Agreements"). Agreements for the services of Messrs. Galgey, Peacock and Chapman were made indirectly with such individuals through the following corporate entities: (a) Mr. Galgey's service agreement was made through Galgey Financial Services Limited CGFSL"); (b) Mr. Peacock's service agreement was made through Oform Associates Limited Oform"); and (c) Mr. Chapman's service agreement was made through Chapman & Chapman ("C&C"). In the respective service agreements with GFSL, Oform, and C&C, each such corporate entity acknowledged to Registrant, among other things, that Messrs. Galgey, Peacock, or Chapman, as applicable, was its exclusive employee and that each such individual's services was to be furnished to Registrant as an independent contractor. Pursuant to the terms of their respective agreements, Messrs. Galgey, Peacock, Chapman, Kuehner, and Tandet were to be paid annual salaries for their services as officers of Registrant in the respective amounts of $85,000, $75,000, $75,000, $25,000, and $25,000. Due to the lack of sufficient funds therefor, Registrant was unable, in varying degrees, to meet its financial obligations to Messrs. Galgey, Peacock, Chapman, and Kuehner under the aforesaid agreements. As a result, Registrant accrued contractual liabilities to such individuals, by way of unpaid salaries and unreimbursed expenses in connection with the transactions with RSL, described above, Registrant entered into settlement agreements with each of Messrs. Galgey, Peacock, Chapman, Tandet and Kuehner pursuant to which Registrant issued shares of its common stock to such persons in satisfaction of monies owed to them in respect of such accrued contractual liabilities and unreimbursed expenses. For a discussion of the terms of such settlements, reference is made to the subtopic "Certain Relationships and Related Transactions-Transactions and Business Relationships with Management" of Item 13 of this Report. Insurance Proceeds. During the year ended December 31, 1992, a property which formed part of one of TRP's development projects was destroyed by fire. The property was demolished on recommendation of the insurance carrier. Proceeds in the amount of approximately $1,859,949 on the fire insurance policy on this property were accrued as income in Registrant's financial statements for the fiscal year ended December 31, 1992, but were received by Registrant during fiscal 1993. All of such proceeds were used to pay general creditors of TRP. The Little Prince. A. Joseph Tandet acquired the worldwide stage, television, and radio rights to the literary work entitled "The Little Prince" by Antoine de Saint-Exupery and referred to herein as the "Work" on July 9, 1965 by agreement with Editions Gallimard, a French publishing company ("Gallimard") as representative of the Estate of Saint-Exupery. Contemporaneously therewith, by agreement with Soliffim, S.A. and TLP Productions, Ltd., Mr. Tandet also acquired the exclusive, worldwide recording, motion picture, commercial and merchandising rights to the Work. All of the foregoing rights were assigned to LPP by Mr. Tandet in 1980. LPP believes that it holds the exclusive right to produce theatrical presentations based upon the Work in the U.S. and in Canada in the English language as well as the non-exclusive right to produce theatrical presentations in Canada in the French language. However, its claims to such rights are presently being disputed by two independent theatrical producers, John Scoullar and Rick Cummins and LPP has instituted litigation with respect to such dispute. For a discussion of the claims by Scoullar and Cummins, which form the basis of such dispute and litigation, reference is made to the subtopic "Legal Proceedings-Scoullar and Cummins Matter" in Item 3 of this Report. On December 31, 1992, LPP authorized Theatreworks USA Corp. ("Theatreworks"), a New York stage production company which produces plays for family audiences, to produce a new musical stage production based upon the Work and geared specifically for a juvenile audience. LPP was paid $5,000 as an advance against two percent (2%) of all gross revenues derived by Theatreworks from the production. The Theatreworks production has been touring since October 1993. To date, revenues generated therefrom have not yet entitled LPP to royalties in an amount equal to the $5,000 already advanced. In the event revenues from the Theatreworks production should reach a level which would entitle LPP to royalties in an amount in excess of the $5,000 previously advanced, LPP can expect to receive additional revenue in respect thereof. There can be no assurance however, that this will prove to be the case. On September 30, 1992, LPP also authorized two independent theatrical producers, John Scoullar and Rick Cummins, to produce another new musical stage production based upon the Work, in New York by December 31, 1993, geared for an adult audience (the "Scoullar Cummins Production"). The Scoullar/Cummins production opened on October 17, 1993 at the 28th Street Theatre in New York City and ran through December 1993. During the fiscal year ended December 31, 1993, LPP derived gross revenues from the this production in the mount of $2,000 by way of an advance payment against royalties. No further royalties have been paid to date. As a result of the foregoing, Messrs. Scoullar and Cummins claim to have obtained from LPP's its right to produce theatrical presentations of the Work in the United States and Canada. LPP has instituted litigation to reform the agreement upon which Scoullar and Cummins base such claim. For a discussion of LPP's dispute with Messrs. Scoullar and Cummins and the ensuing litigation, reference is made to the Subtopic "Legal Proceedings-Scoullar and Cummins Matter" in Item 3 of this Report. Litigation with Gallimard and the Saint-Exupery Family. On February 6, 1992, LPP entered into an agreement with Gallimard and the Saint-Exupery family in settlement of litigation brought by Gallimard and the Saint-Exupery family against LPP in 1990. The settlement agreement provided, among other things, for the preservation of certain television production rights to the Work held by Pontaccio S.p.A. an Italian television production company ("Pontaccio"), payment to LPP of an aggregate amount of $200,000 (the "Settlement Fee") in six payments, a royalty to LPP of three percent (3%) of gross revenues derived from the proposed Pontaccio television production, and LPP's relinquishment of all of its rights to the Work except for the following: (a) the exclusive right to produce theatrical presentations of The Little Prince in the United States of America and in Canada in the English language. For discussion of respecting LPP's retention of these rights, reference is made to the subtopic "Legal Proceedings-Scoullar and Cummins Matter" in Item 3 of this Report); and (b) the non-exclusive right to produce theatrical representations of The Little Prince in Canada in the French language subject to the prior authorization of Gallimard. $150,000 of the $200,000 Settlement Fee were paid by Pontaccio in fiscal 1992. During the fiscal year ended December 31, 1993, Pontaccio paid an additional $50,000 in respect thereof. In addition, Pontaccio remains obligated to pay LPP a 3% television production royalty in the event that it mounts a television production of the Work. Plans for such a production currently include a budget of approximately $6,000,000. However, LPP is unable to state whether, if ever, such a production will be mounted. To date, Pontaccio has not generated any revenues from such proposed television production, and no royalty payments have been made to LPP. The Boys Next Door. In November 1987, in a joint venture with Duet Productions Inc., LPP produced an off-Broadway stage production of "The Boys Next Door" by Tom Griffen. The production was a clear critical, but not a financial, success. The production did however run for more than 70 performances in New York, as a result of which, LPP became entitled to certain subsidiary rights to subsequent performances of the production. During the fiscal year ended December 31, 1994, an amount of $4,500 was accrued in respect of such rights, which mount was subsequently paid to LPP in March 1995. There is no assurance that significant additional revenue, if any, will be earned by LPP in connection with this property. Oil City Symphony. LPP was an associate producer with Duet Productions Inc. of a production of "Oil City Symphony" which was produced off-Broadway in New York City in October 1987 and which ran until April 1989. LPP continues to hold certain touring rights to such production, but to date has realized no revenues therefrom. There can be no assurance that LPP will ever realize revenues from these touring rights. Film Rights. On October 28, 1983, LPP acquired from Ceskoslovensky Filmexport ("CF") the sole and exclusive rights, for a period of 15 years, in the territory of the United States, for the economic exploitation and public exhibition in cinemas of fifteen 35mm and 16mm feature length films made in Czechoslovakia. In exchange therefor, LPP issued $50,000 shares of its common stock to CF, valued at $1.25 per share. LPP has never received any revenues from the exhibition of these films, and during the fiscal year ended December 31, 1993, the distributor of such films advised LPP that such rights are worthless. LPP does not expect to derive any economic benefit from its rights to these films. Real Estate Business. Management believes that Registrant may face competition for the most attractive real estate investment opportunities from other investors who are aware of the opportunities available at this time to purchase properties at significantly deflated prices. Potential investors should note, however, that other investors, some of whom may have greater resources than Registrant, are in the market for real estate investment and present intense competition perforce of their being considerably better established and larger than Registrant in total assets and resources. Management intends to meet such competition by taking advantage of its experience and expertise in the UK real estate market and by using the financial strength which will be afforded to Registrant through its access to equity capital markets. There cannot however be any assurance that Registrant will, in fact, be able to raise equity capital on terms favorable to it or at times necessary to enable it to take advantage of attractive real estate investment opportunities against potential competitors. Theatrical Production Business. The entertainment industry in general, and the production of stage productions on or off-Broadway or in Regional or other theaters in particular, is extremely speculative. Only a small percentage of theatrical productions ever make a profit. Revenues from LPP's theatrical production business are dependent on a variety of factors over which it has no control, including critical and consumer reaction, competition from other productions and the advertising and publicity which LPP and parties external to LPP, such as theatrical reviews, etc. provide for LPP's productions. Audience appeal depends, among other things, upon unpredictable critical reviews and changeable public tastes, factors which cannot be reliably ascertained in advance and over which LPP has no control. LPP's principal competitive disadvantage in this field has been, and continues to be, its extremely limited capital resources. As at the date hereof, LPP does not foresee an increase in the amount of such capital available to it. It is therefore unable to state at this time whether it will ever have sufficient capital to enable it to compete effectively, if at all, in the area of theatrical production. During the fiscal year ended December 31, 1994, Registrant had no employees other than its officers and directors and a full time clerical person employed by TRP in its real estate development business. The clerical person remained in the employ of Registrant until the sale of TRP on March 29, 1994. Since such date, Registrant has had no employees other than officers and directors. Sale of Trip to Bravecorp Limited. On March 29, 1994, Registrant sold all of the issued and outstanding stock of TRP to Bravecorp Limited ("Bravecorp"), a U.K. company wholly owned by Riparian Investments Limited ("RIL") and formed specifically for the purpose of purchasing TRP. For a discussion of the terms of such sale, and the events leading up to it, reference is made to the subtopic "Current Business Activities, Discontinued Real Estate Development Projects-Sale of TRP" of this Item 1. Distribution of Atlantic Properties, Ltd. Stock. On February 15, 1995, Registrant's three current officers and directors, founded Atlantic Properties, Ltd. In consideration of services rendered and unreimbursed expenses incurred in connection with its organization, Atlantic Properties issued 105,000 shares, constituting approximately 2.5% of its total issued and outstanding common stock, to Registrant. On March 30, 1995, Atlantic Properties, Ltd. filed a registration statement on Form S-11 with the Securities and Exchange Commission (SEC File No. 33-90790). The 105,000 shares owned by Registrant were included therein to be registered under the Securities Act of 1933, as amended, for distribution, on a pro rata basis, to the holders of Registrant's common stock of record, on a date to be determined, at the rate of one share of common stock for every two hundred thirty-eight (238) shares of Little Prince stock, without any Consideration being paid by such shareholders. Notwithstanding the foregoing, any person who holds shares of Little Prince common stock as of the initial Record Date in an amount of less than two hundred thirty-eight (238) will receive one share of Atlantic Properties, Ltd. common stock. Prior to the date of the sale of TRP on March 29, 1994, Registrant maintained its corporate headquarters in a suite of offices in a residential and commercial brick landmark building constituting TRP's Pandon Quays development project. This facility consisted of a suite of modern, newly renovated offices of approximately 1,800 square feet, virtually all of which space was dedicated to reception, office, and conference areas. Since the sale of TRP on March 29, 1994, the executive offices of Registrant have been maintained at the headquarters of the Riparian Group at 40 Lowndes Street, Belgravia, London, SW19HX, England. Registrant has no formal lease or agreement with respect to its office facilities and pays no rent or other remuneration for their use. These facilities consist of an approximately 1500 square foot suite of two executive offices and a reception area. LPPL Corp. maintains its headquarters at the office of its president, Mr. A. Joseph Tandet, at 555 Fifth Avenue, New York, NY 10017. Mr. Tandet receives no remuneration from LPPL Corp. or Registrant for the use of this facility or for the clerical and other incidental services provided to LPPL Corp. by Mr. Tandet. Prior to the date of sale of TRP on March 29, 1994, TRP owned several real estate development properties in various stages of completion. For a discussion in more detail of such properties, reference is made to Item 1 of this Report "Current Business Activities-Discontinued Real Estate Development Projects." Gallimard and Saint-Exupery Family Matters. For a discussion on the litigation and subsequent settlement of the captioned matter, reference is made to the subtopic "Business-Theatrical Operations-Litigation with Gallimard and Saint-Exupery Family" of Item 1 of this Report. Scoullar and Cummins Matter. On May 10, 1994, Little Prince Productions, Ltd. commenced an action in the Supreme Court of the State of New York, New York County, entitled Little Prince Productions, Ltd. vs. John Scoullar and Rick Cummins by serving a summons and complaint which demanded reformation of an agreement (The "Scoullar/Cummins Agreement), dated September 30, 1992 by and between Little Prince Productions, Ltd. and two independent theatrical producers, John Scoullar ("Scoullar") and Rick Cummins ("Cummins"). This agreement gave Scoullar and Cummins the right to produce a new musical production based upon the literary work entitled "The Little Prince" by Antoine de Saint-Exupery (referred to herein as the "Work"). LPP filed the summons and complaint in response to claims by Scoullar and Cummins that the Scoullar/Cummins Agreement grants to them the unqualified right to produce theatrical productions based upon the Work, throughout the United States and Canada, utilizing materials from all sources, including those directly connected to the Work. LPP claims that the rights of Scoullar and Cummins to mount theatrical productions of the Work in the United States and Canada is limited to productions based solely upon their own materials. Defendants filed an answer containing a general denial and a counterclaim requesting declaratory judgment in their favor. Depositions are expected to be taken in April 1995 with a trial expected to follow several months thereafter. LPP considers the claims of Scoullar and Cummins to be spurious. LPP is unable to state at this time, what the outcome of this litigation will be. Michael Frazier and Michael Frazier Productions, Inc. Matter. On September 1, 1993, Registrant and A. Joseph Tandet commenced an action (in the Civil Court, County of New York) against Michael Frazier Productions, Inc. and Michael Frazier, individually (collectively "Frazier"). The complaint seeks recompense of $20,630, which Registrant advanced on behalf of Frazier in connection with the settlement of an action which had been brought against LPP and other defendants in December 1990, in the United States District Court for the Northern District of Ohio, entitled "The Cleveland Play House vs. The Hearts Desire Company et al" (the "Cleveland Play House Litigation"). A stipulation was filed, and made an order of the Court, calling for a settlement in the total amount of $5,000 to be paid by Frazier to Registrant in five equal monthly installments of $1,000, with the first installment due April 7, 1995. To date, nothing has been paid in respect of such settlement. There are no other legal proceedings to which Registrant is a party or to which its property is subject, which are material to its business or prospects, and Registrant knows of no other legal proceedings contemplated against it. Item 4. Submission of Matters to a Vote of Security Holders During the fourth quarter of the fiscal year ended December 31, 1994, no matters were submitted to a vote of security holders. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Registrant's common stock, $.01 par value, is traded in the over-the-counter market under the symbol "LTLP." Because LPP did not meet the revised financial criteria for continued inclusion in the National Association of Securities Dealers' Automated Quotation System ("NASDAQ"), it was delisted therefrom, effective May 27, 1992. Since such date, Registrant's common stock has been quoted on the OTC Bulletin Board, provided however that since April 1, 1994, there has been so little trading activity in Registrant's stock that no bids are shown for the quarters subsequent thereto (see Footnote 2 to the Table, below). The following table sets forth representative high and low closing bid prices by calendar quarters as reported by the National Quotation Bureau and the OTC Bulletin Board from January 1, 1993 through March 31, 1995(2). Bid quotations represent prices between dealers, do not include retail mark-ups, mark-downs or other fees or commissions, and do not necessarily represent actual transactions. Calendar Quarter Ended High Bid Low Bid March 31, 1993 1/16 5/16 June 30, 1993 1/8 1/16 September 30, 1993 1/8 1/8 December 31, 1993 1/8 .01(1) March 31, 1994 3/8 .10(1) June 30, 1994 N/A(2) N/A(2) September 30, 1994 N/A(2) N/A(2) December 31, 1994 N/A(2) N/A(2) March 31, 1995 N/A(2) N/A(2) (1) As reported by the National Quotation Bureau (2) Management has been advised by the National Association of Securities Dealers, Inc. that no dealer submitted bid prices for registrant's stock from April 1, 1994 through March 31, 1995. As of April 7, 1995, the number of holders of record of the common stock, $.01 par value, of Registrant was 340. Item 6. Selected Financial Data The financial data set forth below are derived from the consolidated financial statements of Registrant, which were audited by Moore Stephens, independent certified public accountants, for the fiscal years ended December 31, 1994, 1993 and 1992. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operation" and the financial statements, related notes and report of independent auditors, included herein. Specifically, for a detailed discussion of the Discontinued Operations of the Registrant, see Item 1 "Business-Current Business Activities-Discontinued Real Estate Development Project-Sale of TRP" and Notes 1 and 5 to the financial statements incorporated in Item 8 of this Report. Item 7. Management's Discussion and Analysis of Financial Condition and Results On November 16, 1992 (the "Acquisition Date") Registrant acquired all of the issued and outstanding capital stock of Tyne River Properties plc, a company incorporated in England ("TRP"), from the holders thereof in exchange for eleven million, eight hundred ninety-nine thousand, two hundred thirty-six (11,899,236) newly issued shares of Registrant's common stock. The scale of this acquisition was such that the activities of TRP formed the major part of Registrant's activities until the sale on March 29, 1994. As required by US accounting standards, the financial statements for the years ended December 31, 1993 and December 31, 1994, have been prepared to treat TRP as the parent company with balance sheet data and results of operations of Little Prince Productions included only with effect from the Acquisition Date. All the comparative financial information for periods prior to the Acquisition Date through December 31, 1994 therefore relate solely to TRP and its subsidiaries. The balance sheets also reflect the effects of accounting for the acquisition as a merger (purchase type). Balance sheet amounts originally denominated in United Kingdom sterling have been translated into U.S. dollars using the veer-end rate of exchange. Operational results originally denominated in United Kingdom sterling have been translated into U.S. dollars using the average annual rate of exchange. All business transactions effected by TRP are made in United Kingdom sterling. Fluctuations in foreign exchange rates could have, and in the past have at various times had, either negative or positive impacts on Registrant's balance sheet and results of operations. The Consolidated Statement of Shareholders' Equity included in the financial statements, which form a part of this report, shows the impact of changes in the dollar/sterling exchange rate on the value of TRP's assets and results of operations over this and prior periods. Such Statement for the year to December 31, 1994 shows no exchange gain or loss on translation. For the years ended December 31, 1993 and December 31, 1992, the Registrant had an exchange loss on translation of $21,736 and $49,122, respectively. Registrant's operating results are summarized in ITEM 6 Selected financial Data. Generally, the decrease in Registrant's net loss from discontinued operations in 1994 resulted from the Registrants decision to sell TRP in part due to the additional decrease in the value of the A19 Property (as discussed under "Current Business Activities--Discontinued Real Estate Development Projects-Sale of TRP" of Item 1 of this Report). The sale of TRP resulted in a gain of $287,428. The increase in Registrant's net loss from discontinued operations from 1992 to 1993 was substantially the result of cash flow problems of TRP that were caused and exacerbated by a number of factors, including, but not limited to, a severe economic recession in the UK, which had a significant adverse effect on the UK real estate property markets, the cessation of rental revenues from a major property owned by TRP, the refusal of TRP's major lending bank to extend further credit, and the unexpected demand by a major creditor of TRP for payment in full of a major outstanding liability, and the completely unanticipated actions taken by such creditor in issuing a petition to the Court to dissolve TRP's wholly owned subsidiary, Exchange Buildings, Limited ("EBL") and to liquidate its assets. As a result of the foregoing the Registrant was forced to reduce the value of the Exchange Building by $970,000 and the A19 Property by $120,000. In addition, the 1992 Net Loss was reduced by the insurance proceeds on the destination of property which gave rise to an exceptional profit of $1,398,186. Following discontinuance of the real estate development activities, Registrant's continuing business comprises its Theatrical Operations only-see Item 1 Theatrical Operations-and the results have been restated accordingly. All of this income derives from arrangements whereby Registrant receives revenue dependent on the successful staging of theatrical productions. If the theatrical productions are not successful then Registrant's revenue is severely reduced. The timing of receipt of the income is also dependent on the timing of staging the theatrical productions and can therefore fluctuate year on year. Whereas income was received during the 3 years ended December 31, 1994 there is no guarantee that income will continue to be received into the future. Revenue is not sensitive to changes in prices nor the effects of inflation. Registrant's operating costs comprise those costs associated with Registrant's continued compliance with regulatory matters including associated legal and professional costs. The above table indicates the line by line changes in the financial position of the Company over the 3 years ended December 31, 1994, 1993 and 1992. Throughout the period, albeit without success, the Company sought to raise additional liquidity through the issuance of additional shares of its common stock in order to further the property development segment of its business. This business was characterized by large fluctuations in working capital requirements arising from the relatively long duration of projects. In the initial stages, projects would absorb significant cash as properties were under construction. The Company would receive a return on its investment when the completed properties were sold. Given the lack of success in raising funds through the issuance of common stock, the Company had to substantially increase its borrowings. By December 31, 1991 completed properties were becoming available for sale and throughout the course of the following 3 years sales were made. Notwithstanding the Company's investment of additional funds to complete further properties, the level of sales was such that a substantial reduction in the level of working capital invested in development properties was seen during 1992 and 1993. The funds so released were primarily used in those years to reduce the level of mortgage loan outstanding together with related trade creditors. A major fire within one of the development properties under construction in early 1992 led to an insurance claim totalling $1.86 million which was included within the balance sheet at December 31, 1992 and paid during 1993. This accounts for the major part of the increase and subsequent decrease in the totals for Other debtors between December 31, 1991, 1992 and 1993. On March 29, 1994, the Company disposed of the whole of its interest in the share capital of Tyne River Properties pic (see Item 1 Business-Discontinued Real Estate Development Projects-Sale of TRP). The effect of this disposal on the line items above is set out in detail in Note 16 to Registrant's Financial Statements (see Item 8 below). On August 22, 1994, Registrant reached agreement with its Officers and Directors and a firm of professional advisors to issue shares of its Common Stock in full and final settlement of any claims they may have had against Registrant. See Item 13-Settlements with Officers and Directors. A total of 7,750,000 shares of common stock were issued in settlement of liabilities totalling $462,656. On the same day, an additional 3,250,000 shares of common stock were issued for $32,500 to Rapirian Securities Limited who, in addition to acquiring the shares in the common stock, had indicated their intention to give short term financial support to Registrant throughout the period of reorganization. The combined effect of both of these transactions was to improve the liquidity of Registrant by $495,146. Registrant had no material commitments for capital expenditure at any of the years ended December 31, 1994, 1993 and 1992. Currently, Registrant does not have any revenue resources. It must therefore rely on increasing its authorized share capital to either sell to potential investors in either public or private transactions or acquire a suitable business to satisfy the minimum financial criteria for inclusion in the National Association of Securities Dealers, Inc. automated quotation system. For a more detailed description of the Registrant's business plan, please see "Current Business Activities-Proposed Business Plan of RSL" under Item 1 of this Report. In order to make acquisitions of any such properties or businesses, in exchange for issuances of stock in Registrant, a meeting of Registrant's shareholders must be called for the purpose of, among other things, increasing the amount of authorized capital stock. Item 8. Financial Statements and Supplementary Data The consolidated financial statements and related financial information required to be filed are indexed on page F-1 and are incorporated herein. Item 9. Changes in and Disagreements With Accountants on Accounting and As at November 16, 1992, Registrant became the successor to TRP through a reverse acquisition. Pursuant to the Rules and Regulations of the Securities and Exchange Commission, perforce of such acquisition, TRP became, for accounting purposes, the reporting entity constituting the Registrant. KPMG Peat Marwick was previously the certifying accountants for TRP. On March 4, 1993, the board of directors terminated that firm's appointment and engaged Moore Stephens, of St. Paul's House, Warwick Lane, London EC4P 4BN as Registrant's certifying accountants for the fiscal year ended December 31, 1992. Moore Stephens has continued as Registrant's certifying accountants for the fiscal years ended December 31, 1993 and December 31, 1994 and is still presently serving as Registrant's certifying accountants. In connection with the audits of the two fiscal years ended December 31, 1991 and December 31, 1990, there were no disagreements with KPMG Peat Marwick on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to their satisfaction, would have caused them to make reference to the subject matter of the disagreement in connection with their reports. The audit reports of KPMG Peat Marwick on the financial statements of TRP as of and for the fiscal years ended December 31, 1991 and December 31, 1990 did not contain an adverse opinion or a disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles. The decision to change accountants was approved by Registrant's board of directors. Item 10. Directors and Executive Officers of Registrant On September 9, 1994, RSL acquired a major equity position in Registrant pursuant to the RSL Agreement, which also provided for a change in the management of Registrant. For a discussion of the RSL Acquisition and Agreement, reference is made to the subtopic "Current Business Activities-RSL Agreement" of Item 1 of this Report. On February 15, 1995 one of the persons designated by RSL as an officer and director of Registrant was removed for cause and replaced. Directors and Executive Officers During the Year Ended December 31, 1994. The table below sets forth the persons who were the directors and executive officers of Registrant at any time during the year ended December 31, 1994 together with their respective ages, their respective dates of service, the year in which each was first elected or appointed an officer or director, and any other office in Registrant held by each such person. All persons who served as officers of Registrant during this period also served as executive officers. Directors and Executive Officers After the Year Ended December 31, 1994. The table below sets forth the persons who were the directors and executive officers of Registrant at any three after the year ended December 31, 1994 together with their respective ages, their respective dates of service, the ),ear in which each was first elected or appointed an officer or director, and any other office in Registrant held by each such person. All persons who served as officers of Registrant during this period also served as executive officers. Messrs. Kirby, Chapman, and Evans, Registrant's current officers and directors, devote such of their time to Registrant's business and affairs as is required for their executive duties and meetings of the board of directors. On average, this requires an expenditure of 36 hours per week on the Registrant's business. Mr. Tandet devotes the majority of his time to the business affairs of LPP and Mr. Chapman devotes such time as is required for his executive duties and meetings of LPP's board of directors. No family relationship exists between any director or executive officer of Registrant or person contemplated to become such. The following summarizes the present occupation and business experience during the past five years for each person who was a director or executive officer of Registrant at any time during the fiscal year ended December 31, 1994 or thereafter through and including March 31, 1995. No other persons have been nominated or chosen to become directors of Registrant. Adrian P. Kirby has been the president, chief executive officer and chairman of the board of directors of Registrant since October 1, 1994. He was a founder and is a major shareholder of Atlantic Properties, Ltd., and has served as a director and as treasurer of such corporation since its inception on February 15, 1995. In 1993, Mr. Kirby founded The Riparian Group, consisting of Riparian Securities, Ltd., Riparian Investments, Ltd. ("RIL"), and Riparian Properties, Ltd. Mr. Kirby is the Chief Executive Officer of all of the constituent corporations of the Riparian Group. In 1984, Mr. Kirby incorporated Guardacre Investments Limited, and subsequently, Guardacre Securities and Guardacre Properties Limited. Collectively, these corporations were known as the "Guardacre Group." From 1984 through November 1993, Mr. Kirby was the Chief Executive Officer of the Guardacre Group. The constituent corporations of the Guardacre Group were involved in a wide ranging program of investment trading predominantly in the commercial sector of the real estate market until November 1993 when they were sold and Mr. Kirby resigned. Peter N. Chapman has served as treasurer, secretary, and a director of Registrant from November 16, 1992 through the present. He also served as a director and the secretary of TRP from 1986 until March 29, 1994. On April 15, 1994, Barclays Bank foreclosed on Exchange Buildings, Ltd., a principal subsidiary of TRP. Chapman has been employed as a chartered accountant since 1979. He has been self employed since 1990, first independently and subsequently as a partner in Chapman & Chapman, a firm of chartered accountants. From 1988 through January 1990, Mr. Chapman worked for William A. Swales Limited where, commencing in January 1989, he served as Finance Director. From 1985 to 1988 he was employed by Pearson Engineering, initially as Finance Director and subsequently as Joint Managing Director. From 1983 to 1985 Mr. Chapman worked as the Finance Director for T.B. Pearson & Sons Limited. From 1976 to 1983 Mr. Chapman was employed by the public accounting firm of Peat, Marwick, McLintoch in Newcastle Upon Tyne. Mr. Chapman's varied work experience within the accounting profession has been primarily devoted to problem identification, the derivation of practical solutions to those problems and the controlled management of those solutions. Effective November 16, 1992, Mr. Chapman was appointed as an officer and director of LPPL Corp., a wholly owned subsidiary of Registrant. Mr. Chapman received a B.A. degree from Leeds University in 1976 and was admitted as a Fellow of the Institute of Chartered Accountants in England and Wales in 1979. Christopher N.C. Jones served as a director and executive vice president of Registrant from October 1, 1994 until February 15, 1995, when he was removed from such positions for cause. Mr. Jones is an associate of the Royal Institution of Chartered Surveyors and holds a diploma in Estate Management. Since 1959, Mr. Jones has been self employed as an independent commercial property consultant advising pension funds, property companies, and other property, holding clients. Since 1989, Mr. Jones has been a major shareholder and has served as the chief executive of Kingscote Limited, a United Kingdom company. Kingscote Limited held and managed commercial properties throughout the UK until such properties were sold prior to 1991. Robert David Evans has been the executive vice president and a director of Registrant since February 15, 1995. He has also served as the president and a director of Atlantic Properties, Ltd. since its inception on February 15, 1995. Since 1993, Mr. Evans has been self-employed as a business consultant, assisting with acquisitions and disposals of various business entities and with financing of various projects, principally involving gold, diamonds, and oil properties in Russia. From 1988 through 1992, Mr. Evans was Chairman and Chief Executive Officer and a major shareholder of Enterprise Computer Holdings, Plc ("ECH"). ECH is involved in the marketing of computer hardware and software. Terence G. Galgey served as the president and as a director of Registrant from November 16, 1992 until October 1, 1994 when he resigned his positions as required under the terms of the RSL Agreement (see "Current Business Activities-RSL Agreement" of Item 1 of this Report). He also served as the chairman of the board of directors of TRP from 1987 until March 29, 1994. Since 1983, Mr. Galgey has been the chairman and managing director of T.G. Galgey & Co. Limited, a brokerage firm and member of the London Stock Exchange. He has also been a shareholder, officer, and director of Galgey Financial Services Limited (formerly a wholly owned subsidiary of T.G. Galgey & Co. Limited) since 1988. Since 1982, Mr. Galgey has been a shareholder, officer, and director of Galgey Technical Industries Ltd. Both Galgey Financial Services Limited and Galgey Technical Industries Limited currently own assets but conduct no significant operations. William J. Peacock served as executive vice president and as a director of Registrant from November 16, 1992 until October 1, 1994 when he resigned his positions as required under the terms of the RSL Agreement (see "Current Business Activities-RSL Agreement" of Item 1 of this Report). He also served as a director of TRP from 1987 until March 29, 1994. Mr. Peacock is a civil engineer and has an extensive background in property management and development. Since March 1985, Mr. Peacock has been a director of Wincomblee Estates Ltd. and subsidiary companies. He was the founder of Oform Associates Ltd., is a major shareholder, and served as an officer and director thereof from 1983 to 1989. Since 1989, Mr. Peacock has been a director of Oform Associates Ltd. which provided project management, engineering, design and costing services to TRP (see "Related Transactions," below). From 1977 through 1982. Mr. Peacock was an officer and director of Broadacre Developments Ltd. He is a graduate of the Institution of Civil Engineers where he was awarded the James Forrest Silver Medal for published papers relating to civil engineering matters. Carl J. Kuehner served as vice president and a director of Registrant from November 16, 1992 until October 1, 1994 when the resigned his positions as required under the terms of the RSL Agreement (see "Current Business Activities-RSL Agreement" of Item 1 of this Report). He is a licensed real estate broker and has an extensive background as a real estate developer and consultant. He has also participated in the design of an advanced multi-processor computer system and has worked in the areas of dynamic storage management systems and computer systems simulation. Mr. Kuehner has been the president of Real Estate Technology Corp. ("RETC") in Naples, Florida since 1989. From October 1975 until September 1989 he was president of Real Estate Technology Corp., in New Canaan, Connecticut, an affiliate of RETC. Mr. Kuehner received a B.S. degree in physics from the University of Scranton in 1952 and a Master of Science degree in engineering from the University of Pennsylvania in 1964. A. Joseph Tandet served as president, treasurer, and a director of LPP from its inception in April 1980 until November 16, 1992, when he resigned from his positions as president and treasurer and was appointed vice president of Registrant. He served as vice president and a director of Registrant until October 1, 1994 when he resigned his positions as required under the terms of the RSL Agreement (see "Current Business Activities-RSL Agreement" of Item 1 of this Report). Mr. Tandet has been president and a director of LPPL Corp. since its inception in 1980, and continues to serve as such. For more than the past twenty years, Mr. Tender has been an attorney practicing in New York City. Mr. Tandet has also been engaged for more than twenty years in various entertainment and cultural activities in New York City, including the co-production of the off-Broadway play "Blood Wedding," a concert at Philharmonic Hall, and the co-production of the film "The Little Prince." Mr. Tandet also was a co-founder of the Committee for International Composers Concerts, Inc. and the Manhattan Theatre Club, Inc. which he served as president from founding until 1984 and which he presently serves as a Director Emeritus. Mr. Tandet has also produced two Broadway plays, "The Little Prince" and "Born Yesterday," as well as the off Broadway productions, "The Boys Next Door" and "Oil City Symphony." Other theatrical productions by Mr. Tandet include "Hearts Desire," which played in regional productions and a showcase production of "The Witch of Wall Street," at Lincoln Center, New York. Compliance with Section 16(a) of the Exchange Act Any person who is an officer, director, or the beneficial owner, directly or indirectly, of more than 10% of the outstanding common stock of Registrant is required under Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") to file certain reports with the Securities and Exchange Commission (the "Commission") disclosing his or her holdings or transactions in any securities of Registrant. For purposes of this discussion, all such persons required to file such reports will be referred to as "Reporting Persons." Every Reporting Person must file an initial statement of his or her beneficial ownership of Registrant's securities on the Commission's Form 3 within ten days after he or she becomes a Reporting Person. Thereafter (with certain limited exceptions), all changes in his or her beneficial ownership of Registrant's securities must be reported on the Commission's Form 4 on or before the 10th day after the end of file month in which such change occurred. In addition, all Reporting Persons will be obligated to file an annual statement on the Commission's Form 5 within 45 days after the end of the fiscal year unless all reportable transactions have already been reported on an earlier filed Form 3 or Form 4. Transactions reportable on Form 5 will include all changes in a Reporting Person's beneficial ownership of Registrant securities which were not required to be reported on a Form 4 during the fiscal year as well as all holdings and transactions, which should have been reported during the most recent fiscal year on a Form 4, but were not. Statements of holdings which should have been reported on a Form 3 or transactions required to have been reported on a Form 4, which are reported on Form 5 after the end of the fiscal year in which they occurred will represent late Form 3 and Form 4 filings. Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to Registrant during the fiscal year ended December 31, 1994, Registrant knows of no person who was a Reporting Person and was a director, officer, or beneficial owner of more than 10 percent of any class of equity securities of the Registrant, who has failed to file any reports required to be filed on Forms 3 or 4 with respect to his holdings or transactions in Registrant's securities, other than as follows: Forms 3 Forms 4 Not Reported William J. Peacock 1 1 Peter N. Chapman 1 1 Adrian P. Kirby 1 1 2 Christopher N.C. Jones 1 1 Riparian Securities, Ltd. 1 1 2 Registrant expects that all Reporting Persons who failed to file the proper reports due during the fiscal year ended December 31, 1994 will file such reports, albeit on an untimely basis, during the fiscal year ended December 31, 1995. Registrant has no stock option or stock appreciation rights, long term or other incentive compensation plans, deferred compensation plans, stock bonus plans, pension plans, or any other type of compensation plan in place for its executive officers, directors, or other employees and none of its executive officers or directors have ever received compensation of any such types from Registrant pursuant to plans or otherwise. The following table sets forth information concerning the annual compensation received or accrued for services provided in all capacities to Registrant for the years ended December 31, 1994, 1993, and 1992 by Registrant's chief executive officer. None of Registrant's executive officers received or accrued annual compensation in excess of $100,000 in any of such years. All of Registrant's current executive officers have agreed to render services to Registrant solely for the purpose of enhancing the value of their shareholdings in Registrant, until such time as Registrant has the financial resources available to compensate such persons for their services. (See the "Security Ownership of Management" table included in Item 12 of this Report.) Name Position December 31, Salary Adrian P. Kirby(1) President and 1994 $ -0- $ -0- Terence G. Galgey(2) President and 1994 14,250 83,352(3) Terence G. Galgey(2) President and 1993 49,377 Terence G. Galgey(2) President and 1992 9,808 (1) Mr. Kirby became president and chief executive officer of Registrant on October 1, 1994. Mr. Kirby has agreed to render his services to Registrant solely for the purpose of enhancing the value of his shareholdings in Registrant until such time as Registrant has the financial resources available to compensate him for his services. (2) Mr. Galgey took office as Registrant's president and chief executive officer on November 16, 1992 and served as such until October 1, 1994. Under Mr. Galgey's service agreement with Registrant, he was entitled to be paid an annual salary of $85,000 for 1992. The mount shown for 1992 represents sums earned and received by Mr. Galgey for the period from November 16, 1992 to December 31, 1992. Mr. Galgey received all of his compensation from Registrant indirectly through T.G. Galgey & Co., an English company controlled by Mr. Galgey through stock ownership and his positions as an officer and director thereof. Under Mr. Galgey's service contract with Registrant, he was entitled to receive a salary of $85,000 in 1993 and $61,979 in 1994 relating to the period prior to his resignation. Due to a lack of liquidity the Company was unable to pay the amounts due. Only those sums outlined in the table above were paid. At the time of his resignation, $83,352 was outstanding and due under Mr. Galgey's service contract. In full and final settlement of this debt shares in the Company's common stock were issued as set out in Note (3) below. (3)The liability of the Company under the Mr. Galgey's service agreement that was unpaid at the date of his resignation on October 1, 1994 of $83,352 was settled in full by the issuance of 1,250,000 shares in the Company's common stock. The directors of Registrant are not compensated for their services as such. Item 12. Security Ownership of Certain Beneficial Owners and Management Security Ownership of Certain Beneficial Owners The following table sets forth information with respect to the beneficial share ownership, as of March 31, 1995 of Registrant's common stock, $.01 par value, by each person who is known by Registrant to own beneficially more than 5% of Registrant's common stock. Name and Address Amount and Nature of of Beneficial Owner Beneficial Ownership Percent of Class(3) c/o Von Erlach & Partners Adrian P. Kirby(2) 6,240,402 25 Terence G. Galgey(3) 2,250,000 9 John L. Milling(3) 1,250,000 5 115 River Road, Bldg. 12 Frances Katz Levine(3) 1,250,000 5 115 River Road, Bldg. 12 (1) Includes 3,250,000 shares issued to RSL pursuant to the RSL agreement and an aggregate of additional 2,990,402 shares, transferred to RSL by Messrs. Peacock and Chapman, for the nominal consideration of $.0001 per share. All of such shares were transferred by RSL to the Patchouli Foundation on January 17, 1995. Both RSL and the Patchouli Foundation are under the control of Adrian P. Kirby and such transfer was therefore deemed not to involve a change in beneficial ownership. See Footnote 2 to this Table. (2) Includes 6,240,402 shares beneficially owned by the Patchouli Foundation; Mr. Kirby may be deemed to be a beneficial owner of such shares through the investment and voting powers which Mr. Kirby was over such shares through his position as attorney-in-fact for the administrator of the Patchouli Foundation. (3) Issued in September 1994 in partial satisfaction of unpaid fees for legal services rendered and unreimbursed expenses incurred. The following table sets forth information with respect to the share ownership, as of March 31, 1995, of each person who served as an executive officer and/or director of Registrant during the fiscal year ended December 31, 1994, individually and as a group. Name and Address Amount and Nature of of Beneficial Owner Beneficial Ownership Percent of Class(3) Terence G. Galgey 2,250,000 9.0% William J. Peacock 299,437(1) 1.2 Peter N. Chapman 325,000(2) 1.3 Carl J. Kuehner 845,687 3.4 A. Joseph Tandet(3) 478,000 1.9 Adrian P. Kirby(2) 6,240,402 25.0 (1) Excludes 1,500,000 shares which Mr. Peacock sold to RSL on October 7, 1994 as part of the aggregate of 3,000,000 shares which RSL purchased from Messrs. Peacock and Chapman for the nominal consideration of $.0001 per share. (2) Excludes 1,500,000 shares which Mr. Chapman sold to RSL on October 7, 1994 as part of the aggregate of 3,000,000 shares which RSL purchased from Messrs. Peacock and Chapman for the nominal consideration of $.0001 per share. (3) Does not include 500,000 shares which Registrant has agreed to issue to Mr. Tandet in consideration of his agreement to perform extensive legal services on behalf of Registrant's wholly owned subsidiary, LPPL Corp. Such stock issuance will be made at such time as Registrant's certificate of incorporation is amended so as to increase the authorized capital stock thereof. (4) Based upon 24,999,236 shares of common stock, $.01 par value, issued and outstanding as of April 7, 1995. On September 9, 1994, RSL acquired 25% of the issued and outstanding stock of Registrant. On October 1, 1994, changes in the management of Registrant made pursuant to such stock acquisition took effect. See the discussion thereof contained in the subtopic "Current Business Activities-RSL Agreement" in Item 1 of this Report. Registrant is not aware of any arrangements which may at a subsequent date result in a change in control of Registrant. Item 13. Certain Relationships and Related Transactions Transactions and Business Relationships with Management Service and Employment Agreements. Following the November 16, 1992 Reverse Acquisition, Registrant entered into agreements, directly or indirectly,1 with A. Joseph Tandet and the four other executive officers who were appointed as executive officers of Registrant pursuant to the Reverse Acquisition. Such agreements provided for services to, or employment by, Registrant. 1. A service agreement, dated November 16, 1992, with Galgey Financial Services Limited CGFSL") providing for the services of its president, Terence G. Galgey (the "Galgey Service Agreement"); 2. A service agreement, dated November 16, 1992, with Oform Associates Limited ("Oform") providing for the services of its executive vice president, William J. Peacock (the "Peacock Service 3. A service agreement, dated November 16, 1992, with Chapman & Chapman ("C&C") providing for the services of its treasurer and secretary, Peter N. Chapman (the "Chapman Service Agreement"); and 1 In Registrant's respective Service Agreements with GFSL, Oform and C&C each of the foregoing acknowledged to Registrant that Messrs. Galgey, Peacock, or Chapman, as appropriate, was its exclusive employee, that each such individual's services were being furnished to Registrant as an independent contractor, and that accordingly, to the extent that all applicable laws and regulations allowed, the responsibility of complying with all statutory and legal requirements relating to each such respective individual as an employee, would be discharged wholly by GFSL, Oform or C&C, as applicable. The Service Agreements further provided that in the event any person should seek to establish any liability or obligation upon Registrant on the grounds that any of the respective individuals is an employee of Registrant, GFSL, Oform or C&C, as appropriate, would indemnify Registrant and keep it indemnified in respect of any liability or obligation and any related costs, expenses or other losses which Registrant incurred in connection therewith. 4. An employment agreement, dated October 21, 1992, with A. Joseph Tandet providing for Mr. Tandet's employment as the vice president of Registrant and as president of LPPL Corp. (the "Tandet Employment Agreement"). Settlements with Officers and Directors. Registrant was unable in varying degrees to meet its financial obligations under the service and Employment Agreements. As a result, Registrant accrued contractual liabilities arising from unpaid salaries and unreimbursed expenses. In connection with the August 22, 1994 RSL Agreement, Registrant entered into separate settlement agreements with the contracting parties under the respective service and employment agreements. In connection with the RSL stock acquisition and change in management, Messrs. Galgey, Peacock, Chapman, Tandet and Kuekner entered into separate settlement and release agreements with Registrant whereby they accepted, in full and final settlement of any claims they may have had against Registrant respecting accrued but unpaid compensation and reimbursable expenses, shares of Registrant's common stock, valued at approximately $.06 per share, as follows: Torenee G. Galgey $83,352 1,250,000 William J. Peacock 98,103 1,575,000 Peter N. Chapman 100,648 1,625,000 In addition, Registrant agreed to issue 500,000 shares to Mr. Tender, at such time as Registrant's certificate of incorporation is amended so as to increase its authorized capital stock, in consideration of Mr. Tandet's agreeing to render extensive legal services in connection with certain litigation matters of Registrant and its subsidiary LPPL Corp. Loan From Affiliate. During the year ended December 31, 1994 and the period subsequent thereto, the Patchouli Foundation his made loans to Registrant to cover costs and expenses incurred in connection with various corporate activities, including without limitation, legal, accounting, and filing fees incurred in connection with the preparation of Registrants annual reports on Form's 10-K for the years ended December 31, 1993 and 1994. To date, such loans aggregate to approximately $50,000. Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) The following documents are filed as part of this Report. 1. Financial Statements. See Index to financial statements on page f-1 of this Report. 2. Financial Statement Schedules. Financial statement schedules have been omitted for the reason that they are not required or are not applicable, or the required information is shown in the financial statements or notes thereto. 3. Exhibits. Exhibits filed as part of this report are as follows: 2(a) Offer Document relating to the Recommended Offers by RAS Securities Corp. on behalf of Little Prince Productions, Ltd. to acquire the entire issued share capital of Tyne River Properties plc and Notice of Extraordinary General Meeting of Tyne River Properties (b) Announcement; dated November 16, 1992, by RAS Securities Corp. respecting valid acceptances of the Exchange Offer (mailed to TRP 10(a) Agreement, dated October 21, 1992, by and among Little Prince Productions, Ltd., Tyne River Properties plc, Terence G. Galgey, William J. Peacock, and Peter N. Chapman(1) 10(a) (b) Letter, dated November 16, 1992, from the directors of TRP to Registrant consenting to Registrant's declaring the Exchange Offer unconditional and delivering certificate from Barclays Registrars respecting the receipt of acceptances of the Exchange Offer from the holders of 90.38% of the TRP Ordinary shares, and 100% of the TRP Founder and Deferred (c) Service Agreement, dated November 16, 1992, with Galgey Financial Services Limited(2) 10(c) (d) Service Agreement, dated November 16, 1992, with Oform Associates Limited(2) 10(d) (e) Service Agreement, dated November 16, 1992, with Chapman & Chapman(2) 10(e) (f) Employment Agreement, dated October 21,1992, with A. Joseph Tandet(2) 10(f) (g) Agreement, dated August 22, 1994, between Little Prince Productions, Ltd. and Riparian 23* Consent of Moore Stephens L.L.P. (1) Filed with the Securities and Exchange Commission as an exhibit, numbered as indicated above, to Registrant's Form 10-K, dated November 16, 1992, which exhibit is incorporated herein by reference. (2) Filed with the Securities and Exchange Commission as an exhibit, numbered as indicated above, to Registrant's Transition Report on Form 10-K for the period ended November 16, 1992, which exhibit is incorporated herein by reference. (3) Filed with the Securities and Exchange Commission as an exhibit, numbered as indicated above, to Registrant's Form 8-K, dated August 22, 1994, which exhibit is incorporated herein by reference. (b) Reports on Form 8-K No reports on Form 8-K have been filed by Registrant during the last quarter of the period covered by this report. Pursuant to the requirements of Section 13 or 15(d) and Rule 12b-15 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. By /s/ Adrian P. Kirby Consolidated Statements of Operations............................ F-5 Consolidated Statements of Shareholders' Deficit................. F-6 Consolidated Statements of Cash Flows............................ F-7 Notes to Financial Statements.................................... F-9 We have audited the consolidated balance sheets of Little Prince Productions, Ltd., and subsidiaries at December 31, 1994 and 1993 and the related consolidated statements of operations, shareholders' deficit and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements 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 consolidated financial position of Little Prince Productions, Ltd., and subsidiaries as of December 31, 1994 and 1993, and the consolidated results of its operations and cash flows for each of three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. Cash and cash equivalents 5,241 29,933 Investment in US Government Bond Fund Prepaid expenses and taxes 612 27,807 Settlement proceeds receivable (note 11) -- 50,000 Development properties (note 7) -- 3,548,150 Other debtors (note 13) 23,700 74,181 Total current assets 40,453 3,750,071 Furniture, fixtures and equipment -- 2,996 Less: Accumulated depreciation -- (1,033) Net property and equipment -- 1,963 Production rights (note 8) 7,500 10,000 Investment in joint ventures 3,728 728 Total other assets 11,228 10,728 Total Assets $ 51,681 $ 3,762,762 The accompanying notes are an integral part of these financial statements Liabilities and Shareholders' Deficit $ $ Mortgage loan (note 9) -- 2,516,589 Bank loan (note 9) -- 723,325 Other current liabilities (note 14) 55,000 219,547 Total current liabilities 214,145 4,202,881 Minority shareholders' interests -- 85,309 Common stock $0.01 par value Additional paid-in capital 3,006,891 2,621,735 Total shareholders' deficit (162,464) (525,428) Total Liabilities and Shareholders' Deficit $ 51,681 $ 3,762,762 The accompanying notes are an integral part of these financial statements The accompanying notes are an integral part of these financial statements The accompanying notes are an integral part of these financial statements The accompanying notes are an integral part of these financial statements Notes to the Financial Statements 1. Summary of Significant Accounting Policies Business Combination. The accompanying consolidated financial statements give effect to the business combination of Little Prince Productions, Ltd. and Tyne River Properties plc as a reverse acquisition on 16th November 1992 under the purchase method of accounting. Tyne River Properties plc was as at 31st December 1993, a subsidiary of Little Prince Productions, Ltd. On 29th March 1994, Tyne River Properties plc and all other United Kingdom subsidiaries were sold for (pound)1 (see note 5). The financial results in respect of each of the two years ended 31st December 1993 have been restated so as to show the financial results of Tyne River Properties Plc as a discontinued operation. The financial results included in respect of Tyne River Properties plc are for the years ended 31st December 1992 and 1993, and for the period up to 29th March 1994. On 16th November 1992 Little Prince Productions, Ltd. acquired 100% of the issued share capital of Tyne River Properties plc, a company incorporated in the United Kingdom, in exchange for 11,899,236 shares of Little Prince Productions, Ltd. common stock, composing upon their issuance, approximately 85% of the common stock of the Company, issued and outstanding. Due to the relative size of the companies, Tyne River Properties plc was deemed the purchaser. For accounting purposes, the acquisition was treated as a recapitalization of Tyne River Properties plc with Tyne River Properties plc the acquirer (reverse acquisition). The statement of operations for the year ended 31st December 1992 reflects the operations of the Company and LPPL Corp. from 16th November 1992 onwards. As at 31st December 1993 Tyne River Properties plc owned all of the issued and outstanding capital stock of the following companies, all of which are incorporated in England, and whose principal activity was property development, unless otherwise indicated: Selective Construction Projects plc (88.8% interest) Period and Country Estates Limited (Dormant) Little Prince Productions, Ltd. also owned all of the issued and outstanding common stock of LPPL Corp. Formerly inactive until 17th November 1992, this company is now involved in the presentation of theatrical performances. The accompanying notes are an integral part of these financial statements The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Intercompany transactions and balances have been eliminated on consolidation. Basis of accounting, fiscal year The financial statements are presented on the accruals basis of accounting and the fiscal year ends on 31st December of each year. Net sales comprised royalty income. Fixtures and fittings are depreciated over four years on the straight line basis. Development properties are included in the balance sheet date at the lower of cost (including attributable interest and overheads) and net realisable value. Production rights are amortized by systematic charges to income over the estimated remaining life of such rights pursuant to APB17 and the provisions of FAS63. Usually capitalized rights are amortized based on the estimated number of future showings, however, the rights provide for unlimited showings over the period of the agreement and in management's opinion, the estimated number of future showings are not determinable. Where applicable, an additional charge is made in order to write down the value of the rights to their perceived value. Balance sheet amounts denominated in United Kingdom sterling have been translated into U.S. dollars using the year end rate of exchange. Operations results denominated in United Kingdom sterling have been translated into U.S. Dollars using the average annual rate of exchange. The accompanying notes are an integral part of these financial statements For the purposes of the statement of cash flows, the Company considers highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Net loss per share is computed by dividing the net loss by the average number of common shares outstanding during the period. Net sales comprised: 1994 1993 Virtually all royalty income is derived from one payor. The income arises from the Company's interest in various theatrical productions. Bank interest $ 663 $698 4. Provision for Income Taxes No liability to income taxes arises due to the losses of the Company and its subsidiary. As of January 1,1993 the Company adopted Statement of Accounting Standards No. 109 ("FAS 109"), Accounting for Income Taxes. In prior years the Company followed the provisions of Accounting Principles Board Opinion 11. Prior year financial statements have not be restated to reflect the provisions of FAS 109. The accompanying notes are an integral part of these financial statements 4. No cumulative effect of the change in accounting principle to FAS 109 is recorded in the statement of operations as the gross deferred asset of $1,160,000 has been offset by a valuation allowance of the same amount. The gross asset arises from net operating loss carryovers; however, management believes that there will not be enough taxable income in the future to utilize the losses and therefore a valuation allowance has been established for the full amount of the asset. The Company has approximately $2,910,400 of net operating losses which can be used to offset future federal taxable income. The losses expire as follows: The accompanying notes are an integral part of these financial statements 5. (Loss) Income from Discontinued Operations (Loss) income from discontinued operations relates to the financial results of Tyne River Properties Plc., which company was sold on 29th March 1994. The results comprised: Sale of properties 524,175 3,062,958 1,684,280 Rental income 122 28,307 35,466 Operating costs: on development contacts -- (509,190) (1,088,971) Write back of prior year buildings held for -- -- 156,651 Write down of land and development to net realisable -- (152,494) (155,710) destination of property -- -- 1,398,186 Other operating costs (849,365) (4,744,123) (1,799,013) (Loss)/Income from operations (325,068) (2,314,542) 230,889 Interest income 212 3,370 7,307 Interest expense (34) (876) (1,352) provision for income taxes (324,890) (2,312,048) 236,844 Provision for income taxes -- 113,056 (85,346) for income taxes (324,890) (2,198,992) 151,498 Minority interests 12 3,843 11,067 Net (loss)/income (324,878) (2,195,149) 162,565 The accompanying notes are an integral part of these financial statements 5. (Loss) / Income from Discontinued Operations-Continued During the year ended 31st December 1992, a property which formed part of a development project being undertaken by a subsidiary was destroyed by fire. The property has since been demolished upon the recommendation of the group's insurers. The insurance proceeds, which were received in 1993, were $1,859,949 ((pound)91,228,500 at 1992 year end rates); deducting costs attributable to that development project gives rise to an exceptional profit of $1,398,186. On bank loans and overdrafts $ 74,042 $ 404,459 On other loans 34 876 Transfer to development properties (note 7) (74,042) (404,459) United Kingdom corporation tax on profits for the year at 33% $ -- $ -- United Kingdom corporation tax recoverable -- (113,056) 6. Investment in US Government Bond Fund The investment in US Government Bond Fund relates to an investment in a mutual fund comprised of short term debt securities issued by the US Treasury and other US Government agencies. As a mutual fund, investment has no stated maturity date. On 1 January 1994, the Company adopted Statement of Accounting Standards No. 115 ("FAS 115"), Accounting for Certain Investments in Debt and Equity Securities; the cumulative effect of the change in accounting principle was immaterial. The investment is classified as available for sale securities. At 31st December 1994 cost approximates market. During 1994 there were no material gross unrealised gains. The accompanying notes are an integral part of these financial statements Development properties $ -- $3,229,950 Land held for development -- 318,200 Cumulative interest included in development -- 894,941 On 29th March 1994 Tyne River Properties plc and all other United Kingdom subsidiaries were sold. On 4th April 1980, the President of the Company assigned to the Company all of the Rights relating to theatrical productions which he had received, in connection with an agreement with TLP Productions, Ltd., Editions Gallimard and Solifilm S.A. Such Rights and the related value of the shares then issued were recorded in the Company's books at $80,000 plus additional costs of $6,500 for an extension of the Rights and legal fees totalling $86,500. These Rights were subsequently transferred to LPPL Corp. As at 31st December 1994, the unamortized portion of the Rights was $7,500 (1993: $10,000 after a write down of $28,925 in 1993). 9. Mortgage and Bank Loans The mortgage loan was a revolving facility and was secured on a development property. No repayment date was set for this facility. Interest was charged at the prevailing United Kingdom base mortgage rate as charged to owner occupiers plus 2 per cent. The bank loan was secured on a development property. No fixed maturity date existed, but the loan was repayable on demand. Interest was charged at the prevailing United Kingdom bank base rate plus 2 1/2 per cent. The accompanying notes are an integral part of these financial statements 9. Mortgage and Bank Loans Continued Maximum amount outstanding (pound) 1,700,398 2,806,857 3,057,947 Weighted average interest rate (%) 10.3 10.6 13.3 Weighted average loan balance (pound) 1,566,310 1,768,265 2,457,965 Weighted average interest by value (%) 10.3 10.6 13.4 Maximum amount outstanding (pound) 488,733 488,733 488,733 Weighted average loan balance (pound) 488,733 488,733 488,733 Due to the nature of the bank loan whereby interest is charged direct to the bank account, no details of the weighted average interest rate and weighted average interest rate by value have been calculated. On 29th March 1994, Tyne River Properties plc was sold and consequently the mortgage no longer remain within the group. Transactions with related parties comprised: Emoluments $ 43,229 $ 56,250 Consideration to third parties for making available the services of directors 171,355 264,375 The accompanying notes are an integral part of these financial statements Transactions with related parties relate to the following: Mr. A.P. Kirby $ -- $ -- Mr. C.N.C. Jones -- -- Mr. T. Galgey 61,979 95,625 Mr. W.J. Peacock 54,688 120,141 Mr. P.N. Chapman 54,688 84,375 Mr. J. Tandet 25,000 28,125 Mr. C. Kuehner 18,229 28,125 Mr. W.J. Peacock was a director of the Company, until his resignation in August 1994. Oform Associates Limited, a company incorporated in England, of which Mr. W.J. Peacock is a minority shareholder and non-executive director, provided project management, engineering, design and costing services in respect of the development projects carried out by Pandon Developments Limited (a subsidiary of the Company) and was entitled to receive 5.5 per cent of the construction costs of the project (capped at (pound)6,000,000; $8,880,000 at 1993 year end exchange rates). During the year ended 31st December 1993, $35,766 was paid in respect of these services. From this sum, disbursements were made to the Consulting Engineers and Quantity Surveyors employed by Oform Associates Limited for the provision of their services as follows: the Consulting Engineers were entitled to receive 0.67 per cent of the construction costs of the project and Quantity Surveyors were entitled to receive 1.0035 per cent of the construction costs (capped at (pound)6,000,000; $8,880,000 at 1993 year end exchange rates) from the fee paid to Oform Associates Limited. Fees payable in respect of consultancy services provided by Mr. W.J. Peacock in the year amounted to $54,688 (1993 $84,375). All outstanding liabilities due to Mr. W.J. Peacock were sold as part of the settlement agreement (see note 18). Mr. T. Galgey was a director of the Company until his resignation in August 1994. Galgey Financial Services Limited of which Mr. T. Galgey is a director and shareholder, provided consultancy services to the Group. Fees payable in respect of such services in the year amounted to $61,979 (1993: $95,625). All outstanding liabilities due to Mr. T. Galgey were settled as part of the settlement agreement (see note 18). The accompanying notes are an integral part of these financial statements Mr. P.N. Chapman is a director of the Company. Chapman & Chapman, a firm of Chartered Accountants in which Mr. P.N. Chapman is a partner, provided consultancy and accounting services to the Group. Fees payable in respect of such services in the year amounted to $54,688 (1993: $84,375). All outstanding liabilities due to Mr. P.N. Chapman were settled as part of the settlement agreement (see note 18). LPPL Corp. maintains its office at 555 Fifth Avenue, New York, N.Y., the office of Mr. J. Tandet, who was the President of the Company until his resignation in August 1994. Mr. Tandet receives no remuneration for this facility from the Company or from LPPL Corp. Fees payable in respect of his services as a director in the year and for managing the affairs of the Company's operating subsidiary, LPPL Corp, amounted to $25,000 (1993: $28,125). All outstanding liabilities due to Mr. J. Tandet were settled as part of the settlement agreement (see note 18). Mr. C. Kuehner was a director of the Company until his resignation in August 1994. Fees payable in respect of such services in the year amounted to $18,229 (1993: $28,125). All outstanding liabilities due to Mr. C. Kuehner were settled as part of the settlement agreement (see note 18). On 18th December 1990, an action against Little Prince Productions, Ltd. commenced before the Tribunal de Grande Instance of Paris, France. The Plaintiff was seeking a judicial declaration of the termination of an agreement, along with reimbursement of all sums received and damages and legal fees of approximately $200,000. In February 1992, an agreement was reached to settle the above matter whereby Little Prince Productions, Ltd. was to receive $200,000 in return for giving up certain foreign rights to the "Rights" as follows: $50,000 receivable upon full performance of the Settlement Agreement and four receipts of $25,000 each every three months thereafter with a final receipt of $50,000 by November 1993. At the date of the signing of these financial statements, all monies had been received. The accompanying notes are an integral part of these financial statements 11. The Settlement also stipulated that the Company must abandon the corporate name "Little Prince Productions, Ltd." within 18 months from 6th February 1992. As at the date of the signing of these financial statements, the name of the Company has not been changed nor has any action been commenced by the plaintiff. The Company's former Counsel for a rescinded business combination instituted a lawsuit for legal fees of $81,000 in connection therewith. The Company filed a counterclaim against the plaintiff. In December 1992. All parties entered into a settlement agreement and in March 1993, the Group paid $25,000 in full settlement of this matter. In connection with the Group's 41% investment in the production of the musical play "Hearts Desire," the Cleveland Playhouse brought an action in the United States District Court for the Northern District of Ohio for the total sum of $75,000. The litigation was settled for $73,000 in April 1993, with $29,930 applicable to the Group. This amount was settled in the year ended 31st December 1993. On 31st December 1992, the LPPL Corp. authorized Theatreworks USA Corp, a New York stage production company which produces plays for family audiences to produce a new musical stage production based upon the literary work entitled `The Little Prince' (the "Work") and geared specifically for a juvenile audience. LPPL Corp. was paid $5,000 in January 1993 as an advance against two per cent (2%) of all gross revenues derived by Theatreworks from the production. No production has yet been mounted. On 1st December 1992 LPPL Corp. authorized two independent theatrical producers to produce another new musical stage production based upon the Work, in New York by 31st December 1993, geared for an adult audience. LPPL Corp. received a $2,000 advance in May 1993 of against royalties of 1 1/2 per cent of gross weekly box office receipts increasing to 2% upon recoupment of production costs derived from the production. A production was mounted for one week in October 1993. The show was subsequently closed in order to move to a more suitable location and was reopened on 13th November 1993. Pursuant to the terms of their respective agreements with LPPL Corp, the two productions will not be staged at the same time or in the same location. The accompanying notes are an integral part of these financial statements At 31st December 1994 the following components of Other Debtors comprised at least 5% of total current assets: Due from Riparian Securities Limited $ 2,770 Due from former joint venture partner 18,930 At 31st December 1994 the total of Other Current Liabilities is comprised of accrued professional fees. At 31st December 1993 no single component comprised at least 5% of the balance in this account. 15. Post Balance Sheet Event a. In February 1995, the Company entered into an agreement with Atlantic Properties Limited ("Atlantic"), a company incorporated in the State of Delaware, involved in property development. The terms of this agreement included the Company receiving 2-1/2% of the issued share capital of Atlantic, in return for services provided by directors of the Company to Atlantic. b. On 27th July 1995, an action of the Board of Directors by unanimous written consent resolved to authorise, empower and direct a filing of a Proxy Statement with the Securities and Exchange Commission and such other places as may be required. The accompanying notes are an integral part of these financial statements 16. Additional Information on Cash Flows Cash and cash equivalents $ (2,290) $ -- $ -- Development properties (3,141,987) -- -- Accounts receivable and other debtors (33,263) -- -- Property and equipment (1,415) -- -- Accounts payable and accrued income 437,804 -- -- Bank overdraft 18,626 -- -- Minority shareholders' interest 85,321 -- -- Proceeds of disposal 1 -- -- Gain on disposal $ 287,428 $ -- $ -- Changes in the currency translation adjustment included in the Shareholders' deficit section of the Consolidated Balance Sheet are as follows: Currency translation adjustment 1st January $(267,904) $(246,168) $ 229,856 Translation adjustments -- (21,736) (476,024) Adjustment through reserves 267,904 -- -- Currency translation adjustment 31st December -- (267,904) (246,168) On 22nd August 1994, the Company entered into certain agreements (the "Agreements") with Riparian Securities Limited ("Riparian"), a firm of professional advisers and the then directors of the Company. Pursuant to these agreements, a total of 11 million shares of the Registrant's common stock were issued for $495,146. Of the 11 million shares, a total of 7,750,000 were issued to the following individuals and entities in settlement of liabilities totalling $462,656: The accompanying notes are an integral part of these financial statements Terence G. Galgey $ 83,352 1,250,000 William J. Peacock 98,103 1,575,000 Peter N. Chapman 100,648 1,625,000 The remaining 3,250,000 shares were issued to Riparian for $32,500. Subsequent to 22nd August 1994, Riparian acquired an additional 3,000,000 shares of common stock, resulting in Riparian owning 25% of the issued and outstanding common stock of the Company. On 17th January 1995 Riparian transferred its entire holding to the Patchouli Foundation, a Liechtenstein Stiftung. As of 7th March 1995 the Patchouli Foundation owned 25% of the issued and outstanding common stock of the Company. The Agreements also required, among other things, that Messrs. Galgey, Peacock, Kuehner and Tandet resign as directors of the Company, and that Messrs. Kirby and Jones be appointed as directors. The Company also entered into an agreement on 22nd August 1994 to issue 500,000 shares to Mr. J. Tandet, at such time as the Company's certificate of incorporation is amended so as to increase its authorised capital stock, in consideration of Mr. Tandet's agreement to render extensive legal services in connection with certain litigation matters of the group. At the date of the signing of these financial statements, these shares have not been issued. The accompanying notes are an integral part of these financial statements Item 9. Disagreements on Accounting and Financial Disclosure As at November 16, 1992, Registrant became the successor to TRP through a reverse acquisition. Pursuant to the Rules and Regulations of the Securities and Exchange Commission, perforce of such acquisition, TRP became, for accounting purposes, the reporting entity constituting the Registrant. KPMG Peat Marwick was previously the certifying accountants for TRP. On March 4, 1993, the board of directors terminated that firm's appointment and engaged Moore Stephens, of St. Paul's House, Warwick Lane, London EC4P 4BN as Registrant's certifying accountants for the fiscal year ended December 31, 1992. Moore Stephens has continued as Registrant's certifying accountants for the fiscal years ended December 31, 1993 and December 31, 1994 and is still presently serving as Registrant's certifying accountants. In connection with the audits of the two fiscal years ended December 31, 1991 and December 31, 1990, there were no disagreements with KPMG Peat Marwick on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to their satisfaction, would have caused them to make reference to the subject matter of the disagreement in connection with their reports. The audit reports of KPMG Peat Marwick on the financial statements of TRP as of and for the fiscal years ended December 31, 1991 and December 31, 1990 did not contain an adverse opinion or a disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles. The decision to change accountants was approved by Registrant's board of directors. Item 10. Directors and Executive Officers of Registrant On September 9, 1994, RSL acquired a major equity position in Registrant pursuant to the RSL Agreement, which also provided for a change in the management of Registrant. For a discussion of the RSL Acquisition and Agreement, reference is made to the subtopic "Current Business Activities-RSL Agreement" of Item 1 of this Report. On February 15, 1995 one of the persons designated by RSL as an officer and director of Registrant was removed for cause and replaced. For information respecting the individuals designated by RSL to serve as officers and directors of Registrant until the next meeting of the shareholders, reference is made to the discussion thereof contained in Item 1 "Change in Control of Registrant" of Registrant's current report on Form S-K, dated August 22, 1994; Registrant's Notice to Shareholders pursuant to Rule 14f-1 of the 34 Act, filed with the Commission and mailed to Registrant's shareholders on September 21, 1994; and Item 5 "Other Events-Removal and Appointment of Directors" of Registrant's current report on Form S-K, dated February 15, 1995. Directors and Executive Officers During the Year Ended December 31, 1994. The table below sets forth the persons who were the directors and executive officers of Registrant at any time during the year ended December 31, 1994 together with their respective ages, their respective dates of service, the year in which each was first elected or appointed an officer or director, and any other office in Registrant held by each such person. All persons who served as officers of Registrant during this period also served as executive officers. Directors and Executive Officers After the Year Ended December 31, 1994. The table below sets forth the persons who were the directors and executive officers of Registrant at any three after the year ended December 31, 1994 together with their respective ages, their respective dates of service, the ),ear in which each was first elected or appointed an officer or director, and any other office in Registrant held by each such person. All persons who served as officers of Registrant during this period also served as executive officers. Messrs. Kirby, Chapman, and Evans, Registrant's current officers and directors, devote such of their time to Registrant's business and affairs as is required for their executive duties and meetings of the board of directors. Mr. Tandet devotes the majority of his time to the business affairs of LPP and Mr. Chapman devotes such time as is required for his executive duties and meetings of LPP's board of directors. No family relationship exists between any director or executive officer of Registrant or person contemplated to become such. The following summarizes the present occupation and business experience during the past five years for each person who was a director or executive officer of Registrant at an), time during the fiscal year ended December 31, 1994 or thereafter through and including March 31, 1995. No other persons have been nominated or chosen to become directors of Registrant. Adrian P. Kirby has been the president, chief executive officer and chairman of the board of directors of Registrant since October 1, 1994. He was a founder and is a major shareholder of Atlantic Properties, Ltd., and has served as a director and as treasurer of such corporation since its inception on February 15, 1995. In 1993, Mr. Kirby founded The Riparian Group, consisting of Riparian Securities, Ltd., Riparian Investments, Ltd. ("RIL"), and Riparian Properties, Ltd. Mr. Kirby is the Chief Executive Officer of all of the constituent corporations of the Riparian Group. In 1984, Mr. Kirby incorporated Guardacre Investments Limited, and subsequently, Guardacre Securities and Guardacre Properties Limited. Collectively, these corporations were known as the "Guardacre Group." From 1984 through November 1993, Mr. Kirby was the Chief Executive Officer of the Guardacre Group. The constituent corporations of the Guardacre Group were involved in a wide ranging program of investment trading predominantly in the commercial sector of the real estate market until November 1993 when they were sold and Mr. Kirby resigned. Peter N. Chapman has served as treasurer, secretary, and a director of Registrant from November 16, 1992 through the present. He also served as a director and the secretary of TRP from 1986 until March 29, 1994. Mr. Chapman has been employed as a chartered accountant since 1979. He has been self employed since 1990, first independently and subsequently as a partner in Chapman & Chapman, a firm of chartered accountants. From 1988 through January 1990, Mr. Chapman worked for William A. Swales Limited where, commencing in January 1989, he served as Finance Director. From 1985 to 1988 he was employed by Pearson Engineering, initially as Finance Director and subsequently as Joint Managing Director. From 1983 to 1985 Mr. Chapman worked as the Finance Director for T.B. Pearson & Sons Limited. From 1976 to 1983 Mr. Chapman was employed by the public accounting firm of Peat, Marwick, McLintoch in Newcastle Upon Tyne. Mr. Chapman's varied work experience within the accounting profession has been primarily devoted to problem identification, the derivation of practical solutions to those problems and the controlled management of those solutions. Effective November 16, 1992, Mr. Chapman was appointed as an officer and director of LPPL Corp., a wholly owned subsidiary of Registrant. Mr. Chapman received a B.A. degree from Leeds University in 1976 and was admitted as a Fellow of the Institute of Chartered Accountants in England and Wales in 1979. Christopher N.C. Jones served as a director and executive vice president of Registrant from October 1, 1994 until February 15, 1995, when he was removed from such positions for cause. Mr. Jones is an associate of the Royal Institution of Chartered Surveyors and holds a diploma in Estate Management. Since 1959, Mr. Jones has been self employed as an independent commercial property consultant advising pension funds, property companies, and other property, holding clients. Since 1989, Mr. Jones has been a major shareholder and has served as the chief executive of Kingscote Limited, a United Kingdom company. Kingscote Limited held and managed commercial properties throughout the UK until such properties were sold prior to 1991. Robert David Evans has been the executive vice president and a director of Registrant since February 15, 1995. He has also served as the president and a director of Atlantic Properties, Ltd. since its inception on February 15, 1995. Since 1993, Mr. Evans has been self-employed as a business consultant, assisting with acquisitions and disposals of various business entities and with financing of various projects, principally involving gold, diamonds, and oil properties in Russia. From 1988 through 1992, Mr. Evans was Chairman and Chief Executive Officer and a major shareholder of Enterprise Computer Holdings, Plc ("ECH"). ECH is involved in the marketing of computer hardware and software. Terence G. Galgey served as the president and as a director of Registrant from November 16, 1992 until October 1, 1994 when he resigned his positions as required under the terms of the RSL Agreement (see "Current Business Activities-RSL Agreement") of Item 1 of this Report. He also served as the chairman of the board of directors of TRP from 1987 until March 29, 1994. Since 1983, Mr. Galgey has been the chairman and managing director of T.G. Galgey & Co. Limited, a brokerage firm and member of the London Stock Exchange. He has also been a shareholder, officer, and director of Galgey Financial Services Limited (formerly a wholly owned subsidiary of T.G. Galgey & Co. Limited) since 1988. Since 1982, Mr. Galgey has been a shareholder, officer, and director of Galgey Technical Industries Ltd. Both Galgey Financial Services Limited and Galgey Technical Industries Limited currently own assets but conduct no significant operations. William J. Peacock served as executive vice president and as a director of Registrant from November 16, 1992 until October 1, 1994 when he resigned his positions as required under the terms of the RSL Agreement (see "Current Business Activities-RSL Agreement") of Item i of this Report. He also served as a director of TRP from 1987 until March 29, 1994. Mr. Peacock is a civil engineer and has an extensive background in property management and development. Since March 1985, Mr. Peacock has been a director of Wincomblee Estates Ltd. and subsidiary companies. He was the founder of Oform Associates Ltd., is a major shareholder, and served as an officer and director thereof from 1983 to 1989. Since 1989, Mr. Peacock has been a director of Oform Associates Ltd. which provided project management, engineering, design and costing services to TRP (see "Related Transactions," below). From 1977 through 1982. Mr. Peacock was an officer and director of Broadacre Developments Ltd. He is a graduate of the Institution of Civil Engineers where he was awarded the James Forrest Silver Medal for published papers relating to civil engineering matters. Carl J. Kuehner served as vice president and a director of Registrant from November 16, 1992 until October 1, 1994 when the resigned his positions as required under the terms of the RSL Agreement (see "Current Business Activities-RSL Agreement") of Item 1 of this Report. He is a licensed real estate broker and has an extensive background as a real estate developer and consultant. He has also participated in the design of an advanced multi-processor computer system and has worked in the areas of dynamic storage management systems and computer systems simulation. Mr. Kuehner has been the president of Real Estate Technology Corp. ("RETC") in Naples, Florida since 1989. From October 1975 until September 1989 he was president of Real Estate Technology Corp., in New Canaan, Connecticut, an affiliate of RETC. Mr. Kuehner received a B.S. degree in physics from the University of Scranton in 1952 and a Master of Science degree in engineering from the University of Pennsylvania in 1964. A. Joseph Tandet served as president, treasurer, and a director of LPP from its inception in April 1980 until November 16, 1992, when he resigned from his positions as president and treasurer and was appointed vice president of Registrant. He served as vice president and a director of Registrant until October 1, 1994 when he resigned his positions as required under the terms of the RSL Agreement (see "Current Business Activities-RSL Agreement") of Item 1 of this Report. Mr. Tandet has been president and a director of LPPL Corp. since its inception in 1980, and continues to serve as such. For more than the past twenty years, Mr. Tender has been an attorney practicing in New York City. Mr. Tandet has also been engaged for more than twenty years in various entertainment and cultural activities in New York City, including the co-production of the off-Broadway play "Blood Wedding," a concert at Philharmonic Hall, and the co-production of the film "The Little Prince." Mr. Tandet also was a co-founder of the Committee for International Composers Concerts, Inc. and the Manhattan Theatre Club, Inc. which he served as president from founding until 1984 and which he presently serves as a Director Emeritus. Mr. Tandet has also produced two Broadway plays, "The Little Prince" and "Born Yesterday," as well as the off Broadway productions, "The Boys Next Door" and "Oil City Symphony." Other theatrical productions by Mr. Tandet include "Hearts Desire," which played in regional productions and a showcase production of "The Witch of Wall Street," at Lincoln Center, New York. Compliance with Section 16(a) of the Exchange Act Any person who is an officer, director, or the beneficial owner, directly or indirectly, of more than 10% of the outstanding common stock of Registrant is required under Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") to file certain reports with the Securities and Exchange Commission (the "Commission") disclosing his or her holdings or transactions in any securities of Registrant. For purposes of this discussion, all such persons required to file such reports will be referred to as "Reporting Persons." Every Reporting Person must file an initial statement of his or her beneficial ownership of Registrant's securities on the Commission's Form 3 within ten days after he or she becomes a Reporting Person. Thereafter (with certain limited exceptions), all changes in his or her beneficial ownership of Registrant's securities must be reported on the Commission's Form 4 on or before the 10th day after the end of file month in which such change occurred. In addition, all Reporting Persons will be obligated to file an annual statement on the Commission's Form 5 within 45 days after the end of the fiscal year unless all reportable transactions have already been reported on an earlier filed Form 3 or Form 4. Transactions reportable on Form 5 will include all changes in a Reporting Person's beneficial ownership of Registrant securities which were not required to be reported on a Form 4 during the fiscal year as well as all holdings and transactions, which should have been reported during the most recent fiscal year on a Form 4, but were not. Statements of holdings which should have been reported on a Form 3 or transactions required to have been reported on a Form 4, which are reported on Form 5 after the end of the fiscal year in which they occurred will represent late Form 3 and Form 4 filings. Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to Registrant during the fiscal 3,ear ended December 31, 1994, Registrant knows of no person who was a Reporting Person and was a director, officer, or beneficial owner of more than 10 percent of any class of equity securities of the Registrant, who has failed to file any reports required to be filed of Forms 3 or 4 with respect to his holdings or transactions in Registrant's securities since Registrant became publicly held in 1980 other than as follows: Forms 3 Forms 4 Not Reported William J. Peacock 1 1 Peter N. Chapman 1 1 Adrian P. Kirby 1 1 2 Christopher N.C. Jones 1 1 Riparian Securities, Ltd. 1 1 2 Registrant expects that all Reporting Persons who failed to file the proper reports due during the fiscal year ended December 31, 1994 will file such reports, albeit on an untimely basis, during the fiscal year ended December 31, 1995. Registrant has no stock option or stock appreciation rights, long term or other incentive compensation plans, deferred compensation plans, stock bonus plans, pension plans, or any other type of compensation plan in place for its executive officers, directors, or other employees and none of its executive officers or directors have ever received compensation of any such types from Registrant pursuant to plans or otherwise. The following table sets forth information concerning the annual compensation received or accrued for services provided in all capacities to Registrant for the years ended December 31, 1994, 1993, and 1992 by Registrant's chief executive officer. None of Registrant's executive officers received or accrued annual compensation in excess of $100,000 in any of such years. All of Registrant's current executive officers have agreed to render services to Registrant solely for the purpose of enhancing the value of their shareholdings in Registrant, until such time as Registrant has the financial resources available to compensate such persons for their services. (See the "Security Ownership of Management" Table included, below, in Item 12 of this Report.) Name Position December 31, Salary Adrian P. Kirby(1) President and CEO 1994 $ -0- Terence G. Galgey(2) President and CEO 1994 61,979 Terence G. Galgey(2) President and CEO 1993 85,000 Terence G. Galgey(2) President and CEO 1992 9,808 (1) Mr. Kirby became president and chief executive officer of Registrant on October 1, 1994. Mr. Kirby has agreed to render his services to Registrant solely for the purpose of enhancing the value of his shareholdings in Registrant until such time as Registrant has the financial resources available to compensate him for his services. (2) Mr. Galgey took office as Registrant's president and chief executive officer on November 16, 1992 and served as such until October 1, 1994. Under Mr. Galgey's service agreement with Registrant, he was entitled to be paid an annual salary of $85,000 for 1992. The mount shown for 1992 represents sums earned and received by Mr. Galgey for the period from November 16, 1992 to December 31, 1992. Mr. Galgey received all of his compensation from Registrant indirectly through T.G. Galgey & Co., an English company controlled by Mr. Galgey through stock ownership and his positions as an officer and director thereof. Under Mr. Galgey's service agreement with Registrant, he was entitled to be paid an annual sale of $85,000. Due to a lack of sufficient funds, Mr. Galgey received payment of an aggregate of $49,000 from Registrant during 1993. During 1994, Mr. Galgey received a total of $14,250. In settlement of its debt to Mr. Galgey, in respect of accrued and unpaid salary, along with other sums owed by Registrant to Mr. Galgey, Mr. Galgey accepted shares of Registrants common stock valued at approximately $.06 per share. For a discussion of the terms of Registrant's settlement with Mr. Galgey and Registrant's other executive officers and directors, reference is made to the discussion contained in subtopic "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS-Transactions and Business Relationships with Management" of Item 13 of this Report. The directors of Registrant are not compensated for their services as such. Item 12. Security Ownership of Certain Beneficial Owners and Management Security Ownership of Certain Beneficial Owners The following table sets forth information with respect to the beneficial share ownership, as of March 31, 1995 of Registrant's common stock, $.01 par value, by each person who is known by Registrant to own beneficially more than 5% of Registrant's common stock. Name and Address Amount and Nature of of Beneficial Owner Beneficial Ownership Percent of Class(3) c/o Von Erlach & Partners Adrian P. Kirby(2) 6,240,402 25 John L. Milling(3) 1,250,000 5 115 River Road, Bldg. 12 Frances Katz Levine(3) 1,250,000 5 115 River Road, Bldg. 12 (1) Includes 3,250,000 shares issued to RSL pursuant to the RSL agreement and an aggregate of additional 2,990,402 shares, transferred to RSL by Messrs. Peacock and Chapman, for the nominal consideration of $.0001 per share. All of such shares were transferred by RSL to the Patchouli Foundation on January 17, 1995. Both RSL and the Patchouli Foundation are under the control of Adrian P. Kirby and such transfer was therefore deemed not to involve a change in beneficial ownership. See Footnote 2 to this Table. (2) Includes 6,240,402 shares beneficially owned by the Patchouli Foundation; Mr. Kirby may be deemed to be a beneficial owner of such shares through the investment and voting powers which Mr. Kirby was over such shares through his position as attorney-in-fact for the administrator of the Patchouli Foundation. (3) Issued in September 1994 in partial satisfaction of unpaid fees for legal services rendered and unreimbursed expenses incurred. The following table sets forth information with respect to the share ownership, as of March 31, 1995, of each person who served as an executive officer and/or director of Registrant during the fiscal year ended December 31, 1994, individually and as a group. Name and Address Amount and Nature of of Beneficial Owner Beneficial Ownership Percent of Class(3) Terence G. Galgey 2,250,000 9% William J. Peacock 299,437(1) 1.2 Peter N. Chapman 325,000(2) 1.3 Carl J. Kuehner 845,687 3.4 A. Joseph Tandet(3) 478,000 1.9 Adrian P. Kirby(2) 6,240,402 25 (1) Excludes 1,500,000 shares which Mr. Peacock sold to RSL on October 7, 1994 as part of the aggregate of 3,000,000 shares which RSL purchased from Messrs. Peacock and Chapman for the nominal consideration of $.0001 per share. (2) Excludes 1,500,000 shares which Mr. Chapman sold to RSL on October 7, 1994 as part of the aggregate of 3,000,000 shares which RSL purchased from Messrs. Peacock and Chapman for the nominal consideration of $.0001 per share. (3) Does not include 500,000 shares which Registrant has agreed to issue to Mr. Tandet in consideration of his agreement to perform extensive legal services on behalf of Registrant's wholly owned subsidiary, LPPL Corp. Such stock issuance will be made at such time as Registrant's certificate of incorporation is amended so as to increase the authorized capital stock thereof. (4) Based upon 24,999,236 shares of common stock, $.01 par value, issued and outstanding as of April 7, 1995. On September 9, 1994, RSL acquired 25% of the issued and outstanding stock of Registrant. On October 1, 1994, changes in the management of Registrant made pursuant to such stock acquisition took effect. See the discussion thereof contained in the subtopic "Current Business Activities-RSL Agreement" which appears, above, in Item 1 of this Report. Registrant is not aware of any arrangements which may at a subsequent date result in a change in control of Registrant. Item 13. Certain Relationships and Related Transactions Transactions and Business Relationships with Management Service and Employment Agreements. Following the November 16, 1992 Reverse Acquisition, Registrant entered into agreements, directly or indirectly2, with A. Joseph Tandet and the four other executive officers who were appointed as executive officers of Registrant pursuant to the Reverse Acquisition. Such agreements provided for services to, or employment by, Registrant. 5. A service agreement, dated November 16, 1992, with Galgey Financial Services Limited CGFSL") providing for the services of its president, Terence G. Galgey (the "Galgey Service Agreement"); 6. A service agreement, dated November 16, 1992, with Oform Associates Limited ("Oform") providing for the services of its executive vice president, William J. Peacock (the "Peacock Service 7. A service agreement, dated November 16, 1992, with Chapman & Chapman ("C&C") providing for the services of its treasurer and secretary, Peter N. Chapman (the "Chapman Service Agreement"); and 8. An employment agreement, dated October 21, 1992, with A. Joseph Tandet providing for Mr. Tandet's employment as the vice president of Registrant and as president of LPPL Corp. (the "Tandet Employment Agreement"). 2 In Registrant's respective Service Agreements with GFSL, Oform and C&C each of the foregoing acknowledged to Registrant that Messrs. Galgey, Peacock, or Chapman, as appropriate, was its exclusive employee, that each such individual's services were being furnished to Registrant as an independent contractor, and that accordingly, to the extent that all applicable laws and regulations allowed, the responsibility of complying with all statutory and legal requirements relating to each such respective individual as an employee, would be discharged wholly by GFSL, Oform or C&C, as applicable. The Service Agreements further provided that in the event any person should seek to establish any liability or obligation upon Registrant on the grounds that any of the respective individuals is an employee of Registrant, GFSL, Oform or C&C, as appropriate, would indemnify Registrant and keep it indemnified in respect of any liability or obligation and any related costs, expenses or other losses which Registrant incurred in connection therewith. For information respecting the terms and provisions of the foregoing agreements, reference is made to the detailed discussions thereof contained in the subtopic "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" of Item 13 of Registrant's annual report on Form 10-K for the fiscal years ended December 31, 1992 and 1993. Settlements with Officers and Directors. Registrant was unable in varying degrees to meet its financial obligations under the service and Employment Agreements. As a result, Registrant accrued contractual liabilities arising from unpaid salaries and unreimbursed expenses. In connection with the August 22, 1994 RSL Agreement, Registrant entered into separate settlement agreements with the contracting parties under the respective service and employment agreements. In connection with the RSL stock acquisition and change in management, Messrs. Galgey, Peacock, Chapman, Tandet and Kuekner entered into separate settlement and release agreements with Registrant whereby they accepted, in full and final settlement of any claims they may have had against Registrant respecting accrued but unpaid compensation and reimbursable expenses, shares of Registrant's common stock, valued at approximately $.06 per share, as follows: Torenee G. Galgey $83,352 1,250,000 William J. Peacock 98,103 1,575,000 Peter N. Chapman 100,648 1,625,000 In addition, Registrant agreed to issue 500,000 shares to Mr. Tender, at such time as Registrant's certificate of incorporation is amended so as to increase its authorized capital stock, in consideration of Mr. Tandet's agreeing to render extensive legal services in connection with certain litigation matters of Registrant and its subsidiary LPPL Corp. Loan From Affiliate. During the year ended December 31, 1994 and the period subsequent thereto, the Patchouli Foundation his made loans to Registrant to cover costs and expenses incurred in connection with various corporate activities, including without limitation, legal, accounting, and filing fees incurred in connection with the preparation of Registrants annual reports on Form's 10-K for the years ended December 31, 1993 and 1994. To date, such loans aggregate to approximately $50,000. Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K The financial statements filed as a part of this report are as follows: Consolidated balance sheets - December 31, 1994, 1993, and 1992 Consolidated statements of operations - for the years ended December 31, 1994, 1993, and 1992 Consolidated statements of stockholders' equity - for the years ended December 31, 1994, 1993, and 1992 Consolidated statements of cash flows - for the years ended December 31, 1994, 1993, and 1992 Notes to consolidated financial statements Financial statement schedules have been omitted for the reason that they are not required or are not applicable, or the required information is shown in the financial statements or notes thereto. The exhibits filed as a part of this report are as follows: 2(a) Offer Document relating to the Recommended Offers by RAS Securities Corp. on behalf of Little Prince Productions, Ltd. to acquire the entire issued share capital of Tyne River Properties plc and Notice of Extraordinary General Meeting of Tyne River Properties (b) Announcement; dated November 16, 1992, by RAS Securities Corp. respecting valid acceptances of the Exchange Offer (mailed to TRP 10(a)Agreement, dated October 21, 1992, by and among Little Prince Productions, Ltd., Tyne River Properties plc, Terence G. Galgey, William J. Peacock, and Peter N. Chapman(1) 10(a) (b) Letter, dated November 16, 1992, from the directors of TRP to Registrant consenting to Registrant's declaring the Exchange Offer unconditional and delivering certificate from Barclays Registrars respecting the receipt of acceptances of the Exchange Offer from the holders of 90.38% of the TRP Ordinary shares, and 100% of the TRP Founder and Deferred (c) Service Agreement, dated November 16, 1992, with Galgey Financial Services Limited(2) 10(c) (d) Service Agreement, dated November 16, 1992, with Oform Associates Limited(2) 10(d) (e) Service Agreement, dated November 16, 1992, with Chapman & Chapman(2) 10(e) (f) Employment Agreement, dated October 21,1992, with A. Joseph Tandet(2) 10(f) (g) Agreement, dated August 22, 1994, between Little Prince Productions, Ltd. and Riparian (1) Filed with the Securities and Exchange Commission as an exhibit, numbered as indicated above, to Registrant's Form 10-K, dated November 16, 1992, which exhibit is incorporated herein by reference. (2) Filed with the Securities and Exchange Commission as an exhibit, numbered as indicated above, to Registrant's Transition Report on Form 10-K for the period ended November 16, 1992, which exhibit is incorporated herein by reference. (3) Filed with the Securities and Exchange Commission as an exhibit, numbered as indicated above, to Registrant's Form 8-K, dated August 22, 1994, which exhibit is incorporated herein by reference. No reports on Form 8-K have been filed by Registrant during the last quarter of the period covered by this report. 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. By /s/ Adrian P. Kirby 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. By /s/ Adrian P. Kirby	10-K/A	10-K	1996-01-12T00:00:00	1996-01-11T18:19:16
0000008411-96-000004	0000008411-96-000004_0000.txt	Proxy Statement Pursuant to Section 14(a) of the Securities Filed by the registrant [x] Filed by a party other than the registrant [] [] Soliciting material pursuant to Rule 14a-11(c) or Rule 14a-12 (Name of Registrant as Specified in Its Charter) (Name of Person(s) Filing Proxy Statement) Payment of filing fee (Check the appropriate box): [x] $125 per Exchange Act Rule 0-11(c)(l)(ii), 14a-6(i)(l), or 14a-6(j)(2). [] $500 per each party to the controversy pursuant to Exchange Act Rule 14a-6(i)(3). [] Fee computed on table below per Exchange Act Rules 14-a6(i)(4) and 0-11. (1) Title of each class of securities to which transactions (2) Aggregate number of securities to which transaction (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11: N/A (4) Proposed maximum aggregate value of transaction: N/A [] Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the form or schedule and the date of its filing. (1) Amount previously paid: N/A (2) Form, schedule or registration statement no.: N/A 15835 PARK TEN PLACE DRIVE NOTICE OF ANNUAL MEETING OF SHAREHOLDERS Notice is hereby given that, pursuant to the provisions of the Bylaws of Atwood Oceanics, Inc., the Annual Meeting of the Shareholders of Atwood Oceanics, Inc. will be held at the executive offices of Atwood Oceanics, Inc., 15835 Park Ten Place Drive, in the City of Houston, Texas 77084, at 10:00 o'clock A.M., Houston Time, on Thursday, February 8, 1996, for the following purposes: 1. To elect six (6) members of the Board of Directors for the term of office specified in the accompanying Proxy Statement. 2. To act upon shareholder proposal. 3. To transact such other business as may properly come before the meeting or any adjournments thereof. Shareholders of record at the close of business on December 31, 1995 will be entitled to notice of and to vote at the Annual Meeting. Shareholders are cordially invited to attend the meeting in person. Those who will not attend are requested to sign and promptly mail the enclosed proxy for which a stamped return envelope is provided. By Order of the Board of Directors SECURITY HOLDERS ENTITLED TO VOTE Holders of shares of common stock, par value $1.00 ("Common Stock") of Atwood Oceanics, Inc., (hereinafter sometimes called the "Company") of record at the close of business on December 31, 1995 will be entitled to vote at the Annual Meeting of Shareholders to be held February 8, 1996 at 10:00 o'clock A.M., Houston Time, at the executive offices of Atwood Oceanics, Inc., 15835 Park Ten Place Drive, Houston, Texas, 77084 and at any and all adjournments thereof. Shareholders who execute proxies retain the right to revoke them at any time before they are voted. A proxy, when executed and not so revoked, will be voted in accordance therewith. This proxy material is first being mailed to shareholders on January 16, 1996. This proxy is solicited on behalf of the Board of Directors of Atwood Oceanics, Inc. In addition to solicitation by mail, the Company may request banks, brokers and other custodians, nominees and fiduciaries to send proxy material to the beneficial owner of stock and to secure their voting instructions, if necessary. Further solicitation of proxies may be made by telephone, telegram, or oral communication with some shareholders of the Company, following the original solicitation. All such further solicitation will be made by regular employees of the Company and the cost will be borne by the Company. At the close of business on December 31, 1995, the time which has been fixed by the Board of Directors as the record date for determination of shareholders entitled to notice of and to vote at the meeting, there were 6,635,713 shares of Common Stock of the Company outstanding. The election as directors of the persons nominated in this proxy statement, as well as approval of any other matters which may properly come before the meeting, will require the vote of the holders of a majority of the shares entitled to vote and represented in person or by proxy at a meeting at which a quorum is present. Abstentions and broker non-votes (which result when a broker holding shares for a beneficial owner has not received timely voting instructions on certain matters from such beneficial owner) are counted for purposes of determining the presence or absence of a quorum for the transaction of business, but will operate to prevent the election of the directors nominated in this Proxy Statement or the approval of such other matters as may properly come before the meeting to the same extent as a vote withholding authority to vote for the election of directors so nominated or a vote against such other matters. Each share of Common Stock entitles its owner to one vote except with respect to the election of directors. With respect to the election of directors, each shareholder has the right to vote in person or by proxy the number of shares registered in his name for as many persons as there are directors to be elected, or to cumulate such votes and give one candidate as many votes as shall equal the number of directors to be elected multiplied by the number of his shares, or to distribute the votes so cumulated among as many candidates as he may desire. In the event of cumulative voting, the candidates for directors receiving the highest number of votes, up to the number of directors to be elected, shall be elected. If a shareholder desires to exercise his right to cumulate votes for directors, the laws of the State of Texas, the State in which the Company is incorporated, require the shareholder to give the Secretary of the Company written notice of such intention on or before the day preceding the meeting. Such notice should be sent to: Atwood Oceanics, Inc., P. O. Box 218350, Houston, Texas 77218, Attention: James M. Holland. If any shareholder gives such notice, all shareholders have the right to use cumulative voting at the meeting. The persons appointed by the enclosed form of proxy are not expected to exercise the right to cumulate votes for election of the directors named elsewhere in this Proxy Statement, although such persons shall have discretionary authority to do so. The following table reflects certain information known to the Company concerning persons beneficially owning more than 5% of the outstanding Common Stock of the Company as of December 31, 1995 (except as otherwise indicated). The information set forth below (other than with respect to Helmerich & Payne International Drilling Co. and Helmerich & Payne, Inc.) is based on materials furnished to the Company in connection with Securities and Exchange Commission filings by or on behalf of the shareholders named below, as of various dates during the Company's fiscal year. Unless otherwise noted, each shareholder listed below has sole voting and dispositive power with respect to the shares listed. (1) Walter H. Helmerich, III is Chairman and a director, and Hans Helmerich, son of Walter H. Helmerich, III, is President, Chief Executive Officer and a director, respectively, of Helmerich & Payne, Inc. Messrs. Walter H. Helmerich, III and Hans Helmerich, together with other family members and the estate of W.H. Helmerich, deceased, are controlling shareholders of Helmerich & Payne, Inc., which with its wholly-owed subsidiary, Helmerich & Payne International Drilling Co., owns of record and beneficially 1,600,000 shares of Common Stock of the Company. Messrs. Walter H. Helmerich, III and Hans Helmerich have disclaimed beneficial ownership of the Common Stock owned by these companies. (2) Lindner Fund, Inc. ("LFI") and Ryback Management Corporation ("RMC") have no sole voting or dispositive power with respect to any shares of the Company's Common Stock, and each has shared voting and dispositive power with respect to 581,000 shares of the Company's Common Stock. The foregoing information was obtained from Schedule 13G dated January 25, 1995 filed with the Securities and Exchange Commission by RMC and LFI. (3) FLA Asset Management, Inc. is a subsidiary of Associates, Inc. has sole voting power with respect to 319,500 shares, shared voting power with respect to 14,500 shares, sole dispositive power with respect to 446,400 shares and shared dispositive power with respect to 118,600 shares of the Company's Common Stock. FLA Asset Management, Inc. has no sole voting or dispositive power with respect to any shares of the Company's Common Stock, and has shared voting power with respect to 14,500 shares and shared dispositive power with respect to 118,600 shares of the Company's Common Stock. The foregoing information was obtained from an Amendment No. 5 to Schedule 13G dated February 13, 1995 filed with the Securities and Exchange Commission by Forstmann-Leff Associates, Inc. and FLA Asset Management, Inc. (4) FMR Corp. has sole voting power with respect to 326,900 shares and sole dispositive power with respect to 484,600 shares of the Company's Common Stock. Edward C. Johnson 3d has sole dispositive power with respect to 484,600 shares of the Company's Common Stock. The foregoing information was obtained from an Amendment No. 5 to Schedule 13G dated February 13, 1995 filed with the Securities and Exchange Commission by FMR Corp. (5) Wanger Asset Management, Ltd. ("WAM LTD") is the general partner of Wanger Asset Management, L.P. ("WAM L.P."). Ralph Wanger, WAM LTD. and WAM L.P. have no sole voting or dispositive power with respect to any shares of the Company's Common Stock, and have shared voting and dispositive powers with respect to 352,500 shares of the Company's Common Stock. The foregoing information was obtained from an Amendment No. 2 to Schedule 13G dated February 8, 1995 filed with the Securities and Exchange Commission by Ralph Wanger, WAM LTD. and WAM L.P. adjusted by 59,000 shares reported as purchased by WAM L.P. since March 1995 in a report prepared by CDA Equity Intelligence for the Company. It was assumed that Ralph Wanger, WAM LTD. and WAM L.P. had no sole voting or dispositive power, with each having shared voting and dispositive power with respect to the 59,000 shares purchased; therefore the reported data in Amendment No. 2 to Schedule 13G were accordingly adjusted. COMMON STOCK OWNED BY DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth the amount of Common Stock beneficially owned as of the close of business on December 31, 1995 by each of the directors, by each of the named executive officers, and by all directors and executive officers as a group. Unless otherwise indicated below, each of the named persons and members of the group has sole voting and investment power with respect to the shares shown. (1) See Note (1) on page 6 for more information. (2) Less than 1%. (3) All of such shares may be acquired upon the exercise of options. (4) Includes 6,350 shares which may be acquired upon the exercise of options. (5) Includes 26,825 shares which may be acquired upon the exercise of options. Set forth below are the executive officers of the company. The office held, date of first election to that office and the age of each officer as of the close of business on December 31, 1995 are indicated opposite his name. No family relationship exists between any of the above executive officers. All officers of the Company serve at the pleasure of the Board of Directors and may be removed at any time with or without cause. Mr. Irwin joined the Company in July 1979, serving as Operations Manager - Technical Services. He was elected Vice President - Operations in November 1980, Executive Vice President in October 1988, President and Chief Operating Officer in November 1992, and President and Chief Executive Officer in March 1993. Mr. Holland joined the Company as Accounting Manager in April 1977. He was elected Vice President - Finance in May 1981 and Senior Vice President and Secretary in October 1988. Mr. Kelley rejoined the Company in January 1983 as Manager of Operations Administration. He was elected Vice President - Contracts and Administration in October 1988. Mr. Till joined the Company in February 1983 as General Manager - Technical. He was elected Vice President - Technical Services in June 1984 and Vice President - Operations in November 1992. ITEM 1 - ELECTION OF DIRECTORS At the meeting six (6) Directors (leaving one position vacant) are to be elected for terms of one year each. Although the Company's Bylaws provide that the Board of Directors consists of seven (7) persons, the Company has not yet identified a suitable nominee to fill the vacancy. Accordingly, only six (6) persons are nominated for election as directors, and shares may not be voted for a greater number of persons than the number of nominees named. The persons named in the enclosed form of proxy (James M. Holland and Larry P. Till) have advised that they will vote all shares represented by proxies for the election of the six nominees for Director listed below, unless authority to so vote is withheld by the shareholder. Such persons will have the discretion to cumulate the votes of the shares represented by proxy, although the exercise of such discretion is not expected. If any of the nominees listed below becomes unavailable for any reason, the shares represented by the proxies will be voted for the election of such person, if any, as may be designated by the Board. At all times during the previous five years, Mr. Burgess has served as Chief Financial Officer (Senior Vice President) for CIGNA Investment Division, CIGNA Companies. CIGNA is a diversified financial services company with major businesses in insurance, health care, pensions and investments. Mr. Burgess is not a director of any other publicly traded company. At all times during the previous five years, Mr. Dotson has served as Vice President - Drilling of Helmerich & Payne, Inc. and President of Helmerich & Payne International Drilling Co., both located in Tulsa, Oklahoma. Helmerich & Payne, Inc. is a diversified natural resources company with divisions engaged in drilling, exploration, production and real estate development. He serves as a director on the Board of Helmerich & Payne, Inc. At all times during the previous five years, Mr. Walter H. Helmerich, III has served as the Chairman of the Board of Helmerich & Payne, Inc. of Tulsa, Oklahoma, which as a result of its ownership of Common Stock of the Company, may be deemed an affiliate of the Company. In addition to the position Mr. Helmerich holds with Helmerich & Payne, Inc., he serves as a director on the Boards of Liberty Bank & Trust Company of Oklahoma City, N.A., Liberty Bank & Trust Company of Tulsa, N.A., and Liberty Bancorp, Inc. He is the father of Mr. Hans Helmerich, who is also a director of the Company. At all times during the previous five years, Mr. Hans Helmerich has served as the Chief Executive Officer as well as a director of Helmerich & Payne, Inc. of Tulsa, Oklahoma, which as a result of its ownership of Common Stock of the Company, may be deemed an affiliate of the Company. He is a son of Mr. Walter H. Helmerich, III. Mr. Irwin has been employed by the Company in various executive capacities for the last sixteen years. Mr. Irwin is not a director of any other publicly traded company. Mr. Morrissey served as Director and Vice Chairman of the Board of Marine Corporation until the end of 1987 when Marine Corporation was acquired by Banc One Corporation, Columbus, Ohio. Mr. Morrissey is currently retired and is not a director of any other publicly traded company. Pursuant to an agreement between the Company, several of its wholly-owned subsidiaries, and several wholly-owned subsidiaries CIGNA Corporation (including Insurance Company of North America), Philadelphia Investment Corporation of Delaware ("PICD") a wholly-owned subsidiary of CIGNA Corporation, was given the right, under certain circumstances, to nominate one person to be a member of the Board of Directors of the Company. Pursuant to such right, and in accordance with the terms and provisions of the Company's Bylaws, Mr. Burgess was nominated and elected as a member of the Board of Directors of the Company in September 1990. Should Mr. Burgess resign or otherwise vacate his office, another person appointed by PICD will be nominated to fill the unexpired term of office. The Company has standing Audit, Executive and Compensation committees. The Audit Committee members are Messrs. Dotson and Morrissey. This Committee functions to review in general terms the Company's accounting policies and audit procedures and to supervise internal accounting controls. During fiscal 1995, there was one meeting of the Audit Committee. The Executive Committee, composed of Messrs. Dotson, Hans Helmerich and Irwin, meets frequently, generally by telephone conference, for review of major decisions and to act as delegated by the Board. The Compensation Committee's members, Messrs. Hans Helmerich, Burgess and Dotson are responsible for administration of the Company's Stock Option Plans, and for review and approval of all salary and bonus arrangements. During fiscal 1995, there was one meeting of the Compensation Committee. There were four meetings of the Board of Directors held during fiscal 1995, all of which were regularly scheduled meetings. Each director attended, during the time of his membership, at least seventy-five percent of Board and Committee meetings. ITEM 2 - SHAREHOLDER PROPOSAL A shareholder, whose name, address and share ownership will be furnished by the Company promptly upon request, has given notice of its intention to introduce the following proposal at the Annual Meeting. Shareholder Proposal and Supporting Statement We believe the employee and board composition of major corporations should reflect the people in the work force and marketplace of the 21st century if our company is going to remain competitive. Our employees, customers and stockholders are now made up of a greater diversity of backgrounds than ever before. The report of the Department of Labor's 1995 bi-partisan Glass Ceiling Commission, "Good For Business: Making Full Use of the Nation's Human Capital," confirms diversity and inclusiveness in the workplace has a positive impact on the bottom line. A report of Standard and Poor 500 companies provided by Covenant Fund revealed "...firms that succeed in shattering their own glass ceiling racked up stock-market records that were nearly 2 1/2 times better than otherwise - comparable companies." In 1994 the Investor Responsibility Research Center reported inclusiveness at senior management and board levels was only 9% of the fortune 500 companies in a comparable work force of 57% diversity. The Glass Ceiling Commission reported that companies are selecting from only half of the talent of our work force. Therefore we urge our corporation to enlarge its search for the best qualified board members by casting a wider net. If we are to be prepared for the 21st century we must learn how to compete in a growing diverse global market place by promoting and selecting the best people regardless of race, gender or physical challenge. We believe the judgements and perspectives of a diverse board would serve to improve the quality of corporate decision-making. Since the board of directors is responsible for representing shareholder interests in corporate meetings, a growing proportion of stockholders is now attaching value to board inclusiveness. A 1994 Investor Responsibility Research Center survey revealed 37% of respondents cited board diversity as the influencing factor for supporting votes. The Teachers Insurance and Annuity Association and College Retirement Equities Fund, the largest institutional investor in the United States, recently issued a set of corporate governance guidelines including a call for "diversity of directors of experience, sex, age and race." Therefore be it resolved that shareholders request: 1. The nominating committee of the Board in its search for suitable board candidates, make a greater effort to find qualified women and minority candidates for nomination to the Board of Directors. 2. The Board of Directors issue a statement publicly committing the company to a policy of board inclusiveness with a program of steps to take and the timeline expected to move in that direction. 3. The Company issue a report by September 1996 at a reasonable expense that includes a description of: a) efforts to encourage diversified representation to b) criteria for board qualification c) the process of selecting the board candidates d) the process of selecting the board committee members. Board of Directors' Response to Shareholder Proposal The Company's Board of Directors unanimously recommends a vote AGAINST the shareholder proposal. Unlike many other public companies that have large boards of directors, Atwood Oceanics, Inc. has taken a different approach. To maintain a knowledgeable, effective and efficient board of directors and to avoid unnecessary expenses, the number of directors on the Company's board has ranged from six to seven during the last ten years and is currently six. During this period, the contract drilling industry in which the Company competes has experienced significant challenges. Many challenges still exist. When selecting individuals for nomination to the Company's Board of Directors, all qualified candidates are considered based on their knowledge of and participation in the Company and the industry in which the Company operates. The individuals currently on the Company's Board bring to bear a collective 75 years of experience with the Company in fulfilling their duties. The success of the Company under the guidance of its Board is well documented. Under the experienced leadership of the current Board during turbulent market conditions of the 80's and early 90's, the Company maintained a strong balance sheet and met all of its obligations. In recent years, the Company has been towards the top of the industry in earnings per share and cash flow per share. The Board is now challenged to continue its successful leadership of the Company through the current cycle of fluctuating market conditions. The shareholder proposal would require the Board of Directors to make a greater effort to find women and minority candidates, to issue a public statement committing the Company to a policy of board inclusiveness and establishing a timetable for achieving same, and to issue a report describing its efforts, criteria and process of achieving board inclusiveness. Your Board of Directors believes that the shareholder proposal (i) is inappropriately restrictive, (ii) would unduly limit the Company in its selection of directors, (iii) would involve significant costs without any benefit, and (iv) would clearly be detrimental to the best interests of the Company and its shareholders. The Company's Board of Directors unanimously recommends a vote AGAINST the shareholder proposal. In accordance with the Securities and Exchange Commission ("SEC") executive compensation disclosure requirements under Item 402 of Regulation S-K, the following compensation tables and other compensation information are presented to enable shareholders to better understand the compensation of the Company's executive officers. The Company's executive compensation program is administered by the Compensation Committee of the Board of Directors. The Committee is composed of three independent, nonemployee directors. Following review and approval by the Compensation Committee, all issues pertaining to executive compensation are submitted to the full Board of Directors for approval. REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS OF To: The Board of Directors As members of the Compensation Committee, it is our duty to review compensation levels of Company's executive officers and administer the Company's stock option plan. Compensation Policies for Executive Officers In determining the compensation of the Company's executive officers, it is the policy of the Committee to take into account all factors which it considers relevant to the determination, including business conditions prevailing generally and in the Company's industry during such year, the Company's performance in such year in light of such conditions, and the performance of the specific officers under consideration and the business area of the Company for which such officer is responsible. For fiscal year ended September 30, 1995, the compensation program for executive officers consisted of base salary, year-end bonus and Company contributions in a contributory retirement plan. The Company's current compensation levels are within the $1 million limitation on corporate tax deductions under Section 162(m) of the Internal Revenue Code of 1986, as amended, and the Company intends to take the necessary steps in subsequent years to ensure that the Company's future compensation package will comply with such limits on compensation deductibility. Operating results for 1994 and 1995 reflect significant improvements over prior years. Fiscal year 1994 was the Company's first profitable year since 1989 and highest profitable level since 1983. Prior to 1994, as the result of adverse market conditions and operating losses, compensation of executive officers was primarily restricted to base salary, granting of stock options and contributions to a retirement plan. In recognition of the significant improvement in operating performance, the Company awarded bonuses (ranging from $10,500 to $12,750) and granted salary increases to each of the Company's executive officers in December 1994. Mr. Irwin's compensation for fiscal year 1995 included a bonus of $25,000 in addition to an increase of approximately $15,000 in his annual base salary. Subsequent evaluations of Mr. Irwin's compensation will be based upon the same criteria as set forth above with respect to officers generally. December 31, 1995 Hans Helmerich (A) Notwithstanding SEC filings by the Company that have incorporated or may incorporate by reference other SEC filings (including this proxy statement) in their entirety, the Report of the Compensation Committee shall not be incorporated by reference into such filings and shall not be deemed to be "filed" with the SEC except as specifically provided otherwise or to the extent required by Item 402 of Regulation S-K. Compensation Committee Interlocks and Insider Participation No member of the Compensation Committee of the Board of Directors of the Company was, during the 1994-5 fiscal year, an officer or employee of the Company or any of its subsidiaries, or was formerly an officer of the Company or any of its subsidiaries or had any relationships requiring disclosure by the Company under Item 404 of Regulation S-K. During the Company's 1994-5 fiscal year, no executive officer of the Company served as (i) a member of the compensation committee (or other board committee performing equivalent functions) of another entity, one of whose executive officers served on the Compensation Committee of the Board of Directors, (ii) a director of another entity, one of whose executive officers served on the Compensation Committee of the Company, or (iii) a member of the compensation committee (or other board committee performing equivalent functions) of another entity, one of whose executive officers served as a director of the Company. The SEC compensation disclosure rules require that various compensation information be presented in various tables as set forth below. (A) The amounts shown in the "All Other Compensation" column are derived from the following: (i) Mr. Irwin: Annual Company contributions to the defined contribution plan ("DCP") for 1995, 1994 and 1993 of $17,415, $15,900, and $14,858, respectively; Company paid term life and insurance premiums ("TLIP") for 1995, 1994 and 1993 of $1,509, $1,418, and $1,534, respectively; (ii) Mr. Till: Annual Company contribution to the DCP for 1995, 1994, and 1993 of $11,845, $11,013, and $10,459 respectively; Company paid TLIP for 1995, 1994, and 1993 of $2,043, $2,043, and $1621, respectively; (iii) Mr. Holland: Annual Company contributions to the DCP for 1995, 1994, and 1993 of $11,280, $10,488, and $9,901 respectively; Company paid TLIP for 1995, 1994, and 1993 of $2,043, $2,043, and $1,359 respectively; (iv) Mr. Kelley: Annual Company contribution to the DCP for 1995, 1994, and 1993 of $ 9,588, $5,935, and $1,660 respectively; Company paid TLIP for 1995, 1994, and 1993 $1,060, $945, and $886, respectively. (A) At September 30, 1995, all option exercise prices were less than the $20.69 per share market value of the Company's common stock; thus, all options were "in the money". ATWOOD OCEANICS, INC. COMMON STOCK PRICE PERFORMANCE GRAPH Prior to 1995, the peer group data used in the stock price performance graph was based upon the Center for Research in Security Prices ("CRSP") Index for NASDAQ stocks (SIC 1380-1389). Since the NASDAQ stocks (SIC 1380-1389) index includes companies involved in oil services other than drilling, it is management's opinion that a more accurate peer group performance comparison will be obtained through an index based on a self-determined peer group of only drilling companies. A common stock price performance graph consistent with prior year's index information, as well as a common stock price performance graph based on the self-determined peer group of drilling companies, is set forth below: Constituents of the Self-Determined Peer Group: Arethusa Ltd. Dual Drilling Co. Ensco International Inc. Falcon Drilling Company Global Marine Inc. Marine Drilling Co. Inc. Noble Drilling Corp. Reading & Bates Corp. Rowan Companies, Inc. Sonat Offshore Drilling Inc. * Assumes $1000 invested on September 28, 1990; Total returns assumes dividend reinvested; Fiscal year ending September 30 COMPLIANCE WITH SECTION (16(a) OF THE EXCHANGE ACT Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and greater than ten-percent shareholders are required by the regulation to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, and written representations from certain reporting persons that no reports on Form 5 were required for those persons, the Company believes that, during the period from October 1, 1994 through September 30, 1995, all filing requirements applicable to its officers, directors and greater than ten-percent beneficial owners were complied with, except that Mr. Glen P. Kelley filed a report on Form 4 which incorrectly reported a stock option exercise and simultaneous sale of 1825 shares, rather than the 1875 shares actually exercised and sold. Upon being awarded a term contract in August 1994, the Company entered into a joint venture agreement with Helmerich & Payne, Inc. ("H&P") (which together with its wholly-owned subsidiary, Helmerich & Payne International Drilling Co., owns 24.11% of the Company's common stock) for the construction of RIG-200, a new generation platform rig. Under the agreement, H&P manages the design, construction, testing and mobilization of the new rig and the Company will manage the initial installation and daily operation of the new rig. The Company and H&P each have a fifty percent interest in the joint venture. At September 30, 1995, the Company had invested $8.2 million in this $24 million project, with an estimated total investment by the Company to be approximately $12 million. RIG-200 was originally scheduled to commence operating in offshore Australia in early 1996; however, due to project delays in Australia unrelated to the Company's and H&P's activities, the rig is now scheduled to commence operating in early 1997. Three of the Company's directors, namely Walter H. Helmerich III, Hans Helmerich and George S. Dotson, are directors and executive officers of H&P. Effective December 31, 1994, the Company acquired a third- generation semisubmersible drilling rig from one 50 percent owned Texas limited partnership, and the other 50 percent limited partner's interest in another 50 percent owned Texas limited partnership which owns two third-generation semisubmersible drilling rigs, for an aggregate purchase price of approximately $36 million, consisting of approximately $13 million cash, a $3 million promissory note, and assumption of approximately $20 million in long-term notes payable to a bank group. The consideration for the purchase was based on the values of the three rigs, as adjusted by the debt associated with the rigs and the economic consequences to the parties associated with transfer of ownership of the rigs. One of the Company's directors, Robert W. Burgess, is an officer of CIGNA Corporation, which indirectly owned the other 50 percent limited partnership interests, and which, as of the effective date of the transaction, was an indirect beneficial owner of more than 5% of the Company's common stock. As compensation for services as a director of the Company, each director who is not an officer and full time employee of the Company or any of its subsidiaries was paid in 1995 $2,000 per meeting for attendance at regular Board meetings, and $250 per meeting for attendance at special Board and committee meetings. Commencing in 1996, the per meeting compensation will be increased to $2,500. RELATIONSHIP WITH INDEPENDENT PUBLIC ACCOUNTANTS The independent public accounting firm of Arthur Andersen & Co. was selected as auditors by the Company in 1970 and continues to serve in this capacity. Representatives of Arthur Andersen & Co. will be present at the shareholders' meeting, will have the opportunity to make a statement if they so desire and will be available to respond to appropriate questions. Proposals by Shareholders of the Company intended to be presented at the next Annual Meeting of the Shareholders must be received by the Company on or before September 16, 1996 in order to be included in the next Proxy statement and Form of Proxy relating to that meeting. Management does not intend to bring any other matters before the meeting and has not been informed that any matters are to be presented by others. In the event any other matters properly come before the meeting, the persons named in the enclosed form of proxy will vote the proxies in accordance with their judgment on such matters. If you do not contemplate attending the meeting in person, you are respectfully requested to sign, date and return the accompanying proxy in the enclosed, stamped envelope at your earliest convenience. The Company will provide, without charge, upon written request of any shareholder, a copy of its Annual Report on Form 10K including financial statement schedules for the fiscal year ended September 30, 1995 as filed with the Securities and Exchange Commission. Please direct such request to James M. Holland, Secretary, Atwood Oceanics, Inc., P. O. Box 218350, Houston, Texas 77218. By order of the Board of Directors /s/ John R. Irwin, President PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS FOR THE ANNUAL MEETING OF SHAREHOLDERS CALLED FOR The undersigned, having received the Notice of Meeting and Proxy Statement dated January 16, 1996, appoints James M. Holland and Larry P. Till and each or either of them as proxies, with full power of substitution, to represent the undersigned and to vote all shares of the Common Stock of Atwood Oceanics, Inc. standing in the undersigned's name on its books on December 31, 1995 at the Annual Meeting of the Shareholders of the Company to be held February 8, 1996, at the main offices of Atwood Oceanics, Inc., 15835 Park Ten Place Drive, Houston, Texas 77084, 10:00 A.M., Houston Time, and any adjournment thereof, as follows: IF NO CONTRARY SPECIFICATION IS MADE, THIS PROXY WILL BE VOTED WITH AUTHORITY FOR THE ELECTION OF DIRECTORS AND AGAINST THE SHAREHOLDER PROPOSAL. (PLEASE DATE AND SIGN ON REVERSE SIDE) Please mark boxes in blue or black ink. The proxies appointed herein may act by a majority of said proxies present at the meeting (or if only one is present, by that one). (1) ELECTION OF DIRECTORS PROPOSED BY THE COMPANY: ____FOR the nominees listed below ____WITHHOLD AUTHORITY for the nominees ROBERT W. BURGESS WALTER H. HELMERICH, III WILLIAM J. MORRISSEY GEORGE S. DOTSON HANS HELMERICH JOHN R. IRWIN Authority to vote for any specific nominee for director may be withheld by lining through or otherwise striking out such nominee's name. The Board of Directors recommends a vote "AGAINST" item 2. ___ For ___Against ___ Abstain (3) In their discretion, upon other matters that may properly come before the meeting. Management knows of no other matters that may properly be, or which are likely to be, brought before the meeting. The persons named in this proxy or their substitutes will vote in accordance with the recommendations of management on such matters. NOTE: Please sign exactly as name appears above. When signing as trustee or guardian, please give full title. If stock is held in the name of more than one person, each joint owner should sign. Please note any change of address.	DEF 14A	DEF 14A	1996-01-12T00:00:00	1996-01-12T16:04:03
0000883053-96-000008	0000883053-96-000008_0000.txt	40 ACT FILE NO. 811-2271 For Registration under the Securities Act of 1933 of Securities of Unit Investment Trusts Registered on Form N-8B-2. A. Exact Name of Trust: NUVEEN TAX-FREE UNIT TRUST, SERIES 848 B. Name of Depositor: JOHN NUVEEN & CO. INCORPORATED C. Complete address of Depositor's principal executive offices: D. Name and complete address of agents for service: JOHN NUVEEN & CO. INCORPORATED It is proposed that this filing will become effective (check appropriate box) _____ immediately upon filing pursuant to paragraph (b) _____ on (date) pursuant to paragraph (b) of rule 485 _____ 60 days after filing pursuant to paragraph (a) _____ on (date) pursuant to paragraph (a) of rule (485 or 486) E. Title and amount of securities being registered: An indefinite number of Units pursuant to Rule 24f-2 promulgated under the Investment Company Act of 1940, as amended. F. Proposed maximum offering price to the public of the securities being G. Amount of filing fee: $500 (as required by Rule 24f-2) H. Approximate date of proposed sale to the public: As soon as practicable after the effective date of the registration statement ----- Check box if it is proposed that this filing will become effective ----- on (Date) at (Time) pursuant to Rule 487. The registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a) may determine. NUVEEN NUVEEN CALIFORNIA INSURED TRUST 259 (NUVEEN TAX-FREE UNIT TRUSTS SERIES 843) PROSPECTUS--PART A (SPECIFIC TERMS) -- JANUARY 11, 1996 THIS PART A OF THE PROSPECTUS MAY NOT BE DISTRIBUTED UNLESS ACCOMPANIED BY THE THE NUVEEN TAX-EXEMPT UNIT TRUSTS PROSPECTUS, TO WHICH SUCH REFERENCE HEREIN "NUVEEN TAX-EXEMPT UNIT TRUSTS" IN PART B SHALL BE AMENDED TO READ "NUVEEN TAX-FREE UNIT TRUSTS." BOTH PARTS OF THE PROSPECTUS SHOULD BE RETAINED FOR FUTURE REFERENCE. California Insured Trust 259 (the "Trust") consists of a portfolio of interest-bearing obligations issued by or on behalf of the State of California, certain United States Territories or authorities and political subdivisions thereof which, in the opinion of recognized bond counsel to the issuing authorities, provide income which is exempt from Federal income tax and California income tax, to the extent indicated below. The objectives of the Trust are income exempt from Federal and state income taxes, and conservation of capital. The objectives are, of course, dependent upon the continuing ability of the issuers, obligors and/or insurers to meet their respective obligations. The Portfolio of the Trust consists of 8 obligations issued by entities located in California. The Bonds in the Trust are either general obligations of the governmental entity issuing them and are backed by the taxing power thereof or are payable as to principal and interest from the income of a specific project or authority and are not supported by the issuer's power to levy taxes. The sources of payment for the Bonds are divided as follows: Approximately 40.0% of the aggregate principal amount of the Bonds in the Trust (accounting for approximately 37.5% of the aggregate offering price of the Bonds) are original issue discount obligations. Certain of these original issue discount obligations, amounting to 5.0% of the aggregate principal amount and 1.9% of the aggregate offering price of the Bonds in the Trust, are "zero coupon" bonds. See "RISK FACTORS" in Part B of this Prospectus for a discussion of the characteristics of such obligations and of the risks associated therewith. All of the Bonds in the Trust are covered by policies of insurance obtained from the MBIA Insurance Corporation guaranteeing payment of principal and interest when due. As a result of such insurance, the Bonds in the Trust have received a rating of "Aaa" by Moody's and both the Bonds in the Trust and the Units of the Trust have received a rating of "AAA" by Standard & Poor's. The Trust is considered to be concentrated in Bonds of Dedicated-Tax Supported Revenue Issuers whose revenues are subject to certain risks including changes in the local economy and the ability to collect taxes in a timely fashion. For a discussion of the risks associated with investments in the bonds of various issuers, see "RISK FACTORS" in Part B of this Prospectus. REGARDING THE NUVEEN CALIFORNIA INSURED TRUST 259 ON THE BUSINESS DAY PRIOR TO THE DATE OF DEPOSIT, JANUARY 10, 1996 Sponsor and Evaluator........ John Nuveen & Co. Incorporated Trustee...................... The Chase Manhattan Bank, N.A. The income, expense and distribution data set forth below have been calculated for Unitholders receiving monthly, quarterly or semi-annual distribution options. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This Prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any State. The evaluation time for purpose of sale, purchase or redemption of Units is 4 p.m. Eastern time or as of any earlier closing time on a day on which the New York Stock Exchange is scheduled in advance to close at such earlier time. (See "HOW IS THE PUBLIC OFFERING PRICE DETERMINED?" in Part B of this Prospectus.) (1) Units are offered at the Public Offering Price plus accrued interest from the preceding Record Date to, but not including, the date of settlement (normally three business days after purchase). The Date of Deposit of the Fund has been designated as the First Record Date for all plans of distribution of the Trust and, accordingly, for Units purchased on the Date of Deposit, $.08 of accrued interest to the Settlement Date will be added to the Public Offering Price. (See "WHAT IS ACCRUED INTEREST?" in Part B of (2) The Average Maturity of Bonds in the Trust is calculated based upon the stated maturities of the Bonds in the Trust (or, with respect to Bonds for which funds or securities have been placed in escrow to redeem such Bonds on a stated call date, based upon such call date). The Average Maturity of Bonds in the Trust may increase or decrease from time to time as Bonds mature or are called or sold. (3) Assumes delivery of all Bonds. (See "COMPOSITION OF TRUSTS" appearing in Part B of this Prospectus.) Interest income does not include accretion of original issue discount on "zero coupon" Bonds, Stripped Obligations or other original issue discount Bonds. (See "RISK FACTORS" in Part B of this (4) The amount and timing of interest distributions from the Trust under the various plans of distribution are set forth below. It is anticipated that the amount of interest to be distributed per Unit in each year under each plan of distribution will initially be substantially equal to the Estimated Net Annual Interest Income per Unit for that plan. The amount of interest to be distributed annually per Unit, will generally change as Bonds are redeemed, mature or are sold or as fees and expenses increase or decrease. (5) Estimated Long Term Return for the Trust represents the average of the yields to maturity (or call) of the Bonds in the Trust's portfolio calculated in accordance with accepted bond practices and adjusted to reflect a compounding factor, expenses and sales charges. Estimated Current Return is computed by dividing the Net Annual Interest Income per Unit by the Public Offering Price, and in contrast to Estimated Long Term Return does not reflect the amortization of premium or accretion of discount, if any. For more information see "WHAT ARE ESTIMATED LONG TERM RETURN AND ESTIMATED CURRENT RETURN?" in Part B of this Prospectus. (6) Each Trustee annual fee is per $1,000 principal amount of the underlying Bonds in the Trust for that portion of the Trust that represents a particular plan of distribution. (7) The Trust (and therefore Unitholders) will bear all or a portion of its organizational costs (including costs of preparing the registration statements, the trust indenture and other closing documents, registering Units with the Securities and Exchange Commission and states, the initial audit of the Trust portfolio, legal fees and the initial fees and expenses of the Trustee but not including the expenses incurred in the printing of preliminary and final prospectuses, and expenses incurred in the preparation and printing of brochures and other advertising materials and any other selling expenses) as is common for mutual funds. Total organizational expenses will be amortized over a five year period. See "WHAT ARE NORMAL TRUST OPERATING EXPENSES?" in Part B of this Prospectus and "Statement of Condition." Historically, the sponsors of unit investment trusts have paid all the costs of establishing such trusts. Details of interest distributions per Unit of the Trust under the various plans appear in the following table based upon estimated Net Annual Interest Income at the Date of Deposit: * Record Dates for semi-annual distributions are May 1 and November 1; for quarterly distributions, they are February 1, May 1, August 1 and November 1. Record Dates for monthly distributions are the first day of each month. Distribution Dates under each distribution plan are the fifteenth day of the month in which the respective Record Date occurred. For additional information see "WHEN ARE DISTRIBUTIONS MADE TO UNITHOLDERS?" in Part B of this Prospectus. (1) The first distribution will be paid to all Unitholders, regardless of the distribution plan selected. Such distribution may be more or less than a regular monthly distribution. (3) The second distribution under the semi-annual distribution plan represents a 3-month distribution; subsequent semi-annual distributions will be regular 6-month distributions. The financial condition of the State of California is affected by various national, economic, social and environmental policies and conditions. Additionally, limitations imposed by constitutional amendments, legislative measures, or voter initiatives on the State and its local governments concerning taxes, bond indebtedness and other matters may constrain the revenue-generating capacity of the State and its local governments and, therefore, the ability of the issuers of the Bonds to satisfy their obligations. The State faces a structural imbalance in its budget with the largest programs supported by the General Fund (education, health, welfare and corrections) growing at rates higher than the growth rates for the principal revenue sources of the General Fund. The economic vitality of the State and its various regions and, therefore, the ability of the State and its local governments to satisfy the Bonds, are affected by numerous factors, such as natural disasters and cutbacks in federal defense spending. The California economy continues to show weakness in manufacturing, particularly aerospace, construction, services and trade. California's population increase has resulted in traffic congestion, school overcrowding and high housing costs which have caused an increase demand for government services and which may impede future economic growth. The State is a party to numerous lawsuits in which an adverse final decision could materially affect the State's governmental operations and consequently its ability to pay debt service on its obligations. On December 7, 1994, Orange County, California, together with its pooled investment fund (the "POOLED FUND") filed for protection under Chapter 9 of the federal Bankruptcy Code. Many governmental entities kept moneys in the Pool Fund. All outstanding general obligations bonds of the State are rated "A" by Standard and Poor's and "A1" by Moody's. Further information concerning California risk factors may be obtained upon written or telephonic request to the Trustee as described in "OTHER INFORMATION -- Supplemental Information" appearing in Part B of this Prospectus. For a discussion of the Federal tax status of income earned on Trust Units, see "WHAT IS THE TAX STATUS OF UNITHOLDERS?" in Part B of this Prospectus. In the opinion of Orrick, Herrington & Sutcliffe, special California counsel to the Trust, under existing California income and property tax law applicable to individuals who are California residents: The Trust is not an association taxable as a corporation and the income of the Trust will be treated as the income of the Unitholders under the income tax laws of California. Interest on the underlying securities (which may include bonds or other obligations issued by the governments of Puerto Rico, the Virgin Islands, Guam or the Northern Mariana Islands) which is exempt from tax under California personal income tax and property tax laws when received by the Trust will, under such laws, retain its status as tax-exempt interest when distributed to Unitholders. However, interest on the underlying securities attributed to a Unitholder which is a corporation subject to the California franchise tax laws may be includable in its gross income for purposes of determining its California franchise tax. Under California income tax law, each Unitholder in the Trust will have a taxable event when the Trust disposes of a security (whether by sale, exchange, redemption or payment at maturity) or when the Unitholder redeems or sells Units. Because of the requirement that tax cost basis be reduced to reflect amortization of bond premium, under some circumstances a Unitholder may realize taxable gain when Units are sold or redeemed for an amount equal to, or less than, their original cost. The total tax cost of each Unit to a Unitholder is allocated among each of the bond issues held in the Trust (in accordance with the proportion of the Trust comprised by each bond issue) in order to determine his per unit tax cost for each bond issue; and the tax cost reduction requirements relating to amortization of bond premium will apply separately to the per unit cost of each bond issue. Unitholders' bases in their Units, and the bases for their fractional interest in each Trust asset, may have to be adjusted for their pro rata share of accrued interest received, if any, on securities delivered after the Unitholders' respective settlement dates. Under the California personal property tax laws, bonds (including the bonds in the Trust as well as "regular-way" and "when-issued" contracts for the purchase of bonds) or any interest therein is exempt from such tax. Any proceeds paid under the insurance policy issued to the Trustee of the fund with respect to the bonds in the Trust as well as "regular-way" and "when-issued" contracts for the purchase of bonds which represent maturing interest on defaulted obligations held by the Trustee will be exempt from California personal income tax if, and to the same extent as, such interest would have been so exempt if paid by the issuer of the defaulted obligations. Under Section 17280(b)(2) of the California Revenue and Taxation Code, interest on indebtedness incurred or continued to purchase or carry Units of the Trust is not deductible for the purposes of the California personal income tax. While there presently is no California authority interpreting this provision, Section 17280(b)(2) directs the California Franchise Tax Board to prescribe regulations determining the proper allocation and apportionment of interest costs for this purpose. The Franchise Tax Board has not yet proposed or prescribed such regulations. In interpreting the generally similar Federal provision, the Internal Revenue Service has taken the position that such indebtedness need not be directly traceable to the purchase or carrying of Units (although the Service has not contended that a deduction for interest on indebtedness incurred to purchase or improve a personal residence or to purchase goods or services for personal consumption will be disallowed). In the absence of conflicting regulations or other California authority, the California Franchise Tax Board generally has interpreted California statutory tax provisions in accord with Internal Revenue Service interpretations of similar Federal provisions. NUVEEN CALIFORNIA INSURED TRUST 259 (NUVEEN TAX-FREE UNIT TRUST SERIES 843) SCHEDULE OF INVESTMENTS AT THE DATE OF DEPOSIT, JANUARY 11, 1996 (1) The Sponsor's contracts to purchase Bonds were entered into on January 10, 1996. Other information regarding the Bonds in the Trust on the Date of Deposit is as follows: In addition, the difference between the Trustee's determination of Offering Price and Bid Price (as a percentage of principal amount) is .49%. Neither cost to Sponsor nor profit (or loss) to Sponsor reflects underwriting profits or losses received or incurred by the Sponsor through its participation in underwriting syndicates. The Sponsor did not participate as either the sole underwriter or as a manager or member of a syndicate that acted as the original underwriter of any of the Bonds. (2) The Bonds are first subject to optional redemption in the years, and at the prices, shown. Unless otherwise indicated, the Bonds, except for Bonds issued at a substantial original issue discount, are redeemable at declining prices (but not below par value) in subsequent years. Original issue discount bonds, including zero coupon bonds, are generally redeemable at prices based on the issue price plus the amount of original issue discount accreted to redemption plus, if applicable, some premium, the amount of which will decline in subsequent years. The Bonds may also be subject to sinking fund redemption without premium prior to the dates shown. Certain Bonds may be subject to redemption without premium prior to the date shown pursuant to special or mandatory call provisions specified in the instruments setting forth the terms and provisions of such Bonds. See "COMPOSITION OF TRUSTS", "WHAT IS THE TAX STATUS OF UNITHOLDERS?" and "RISK FACTORS" in Part B of this Prospectus. (3) All the Bonds in the Insured Trusts, as insured by the Insurer, are rated AAA by Standard & Poor's and Aaa by Moody's. The insurance obtained by the Trust guarantees the payment of interest and principal on the Bonds when due but does not cover certain market risks associated with fixed income securities such as accelerated payments, premiums payable on mandatory redemptions or interest rate risks. (See "WHY AND HOW ARE THE BONDS INSURED?" in Part B of this Prospectus and "Description of Ratings" in the Information Supplement.) NUVEEN CALIFORNIA INSURED TRUST 259 (Nuveen Tax-Free Unit Trust, Series 843) AS OF JANUARY 11, 1996 (1) Represented by contracts to purchase Tax-Exempt Bonds which include "when issued" or "regular way" or "delayed delivery" contracts for which an irrevocable letter of credit issued by a major commercial bank has been deposited with the Trustee on the Date of Deposit. The amount of such letter of credit and any cash deposited exceeds the amount necessary for the purchase of the Bonds plus accrued interest to the Date of Deposit. At the Date of Deposit, Bonds may have been delivered to the Sponsor pursuant to certain of these contracts; the Sponsor has assigned to the Trustee all of its rights, title and interest in and to such Bonds. (2) Aggregate value (at offering prices) as of the Date of Deposit of the Bonds listed under "Schedule of Investments" herein, and their aggregate cost to the Trust are the same. Such offering prices were determined by Kenny S&P Evaluation Services, a division of J.J. Kenny Co., Inc., as of the close of business on the business day prior to the Date of Deposit. (See "HOW WAS THE PRICE OF THE BONDS DETERMINED AT THE DATE OF DEPOSIT?" in Part B of this Prospectus.) Insurance coverage providing for the timely payment, when due, of all principal of and interest on the Bonds in an Insured Trust has been obtained by the Sponsor or by the issuers of such Bonds. Such insurance does not guarantee the market value of the Bonds or the value of the Units. Both the bid and the offering prices of the underlying Bonds and of the Units may include value attributable to such policies of insurance. (3) The Trust (and therefore Unitholders) will bear all or a portion of its estimated organizational costs which will be deferred and amortized over five years from the Date of Deposit. (4) Representing, as set forth in "WHAT IS ACCRUED INTEREST?" in Part B of this Prospectus, advancement by the Trustee of an amount equal to the accrued Bond interest as of the Date of Deposit. (5) Aggregate Public Offering Price (exclusive of accrued interest) computed as set forth under "HOW IS THE PUBLIC OFFERING PRICE DETERMINED?" in Part B of this Prospectus. (6) The gross underwriting commission of 4.90% of the Public Offering Price has been calculated on the assumption that the Units sold are not subject to a reduction of sales charge for quantity purchases. In single transactions involving 500 Units or more, the sales charge is reduced. (See "HOW IS THE PUBLIC OFFERING PRICE DETERMINED?" in Part B of this Prospectus.) REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE BOARD OF DIRECTORS OF JOHN NUVEEN & CO. INCORPORATED AND UNITHOLDERS OF CALIFORNIA INSURED TRUST 259: We have audited the accompanying statement of condition and the schedule of investments at date of deposit (included in Part A of this Prospectus) of California Insured Trust 259 (contained in Nuveen Tax-Free Unit Trust, Series 843), as of January 11, 1996. These financial statements are the responsibility of the Sponsor. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of the irrevocable letter of credit arrangement for the purchase of securities, described in Note (1) to the statement of condition, by correspondence with the Trustee. An audit also includes assessing the accounting principles used and significant estimates made by the Sponsor, 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 statement of condition and the schedule of investments at date of deposit referred to above present fairly, in all material respects, the financial position of California Insured Trust 259 as of January 11, 1996, in conformity with generally accepted accounting principles. THIS PART B OF THE PROSPECTUS MAY NOT BE DISTRIBUTED UNLESS ACCOMPANIED BY PART A. BOTH PARTS OF THIS PROSPECTUS SHOULD BE RETAINED FOR FUTURE REFERENCE. FURTHER DETAIL REGARDING CERTAIN OF THE INFORMATION PROVIDED IN THE PROSPECTUS MAY BE OBTAINED WITHIN FIVE BUSINESS DAYS OF WRITTEN OR TELEPHONIC REQUEST TO THE TRUSTEE AT 770 BROADWAY, NEW YORK, NY 10003 OR (800) 257-8787. INTEREST INCOME TO A TRUST AND TO UNITHOLDERS, IN THE OPINION OF COUNSEL, UNDER EXISTING LAW IS EXEMPT FROM FEDERAL INCOME TAX. CAPITAL GAINS, IF ANY, ARE SUBJECT TO TAX. IN ADDITION, INTEREST INCOME OF STATE TRUSTS IS, IN THE OPINION OF COUNSEL, EXEMPT, TO THE EXTENT INDICATED, FROM STATE AND LOCAL TAXES. INTEREST INCOME OF ANY TRUST OTHER THAN A STATE TRUST MAY BE SUBJECT TO STATE AND LOCAL TAXES. CURRENTLY OFFERED AT PUBLIC OFFERING PRICE PLUS INTEREST ACCRUED TO THE DATE OF SETTLEMENT. MINIMUM PURCHASE-- EITHER $5,000 OR 50 UNITS, WHICHEVER IS LESS. THIS NUVEEN TAX-EXEMPT UNIT TRUST SERIES consists of the underlying separate unit investment trust set forth in Part A to this Prospectus. Each Trust initially consists of delivery statements relating to contracts to purchase Bonds and, thereafter, will consist of a diversified portfolio of obligations issued by or on behalf of states and territories of the United States and authorities and political subdivisions thereof (see "Schedule of Investments" appearing in Part A of this Prospectus). Except in specific instances as noted in Part A of this Prospectus, the information contained in this Part B shall apply to each Trust in its entirety. All obligations in each Traditional Trust are rated in the category "A" or better by Standard & Poor's, a division of the McGraw Hill Companies ("Standard & Poor's") or Moody's Investors Service, Inc. ("Moody's") on the Date of Deposit. All obligations in each Insured Trust are covered by policies of insurance obtained from the MBIA Insurance Corporation guaranteeing payment of principal and interest when due. All such policies of insurance remain effective so long as the obligations are outstanding. As a result of such insurance, the Bonds in each portfolio of the Insured Trusts have received a rating of "Aaa" by Moody's and the Bonds in the Insured Trusts and the Units of each such Trust have received a rating of "AAA" by Standard & Poor's. INSURANCE RELATES ONLY TO THE BONDS IN THE INSURED TRUSTS AND NOT TO THE UNITS OFFERED HEREBY OR TO THEIR MARKET VALUE. (See "WHY AND HOW ARE THE BONDS THE OBJECTIVES of a Trust are tax-exempt income and conservation of capital through a diversified investment in tax-exempt Bonds. The payment of interest and the preservation of principal are, of course, dependent upon the continuing ability of the issuers of Bonds and of any insurer thereof to meet their obligations thereunder. There is no guarantee that a Trust's objectives will be DISTRIBUTIONS of interest received by a Trust will be made semi-annually unless the Unitholder elects to receive them monthly or quarterly. (See "WHEN ARE DISTRIBUTIONS MADE TO UNITHOLDERS?".) Distribution of funds in the Principal Account, if any, will ordinarily be made semi-annually. FOR ESTIMATED LONG TERM RETURNS AND ESTIMATED CURRENT RETURNS to Unitholders in each Trust on the business day prior to the Date of Deposit. (See Part A of this Prospectus and "WHAT ARE ESTIMATED LONG TERM RETURN AND ESTIMATED CURRENT THE PUBLIC OFFERING PRICE per Unit of each Trust during the initial offering period is equal to a pro rata share of the OFFERING prices of the Bonds in such Trust's portfolio plus a sales charge of up to 4.90% of the Public Offering Price (equivalent to 5.152% of the net amount invested); the sales charge is somewhat lower on Trusts with lesser average maturities. (See "HOW IS THE PUBLIC OFFERING PRICE DETERMINED?".) The Secondary Market Public Offering Price per Unit for each Trust will be equal to a pro rata share of the sum of BID prices of the Bonds in such Trust plus the sales charges determined based on the number of years remaining to the maturity of each Bond. Accrued interest from the preceding Record Date to, but not including, the settlement date (normally three business days after purchase) is added to the Public Offering Price. The sales charge is reduced on a graduated scale for sales involving at least $50,000 or 500 Units and will be applied on whichever basis is more favorable to the purchaser. (See "HOW IS THE PUBLIC OFFERING PRICE DETERMINED?".) A UNITHOLDER MAY REDEEM UNITS at the office of the Trustee at prices based upon the BID prices of the Bonds. The price received upon redemption may be more or less than the amount paid by Unitholders, depending upon the value of the Bonds on the date of tender for redemption. (See "HOW UNITS MAY BE REDEEMED WITHOUT CHARGE?".) The Sponsor, although not required to do so, intends to make a secondary market for the Units of the Trusts at prices based upon the BID prices of the Bonds in the respective Trusts. (See "MARKET FOR UNITS".) RETAIN BOTH PART A AND PART B OF THIS PROSPECTUS FOR FUTURE REFERENCE. RISK FACTORS. An investment in a Trust should be made with an understanding of the risks associated therewith, including, among other factors, the inability of the issuer or an insurer to pay the principal of or interest on a bond when due, volatile interest rates, early call provisions, and changes to the tax status of the Bonds. See Part A of this Prospectus and "RISK FACTORS." UNITS OF THE TRUST ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK AND ARE NOT FEDERALLY INSURED OR OTHERWISE PROTECTED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER AGENCY AND INVOLVE INVESTMENT RISK, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. WHAT IS THE NUVEEN TAX-EXEMPT UNIT TRUST? This Nuveen Tax-Exempt Unit Trust is one of a series of separate but similar investment companies created by the Sponsor, each of which is designated by a different Series number. The underlying unit investment trusts contained in this Series are combined under one Trust Indenture and Agreement. Specific information regarding this Trust is set forth in Part A of this Prospectus. The various Nuveen Tax-Exempt Unit Trusts are collectively referred to herein as the "Trusts"; the trusts in which few or none of the Bonds are insured are sometimes referred to as the "Traditional Trusts", the trusts in which all of the Bonds are insured as described herein are sometimes referred to as the "Insured Trusts", and the state trusts (both Traditional and Insured) are sometimes referred to as the "State Trusts." This Series was created under the laws of the State of New York pursuant to a Trust Indenture and Agreement dated the Date of Deposit (the "Indenture") between John Nuveen & Co. Incorporated (the "Sponsor") and The Chase Manhattan Bank, N.A. (the "Trustee"). The Sponsor has deposited with the Trustee delivery statements relating to contracts for the purchase of municipal debt obligations together with funds represented by an irrevocable letter of credit issued by a major commercial bank in the amount, including accrued interest, required for their purchase (or the obligations themselves) (the "Bonds"). See "Schedule of Investments" in Part A of this Prospectus, for a description of the Securities deposited in a Trust. See "SUMMARY OF PORTFOLIOS" and "RISK FACTORS" for a discussion of zero coupon bonds and stripped obligations included in the Trusts, if any. Some of the delivery statements may relate to contracts for the purchase of "when issued" or other Bonds with delivery dates after the date of settlement for a purchase made on the Date of Deposit. See the "Schedule of Investments" in Part A of this Prospectus and "COMPOSITION OF TRUSTS". For a discussion of the Sponsor's obligations in the event of a failure of any contract for the purchase of any of the Bonds and its limited right to substitute other bonds to replace any failed contract, see "COMPOSITION OF TRUSTS." Payment of interest on the Bonds in each Insured Trust, and of principal at maturity, is guaranteed under policies of insurance obtained by the Sponsor or by the issuers of the Bonds. (See "WHY AND HOW ARE THE BONDS INSURED?".) AS A GENERAL MATTER, NEITHER THE ISSUER NOR THE SPONSOR HAS OBTAINED INSURANCE WITH RESPECT TO THE BONDS IN ANY TRADITIONAL TRUST. The Trustee has delivered to the Sponsor registered Units which represent ownership of the entire Trust, and which are offered for sale by this Prospectus. Each Unit of a Trust represents a fractional undivided interest in the principal and net income of such Trust in the ratio set forth in "Essential Information" in Part A of this Prospectus. Units may only be sold in states in which they are registered. To the extent that any Units of any Trust are redeemed by the Trustee, the aggregate value of the Trust's assets will decrease by the amount paid to the redeeming Unitholder, but the fractional undivided interest of each unredeemed Unit in such Trust will increase proportionately. The Sponsor will initially, and from time to time thereafter, hold Units in connection with their offering. WHAT ARE THE OBJECTIVES OF THE TRUSTS? The objectives of the Trusts are income exempt from Federal income tax and, in the case of State Trusts, where applicable, state income and intangibles taxes, and conservation of capital, through an investment in obligations issued by or on behalf of states and territories of the United States and authorities and political subdivisions thereof, the interest on which is, in the opinion of recognized bond counsel to the issuing governmental authorities, exempt from Federal income tax under existing law and certain state income tax and intangibles taxes, if any, for purchasers who qualify as residents of that State in which Bonds are issued. Insurance guaranteeing the timely payment, when due, of all principal and interest on the Bonds in each Insured Trust has been obtained by the Sponsor or by the issuers of such Bonds from MBIA Insurance Corporation, and as a result of such insurance the obligations in the Insured Trusts are rated "Aaa" by Moody's and "AAA" by Standard & Poor's. (See "WHY AND HOW ARE THE BONDS INSURED?".) All obligations in each Traditional Trust are rated in the category "A" or better (SP-1 or MIG 2 or better in the case of short term obligations included in a Short Term Traditional Trust) by Standard & Poor's or Moody's (including provisional or conditional ratings). In addition, certain Bonds in certain Traditional Trusts may be covered by insurance guaranteeing the timely payment, when due, of all principal and interest. There is, of course, no guarantee that the Trusts' objectives will be achieved. For a comparison of net after-tax return for various tax brackets see the "TAXABLE EQUIVALENT ESTIMATED CURRENT RETURN TABLES" included in the Appendices to the Information Supplement of this Prospectus. In selecting Bonds for the respective Trusts, the following factors, among others, were considered: (i) the Standard & Poor's Corporation rating of the Bonds or the Moody's Investors Service, Inc. rating of the Bonds (see "WHAT ARE THE OBJECTIVES OF THE TRUSTS?" for a description of minimum rating standards), (ii) the prices of the Bonds relative to other bonds of comparable quality and maturity, (iii) the diversification of Bonds as to purpose of issue and location of issuer, (iv) the maturity dates of the Bonds, and (v) in the case of the Insured Trusts only, the availability of MBIA Insurance Corporation insurance on such Bonds. (See "WHY AND HOW ARE THE BONDS INSURED?".) An investment in Units of any Trust should be made with an understanding of the risks that such an investment may entail. Each Trust consists of fixed-rate municipal debt obligations. As such, the value of the debt obligations and therefore of the Units will decline with increases in interest rates. In general, the longer the period until the maturity of a Bond, the more sensitive its value will be to fluctuations in interest rates. The Sponsor cannot predict the extent or timing of such fluctuations and, accordingly, their effect upon the value of the debt obligations. Additional risk factors include the ability of the issuer, or, if applicable, an insurer, to make payments of interest and principal when due, "mandatory put" features, early call provisions and the potential for changes in the tax status of the Bonds. As set forth in Part A of this Prospectus, the Trusts may contain or be concentrated in one or more of the types of bonds discussed below. The following paragraphs briefly discuss certain circumstances which may adversely affect the ability of issuers of Bonds held in the portfolio of a Trust to make payment of principal and interest thereon, and which also therefore may adversely affect the ratings of such Bonds. With respect to Insured Trusts, however, because of the insurance obtained by the Sponsor or by the issuers of the Bonds, such changes should not adversely affect an Insured Trust's receipt of principal and interest, the Standard & Poor's AAA or Moody's Aaa ratings of the Bonds in the Insured Trust portfolio, or the Standard & Poor's AAA rating of the Units of each such Insured Trust. The Bonds described below may be subject to special or extraordinary redemption provisions. For economic risks specific to the individual Trusts, see Part A of this Prospectus and the Appendices to the Information Supplement of this Prospectus. HEALTH FACILITY OBLIGATIONS are obligations of issuers whose revenues are derived from services provided by hospitals or other health care facilities, including nursing homes. The ability of such issuers to make debt service payments on these obligations is dependent on various factors, including occupancy levels of the facility, demand for services, wages of employees, overhead expenses, competition from other similar providers, government regulation, the cost of malpractice insurance, and the degree of governmental financial assistance, including Medicare and Medicaid. HOUSING OBLIGATIONS are obligations of issuers whose revenues are primarily derived from mortgage loans on single family residences or housing projects for low to moderate income families. Housing obligations are generally prepayable at any time and therefore their average life will ordinarily be less than their stated maturities. The ability of such issuers to make debt service payments on these obligations is dependent on various factors, including occupancy levels, rental income, mortgage default rates, taxes, operating expenses, governmental regulations and the appropriation of subsidies. INDUSTRIAL REVENUE OBLIGATIONS are industrial revenue bonds ("IRBs"), including pollution control revenue bonds, which are tax-exempt securities issued by states, municipalities, public authorities or similar entities to finance the cost of acquiring, constructing or improving various industrial projects. Debt service payment on IRBs is dependent upon various factors, including the creditworthiness of the corporate operator of the project and, if applicable, corporate guarantor, revenues generated from the project, expenses associated with the project and regulatory and environmental restrictions. ELECTRIC UTILITY OBLIGATIONS are obligations of issuers whose revenues are primarily derived from the sale of electric energy. The ability of such issuers to make debt service payments on these obligations is dependent on various factors, including the rates for electricity, the demand for electricity, the degree of competition, governmental regulation, overhead expenses and variable costs, such as fuel. TRANSPORTATION FACILITY REVENUE OBLIGATIONS are obligations of issuers which are payable from and secured by revenues derived from the ownership and operation of airports, public transit systems and ports. The ability of issuers to make debt service payments on airport obligations is dependent on the capability of airlines to meet their obligations under use agreements. Due to increased competition, deregulation, increased fuel costs and other factors, many airlines may have difficulty meeting their obligations under these use agreements. Bonds that are secured primarily by the revenue collected by a public transit system typically are additionally secured by a pledge of sales tax receipts collected at the state or local level, or of other governmental financial assistance. The revenue of issuers of transit system obligations will be affected by variations in utilization, which in turn may be affected by the degree of local governmental subsidization, competition from other forms of transportation, and increased costs. Port authorities derive their revenues primarily from fees imposed on ships using the facilities which may fluctuate depending on the local economy and on competition from competing forms of transportation such as air, rail and trucks. The revenues of issuers which derive their payments from bridge, road or tunnel toll revenues could be adversely affected by increases in fuel costs, competition from toll-free vehicular bridges and roads and alternative modes of transportation. WATER AND/OR SEWERAGE OBLIGATIONS are obligations of issuers whose revenues are payable from user fees from the sale of water and/or sewerage services. The problems of such issuers include the ability to obtain rate increases, population declines, the limitations on operations and increased costs and delays attributable to environmental considerations, the difficulties obtaining new supplies of fresh water, the effect of conservation programs and in "no-growth" zoning ordinances. UNIVERSITY AND COLLEGE REVENUE OBLIGATIONS are obligations of issuers whose revenues are derived mainly from tuition, dormitory revenues, grants and endowments. General problems faced by such issuers include declines in the number of "college" age individuals, possible inability to raise tuitions and fees, the uncertainty of continued receipt of Federal grants and state funding, and government legislation or regulations which may adversely affect the revenues or costs of such issuers. DEDICATED-TAX SUPPORTED OBLIGATIONS are obligations of issuers which are payable from and secured by tax revenues from a designated source, which revenues are pledged to secure the bonds. The various types of Bonds described below differ in structure and with respect to the rights of the bondholders to the underlying property. Each type of dedicated-tax supported Bond has distinct risks, only some of which are set forth below. One type of dedicated-tax supported Bond is secured by the incremental tax received on either real property or on sales within a specifically defined geographical area; such tax generally will not provide bondholders with a lien on the underlying property or revenues. Another type of dedicated-tax supported Bond is secured by a special tax levied on real property within a defined geographical area in such a manner that the tax is levied on those who benefit from the project; such bonds typically provide for a statutory lien on the underlying property for unpaid taxes. A third type of dedicated-tax supported Bond may be secured by a tax levied upon the manufacture, sale or consumption of commodities or upon the license to pursue certain occupations or upon corporate privileges within a taxing jurisdiction. As to any of these types of Bonds, the ability of the designated revenues to satisfy the interest and principal payments on such bonds may be affected by changes in the local economy, the financial success of the enterprise responsible for the payment of the taxes, the value of any property on which taxes may be assessed and the ability to collect such taxes in a timely fashion. Each of these factors will have a different affect on each distinct type of dedicated-tax supported bonds. MUNICIPAL LEASE OBLIGATIONS are obligations that are secured by lease payments of a governmental entity and are normally subject to annual budget appropriations of the leasing governmental entity. A governmental entity that enters into such a lease agreement cannot obligate future governments to appropriate for and make lease payments but covenants to take such action as is necessary to include any lease payments due in its budgets and to make the appropriations therefor. A governmental entity's failure to appropriate for and to make payments under its lease obligation could result in insufficient funds available for payment of the obligations secured thereby. ORIGINAL ISSUE DISCOUNT OBLIGATIONS AND STRIPPED OBLIGATIONS are bonds which were issued with nominal interest rates less than the rates then offered by comparable securities and as a consequence were originally sold at a discount from their face, or par, values. In a stable interest rate environment, the market value of an original issue discount bond would tend to increase more slowly in early years and in greater increments as the bond approached maturity. Certain of the original issue discount obligations in a Trust may be zero coupon bonds. Zero coupon bonds do not provide for the payment of any current interest; the buyer receives only the right to receive a final payment of the face amount of the bond at its maturity. Zero coupon bonds are subject to substantially greater price fluctuations during periods of changing market interest rates than are securities of comparable quality that pay interest currently. Original issue discount obligations, including zero coupon bonds, may be subject to redemption at prices based on the issue price plus the amount of original issue discount accreted to redemption (the "accreted value") plus, if applicable, some premium. Pursuant to such call provisions, an original issue discount bond may be called prior to its maturity date at a price less than its face value. See the "Schedule of Investments" appearing in Part A of this Prospectus for more information about the call provisions of portfolio Bonds. Certain of the Bonds in a Trust may be stripped obligations, which represent evidences of ownership with respect to either the principal amount of or a payment of interest on a tax-exempt obligation ("Stripped Obligations"). Each Stripped Obligation has been purchased at a discount from the amount payable at maturity. A Stripped Obligation therefore has economic characteristics similar to zero coupon bonds, as described above. Unitholders should consult their own tax advisers with respect to the state and local tax consequences of owning original issue discount bonds or Stripped Obligations. Under applicable provisions governing determination of state and local taxes, interest on original issue discount obligations or Stripped Obligations may be deemed to be received in the year of accrual even though there is no corresponding cash payment. Certain bonds may carry a "mandatory put" (also referred to as a "mandatory tender" or "mandatory repurchase") feature pursuant to which the holder of such bonds will receive payment of the full principal amount thereof on a stated date prior to the maturity date unless such holder affirmatively acts to retain the bond. The Trustee does not have the authority to act to retain Bonds with such features; accordingly, it will receive payment of the full principal amount of any such Bonds on the stated put date and such date is therefore treated as the maturity date of such Bonds in selecting Bonds for the respective Trusts and for purposes of calculating the average maturity of the Bonds in any Trust. Each Trust initially consists of delivery statements relating to contracts to purchase Bonds (or of such Bonds) as are listed under "Schedule of Investments" in Part A of this Prospectus and, thereafter, of such Bonds as may continue to be held from time to time (including certain securities deposited in the Trust in substitution for Bonds not delivered to a Trust or in exchange or substitution for Bonds upon certain refundings), together with accrued and undistributed interest thereon and undistributed cash realized from the disposition of Bonds. "WHEN-ISSUED" AND "DELAYED DELIVERY" TRANSACTIONS. The contracts to purchase Bonds delivered to the Trustee represent an obligation by issuers or dealers to deliver Bonds to the Sponsor for deposit in the Trusts. Certain of the contracts relate to Bonds which have not been issued as of the Date of Deposit and which are commonly referred to as "when issued" or "when, as and if issued" Bonds. Although the Sponsor believes it unlikely, if such Bonds, or replacement bonds described below, are not acquired by a Trust or if their delivery is delayed, the Estimated Current Returns and Estimated Long Term Returns shown in Part A of this Prospectus may be reduced. Certain of the contracts for the purchase of Bonds provide for delivery dates after the date of settlement for purchases made on the Date of Deposit. Interest on such "when issued" and "delayed delivery" Bonds accrues to the benefit of Unitholders commencing with the first settlement date for the Units. However, in the opinion of counsel, Unitholders who purchase their Units prior to the date such Bonds are actually delivered to the Trustee must reduce the tax basis of their Units for interest accruing on such Bonds during the interval between their purchase of Units and the delivery of the Bonds because such amounts constitute a return of principal. As a result of such adjustment, the Estimated Current Returns set forth in Part A of this Prospectus (which are based on the Public Offering Price as of the business day prior to the Date of Deposit) may be slightly lower than Unitholders will receive after the first year, assuming the Portfolio does not change and estimated annual expense does not vary from that set forth under "Essential Information" in Part A of this Prospectus. Those Bonds in each Trust purchased with delivery dates after the date of settlement for purchases made on the Date of Deposit are so noted in the "Schedule of Investments" in Part A of this Prospectus. LIMITED REPLACEMENT OF CERTAIN BONDS. Neither the Sponsor nor the Trustee shall be liable in any way for any default, failure or defect in any Bond. In the event of a failure to deliver any Bond that has been purchased for a Trust under a contract, including those Bonds purchased on a when, as and if issued basis ("Failed Bonds"), the Sponsor is authorized under the Indenture to direct the Trustee to acquire other specified Bonds ("Replacement Bonds") to make up the original corpus of the Trust within 20 days after delivery of notice of the failed contract and the cost to the Trust (exclusive of accrued interest) may not exceed the amount of funds reserved for the purchase of the Failed Bonds. The Replacement Bonds must satisfy the criteria previously described for the Trusts and shall be substantially identical to the Failed Bonds they replace in terms of (i) the exemption from federal and state taxation; (ii) maturity and; (iii) cost to the Trust. In addition, Replacement Bonds shall not be "when, as and if issued" Bonds. Whenever a Replacement Bond has been acquired for a Trust, the Trustee shall, within five days after the delivery thereof, mail or deliver a notice of such acquisition to all Unitholders of the Trust involved. Once the original corpus of the Trust is acquired, the Trustee will have no power to vary the investment of the Trust. To the extent Replacement Bonds are not acquired, the Sponsor shall refund to all Unitholders of the Trust involved the sales charge attributable to such Failed Bonds not replaced, and the principal and accrued interest attributable to such Bonds shall be distributed not more than 30 days after the determination of such failure or at such earlier time as the Trustee in its sole discretion deems to be in the interest of the Unitholders. Any such accrued interest paid to Unitholders will be paid by the Sponsor and, accordingly, will not be treated as tax-exempt income. In the event Failed Bonds in a Trust could not be replaced, the Net Annual Interest Income per Unit for such Trust would be reduced and the Estimated Current Return thereon might be lowered. SALE, MATURITY AND REDEMPTION OF BONDS. Certain of the Bonds may from time to time under certain circumstances be sold or redeemed or will mature in accordance with their terms. The proceeds from such events will be used to pay for Units redeemed or distributed to Unitholders and not reinvested; accordingly, no assurance can be given that a Trust will retain for any length of time its present size and composition. All of the Bonds in each Trust are subject to being called or redeemed in whole or in part prior to their stated maturities pursuant to the optional redemption provisions described in the "Schedule of Investments" in Part A of this Prospectus and in most cases pursuant to sinking fund, special or extraordinary redemption provisions. See the discussion of the various types of bond issues, above, for information on the call provisions of such bonds, particularly single family mortgage revenue bonds. The exercise of redemption or call provisions will (except to the extent the proceeds of the called Bonds are used to pay for Unit redemptions) result in the distribution of principal and may result in a reduction in the amount of subsequent interest distributions; it may also affect the current return on Units of the Trust involved. The exercise of redemption or call provisions is more likely to occur in situations where when the Bonds have an offering side evaluation which represents a premium over par (as opposed to a discount from par). (In the case of original issue discount bonds, such redemption is generally to be made at the issue price plus the amount of original issue discount accreted to the date of redemption; such price is referred to herein as "accreted value"). Because Bonds may have been valued at prices above or below par value or the then current accreted value at the time Units were purchased, Unitholders may realize gain or loss upon the redemption of portfolio Bonds. (See "WHAT IS THE TAX STATUS OF UNITHOLDERS?" and "WHEN ARE DISTRIBUTIONS MADE TO UNITHOLDERS?" in Part B and the "Schedule of Investments" in Part A of this CERTAIN TAX MATTERS; LITIGATION. Certain of the Bonds in a Trust's portfolio may be subject to continuing requirements such as the actual use of bond proceeds, manner of operation of the project financed from bond proceeds or rebate of excess earnings on bond proceeds that may affect the exemption of interest on such Bonds from Federal income taxation. Although at the time of issuance of each of the Bonds in each Trust an opinion of bond counsel was rendered as to the exemption of interest on such obligations from Federal income taxation, and the issuers covenanted to comply with all requirements necessary to retain the tax-exempt status of the Bonds, there can be no assurance that the respective issuers or other obligors on such obligations will fulfill the various continuing requirements established upon issuance of the Bonds. A failure to comply with such requirements may cause a determination that interest on such obligations is subject to Federal income taxation, perhaps even retroactively from the date of issuance of such Bonds, thereby reducing the value of the Bonds and subjecting Unitholders to unanticipated tax liabilities. To the best knowledge of the Sponsor, there is no litigation pending as of the Date of Deposit in respect of any Bonds which might reasonably be expected to have a material adverse effect on any of the Trusts. It is possible that after the Date of Deposit, litigation may be initiated with respect to Bonds in any Trust. Any such litigation may affect the validity of such Bonds or the tax-exempt nature of the interest thereon, but while the outcome of litigation of such nature can never be entirely predicted, the opinions of bond counsel to the issuer of each Bond on the date of issuance state that such Bonds were validly issued and that the interest thereon is, to the extent indicated, exempt from Federal income tax. WHY AND HOW ARE THE BONDS INSURED? Insurance guaranteeing the timely payment, when due, of all principal and interest on the Bonds in each Insured Trust has been obtained by the Sponsor or by the issuers or underwriters of the Bonds from the MBIA Insurance Corporation (the "Insurer"). Certain of the Bonds in an Insured Trust may be covered by a policy or policies of insurance obtained by the issuers or underwriters of the Bonds from Municipal Bond Insurance Association (the "Association") or Bond Investors Guaranty Insurance Company ("BIG"). The claims-paying ability of both the Insurer and the Association was rated "AAA Prime Grade" by Standard & Poor's. Moody's rates all bond issuers insured by either the Insurer or the Association "Aaa" and short-term loans "MIG 1," both designated to be of the highest quality. The Insurer has issued a policy or policies of insurance covering each of the Bonds in the Insured Trusts, each policy to remain in force until the payment in full of such Bonds and whether or not the Bonds continue to be held by an Insured Trust. By the terms of each policy the Insurer will unconditionally guarantee to the holders or owners of the Bonds the payment, when due, required of the issuer of the Bonds of an amount equal to the principal of and interest on the Bonds as such payments shall become due but not be paid (except that in the event of any acceleration of the due date of principal by reason of mandatory or optional redemption, default or otherwise, the payments guaranteed will be made in such amounts and at such times as would have been due had there not been an acceleration). Insurance guaranteeing the timely payment, when due, of all principal and interest on certain Bonds in a Traditional Trust may have been obtained by the Sponsor, issuer or underwriter of the particular Bonds involved or by another party. Such insurance, which provides coverage substantially the same as that obtained with respect to Bonds in Insured Trusts as described above, is effective so long as the insured Bond is outstanding and the insurer remains in business. Insurance relates only to the particular Bond and not to the Units offered hereby or to their market value. Insured Bonds have received a rating of "Aaa" by Moody's and/or "AAA" by Standard & Poor's in recognition of such insurance. If a Bond in a Traditional Trust is insured, the "Schedule of Investments" appearing in Part A of this Prospectus will identify the insurer. The Sponsor to date has purchased and presently intends to purchase insurance for Bonds in Traditional Trusts exclusively from the Insurer. There can be no assurance that any insurer listed therein will be able to satisfy its commitments in the event claims are made in the future. However, Standard & Poor's and/or Moody's have rated the claims-paying ability of each insurer "AAA" or "Aaa," respectively. The Insurer is the principal operating subsidiary of MBIA, Inc., a New York Stock Exchange listed company. MBIA, Inc. is not obligated to pay the debts of or claims against the Insurer. The Insurer is a limited liability corporation rather than a several liability association. The Insurer is domiciled in the State of New York and licensed to do business in all 50 states, the District of Columbia, the Commonwealth of Puerto Rico, the Commonwealth of the Northern Mariana Islands, the Virgin Islands of the United States and the Territory of Guam. The Insurer has one European branch in the Republic of France. As of June 30, 1995 the Insurer had admitted assets of $3.6 billion (unaudited), total liabilities of $2.4 billion (unaudited), and total capital and surplus of $1.2 billion (unaudited) determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities. As of December 31, 1994, the Insurer had admitted assets of $3.4 billion (audited), total liabilities of $2.3 billion (audited), and total capital and surplus of $1.1 billion (audited) determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities. The Association is comprised of the five insurance companies set forth in the following table, which provides certain unaudited financial information with respect to each of the five insurance companies comprising the Association. FIVE MEMBER COMPANIES ASSETS AND POLICYHOLDERS' SURPLUS (UNAUDITED) AS OF SEPTEMBER 30, 1994. Insurance companies are subject to extensive regulation and supervision where they do business by state insurance commissioners who regulate the standards of solvency which must be maintained, the nature of and limitations on investments, reports of financial condition, and requirements regarding reserves for unearned premiums, losses and other matters. A significant portion of the assets of insurance companies are required by law to be held in reserve against potential claims on policies and is not available to general creditors. Although the federal government does not regulate the business of insurance, federal initiatives including pension regulation, controls on medical care costs, minimum standards for no-fault automobile insurance, national health insurance, tax law changes affecting life insurance companies and repeal of the antitrust exemption for the insurance business can significantly impact the insurance business. The above ratings are not recommendations to buy, sell or hold the Bonds, and such ratings may be subject to revision or withdrawal at any time by the rating agencies. Any downward revision or withdrawal of either or both ratings may have an adverse effect on the market price of the Bonds. See the Information Supplement--for further information concerning insurance. Because the insurance on the Bonds, if any, will be effective so long as the Bonds are outstanding, such insurance will be taken into account in determining the market value of the Bonds and therefore some value attributable to such insurance will be included in the value of the Units of the Insured Trusts. The insurance does not, however, guarantee the market value of the Bonds or of the Units. HOW IS THE PUBLIC OFFERING PRICE DETERMINED? The Public Offering Price of the Units of each Trust is equal to the Trustee's determination of the aggregate OFFERING prices of the Bonds deposited therein (minus any advancement to the principal account of the Trust made by the Trustee) plus a sales charge set forth in "Essential Information" in Part A of this Prospectus, in each case adding to the total thereof cash held by the Trust, if any, and dividing the sum so obtained by the number of Units outstanding in the Trust. See "UNIT VALUE AND EVALUATION." The sales charge applicable to quantity purchases is reduced on a graduated scale for sales to any purchaser of at least $50,000 or 500 Units and will be applied on whichever basis is more favorable to the purchaser. For purposes of calculating the applicable sales charge, purchasers who have indicated their intent to purchase a specified amount of Units of any Trust in the primary or secondary offering period by executing and delivering a letter of intent to the Sponsor, which letter of intent must be in a form acceptable to the Sponsor and shall have a maximum duration of thirteen months, will be eligible to receive a reduced sales charge according to the following tables based on the amount of intended aggregate purchases as expressed in the letter of intent. Due to administrative limitations and in order to permit adequate tracking, the only secondary market purchases that will be permitted to be applied toward the intended specified amount and that will receive the corresponding reduced sales charge are those Units that are acquired through or from the Sponsor. By establishing a letter of intent, a Unitholder agrees that the first purchase of Units following the execution of such letter of intent will be at least 5% of the total amount of the intended aggregate purchases expressed in such Unitholder's letter of intent. Further, through the establishment of the letter of intent, such Unitholder agrees that Units representing 5% of the total amount of the intended purchases will be held in escrow by the Trustee pending completion of these purchases. All distributions on Units held in escrow will be credited to such Unitholder's account. If total purchases prior to the expiration of the letter of intent period equal or exceed the amount specified in a Unitholder's letter of intent, the Units held in escrow will be transferred to such Unitholder's account. If the total purchases are less than the amount specified, the Unitholder involved must pay the Sponsor an amount equal to the difference between the amounts paid for these purchases and the amounts which would have been paid if the higher sales charge had been applied. If such Unitholder does not pay the additional amount within 20 days after written request by the Sponsor or the Unitholder's securities representative, the Sponsor will instruct the Trustee to redeem an appropriate number of the escrowed Units to meet the required payment. By establishing a letter of intent, a Unitholder irrevocably appoints the Sponsor as attorney to give instructions to redeem any or all of such Unitholder's escrowed Units, with full power of substitution in the premises. A Unitholder or his securities representative must notify the Sponsor whenever such Unitholder makes a purchase of Units that he wishes to be counted towards the intended amount. Sales charges during the primary offering period are as follows: Breakpoint sales charges are computed both on a dollar basis and on the basis of the number of Units purchased, using the equivalent of 500 Units to $50,000, 2,500 Units to $250,000 etc., and will be applied on that basis which is more favorable to the purchaser. For "secondary market" sales the Public Offering Price per Unit of each Trust is determined by adding to the Trustee's determination of the BID price of each Bond in the Trust a sales charge determined in accordance with the table set forth below based upon the number of years remaining to the maturity of each such Bond. See "UNIT VALUE AND EVALUATION." The effect of this method of sales charge calculation will be that different sales charge rates will be applied to the various Bonds in a Trust portfolio based upon the maturities of such Bonds. As shown, the sales charge on Bonds in each maturity range (and therefore the aggregate sales charge on the purchase) is reduced with respect to purchases of at least $50,000 or 500 Units: Breakpoint sales charges are computed both on a dollar basis and on the basis of the number of Units purchased, using the equivalent of 500 Units to $50,000, 2,500 Units to $250,000, etc., and will be applied on that basis which is more favorable to the purchaser. The secondary market sales charges above are expressed as a percent of the net amount invested; expressed as a percent of the Public Offering Price, the maximum sales charge on any Trust, including one consisting entirely of Bonds with 16 years or more to maturity, would be 5.50% (5.820% of the net amount invested). The actual secondary market sales charge included in the Public Offering Price of any particular Trust will depend on the maturities of the Bonds in the portfolio of such Trust. Pursuant to the terms of the Indenture, the Trustee may terminate a Trust if the net asset value of such Trust, as shown by any evaluation, is less than 20% of the original principal amount of the Trust. At all times while Units are being offered for sale, the Sponsor will appraise or cause to be appraised daily the value of the underlying Bonds in each Trust as of 4:00 p.m. eastern time on each day on which the New York Stock Exchange (the "Exchange") is normally open and will adjust the Public Offering Price of the Units commensurate with such appraisal. Such Public Offering Price will be effective for all orders received by a dealer or the Sponsor at or prior to 4:00 p.m. eastern time on each such day. Orders received after that time, or on a day when the Exchange is closed for a scheduled holiday or weekend, will be held until the next determination of price. Accrued interest from the preceding Record Date to, but not including, the settlement date of the transaction (three business days after purchase) will be added to the Public Offering Price to determine the purchase price of Units. See "WHAT IS ACCRUED INTEREST?". The graduated sales charges set forth above will apply on all applicable purchases of Nuveen investment company securities on any one day by the same purchaser in the amounts stated, and for this purpose purchases of this Series will be aggregated with concurrent purchases of any other Series or of shares of any open-end management investment company of which the Sponsor is principal underwriter and with respect to the purchase of which a sales charge is imposed. Purchases by or for the account of an individual and his or her spouse and children under 21 years of age ("immediate family members") will be aggregated to determine the applicable sales charge. The graduated sales charges are also applicable to a trustee or other fiduciary purchasing securities for a single trust estate or single fiduciary account. Units may be purchased at the Public Offering Price without a sales charge by officers or directors and by bona fide, full-time employees of Nuveen, Nuveen Advisory Corp., Nuveen Institutional Advisory Corp. and The John Nuveen Company, including in each case these individuals and their immediate family members (as defined above). Units may be purchased in the primary or secondary market at the Public Offering Price for non-breakpoint purchases minus the concession the Sponsor typically allows to brokers and dealers for non-breakpoint purchases (see "HOW UNITS OF THE TRUSTS ARE DISTRIBUTED TO THE PUBLIC?") by (1) investors who purchase Units through registered investment advisers, certified financial planners and registered broker-dealers who in each case either charge periodic fees for financial planning, investment advisory or asset management services, or provide such services in connection with the establishment of an investment account for which a comprehensive "wrap fee" charge is imposed, (2) bank trust departments investing funds over which they exercise exclusive discretionary investment authority and that are held in a fiduciary, agency, custodial or similar capacity, (3) any person who for at least 90 days, has been an officer, director or bona fide employee of any firm offering Units for sale to investors or their immediate family members (as defined above) and (4) officers and directors of bank holding companies that make Units available directly or through subsidiaries or bank affiliates. Notwithstanding anything to the contrary in this Prospectus, such investors, bank trust departments, firm employees and bank holding company officers and directors who purchase Units through this program will not receive sales charge reductions for quantity purchases. The initial or primary Public Offering Price of the Units in each Trust is based upon a pro rata share of the OFFERING prices per Unit of the Bonds in such Trust plus the applicable sales charge. The secondary market Public Offering Price of each Trust is based upon a pro rata share of the BID prices per Unit of the Bonds in such Trust plus the applicable sales charge. The OFFERING prices of Bonds in a Trust may be expected to average between 1/2% to 2% more than the BID prices of such Bonds. The difference between the bid side evaluation and the offering side evaluation of the Bonds in each Trust on the business day prior to the Date of Deposit is shown in the discussion of each Trust portfolio. Whether or not Units are being offered for sale, the Sponsor will determine the aggregate value of each Trust as of 4:00 p.m. eastern time: (i) on each June 30 or December 31 (or, if such date is not a business day, the last business day prior thereto), (ii) on any day on which a Unit is tendered for redemption (or the next succeeding business day if the date of tender is a non-business day) and (iii) at such other times as may be necessary. For this purpose, a "business day" shall be any day on which the Exchange is normally open. (See "UNIT VALUE During the initial public offering period, the Sponsor intends to offer to purchase Units of each Trust at a price equivalent to the pro rata share per Unit of the OFFERING prices of the Bonds in such Trust (plus accrued interest). Afterward, although it is not obligated to do so, the Sponsor intends to maintain a secondary market for Units of each Trust at its own expense and continuously to offer to purchase Units of each Trust at prices, subject to change at any time, which are based upon the BID prices of Bonds in the respective portfolios of the Trusts. UNITHOLDERS WHO WISH TO DISPOSE OF THEIR UNITS SHOULD INQUIRE OF THE TRUSTEE OR THEIR BROKER AS TO THE CURRENT REDEMPTION PRICE. (See "HOW UNITS MAY BE REDEEMED WITHOUT CHARGE?".) In connection with its secondary marketmaking activities, the Sponsor may from time to time enter into secondary market joint account agreements with other brokers and dealers. Pursuant to such an agreement the Sponsor will purchase Units from the broker or dealer at the bid price and will place the Units into a joint account managed by the Sponsor; sales from the account will be made in accordance with the then current prospectus and the Sponsor and the broker or dealer will share profits and losses in the joint account in accordance with the terms of their joint account agreement. Certificates, if any, for Units are delivered to the purchaser as promptly after the date of settlement (three business days after purchase) as the Trustee can complete the mechanics of registration, normally within 48 hours after registration instructions are received. Purchasers of Units to whom Certificates are issued will be unable to exercise any right of redemption until they have received their Certificates as tender of the Certificate, properly endorsed for transfer. (See "HOW UNITS MAY BE REDEEMED WITHOUT CHARGE?".) Accrued interest is the accumulation of unpaid interest on a bond from the last day on which interest thereon was paid. Interest on Bonds in each Trust is accounted for daily on an accrual basis. For this reason, the purchase price of Units of a Trust will include not only the Public Offering Price but also the proportionate share of accrued interest to the date of settlement. Accrued interest does not include accrual of original issue discount on zero coupon bonds, Stripped Obligations or other original issue discount bonds. Interest accrues to the benefit of Unitholders commencing with the settlement date of their purchase transaction. In an effort to reduce the amount of accrued interest that investors would have to pay in addition to the Public Offering Price, the Trustee has agreed to advance to each Trust the amount of accrued interest due on the Bonds as of the Date of Deposit (which has been designated the first Record Date for all plans of distribution). This accrued interest will be paid to the Sponsor as the holder of record of all Units on the Date of Deposit. Consequently, the amount of accrued interest to be added to the Public Offering Price of Units will include only accrued interest from the Date of Deposit to, but not including, the date of settlement of the investor's purchase (three business days after purchase), less any distributions from the related Interest Account. The Trustee will recover its advancements (without interest or other cost to the Trusts) from interest received on the Bonds deposited in each Trust. The Trustee has no cash for distribution to Unitholders until it receives interest payments on the Bonds in the Trusts. Since municipal bond interest is accrued daily but paid only semi-annually, during the initial months of the Trusts, the Interest Accounts, consisting of accrued but uncollected interest and collected interest (cash), will be predominantly the uncollected accrued interest that is not available for distribution. However, due to advances by the Trustee, the Trustee will provide a first distribution between approximately 30 and 60 days after the Date of Deposit. Assuming each Trust retains its original size and composition and expenses and fees remain the same, annual interest collected and distributed will approximate the estimated Net Annual Interest Income stated herein. However, the amount of accrued interest at any point in time will be greater than the amount that the Trustee will have actually received and distributed to the Unitholders. Therefore, there will always remain an item of accrued interest that is included in the Purchase Price and the redemption price of the Units. Interest is accounted for daily and a proportionate share of accrued and undistributed interest computed from the preceding Record Date is added to the daily valuation of each Unit of each Trust. (See Part A of this Prospectus and "WHEN ARE DISTRIBUTIONS MADE TO UNITHOLDERS?".) As Bonds mature, or are redeemed or sold, the accrued interest applicable to such bonds is collected and subsequently distributed to Unitholders. Unitholders who sell or redeem all or a portion of their Units will be paid their proportionate share of the remaining accrued interest to, but not including, the third business day following the date of sale or tender. WHAT ARE ESTIMATED LONG TERM RETURN AND ESTIMATED CURRENT RETURN? The Estimated Long Term Return for each Trust is a measure of the return to the investor expected to be earned over the estimated life of the Trust. The Estimated Long Term Return represents an average of the yields to maturity (or call) of the Bonds in the Trust's portfolio calculated in accordance with accepted bond practice and adjusted to reflect expenses and sales charges. Under accepted bond practice, tax-exempt bonds are customarily offered to investors on a "yield price" basis, which involves computation of yield to maturity or to an earlier call date (whichever produces the lower yield), and which takes into account not only the interest payable on the bonds but also the amortization or accretion of any premium over, or discount from, the par (maturity) value inherent in the bond's purchase price. In the calculation of Estimated Long Term Return, the average yield for the Trust's portfolio is derived by weighting each Bond's yield by the market value of the Bond and by the amount of time remaining to the date to which the Bond is priced. This weighted average yield is then adjusted to reflect estimated expenses, is compounded, and is reduced by a factor which represents the amortization of the sales charge over the expected average life of the Trust. The Estimated Long Term Return calculation does not take into account the effect of a first distribution which may be less than a regular distribution or may be paid at some point after 30 days (or a second distribution which may be less than a normal distribution for Unitholders who choose quarterly or semi-annual plans of distribution), and it also does not take into account the difference in timing of payments to Unitholders who choose quarterly or semi-annual plans of distribution, each of which will reduce the return. Estimated Current Return is computed by dividing the Net Annual Interest Income per Unit by the Public Offering Price. In contrast to Estimated Long Term Return, Estimated Current Return does not reflect the amortization of premium or accretion of discount, if any, on the Bonds in the Trust's portfolio. Net Annual Interest Income per Unit is calculated by dividing the annual interest income to the Trust, less estimated expenses, by the number of Units outstanding. Net Annual Interest Income per Unit, used to calculate Estimated Current Return, will vary with changes in fees and expenses of the Trustee and the Evaluator and with the redemption, maturity, exchange or sale of Bonds. A Unitholder's actual return may vary significantly from the Estimated Long-Term Return, based on their holding period, market interest rate changes, other factors affecting the prices of individual bonds in the portfolio, and differences between the expected remaining life of portfolio bonds and the actual length of time that they remain in the Trust; such actual holding periods may be reduced by termination of the Trust, as described in "OTHER INFORMATION." Since both the Estimated Current Return and the Estimated Long Term Return quoted herein are based on the market value of the underlying Bonds on the business day prior to the Date of Deposit, subsequent calculations of these performance measures will reflect the then current market value of the underlying Bonds and may be higher or lower. The Sponsor will provide estimated cash flow information relating to a Trust without charge to each potential investor in a Trust who receives this prospectus and makes an oral or written request to the Sponsor for such information. A portion of the monies received by a Trust may be treated, in the first year only, as a return of principal due to the inclusion in the Trust portfolio of "when-issued" or other Bonds having delivery dates after the date of settlement for purchases made on the Date of Deposit. A consequence of this treatment is that in the computation of Estimated Current Return for the first year, such monies are excluded from Net Annual Interest Income and treated as an adjustment to the Public Offering Price. (See "Essential Information" appearing in Part A of this Prospectus, "COMPOSITION OF TRUSTS" and "WHAT IS THE TAX A comparison of tax-free and equivalent taxable estimated current returns with the returns on various taxable investments is one element to consider in making an investment decision. The Sponsor may from time to time in its advertising and sales materials compare the then current estimated returns on a Trust and returns over specified periods on other similar Nuveen Trusts with returns on taxable investments such as corporate or U.S. Government bonds, bank CD's and money market accounts or money market funds, each of which has investment characteristics that may differ from those of the Trust. U.S. Government bonds, for example, are backed by the full faith and credit of the U.S. Government and bank CD's and money market accounts are insured by an agency of the federal government. Money market accounts and money market funds provide stability of principal, but pay interest at rates that vary with the condition of the short-term debt market. The investment characteristics of the Trusts are described more fully elsewhere in the Prospectus. HOW WAS THE PRICE OF THE BONDS DETERMINED AT THE DATE OF DEPOSIT? The prices at which the Bonds deposited in the Trusts would have been offered to the public on the business day prior to the Date of Deposit were determined by the Trustee on the basis of an evaluation of such Bonds prepared by Kenny S&P Evaluation Services, a division of J. J. Kenny Co., Inc., a firm regularly engaged in the business of evaluating, quoting or appraising comparable bonds. With respect to Bonds in Insured Trusts and insured Bonds in Traditional Trusts, Kenny S&P Evaluation Services, a division of J. J. Kenny Co., Inc., evaluated the Bonds as so insured. (See "WHY AND HOW ARE THE BONDS INSURED?".) The amount by which the Trustee's determination of the OFFERING PRICES of the Bonds deposited in the Trusts was greater or less than the cost of such Bonds to the Sponsor was PROFIT OR LOSS to the Sponsor exclusive of any underwriting profit. (See Part A of this Prospectus.) The Sponsor also may realize FURTHER PROFIT OR SUSTAIN FURTHER LOSS as a result of fluctuations in the Public Offering Price of the Units. Cash, if any, made available to the Sponsor prior to the settlement date for a purchase of Units, or prior to the acquisition of all Portfolio securities by a Trust, may be available for use in the Sponsor's business, and may be of benefit to the Sponsor. WHAT IS THE TAX STATUS OF UNITHOLDERS? At the respective times of issuance of the Bonds, opinions relating to the validity thereof and to the exemption of interest thereon from Federal income tax were rendered by bond counsel to the respective issuing authorities. In addition, with respect to State Trusts, where applicable, bond counsel to the issuing authorities rendered opinions as to the exemption of interest on such Bonds, when held by residents of the state in which the issuers of such Bonds are located, from state income taxes and certain state or local intangibles and local income taxes. For a discussion of the tax status of State Trusts see Part A of this Prospectus. Neither the Sponsor nor its counsel have made any special review for the Trusts of the proceedings relating to the issuance of the Bonds or of the basis for the opinions rendered in connection therewith. If the interest on a Bond should be determined to be taxable, the Bond would generally have to be sold at a substantial discount. In addition, investors could be required to pay income tax on interest received prior to the date of which interest is determined to be taxable. Federally tax-exempt income, including income on Units of the Trusts, will be taken into consideration in computing the portion, if any, of social security benefits received that will be included in a taxpayer's gross income subject to the Federal income tax. Gain realized on the sale or redemption of the Bonds by the Trustee or of a Unit by a Unitholder is includable in gross income for Federal income tax purposes, and may be includable in gross income for state tax purposes. (Such gain does not include any amounts received in respect of tax-exempt accrued interest or accrued original issue discount, if any.) A portion of a Unitholder's gain, to the extent of accreted market discount, may be treated as ordinary income rather than capital gain if the Bonds were purchased by a Trust at a market discount or if the Unitholder purchased his or her Units at a market discount on or after April 30, 1993. Market discount can arise based on the price the Trust pays for the Bonds or the price a Unitholder pays for his or her Units. Market discount that accretes while the Trust holds a Bond would be recognized as ordinary income by the Unitholders when principal payments are received on the Bond, upon sale or at redemption (including early redemption), or upon the sale or redemption of his or her Units, unless a Unitholder elects to include market discount in taxable income as it accrues. The market discount rules are complex and Unitholders should consult their tax advisors regarding these rules and their application. In the opinion of Chapman and Cutler, Counsel to the Sponsor, under existing law: (1) the Trusts are not associations taxable as corporations for Federal income tax purposes. Tax-exempt interest received by each of the Trusts on Bonds deposited therein will retain its status as tax-exempt interest, for Federal income tax purposes, when received by the Trusts and when distributed to the Unitholders, except that the alternative minimum tax and environmental tax (the "Superfund Tax") applicable to corporate Unitholders may, in certain circumstances, include in the amount on which such taxes are calculated a portion of the interest income received by the Trust. See "CERTAIN TAX MATTERS APPLICABLE TO (2) each Unitholder of a Trust is considered to be the owner of a pro rata portion of such Trust under Subpart E, subchapter J of Chapter 1 of the Internal Revenue Code of 1986 (the "Code") and will have a taxable event when the Trust disposes of a Bond or when the Unitholder redeems or sells Units. Unitholders must reduce the tax basis of their Units for their share of accrued interest received by the Trust, if any, on Bonds delivered after the date the Unitholders pay for their Units and, consequently, such Unitholders may have an increase in taxable gain or reduction in capital loss upon the disposition of such Units. Gain or loss upon the sale or redemption of Units is measured by comparing the proceeds of such sale or redemption with the adjusted basis of the Units. If the Trustee disposes of Bonds (whether by sale, payment at maturity, redemption or otherwise), gain or loss is recognized to the Unitholder. The amount of any such gain or loss is measured by comparing the Unitholder's pro rata share of the total proceeds from such disposition with the Unitholder's basis for his or her fractional interest in the asset disposed of. In the case of a Unitholder who purchases Units, such basis (before adjustment for earned original issue discount and amortized bond premium, if any) is determined by apportioning the cost of the Units among each of the Trust assets ratably according to value as of the date of acquisition of the Units. The tax cost reduction requirements of said Code relating to amortization of bond premium may, under some circumstances, result in the Unitholder realizing a taxable gain when his or her Units are sold or redeemed for an amount equal to their original cost; and (3) any amounts paid on defaulted Bonds held by the Trustee under policies of insurance issued with respect to such Bonds will be excludable from Federal gross income if, and to the same extent as, such interest would have been so excludable if paid by the respective issuer provided that, at the time such policies are purchased, the amounts paid for such policies are reasonable, customary and consistent with the reasonable expectation that the issuer of the bonds, rather than the insurer, will pay debt service on the bonds. Paragraph (2) of this opinion is accordingly applicable to policy proceeds representing maturing interest. In the opinion of Carter, Ledyard & Milburn, counsel to the Trustee, and, in the absence of a New York Trust from the Series, special counsel for the Series for New York tax matters, under existing law: Under the income tax laws of the State and City of New York, each Trust is not an association taxable as a corporation and the income of each Trust will be treated as the income of the Unitholders. For a summary of each opinion of special counsel to the respective State Trusts for state tax matters, see Part A of this Prospectus. ALL STATEMENTS IN THE PROSPECTUS CONCERNING EXEMPTION FROM FEDERAL, STATE OR OTHER TAXES ARE THE OPINION OF COUNSEL AND ARE TO BE SO CONSTRUED. The Internal Revenue Code provides that interest on indebtedness incurred or continued to purchase or carry obligations, the interest on which is wholly exempt from Federal income taxes, is not deductible. Because each Unitholder is treated for Federal income tax purposes as the owner of a pro rata share of the Bonds owned by the applicable Trust, interest on borrowed funds used to purchase or carry Units of such Trust will not be deductible for Federal income tax purposes. Under rules used by the Internal Revenue Service for determining when borrowed funds are considered used for the purpose of purchasing or carrying particular assets, the purchase of Units may be considered to have been made with borrowed funds even though the borrowed funds are not directly traceable to the purchase of Units (however, these rules generally do not apply to interest paid on indebtedness incurred to purchase or improve a personal residence). Similar rules are generally applicable for state tax purposes. Special rules apply in the case of certain financial institutions that acquire Units. Investors with questions regarding these issues should consult with their tax advisers. For purposes of computing the alternative minimum tax for individuals and corporations, interest on certain specified tax-exempt private activity bonds is included as a preference item. The Trusts do not include any such bonds. CERTAIN TAX MATTERS APPLICABLE TO CORPORATE UNITHOLDERS. In the case of certain corporations, the alternative minimum tax and the Superfund Tax depend upon the corporation's alternative minimum taxable income ("AMTI"), which is the corporation's taxable income with certain adjustments. One of the adjustment items used in computing AMTI and the Superfund Tax of a corporation (other than an S corporation, Regulated Investment Company, Real Estate Investment Trust, or REMIC) is an amount equal to 75% of the excess of such corporation's "adjusted current earnings" over an amount equal to its AMTI (before such adjustment item and the alternative tax net operation loss deduction). Although tax-exempt interest received by each of the Trusts on Bonds deposited therein will not be included in the gross income of corporations for Federal income tax purposes, "adjusted current earnings" includes all tax-exempt interest, including interest on all Bonds in the Trust and tax-exempt original issue discount. Corporate Unitholders are urged to consult their own tax advisers with respect to the particular tax consequences to them resulting under the Federal tax law, including the corporate alternative minimum tax, the Superfund Tax and the branch profits tax imposed by Section 884 of the Code. EXCEPT AS NOTED ABOVE AND IN PART A OF THIS PROSPECTUS, THE EXEMPTION OF INTEREST ON STATE AND LOCAL OBLIGATIONS FOR FEDERAL INCOME TAX PURPOSES DOES NOT NECESSARILY RESULT IN EXEMPTION UNDER THE INCOME OR OTHER TAX LAWS OF ANY STATE OR CITY. THE LAWS OF THE SEVERAL STATES VARY WITH RESPECT TO THE TAXATION OF SUCH OBLIGATIONS. WHAT ARE NORMAL TRUST OPERATING EXPENSES? No annual advisory fee is charged to the Trusts by the Sponsor. The Sponsor does, however, receive a fee as set forth in "Essential Information" in Part A of this Prospectus for regularly evaluating the Bonds and for maintaining surveillance over the portfolio. (See "UNIT VALUE AND EVALUATION.") The Trustee receives for ordinary recurring services an annual fee for each plan of distribution for each Trust as set forth in "Essential Information" appearing in Part A of this Prospectus. Each annual fee is per $1,000 principal amount of the underlying Bonds in a Trust for that portion of the Trust that represents a particular plan of distribution. The Trustee's fee may be periodically adjusted in response to fluctuations in short-term interest rates (reflecting the cost to the Trustee of advancing funds to a Trust to meet scheduled distributions) and may be further adjusted in accordance with the cumulative percentage increase of the United States Department of Labor's Consumer Price Index entitled "All Services Less Rent of Shelter" since the establishment of the Trusts. The Trustee has the use of funds, if any, being held in the Interest and Principal Accounts of each Trust for future distributions, payment of expenses and redemptions. These Accounts are non-interest bearing to Unitholders. Pursuant to normal banking procedures, the Trustee benefits from the use of funds held therein. Part of the Trustee's compensation for its services to the Fund is expected to result from such use of these funds. Premiums for the policies of insurance obtained by the Sponsor or by the Bond issuers with respect to the Bonds in the Insured Trusts and with respect to insured Bonds in Traditional Trusts have been paid in full prior to the deposit of the Bonds in the Trusts, and the value of such insurance has been included in the evaluation of the Bonds in each Trust and accordingly in the Public Offering Price of Units of each Trust. There are no annual continuing premiums for such insurance. All or a portion of the expenses incurred in establishing the Trusts, including costs of preparing the registration statement, the trust indenture and other closing documents, registering Units with the Securities and Exchange Commission and states, the initial audit of each Trust portfolio, legal fees, the initial fees and expenses of the Trustee and any other non-material out-of-pocket expenses, will be paid by the Trusts and amortized over the first five years of such Trusts. The following are additional expenses of the Trusts and, when paid by or are owed to the Trustee, are secured by a lien on the assets of the Trust or Trusts to which such expenses are allocable: (1) the expenses and costs of any action undertaken by the Trustee to protect the Trusts and the rights and interests of the Unitholders; (2) all taxes and other governmental charges upon the Bonds or any part of the Trusts (no such taxes or charges are being levied or made or, to the knowledge of the Sponsor, contemplated); (3) amounts payable to the Trustee as fees for ordinary recurring services and for extraordinary non-recurring services rendered pursuant to the Indenture, all disbursements and expenses including counsel fees (including fees of bond counsel which the Trustee may retain) sustained or incurred by the Trustee in connection therewith; and (4) any losses or liabilities accruing to the Trustee without negligence, bad faith or willful misconduct on its part. The Trustee is empowered to sell Bonds in order to pay these amounts if funds are not otherwise available in the applicable Interest and Principal Accounts. The Indenture requires each Trust to be audited on an annual basis at the expense of the Trust by independent public accountants selected by the Sponsor. The Trustee shall not be required, however, to cause such an audit to be performed if its cost to a Trust shall exceed $.05 per Unit on an annual basis. Unitholders of a Trust covered by an audit may obtain a copy of the audited financial statements upon request. WHEN ARE DISTRIBUTIONS MADE TO UNITHOLDERS? Interest received by the Trustee on the Bonds in each Trust, including that part of the proceeds of any disposition of Bonds which represents accrued interest and including any insurance proceeds representing interest due on defaulted Bonds, shall be credited to the "Interest Account" of such Trust and all other moneys received by the Trustee shall be credited to the "Principal Account" of such Trust. The pro rata share of cash in the Principal Account in each Trust will be computed as of each semi-annual Record Date and distributions to the Unitholders as of such Record Date will be made on or shortly after the fifteenth day of the month. Proceeds received from the disposition, including sale, call or maturity, of any of the Bonds and all amounts paid with respect to zero coupon bonds and Stripped Obligations will be held in the Principal Account and either used to pay for Units redeemed or distributed on the Distribution Date following the next semi-annual Record Date. The Trustee is not required to make a distribution from the Principal Account of any Trust unless the amount available for distribution in such account equals at least ten cents per Unit. The pro rata share of the Interest Account in each Trust will be computed by the Trustee each month as of each Record Date and distributions will be made on or shortly after the fifteenth day of the month to Unitholders of such Trust as of the Record Date who are entitled to distributions at that time under the plan of distribution chosen. Persons who purchase Units between a Record Date and a Distribution Date will receive their first distribution on the Distribution Date following the next Record Date under the applicable plan of distribution. Purchasers of Units who desire to receive interest distributions on a monthly or quarterly basis may elect to do so at the time of purchase during the initial public offering period. Those indicating no choice will be deemed to have chosen the semi-annual distribution plan. All Unitholders, however, who purchase Units during the initial public offering period and who hold them of record on the first Record Date will receive the first distribution of interest. Thereafter, Record Dates for monthly distributions will be the first day of each month; Record Dates for quarterly distributions will be the first day of February, May, August and November; and Record Dates for semi-annual distributions will be the first day of May and November. See Part A of this Prospectus for details of distributions per Unit of each Trust under the various plans based upon estimated Net Annual Interest Income at the Date of Deposit. The amount of the regular distributions will generally change when Bonds are redeemed, mature or are sold or when fees and expenses increase or decrease. For the purpose of minimizing fluctuations in the distributions from the Interest Account of a Trust, the Trustee is authorized to advance such amounts as may be necessary to provide for interest distributions of approximately equal amounts. The Trustee shall be reimbursed, without interest, for any such advances from funds in the Interest Account of such Trust. The Trustee's fee takes into account the costs attributable to the outlay of capital needed to make such advances. The plan of distribution selected by a Unitholder will remain in effect until changed. Unitholders purchasing Units in the secondary market will initially receive distributions in accordance with the election of the prior owner. Unitholders desiring to change their plan of distribution may do so by sending a written notice requesting the change, together with any Certificate(s), to the Trustee. The notice and any Certificate(s) must be Trustee not later than the semi-annual Record Date to be effective as of the semi-annual distribution following the subsequent semi-annual Record Date. Unitholders are requested to make any such changes within 45 days prior to the applicable Record Date. Certificates should only be sent by registered or certified mail to minimize the possibility of their being lost or stolen. (See "OWNERSHIP AND TRANSFER OF UNITS.") As of the first day of each month the Trustee will deduct from the Interest Account of a Trust or, to the extent funds are not sufficient therein, from the Principal Account of a Trust, amounts needed for payment of expenses of such Trust. The Trustee also may withdraw from said accounts such amount, if any, as it deems necessary to establish a reserve for any governmental charges payable out of such Trust. Amounts so withdrawn shall not be considered a part of the Trust's assets until such time as the Trustee shall return all or any part of such amounts to the appropriate account. In addition, the Trustee shall withdraw from the Interest Account and the Principal Account of a Trust such amounts as may be necessary to cover redemptions of Units of such Trust by the Trustee. Funds which are available for future distributions, redemptions and payment of expenses are held in accounts which are non-interest bearing to Unitholders and are available for use by the Trustee pursuant to normal banking procedures. The Sponsor is also the principal underwriter of the Accumulation Funds described in the following table. Each of these funds is an open-end, diversified management investment company into which Unitholders may choose to reinvest Trust distributions automatically, without any sales charge. (Reinvestment generally is available only to Unitholders who are residents of the states for which such portfolios are named.) Unitholders may reinvest both interest and principal distributions or principal distributions only. Each Accumulation Fund has investment objectives which differ in certain respects from those of the Trusts and may invest in securities which would not be eligible for deposit in the Trusts. The investment adviser to each Accumulation Fund is Nuveen Advisory Corp., a wholly-owned subsidiary of the Sponsor. For a more detailed description, Unitholders of each Accumulation Fund should read carefully the prospectus of the Accumulation Fund in which they are interested. For additional information concerning the Accumulation Plan see the Information Supplement of this Prospectus. Shareholder Services, Inc. will mail to each participant in the Accumulation Plan a quarterly statement containing a record of all transactions involving purchases of Accumulation Fund shares (or fractions thereof) with Trust interest distributions or as a result of reinvestment of Accumulation Fund dividends. Any to purchase shares of an Accumulation Fund will be separately confirmed by Shareholder Services, Inc. Unitholders will also receive distribution statements from the Trustee detailing the amounts transferred to their Accumulation Fund accounts. Participants may at any time, by so notifying the Trustee in writing, elect to change the Accumulation Fund into which their distributions are being reinvested, to change from principal only reinvestment to reinvestment of both principal and interest or vice versa, or to terminate their participation in the Accumulation Plan altogether and receive future distributions on their Units in cash. There will be no charge or other penalty for such change of election or termination. The character of Trust distributions for income tax purposes will remain unchanged even if they are reinvested in an Accumulation Fund. HOW DETAILED ARE REPORTS TO UNITHOLDERS? The Trustee shall furnish Unitholders of a Trust in connection with each distribution, a statement of the amount of interest, if any, and the amount of other receipts (received since the preceding distribution) being distributed, expressed in each case as a dollar amount representing the pro rata share of each Unit of a Trust outstanding and a year to date summary of all distributions paid on said Units. Within a reasonable period of time after the end of each calendar year, the Trustee shall furnish to each person who at any time during the calendar year was a registered Unitholder of a Trust a statement with respect to such Trust (i) as to the Interest Account: interest received (including amounts representing interest received upon any disposition of Bonds), and, except for any State Trust, the percentage of such interest by states in which the issuers of the Bonds are located, deductions for fees and expenses of such Trust, redemption of Units and the balance remaining after such distributions and deductions, expressed in each case both as a total dollar amount and as a dollar amount representing the pro rata share of each Unit outstanding on the last business day of such calendar year; (ii) as to the Principal Account: the dates of disposition of any Bonds and the net proceeds received therefrom (excluding any portion representing accrued interest), the amount paid for purchase of Replacement Bonds, the amount paid upon redemption of Units, deductions for payment of applicable taxes and fees and expenses of the Trustee, and the balance remaining after such distributions and deductions expressed both as a total dollar amount and as a dollar amount representing the pro rata share of each Unit outstanding on the last business day of such calendar year; (iii) a list of the Bonds held and the number of Units outstanding on the last business day of such calendar year; (iv) the Unit Value based upon the last computation thereof made during such calendar year; and (v) amounts actually distributed during such calendar year from the Interest Account and from the Principal Account, separately stated, expressed both as total dollar amounts and as dollar amounts representing the pro rata share of each Unit outstanding. Each annual statement will reflect pertinent information in respect of all plans of distribution so that Unitholders may be informed regarding the results of other plans of distribution. The value of each Trust is determined by the Sponsor on the basis of (1) the cash on hand in the Trust or moneys in the process of being collected, (2) the value of the Bonds in the Trust based on the BID prices of the Bonds and (3) interest accrued thereon not subject to collection, LESS (1) amounts representing taxes or governmental charges payable out of the Trust and (2) the accrued expenses of the Trust. The result of such computation is divided by the number of Units of such Trust outstanding as of the date thereof to determine the per Unit value ("Unit Value") of such Trust. The Sponsor may determine the value of the Bonds in each Trust (1) on the basis of current BID prices of the Bonds obtained from dealers or brokers who customarily deal in bonds comparable to those held by the Trust, (2) if bid prices are not available for any of the Bonds, on the basis of bid prices for comparable bonds, (3) by causing the value of the Bonds to be determined by others engaged in the practice of evaluating, quoting or appraising comparable bonds or (4) by any combination of the above. Although the Unit Value of each Trust is based on the BID prices of the Bonds, the Units are sold initially to the public at the Public Offering Price based on the OFFERING prices of the Bonds. Because the insurance obtained by the Sponsor or by the issuers of Bonds with respect to the Bonds in the Insured Trusts and with respect to insured Bonds in Traditional Trusts is effective so long as such Bonds are outstanding, such insurance will be taken into account in determining the bid and offering prices of such Bonds and therefore some value attributable to such insurance will be included in the value of Units of Trusts that include such Bonds. HOW UNITS OF THE TRUSTS ARE DISTRIBUTED TO THE PUBLIC John Nuveen & Co. Incorporated is the Sponsor and sole Underwriter of the Units. It is the intention of the Sponsor to qualify Units of National, Long Intermediate, Intermediate, Short Intermediate and Short Term Trusts for sale under the laws of substantially all of the states of the United States of America, and Units of State Trusts only in the state for which the Trust is named and selected other states. Promptly following the deposit of Bonds in exchange for Units of the Trusts, it is the practice of the Sponsor to place all of the Units as collateral for a letter or letters of credit from one or more commercial banks under an agreement to release such Units from time to time as needed for distribution. Under such an arrangement the Sponsor pays such banks compensation based on the then current interest rate. This is a normal warehousing arrangement during the period of distribution of the Units to public investors. To facilitate the handling of transactions, sales of Units shall be limited to transactions involving a minimum of either $5,000 or 50 Units, whichever is less. The Sponsor reserves the right to reject, in whole or in part, any order for the purchase of Units. The Sponsor plans to allow a discount to brokers and dealers in connection with the primary distribution of Units and also in secondary market transactions. The primary market discounts are as follows: Breakpoint sales charges and related dealer concessions are computed both on a dollar basis and on the basis of the number of Units purchased, using the equivalent of 500 Units to $50,000, 2,500 Units to $250,000 etc. and will be applied on that basis which is more favorable to the purchaser. The Sponsor currently intends to maintain a secondary market for Units of each Trust. See "MARKET FOR UNITS." The amount of the dealer concession on secondary market purchases of Trust Units through the Sponsor will be computed based upon the value of the Bonds in the Trust portfolio, including the sales charge computed as described in "HOW IS THE PUBLIC OFFERING PRICE DETERMINED?", and adjusted to reflect the cash position of the Trust principal account, and will vary with the size of the purchase as shown in the following table: Breakpoint sales charges and related dealer concessions are computed both on a dollar basis and on the basis of the number of Units purchased, using the equivalent of 500 Units to $50,000, 2,500 Units to $250,000, etc., and will be applied on that basis which is more favorable to the purchaser. The Sponsor reserves the right to change the foregoing dealer concessions from time to time. Registered investment advisers, certified financial planners and registered broker-dealers who in each case either charge periodic fees for financial planning, investment advisory or asset management services, or provide such services in connection with the establishment of an investment account for which a comprehensive "wrap fee" charge is imposed, and bank trust departments investing funds over which they exercise exclusive discretionary investment authority and that are held in a fiduciary, agency, custodial or similar capacity, are not entitled to receive any dealer concession for primary or secondary market purchases in which an investor purchases any number of Units at the Public Offering Price for non-breakpoint purchases minus the concession the sponsor typically allows to brokers and dealers for non-breakpoint purchases (see "HOW IS THE PUBLIC OFFERING PRICE DETERMINED?"). Certain commercial banks are making Units of the Trusts available to their customers on an agency basis. A portion of the sales charge paid by these customers is retained by or remitted to the banks in the amounts shown in the above table. The Glass-Steagall Act prohibits banks from underwriting Trust Units; the Act does, however, permit certain agency transactions and banking regulators have not indicated that these particular agency transactions are not permitted under the Act. In Texas and in certain other states, any bank making Units available must be registered as a broker-dealer under state law. OWNERSHIP AND TRANSFER OF UNITS The ownership of Units is evidenced by book entry positions recorded on the books and records of the Trustee unless the Unitholder expressly requests that the purchased Units be evidenced in Certificate form. The Trustee is authorized to treat as the owner of Units that person who at the time is registered as such on the books of the Trustee. Any Unitholder who holds a Certificate may change to book entry ownership by submitting to the Trustee the Certificate along with a written request that the Units represented by such Certificate be held in book entry form. Likewise, a Unitholder who holds Units in book entry form may obtain a Certificate for such Units by written request to the Trustee. Units may be held in denominations of one Unit or any multiple or fraction thereof. Fractions of Units are computed to three decimal places. Any Certificates issued will be numbered serially for identification, and are issued in fully registered form, transferable only on the books of the Trustee. Book entry Unitholders will receive a Book Entry Position Confirmation reflecting their ownership. For Trusts allowing optional plans of distribution, Certificates for Units will bear an appropriate notation on their face indicating which plan of distribution has been selected. When a change is made, the existing Certificates must be surrendered to the Trustee and new Certificates issued to reflect the currently effective plan of distribution. There will be no charge for this service. Holders of book entry Units can change their plan of distribution by making a written request to the Trustee, which will issue a new Book Entry Position Confirmation to reflect such change. Units are transferable by making a written request to the Trustee and, in the case of Units evidenced by Certificate(s), by presenting and surrendering such Certificate(s) to the Trustee, at its address listed on the back cover of this Part B of the Prospectus, properly endorsed or accompanied by a written instrument or instruments of transfer. The Certificate(s) should be sent registered or certified mail for the protection of the Unitholder. Each Unitholder must sign such written request, and such Certificate(s) or transfer instrument, exactly as his name appears on (a) the face of the Certificate(s) representing the Units to be transferred, or (b) the Book Entry Position Confirmation(s) relating to the Units to be transferred. Such signature(s) must be guaranteed by a guarantor acceptable to the Trustee. In certain instances the Trustee may require additional documents such as, but not limited to, trust instruments, certificates of death, appointments as executor or administrator or certificates of corporate authority. Mutilated Certificates must be surrendered to the Trustee in order for a replacement Certificate to be issued. Although at the date hereof no charge is made and none is contemplated, a Unitholder may be required to pay $2.00 to the Trustee for each Certificate reissued or transfer of Units requested and to pay any governmental charge which may be imposed in connection therewith. REPLACEMENT OF LOST, STOLEN OR DESTROYED CERTIFICATES. To obtain a new Certificate replacing one that has been lost, stolen, or destroyed, the Unitholder must furnish the Trustee with sufficient indemnification and pay such expenses as the Trustee may incur. This indemnification must be in the form of an Open Penalty Bond of Indemnification. The premium for such an indemnity bond may vary, but currently amounts to 1% of the market value of the Units represented by the Certificate. In the case however, of a Trust as to which notice of termination has been given, the premium currently amounts to 0.5% of the market value of the Units represented by such Certificate. HOW UNITS MAY BE REDEEMED WITHOUT CHARGE Unitholders may redeem all or a portion of their Units by (1) making a written request for such redemption (book entry Unitholders may use the redemption form on the reverse side of their Book Entry Position Confirmation) to the Trustee at its address listed on the back cover of this Part B of the Prospectus (redemptions of 1,000 Units or more will require a signature guarantee), (2) in the case of Units evidenced by a Certificate, by also tendering such Certificate to the Trustee, duly endorsed or accompanied by proper instruments of transfer with signatures guaranteed as explained above, or provide satisfactory indemnity required in connection with lost, stolen or destroyed Certificates and (3) payment of applicable governmental charges, if any. Certificates should be sent only by registered or certified mail to minimize the possibility of their being lost or stolen. (See "OWNERSHIP AND TRANSFER OF UNITS".) No redemption fee will be charged. A Unitholder may authorize the Trustee to honor telephone instructions for the redemption of Units held in book entry form. Units represented by Certificates may not be redeemed by telephone. The proceeds of Units redeemed by telephone will be sent by check either to the Unitholder at the address specified on his account or to a financial institution specified by the Unitholder for credit to the account of the Unitholder. A Unitholder wishing to use this method of redemption must complete a Telephone Redemption Authorization Form and furnish the Form to the Trustee. Telephone Redemption Authorization Forms can be obtained from a Unitholder's registered representative or by calling the Trustee. Once the completed Form is on file, the Trustee will honor telephone redemption requests by any person. The time a telephone redemption request is received determines the "date of tender" as discussed below. The redemption proceeds will be mailed within three business days following the telephone redemption request. Only Units held in the name of individuals may be redeemed by telephone; accounts registered in broker name, or accounts of corporations or fiduciaries (including among others, trustees, guardians, executors and administrators) may not use the telephone redemption privilege. On the third business day following the date of tender, the Unitholder will be entitled to receive in cash for each Unit tendered an amount equal to the Unit Value of such Trust determined by the Trustee, as of 4:00 p.m. eastern time on the date of tender as defined hereafter, plus accrued interest to, but not including, the third business day after the date of tender ("Redemption Price"). The price received upon redemption may be more or less than the amount paid by the Unitholder depending on the value of the Bonds on the date of tender. Unitholders should check with the Trustee or their broker to determine the Redemption Price before tendering Units. The "date of tender" is deemed to be the date on which the request for redemption of Units is received in proper form by the Trustee, except that as regards a redemption request received after 4:00 p.m. eastern time or on any day on which the New York Stock Exchange (the "Exchange") is normally closed, the date of tender is the next day on which such Exchange is normally open for trading and such request will be deemed to have been made on such day and the redemption will be effected at the Redemption Price computed on that day. Accrued interest paid on redemption shall be withdrawn from the Interest Account of the appropriate Trust or, if the balance therein is insufficient, from the Principal Account of such Trust. All other amounts paid on redemption shall be withdrawn from the Principal Account. The Trustee is empowered to sell underlying Bonds of a Trust in order to make funds available for redemption. (See "HOW BONDS MAY BE REMOVED FROM THE TRUSTS.") Units so redeemed shall be cancelled. To the extent that Bonds are sold from a Trust, the size and diversity of such Trust will be reduced. Such sales may be required at a time when Bonds would not otherwise be sold and might result in lower prices than might otherwise be realized. The Redemption Price is determined on the basis of the BID prices of the Bonds in each Trust, while the initial Public Offering Price of Units will be determined on the basis of the OFFERING prices of the Bonds as of 4:00 p.m. eastern time on any day on which the Exchange is normally open for trading and such determination is made. As of any given time, the difference between the bid and offering prices of such Bonds may be expected to average 1/2% to 2% of principal amount. In the case of actively traded Bonds, the difference may be as little as 1/4 to 1/2 of 1%, and in the case of inactively traded Bonds such difference usually will not exceed 3%. The right of redemption may be suspended and payment postponed for any period during which the Securities and Exchange Commission determines that trading in the municipal bond market is restricted or an emergency exists, as a result of which disposal or evaluation of the Bonds is not reasonably practicable, or for such other periods as the Securities and Exchange Commission may by order permit. Under regulations issued by the Internal Revenue Service, the Trustee will be required to withhold a specified percentage of the principal amount of a Unit redemption if the Trustee has not been furnished the redeeming Unitholder's tax identification number in the manner required by such regulations. Any amount so withheld is transmitted to the Internal Revenue Service and may be recovered by the Unitholder only when filing his or her tax return. Under normal circumstances the Trustee obtains the Unitholder's tax identification number from the selling broker at the time the Certificate or Book Entry Return Confirmation is issued, and this number is printed on the Certificate or Book Entry Return Confirmation and on distribution statements. If a Unitholder's tax identification number does not appear as described above, or if it is incorrect, the Unitholder should contact the Trustee before redeeming Units to determine what action, if any, is required to avoid this "back-up withholding." HOW UNITS MAY BE PURCHASED BY THE SPONSOR The Trustee will notify the Sponsor of any tender of Units for redemption. If the Sponsor's bid in the secondary market at that time equals or exceeds the Redemption Price it may purchase such Units by notifying the Trustee before the close of business on the second succeeding business day and by making payment therefor to the Unitholder not later than the day on which payment would otherwise have been made by the Trustee. (See "HOW UNITS MAY BE REDEEMED WITHOUT CHARGE.") The Sponsor's current practice is to bid at the Redemption Price in the secondary market. Units held by the Sponsor may be tendered to the Trustee for redemption as any other Units. HOW BONDS MAY BE REMOVED FROM THE TRUSTS Bonds will be removed from a Trust as they mature or are redeemed by the issuers thereof. See Part A of this Prospectus and "RISK FACTORS" for a discussion of call provisions of portfolio Bonds. The Indenture also empowers the Trustee to sell Bonds for the purpose of redeeming Units tendered by any Unitholder, and for the payment of expenses for which income may not be available. Under the Indenture the Sponsor is obligated to provide the Trustee with a current list of Bonds in each Trust to be sold in such circumstances. In deciding which Bonds should be sold the Sponsor intends to consider, among other things, such factors as: (1) market conditions; (2) market prices of the Bonds; (3) the effect on income distributions to Unitholders of the sale of various Bonds; (4) the effect on principal amount of underlying Bonds per Unit of the sale of various Bonds; (5) the financial condition of the issuers; and (6) the effect of the sale of various Bonds on the investment character of the Trust. Such sales, if required, could result in the sale of Bonds by the Trustee at prices less than original cost to the Trust. To the extent Bonds are sold, the size and diversity of such Trust will be reduced. In addition, the Sponsor is empowered to direct the Trustee to liquidate Bonds upon the happening of certain other events, such as default in the payment of principal and/or interest, an action of the issuer that will adversely affect its ability to continue payment of the principal of and interest on its Bonds, or an adverse change in market, revenue or credit factors affecting the investment character of the Bonds. If a default in the payment of the principal of and/or interest on any of the Bonds occurs, and if the Sponsor fails to instruct the Trustee whether to sell or continue to hold such Bonds within 30 days after notification by the Trustee to the Sponsor of such default, the Indenture provides that the Trustee shall liquidate said Bonds forthwith and shall not be liable for any loss so incurred. The Sponsor may also direct the Trustee to liquidate Bonds in a Trust if the Bonds in the Trust are the subject of an advanced refunding, generally considered to be when refunding bonds are issued and the proceeds thereof are deposited in irrevocable trust to retire the refunded Bonds on their redemption date. Except as stated in "COMPOSITION OF TRUSTS" regarding the limited right of substitution of Replacement Bonds for Failed Bonds, and except for refunding securities that may be exchanged for Bonds under certain conditions specified in the Indenture, the Indenture does not permit either the Sponsor or the Trustee to acquire or deposit bonds either in addition to, or in substitution for, any of the Bonds initially deposited in a Trust. The Trustee and its address are stated on the back cover of this Part B of the Prospectus. The Trustee is subject to supervision and examination by the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System and either the Comptroller of the Currency or state banking authorities. LIMITATIONS ON LIABILITIES OF SPONSOR AND TRUSTEE The Sponsor and the Trustee shall be under no liability to Unitholders for taking any action or for refraining from any action in good faith pursuant to the Indenture, or for errors in judgment, but shall be liable only for their own negligence, lack of good faith or willful misconduct. The Trustee shall not be liable for depreciation or loss incurred by reason of the sale by the Trustee of any of the Bonds. In the event of the failure of the Sponsor to act under the Indenture, the Trustee may act thereunder and shall not be liable for any action taken by it in good faith under the Indenture. The Trustee shall not be liable for any taxes or other governmental charges imposed upon or in respect of the Bonds or upon the interest thereon or upon it as Trustee under the Indenture or upon or in respect of any Trust which the Trustee may be required to pay under any present or future law of the United States of America or of any other taxing authority having jurisdiction. In addition, the Indenture contains other customary provisions limiting the liability of the Trustee. The Trustee or any successor trustee may resign by executing an instrument of resignation in writing and filing same with the Sponsor and mailing a copy of a notice of resignation to all Unitholders then of record. Upon receiving such notice, the Sponsor is required to promptly appoint a successor trustee. If the Trustee becomes incapable of acting or is adjudged a bankrupt or insolvent, or a receiver or other public officer shall take charge of its property or affairs, the Sponsor may remove the Trustee and appoint a successor by written instrument. The resignation or removal of a trustee and the appointment of a successor trustee shall become effective only when the successor trustee accepts its appointment as such. Any successor trustee shall be a corporation authorized to exercise corporate trust powers, having capital, surplus and undivided profits of not less than $5,000,000. Any corporation into which a trustee may be merged or with which it may be consolidated, or any corporation resulting from any merger or consolidation to which a trustee shall be a party, shall be the successor trustee. If upon resignation of a trustee no successor has been appointed and has accepted the appointment within 30 days after notification, the retiring trustee may apply to a court of competent jurisdiction for the appointment of a successor. If the Sponsor fails to undertake any of its duties under the Indenture, and no express provision is made for action by the Trustee in such event, the Trustee may, in addition to its other powers under the Indenture (1) appoint a successor sponsor or (2) terminate the Indenture and liquidate the Trusts. John Nuveen & Co. Incorporated, the Sponsor and Underwriter, was founded in 1898 and is the oldest and largest investment banking firm specializing in the underwriting and distribution of tax-exempt securities and maintains the largest research department in the investment banking community devoted exclusively to the analysis of municipal securities. In 1961 the Sponsor began sponsoring the Nuveen Tax-Exempt Unit Trust and, since this time, it has issued more than $30 billion in tax-exempt unit trusts, including over $8 billion in insured trusts. The Sponsor is also principal underwriter of 16 mutual funds and 60 closed-end funds. These registered open-end and closed-end investment companies currently have approximately $32.8 billion in tax-exempt securities under management. Nationwide, more than 1,000,000 individual investors have purchased Nuveen's tax exempt trusts and funds. The present corporation was organized in 1967 as a wholly-owned subsidiary of Nuveen Corporation, successor to the original John Nuveen & Co. founded in 1898 as a sole proprietorship and incorporated in 1953. In 1974, John Nuveen & Co. Incorporated became a wholly-owned subsidiary of The St. Paul Companies, Inc., a financial services management company located in St. Paul, Minnesota. On May 19, 1992, common shares comprising a minority interest in The John Nuveen Company ("JNC"), a newly organized corporation which holds all of the shares of Nuveen, were sold to the general public in an initial public offering. St. Paul retains a controlling interest in JNC with over 70% of JNC's shares. The Sponsor is a member of the National Association of Securities Dealers, Inc. and the Securities Industry Association and has its principal offices located in Chicago (333 W. Wacker Drive) and New York (Swiss Bank Tower, 10 East 50th Street). It maintains 14 regional offices. To help advisers and investors better understand and more efficiently use an investment in the Trust to reach their investment goals, the Sponsor may advertise and create specific investment programs and systems. For example, such activities may include presenting information on how to use an investment in the Trust, alone or in combination with an investment in other mutual funds or unit investment trusts sponsored by Nuveen, to accumulate assets for future education needs or periodic payments such as insurance premiums. The Trust's sponsor may produce software or additional sales literature to promote the advantages of using the Trust to meet these and other specific investor needs. The Indenture may be amended by the Trustee and the Sponsor without the consent of any of the Unitholders (1) to cure any ambiguity or to correct or supplement any provision thereof which may be defective or inconsistent, or (2) to make such other provisions as shall not adversely affect the Unitholders, provided, however, that the Indenture may not be amended to increase the number of Units in any Trust or to permit the deposit or acquisition of bonds either in addition to, or in substitution for any of the Bonds initially deposited in any Trust except as stated in "COMPOSITION OF TRUSTS" regarding the limited right of substitution of Replacement Bonds and except for the substitution of refunding bonds under certain circumstances. The Trustee shall advise the Unitholders of any amendment promptly after execution thereof. Each Trust may be liquidated at any time by written consent of 100% of the Unitholders or by the Trustee when the value of such Trust, as shown by any evaluation, is less than 20% of the original principal amount of such Trust and will be liquidated by the Trustee in the event that Units not yet sold aggregating more than 60% of the Units originally created are tendered for redemption by the Sponsor thereby reducing the net worth of such Trust to less than 40% of the principal amount of the Bonds originally deposited in the portfolio. (See "Essential Information" appearing in Part A of this Prospectus.) The sale of Bonds from the Trusts upon termination may result in realization of a lesser amount than might otherwise be realized if such sale were not required at such time. For this reason, among others, the amount realized by a Unitholder upon termination may be less than the principal amount of Bonds originally represented by the Units held by such Unitholder. The Indenture will terminate upon the redemption, sale or other disposition of the last Bond held thereunder, but in no event shall it continue beyond the end of the calendar year preceding the fiftieth anniversary of its execution for National and State Trusts, beyond the end of the calendar year preceding the twentieth anniversary of its execution for Long Intermediate, and Intermediate Trusts or beyond the end of the calendar year preceding the tenth anniversary of its execution for Short Intermediate and Short Term Trusts. Written notice of any termination specifying the time or times at which Unitholders may surrender their Certificates, if any, for cancellation shall be given by the Trustee to each Unitholder at the address appearing on the registration books of the Trust maintained by the Trustee. Within a reasonable time thereafter the Trustee shall liquidate any Bonds in the Trust then held and shall deduct from the assets of the Trust any accrued costs, expenses or indemnities provided by the Indenture which are allocable to such Trust, including estimated compensation of the Trustee and costs of liquidation and any amounts required as a reserve to provide for payment of any applicable taxes or other governmental charges. The Trustee shall then distribute to Unitholders of such Trust their pro rata share of the balance of the Interest and Principal Accounts. With such distribution the Unitholders shall be furnished a final distribution statement, in substantially the same form as the annual distribution statement, of the amount distributable. At such time as the Trustee in its sole discretion shall determine that any amounts held in reserve are no longer necessary, it shall make distribution thereof to Unitholders in the same manner. The legality of the Units offered hereby has been passed upon by Chapman and Cutler, 111 West Monroe Street, Chicago, Illinois 60603. Special counsel for the Trusts for respective state tax matters are named in "Tax Status" for each Trust appearing in Part A of this Prospectus. Carter, Ledyard & Milburn, 2 Wall Street, New York, New York 10005, has acted as counsel for the Trustee with respect to the Series, and, in the absence of a New York Trust from the Series, as special New York tax counsel for the Series. The "Statement of Condition" and "Schedule of Investments" at Date of Deposit included in Part A of this Prospectus have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their report in Part A of this Prospectus, and are included herein in reliance upon the authority of said firm as experts in giving said report. Upon written or telephonic request to the Trustee, investors will receive at no cost to the investor supplemental information about this Trust, which has been filed with the Securities and Exchange Commission and is intended to supplement information contained in Part A and Part B of this Prospectus. The supplemental information includes more detailed information concerning certain of the Bonds included in the Trusts contained in the applicable Series and more specific risk information concerning the individual state Trusts. This supplement also includes additional general information about the Sponsor and the Trusts. Except as to statements made herein furnished by the Trustee, the Trustee has assumed no responsibility for the accuracy, adequacy and completeness of the information contained in this Prospectus. This Prospectus does not contain all of the information set forth in the registration statement and exhibits relating thereto, filed with the Securities and Exchange Commission, Washington, D.C., under the Securities Act of 1933, and to which reference is made. No person is authorized to give any information or to make representations not contained in this Prospectus or in supplemental information or sales literature prepared by the Sponsor, and any information or representation not contained therein must not be relied upon as having been authorized by either the Trusts, the Trustee or the Sponsor. This Prospectus does not constitute an offer to sell, or a solicitation of an offer to buy, securities in any State to any person to whom it is not lawful to make such offer in such state. The Trusts are registered as a Unit Investment Trust under the Investment Company Act of 1940. Such registration does not imply that the Trusts or any of their Units has been guaranteed, sponsored, recommended or approved by the United States or any State or agency or officer thereof. This Information Supplement provides additional information concerning the structure, operations and risks of a Nuveen Tax-Free Unit Trust not found in the prospectuses for the Trusts. This Information Supplement is not a prospectus and does not include all of the information that a prospective investor should consider before investing in a Trust. This Information Supplement should be read in conjunction with the prospectus for the Trust in which an investor is considering investing ("Prospectus"). Copies of the Prospectus can be obtained by calling or writing the Trustee at the telephone number and address indicated in Part B of the Prospectus. This Information Supplement has been created to supplement information contained in the Prospectus. This Information Supplement is dated January 11, 1996. Capitalized terms have been defined in the Prospectus. An investment in Units of any Trust should be made with an understanding of the risks that such an investment may entail. These include the ability of the issuer, or, if applicable, an insurer, to make payments of interest and principal when due, the effects of changes in interest rates generally, early call provisions and the potential for changes in the tax status of the Bonds. As set forth in the portfolio summaries in Part A of this Prospectus, the Trusts may contain or be concentrated in one or more of the types of bonds discussed below. The following paragraphs discuss certain circumstances which may adversely affect the ability of issuers of Bonds held in the portfolio of a Trust to make payment of principal and interest thereon or which may adversely affect the ratings of such Bonds; with respect to Insured Trusts, however, because of the insurance obtained by the Sponsor or by the issuers of the Bonds, such changes should not adversely affect an Insured Trust's receipt of principal and interest, the Standard & Poor's AAA or Moody's Aaa ratings of the Bonds in the Insured Trust portfolio, or the Standard & Poor's AAA rating of the Units of each such Insured Trust. For economic risks specific to the individual Trusts, see "Risk Factors" for each Trust. HEALTH FACILITY OBLIGATIONS. Some of the Bonds in a Trust may be obligations of issuers whose revenues are derived from services provided by hospitals or other health care facilities, including nursing homes. Ratings of bonds issued for health care facilities are sometimes based on feasibility studies that contain projections of occupancy levels, revenues and expenses. A facility's gross receipts and net income available for debt service may be affected by future events and conditions including, among other things, demand for services, the ability of the facility to provide the services required, an increasing shortage of qualified nurses or a dramatic rise in nursing salaries, physicians' confidence in the facility, management capabilities, economic developments in the service area, competition from other similar providers, efforts by insurers and governmental agencies to limit rates, legislation establishing state rate-setting agencies, expenses, government regulation, the cost and possible unavailability of malpractice insurance, and the termination or restriction of governmental financial assistance, including that associated with Medicare, Medicaid and other similar third party payor programs. Medicare reimbursements are currently calculated on a prospective basis and are not based on a provider's actual costs. Such method of reimbursement may adversely affect reimbursements to hospitals and other facilities for services provided under the Medicare program and thereby may have an adverse effect on the ability of such institutions to satisfy debt service requirements. In the event of a default upon a bond secured by hospital facilities, the limited alternative uses for such facilities may result in the recovery upon such collateral not providing sufficient funds to fully repay the bonds. Certain hospital bonds provide for redemption at par upon the damage, destruction or condemnation of the hospital facilities or in other special circumstances. HOUSING OBLIGATIONS. Some of the Bonds in a Trust may be obligations of issuers whose revenues are primarily derived from mortgage loans to housing projects for low to moderate income families. Such issues are generally characterized by mandatory redemption at par or, in the case of original issue discount bonds, accreted value in the event of economic defaults and in the event of a failure of the operator of a project to comply with certain covenants as to the operation of the project. The failure of such operator to comply with certain covenants related to the tax-exempt status of interest on the Bonds, such as provisions requiring that a specified percentage of units be rented or available for rental to low or moderate income families, potentially could cause interest on such Bonds to be subject to Federal income taxation from the date of issuance of the Bonds. The ability of such issuers to make debt service payments will be affected by events and conditions affecting financed projects, including, among other things, the achievement and maintenance of sufficient occupancy levels and adequate rental income, employment and income conditions prevailing in local labor markets, increases in taxes, utility costs and other operating expenses, the managerial ability of project managers, changes in laws and governmental regulations, the appropriation of subsidies, and social and economic trends affecting the localities in which the projects are located. Occupancy of such housing projects may be adversely affected by high rent levels and income limitations imposed under Federal and state programs. SINGLE FAMILY MORTGAGE REVENUE BONDS. Some of the Bonds in a Trust may be single family mortgage revenue bonds, which are issued for the purpose of acquiring from originating financial institutions notes secured by mortgages on residences located within the issuer's boundaries and owned by persons of low or moderate income. Mortgage loans are generally partially or completely prepaid prior to their final maturities as a result of events such as sale of the mortgaged premises, default, condemnation or casualty loss. Because these bonds are subject to extraordinary mandatory redemption in whole or in part from such prepayments of mortgage loans, a substantial portion of such bonds will probably be redeemed prior to their scheduled maturities or even prior to their ordinary call dates. Extraordinary mandatory redemption without premium could also result from the failure of the originating financial institutions to make mortgage loans in sufficient amounts within a specified time period. The redemption price of such issues may be more or less than the offering price of such bonds. Additionally, unusually high rates of default on the underlying mortgage loans may reduce revenues available for the payment of principal of or interest on such mortgage revenue bonds. Single family mortgage revenue bonds issued after December 31, 1980 were issued under Section 103A of the Internal Revenue Code of 1954, as amended, or Section 143 of the Internal Revenue Code of 1986, which Sections contain certain requirements relating to the use of the proceeds of such bonds in order for the interest on such bonds to retain its tax-exempt status. In each case, the issuer of the bonds has covenanted to comply with applicable requirements and bond counsel to such issuer has issued an opinion that the interest on the bonds is exempt from Federal income tax under existing laws and regulations. There can be no assurance that such continuing requirements will be satisfied; the failure to meet such requirements could cause interest on the Bonds to be subject to Federal income taxation, possibly from the date of issuance of the Bonds. FEDERALLY ENHANCED OBLIGATIONS. Some of the mortgages which secure the various health care or housing projects which underlie the previously discussed Health Facility, Housing, and Single Family Mortgage Revenue Obligations (the "Obligations") in a Trust may be insured by the Federal Housing Administration ("FHA"). Under FHA regulations, the maximum insurable mortgage amount cannot exceed 90% of the FHA's estimated value of the project. The FHA mortgage insurance does not constitute a guarantee of timely payment of the principal of and interest on the Obligations. Payment of mortgage insurance benefits may be (1) less than the principal amount of Obligations outstanding or (2) delayed if disputes arise as to the amount of the payment or if certain notices are not given to the FHA within the prescribed time periods. In addition, some of the previously discussed Obligations may be secured by mortgage-backed certificates guaranteed by the Government National Mortgage Association ("GNMA"), a wholly owned corporate instrumentality of the United States, and/or the Federal National Mortgage Association ("Fannie Mae") a federally chartered and stockholder-owed corporation. GNMA and Fannie Mae guarantee timely payment of principal and interest on the mortgage-backed certificates, even where the underlying mortgage payments are not made. While such mortgage-backed certificates are often pledged to secure payment of principal and interest on the Obligations, timely payment of interest and principal on the Obligations is not insured or guaranteed by the United States, GNMA, Fannie Mae or any other governmental agency or instrumentality. The GNMA mortgage-backed certificates constitute a general obligation of the United States backed by its full faith and credit. The obligations of Fannie Mae, including its obligations under the Fannie Mae mortgage-backed securities, are obligations solely of Fannie Mae and are not backed by, or entitled to, the full faith and credit of the United States. INDUSTRIAL REVENUE OBLIGATIONS. Certain of the Bonds in a Trust may be industrial revenue bonds ("IRBs"), including pollution control revenue bonds, which are tax-exempt securities issued by states, municipalities, public authorities or similar entities to finance the cost of acquiring, constructing or improving various industrial projects. These projects are usually operated by corporate entities. Issuers are obligated only to pay amounts due on the IRBs to the extent that funds are available from the unexpended proceeds of the IRBs or receipts or revenues of the issuer under an arrangement between the issuer and the corporate operator of a project. The arrangement may be in the form of a lease, installment sale agreement, conditional sale agreement or loan agreement, but in each case the payments to the issuer are designed to be sufficient to meet the payments of amounts due on the IRBs. Regardless of the structure, payment of IRBs is solely dependent upon the creditworthiness of the corporate operator of the project and, if applicable, corporate guarantor. Corporate operators or guarantors may be affected by many factors which may have an adverse impact on the credit quality of the particular company or industry. These include cyclicality of revenues and earnings, regulatory and environmental restrictions, litigation resulting from accidents or environmentally-caused illnesses, extensive competition and financial deterioration resulting from a corporate restructuring pursuant to a leveraged buy-out, takeover or otherwise. Such a restructuring may result in the operator of a project becoming highly leveraged which may have an impact on such operator's creditworthiness which in turn would have an adverse impact on the rating and/or market value of such Bonds. Further, the possibility of such a restructuring may have an adverse impact on the market for and consequently the value of such Bonds, even though no actual takeover or other action is ever contemplated or effected. The IRBs in a Trust may be subject to special or extraordinary redemption provisions which may provide for redemption at par or, in the case of original issue discount bonds, accreted value. The Sponsor cannot predict the causes or likelihood of the redemption of IRBs in a Trust prior to the stated maturity of such Bonds. ELECTRIC UTILITY OBLIGATIONS. Some of the Bonds in a Trust may be obligations of issuers whose revenues are primarily derived from the sale of electric energy. The problems faced by such issuers include the difficulty in obtaining approval for timely and adequate rate increases from the applicable public utility commissions, the difficulty of financing large construction programs, increased competition, reductions in estimates of future demand for electricity in certain areas of the country, the limitations on operations and attributable to environmental considerations, the difficulty of the capital market in absorbing utility debt, the difficulty in obtaining fuel at reasonable prices and the effect of energy conservation. All of such issuers have been experiencing certain of these problems in varying degrees. In addition, Federal, state and municipal governmental authorities may from time to time review existing, and impose additional, regulations governing the licensing, construction and operation of nuclear power plants, which may adversely affect the ability of the issuers of certain of the Bonds in a Trust to make payments of principal and/or interest on such Bonds. TRANSPORTATION FACILITY REVENUE BONDS. Some of the Bonds in a Trust may be obligations of issuers which are payable from and secured by revenues derived from the ownership and operation of airports, public transit systems and ports. The major portion of an airport's gross operating income is generally derived from fees received from airlines pursuant to use agreements which consist of annual payments for airport use, occupancy of certain terminal space, service fees and leases. Airport operating income may therefore be affected by the ability of the airlines to meet their obligations under the use agreements. The air transport industry is experiencing significant variations in earnings and traffic, due to increased competition, excess capacity, increased costs, deregulation, traffic constraints and other factors, and several airlines are experiencing severe financial difficulties. In particular, facilities with use agreements involving airlines experiencing financial difficulty may experience a reduction in revenue due to the possible inability of these airlines to meet their use agreement obligations because of such financial difficulties and possible bankruptcy. The Sponsor cannot predict what effect these industry conditions may have on airport revenues which are dependent for payment on the financial condition of the airlines and their usage of the particular airport facility. Bonds that are secured primarily by the revenue collected by a public transit system typically are additionally secured by a pledge of sales tax receipts collected at the state or local level, or of other governmental financial assistance. Transit system net revenues will be affected by variations in utilization, which in turn may be affected by the degree of local governmental subsidization, demographic and population shifts, and competition from other forms of transportation; and by increased costs, including costs resulting from previous deferrals of maintenance. Port authorities derive their revenues primarily from fees imposed on ships using the facilities. The rate of utilization of such facilities may fluctuate depending on the local economy and on competition from competing forms of transportation such as air, rail and trucks. WATER AND/OR SEWERAGE OBLIGATIONS. Some of the Bonds in a Trust may be obligations of issuers whose revenues are derived from the sale of water and/or sewerage services. Such Bonds are generally payable from user fees. The problems of such issuers include the ability to obtain timely and adequate rate increases, population decline resulting in decreased user fees, the difficulty of financing large construction programs, the limitations on operations and increased costs and delays attributable to environmental considerations, the increasing difficulty of obtaining or discovering new supplies of fresh water, the effect of conservation programs and the impact of "no-growth" zoning ordinances. All of such issuers have been experiencing certain of these problems in varying degrees. UNIVERSITY AND COLLEGE REVENUE OBLIGATIONS. Some of the Bonds in a Trust may be obligations of issuers which are, or which govern the operation of, colleges and universities and whose revenues are derived mainly from tuition, dormitory revenues, grants and endowments. General problems of such issuers include the prospect of a declining percentage of the population consisting of "college" age individuals, possible inability to raise tuitions and fees sufficiently to cover increased operating costs, the uncertainty of continued receipt of Federal grants and state funding, and government legislation or regulations which may adversely affect the revenues or costs of such issuers. All of such issuers have been experiencing certain of these problems in varying degrees. BRIDGE AUTHORITY AND TOLLROAD OBLIGATIONS. Some of the Bonds in a Trust may be obligations of issuers which derive their payments from bridge, road or tunnel toll revenues. The revenues of such an issuer could be adversely affected by competition from toll-free vehicular bridges and roads and alternative modes of transportation. Such revenues could also be adversely affected by a reduction in the availability of fuel to motorists or significant increases in the costs thereof. Specifically, governmental regulations restricting the use of vehicles in the New York City metropolitan area may adversely affect revenues of the Triborough Bridge and Tunnel Authority. DEDICATED-TAX SUPPORTED BONDS. Some of the Bonds in a Trust may be obligations of issuers which are payable from and secured by tax revenues from a designated source, which revenues are pledged to secure the bonds. The various types of Bonds described below differ in structure and with respect to the rights of the bondholders to the underlying property. Each type of dedicated-tax supported Bond has distinct risks, only some of which are set forth below. One type of dedicated-tax supported Bond is secured by the incremental tax received on either real property or on sales within a specifically defined geographical area; such tax generally will not provide bondholders with a lien on the underlying property or revenues. Another type of dedicated-tax supported Bond is secured by a special tax levied on real property within a defined geographical area in such a manner that the tax is levied on those who benefit from the project; such bonds typically provide for a statutory lien on the underlying property for unpaid taxes. A third type of dedicated-tax supported Bond may be secured by a tax levied upon the manufacture, sale or consumption of commodities or upon the license to pursue certain occupations or upon corporate privileges within a taxing jurisdiction. As to any of these types of Bonds, the ability of the designated revenues to satisfy the interest and principal payments on such bonds may be affected by changes in the local economy, the financial success of the enterprise responsible for the payment of the taxes, the value of any property on which taxes may be assessed and the ability to collect such taxes in a timely fashion. Each of these factors will have a different affect on each distinct type of dedicated-tax supported bonds. MUNICIPAL LEASE BONDS. Some of the Bonds in a Trust may be obligations that are secured by lease payments of a governmental entity. Such payments are normally subject to annual budget appropriations of the leasing governmental entity. A governmental entity that enters into such a lease agreement cannot obligate future governments to appropriate for and make lease payments but covenants to take such action as is necessary to include any lease payments due in its budgets and to make the appropriations therefor. A governmental entity's failure to appropriate for and to make payments under its lease obligation could result in insufficient funds available for payment of the obligations secured thereby. ORIGINAL ISSUE DISCOUNT BONDS AND STRIPPED OBLIGATIONS. Certain of the Bonds in a Trust may be original issue discount bonds. These Bonds were issued with nominal interest rates less than the rates then offered by comparable securities and as a consequence were originally sold at a discount from their face, or par, values. This original issue discount, the difference between the initial purchase price and face value, is deemed under current law to accrue on a daily basis and the accrued portion is treated as tax-exempt interest income for federal income tax purposes. On sale or redemption, gain, if any, realized in excess of the earned portion of original issue discount will be taxable as capital gain. See "What is the Tax Status of Unitholders". The current value of an original issue discount bond reflects the present value of its face amount at maturity. In a stable interest rate environment, the market value of an original issue discount bond would tend to increase more slowly in early years and in greater increments as the bond approached maturity. Certain of the original issue discount bonds in a Trust may be zero coupon bonds. Zero coupon bonds do not provide for the payment of any current interest; the buyer receives only the right to receive a final payment of the face amount of the bond at its maturity. The effect of owning a zero coupon bond is that a fixed yield is earned not only on the original investment but also, in effect, on all discount earned during the life of the obligation. This implicit reinvestment of earnings at the same rate eliminates the risk of being unable to reinvest the income on such obligation at a rate as high as the implicit yield, but at the same time also eliminates the holder's ability to reinvest at higher rates in the future. For this reason, zero coupon bonds are subject to substantially greater price fluctuations during periods of changing market interest rates than are securities of comparable quality that pay interest currently. Original issue discount bonds, including zero coupon bonds, may be subject to redemption at prices based on the issue price plus the amount of original issue discount accreted to redemption (the "accreted value") plus, if applicable, some premium. Pursuant to such call provisions an original issue discount bond may be called prior to its maturity date at a price less than its face value. See the "Schedules of Investments" for more information about the call provisions of portfolio Bonds. Certain of the Bonds in a Trust may be Stripped Obligations, which represent evidences of ownership with respect to either the principal amount of or a payment of interest on a tax-exempt obligation. An obligation is "stripped" by depositing it with a custodian, which then effects a separation in ownership between the bond and any interest payment which has not yet become payable, and issues evidences of ownership with respect to such constituent parts. A Stripped Obligation therefore has economic characteristics similar to zero coupon bonds, as described above. Each Stripped Obligation has been purchased at a discount from the amount payable at maturity. With respect to each Unitholder, the Internal Revenue Code treats as "original issue discount" that portion of the discount which produces a yield to maturity (as of the date of purchase of the Unitholder's Units) equal to the lower of the coupon rate of interest on the underlying obligation or the yield to maturity on the basis of the purchase price of the Unitholder's Units which is allocable to each Stripped Obligation. Original issue discount which accrues with respect to a Stripped Obligation will be exempt from Federal income taxation to the same extent as interest on the underlying obligations. (See "WHAT IS THE TAX STATUS OF UNITHOLDERS?" in Part B of this Prospectus.) Unitholders should consult their own tax advisers with respect to the state and local tax consequences of owning original issue discount bonds or Stripped Obligations. Under applicable provisions governing determination of state and local taxes, interest on original issue discount bonds or Stripped Obligations may be deemed to be received in the year of accrual even though there is no corresponding cash payment. WHY AND HOW ARE THE BONDS INSURED? INSURED TRUSTS--Insurance guaranteeing the timely payment, when due, of all principal and interest on the Bonds in each Insured Trust has been obtained by the Sponsor or by the issuers or underwriters of Bonds from the MBIA Insurance Corporation (the "Insurer"). Some of the Bonds in each Insured Trust may be covered by a policy or policies of insurance obtained by the issuers or underwriters of the Bonds from Municipal Bond Insurance Association (the "Association") or Bond Investors Guaranty Insurance Company ("BIG"). The Insurer has issued a policy or policies of insurance covering each of the Bonds in the Insured Trusts, each policy to remain in force until the payment in full of such Bonds and whether or not the Bonds continue to be held by an Insured Trust. By the terms of each policy the Insurer will unconditionally guarantee to the holders or owners of the Bonds the payment, when due, required of the issuer of the Bonds of an amount equal to the principal of and interest on the Bonds as such payments shall become due but not be paid (except that in the event of any acceleration of the due date of principal by reason of mandatory or optional redemption, default or otherwise, the payments guaranteed will be made in such amounts and at such times as would have been due had there not been an acceleration). The Insurer will be responsible for such payments, less any amounts received by the holders or owners of the Bonds from any trustee for the bond issuers or from any other sources other than the Insurer. The Insurer's policies relating to small industrial development bonds and pollution control revenue bonds also guarantee the full and complete payments required to be made by or on behalf of an issuer of Bonds pursuant to the terms of the Bonds if there occurs an event which results in the loss of the tax-exempt status of the interest on such Bonds, including principal, interest or premium payments, if any, as and when thereby required. The Insurer has indicated that its insurance policies do not insure the payment of principal or interest on bonds which are not required to be paid by the issuer thereof because the bonds were not validly issued; as indicated under "What is the Tax Status of Unitholders?" the respective issuing authorities have received opinions of bond counsel relating to the valid issuance of each of the Bonds in the Insured Trusts. The Insurer's policy also does not insure against non-payment of principal of or interest on the Bonds resulting from the insolvency, negligence or any other act or omission of the trustee or other paying agent for the Bonds. The policy is not covered by the Property/Casualty Insurance Security Fund specified in Article 76 of the New York Insurance Law. The policies are non-cancellable and the insurance premiums have been fully paid on or prior to the Date of Deposit, either by the Sponsor or, if a policy has been obtained by a Bond issuer, by such issuer. Upon notification from the trustee for any bond issuer or any holder or owner of the Bonds or coupons that such trustee or paying agent has insufficient funds to pay any principal or interest in full when due, the Insurer will be obligated to deposit funds promptly with State Street Bank and Trust Company, N.A., New York, New York, as fiscal agent for the Insurer, sufficient to fully cover the deficit. If notice of nonpayment is received on or after the due date, the Insurer will provide for payment within one business day following receipt of the notice. Upon payment by the Insurer of any Bonds, coupons, or interest payments, the Insurer shall succeed to the rights of the owner of such Bonds, coupons or interest payments with respect thereto. The Insurer is the principal operating subsidiary of MBIA, Inc., a New York Stock Exchange listed company. MBIA, Inc. is not obligated to pay the debts of or claims against the Insurer. The Insurer is a limited liability corporation rather than a several liability association. The Insurer is domiciled in the State of New York and licensed to do business in all 50 states, the District of Columbia, the Commonwealth of Puerto Rico, the Commonwealth of the Northern Mariana Islands, the Virgin Islands of the United States and the Territory of Guam. The Insurer has one European branch in the Republic of France. As of September 30, 1995 the Insurer had admitted assets of $3.7 billion (unaudited), total liabilities of $2.5 billion (unaudited), and total capital and surplus of $1.2 billion (unaudited) determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities. As of December 31, 1994, the Insurer had admitted assets of $3.4 billion (audited), total liabilities of $2.3 billion (audited), and total capital and surplus of $1.1 billion (audited) determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities. Copies of the Insurer's year end financial statements prepared in accordance with statutory accounting practices are available from the Insurer. The address of the Insurer is 113 King Street, Armonk, New York 10504. Each insurance company comprising the Association will be severally and not jointly obligated under the Association policy in the following respective percentages: The AEtna Casualty and Surety Company, 33%; Fireman's Fund Insurance Company, 30%; The Travelers Indemnity Company, 15%; AEtna Insurance Company (now known as CIGNA Property and Casualty Company), 12%; and The Continental Insurance Company, 10%. As a several obligor, each such insurance company will be obligated only to the extent of its percentage of any claim under the Association policy and will not be obligated to pay any unpaid obligation of any other member of the Association. Each insurance company's participation is backed by all of its assets. However, each insurance company is a multiline insurer involved in several lines of insurance other than municipal bond insurance, and the assets of each insurance company also secure all of its other insurance policy and surety bond obligations. The following table sets forth certain unaudited financial information with respect to the five insurance companies comprising the Association. The statistics, which have been furnished by the Association, are as reported by the insurance companies to the New York State Insurance Department and are determined in accordance with statutory accounting principles. No representation is made herein as to the accuracy or adequacy of such information or as to the absence of material adverse changes in such information subsequent to the date thereof. In addition, these numbers are subject to revision by the New York State Insurance Department which, if revised, could either increase or decrease the amounts. FIVE MEMBER COMPANIES ASSETS AND POLICYHOLDERS' SURPLUS (UNAUDITED) AS OF SEPTEMBER 30, 1994. Standard & Poor's Corporation rates all new issues insured by the Association "AAA" Prime Grade. Moody's Investors Service rates all bond issues insured by the Association "Aaa" and short term loans "MIG 1", both designated to be of the highest quality. Each such rating should be evaluated independently of any other rating. No application has been made to any other rating agency in order to obtain additional ratings on the Bonds. The ratings reflect the respective rating agency's current assessment of the creditworthiness of the Association and its ability to pay claims on its policies of insurance. Any further explanation as to the significance of the above ratings may be obtained only from the applicable rating agency. Moody's Investors Service rates all bond issues insured by the Insurer "Aaa" and short-term loans "MIG 1," both designated to be of the highest quality. Standard & Poor's Ratings Group, a division of McGraw Hill ("Standard & Poor's") rates all new issues insured by the Insurer "AAA" Prime Grade." The Moody's Investors Service rating of the Insurer should be evaluated independently of the Standard & Poor's Corporation rating of the Insurer. No application has been made to any other rating agency in order to obtain additional ratings on the Bonds. The ratings reflect the respective rating agency's current assessment of the creditworthiness of the Insurer and its ability to pay claims on its policies of insurance (See "Description of Ratings.") Any further explanation as to the significance of the above ratings may be obtained only from the applicable rating agency. The above ratings are not recommendations to buy, sell or hold the Bonds, and such ratings may be subject to revision or withdrawal at any time by the rating agencies. Any downward revision or withdrawal of either or both ratings may have an adverse effect on the market price of the Bonds. Because the insurance on the Bonds will be effective so long as the Bonds are outstanding, such insurance will be taken into account in determining the market value of the Bonds and therefore some value attributable to such insurance will be included in the value of the Units of the Insured Trusts. The insurance does not, however, guarantee the market value of the Bonds or of the Units. TRADITIONAL TRUSTS--Insurance guaranteeing the timely payment, when due, of all principal and interest on certain Bonds in a Traditional Trust may have been obtained by the Sponsor, issuer or underwriter of the particular Bonds involved or by another party. Such insurance, which provides coverage substantially the same as that obtained with respect to Bonds in Insured Trusts as described above, is effective so long as the insured Bond is outstanding and the insurer remains in business. Insurance relates only to the particular Bond and not to the Units offered hereby or to their market value. Insured Bonds have received a rating of "Aaa" by Moody's Investors Service, Inc. and/or "AAA" by Standard & Poor's Corporation in recognition of such insurance. If a Bond in a Traditional Trust is insured, the Schedule of Investments in Part A of this Prospectus will identify the insurer. Such insurance will be provided by Financial Guaranty Insurance Company ("FGIC"), AMBAC Indemnity Corporation ("AMBAC"), Bond Investors Guaranty Insurance Company, now known as Corp. of Illinois ("BIG"), Capital Guaranty Insurance Company ("CGIC"), Financial Security Assurance, Inc. ("FSA"), Municipal Bond Insurance Association (the "Association"), MBIA Insurance Corporation ("MBIA") or Connie Lee Insurance Company ("ConnieLee"). The Sponsor to date has purchased and presently intends to purchase insurance for Bonds in Traditional Trusts exclusively from MBIA (see the preceding disclosure regarding MBIA). There can be no assurance that any insurer listed therein will be able to satisfy its commitments in the event claims are made in the future. However, Standard & Poor's Corporation has rated the claims-paying ability of each insurer "AAA," and Moody's Investors Service has rated all bonds insured by each such insurer, except ConnieLee, "Aaa." Moody's Investor's Service gives no ratings for bonds insured by ConnieLee. Because any such insurance will be effective so long as the insured Bonds are outstanding, such insurance will be taken into account in determining the market value of such Bonds and therefore some value attributable to such insurance will be included in the value of the Units of the Trust that includes such Bonds. The insurance does not, however, guarantee the market value of the Bonds or of the Units. The Sponsor, John Nuveen & Co. Incorporated, is also the principal underwriter of the Nuveen Municipal Bond Fund, Inc. (the "Bond Fund"), Nuveen Tax-Free Reserves, Inc. ("Tax-Free Reserves"), Nuveen California Tax-Free Fund, Inc. (the "California Fund"), Nuveen Tax-Free Bond Fund, Inc. ("Tax-Free Bond Fund"), Nuveen Insured Tax-Free Bond Fund, Inc. (the "Insured Bond Fund") and Nuveen Tax-Free Money Market Fund, Inc. (the "Money Market Fund") and the Nuveen Multistate Tax-Free Trust (the "Multistate Trust"). Each of these funds (together, the "Accumulation Funds") is an open-end, diversified management investment company into which Unitholders may choose to reinvest Trust distributions automatically, without any sales charge. (Reinvestment in the California Fund is available only to Unitholders who are California residents. Reinvestment in the State Portfolios of the Tax-Free Bond Fund, the Insured Bond Fund, the Money Market Fund and the Multistate Trust is available only to Unitholders who are residents of the states for which such portfolios are named.) Unitholders may reinvest both interest and principal distributions or principal distributions only. Each Accumulation Fund has investment objectives which differ in certain respects from those of the Trusts and may invest in securities which would not be eligible for deposit in the Trusts. The investment adviser to each Accumulation Fund is Nuveen Advisory Corp., a wholly-owned subsidiary of the Sponsor. The following is a general description of the investment objectives and policies of each Accumulation Fund. For a more detailed description, Unitholders should read the prospectus of the Accumulation Fund in which they are interested. The Bond Fund has the objective of providing, through investment in a professionally managed portfolio of long-term municipal bonds, as high a level of current interest income exempt from Federal income tax as is consistent with preservation of capital. The Bond Fund may include in its portfolio tax-exempt bonds rated Baa or BBB or better by Moody's or Standard & Poor's, unrated bonds which, in the opinion of the investment adviser, have credit characteristics equivalent to bonds rated Baa or BBB or better, and certain temporary investments, including securities the interest income from which may be subject to Federal income tax. Tax-Free Reserves is a "money market" fund that includes in its portfolio only obligations maturing within one year from the date of acquisition, maintains an average maturity of all investments of 120 days or less, values its portfolio at amortized cost and seeks to maintain a net asset value of $1.00 per share. It provides checkwriting and expedited wire redemption privileges for its shareholders. Tax-Free Reserves has the objective of providing, through investment in a professionally managed portfolio of high quality short-term municipal obligations, as high a level of current interest income exempt from Federal income tax as is consistent with preservation of capital and the maintenance of liquidity. Tax- Free Reserves may include in its portfolio municipal obligations rated Aaa, Aa, MIG-1, VMIG-1 or Prime-1 by Moody's or AAA, AA, SP-1 or A-1 by Standard & Poor's, unrated municipal obligations that, in the opinion of the investment adviser, have credit characteristics equivalent to obligations rated as above, tax-exempt obligations backed by the U.S. Government, and temporary investments that may be subject to Federal income tax. The California Fund has the objective of providing, through investment in professionally managed portfolios of California municipal obligations, as high a level of current interest income exempt from both Federal and California income taxes as is consistent with the investment policies of each of the portfolios of the California Fund and with preservation of capital. Each portfolio of the California Fund may include temporary investments that may be subject to tax. California Unitholders may reinvest in one of three portfolios of the California Fund: The Nuveen California Tax-Free Value Fund, the Nuveen California Insured Tax-Free Value Fund and the Nuveen California Tax-Free Money Market Fund. The Nuveen California Tax-Free Value Fund invests primarily in long-term investment grade California tax-exempt bonds (I.E., bonds rated in the four highest categories by Moody's or Standard & Poor's or, if unrated, that have equivalent credit characteristics). The Nuveen California Insured Tax-Free Value Fund invests primarily in the same type of investments as the Special Bond Portfolio, each of which is covered by insurance guaranteeing the timely payment of principal and interest or is backed by a deposit of U.S. Government securities. The Nuveen California Tax-Free Money Market Fund invests primarily in high-quality short term California tax- exempt money market instruments (I.E., obligations rated in the two highest categories by Moody's or Standard & Poor's or, if unrated, that have equivalent credit characteristics). This portfolio will include only obligations maturing within one year from the date of acquisition, will maintain an average maturity of all investments of 120 days or less, will value its portfolio at amortized cost and will seek to maintain a net asset value of $1.00 per share. The Nuveen California Tax-Free Money Market Fund provides for an expedited wire redemption privilege. The Tax-Free Bond Fund consists of the Nuveen Massachusetts Tax-Free Value Fund, the Nuveen New York Tax-Free Value Fund, the Nuveen Ohio Tax-Free Value Fund, and the Nuveen New Jersey Tax-Free Value Fund, which are each available for reinvestment to Unitholders who are residents of the state for which such portfolio is named. The Tax-Free Bond Fund has the objective of providing, through investment in a professionally managed portfolio of municipal bonds, as high a level of current interest income exempt both from Federal income tax and from the income tax imposed by each portfolio's designated state as is consistent with preservation of capital. The Tax-Free Bond Fund may include in each of its portfolios tax-exempt bonds rated Baa or BBB or better; unrated bonds which, in the opinion of the investment adviser, have credit characteristics equivalent to bonds rated Baa or BBB or better; and certain temporary investments, including securities the interest income from which may be subject to Federal and state income tax. The Insured Bond Fund consists of the Nuveen Insured Municipal Bond Fund, the Nuveen Massachusetts Insured Tax-Free Value Fund and the Nuveen New York Insured Tax-Free Value Fund, which are each available for reinvestment to Unitholders. (The Massachusetts and New York Portfolios are available only to those Unitholders who are residents of the state for which the portfolio is named.) The Insured Bond Fund has the objective of providing, through investment in professionally managed portfolios of municipal bonds, as high a level of current interest income exempt from both Federal income tax and, in the case of designated state portfolios, from the income tax imposed by each portfolio's designated state, as is consistent with preservation of capital. The Insured Bond Fund may include in each of its portfolios the same type of investments as the Tax-Free Bond Fund, each of which is covered by insurance guaranteeing the timely payment of principal and interest or is backed by a deposit of U.S. Government securities. The Money Market Fund consists of the Nuveen Massachusetts Tax-Free Money Market Fund and the Nuveen New York Tax-Free Money Market Fund, which are each available for reinvestment to Unitholders who are residents of the state for which such portfolio is named. The Money Market Fund includes in its portfolios only obligations maturing within one year from the date of acquisition, maintains an average maturity of 120 days or less, values its portfolios at amortized cost and seeks to maintain a net asset value of $1.00 per share. The Money Market Fund has the objective of providing, through investment in professionally managed portfolios of high quality short-term municipal obligations, as high a level of current interest income exempt both from Federal income tax and from the income tax imposed by each portfolio's designated state as is consistent with stability of principal and the maintenance of liquidity. The Money Market Fund may include in each of its portfolios municipal obligations rated Aaa, Aa, MIG-1, MIG- 2, VMIG-1, VMIG-2, Prime 1 or Prime 2 by Moody's or AAA, AA, SP-1, SP-2, A-1 or A-2 by Standard & Poor's; unrated municipal obligations that, in the opinion of the investment adviser, have credit characteristics equivalent to obligations rated as above; and temporary investments that may be subject to Federal and state income tax. The Multistate Trust consists of the Nuveen Arizona Tax-Free Value Fund, the Nuveen Florida Tax-Free Value Fund, the Nuveen Maryland Tax-Free Value Fund, the Nuveen Michigan Tax-Free Value Fund, the Nuveen New Jersey Tax-Free Value Fund, the Nuveen Pennsylvania Tax-Free Value Fund and the Nuveen Virginia Tax Free Value Fund, which are each available for reinvestment to Unitholders who are residents of the state for which such portfolio is named. The Multistate Trust has the objective of providing, through investment in a professionally managed portfolio of municipal bonds, as high a level of current interest income exempt from both regular Federal income tax and the applicable state personal income tax as is consistent with preservation of capital. The Multistate Trust may include in each of its portfolios tax-exempt bonds rated "Baa" or "BBB" or better, unrated bonds which, in the opinion of the investment advisor, have credit characteristics equivalent to bonds rated "baa" or "BBB" or better, limited to no more than 20% of the Multistate Trust's assets, and certain temporary investments that may be subject to Federal and state income tax. Each person who purchases Units of a Trust may become a participant in the Accumulation Plan and elect to have his or her distributions on Units of the Trust invested directly in shares of one of the Accumulation Funds. Reinvesting Unitholders may select any interest distribution plan. Thereafter, each distribution of interest income or principal on the participant's Units (principal only in the case of a Unitholder who has chosen to reinvest only principal distributions) will, on the applicable distribution date, or the next day on which the New York Stock Exchange is normally open ("business day") if the distribution date is not a business day, automatically be received by Shareholder Services, Inc., transfer agent for each of the Accumulation Funds, on behalf of such participant and applied on that date to purchase shares (or fractions thereof) of the Accumulation Fund chosen at net asset value as computed as of 4:00 p.m. eastern time on each such date. All distributions will be reinvested in the Accumulation Fund chosen and no part thereof will be retained in a separate account. These purchases will be made without a sales charge. John Nuveen & Co. Incorporated, the Sponsor and Underwriter, was founded in 1898 and is the oldest and largest investment banking firm specializing in the underwriting and distribution of tax-exempt securities and maintains the largest research department in the investment banking community devoted exclusively to the analysis of municipal securities. In 1961 the Sponsor began sponsoring the Nuveen Tax-Free Unit Trust and, since this time, it has issued more than $30 billion in tax-exempt unit trusts, including over $8 billion in insured trusts. The Sponsor is also principal underwriter of the Nuveen Municipal Bond Fund, Inc., the Nuveen Tax-Free Money Market Fund, Inc., Nuveen Tax-Free Reserves, Inc., Nuveen California Tax-Free Fund, Inc., Nuveen Tax-Free Bond Fund, Inc., Nuveen Insured Tax-Free Bond Fund, Inc. and Nuveen Tax-Exempt Money Market Fund, Inc., all registered open-end management investment companies, and acted as co-managing underwriter of Nuveen Municipal Value Fund, Inc., Nuveen California Municipal Value Fund, Inc., Nuveen New York Municipal Value Fund, Inc., Nuveen Municipal Income Fund, Inc., Nuveen California Municipal Income Fund, Inc., Nuveen New York Municipal Income Fund, Inc., Nuveen Premium Income Municipal Fund, Inc., Nuveen Performance Plus Municipal Fund, Inc., Nuveen California Performance Plus Municipal Fund, Inc., Nuveen New York Performance Plus Municipal Fund, Inc., Nuveen Municipal Advantage Fund, Inc., Nuveen Municipal Market Opportunity Fund, Inc., Nuveen California Municipal Market Opportunity Fund, Inc., Nuveen New York Municipal Market Opportunity Fund, Inc., Nuveen Investment Quality Municipal Fund, Inc., Nuveen California Investment Quality Municipal Fund, Inc., Nuveen New York Investment Quality Municipal Fund, Inc., Nuveen Insured Quality Municipal Fund, Inc., Nuveen Florida Investment Quality Municipal Fund, Nuveen Pennsylvania Investment Quality Municipal Fund, Nuveen New Jersey Investment Quality Municipal Fund, Inc., and the Nuveen Select Quality Municipal Fund, Inc., Nuveen California Quality Municipal Fund, Inc., Nuveen New York Select Quality Municipal Fund, Inc., Nuveen Quality Income Municipal Fund, Inc., Nuveen Insured Municipal Opportunity Fund, Inc., Nuveen Florida Quality Income Municipal Fund, Nuveen Michigan Quality Income Municipal Fund, Inc., Nuveen New Jersey Quality Income Municipal Fund, Inc., Nuveen Ohio Quality Income Municipal Fund, Inc., Nuveen Pennsylvania Quality Income Municipal Fund, Nuveen Texas Quality Income Municipal Fund, Nuveen California Quality Income Municipal Fund, Inc., Nuveen New York Quality Income Municipal Fund, Inc., Nuveen Premier Insured Municipal Income Fund, Inc., Nuveen Select Tax Free Income Portfolio, Nuveen Select Tax Free Income Portfolio 2, Nuveen Insured California Select Tax-Free Income Portfolio, Nuveen Insured New York Select Tax-Free Income Portfolio, Nuveen Premium Income Municipal Fund 2, Inc., Nuveen Select Tax Free Income Portfolio 3, Nuveen Select Maturities Municipal Fund, Nuveen Insured California Premium Income Municipal Fund, Inc., Nuveen Arizona Premium Income Municipal Fund, Inc., Nuveen Insured Premium Income Municipal Fund, Inc., Nuveen Insured Florida Premium Income Municipal Fund, Nuveen Michigan Premium Income Municipal Fund, Inc., Nuveen New Jersey Premium Income Municipal Fund, Inc., Nuveen Insured New York Premium Income Municipal Fund, Inc., Nuveen Ohio Premium Income Municipal Fund, Inc., Nuveen Pennsylvania Premium Income Municipal Fund, Nuveen Texas Premium Income Municipal Fund, Nuveen Premium Income Municipal Fund 4, Inc., Nuveen Pennsylvania Premium Income Municipal Fund 2, Nuveen Insured Florida Premium Income Municipal Fund 2, Nuveen Maryland Premium Income Municipal Fund, Nuveen Virginia Premium Income Municipal Fund, Nuveen Massachusetts Premium Income Municipal Fund, Nuveen Insured California Premium Income Municipal Fund 2, Inc., Nuveen Insured New York Premium Income Municipal Fund 2, Nuveen New Jersey Premium Income Municipal Fund 2, Nuveen Washington Premium Income Municipal Fund, Nuveen Michigan Premium Income Municipal Fund 2, Nuveen Georgia Premium Income Municipal Fund, Nuveen Missouri Premium Income Municipal Fund, Nuveen Connecticut Premium Income Municipal Fund, Nuveen North Carolina Premium Income Municipal Fund, Nuveen New Jersey Premium Income Municipal Fund 3, Nuveen Florida Premium Income Municipal Fund, Nuveen New York Premium Income Municipal Fund, Nuveen California Premium Income Municipal Fund, Nuveen Pennsylvania Premium Income Municipal Fund 3, Nuveen Maryland Income Municipal Fund 2, Nuveen Virginia Premium Income Municipal Fund 2, Nuveen Ohio Premium Income Municipal Fund 2, Nuveen Insured Premium Income Municipal Fund 2, Nuveen California Premium Income Municipal Fund 2, all registered closed-end management investment companies. These registered open-end and closed-end investment companies currently have approximately $32.8 billion in tax-exempt securities under management. Nationwide, more than 1,000,000 individual investors have purchased Nuveen's tax exempt trusts and funds. The present corporation was organized in 1967 as a wholly-owned Corporation, successor to the original John Nuveen & Co. founded in 1898 as a sole proprietorship and incorporated in 1953. In 1974, John Nuveen & Co. Incorporated became a wholly-owned subsidiary of The St. Paul Companies, Inc., a financial services management company located in St. Paul, Minnesota. On May 19, 1992, common shares comprising a minority interest in The John Nuveen Company ("JNC"), a newly organized corporation which holds all of the shares of Nuveen, were sold to the general public in an initial public offering. St. Paul retains a controlling interest in JNC with over 70% of JNC's shares. The Sponsor is a member of the National Association of Securities Dealers, Inc. and the Securities Industry Association and has its principal offices located in Chicago (333 W. Wacker Drive) and New York (Swiss Bank Tower, 10 East 50th Street). It maintains 14 regional offices. To help advisers and investors better understand and more efficiently use an investment in the Trust to reach their investment goals, the Trust's sponsor, John Nuveen & Co. Incorporated, may advertise and create specific investment programs and systems. For example, such activities may include presenting information on how to use an investment in the Trust, alone or in combination with an investment in other mutual funds or unit investment trusts sponsored by Nuveen, to accumulate assets for future education needs or periodic payments such as insurance premiums. The Trust's sponsor may produce software or additional sales literature to promote the advantages of using the Trust to meet these and other specific investor needs. STANDARD & POOR'S CORPORATION. A description of the applicable Standard & Poor's Corporation rating symbols and their meanings follows: A Standard & Poor's rating is a current assessment of the creditworthiness of an obligor with respect to a specific debt obligation. This assessment may take into consideration obligors such as guarantors, insurers or lessees. The rating is not a recommendation to purchase, sell or hold a security, inasmuch as it does not comment as to market price or suitability for a particular investor. The ratings are based on current information furnished by the issuer or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any rating and may, on occasion, rely on unaudited financial information. The ratings may be changed, suspended or withdrawn as a result of changes in, or unavailability of, such information, or for other circumstances. The ratings are based, in varying degrees, on the following considerations: I. Likelihood of default--capacity and willingness of the obligor as to the timely payment of interest and repayment of principal in accordance with the terms of the obligation; II. Nature of and provisions of the obligation; III. Protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization or other arrangements under the laws of bankruptcy and other laws affecting creditors' rights. AAA--This is the highest rating assigned by Standard & Poor's to a debt obligation. Capacity to pay interest and repay principal is extremely strong. AA--Bonds rated AA have a very strong capacity to pay interest and repay principal, and differ from the highest rated issues only in small degree. A--Bonds rated A have a strong capacity to pay interest and repay principal, although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than bonds in higher rated categories. BBB--Bonds rated BBB are regarded as having an adequate capacity to pay interest and repay principal. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for bonds in this category than for bonds in the higher rated categories. PLUS (+) OR MINUS (-): The ratings from "AA" to "BB" may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. PROVISIONAL RATINGS: The letter "p" indicates that the rating is provisional. A provisional rating assumes the successful completion of the project being financed by the issuance of the bonds being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful and timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, As published by the rating companies. makes no comment on the likelihood of, or the risk of default upon failure of, such completion. Accordingly, the investor should exercise his own judgment with respect to such likelihood and risk. NOTE RATINGS: A Standard & Poor's note rating reflects the liquidity concerns and market access risks unique to notes. Notes due in 3 years or less will likely receive a note rating. Notes maturing beyond 3 years will most likely receive a long-term debt rating. Note rating symbols are as follows: SP-1 Very strong or strong capacity to pay principal and interest. Those issues determined to possess overwhelming safety characteristics will be given a plus (+) designation. SP-2 Satisfactory capacity to pay principal and interest. RATINGS OF INSURED TRUST UNITS A Standard & Poor's rating on the units of an insured investment trust (hereinafter referred to collectively as "units" and "trusts") is a current assessment of creditworthiness with respect to the investment held by such trust. This assessment takes into consideration the financial capacity of the issuers and of any guarantors, insurers, lessees or mortgagors with respect to such investments. The assessment, however, does not take into account the extent to which trust expenses or portfolio asset sales for less than the trust purchase price will reduce payment to the unitholder of the interest and principal required to be paid on the portfolio assets. In addition, the rating is not a recommendation to purchase, sell or hold units, inasmuch as the rating does not comment as to market price of the units or suitability for a particular investor. Units rated "AAA" are composed exclusively of assets that are rated "AAA" by Standard & Poor's and/or certain short-term investments. Standard & Poor's defines its AAA rating for such assets as the highest rating assigned by Standard & Poor's to a debt obligation. Capacity to pay interest and repay principal is very strong. However, unit ratings may be subject to revision or withdrawal at any time by Standard & Poor's and each rating should be evaluated independently of any other rating. MOODY'S INVESTORS SERVICE, INC. A brief description of the applicable Moody's Investors Service, Inc. rating symbols and their meanings follows: Aaa--Bonds which are rated Aaa are judged to be the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Their safety is so absolute that, with the occasional exception of oversupply in a few specific instances, characteristically, their market value is affected solely by money market fluctuations. Aa--Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuations of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in Aaa securities. Their market value is virtually immune to all but money market influences, with the occasional exception of oversupply in a few specific instances. A--Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. The market value of A-rated bonds may be influenced to some degree by economic performance during a sustained period of depressed business conditions, but, during periods of normalcy, A-rated bonds frequently move in parallel with Aaa and Aa obligations, with the occasional exception of oversupply in a few specific instances. Moody's bond rating symbols may contain numerical modifiers of a generic rating classification. The modifier 1 indicates that the bond ranks at the high end of its category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the issue ranks in the lower end of its generic rating category. Baa--Bonds which are rated Baa are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. The market value of Baa-rated bonds is more sensitive to changes in economic circumstances, and aside from occasional speculative factors applying to some bonds of this class, Baa market valuations move in parallel with Aaa, Aa and A obligations during periods of economic normalcy, except in instances of oversupply. Con. (--)--Bonds for which the security depends upon the completion of some act or the fulfillment of some condition are rated conditionally. These are bonds secured by (a) earnings of projects under construction, (b) earnings of projects unseasoned in operation experience, (c) rentals which begin when (d) payments to which some other limiting condition attaches. Parenthetical rating denotes probable credit stature upon completion of construction or elimination of basis of condition. MIG 1-- This designation denotes best quality. There is present strong protection by established cash flows, superior liquidity support or demonstrated broad-based access to the market for refinancing. MIG 2-- This designation denotes high quality. Margins of protection are ample although not so large as in the preceding group. HOW THE TRUST COMPARES PERFORMANCE The Sponsor may compare the estimated returns of the Trust with the returns or yields of other tax-free and taxable investments, often on a taxable equivalent basis. In addition, the Sponsor from time to time may quote various performance measures and studies in order to compare the historical returns available from an investment in municipal securities with investments in both tax-free and taxable securities. In September 1995, Nuveen Research prepared one such study which compared the after-tax value of $100,000 initially invested in 1975 in various asset classes including municipal bonds, treasury bonds and corporate bonds. As indicated in the chart provided below, the 20-year study shows that municipal bonds significantly outperformed corporate and treasury bonds once the effects of taxes were factored in. In fact, over the 20-year period, municipal bond returns in dollars were more than double those of treasury bonds. AFTER-TAX VALUE OF $100,000 INVESTED IN 1975 The graph appearing on this page of the Information Supplement compares after-tax total returns of $100,000 initially in 1975 in each of the Lehman Brothers MuniBond Index, Long-Term Treasury Index and Long-Term Corporate Index. As indicated in the graph, such an investment in the Lehman Brothers MuniBond Index, Long-Term Treasury Index and Long-Term Corporate Index would have appreciated to $448,740, $267,668, and $304,049, respectively at the end of 1994. The graph assumes all proceeds of investment are reinvested at the respective index rates at the time of reinvestment and also assumes that 20% of the assets in each category are turned over annually and proceeds are reinvested in the respective indexes. The tax rates assumed to generate the after-tax total returns were based upon the income and capital gain rates applicable each year from 1975-1994 for an investor who earned the inflation-adjusted equivalents of $400,000 in 1994. In addition, treasury returns were "grossed up" an assumed 5% to take into account the Treasuries' exemption from state income tax. The graph is for illustrative purposes only, and does not represent the return or performance of any Nuveen Tax-Free Unit Trust and is not intended to predict future results. * The graph compares after-tax total returns using the Lehman Brothers MuniBond Index, Long-Term Treasury Index and Long-Term Corporate Index. The graph assumes all proceeds of investment are reinvested at the respective index rates at the time of reinvestment and also assumes that 20% of the assets in each category are turned over annually and proceeds are reinvested in the respective indexes. The tax rates assumed to generate the after-tax total returns were based upon the income and capital gain rates applicable each year from 1975-1994 for an investor who earned the inflation-adjusted equivalents of $400,000 in 1994. In addition, treasury returns were "grossed up" an assumed 5% to take into account the Treasuries' exemption from state income tax. The graph is for illustrative purposes only, and does not represent the return or performance of any Nuveen Tax-Free Unit Trust and is not intended to predict future results. A comparison of the estimated returns of the Trust and the historic performance of municipal bonds to the returns and performance of other investments is one element to consider in making an informed investment decision. Taxable investments have investment characteristics that differ from those of the Trust. U.S. Government bonds are long-term investments backed by the full faith and credit of the U.S. Government and are subject to federal income tax but are exempt from state income taxes. Bank CDs are generally short-term FDIC insured investments, which pay fixed principal and interest but are subject to fluctuating rollover rates. Both bank CDs and corporate bonds are generally subject to both federal and state income taxes. Money market funds are short term investment with stable net asset values, fluctuating yields and special features that enhance liquidity. HOW TO CALCULATE YOUR ESTIMATED INCOME The examples provided below illustrate how to calculate the estimated annual income generated by a hypothetical $10,000 investment in each respective Trust. The illustrations assume that the investment was made on the day prior to the date of deposit by an investor electing the monthly distribution plan. These examples are for illustrative purposes only and not intended to reflect or predict the results of any actual investment. As described above, except to the extent the Fund invests in temporary investments, the Fund will invest substantially all of its assets in California Municipal Obligations. The Fund is therefore susceptible to political, economic or regulatory factors affecting issuers of California Municipal Obligations. These include the possible adverse effects of certain California constitutional amendments, legislative measures, voter initiatives and other matters that are described below. The following information provides only a brief summary of the complex factors affecting the financial situation in California (the "State") and is derived from sources that are generally available to investors and are believed to be accurate. No independent verification has been made of the accuracy or completeness of any of the following information. It is based in part on information obtained from various State and local agencies in California or contained in Official Statements for various California Municipal Obligations. There can be no assurance that future statewide or regional economic difficulties, and the resulting impact on State or local governmental finances generally, will not adversely affect the market value of California Municipal Obligations held in the portfolio of the Fund or the ability of particular obligors to make timely payments of debt service on (or relating to) those obligations. California's economy is the largest among the 50 states and one of the largest in the world. The State's population of almost 32 million represents 12.3% of the total United States population and grew by 27% in the 1980s. While the State's substantial population growth during the 1980s stimulated local economic growth and diversification and sustained a real estate boom between 1984 and 1990, it has increased strains on the State's limited water resources and its infrastructure. Resultant traffic congestion, school overcrowding and high housing costs have increased demands for government services and may impede future economic growth. Population growth has slowed between 1991 and 1993 even while substantial immigration has continued, due to a significant increase in outmigration by California residents. Generally, the household incomes of new residents have been substantially lower (and their education and social service utilization higher) than those of departing households, which may have a major long-term socioeconomic and fiscal impact. However, with the California economy improving, the recent net outmigration within the Continental U.S. is expected to decrease or be reversed. From mid-1990 to late 1993, the State's economy suffered its worst recession since the 1930s, with recovery starting later than for the nation as a whole. The State has experienced the worst job losses of any post-war recession. Prerecession job levels may not be realized until near the end of the decade. The largest job losses have been in Southern California, led by declines in the aerospace and construction industries. Weakness statewide occurred in manufacturing, construction, services and trade. Additional military base closures will have further adverse effects on the State's economy later in the decade. Since the start of 1994, the California economy has shown signs of steady recovery and growth. The State Department of Finance reports net job growth, particularly in construction and related manufacturing, wholesale and retail trade, transportation, recreation and services. This growth has offset the continuing but slowing job losses in the aerospace industry and restructuring of the finance and utility sectors. Unemployment in the State was down substantially in 1994 from its 10% peak in January, 1994, but still remains higher than the national average rate. Retail sales were up strongly in 1994 from year-earlier figures. Delay or slowdown in recovery will adversely affect State revenues. CONSTITUTIONAL LIMITATIONS ON TAXES AND APPROPRIATIONS LIMITATION ON TAXES. Certain California municipal obligations may be obligations of issuers which rely in whole or in part, directly or indirectly, on AD VALOREM property taxes as a source of revenue. The taxing powers of California local governments and districts are limited by Article XIIIA of the California Constitution, enacted by the voters in 1978 and commonly known as "Proposition 13." Briefly, Article XIIIA limits to 1% of full cash value the rate of AD VALOREM property taxes on real property and generally restricts the reassessment of property to the rate of inflation, not to exceed 2% per year, or decline in value, or in the case of new construction or change of ownership (subject to a number of exemptions). Taxing entities may, however, raise AD VALOREM taxes above the 1% limit to pay debt service on voter-approved bonded indebtedness. Under Article XIIIA, the basic 1% AD VALOREM tax levy is applied against the assessed value of property as of the owner's date of acquisition (or as of March 1, 1975, if acquired earlier), subject to certain adjustments. This system has resulted in widely varying amounts of tax on similarly situated properties. filed challenging the acquisition-based assessment system of Proposition 13 and on June 18, 1992 the U.S. Supreme Court announced a decision upholding Proposition 13. Article XIIIA prohibits local governments from raising revenues through AD VALOREM property taxes above the 1% limit; it also requires voters of any governmental unit to give two-thirds approval to levy any "special tax." Court decisions, however, allowed non-voter approved levy of "general taxes" which were not dedicated to a specific use. In response to these decisions, the voters of the State in 1986 adopted an initiative statute which imposed significant new limits on the ability of local entities to raise or levy general taxes, except by receiving majority local voter approval. Significant elements of this initiative, "Proposition 62," have been overturned in recent court cases. An initiative proposed to re-enact the provisions of Proposition 62 as a constitutional amendment was defeated by the voters in November 1990, but such a proposal may be renewed in the future. APPROPRIATIONS LIMITS. California and its local governments are subject to an annual "appropriations limit" imposed by Article XIIIB of the California Constitution, enacted by the voters in 1979 and significantly amended by Propositions 98 and 111 in 1988 and 1990, respectively. Article XIIIB prohibits the State or any covered local government from spending "appropriations subject to limitation" in excess of the appropriations limit imposed. "Appropriations subject to limitation" are authorizations to spend "proceeds of taxes," which consists of tax revenues and certain other funds, including proceeds from regulatory licenses, user charges or other fees, to the extent that such proceeds exceed the cost of providing the product or service, but "proceeds of taxes" excludes most State subventions to local governments. No limit is imposed on appropriations of funds which are not "proceeds of taxes," such as reasonable user charges or fees, and certain other non-tax funds, including bond proceeds. Among the expenditures not included in the Article XIIIB appropriations limit are (1) the debt service cost of bonds issued or authorized prior to January 1, 1979, or subsequently authorized by the voters, (2) appropriations arising from certain emergencies declared by the Governor, (3) appropriations for qualified capital outlay projects, (4) appropriations by the State of post-1989 increases in gasoline taxes and vehicle weight fees, and (5) appropriations made in certain cases of emergency. The appropriations limit for each year is adjusted annually to reflect changes in cost of living and population, and any transfers of service responsibilities between government units. The definitions for such adjustments were liberalized in 1990 to follow more closely growth in California's economy. "Excess" revenues are now measured over a two-year cycle. With respect to local governments, excess revenues must be returned by a revision of tax rates or fee schedules within the two subsequent fiscal years. The appropriations limit for a local government may be overridden by referendum under certain conditions for up to four years at a time. With respect to the State, 50% of any excess revenues is to be distributed to K-12 school districts and community college districts (collectively, "K-14 districts") and the other 50% is to be refunded to taxpayers. With more liberal annual adjustment factors since 1988, and depressed revenues since 1990 because of the recession, few governments, including the State, are currently operating near their spending limits, but this condition may change over time. Local governments may by voter approval exceed their spending limits for up to four years. Because of the complex nature of Articles XIIIA and XIIIB of the California Constitution, the ambiguities and possible inconsistencies in their terms, and the impossibility of predicting future appropriations or changes in population and cost of living, and the probability of continuing legal challenges, it is not currently possible to determine fully the impact of Article XIIIA or Article XIIIB on California Municipal Obligations or on the ability of California or local governments to pay debt service on such California Municipal Obligations. It is not presently possible to predict the outcome of any pending litigation with respect to the ultimate scope, impact or constitutionality of either Article XIIIA or Article XIIIB, or the impact of any such determinations upon State agencies or local governments, or upon their ability to pay debt service on their obligations. Future initiatives or legislative changes in laws or the California Constitution may also affect the ability of the State or local issuers to repay their obligations. OBLIGATIONS OF THE STATE OF CALIFORNIA. Under the California Constitution, debt service on outstanding general obligation bonds is the second charge to the General Fund after support of the public school system and public institutions of higher education. Total outstanding general obligation bond and lease purchase debt of the State increased from $9.4 billion at June 30, 1987 to $23.5 billion at June 30, 1994. In FY1993-94, debt service on general obligation bonds and lease purchase debt was approximately 5.2% of General Fund revenues. RECENT FINANCIAL RESULTS. The principal sources of General Fund revenues in 1992-93 were the California personal income tax (44% of total revenues), the sales tax (38%), bank and corporation taxes (12%), and the gross premium tax on insurance (3%). California maintains a Special Fund for Economic Uncertainties (the "Economic Uncertainties Fund"), derived from General Fund revenues, as a reserve to meet cash needs of the General Fund. GENERAL. Throughout the 1980's, State spending increased rapidly as the State population and economy also grew rapidly, including increased spending for many assistance programs to local governments, which were constrained by Proposition 13 and other laws. The largest State program is assistance to local public school districts. In 1988, an initiative (Proposition 98) was enacted which (subject to suspension by a two-thirds vote of the Legislature and the Governor) guarantees local school districts and community college districts a minimum share of State General Fund revenues (currently about 33%). Since the start of 1990-91 Fiscal Year, the State has faced adverse economic, fiscal, and budget conditions. The economic recession seriously affected State tax revenues. It also caused increased expenditures for health and welfare programs. The State is also facing a structural imbalance in its budget with the largest programs supported by the General Fund (education, health, welfare and corrections) growing at rates higher than the growth rates for the principal revenue sources of the General Fund. These structured concerns will be exacerbated in coming years by the expected need to substantially increase capital and operating funds for corrections as a result of a "Three Strikes" law enacted in 1994. As a result, the State entered a period of budget imbalance, with expenditures exceeding revenues for four of the five fiscal years ending in 1991-92; revenues and expenditures were about equal in 1992-93. By June 30, 1993, the State's General Fund had an accumulated deficit, on a budget basis, of approximately $2.8 billion. RECENT BUDGETS. The state failed to enact its 1992-93 budget by July 1, 1992. Although the State had no legal authority to pay many of its vendors, certain obligations (such as debt service, school apportionments, welfare payments, and employee salaries) were payable because of continuing or special appropriations, or court orders. However, the State Controller did not have enough cash to pay as they came due all of these ongoing obligations, as well as valid obligations incurred in the prior fiscal year. Starting on July 1, 1992, the Controller was required to issue "registered warrants" in lieu of normal warrants backed by cash to pay many State obligations. Available cash was used to pay constitutionally mandated and priority obligations. Between July 1 and September 3, 1992, the Controller issued an aggregate of approximately $3.8 billion of registered warrants all of which were called for redemption by September 4, 1992 following enactment of the 1992-93 Budget Act and issuance by the State of short-term notes. The 1992-93 Budget Act, when finally adopted, was projected to eliminate the State's accumulated deficit, with additional expenditure cuts and a $1.3 billion transfer of State education funding costs to local governments by shifting local property taxes to school districts. However, as the recession continued longer and deeper than expected, revenues once again were far below projections, and only reached a level just equal to the amount of expenditures. Thus, the State continued to carry its $2.8 billion budget deficit at June 30, 1993. The 1993-94 Budget Act represented a third consecutive year of difficult budget choices. As in the prior year, the budget contained no general state tax increases, and relied principally on expenditure cuts, particularly for health and welfare and higher education, a two-year suspension of the renters' tax credit, some one-time and accounting adjustments, and -- the largest component -- an additional $2.6 billion transfer of property taxes from local government, particularly counties, to school districts to reduce State education funding requirements. A temporary state sales tax scheduled to expire on June 30, 1993 was extended for six months, and dedicated to support local government public safety costs. A major feature of the budget was a two-year plan to eliminate the accumulated deficit by borrowing into the 1994-95 fiscal year. With the recession still continuing longer than expected, the General Fund had $800 million less revenue and $800 million higher expenditures than budgeted. As a result revenues only exceed expenditures by about $500 million. However, this was the first operating surplus in four years and reduced the accumulated deficit to $2.0 billion at June 30, 1994 (after taking account of certain other accounting reserves). CURRENT BUDGET. The 1994-95 Budget Act was passed on July 8, 1994, and provides for an estimated $41.9 billion of General Fund revenues, and $40.9 billion of expenditures. The budget assumed receipt of about $750 million of new federal assistance for the costs of incarceration, education, health and welfare related to undocumented immigrants. Other major components of the budget include further reductions in health and welfare costs and miscellaneous government costs, some additional transfers of funds from local government, and a plan to defer retirement of $1 billion of the accumulated budget deficit to the 1995-96 fiscal year. The federal government has apparently budgeted only $33 million of the expected immigration aid. However, this shortfall is expected to be almost fully offset by higher than projected revenues, and lower than projected caseload growth, as the economy improves. The State issued $7.0 billion of short-term debt in July, 1994 to meet its cash flow needs and to finance the deferral of part of the accumulated budget deficit to the 1995-96 fiscal year. In order to assure repayment of the $4 billion, 22-month part of this borrowing, the State enacted legislation (the "Trigger Law") which can lead to automatic, across-the-board cuts in General Fund expenditures in either the 1994-95 or 1995-96 fiscal years if cash flow projections made at certain times during those years show deterioration from the projections made in July 1994 when the borrowings were made. On November 15, 1994, the State Controller as part of the Trigger Law reported that the cash position of the General Fund on June 30, 1995 would be about $580 million better than earlier projected, so no automatic budget adjustments were required in 1994-95. The Controller's report showed that loss of federal funds was offset by higher revenues, lower expenditures, and certain other increases in cash resources. PROPOSED 1995-96 BUDGET. On January 10, 1995, the Governor presented his proposed FY 1995-96 Budget. This budget projects total General Fund revenues and transfers of $42.5 billion, and expenditures of $41.7 billion, to complete the elimination of the accumulated deficits from earlier years. However, this proposal leaves no cushion, as the projected budget reserve at June 30, 1996 would be only about $92 million. While proposing increases in funding for schools, universities and corrections, the Governor proposes further cuts in welfare programs, and a continuation of the "realignment" of functions with counties which would save the State about $240 million. The Governor also expects about $800 million in new federal aid for the State's costs of incarcerating and educating illegal immigrants. The Budget proposal also does not account for possible additional costs if the State loses its appeals on lawsuits which are currently pending concerning such matters as school funding and pension payments, but these appeals could take several years to resolve. Part of the Governor's proposal also is a 15% cut in personal income and corporate taxes, to be phased in over three years, starting with calendar year 1996 (which would have only a small impact on 1995-96 income). The State's difficult financial condition for the current and upcoming budget years will result in continued pressure upon almost all local governments, particularly school districts and counties which depend on State aid. Despite efforts in recent years to increase taxes and reduce governmental expenditures, there can be no assurance that the State will not face budget gaps in the future. BOND RATING. State general obligation bonds ratings were reduced in July, 1994 to "A1" by Moody's and "A" by S&P. Both of these ratings were reduced from "AAA" levels which the State held until late 1991. There can be no assurance that such ratings will be maintained in the future. It should be noted that the creditworthiness of obligations issued by local California issuers may be unrelated to the creditworthiness of obligations issued by the State of California, and that there is no obligation on the part of the State to make payment on such local obligations in the event of default. LEGAL PROCEEDINGS. The State is involved in certain legal proceedings (described in the State's recent financial statements) that, if decided against the State, may require the State to make significant future expenditures or may substantially impair revenues. Trial courts have recently entered tentative decisions or injunctions which would overturn several parts of the state's recent budget compromises. The matters covered by these lawsuits include a deferral of payments by the State to the Public Employees Retirement System, reductions in welfare payments, and the use of certain cigarette tax funds for health costs. All of these cases are subject to further proceedings and appeals, and if the State eventually loses, the final remedies may not have to be implemented in one year. OTHER ISSUERS OF CALIFORNIA MUNICIPAL OBLIGATIONS. There are a number of state agencies, instrumentalities and political subdivisions of the State that issue Municipal Obligations, some of which may be conduit revenue obligations payable from payments from private borrowers. These entities are subject to various economic risks and uncertainties, and the credit quality of the securities issued by them may vary considerably from the credit quality of the obligations backed by the full faith and credit of the State. STATE ASSISTANCE. Property tax revenues received by local governments declined more than 50% following passage of Proposition 13. Subsequently, the California Legislature enacted measures to provide for the redistribution of the State's General Fund surplus to local agencies, the reallocation of certain State revenues to local agencies and the assumption of certain governmental functions by the State to assist municipal issuers to raise revenues. Through 1990-91, local assistance (including public schools) accounted for approximately 75% of General Fund spending. To reduce State General Fund support for school districts, the 1992-93 and 1993-94 Budget Acts caused local governments to transfer $3.9 billion of property tax revenues to school districts, representing loss of all of the post-Proposition 13 "bailout" aid. The largest share of these transfers came from counties, and the balance from cities, special districts and redevelopment agencies. In order to make up this shortfall, the Legislature proposed and voters approved in 1993 dedicating 0.5% of the sales tax to cities for public safety purposes. In addition, the Legislature has changed laws to relieve local governments of certain mandates, allowing them to reduce costs. To the extent the State should be constrained by its Article XIIIB appropriations limit, or its obligation to conform to Proposition 98, or other fiscal considerations, the absolute level, or the rate of growth, of State assistance to local governments may be reduced. Any such reductions in State aid could compound the serious fiscal constraints already experienced by many local governments, particularly counties. At least one rural county (Butte) publicly announced that it might enter bankruptcy proceedings in August 1990, although such plans were put off after the Governor approved legislation to provide additional funds for the county. Other counties have also indicated that their budgetary condition is extremely grave. The Richmond Unified School District (Contra Costa County) entered bankruptcy proceedings in May 1991 but the proceedings have been dismissed. ASSESSMENT BONDS. California Municipal Obligations which are assessment bonds may be adversely affected by a general decline in real estate values or a slowdown in real estate sales activity. In many cases, such bonds are secured by land which is undeveloped at the time of issuance but anticipated to be developed within a few years after issuance. In the event of such reduction or slowdown, such development may not occur or may be delayed, thereby increasing the risk of a default on the bonds. Because the special assessments or taxes securing these bonds are not the personal liability of the owners of the property assessed, the lien on the property is the only security for the bonds. Moreover, in most cases the issuer of these bonds is not required to make payments on the bonds in the event of delinquency in the payment of assessments or taxes, except from amounts, if any, in a reserve fund established for the bonds. CALIFORNIA LONG-TERM LEASE OBLIGATIONS. Certain California long-term lease obligations, though typically payable from the general fund of the municipality, are subject to "abatement" in the event the facility being leased is unavailable for beneficial use and occupancy by the municipality during the term of the lease. Abatement is not a default, and there may be no remedies available to the holders of the certificates evidencing the lease obligation in the event abatement occurs. The most common cases of abatement are failure to complete construction of the facility before the end of the period during which lease payments have been capitalized and uninsured casualty losses to the facility (E.G., due to earthquake). In the event abatement occurs with respect to a lease obligation, lease payments may be interrupted (if all available insurance proceeds and reserves are exhausted) and the certificates may not be paid when due. Several years ago the Richmond Unified School District (the "District") entered into a lease transaction in which certain existing properties of the District were sold and leased back in order to obtain funds to cover operating deficits. Following a fiscal crisis in which the District's finances were taken over by a State receiver (including a brief period under bankruptcy court protection), the District failed to make rental payments on this lease, resulting in a lawsuit by the Trustee for the Certificate of Participation holders, in which the State was a named defendant (on the grounds that it controlled the District's finances). One of the defenses raised in answer to this lawsuit was the invalidity of the District's lease. The trial court has upheld the validity of the lease and the case has been settled. Any ultimate judgment in any future case against the position asserted by the Trustee in the Richmond case may have adverse implications for lease transactions of a similar nature by other California entities. OTHER CONSIDERATIONS. The repayment of industrial development securities secured by real property may be affected by California laws limiting foreclosure rights of creditors. Securities backed by health care and hospital revenues may be affected by changes in State regulations governing cost reimbursements to health care providers under Medi-Cal (the State's Medicaid program), including risks related to the policy of awarding exclusive contracts to certain hospitals. Limitations on AD VALOREM property taxes may particularly affect "tax allocation" bonds issued by California redevelopment agencies. Such bonds are secured solely by the increase in assessed valuation of a redevelopment project area after the start of redevelopment activity. In the event that assessed values in the redevelopment project decline (E.G., because of a major natural disaster such as an earthquake), the tax increment revenue may be insufficient to make principal and interest payments on these bonds. Both Moody's and S&P suspended ratings on California tax allocation bonds after the enactment of Articles XIIIA and XIIIB, and only resumed such ratings on a selective basis. Proposition 87, approved by California voters in 1988, requires that all revenues produced by a tax rate increase go directly to the taxing entity which increased such tax rate to repay that entity's general obligation indebtedness. As a result, redevelopment agencies (which, typically, are the issuers of tax allocation securities) no longer receive an increase in tax increment when taxes on property in the project area are increased to repay voter-approved bonded indebtedness. The effect of these various constitutional and statutory changes upon the ability of California municipal securities issuers to pay interest and principal on their obligations remains unclear. Furthermore, other measures affecting the taxing or spending authority of California or its political subdivisions may be approved or enacted in the future. Legislation has been or may be introduced which would modify existing taxes or other revenue-raising measures or which either would further limit or, alternatively, would increase the abilities of state and local governments to impose new taxes or increase existing taxes. It is not presently possible to predict the extent to which any such legislation will be enacted. Nor is it presently possible to determine the impact of any such legislation on California Municipal Obligations in which the Fund may invest, future allocations of state revenues to local governments or the abilities of state or local governments to pay the interest on, or repay the principal of, such California Municipal Obligations. Substantially all of California is within an active geologic region subject to major seismic activity. Northern California in 1989 and Southern California in 1994 experienced major earthquakes causing billions of dollars in damages. The federal government provided more than $13 billion in aid for both earthquakes, and neither event is expected to have any long-term negative economic impact. Any California Municipal Obligation in the California Traditional Trust could be affected by an interruption of revenues because of damaged facilities, or, consequently, income tax deductions for casualty losses or property tax assessment reductions. Compensatory financial assistance could be constrained by the inability of (i) an issuer to have obtained earthquake insurance coverage at reasonable rates; (ii) an insurer to perform on its contracts of insurance in the event of widespread losses; or (iii) the Federal or State government to appropriate sufficient funds within their respective budget limitations. On January 17, 1994, a major earthquake with an estimated magnitude of 6.8 on the Richter scale struck the Los Angeles area, causing significant property damage to public and private facilities, presently estimated at $15-20 billion. While over $9.5 billion of federal aid, and a projected $1.9 billion of State aid, plus insurance proceeds, will reimburse much of that loss, there will be some ultimate loss of wealth and income in the region, in addition to costs of the disruption caused by the event. Short-term economic projections are generally neutral, as the infusion of aid will restore billions of dollars to the local economy within a few months; already the local construction industry has picked up. Although the earthquake will hinder recovery from the recession in Southern California, already hard-hit, its long-term impact is not expected to be material in the context of the overall wealth of the region. Almost five years after the event, there are few remaining effects of the 1989 Loma Prieta earthquake in northern California (which, however, caused less severe damage than Northridge). On December 7, 1994, Orange County, California (the "County"), together with its pooled investment fund (the "Pooled Fund") filed for protection under Chapter 9 of the federal Bankruptcy Code, after reports that the Pooled Fund had suffered significant market losses in its investments caused a liquidity crisis for the Pooled Fund and the County. More than 180 other public entities, most but not all located in the County, were also depositors in the Pooled Fund. As of mid-January, 1995, the County estimated the Pooled Fund's loss at about $1.64 billion of its initial deposits of around $7.5 billion. The Pooled Fund has been almost completely restructured to reduce its exposure to changes in interest rates. Many of the entities which kept moneys in the Pooled Fund, including the County, are facing cash flow difficulties because of the bankruptcy filing and may be required to reduce programs or capital projects. The County and some of these entities have, and others may in the future, default in payment of their obligations. Moody's and Standard & Poor's have suspended, reduced to below investment grade levels, or placed on "Credit Watch" various securities of the County and the entities participating in the Pooled Fund. The State of California has no obligation with respect to any obligations or securities of the County or any of the other participating entities, although under existing legal precedents, the State may be obligated to ensure that school districts have sufficient funds to operate. CALIFORNIA TAXABLE ESTIMATED CURRENT RETURN TABLE The following tables show the approximate taxable estimated current returns for individuals that are equivalent to tax-exempt estimated current returns under combined Federal and state taxes, using published 1996 marginal Federal tax rates and marginal state tax rates currently available and scheduled to be in effect. The tables incorporate increased tax rates for higher-income taxpayers that were included in the Revenue Reconciliation Act of 1993. The table assumes that federal taxable income is equal to state income subject to tax, and for cases in which more than one state rate falls within a Federal bracket, the state rate corresponding to the highest income within that Federal bracket is used. The combined state and Federal tax brackets shown reflect the fact that state tax payments are currently deductible for Federal tax purposes. The table does not reflect any local taxes or any taxes other than personal income tax. The tables illustrate what you would have to earn on taxable investments to equal the tax-exempt estimated current return for your income tax bracket. A taxpayer's marginal tax rate is affected by both his taxable income and his adjusted gross income. Locate your adjusted gross and your taxable income (which is your adjusted gross income reduced by any deductions and exemptions), then locate your tax bracket based on joint or single tax filing. Read across to the equivalent taxable estimated current return you would need to match the tax-free income. COMBINED MARGINAL TAX RATES FOR JOINT TAXPAYERS WITH FOUR PERSONAL EXEMPTIONS COMBINED MARGINAL TAX RATES FOR SINGLE TAXPAYERS WITH ONE PERSONAL EXEMPTION	S-6EL24	S-6EL24	1996-01-12T00:00:00	1996-01-12T15:54:26
0000891836-96-000005	0000891836-96-000005_0001.txt	Thomas M. Daly, Jr. Nigel D. Muir Investor Relations Roy Winnick Praxair, Inc. Scott S. Cunningham Kekst and Company 203-837-2240 Praxair, Inc. PRAXAIR COMPLETES TENDER OFFER FOR CBI INDUSTRIES, INC. DANBURY, Conn., January 12, 1996 -- Praxair, Inc. (NYSE: PX) said today that it has completed its tender offer for all the outstanding common shares of CBI Industries, Inc. (NYSE: CBI) at $33 net per share. The offer expired, as scheduled, at midnight Eastern time on Thursday, January 11, 1996. As of the termination of the offer, based on a preliminary count from the Depositary, the Bank of New York, approximately 40, 863,514 CBI shares had been tendered and accepted for payment. This includes approximately 8,131,792 shares tendered pursuant to guarantees of delivery that have not yet been delivered. These tendered shares, together with the 79,300 shares of CBI common stock that Praxair currently owns, represent approximately 90 percent of the outstanding shares of CBI common stock. H. William Lichtenberger, Praxair's chairman and chief executive officer, said, "With the successful completion of this tender offer, we will now move quickly to realize the full potential of the combined businesses." Praxair is the largest industrial gases company in North and South America, and one of the largest worldwide, with 1994 sales of $2.7 billion. The company produces, sells and distributes atmospheric, process and specialty gases, and high-performance surface coatings. Praxair is a leader in the commercialization of new technologies that bring productivity and environmental benefits to a diverse group of industries. CBI Industries, Inc., with 1994 sales of $1.9 billion, has subsidiaries operating throughout the world producing and distributing carbon dioxide and industrial gases; designing, engineering, fabricating and erecting metal plate structures and executing other contracting services; and providing oil and refined petroleum product storage and blending facilities.	SC 14D1/A	EX-99	1996-01-12T00:00:00	1996-01-12T17:17:40
0000820626-96-000007	0000820626-96-000007_0000.txt	As filed with the Securities and Exchange Commission on January 12, The Securities Act of 1933 (Exact name of registrant as specified in its charter) (State or other jurisdiction I.R.S. 2100 Sanders Road, Northbrook, Illinois 60062 (Address of Principal Executive Offices) (Zip (Full title of the plan) (Name, address and telephone number, including area code, of agent Amount to be Maximum Maximum Amount Title of Price Per Offering tion $1.00 par value 1,000,000 (1) $38,500,000 Purchase Rights 1,000,000 (2) (2) (2) (1) Estimated solely for the purpose of calculating the registration fee and, pursuant to Rules 457(h)(1) and 457(c) under the Securities Act of 1933, based upon the average of the high and low sale prices of the Common Stock of IMC Global Inc. on The New York Stock Exchange Composite Tape on January 11, 1996. (2) The Company's Preferred Stock Purchase Rights initially are carried and traded with the shares of Common Stock of the Company being registered hereunder. Value attributable to such Preferred Stock Purchase Rights, if any, is reflected in the market price of the Common Stock. Item 3. Incorporation of Documents by Reference The following documents heretofore filed with the Securities and Exchange Commission (the "Commission") by IMC Global Inc. (the "Company") are incorporated herein by reference: (a) The Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1995. (b) The Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995. (c) The Company's Current Reports on Form 8-K filed August 17, 1995 and October 17, 1995. (d) The description of the Company's common stock, par value $1.00 per share (the "Common Stock"), which is contained in the Registration Statement on Form 8- A filed with the Commission on March 6, 1989 under Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including any subsequent amendment or any report filed for the purpose of updating such description. (g) The description of the Preferred Stock Purchase Rights which is contained in the Registration Statement on Form 8-A filed with the Commission on June 23, 1989, under the Exchange Act, including any subsequent amendment or report filed for the purpose of updating such description. All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 and 15(d) of the Exchange Act after the date of this Registration Statement and prior to the filing of a post-effective amendment to this Registration Statement which indicates that all securities offered hereby have been sold or which deregisters all securities then remaining unsold, shall be deemed to be incorporated by reference into this Registration Statement and to be a part hereof from the filing of such documents. Item 4. Description of Securities Item 5. Interests of Named Experts and Counsel The legal matters in connection with the issuance and due authorization of the Common Stock offered hereby have been passed upon by Marschall I. Smith, Esq., Senior Vice President, General Counsel and Secretary of the Corporation. As of November 1, 1995, Mr. Smith was the beneficial owner of 27,210 shares of IMC Global Inc.'s Common Stock. Item 6. Indemnification of Directors and Officers Reference is made to Section 145 of the Delaware General Corporation Law of the State of Delaware which provides for indemnification of directors and officers in certain circumstances. The Company has insurance to indemnify its directors and officers for those liabilities in respect of such indemnification insurance is permitted under the laws of the State of Delaware. The Company's Restated Certificate of Incorporation provides that to the fullest extent permitted by Delaware law a director shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of duty as a Item 7. Exemption from Registration Claimed The Exhibits accompanying this Registration Statement are listed on the accompanying Exhibit Index. (a) The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of this Registration Statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in this Registration Statement. (iii) To include any material information with respect to the plan of distribution not previously disclosed in this Registration Statement or any material change to such information in this Registration Statement; provided, however, that paragraphs (a)(1)(i) and (a)(1)(ii) do not apply if the information required to be included in a post-effective amendment by those paragraphs is contained in periodic reports filed with or furnished to the Commission by the registrant pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 that are incorporated by reference in this Registration Statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post- effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post effective amendment any of the securities being registered which remain unsold at the termination of the offering. (b) The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933, each filing of the registrant's annual report pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 that is incorporated by reference in this Registration Statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (c) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue. Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-8 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in Northbrook, Illinois, on this 12th day of January, 1996. Pursuant to the requirements of the Securities Act 1933, this Registration Statement has been signed by the following persons in the capacities indicated on this 12th day of January, 1996. INDEX TO EXHIBITS TO REGISTRATION STATEMENT ON FORM S-8 4.1 1988 Stock Option and Award Plan, as amended and restated. 4.2 Restated Certificate of Incorporation of IMC Global Inc. (incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated October 21, 1994). 4.3 Rights Agreement dated June 21, 1989 between the Company and The First National Bank of Chicago, as amended, (incorporated by reference to Exhibit 10.35 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1989 and to the Company's Current Report on form 8-A/A dated September 7, 1995). 4.4 Bylaws of the Company (incorporated by reference to the Company's Current Report on Form 8-K dated July 2, 1991). 5 Opinion of Marschall I. Smith 23.1 Consent of independent auditors. 23.2 Consent of Marschall I. Smith (included in the filed as Exhibit 5). *24 Powers of Attorney.	S-8	S-8	1996-01-12T00:00:00	1996-01-12T17:10:55
0000950130-96-000108	0000950130-96-000108_0001.txt	OFFER TO PURCHASE FOR CASH ALL OUTSTANDING SHARES OF COMMON STOCK A WHOLLY OWNED SUBSIDIARY OF THE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 12:00 MIDNIGHT, NEW YORK CITY TIME, ON FRIDAY, FEBRUARY 9, 1996, UNLESS THE OFFER IS EXTENDED. LAC ACQUISITION CORPORATION HAS AGREED, SUBJECT TO THE TERMS AND CONDITIONS OF THE OFFER, TO EXTEND THE OFFER UNTIL IMMEDIATELY AFTER THE TIME OF THE SPIN- OFF RECORD DATE (AS DEFINED BELOW). THE OFFER IS BEING MADE AS A PART OF A SERIES OF TRANSACTIONS THAT ARE EXPECTED TO RESULT IN (I) THE DISTRIBUTION TO THE STOCKHOLDERS OF LORAL CORPORATION (THE "COMPANY") OF SHARES OF STOCK IN LORAL SPACE & COMMUNICATIONS LTD., A NEWLY-FORMED BERMUDA COMPANY ("LORAL SPACE" OR "SPINCO"), THAT WILL OWN AND MANAGE SUBSTANTIALLY ALL OF THE COMPANY'S SPACE AND SATELLITE TELECOMMUNICATIONS INTERESTS, INCLUDING THE COMPANY'S DIRECT AND INDIRECT INTERESTS IN GLOBALSTAR, L.P. ("GLOBALSTAR") AND SPACE SYSTEMS/LORAL, INC. ("SS/L") AND CERTAIN OTHER ASSETS OF THE COMPANY (THE "SPIN-OFF") AND (II) THE ACQUISITION OF THE COMPANY'S DEFENSE ELECTRONICS AND SYSTEMS INTEGRATION BUSINESSES BY LOCKHEED MARTIN CORPORATION ("PARENT") PURSUANT TO THE OFFER AND MERGER DESCRIBED HEREIN. THE BOARD OF DIRECTORS OF THE COMPANY HAS UNANIMOUSLY APPROVED THE OFFER, THE MERGER AND THE SPIN-OFF, DETERMINED THAT THE OFFER, THE MERGER AND THE SPIN-OFF ARE FAIR TO THE STOCKHOLDERS OF THE COMPANY AND ARE IN THE BEST INTERESTS OF THE STOCKHOLDERS OF THE COMPANY, AND RECOMMENDS ACCEPTANCE OF THE OFFER AND APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AND THE MERGER BY THE STOCKHOLDERS OF THE COMPANY. THE OFFER IS CONDITIONED UPON, AMONG OTHER THINGS, THERE BEING VALIDLY TENDERED AND NOT WITHDRAWN PRIOR TO THE EXPIRATION DATE A NUMBER OF SHARES OF COMMON STOCK PAR VALUE $0.25 PER SHARE (INCLUDING THE ASSOCIATED RIGHTS) (COLLECTIVELY, THE "SHARES"), WHICH, WHEN ADDED TO THE SHARES THEN BENEFICIALLY OWNED BY PARENT AND ITS AFFILIATES, CONSTITUTES AT LEAST TWO-THIRDS OF THE TOTAL NUMBER OF SHARES OUTSTANDING AND TWO-THIRDS OF THE VOTING POWER OF THE SHARES THEN OUTSTANDING ON A FULLY DILUTED BASIS. Any stockholder desiring to tender Shares should either (1) complete and sign the Letter of Transmittal (or facsimile thereof) in accordance with the instructions in the Letter of Transmittal and deliver it to the Depositary with the certificate(s) representing tendered Shares and all other required documents or tender such Shares pursuant to the procedures for book-entry transfer set forth in Section 3 or (2) request his or her broker, dealer, commercial bank, trust company or other nominee to effect the transaction for him or her. A stockholder having Shares registered in the name of a broker, dealer, commercial bank, trust company or other nominee must contact such person if he or she desires to tender such Shares. Any stockholder who desires to tender Shares and whose certificates representing such Shares are not immediately available or who cannot comply with the procedures for book-entry transfer on a timely basis may tender such Shares pursuant to the guaranteed delivery procedure set forth in Section 3. Questions and requests for assistance or additional copies of this Offer to Purchase and the Letter of Transmittal may be directed to the Information Agent or the Dealer Manager at their respective addresses and telephone numbers set forth on the back cover of this Offer to Purchase. Additional copies of this Offer to Purchase, the Letter of Transmittal and the other tender offer materials may also be obtained from the Information Agent, the Dealer Manager or from brokers, dealers, commercial banks or trust companies. The Dealer Manager for the Offer is: BEAR, STEARNS & CO. INC. Schedule I--Directors and Executive Officers of Parent and the Purchaser Schedule II--Certain Information About Parent Required by New York Law Exhibit A--Agreement and Plan of Merger To the Holders of Common Stock of LORAL CORPORATION: LAC Acquisition Corporation (the "Purchaser"), a New York corporation and a wholly owned subsidiary of Lockheed Martin Corporation, a Maryland corporation ("Parent"), hereby offers to purchase all outstanding shares of common stock (the "Common Stock"), par value $0.25 per share, of Loral Corporation, a New York corporation (the "Company"), and the associated preferred stock purchase rights (the "Rights"; and together with the Common Stock, the "Shares") at $38.00 per Share, net to the seller in cash, without interest, upon the terms and subject to the conditions set forth in this Offer to Purchase and in the related Letter of Transmittal (which together constitute the "Offer"). The Rights will be issued on January 22, 1996 pursuant to a Rights Agreement, dated as of January 10, 1996 (as amended), between the Company and The Bank of New York (the "Rights Agreement"), and will be evidenced by and trade with certificates evidencing the Common Stock. See Section 10 for a brief description of the Rights Agreement and its application to the Offer and the Merger (as hereinafter defined). Tendering stockholders will not be obligated to pay brokerage fees or commissions or, except as set forth in Instruction 6 of the Letter of Transmittal, stock transfer taxes on the purchase of Shares by the Purchaser pursuant to the Offer. The Purchaser will pay all charges and expenses of Bear, Stearns & Co. Inc. ("Bear Stearns"), which is acting as Dealer Manager for the Offer (in such capacity, the "Dealer Manager"), First Chicago Trust Company of New York (the "Depositary") and Morrow & Co. (the "Information Agent") incurred in connection with the Offer. See Section 17. For purposes of this Offer to Purchase, references to "Section" are references to a section of this Offer to Purchase, unless the context otherwise requires. THE OFFER IS CONDITIONED UPON, AMONG OTHER THINGS, THERE BEING VALIDLY TENDERED AND NOT WITHDRAWN PRIOR TO THE EXPIRATION DATE (AS DEFINED BELOW) A NUMBER OF SHARES WHICH WHEN ADDED TO THE SHARES THEN BENEFICIALLY OWNED BY PARENT REPRESENT AT LEAST TWO-THIRDS OF THE TOTAL NUMBER OF SHARES OUTSTANDING AND TWO-THIRDS OF THE VOTING POWER OF THE SHARES OUTSTANDING ON A FULLY DILUTED BASIS (THE "MINIMUM CONDITION"). SEE SECTION 15. THE BOARD OF DIRECTORS OF THE COMPANY (THE "BOARD OF DIRECTORS" OR THE "BOARD") HAS UNANIMOUSLY APPROVED THE OFFER, THE MERGER AND THE SPIN-OFF, DETERMINED THAT THE OFFER, THE MERGER AND THE SPIN-OFF ARE FAIR TO THE STOCKHOLDERS OF THE COMPANY AND ARE IN THE BEST INTERESTS OF THE STOCKHOLDERS OF THE COMPANY, AND RECOMMENDS ACCEPTANCE OF THE OFFER AND APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AND THE MERGER BY THE STOCKHOLDERS OF THE COMPANY. The Offer is being made pursuant to an Agreement and Plan of Merger, dated as of January 7, 1996 (the "Merger Agreement"), among Parent, the Purchaser and the Company. The Merger Agreement provides, among other things, that, upon the terms and subject to the conditions therein, as soon as practicable after the satisfaction or waiver of certain conditions, including the consummation of the Offer and the Spin-Off and the approval and adoption of the Merger Agreement by the stockholders of the Company, if required by applicable law, the Purchaser will be merged with and into the Company (the "Merger"), with the Company being the corporation surviving the Merger (the "Surviving Corporation"). Each issued and outstanding Share (other than Dissenting Shares (as hereinafter defined)) not owned by Parent, the Purchaser, the Company or any of their subsidiaries other than a Retained Subsidiary (as defined in Section 10) will be converted into and represent the right to receive $38.00 in cash or any higher price that may be paid per Share in the Offer, without interest (the "Merger Price"). See Section 10. Following the consummation of the Offer, the Company will distribute (the "Spin-Off") common stock (the "Loral Space Shares" or "Spinco Shares") of Loral Space & Communications, Ltd. a newly-formed Bermuda company and a wholly owned subsidiary of the Company ("Loral Space" or "Spinco"), to the holders of Shares on a record date to be determined by the Board of Directors of the Date"), in accordance with the terms of a Restructuring, Financing and Distribution Agreement, dated as of January 7, 1996, among Parent, the Company, Loral Space and certain subsidiaries of the Company (the "Distribution Agreement"). The parties to the Distribution Agreement have agreed to use their reasonable efforts to cause the Spin-Off Record Date to be established so as to occur immediately prior to the acceptance for payment of Shares by the Purchaser pursuant to the Offer and have also agreed that in no event shall the Spin-Off Record Date be established so as to occur as of or at any time after the acceptance for payment by the Purchaser of the Shares pursuant to the Offer. As a result, a record holder of Shares who tenders Shares pursuant to the Offer (and who does not subsequently withdraw and sell such Shares) is expected to be the record holder thereof on the Spin-Off Record Date. Accordingly, in the event that Shares are accepted for payment pursuant to the Offer, such record holders will be entitled to receive, in respect of each Share tendered, $38.00 net in cash (without interest) from the Purchaser and one Loral Space Share from the Company. As a result of the Spin- Off, Loral Space will own and manage substantially all of the space and satellite telecommunications interests of the Company and its subsidiaries, including, without limitation, the Company's interests in Globalstar, L.P. ("Globalstar") and Space Systems/Loral, Inc. ("SS/L") and certain other assets of the Company. In addition, pursuant to the terms of the Distribution Agreement, cash which Parent will provide in the amount of $712,400,000, subject to adjustment under certain circumstances, will be included in the assets contributed to Loral Space by the Company in connection with the Spin- Off (the "Spinco Cash Amount"), of which $344,000,000 is being contributed by the Company to Loral Space in consideration for the acquisition by the Company of shares of preferred stock of Spinco that is convertible into 20% of Loral Space's common stock on a fully diluted basis. After the Spin-Off, the Company will continue to own and operate the defense electronics and systems integration businesses and other businesses of the Company not transferred to Loral Space (collectively, the "Retained Business") and the preferred stock referred to above. Accordingly, upon consummation of the Offer, the Spin-Off and the Merger, Parent will have acquired the Retained Business and a 20% fully-diluted equity interest in Loral Space. Consummation of the Offer is conditioned upon, among other things, the Spin-Off Record Date having been set (the "Spin-Off Condition"). The Spin-Off Record Date is not expected to occur until immediately prior to the expiration of the Offer. The Merger is conditioned upon, among other things, the Spin-Off having been consummated in all material respects. The distribution of the Loral Space Shares pursuant to the Spin-Off is conditioned upon the Purchaser having notified the Company that it is prepared to immediately accept for payment Shares tendered pursuant to the Offer. In the Merger Agreement, the Purchaser has agreed to extend the Offer to the first business day following the Spin-Off Record Date. The Company has advised Parent and the Purchaser that, prior to the time notice of the Spin-Off Record Date is given and at least ten days prior to the Expiration Date (as defined below), it expects to distribute to holders of Shares an information statement or a prospectus with respect to the business, operations and management of Loral Space (the "Information Statement"). See Section 10. Lazard Freres & Co. LLC ("Lazard Freres"), one of the financial advisors to the Company, has delivered to the Board of Directors of the Company its written opinion that the aggregate consideration to be received by the holders of Shares in the Offer, the Merger and the Spin-Off is fair to the holders of such Shares from a financial point of view. A copy of such opinion is included with the Company's Solicitation/Recommendation Statement on Schedule 14D-9 (the "Schedule 14D-9"), which is being mailed to stockholders concurrently herewith, and stockholders are urged to read the opinion in its entirety for a description of the assumptions made, factors considered and procedures followed by Lazard Freres. According to the Company, as of December 31, 1995, there were 173,068,379 Shares outstanding and 11,131,234 Shares that may be issued prior to the Expiration Date upon the exercise of stock options and other rights issued under the Company's stock option plans. As a result, the Purchaser believes that the Minimum Condition would be satisfied if at least 122,799,742 Shares are validly tendered and not withdrawn prior to the Expiration Date. THIS OFFER TO PURCHASE AND THE RELATED LETTER OF TRANSMITTAL CONTAIN IMPORTANT INFORMATION AND SHOULD BE READ IN THEIR ENTIRETY BEFORE ANY DECISION IS MADE WITH RESPECT TO THE OFFER. 1. TERMS OF THE OFFER; EXPIRATION DATE. Upon the terms and subject to the conditions of the Offer, the Purchaser will accept for payment and pay for all Shares that have been validly tendered prior to the Expiration Date and not withdrawn as permitted by Section 4. The term "Expiration Date" means 12:00 Midnight, New York City time, on February 9, 1996, unless and until the Purchaser, as provided below, shall have extended the period of time for which the Offer is open, in which event the term "Expiration Date" means the latest time and date at which the Offer, as so extended by the Purchaser, shall expire. Pursuant to the Merger Agreement, the Purchaser, subject to the terms and conditions of the Offer, will extend the period of time during which the Offer is open if the Offer would otherwise expire prior to the Spin-Off Record Date or the expiration or termination of any applicable waiting period under the Antitrust Laws (as defined in Section 10 below). The Purchaser will not otherwise extend the period of time during which the Offer is open unless any of the conditions described in Section 15 shall not have been satisfied, or unless Parent reasonably determines that such extension is necessary to comply with any legal or regulatory requirements relating to the Offer or the Spin-off. The Purchaser expressly reserves the right to amend the terms and conditions of the Offer; provided that, without the consent of the Company, no amendment may be made which (i) decreases the price per Share or changes the form of consideration payable in the Offer, (ii) decreases the number of Shares sought, or (iii) imposes additional conditions to the Offer or amends the terms of the Offer in a manner materially adverse to the holders of Shares. The Offer is subject to certain conditions set forth in Section 15, including satisfaction of the Minimum Condition, the Spin-Off Condition and the expiration or termination of any waiting period under the Antitrust Laws. If any such condition is not satisfied prior to the expiration of the Offer, the Purchaser may, subject to the terms of the Merger Agreement, (i) terminate the Offer and return all tendered Shares to tendering stockholders, (ii) extend the Offer and, subject to withdrawal rights as set forth in Section 4, retain all such Shares until the expiration of the Offer as so extended, (iii) other than as described in Section 15, waive such condition and, subject to any requirement to extend the period of time during which the Offer is open, purchase all Shares validly tendered and not withdrawn by the Expiration Date or (iv) delay acceptance for payment of (whether or not the Shares have theretofore been accepted for payment), or payment for, any Shares tendered and not withdrawn, subject to applicable law, until satisfaction or waiver of the conditions to the Offer. In the Merger Agreement, the Purchaser has agreed, subject to the conditions in Section 15 and its rights under the Offer, to accept for payment Shares as promptly as practicable following the expiration of the Offer. For a description of the Purchaser's right to extend the period of time during which the Offer is open, and to amend, delay or terminate the Offer, see Section 14. The Company has provided or will provide (upon request of Parent or the Purchaser) the Purchaser with the Company's stockholder list and security position listings for the purpose of disseminating the Offer to holders of Shares. This Offer to Purchase and the related Letter of Transmittal will be mailed to record holders of Shares and will be furnished to brokers, banks and similar persons whose names, or the names of whose nominees, appear on the stockholder list or, if applicable, who are listed as participants in a clearing agency's security position listing for subsequent transmittal to beneficial owners of Shares. 2. ACCEPTANCE FOR PAYMENT AND PAYMENT. Upon the terms and subject to the conditions of the Offer, the Purchaser will accept for payment and pay for all Shares validly tendered and not properly withdrawn by the Expiration Date as soon as practicable after the later of (i) the Expiration Date and (ii) the satisfaction or waiver of the conditions set forth in Section 15 (the "Offer Purchaser Date"). For a description of the Purchaser's right to terminate the Offer and not accept for payment or pay for Shares or to delay acceptance for payment or payment for Shares, see Section 14. For purposes of the Offer, the Purchaser shall be deemed to have accepted for payment tendered Shares when, as and if the Purchaser gives oral or written notice to the Depositary of its acceptance of the tender of such Shares. Payment for Shares accepted for payment pursuant to the Offer will be made by deposit of the purchase price with the Depositary, which will act as agent for the tendering stockholders for the purpose of receiving payments from the Purchaser and transmitting such payments to tendering stockholders. In all cases, payment for Shares accepted for payment pursuant to the Offer will be made only after timely receipt by the Depositary of certificates for such Shares (or of a confirmation of a book-entry transfer of such Shares into the Depositary's account at one of the Book-Entry Transfer Facilities (as defined in Section 3)), a properly completed and duly executed Letter of Transmittal (or facsimile thereof) and any other required documents. For a description of the procedure for tendering Shares pursuant to the Offer, see Section 3. Accordingly, payment may be made to tendering stockholders at different times if delivery of the Shares and other required documents occur at different times. UNDER NO CIRCUMSTANCES WILL INTEREST BE PAID BY THE PURCHASER ON THE CONSIDERATION PAID FOR SHARES PURSUANT TO THE OFFER, REGARDLESS OF ANY DELAY IN MAKING SUCH PAYMENT. If the Purchaser increases the consideration to be paid for Shares pursuant to the Offer, the Purchaser will pay such increased consideration for all Shares purchased pursuant to the Offer. The Purchaser reserves the right to transfer or assign, in whole or from time to time in part, to one or more of its affiliates the right to purchase Shares tendered pursuant to the Offer, but any such transfer or assignment will not relieve the Purchaser of its obligations under the Offer or prejudice the rights of tendering stockholders to receive payment for Shares validly tendered and accepted for payment. If any tendered Shares are not purchased pursuant to the Offer for any reason, or if certificates are submitted for more Shares than are tendered, certificates for such unpurchased or untendered Shares will be returned (or, in the case of Shares tendered by book-entry transfer, such Shares will be credited to an account maintained at one of the Book-Entry Transfer Facilities), without expense to the tendering stockholder, as promptly as practicable following the expiration or termination of the Offer. 3. PROCEDURE FOR TENDERING SHARES. To tender Shares pursuant to the Offer, either (a) a properly completed and duly executed Letter of Transmittal (or facsimile thereof) and any other documents required by the Letter of Transmittal must be received by the Depositary at one of its addresses set forth on the back cover of this Offer to Purchase and either (i) certificates for the Shares to be tendered must be received by the Depositary at one of such addresses or (ii) such Shares must be delivered pursuant to the procedures for book-entry transfer described below (and a confirmation of such delivery received by the Depositary including an Agent's Message (as defined below) if the tendering stockholder has not delivered a Letter of Transmittal), in each case prior to the Expiration Date, or (b) the guaranteed delivery procedure described below must be complied with. The term "Agent's Message" means a message transmitted by a Book-Entry Transfer Facility to and received by the Depositary and forming a part of a book-entry confirmation, which states that such Book-Entry Transfer Facility has received an express acknowledgement from the participant in such Book-Entry Transfer Facility tendering the Shares which are the subject of such book-entry confirmation that such participant has received and agrees to be bound by the terms of the Letter of Transmittal and that the Company may enforce such agreement against such participant. The Depositary will establish an account with respect to the Shares at each of The Depository Trust Company, Midwest Securities Trust Company and Philadelphia Depository Trust Company (collectively referred to as the "Book- Entry Transfer Facilities") for purposes of the Offer within two business days after the date of this Offer to Purchase, and any financial institution that is a participant in the system of any Book-Entry Transfer Facility may make delivery of Shares by causing such Book-Entry Transfer Facility to transfer such Shares into the Depositary's account in accordance with the procedures of such Book-Entry Transfer Facility. However, although delivery of Shares may be effected through book-entry transfer, the Letter of Transmittal (or facsimile thereof) properly completed and duly executed together with any required signature guarantees or an Agent's Message and any other required documents must, in any case, be received by the Depositary at one of its addresses set forth on the back cover of this Offer to Purchase prior to the Expiration Date, or the guaranteed delivery procedure described below must be complied with. Delivery of the Letter of Transmittal and any other required documents to a Book-Entry Transfer Facility does not constitute delivery to the Depositary. Except as otherwise provided below, all signatures on a Letter of Transmittal must be guaranteed by a recognized member of a Medallion Signature Guarantee Program (each, of the foregoing an "Eligible Institution"). Signatures on a Letter of Transmittal need not be guaranteed (a) if the Letter of Transmittal is signed by the registered holder of the Shares tendered therewith and such holder has not completed the box entitled "Special Payment Instructions" on the Letter of Transmittal or (b) if such Shares are tendered for the account of an Eligible Institution. See Instructions 1 and 5 of the Letter of Transmittal. If a stockholder desires to tender Shares pursuant to the Offer and such stockholder's certificates evidencing such Shares are not immediately available or such stockholder cannot deliver such Shares and all other required documents to the Depositary by the Expiration Date, or such stockholder cannot complete the procedure for delivery by book-entry transfer on a timely basis, such Shares may nevertheless be tendered if all of the following conditions are met: (i) such tender is made by or through an Eligible Institution; (ii) a properly completed and duly executed Notice of Guaranteed Delivery substantially in the form provided by the Purchaser is received by the Depositary (as provided below) by the Expiration Date; and (iii) the certificates for such Shares (or a confirmation of a book-entry transfer of such Shares into the Depositary's account at one of the Book- Entry Transfer Facilities), together with a properly completed and duly executed Letter of Transmittal (or facsimile thereof) with any required signature guarantee or an Agent's Message and any other documents required by the Letter of Transmittal, are received by the Depositary within five New York Stock Exchange, Inc. ("NYSE") trading days after the date of execution of the Notice of Guaranteed Delivery. The Notice of Guaranteed Delivery may be delivered by hand or transmitted by telegram, telex, facsimile transmission or mail to the Depositary and must include a guarantee by an Eligible Institution in the form set forth in such Notice. THE METHOD OF DELIVERY OF SHARE CERTIFICATES AND ALL OTHER REQUIRED DOCUMENTS, INCLUDING THROUGH BOOK-ENTRY TRANSFER FACILITIES, IS AT THE OPTION AND RISK OF THE TENDERING STOCKHOLDER AND THE DELIVERY WILL BE DEEMED MADE ONLY WHEN ACTUALLY RECEIVED BY THE DEPOSITARY. IF CERTIFICATES FOR SHARES ARE SENT BY MAIL, REGISTERED MAIL WITH RETURN RECEIPT REQUESTED, PROPERLY INSURED, IS RECOMMENDED. Under the federal income tax laws, the Depositary will be required to withhold 31% of the amount of any payments made to certain stockholders pursuant to the Offer. In order to avoid such backup withholding, each tendering stockholder must provide the Depositary with such stockholder's correct taxpayer identification number and certify that such stockholder is not subject to such backup withholding by completing the Substitute Form W-9 included in the Letter of Transmittal (see Instruction 10 of the Letter of Transmittal) or by filing a Form W-9 with the Depositary prior to any such payments. If the stockholder is a nonresident alien or foreign entity not subject to back-up withholding, the stockholder must give the Depositary a completed Form W-8 Certificate of Foreign Status prior to receipt of any payments. By executing a Letter of Transmittal, a tendering stockholder irrevocably appoints designees of the Purchaser as such stockholder's proxies in the manner set forth in the Letter of Transmittal to the full extent of such stockholder's rights with respect to the Shares tendered by such stockholder and accepted for payment by the Purchaser (and any and all other Shares or other securities issued or issuable in respect of such Shares on or after January 7, 1996, other than any Loral Space Shares distributed in respect of the Shares in connection with the Spin-Off). All such proxies shall be irrevocable and coupled with an interest in the tendered Shares. Such appointment is effective only upon the acceptance for payment of such Shares by the Purchaser. Upon such acceptance for payment, all prior proxies and consents granted by such stockholder with respect to such Shares and other securities will, without further action, be revoked, and no subsequent proxies may be given nor subsequent written consents executed by such stockholder (and, if given or executed, will be deemed ineffective). Such designees of the Purchaser will be empowered to exercise all voting and other rights of such stockholder as they, in their sole discretion, may deem proper at any annual, special or adjourned meeting of the Company's stockholders, by written consent or otherwise. The Purchaser reserves the right to require that, in order for Shares to be validly tendered, immediately upon the Purchaser's acceptance for payment of such Shares, the Purchaser is able to exercise full voting rights with respect to such Shares and other securities (including voting at any meeting of stockholders then scheduled or acting by written consent without a meeting). The NYSE has advised Parent and the Purchaser that it expects that commencing two business days prior to the Spin-Off Record Date and up to the date Shares are distributed pursuant to the Spin-Off, the Shares will trade on the NYSE with due bills attached. Such due bills will entitle a purchaser of a Share during such period to receive one Loral Space Share from the seller of the Share, when and if such seller receives Spinco Shares in the Distribution. If Shares are not accepted for purchase pursuant to the Offer and Spinco Shares are not issued in the Distribution, the due bills will become null and void. Due bills are separate instruments from the Shares which are the subject of the Offer; accordingly, due bills should not be tendered to the Purchaser in the Offer. A tender of Shares pursuant to any one of the procedures described above will constitute the tendering stockholder's acceptance of the terms and conditions of the Offer, as well as the tendering stockholder's representation and warranty that such stockholder has the full power and authority to tender and assign the Shares tendered, as specified in the Letter of Transmittal. The Purchaser's acceptance for payment of Shares tendered pursuant to the Offer will constitute a binding agreement between the tendering stockholder and the Purchaser upon the terms and subject to the conditions of the Offer. All questions as to the form of documents and the validity, eligibility (including time of receipt) and acceptance for payment of any tender of Shares will be determined by the Purchaser, in its sole discretion, which determination shall be final and binding. The Purchaser reserves the absolute right to reject any or all tenders of Shares determined by it not to be in proper form or the acceptance for payment of or payment for which may, in the opinion of the Purchaser's counsel, be unlawful. The Purchaser also reserves the absolute right to waive any defect or irregularity in any tender of Shares. No tender of Shares will be deemed to have been properly made until all defects and irregularities relating thereto have been cured or waived. The Purchaser's interpretation of the terms and conditions of the Offer in this regard will be final and binding. None of the Purchaser, Parent, the Dealer Manager, the Depositary, the Information Agent or any other person will be under any duty to give notification of any defect or irregularity in tenders or incur any liability for failure to give any such notification. 4. WITHDRAWAL RIGHTS. Tenders of Shares made pursuant to the Offer may be withdrawn at any time prior to the Expiration Date. Thereafter, such tenders are irrevocable, except that they may be withdrawn after March 11, 1996 unless theretofore accepted for payment as provided in this Offer to Purchase. To be effective, a written, telegraphic, telex or facsimile transmission notice of withdrawal must be timely received by the Depositary at one of its addresses set forth on the back cover of this Offer to Purchase and must specify the name of the person who tendered the Shares to be withdrawn and the number of Shares to be withdrawn and the name of the registered holder of the Shares, if different from that of the person who tendered such Shares. If the Shares to be withdrawn have been delivered to the Depositary, a signed notice of withdrawal with (except in the case of Shares tendered by an Eligible Institution) signatures guaranteed by an Eligible Institution must be submitted prior to the release of such Shares. In addition, such notice must specify, in the case of Shares tendered by delivery of certificates, the name of the registered holder (if different from that of the tendering stockholder) and the serial numbers shown on the particular certificates evidencing the Shares to be withdrawn. Withdrawals may not be rescinded, and Shares withdrawn will thereafter be deemed not validly tendered for purposes of the Offer. However, withdrawn Shares may be retendered by again following one of the procedures described in Section 3 at any time prior to the Expiration Date. All questions as to the form and validity (including time of receipt) of any notice of withdrawal will be determined by the Purchaser, in its sole discretion, which determination shall be final and binding. None of the Purchaser, Parent, the Dealer Manager, the Depositary, the Information Agent or any other person will be under any duty to give notification of any defect or irregularity in any notice of withdrawal or incur any liability for failure to give any such notification. 5. CERTAIN TAX CONSIDERATIONS. The following summary addresses the material federal income tax consequences to holders of Shares who sell their Shares in the Offer. The summary does not address all aspects of federal income taxation that may be relevant to particular holders of Shares and thus, for example, may not be applicable to holders of Shares who are not citizens or residents of the United States or holders of Shares who are employees and who acquired their Shares pursuant to the exercise of incentive stock options; nor does this summary address the effect of any applicable foreign, state, local or other tax laws. The discussion assumes that each holder of Shares holds such Shares as a capital asset within the meaning of Section 1221 of the Internal Revenue Code of 1986, as amended (the "Code"). STOCKHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE PRECISE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES OF THE PROPOSED TRANSACTIONS. Tax Consequences of Receipt of Cash and Loral Space Shares. Assuming that the Purchaser accepts Shares pursuant to the Offer, and the Spin-Off and the Merger are consummated, stockholders who hold their Shares of record on the Spin-Off Record Date, and who also tender their Shares in the Offer or have such Shares exchanged for the Merger Price upon consummation of the Merger, will receive for each such Share consideration consisting of (i) one Loral Space Share and (ii) $38.00 in cash. Stockholders who hold their Shares of record on the Spin-Off Record Date, and who sell such Shares after the date as of which the Spin-Off shall be effected (the "Distribution Date") other than pursuant to the Offer or the Merger, will receive consideration consisting of (i) one Loral Space Share for each Share held on the Spin-Off Record Date and (ii) the proceeds from the sale of their Shares. In each of the above- mentioned cases, the receipt of such consideration will be a taxable transaction for federal income tax purposes. The proper federal income tax characterization of the Spin-Off as either a dividend or as proceeds from the sale or exchange of Shares is unclear. When addressing the issue of whether a distribution from a corporation in connection with a disposition of all of the shares of that corporation is treated as sale proceeds or as an ordinary income dividend, the courts and the Internal Revenue Service ("IRS") have each reached inconsistent positions and have used inconsistent methods of analysis. Certain authorities support treatment of the Offer, the Spin-Off and the Merger as a single integrated transaction in which a holder of Shares receives the cash in an actual exchange for a portion of such holder's Shares and receives the Loral Space Shares in a constructive redemption of such holder's remaining Shares. Parent and the Company have agreed to treat the purchase of Shares in the Offer, the Spin-Off and the Merger in accordance with this analysis for all tax purposes. If this treatment applies, a holder of Shares would recognize gain or loss equal to the difference between (i) the sum of the amount of cash plus the fair market value of the Loral Space Shares received (which fair market value generally should equal the average trading value per Loral Space Share on the Distribution Date) and (ii) such holder's adjusted tax basis for such holder's Shares. Such gain or loss will be capital gain or loss and will be long-term capital gain or loss if, on the date of the exchange, the stockholder has held the Shares for more than one year. Although there are authorities supporting the view that the Loral Space Shares received in the Spin-Off should be treated as having been received in a constructive redemption of a portion of the Shares, certain other authorities support treating the receipt of the Loral Space Shares as taxable in an independent transaction. If the Spin-Off was treated as an independent transaction, the fair market value of the Loral Space Shares would be taxable to the recipient as a distribution from the Company under Section 301 of the Code. It is also possible that the portion of the value of the Loral Space Shares equal to a pro rata portion of some or all of the Loral Space Cash Amount could be treated as received in exchange for such holder's Shares, with only the remaining portion of the value of the Loral Space Shares treated as a distribution under Section 301. In either case, the cash received by a holder of Shares would still be treated as received in exchange for such holder's Shares and would be subject to tax in the manner described above. Under Section 301 of the Code, the amount of the distribution would be taxable as a dividend for federal income tax purposes to the extent of the Company's current and accumulated earnings and profits. The amount of the distribution that exceeds such earnings and profits would first be treated as a non-taxable return of capital to the extent of the stockholder's tax basis in such stockholder's Shares, and such stockholder's tax basis in such Shares would be reduced accordingly (but not below zero), and thereafter as capital gain. The determination of a corporation's earnings and profits requires complex factual and legal analyses; moreover, the amount of a corporation's current earnings and profits cannot be determined until the close of its taxable year. Nonetheless, the Company has informed the Purchaser that the Company believes, based upon present estimates of its current and accumulated earnings and profits, that the Company's earnings and profits should exceed the amount of any such distribution. To the extent, if any, that the receipt of Loral Space Shares is treated as a dividend under the foregoing rules, certain corporate stockholders may be eligible for the "dividends received deduction" ("DRD") with respect to such dividend, subject to certain holding period and other limitations. Any such dividend received by a corporate stockholder eligible for the DRD would constitute an "extraordinary dividend" provisions of Section 1059 of the Code if, in general, the value of the distribution, together with any other distributions received by such holder with respect to its Shares during the 85-day period preceding the Spin-Off, exceeds 10% of the holder's basis in its Shares. If Section 1059 were to apply, a corporate stockholder that has not held its Shares for a period of two years prior to the dividend announcement date would be required to reduce its basis in (thereby increasing its gain on the disposition of) such Shares by the portion of the dividend that was excluded from income by reason of the DRD. Under current law, the maximum federal tax rate applicable to long-term capital gains recognized by an individual is 28%, and the maximum federal tax rate applicable to ordinary income (including dividends) and short-term capital gains recognized by individuals is 39.6%. The maximum federal tax rate applicable to all capital gains and ordinary income recognized by a corporation is 35%. It is possible that legislation may be enacted that would reduce the maximum federal tax rate applicable to long-term capital gains, possibly with retroactive effect. It is not possible to predict whether or in what form any such legislation may be enacted. Regardless of whether the receipt of the Loral Space Shares is treated as a constructive redemption or a distribution under Section 301 of the Code, a holder's tax basis in the Spinco Shares generally will be equal to the fair market value of the Loral Space Shares on the Distribution Date, and such holder's holding period for the Loral Space Shares will begin on the day after the Distribution Date. Dissenters. A holder of Shares who does not sell Shares in the Offer or the Merger and who exercises and perfects his rights under the NYBCL to demand fair value for such Shares (See Section 10) will recognize capital gain or loss (and may recognize an amount of interest income) attributable to any payment received pursuant to the exercise of such rights and may recognize capital gain or loss or dividend income on the receipt of Loral Space Shares based upon the principles described above. Withholding. Unless a stockholder complies with certain reporting and/or certification procedures or is an exempt recipient under applicable provisions of the Code (and regulations promulgated thereunder), such stockholder may be subject to a "backup" withholding tax of 31% with respect to any payments received in the Offer, the Merger or as a result of the exercise of the holder's dissenters' rights. Stockholders should contact their brokers to ensure compliance with such procedures. Foreign stockholders should consult with their tax advisors regarding withholding taxes in general. THE FOREGOING SUMMARY OF FEDERAL INCOME TAX CONSEQUENCES IS INCLUDED HEREIN FOR GENERAL INFORMATION PURPOSES ONLY. ACCORDINGLY, EACH HOLDER OF SHARES IS URGED TO CONSULT HIS OR HER OWN TAX ADVISOR REGARDING THE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES OF THE OFFER, THE MERGER AND THE SPIN-OFF. 6. PRICE RANGE OF SHARES; DIVIDENDS. The Shares are listed and traded on the NYSE under the Symbol "LOR". The following table sets forth, for the calendar periods indicated, the high and low sales prices and dividends paid per share for the Shares on the NYSE as adjusted to reflect the two-for-one stock split distributed on October 7, 1993 and the two-for-one stock split distributed on September 29, 1995. The Merger Agreement prohibits the Company from declaring or paying any dividend or distribution on the Shares (other than the Spin-Off), except that the Company may declare and pay to holders of Shares regular quarterly dividends of not more than $0.08 per Share on the dividend and payment dates normally applicable to the Shares. The closing sales price of the Shares as reported by the NYSE was $36.25 per share on January 5, 1996 and $44.00 per share on January 11, 1996, the last full day of trading prior to the first public announcement of the Offer. STOCKHOLDERS ARE URGED TO OBTAIN A CURRENT MARKET QUOTATION FOR THE SHARES. 7. CERTAIN INFORMATION CONCERNING THE COMPANY. The Company is a New York corporation and its principal executive offices are located at 600 Third Avenue, New York, New York 10016. Through its subsidiaries and divisions, the Company is a leading supplier of advanced electronic systems, components and services to U.S. and foreign governments for defense and non-defense applications, The Company's principal business areas are: electronic combat; training and simulation; tactical weapons; command, control, communications and intelligence (C/3/I)/reconnaissance; systems integration; and telecommunications and space systems. The Company has achieved an incumbent position on a wide range of existing programs through internal growth and development and a series of acquisitions focused on its core technologies. The Company is subject to the information requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and is required to file reports and other information with the Securities and Exchange Commission (the "Commission") relating to its business, financial condition and other matters. Information, as of particular dates, concerning the Company's directors and officers, their remuneration, options granted to them, the principal holders of the Company's securities and any material interest of such persons in transactions with the Company is required to be described in periodic statements distributed to the Company's stockholders and filed with the Commission. These reports, proxy statements and other information, including the Company's Annual Report on Form 10-K for the year ended March 31, 1995 (the "Company 10-K") and the Schedule 14D-9, should be available for inspection and copying at the Commission's office at 450 Fifth Street, N.W., Washington D.C. 20549, and at the regional offices of the Commission located at 75 Park Place, New York, New York 10007 and Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of this material may also be obtained by mail, upon payment of the Commission's customary fees, from the Commission's principal office at 450 Fifth Street, N.W., Washington, D.C. 20549. The above information concerning the Company and the information contained herein regarding the Spin-Off have been taken from or based upon the Company 10-K and other publicly available documents on file with the Commission, other publicly available information and information provided by the Company. Although neither the Purchaser nor Parent has any knowledge that would indicate that such information is untrue, neither the Purchaser nor Parent nor the Dealer Manager takes any responsibility for, or makes any representation with respect to, the accuracy or completeness of such information or for any failure by the Company to disclose events that may have occurred and may affect the significance or accuracy of any such information but which are unknown to the Purchaser or Parent or the Dealer Manager. Summary Financial Information for the Company. The following table sets forth certain summary consolidated financial information with respect to the Company and its subsidiaries excerpted or derived from the audited financial statements contained in the Company's annual report on Form 10-K and the unaudited financial information contained in the Company's Quarterly Reports on Form 10-Q for the six months ended September 30, 1995 and 1994. More comprehensive financial information is included in such reports and other documents filed by the Company with the Commission, and the following summary is qualified in its entirety by reference to such documents (which may be inspected and obtained as described above), including the financial statements and related notes contained therein. Neither Parent nor the Purchaser nor the Dealer Manager assumes any responsibility for the accuracy of the financial information set forth below. Note 1: The accompanying unaudited, consolidated, summary financial information consists of the consolidated financial information of the various businesses of the Company. Summary Financial Information for Retained Business. The summary unaudited financial data for the Retained Business (the "Retained Business Financial Data") in the following table has been provided to Parent and the Purchaser by the Company. The Company has advised Parent and the Purchaser that the Retained Business Financial Data has been derived from the consolidated financial statements of the Company. This financial data is presented in considerably less detail than complete financial statements and does not include all of the disclosures required by generally accepted accounting principles. Neither Parent nor the Purchaser nor the Dealer Manager assumes any responsibility for the accuracy of the Retained Business Financial Statements. Note 1: The accompanying unaudited, consolidated, summary financial information consists of the consolidated financial information of the various businesses of the Company which constitute the Retained Business. Projected Financial Information. In the course of the discussions between representatives of Parent and the Company (see Section 10), the Company provided Parent with certain projected financial data for the fiscal years ending March 31, 1996, March 31, 1997, March 31, 1998 and March 31, 1999. This data was not prepared with a view to public disclosure or compliance with published guidelines of the Commission or the guidelines established by the American Institute of Certified Public Accountants regarding projections, and is included in this Offer to Purchase only because it was provided to Parent. The Company's independent auditors have not examined, compiled or applied any procedures with respect to this data and express no opinion or any kind of assurance thereon. None of Parent, the Purchaser or the Company, or any of their respective financial advisors or the Dealer Manager assumes any responsibility for the validity, reasonableness, accuracy or completeness of this projected data. While presented with numerical specificity, this projected data is based upon a variety of assumptions relating to the businesses of the Company which may not be realized and is subject to significant uncertainties and contingencies, many of which are beyond the control of the Company and, therefore, this projected data is inherently imprecise, and there can be no assurance that projected financial results or any valuation assumed therein will be realized. It is expected that there will be a difference between actual and estimated or projected results and actual results may vary materially from those shown. The Company does not intend to update or otherwise revise this projected data prior to the consummation of the Merger. The projected financial data set forth below should be read together with the Retained Business Financial Data included above. * "Cash Flow" consists of net cash from opeerating activities, less net capital expenditures, plus proceeds of stock purchases by employee benefit plans and exercises of stock options, in each case during the year in question. 8. CERTAIN INFORMATION CONCERNING THE PURCHASER AND PARENT. The Purchaser is a newly formed New York corporation and a wholly owned subsidiary of Parent. To date, Purchaser has not conducted any business other than in connection with the Offer. Until immediately prior to the time the Purchaser purchases Shares pursuant to the Offer, it is not anticipated that the Purchaser will have any significant assets or liabilities or engage in activities other than those incident to its formation and capitalization and the transactions contemplated by the Offer. Because the Purchaser is a newly formed corporation and has minimal assets and capitalization, no meaningful financial information regarding the Purchaser is available. Parent is a holding company for the Lockheed Corporation and the Martin Marietta Corporation and their respective subsidiaries. The businesses of Parent are organized into five major operating sectors: Aeronautics; Electronics; Energy and Environment; Information and Technology Services; and Space and Strategic Missiles. Prior to the Offer, Parent began a process designed to result in the merger of the five largest direct or indirect subsidiaries of Parent with and into Parent. These subsidiaries include Lockheed Corporation and Martin Marietta Corporation. This process is not related to the Offer and it is presently anticipated that these mergers will occur effective as of January 28, 1996. The mergers are subject to certain conditions including the approval of the Boards of Directors of the various companies involved. The principal executive offices of Parent and Purchaser are located at 6801 Rockledge Drive, Bethesda, Maryland 20817. The name, citizenship, business address, principal occupation or employment and five-year employment history of each of the directors and executive officers of the Purchaser and Parent are set forth in Schedule I hereto. Set forth below is a summary of certain consolidated financial information with respect to Parent and its consolidated subsidiaries excerpted or derived from the information contained in or incorporated by reference into Parent's Annual Report on Form 10-K for the year ended December 31, 1994 filed with the Commission pursuant to Rule 15d-2 of the Exchange Act (the "Parent 10-K") and Parent's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995. More comprehensive financial information is included in or incorporated by reference into the Parent 10-K and other documents filed by Parent, Martin Marietta Corporation and Lockheed Corporation with the Commission, and the financial information summary set forth below is qualified in its entirety by reference to the Parent 10-K and such other documents and all the financial information and related notes contained therein. (IN MILLIONS, EXCEPT PER SHARE DATA) Parent is subject to the informational filing requirements of the Exchange Act and is required to file reports and other information with the Commission relating to its business, financial condition and other matters. Information, as of particular dates, concerning Parent's directors and executive officers, 1. Reflects the adoption of Statement of Financial Accounting Standards (SFAS) No. 106, Employers' Accounting for Postretirement Benefits Other than Pensions, and SFAS No. 112, Employers' Accounting for Postemployment Benefits. 2. Reflects the purchase of Lockheed Fort Worth Company effective February 28, 1993 and the GE Aerospace business combination effective April 2, 1993. 3. Reflects the adoption of Statement of Position No. 93-6, Employers' Accounting for Employee Stock Ownership Plans. principal holders of Parent's securities and any material interest of such persons in transactions with Parent is required to be described in periodic statements delivered to Parent's stockholders and filed with the Commission. Parent has not been a reporting company under the Exchange Act for a full year and certain of these documents are not yet due to be, and therefore have not been, filed with the Commission. As described above, Parent is a holding company for Lockheed Corporation and Martin Marietta Corporation, each of which was subject to the informational requirements of the Exchange Act with respect to events through March 15, 1995 (at which time Lockheed Corporation and Martin Marietta Corporation combined and become subsidiaries of Parent), and was required to file reports and other information with the Commission relating to its business, financial condition and other matters. Such reports and other information, including the Parent 10-K, may be inspected and copies may be obtained from the offices of the Commission in the same manner as set forth in Section 7. For information regarding certain material business relationships during the previous three fiscal years of the Company between the Company and its affiliates, on the one hand, and the Parent and its affiliates, on the other hand, see the information set forth on Schedule III attached hereto. Except as set forth in the immediately preceding paragraph or elsewhere in this Offer to Purchase, none of Parent, the Purchaser or any of their affiliates (collectively the "Purchaser Entities"), or, to the best knowledge of any of the Purchaser Entities, any of the persons listed on Schedule I, has any contract, arrangement, understanding or relationship with any other person with respect to any securities of the Company, including, but not limited to, any contract, arrangement, understanding or relationship concerning the transfer or the voting of any securities of the Company, joint ventures, loan or option arrangements, puts or calls, guaranties of loans, guaranties against loss or the giving or withholding of proxies. Except as set forth in this Offer to Purchase, none of the Purchaser Entities, or, to the best knowledge of any of the Purchaser Entities, any of the persons listed on Schedule I, has had, since April 1, 1993, any business relationships or transactions with the Company or any of its executive officers, directors or affiliates that would require reporting under the rules of the Commission. Except as set forth in this Offer to Purchase, since April 1, 1993, there have been no contacts, negotiations or transactions between the Purchaser Entities, or their respective subsidiaries or, to the best knowledge of any of the Purchaser Entities, any of the persons listed on Schedule I, and the Company or its affiliates, concerning a merger, consolidation or acquisition, tender offer or other acquisition of securities, election of directors or a sale or other transfer of a material amount of assets. None of the Purchaser Entities or, to the best knowledge of any of the Purchaser Entities, any of the persons listed on Schedule I, beneficially owns any Shares or has effected any transactions in the Shares in the past 60 days. 9. SOURCE AND AMOUNTS OF FUNDS. The total amount of funds required by the Purchaser to acquire all outstanding Shares pursuant to the Offer and the Merger, to consummate the transactions contemplated by the Offer, the Merger Agreement and the Distribution Agreement, to refinance certain indebtedness of the Company, and to pay fees and expenses relating to the Offer and the Merger is estimated to be approximately $8.4 billion. These funds will be provided to the Purchaser by Parent either through an equity investment in, or debt financing provided to, Purchaser or a combination thereof. Parent intends to obtain these funds, together with the funds necessary to provide working capital to support the combined operations of Parent and its subsidiaries, including the Company and its subsidiaries following the closing of the Offer, from loans to be provided by Morgan Guaranty Trust Company of New York (together with its affiliates, "Morgan Guaranty"), Bank of America National Trust and Savings Association (together with its affiliates, "Bank of America"; collectively with Morgan Guaranty, the "Co-Arrangers"), Citibank USA, (together with its affiliates, "Citibank") Inc., as managing agent, and a syndicate of other commercial banks (the "Banks") to be formed by the Co- Arrangers. It is anticipated that the loans to be provided by Morgan Guaranty, Bank of America, Citibank, and the other Banks (which are collectively referred to as the "Bank Financing") will be fully and unconditionally guaranteed by Purchaser and certain other subsidiaries of Parent and are collectively referred to as the "Bank Financing." Alternatively, Parent may obtain all or a portion of the necessary financing through the issuance of commercial paper backed by the Bank Financing. The existing revolving credit facilities of Parent and the Company will be terminated in connection with the closing of the Offer and the consummation of the Bank Financing. Set forth below is a summary description of the Bank Financing. Consummation of the Bank Financing is subject to, among other things, successful syndication of the Bank Financing and the negotiation and execution of definitive financing agreements on terms satisfactory to Parent, Purchaser and the Co-Arrangers. The summary description does not purport to be complete, and there can be no assurance that the terms set forth below will be contained in such agreements or that such agreements will not contain additional provisions. Parent has received commitments from Morgan Guaranty and Bank of America pursuant to which each of them has agreed to provide up to $1.375 billion of the Bank Financing, and from Citibank pursuant to which it has agreed to provide up to $750 million of the Bank Financing. The Co-Arrangers also have agreed to act as agents for an anticipated commercial bank syndicate (including the Co-Arrangers and Citibank). Morgan Guaranty has advised Parent that, based upon its knowledge of, and experience in, the loan syndication market and subject to certain assumptions, it is highly confident that it will be able to arrange a syndicate of lenders for an additional $6.5 billion. Parent has agreed to pay certain fees to Morgan Guaranty, Bank of America and to Citibank as managing agent, and has agreed to pay Bank of America, as Administrative Agent under the Credit Facilities, an annual administrative fee. Parent also has agreed to pay certain of the expenses of the Co-Arrangers incurred in connection with the Bank Financing and to provide the Co- Arrangers, Citibank, as the Managing Agent, and their respective directors, officers, employees, and affiliates with customary indemnification. The Bank Financing will consist of two facilities which will be entered into prior to or concurrently with the consummation of the Offer. The credit facilities will consist of a 364-day unsecured revolving credit facility in the amount of $5 billion (the "Short-Term Facility") and a five-year unsecured revolving credit facility in the amount of $5 billion (the "Five-Year Facility"). The Short-Term Facility and the Five-Year Facility are collectively referred to as the "Credit Facilities." The Short-Term Facility will have a final maturity 364 days after the date of execution of the definitive financing agreement for the Short-Term Facility. There will be no required prepayments or scheduled reductions of availability of loans under the Credit Facilities. Revolving loans under the Credit Facilities will bear interest, at the option of Parent, at (i) a base rate equal to the higher of the rate announced from time to time by Bank of America as its reference rate or the daily Federal Funds rate plus 0.5%; (ii) the London interbank offered rate ("LIBOR") for one-, two-, three-, six- (or subject to the Banks' consent) twelve-month periods plus an interest rate margin based on the rating for senior, unsecured long-term debt of Parent announced from time to time by Standard & Poor's Corporation ("S&P") and Moody's Investor Services, Inc. ("Moody's"); (iii) a reserve- and FDIC insurance-adjusted rate for 30-,60-, 90-, or 180-day certificates of deposit (the "CD Rate") plus an interest rate margin based on the rating for senior, unsecured long-term debt of Parent announced from time to time by S&P and Moody's, and D&P; or (iv) a money market bid rate based on competitive bids solicited of the Banks and accepted by Parent pursuant to an auction mechanism under the Credit Facilities. The interest rate margins over LIBOR and the CD Rate range from .165% and .29%, respectively, to .31% and .435%, respectively, for the Short-Term Facility, and from .145% and .27%, respectively, to .50% and .625%, respectively, for the Five-Year Facility, depending on the level of such ratings. Interest will be payable quarterly in arrears based on a 365/366-day year for the reference rate used in determining the rate on base rate loans and will be payable semi-annually in arrears or at the end of the relevant interest period, whichever is sooner, based on a 360- day year and the actual number of days elapsed for LIBOR and CD Rate loans. Money market bid rate loans will bear interest at rates established on the basis of a bidding procedure and interest will be payable at such times as are determined by such procedures. Facility fees under the Credit Facilities will be payable to each Bank on the amount of its commitment, whether used or unused, based on the rating for senior, unsecured long-term debt of Parent announced from time to time by S&P and Moody's and D&P. The facility fees for the Short-Term Facility will range from .06% to .09% and the facility fees for the Five-Year Facility will range from .08% to .25%, depending on the level of such ratings. Each Bank's obligation to make loans under the Credit Facilities will be subject to, among other things, the negotiation, execution, and delivery of definitive financing agreements (collectively, the "Bank Financing Agreements"), and the compliance by Parent and Purchaser thereunder. The covenants in the Bank Financing Agreements will include but not be limited to covenants limiting the ability of Parent and certain of its subsidiaries to encumber certain of their assets, and a covenant not to exceed a maximum leverage ratio. It is anticipated that the Bank Financing Agreements will include terms, conditions, representations, warranties, covenants, indemnities, events of default, and other provisions customary in such agreements. Following closing of the Offer, it is anticipated that Parent will refinance all or a portion of the borrowings under the Credit Facilities contemplated herein with funds raised in the public or private securities markets. In the event the Offer has not been consummated by April 30, 1996 the Offer is conditioned upon obtaining the financing described herein (the "Financing Condition"). See Section 15. 10. BACKGROUND OF THE OFFER; THE MERGER AGREEMENT; THE SPIN-OFF; THE RIGHTS AGREEMENT. Reductions in the Federal defense budgets for research, development, test and evaluation and procurement over the last several years have caused continued pressures on participants in the aerospace/defense industry to consolidate in order to maintain critical mass and production economies. Both Parent and the Company have been active participants in the consolidation of the industry. In light of the anticipated continuation of the recent consolidations in the aerospace/defense industry, the management and Board of Directors of the Company have reviewed periodically the Company's strategic plans, including but not limited to the possibility of making acquisitions and potential internal investments and entering into joint ventures and business combinations with companies engaged in a similar or related business. Similarly, the management and Board of Directors of Parent have reviewed periodically Parent's strategic plans, including but not limited to the possibility of making acquisitions and potential internal investments and entering into joint ventures and business combinations with companies engaged in a similar or related business. On July 31, 1995, representatives of Bear Stearns met with Mr. Bernard L. Schwartz, the chairman and chief executive officer of the Company, to review certain recent developments in the defense industry, including certain current trends and opportunities with respect to the consolidation of the defense industry. At this meeting Mr. Schwartz stated to Bear Stearns that the Company might be willing to consider a possible transaction with Parent if Parent was similarly interested. On August 11, 1995 and again on August 24, 1995, representatives of Bear Stearns met with certain members of the senior management of Parent, including Mr. Daniel M. Tellep, Chairman of the Board and Chief Executive Officer of Parent, and Mr. Norman R. Augustine, the President of Parent, in order to also review developments in the defense industry. At these meetings representatives of Bear Stearns indicated that the Company might be willing to consider a possible transaction with Parent. On September 14, 1995, Mr. Augustine and Mr. Schwartz were attending a meeting at the Pentagon with certain government officials on an unrelated matter. After this meeting Mr. Augustine and Mr. Schwartz briefly discussed the general topic of a possible transaction between Parent and the Company and they agreed to meet at a subsequent date to discuss the matter further. Thereafter, on September 20, 1995, Mr. Augustine and Mr. Schwartz met to discuss the broad outlines of a possible transaction between Parent and the Company. On the following day, September 21, 1995, Mr. Tellep had a telephone conversation with Mr. Schwartz following up on the matters discussed at the meeting between Mr. Schwartz and Mr. Augustine the day before. On September 28, during a regularly-scheduled meeting of the Parent Board, Mr. Tellep informed the Parent Board of the discussions with senior management of the Company and members of Parent's management. During the course of discussions over September and October, the parties discussed various transaction structures, including a structure whereby the Company would sell its defense and systems integration-related businesses to Parent and spin-off the Space and telecommunications-related businesses of the Company to the Company's stockholders. In addition, during this period the parties initially discussed a possible stock-for-stock merger transaction involving only the defense-related businesses of the Company in which the Company's stockholders would receive stock consideration having a value of approximately $32 per share in a stock for stock transaction in a stock-for-stock transaction (assuming pooling-of-interests accounting treatment). At a meeting on October 31, 1995, and at a later meeting on November 8, 1995, representatives of both parties, including Messrs. Tellep, Augustine and Schwartz, met to further discuss the possibility of a transaction between Parent and the Company. In particular, the parties discussed certain management and organizational issues, as well as certain broad transaction valuation parameters. Messrs. Tellep, Augustine and Schwartz agreed that representatives of the two companies should meet to explore various possibilities. On November 17, 1995, and at subsequent meetings during the remainder of November (including meetings on November 27-28, 1995), members of the management of Parent and the Company, together with their respective legal counsel and representatives of Bear Stearns, met to discuss several different possible transaction structures and various financial, operational, accounting and legal issues relating to a transaction between Parent and the Company. The discussions at these meetings focused initially on structuring the proposed transaction as a stock-for-stock merger, but due to pooling-of-interests accounting and other concerns with such a transaction structure, the parties agreed to pursue an all-cash transaction instead. Additionally, the parties had preliminary discussions regarding the possibility of Parent acquiring a 20% equity interest in Loral Space. On December 1, 1995, during a special telephonic meeting of the Parent Board, Mr. Tellep updated the Parent Board with respect to the current discussions between senior management of the Company and members of Parent's management and discussed with the Parent Board certain of the business and other issues which had been raised in the course of those discussions. On December 4, 1995, Parent and the Company entered into a Confidentiality and Standstill Agreement (the "Confidentiality and Standstill Agreement"), relating to, among other things, the information to be provided by each company to the other and limiting the ability of each party for three years to acquire any voting securities or assets of, or solicit proxies or make a public announcement of a proposal for any extraordinary transaction with respect to, the other party. Parent and the Company subsequently obtained various financial and other information regarding each other's business. At a meeting on December 5, 1995, Messrs. Tellep, Augustine and Schwartz, and Mr. Frank C. Lanza, the President and Chief Operating Officer of the Company, met to further discuss the proposed transaction between Parent and the Company, and various operational and management issues related thereto. On the same day, other officers and certain legal representatives of the two companies, as well as representatives of Bear Stearns, met to discuss structure and business issues, and commenced financial due diligence. On December 7, 1995, during a regularly-scheduled meeting of the Parent Board, Parent's management provided the members of the Parent Board with an update of the recent discussions between the senior management of the Company and members of Parent's management. Representatives of Bear Stearns also reviewed with the Parent Board various financial and industry-related issues relating to a possible transaction with the Company. During this period, meetings also occurred between certain members of the management of Parent, the Company and representatives of Bear Stearns to continue negotiating price and to discuss, among other things, various organizational and operational aspects of a possible transaction. In addition, during this period the legal representatives of each company met to discuss, among other things, the possible structure of a transaction and related legal issues. At meetings held in early December, Messrs. Tellep, Augustine and Schwartz, together with representatives of Bear Stearns and certain legal counsel of both parties, continued their discussions as to specific organizational and operational issues related to the proposed transaction. Although the parties had made progress at these meetings, the parties acknowledged that there were still very significant issues relating to a proposed transaction that were not yet resolved and that further study by each party of the various issues which had been raised by the proposed transaction would be beneficial. On December 15, 1995, at a special telephonic meeting of the Parent Board, Parent's management provided the members of the Parent Board with a further update of the recent discussions between the senior management of the Company and members of Parent's management, and the outstanding issues between the parties relating to price, management structure and various other matters. During the week commencing December 18, 1995, Parent and its legal advisers delivered initial drafts of the principal transaction documents to the Company and its legal advisers, and over the next two weeks the parties and their respective legal counsel met to discuss and negotiate with respect to the principal transaction documents. At subsequent meetings on December 21, 1995 and December 22, 1995 involving Messrs. Tellep, Augustine and Schwartz and various other members of the management of both Parent and the Company, along with representatives of Bear Stearns and certain legal counsel to Parent and the Company, the parties continued to discuss the structure of the proposed transaction, various operational and management issues relating to the transaction, and various price, timing and other significant terms and conditions related thereto. Although substantial progress was made at these latter meetings with respect to certain outstanding issues relating to the proposed transaction, certain issues remained unresolved. Commencing on January 2, 1996, members of Parent management met with members of the Company's management to review various information relating to the Company and to conduct a detailed due diligence review relating to the proposed transaction. In addition, during this period, legal representatives of each company and various outside financial and accounting advisors of Parent and the Company met to conduct business, financial, accounting and legal due diligence, to discuss outstanding legal and other issues and to continue to negotiate the terms of the Merger Agreement, the Distribution Agreement and the other transaction documents. At a special meeting of the Parent Board on January 7, 1996, a presentation regarding a possible transaction with the Company was made to the Parent Board by senior management. The presentation to and discussion by the Parent Board was wide-ranging and included, among other things, a review of (i) management's current view of the financial condition and prospects of the Company and Parent; (ii) the strategic value of the proposed transaction and the possible effects of the transaction on Parent's stockholders, operations, customers and future growth and its financial condition and prospects; and (iii) the current state of the industry consolidation and potential consolidation opportunities and trends in the foreseeable future. A review of the Company's organization, businesses, management and financials was provided to the Parent Board, together with a discussion of the potential strategic benefits of the proposed transaction. A summary of the financial implications was also provided, as well as a comparison of the transaction to other strategic alternatives available to Parent. In addition, Bear Stearns presented its views as to possible market reactions and competitive responses to the potential transaction. The General Counsel of the Company and one of the representatives of Parent's outside legal advisors also reviewed with Parent's Board the duties of the directors in considering such transaction and various legal issues relating to the proposed transaction. In addition, Bear Stearns rendered its written opinion to the Parent Board that the Offer, the Merger and the acquisition of twenty percent (20%) equity interest in Loral Space, taken as a whole, were fair from a financial point of view to the stockholders of Parent. After receiving such advice and after reviewing various additional information relating to the transaction, the Parent Board unanimously approved the terms and conditions of the proposed transaction with the Company, including the terms and conditions of the Merger Agreement, the Distribution Agreement and the other transaction documents contemplated thereby. The parties executed the Merger Agreement and the Distribution Agreement as of January 7, 1996 and publicly announced the transaction on January 8, 1996. On January 12, 1996, Purchaser commenced the Offer. The following is a summary of certain provisions of the Merger Agreement. A copy of the Merger Agreement (with certain Exhibits omitted) is attached hereto as Exhibit A and is incorporated herein by reference. The following summary is qualified in its entirety by reference to the Merger Agreement. The Offer. The Merger Agreement provides for the making of the Offer by the Purchaser. The Purchaser has agreed to accept for payment and pay for all Shares tendered pursuant to the Offer as soon as practicable following the Expiration Date and to extend the Offer until immediately following the Spin- Off Record Date and the expiration or termination of any applicable waiting period under the Antitrust Laws. The obligation of Purchaser to accept for payment and pay for Shares tendered pursuant to the Offer is subject to (i) the satisfaction or waiver of all of the conditions to the Spin-Off, (ii) the tender and non-withdrawal of Shares which, when added to the Shares then beneficially owned by Parent, constitutes two-thirds of the outstanding Shares and represents two-thirds of the voting power of the outstanding Shares on a fully diluted basis, and (iii) the satisfaction of certain other conditions described in Section 15. The Purchaser has agreed that, without the written consent of the Company, no amendment to the Offer may be made which changes the form of consideration to be paid or decreases the price per Share, the number of Shares sought in the Offer or which imposes additional conditions to the Offer other than those described in Section 15 or amends any other term of the Offer in any manner materially adverse to holders of Shares. The Merger. The Merger Agreement provides that, following the purchase of Shares pursuant to the Offer, and the satisfaction or waiver of the other conditions to the Merger, the Purchaser will be merged with and into the Company. The Merger will become effective at such time (the "Effective Time") as a certificate of merger or, if applicable, a certificate of ownership and merger, is filed with the Secretary of State of the State of New York in the manner required by the New York Business Corporation Law (the "NYBCL"). At the Effective Time, (i) except as provided in (ii) below, each Share issued and outstanding immediately prior to the Effective Time will be converted into the right to receive $38.00 in cash, or any higher price paid per Share in the Offer, without interest (the "Merger Price"); (ii) (a) each Share held in the treasury of the Company or held by any subsidiary of the Company (other than a subsidiary that will be owned directly or indirectly by the Company following the Spin-Off (each such company a "Retained Subsidiary")) and each Share held by Parent or any subsidiary of Parent immediately prior to the Effective Time will be cancelled and retired and cease to exist; provided, that Shares held beneficially or of record by any plan, program or arrangement sponsored or maintained for the benefit of employees of Parent or the Company or any subsidiaries thereof will not be deemed to be held by Parent or the Company regardless of whether Parent or the Company has, directly or indirectly, the power to vote or control the disposition of such shares; (b) each Share held by any holder who has not voted in favor of the Merger and has delivered a written objection to the Merger and demanded fair value with respect to such Share in accordance with Section 623 of the NYBCL will not be converted into or be exchangeable for the right to receive the Merger Price (the "Dissenting Shares"); and (iii) each share of common stock of the Purchaser issued and outstanding immediately prior to the time of the Effective Date will be converted into and exchangeable for one share of common stock of the Surviving Corporation. The Company will take all actions (including, but not limited to, obtaining any and all consents from employees to the matters contemplated by Section 2.10 of the Merger Agreement) necessary to provide that all outstanding options and other rights to acquire Shares ("Stock Options") granted under any stock option plan, program or similar arrangement of the Company or any subsidiary of the Company, each as amended (the "Option Plans"), will become fully exercisable and vested on the date (the "Vesting Date") which will be set by the Company and which, in any event, shall be not less than 30 days prior to the consummation of the Offer, whether or not otherwise exercisable and vested. All Stock Options which are outstanding immediately prior to Purchaser's acceptance for payment and payment for Shares tendered pursuant to the Offer will be cancelled as of the consummation of the Offer and the holders thereof (other than holders who are subject to the reporting requirements of Section 16(a) of the Exchange Act) will be entitled to receive from the Company, for each Share subject to such Stock Option, (1) an amount in cash equal to the difference between the Merger Price and the exercise price per share of such Stock Option, which amount will be payable upon consummation of the Offer, plus (2) one share of common stock, par value $0.01 per Share of Loral Space ("Loral Space Common Stock" or "Spinco Common Stock"), which will be held by an escrow agent pending delivery on the Distribution Date. All applicable withholding taxes attributable to the payments made hereunder or to distributions contemplated hereby will be deducted from the amounts payable under clause (1) above and all such taxes attributable to the exercise of Stock Options on or after the Vesting Date will be withheld from the proceeds received in the Offer or the Merger, as the case may be, in respect of the Shares issuable on such exercise. The Company will take all actions (including, but not limited to, obtaining any and all consents from employees to the matters contemplated by the Merger Agreement) necessary to provide that all restrictions on transferability with respect to each Share which is granted pursuant to the Company's 1987 Restricted Stock Purchase Plan (the "1987 Plan") and which is outstanding and not vested on the Vesting Date will lapse, and each such Share will become free of restrictions as of the Vesting Date. All applicable withholding taxes attributable to the vesting of restricted Shares will be withheld from the proceeds received in respect of such Shares in the Offer or the Merger, as the case may be. Except as provided in the Merger Agreement or as otherwise agreed to by the parties and to the extent permitted by the Option Plans and the 1987 Plan, (i) the Option Plans and the 1987 Plan will terminate as of the Effective Time and the provisions in any other plan, program or arrangement, providing for the issuance or grant by the Company or any of its subsidiaries of any interest in respect of the capital stock of the Company or any of its subsidiaries will be deleted as of the Effective Time and (ii) the Company will use all reasonable efforts to ensure that following the Effective Time no holder of Stock Options or any participant in the Option Plans or any other such plans, programs or arrangements will have any right thereunder to acquire any equity securities of the Company, the Surviving Corporation or any subsidiary thereof. The Merger Agreement provides that the restated certificate of incorporation and by-laws of the Company at the Effective Time will be the certificate of incorporation and by-laws of the Surviving Corporation until amended in accordance with applicable law; provided, that promptly following the Effective Time, the certificate of incorporation of the Company will be amended to change the name of the Surviving Corporation so that the word "Loral" will be deleted therefrom. The Merger Agreement also provides that the directors and officers of the Purchaser at the Effective Time will be the initial directors and officers of the Surviving Corporation and will hold office from the Effective Time until their respective successors are duly elected or appointed and qualify in the manner provided in the certificate of incorporation and by-laws of the surviving corporation, or as otherwise provided by applicable law. Recommendation. In the Merger Agreement, the Company states that the Board of Directors has unanimously (i) determined that the Offer, the Merger and the Spin-Off are fair to and in the best interests of the stockholders of the Company and (ii) resolved to recommend acceptance of the Offer and approval and adoption of the Merger Agreement and the Merger by the stockholders of the Company. Interim Agreements of Parent, Purchaser and the Company. Pursuant to the Merger Agreement, the Company has covenanted and agreed that, during the period from the date of the Merger Agreement to the consummation of the Offer and until such time as the directors designated by Parent in accordance with the Merger Agreement constitute in their entirety a majority of the Company's Board of Directors (the "Board Reorganization"), the Company and its subsidiaries (other than Loral Space and the Loral Space Companies (as defined below)) will each conduct its operations according to its ordinary course of business, consistent with past practice, and will use its commercially reasonable efforts to (i) preserve intact its business organization, (ii) maintain its material rights and franchises, (iii) keep available the services of its officers and key employees, and (iv) keep in full force and effect insurance comparable in amount and scope of coverage to that maintained as of the date of the Merger Agreement (collectively the "Ordinary Course Obligations"); provided, that Loral Space and the Loral Space Companies will comply with the Ordinary Course Obligations to the extent that non-compliance therewith could adversely affect the Retained Business or adversely affect (or materially delay) the consummation of the Offer, the Merger or the Spin-Off. "Loral Space Companies" means Loral General Partner, Inc., a Delaware corporation ("LGP"), SS/L, Globalstar, Globalstar Telecommunications Limited, a company organized under the laws of Bermuda ("GTL"), Loral Globalstar, L.P., a Delaware limited partnership, Loral Globalstar Limited, a Cayman Islands corporation ("LGL"), K&F Industries, Inc., a Delaware corporation ("K&F"), Loral/QUALCOMM Partnership, L.P., a Delaware limited partnership ("LQP"), Loral/QUALCOMM Satellite Services. L.P., a Delaware limited partnership ("LQSS"), Continental Satellite Corporation, a California corporation ("Continental"), Loral Travel Services Inc., a Delaware corporation, Loral Properties Inc., a Delaware corporation and each of the subsidiaries of such companies. Without limiting the generality of and in addition to the foregoing, and except as otherwise contemplated by the Merger Agreement, the Tax Sharing Agreement (as defined below) or the Distribution Agreement (the Tax Sharing Agreement together with the Distribution Agreement, the "Ancillary Agreements"), prior to the consummation of the Offer and the Board Reorganization, neither the Company nor any of its subsidiaries (other than Loral Space and the Loral Space Companies insofar as any action of the type specified below could not adversely affect the Retained Business and could not adversely affect (or materially delay) the Offer, the Spin-Off or the Merger) will, without the prior written consent of Parent: (a) amend its charter or by-laws other than filing a Certificate of Amendment of the Company's restated certificate of incorporation as contemplated by the Rights Agreement; (b) subject to certain exceptions, authorize for issuance, issue, sell, deliver or agree to commit to issue, sell or deliver (whether through the issuance or granting of options, warrants, commitments, subscriptions, rights to purchase or otherwise) any stock of any class or any other securities or amend any of the terms of any such securities or agreements (subject to certain exceptions); (c) split, combine or reclassify any shares of its capital stock, declare, set aside or pay any dividend or other distribution (whether in cash, stock or property or any combination thereof) in respect of its capital stock (other than pursuant to the Rights Agreement) or redeem or otherwise acquire any of its securities or any securities of its subsidiaries (other than pursuant to the Rights Agreement); provided, that the Company may declare and pay to holders of Shares regular quarterly dividends of not more than $0.08 per Share on the dividend declaration and payment dates normally applicable to the Shares; (d) (i) pledge or otherwise encumber shares of Capital Stock of the Company or any of its subsidiaries; or (ii) except in the ordinary course of business consistent with past practices, (A) incur, assume or prepay any long-term debt or incur, assume, or prepay letters of credit or any material short-term debt; (B) assume, guarantee, endorse or otherwise become liable or responsible (whether directly, contingently or otherwise) for any material obligations of any other person except wholly owned subsidiaries of the Company; (C) make any material loans, advances or capital contributions to, or investments in, any other person; (iii) change the practices of the Company and its Retained Subsidiaries with respect to the timing of payments or collections; or (D) mortgage or pledge any assets of the Retained Business, or create or permit to exist any material lien thereupon; (e) except (i) as disclosed in the Disclosure Schedule to the Merger Agreement and except for entered into in the ordinary course of business consistent with past practices, (ii) as required by law or (iii) as specifically provided for in the Merger Agreement or Distribution Agreement enter into, adopt or materially amend any bonus, profit sharing, compensation, severance, termination, stock option, stock appreciation right, restricted stock, performance unit, pension, retirement, deferred compensation, employment, severance or other employee benefit agreements, trusts, plans, funds or other arrangements of or for the benefit or welfare of any Retained Employee (i.e., all current and former officers and employees of the Company and its subsidiaries, other than Loral Space employees) (or any other person for whom the Retained Business will have liability), or (except for normal increases in the ordinary course of business that are consistent with past practices) increase in any manner the compensation or fringe benefits of any Retained Employee (or any other person for whom the Retained Business will have liability), or pay any benefit not required by any existing plan and arrangement (including, without limitation, the granting of stock options, stock appreciation rights, shares of restricted stock or performance units) or enter into any contract, agreement, commitment or arrangement to do any of the foregoing; (f) transfer, sell, lease, license or dispose of any lines of business, subsidiaries, divisions, operating units or facilities (other than facilities currently closed or currently proposed to be closed) relating to the Retained Business outside the ordinary course of business or enter into any material commitment or transaction with respect to the Retained Business outside the ordinary course of business; (g) acquire or agree to acquire, by merging or consolidating with, by purchasing an equity interest in or a portion of the assets of, or by any other manner, any business or any corporation, partnership, association or other business organization or division thereof, or otherwise acquire or agree to acquire any assets of any other person (other than the purchase of assets in the ordinary course of business and consistent with past practice), in each case where such action would be material to the Retained Business; (h) except as may be required by law or as disclosed in the Disclosure Schedule to the Merger Agreement, take any action to terminate or materially amend any of its pension or retiree medical plans with respect to or for the benefit of Retained Employees or any other person for whom the Retained Business will have liability; (i) materially modify, amend or terminate (1) any significant contract related to the Retained Business or waive any material rights or claims of the Retained Business, except in the ordinary course of business consistent with past practice; or (2) any contract having an aggregate contract value of $100 million or greater, whether or not in the ordinary course of business consistent with past practice, unless such modification, amendment or termination does not materially diminish the projected profit or materially increase the projected loss anticipated from such contract; provided, that nothing contained in this clause shall limit the Company and its subsidiaries in connection with programs or contracts with respect to which Parent or a subsidiary of Parent has submitted, or is reasonably expected to submit, a competing bid; provided further, that the provisions of this clause will not apply to any arrangement, agreement or contract proposal previously submitted by the Company or a subsidiary thereof which proposal, upon acceptance thereof, cannot be revised or withdrawn; (j) effect any material change in any of its methods of accounting in effect as of March 31, 1995, except as may be required by law or generally accepted accounting principles; (k) except as expressly provided in the Merger Agreement, amend, modify, or terminate the Rights Agreement or redeem any Rights thereunder; provided, that if the Board of Directors of the Company by a majority vote determines in its good faith judgment, based as to legal matters upon the written opinion of legal counsel, that the failure to redeem any Rights would likely constitute a breach of the Board's fiduciary duty, the Rights may be redeemed; (l) enter into any material arrangement, agreement or contract that individually or in the aggregate with other material arrangements, agreements and contacts entered into after the date of the Merger Agreement, the Company reasonably expects will adversely affect in a significant manner the Retained Business after the date of the Merger Agreement; provided, that nothing contained in this clause will limit the Company and its subsidiaries from submitting bids for programs or contracts with respect to which the Company reasonably expects Parent or a subsidiary of Parent to submit a bid; and (m) enter into a legally binding commitment with respect to, or any agreement to take, any of the foregoing actions. Acquisition Proposals. In the Merger Agreement, the Company has agreed that the Company and its officers, directors, employees, representatives and agents will immediately cease any existing discussions or negotiations with any parties conducted prior to the date of the Merger Agreement with respect to any Acquisition Proposal (as defined below). The Company and its subsidiaries may not, and will use their best efforts to cause their respective officers, directors, employees and investment bankers, attorneys, accountants or other agents retained by the Company or any of its subsidiaries not to, (i) initiate or solicit, directly or indirectly, any inquiries with respect to, or the making of any Acquisition Proposal, or (ii) except as permitted below, engage in negotiations or discussions with, or furnish any information or data to any Third Party (as defined below) (other than the transactions contemplated by the Merger Agreement and by the Ancillary Agreements). Notwithstanding anything to the contrary contained in the Merger Agreement, the Company may furnish information to, and participate in discussions or negotiations (including, as a part thereof, making any counter-proposal) with, any Third Party which submits an unsolicited written Acquisition Proposal to the Company if the Company's Board of Directors by a majority vote determines in its good faith judgment, based as to legal matters upon the written opinion of legal counsel, that the failure to furnish such information or participate in such discussions or negotiations would likely constitute a breach of the Board's fiduciary duties under applicable law; provided, that nothing in the Merger Agreement will prevent the Board from taking, and disclosing to the Company's shareholders, a position contemplated by Rules 14D-9 and 14e-2 promulgated under the Exchange Act with regard to any tender offer; provided further, that the Board will not recommend that the shareholders of the Company tender their Shares in connection with any such tender offer unless the Board by a majority vote determines in its good faith judgment, based as to legal matters on the written opinion of legal counsel, that failing to take such action would likely constitute a breach of the Board's fiduciary duty; provided further, that the Company may not enter into any agreement with respect to any Acquisition Proposal except concurrently with or after the termination of the Merger Agreement (except with respect to confidentiality and standstill agreements to the extent expressly permitted below). The Company will promptly provide Parent with a copy of any written Acquisition Proposal received and a written statement with respect to any non-written Acquisition Proposal received, which statement shall include the identity of the parties making the Acquisition Proposal and the terms thereof. The Company will promptly inform Parent of the status and content of any discussions regarding any Acquisition Proposal with a Third Party. In no event will the Company provide non-public information regarding the Retained Business to any Third Party making an Acquisition Proposal unless such party enters into a confidentiality agreement containing provisions designed to reasonably protect the confidentiality of such information. In the event that following the date of the Merger Agreement the Company enters into a confidentiality agreement with any Third Party which does not include terms and conditions which are substantially similar to the "standstill" provisions of the confidentiality agreement between the Company and Parent, dated as of December 4, 1995, then Parent and its affiliates will be released from their obligations under such standstill provisions to the same extent as such Third Party. "Acquisition Proposal" means any bona fide proposal, whether in writing or otherwise, made by a Third Party to acquire beneficial ownership (as defined in Rule 13(d) under the Exchange Act) of all or a material portion of the assets of, or any material equity interest in, any of the Company, a Retained Subsidiary or the Retained Business pursuant to a merger, consolidation or other business combination, sale of shares of capital stock, sale of assets, tender offer or exchange offer or similar transaction involving either the Company, a Retained Subsidiary or the Retained Business, including, without limitation, any single or multi-step transaction or series of related transactions which is structured to permit such Third Party to acquire beneficial ownership of any material portion of the assets of, or any material portion of the equity interest in, either the Company, a Retained Subsidiary or the Retained Business (other than the transactions contemplated by the Merger Agreement and the Ancillary Agreements); provided, however, that the term "Acquisition Proposal" does not include any transactions which relate solely to the businesses to be owned by Loral Space and the Loral Space Companies following the Spin-Off and which do not have a material adverse effect on the consummation of the Offer, the Merger, the Spin-Off or the transactions contemplated by the Merger Agreement. Board Representation. The Merger Agreement provides that in the event that Purchaser acquires at least a majority of the Shares outstanding pursuant to the Offer, Parent will be entitled to designate for appointment or election to the Company's Board of Directors, upon written notice to the Company, such number of persons so that such designees of Parent constitute the same percentage (but in no event less than a majority) of the Company's Board of Directors (rounded up to the next whole number) as the percentage of Shares acquired in connection with the Offer. Prior to the consummation of the Offer, the Board of Directors of the Company will obtain the resignation of such number of directors as is necessary to enable such number of Parent designees to be so elected. In connection therewith, the Company will mail to the stockholders of the Company the information required by Section 14(f) of the Exchange Act and Rule 14f-1 thereunder unless such information has previously been provided to such stockholders in the Schedule 14D-9. Parent and the Purchaser will provide to the Company in writing, and be solely responsible for, any information with respect to such companies and their nominees, officers, directors and affiliates required by such Section and Rule. Notwithstanding the foregoing, the parties to the Merger Agreement will use their respective best efforts to ensure that at least three of the members of the Company's Board of Directors will, at all times prior to the Effective Time be, Continuing Directors (as defined in the Merger Agreement). Miscellaneous Agreements. Pursuant to the Merger Agreement, the Company has agreed to amend, and has amended, the Rights Agreement as necessary (i) to prevent the Merger Agreement or the transactions contemplated by the Merger Agreement or Distribution Agreement (including, without limitation, the publication or other announcement of the Offer and the consummation of the Offer and the Merger) from resulting in the distribution of separate rights certificates or the occurrence of a "Distribution Date" under the Rights Agreement or being deemed to be a "Triggering Event" or a "Section 13 Event" under the Rights Agreement and (ii) to provide that neither Parent nor the Purchaser will be deemed to be an "Acquiring Person" under the Rights Agreement by reason of such transactions. Pursuant to the Merger Agreement, if required under applicable law in order to consummate the Merger, the Company, acting through its Board of Directors, will, in accordance with applicable law, its restated certificate of incorporation and by-laws and the rules and regulations of the NYSE: (a) duly call, give notice of, convene and hold a special meeting of its stockholders as soon as practicable following the consummation of the Offer for the purpose of considering and taking action on the Merger Agreement (the "Stockholders' Meeting"); (b) subject to its fiduciary duties under applicable laws as advised by counsel, include in the Information Statement prepared by the Company for distribution to stockholders of the Company in advance of the Stockholders' Meeting in accordance with Regulation 14C promulgated under the Exchange Act (the "Information Statement") the recommendation of its Board of Directors referred to above; and (c) use its best efforts to (i) obtain and furnish the information required to be included by it in the Information Statement, and, after consultation with Parent, respond promptly to any comments made by the Commission with respect to the Information Statement and any preliminary version thereof and cause the Information Statement to be mailed to its stockholders following the consummation of the Offer and (ii) obtain the necessary approvals of the Merger Agreement by its stockholders. Parent will provide the Company with the information concerning Parent and Purchaser required to be included in the Information Statement and will vote, or cause to be voted, all Shares owned by it or its subsidiaries in favor of approval and adoption of the Merger Agreement. In accordance with the Merger Agreement, simultaneously with the execution of the Merger Agreement, the Company and certain of its subsidiaries entered into the Distribution Agreement. Immediately prior to the Spin-Off Record Date, the Company, Loral Space and certain other parties will enter into the Tax Sharing Agreement. From and after the Effective Time, Parent shall cause the Surviving Corporation to perform any and all obligations and agreements of the Company set forth in the Merger Agreement or in the Ancillary Agreements or in any other agreements contemplated in the Merger Agreement or in the Ancillary Agreements. Parent and Purchaser accept and agree that, subject to the provisions of the Distribution Agreement, the form of certificate of incorporation and by-laws of Loral Space adopted in contemplation of the Spin- Off will be as agreed to by the Company and Loral Space in their sole discretion; provided, that nothing in the certificates of incorporation and by-laws will adversely affect or otherwise limit (i) Loral Space's ability to perform its obligations under the Ancillary Agreements or the other agreements contemplated by the Distribution Agreement or (ii) the Company's or its affiliates' rights under the Stockholders Agreement. In no event shall Parent or Purchaser or any of their subsidiaries be entitled to receive any shares of Loral Space Common Stock as a distribution with respect to Shares purchased upon consummation of the Offer. If, for any reason, any shares of Spinco Common Stock distributed in the Spin-Off are received by Parent or Purchaser or any of their subsidiaries with respect to Shares acquired by Purchaser in the Offer, then Parent or Purchaser will convey, on behalf of the Company, such shares of Loral Space to the stockholders of the Company who would have otherwise received such shares of Loral Space pursuant to the Distribution Agreement; provided, that the foregoing provisions will not apply with respect to Shares held by Parent or any of its subsidiaries prior to the date of the Merger Agreement. If the Company reasonably determines that the Spin-Off may not be effected without registering the shares of common stock of Spinco to be distributed in the Spin-Off pursuant to the Securities Act, the Company, Parent and Purchaser, as promptly as practicable, will use their respective best efforts to cause the shares of Loral Space to be registered pursuant to the Securities Act and thereafter effect the Spin-Off in accordance with the terms of the Distribution Agreement including, without limitation, by preparing and filing on an appropriate form a registration statement under the Securities Act covering the shares of Loral Space and using their respective best efforts to cause such registration statement to be declared effective and preparing and making such other filings as may be required under applicable state securities Laws. Parent will, and will cause the Surviving Corporation to, treat the Spin-Off for purposes of all federal and state taxes as an integrated transaction with the Offer and the Merger and thus report the Spin-Off as a constructive redemption of a number of Shares equal in value to the value of the Loral Space Common Stock distributed in the Spin-Off. Employment Agreements. Prior to the Spin-Off, the Company will use its best efforts to, and will use its best efforts to cause its subsidiaries to, assign to Loral Space or subsidiaries of Loral Space or terminate all employment agreements with employees of the Company who are not Retained Employees (the "Employment Agreements") and all individual severance agreements with employees of the Company who are not Retained Employees (the "Severance Agreements"). The parties acknowledge and agree that, whether or not such Employment Agreements and Severance Agreements are so assigned or terminated, all liabilities under or arising from such Employment Agreements and Severance Agreements other than as expressly contemplated in the Distribution Agreement or the Merger Agreement will be deemed to be Loral Space Liabilities (as defined in Section 10), with respect to which Loral Space will indemnify the Company and Parent as provided therein. Parent acknowledges and agrees that all employment agreements and severance agreements with the Retained Employees will be binding and enforceable obligations of the Surviving Corporation, except as the parties thereto may otherwise agree. The parties to the Merger Agreement acknowledge and agree that all liabilities under or arising from such agreements with the Retained Employees from and after the consummation of the Offer will be deemed to be Company Liabilities (as defined in the Distribution Agreement), with respect to which the Company and Parent will indemnify Spinco as provided therein. Fiscal Year Ended March 31, 1996 Bonus. Parent agrees to cause the Company to pay in cash to each Company Bonus Employee (as defined below) to the extent not previously paid, all bonus compensation payable with respect to the fiscal year of the Company ending March 31, 1996 under any bonus program of the Company or its subsidiaries in which such Company Bonus Employee participated prior to the consummation of the Offer or under any employment agreement. Such bonus compensation will be paid at the time or times that comparable bonus compensation was paid to a similarly situated employee after March 31, 1995 with respect to the fiscal year ended March 31, 1995. Bonus compensation which is based on objective criteria will be calculated and paid in accordance with such criteria. With respect to bonus compensation which is wholly or partially discretionary, such bonus compensation will be determined and paid on a basis consistent with past practices of the Company. Subject to the conditions regarding the aggregate amount of discretionary bonuses as described below, the amount of discretionary bonus compensation to be paid to any Company Bonus Employee will be determined by the Chief Executive Officer of the Company in office immediately prior to the date of the consummation of the Offer or by his designee. "Company Bonus Employee" means a person (other than any current or former officer or employee of Loral Space, any Loral Space Company or the Loral Space Business (the "Loral Space Employees")), employed by the Company or any of its subsidiaries immediately prior to the date the Offer is consummated, who was eligible to receive a bonus under any bonus program of the Company or any of its subsidiaries in effect at December 31, 1995, or under any employment agreement in effect on such date, with respect to the fiscal year ending March 31, 1996. Spinco agrees to pay in cash to each Loral Space Bonus Employee (as defined below) to the extent not previously paid, all bonus compensation payable with respect to the fiscal year of the Company ending March 31, 1996 under any bonus program of the Company or its subsidiaries in which such Loral Space Bonus Employee participated prior to the consummation of the Offer or under any employment agreement. Such bonus compensation will be paid at the time or times that comparable bonus compensation was paid to any similarly situated employee after March 31, 1995 with respect to the fiscal year ended March 31, 1995. Bonus compensation which is based on objective criteria will be calculated and paid in accordance with such criteria. With respect to bonus compensation which is wholly or partially discretionary, such bonus compensation will be determined and paid on a basis consistent with past practices of the Company. Subject to the following paragraph, the amount of discretionary bonus compensation to paid to any Spinco Bonus Employee will be determined by Loral Space. "Loral Space Bonus Employee" means any Loral Space Employee employed by the Company or any of its subsidiaries immediately prior to the date the Offer is consummated, who was eligible to receive a bonus under any bonus program of the Company or any of its subsidiaries in effect at December 31, 1995, or under any employment agreement in effect on such date, with respect to the fiscal year ending March 31, 1996. Upon payment of such bonuses to Loral Space Bonus Employees, Spinco shall submit to Parent a statement showing the individual and aggregate bonus amounts paid to Loral Space Bonus Employees, and Parent will thereupon promptly pay to Loral Space (or cause the Company to pay to Loral Space) the aggregate amount of bonuses so paid; provided, that if the consummation of the Offer occurs prior to March 31, 1996, the amount of such reimbursement will be a prorated amount of the aggregate bonus amounts so paid, based on a fraction, the numerator of which is the number of days of the Company's fiscal year ending March 31, 1996 which had elapsed as of the consummation of the Offer, and the denominator of which is 365. The aggregate amount of discretionary bonuses payable to all Company Bonus Employees and Loral Space Bonus Employees as a group for the fiscal year ending March 31, 1996 will not exceed a dollar amount to be mutually agreed to by the Chief Executive Officer of Parent and the Chief Executive Officer of Loral Space; provided, that in the event the Chief Executive Officer of Parent and the Chief Executive Officer of Loral Space cannot agree on such dollar amount, the maximum aggregate amount of discretionary bonuses payable to Company Bonus Employees and Spinco Bonus Employees shall be based on the aggregate amount of discretionary bonuses paid to all such employees for the Company's fiscal year ending March 31, 1995, increased by a percentage equal to the average of the percentage increases in discretionary bonuses paid to all such employees over the Company's three fiscal years ending March 31, 1993, 1994 and 1995. Transaction Bonus. Pursuant to the "change of control" provisions of the Restated Employment Agreement between the Company and Bernard L. Schwartz dated April 1, 1990, as amended June 14, 1994, the Company will, subject to the following sentences of this paragraph, make a cash payment to Mr. Schwartz upon consummation of or following the Offer, calculated in accordance with such agreement, less $18 million waived by Mr. Schwartz. The net amount payable to Mr. Schwartz, taking this waiver into account, is approximately $18 million. The Company also may make a cash payment of a bonus (inclusive of the amount paid to Mr. Schwartz pursuant to the preceding sentence, the "Transaction Bonus") to Transaction Bonus Employees (as defined below) other than Mr. Schwartz; provided, that the aggregate Transaction Bonus paid will not exceed $40 million; and provided further, that the Transaction Bonus payable to any Transaction Bonus Employee will not exceed the maximum amount which can be paid at such time without such amounts being treated as "excess parachute payments" within the meaning of Section 280G of the Code, taking into account all payments made on or prior to the time the Transaction Bonus is paid (including the value of accelerated vesting of stock options or restricted shares granted under the 1987 Plan determined in accordance with proposed regulations promulgated under Section 280G of the Code) which constitute parachute payments for purposes of Section 280G of the Code. The Transaction Bonus may be paid by the Company, in its discretion, prior to, on or immediately following, the date the Offer is consummated. "Transaction Bonus Employee" means Mr. Schwartz and each person employed by the Company or any of its subsidiaries on or prior to the date the Offer is consummated who is selected by Mr. Schwartz to receive a Transaction Bonus. Employment Protection Agreements. The Company may provide for employment protection payments to be made to certain Company employees upon qualifying terminations of employment pursuant to "Employment Protection Agreements" and an "Employment Protection Plan" (each substantially in the forms attached to the Merger Agreement as Exhibits C and D, respectively; together, the "Employment Protection Arrangements") occurring after a change in control of the Company; provided that (i) neither the execution of the Merger Agreement nor the Distribution Agreement, nor any transaction contemplated thereby, will constitute a change in control of the Company for any purpose under the Employment Protection Arrangements or give rise to any rights thereunder and (ii) the Employment Protection Arrangements will terminate as of the consummation of the Offer and no rights thereunder will continue after the consummation of the Offer. Supplemental Severance Program. Prior to the Effective Time, the Company will adopt a severance plan substantially in the form attached to the Merger Agreement as Exhibit E (the "Supplemental Severance Plan") covering up to 150 employees of the Company or its subsidiaries selected by the Company prior to the Effective Time. The Supplemental Severance Program will provide enhanced severance benefits to Company employees upon a dismissal without "cause" or a voluntary termination for "good reason" within twenty-four months after the consummation of the Offer. The benefits under this program, which are payable in addition to a participant's regular severance benefits, will generally be equal to one year's base salary and bonus, plus the cost of acquiring continued welfare benefits coverage for a period of one year. Also, if a participant's regular severance benefits are reduced after the consummation of the Offer, the benefits payable under the program are increased by an equivalent amount. In no event may the payments made to any participant exceed the maximum amount which can be so paid without causing the payments to be treated as "excess parachute payments" for purposes of Section 280G of the Code. Employee Benefits. Except with respect to accruals under any defined benefit pension plans, Parent will, or will cause the Company to, give Retained Employees full credit for purposes of eligibility, vesting and determination of the level of benefits under any employee benefit plans or arrangements maintained by the Parent, the Company or any subsidiary of Parent or Company for such Retained Employees' service with the Company or any subsidiary of the Company to the same extent recognized by the Company immediately prior to the Effective Time. Parent will, or will cause the Company to, (i) waive all limitations as to pre-existing conditions, exclusions and waiting periods with respect to participation and coverage requirements applicable to the Retained Employees under any welfare plans that such employees may be eligible to participate in after the Effective Time, other than limitations or waiting periods that are already in effect with respect to such employees and that have not been satisfied as of the Effective Time under any welfare plan maintained for the Retained Employees immediately prior to the Effective Time, and (ii) provide each Retained Employee with credit for any co-payments and deductibles paid prior to the Effective Time in satisfying any applicable deductible or out-of-pocket requirements under any welfare plans that such employees are eligible to participate in after the Effective Time. Subject to the terms and conditions of the Merger Agreement and without limitation to the provisions below, Parent, Purchaser and the Company agree to use all reasonable efforts to take, or cause to be taken, all action, and to do, or cause to be done, all things reasonably necessary, proper or advisable under applicable laws and regulations to consummate and make effective the transactions contemplated by the Merger Agreement and the Ancillary Agreements (including, without limitation, (i) cooperating in the preparation and filing of the Offer documents, the Schedule 14D-9, the Form 10, the Information Statement and any amendments to any thereof; (ii) cooperating in making available information and personnel in connection with presentations, whether in writing or otherwise, to prospective lenders to Parent and Purchaser that may be asked to provide financing for the transactions contemplated by the Merger Agreement; (iii) taking of all action reasonably necessary, proper or advisable to secure any necessary consents or waivers under existing debt obligations of the Company and its subsidiaries or amend the notes, indentures or agreements relating thereto to the extent required by such notes, indentures or agreements or redeem or repurchase such debt obligations; (iv) contesting any pending legal proceeding relating to the Offer, the Merger or the Spin-Off; and (v) executing any additional instruments necessary to consummate the transactions contemplated by the Merger Agreement and the Ancillary Agreements). In case at any time after the Effective Time any further action is necessary to carry out the purposes of the Merger Agreement, the proper officers and directors of each party will use all reasonable efforts to take all such necessary action. Each of the Company, Parent and Purchaser shall cooperate and use their respective reasonable efforts to make all filings and obtain all consents and approvals of governmental authorities (including, without limitation, the Federal Communication Commission ("FCC")) and other third parties necessary to consummate the transactions contemplated by the Merger Agreement and the Ancillary Agreements. Each of the parties to the Merger Agreement will furnish to the other party such necessary information and reasonable assistance as such other persons may reasonably request in connection with the foregoing. In addition to and without limiting the agreements of Parent and Purchaser described in the immediately preceding paragraph, Parent, Purchaser and the Company will (i) take promptly all actions necessary to make the filings required of Parent, Purchaser or any of their affiliates under the applicable Antitrust Laws, (ii) comply at the earliest practicable date with any request for additional information or documentary material received by Parent, Purchaser or any of their affiliates from the Federal Trade Commission ("FTC") or the Antitrust Division of the Department of Justice (the "Antitrust Division") pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act") and from the Commission or other foreign governmental or regulatory authority pursuant to the Antitrust Laws, and (iii) cooperate with the Company in connection with any filing of the Company under applicable Antitrust Laws and in connection with resolving any investigation or other inquiry concerning the transactions contemplated by the Merger Agreement or the Ancillary Agreements commenced by any of the FTC, the Antitrust Division, state attorneys general, the Commission, or other foreign governmental or regulatory authorities. In furtherance and not in limitation of the covenants of Parent and Purchaser described above, Parent, Purchaser and the Company shall each use all reasonable efforts to resolve such objections, if any, as may be asserted with respect to the Offer, the Spin-Off, the Merger or any other transactions contemplated by the Merger Agreement or the Ancillary Agreements under any Antitrust Law. If any administrative, judicial or legislative action or proceeding is instituted (or threatened to be instituted) challenging the Offer, the Spin-Off, the Merger or any other transactions contemplated by the Merger Agreement or the Ancillary Agreements as violative of any Antitrust Law, Parent, Purchaser and the Company will each cooperate to contest and resist any such action or proceeding, and to have vacated, lifted, reversed or overturned any decree, judgment, injunction or other order (whether temporary, preliminary or permanent) (any such decree, judgment, injunction or other order is hereafter referred to as an "Order") that is in effect and that restricts, prevents or prohibits consummation of the Offer, the Spin-Off, the Merger or any other transactions contemplated by the Merger Agreement or the Ancillary Agreements, including, without limitation, by pursuing all reasonable avenues of administrative and judicial appeal. Parent and Purchaser will each also use their respective reasonable efforts to take all reasonable action, including, without limitation, agreeing to hold separate or to divest any of the businesses or assets of Parent or Purchaser or any of their affiliates, or, following the consummation of the Offer or the Effective Time, of the Company or any of the Retained Subsidiaries, as may be required (i) by the applicable governmental or regulatory authority (including without limitation the FTC, the Antitrust Division, any state attorney general or any foreign governmental or regulatory authority) in order to resolve such objections as such governmental or regulatory authority may have to such transactions under any Antitrust Law, or (ii) by any domestic or foreign court or other tribunal, in any action or proceeding brought by a private party or governmental or regulatory authority challenging such transactions as violative of any Antitrust Law, in order to avoid the entry of, or to effect the dissolution, vacating, lifting, altering or reversal of, any Order that has the effect of restricting, preventing or prohibiting the consummation of the Offer, the Spin-Off, the Merger or any other transactions contemplated by the Merger Agreement or the Ancillary Agreements; provided that Parent will not be required to take any action, divest any asset or enter into any consent decree if the taking of such action, disposing of such asset or entering into such decree would have a Significant Adverse Effect. "Significant Adverse Effect" means any change or effect that, in Parent's judgment, is reasonably likely to adversely affect in a substantial way the benefits and opportunities which Parent reasonably expects to receive from the acquisition of the Retained Business or from Parent's current business. Each of the Company, Parent and Purchaser will promptly inform the other party of any material communication received by such party from the FTC, the Antitrust Division, the Commission or any other governmental or regulatory authority regarding any of the transactions contemplated by the Merger Agreement. Parent and/or Purchaser will promptly advise the Company with respect to any understanding, undertaking or agreement (whether oral or written) which it proposes to make or enter into with any of the foregoing parties with regard to any of the transactions contemplated by the Merger Agreement. "Antitrust Law" means the Sherman Act, as amended, the Clayton Act, as amended, the HSR Act, the Federal Trade Commission Act, as amended, EC Merger Regulations and all other federal, state and foreign statutes, rules, regulations, orders, decrees, administrative and judicial doctrines, and other laws that are designed or intended to prohibit, restrict or regulate actions having the purpose or effect of monopolization or restraint of trade. Representations and Warranties. The Merger Agreement contains certain representations and warranties of the parties including, without limitation, representations by the Company as to organization, capitalization, authority relative to the Merger Agreement, consents and approvals, absence of certain changes concerning the Company's business, undisclosed liabilities, reports, offer documents, no default, litigation and compliance with law, employee benefit plans, assets and intellectual property, certain contracts and arrangements, taxes, Retained Business FCC licenses, labor matters, Rights Agreement and certain fees. Conditions to the Merger. Pursuant to the Merger Agreement, the obligations of each of Parent, the Purchaser and the Company to effect the Merger are subject to the satisfaction or waiver, at or prior to the Effective Time, of certain conditions, including: (a) if required by applicable law, the Merger Agreement will have been adopted by the affirmative vote of the stockholders of the Company by the requisite vote in accordance with applicable law; (b) no statute, rule, regulation, order, decree, or injunction will have been enacted, entered, promulgated or enforced by any court or governmental authority which prohibits or restricts the consummation of the Merger, (c) any waiting period applicable to the Merger under the Antitrust Laws will have terminated or expired and all approvals required under the Antitrust Laws will have been received; (d) the Spin-Off will have been consummated in all material respects; and (e) the Offer will not have been terminated in accordance with its terms prior to the purchase of any Shares. Except if the Purchaser has accepted for payment and paid for Shares validly tendered pursuant to the Offer or fails to accept for payment any Shares pursuant to the Offer in violation of the terms thereof, the obligation of the Company to effect the Merger is further subject to the satisfaction at or prior to the Effective Time of the following conditions: (a) the representations and warranties of Parent and the Purchaser contained in the Merger Agreement will be true and correct in all material respects at and as of the Effective Time as if made at and as of such time; and (b) each of Parent and the Purchaser will have performed in all material respects its obligations under the Merger Agreement required to be performed by it at or prior to the Effective Time pursuant to the terms thereof. Except if the Purchaser has accepted for payment and paid for Shares validly tendered pursuant to the Offer or fails to accept for payment any Shares pursuant to the Offer in violation of the terms thereof, the obligations of Parent and the Purchaser to effect the Merger are further subject to the satisfaction at or prior to the Effective Time of the following conditions: (a) the representations and warranties of the Company contained in the Merger Agreement will be true and correct in all material respects at and as of the Effective Time as if made at and as of such time; (b) the Company will have delivered to Purchaser certain legal opinions in connection with the Company's public indebtedness; and (c) the Company will have performed in all material respects each of its obligations under the Merger Agreement required to be performed by it at or prior to the Effective Time pursuant to the terms thereof. Termination. The Merger Agreement may be terminated and the Offer and the Merger may be abandoned at any time (notwithstanding approval of the Merger by the stockholders of the Company) prior to the Effective Time: (a) by mutual written consent of Parent, the Purchaser and the Company; (b) by Parent, Purchaser or the Company if any court of competent jurisdiction in the United States or other United States governmental body will have issued a final order, decree or ruling or taken any other final action restraining, enjoining prohibiting the consummation of the Offer, the Spin-Off or the Merger and such order, decree, ruling or other action is or shall have become nonappealable; (c) by Parent or Purchaser if due to an occurrence or circumstance which would result in a failure to satisfy any of the conditions set forth in Section 15, Purchaser will have (i) failed to commence the Offer within the time required by Regulation 14D under the Exchange Act, (ii) terminated the Offer, or (iii) failed to pay for Shares pursuant to the Offer prior to June 30, 1996; (d) by the Company if (i) there is no material breach of any representation, warranty, covenant or agreement on the part of the Company and Purchaser has (A) failed to commence the Offer within the time required by Regulation 14D under the Exchange Act, (B) terminated the Offer or (C) failed to pay for Shares pursuant to the Offer prior to June 30, 1996 or (ii) prior to the purchase of Shares pursuant to the Offer, a Third Party has made a bona fide offer that the Board of Directors of the Company by a majority vote determines in its good faith judgment and in the exercise of its fiduciary duties, based as to legal matters on the written opinion of legal counsel, is a Higher Offer (as defined below); provided, that such termination under this clause (ii) will not be effective until payment of the fee discussed below; (e) by Parent or Purchaser prior to the purchase of Shares pursuant to the Offer, if (i) there has been a breach of any representation or warranty on the part of the Company or Spinco contained in the Merger Agreement or the Distribution Agreement resulting in a Material Adverse Effect (as defined in the Merger Agreement) or materially adversely affecting (or materially delaying) the consummation of the Offer, (ii) there will have been a breach of any covenant or agreement on the part of the Company or Spinco under either the Merger Agreement or the Distribution Agreement resulting in a Material Adverse Effect or materially adversely affecting (or materially delaying) the consummation of the Offer, which will not have been cured prior to the earlier of (A) 10 days following notice of such breach or (B) two business days prior to the date on which the Offer expires, (iii) the Company will engage in Active Negotiations (as defined below) with a Third Party with respect to a Third Party Acquisition (as defined below), (iv) the Board of Directors of the Company will have withdrawn or modified (including effecting any amendment of Schedule 14D-9) in a manner adverse to Purchaser, its approval or recommendation of the Offer, the Spin-Off, the Merger, the Merger Agreement or the Distribution Agreement, will have recommended to the Company's stockholders another offer, will have authorized the redemption of any Rights (whether or not in accordance with the Merger Agreement) after the Company's receipt of an Acquisition Proposal, or will have adopted any resolution to effect any of the foregoing or (v) the number of shares validly tendered and not withdrawn when added to the shares beneficially owned by Parent, prior to the expiration of the Offer, does not constitute at least two-thirds of the Shares, determined on a fully diluted basis, and on or prior to such date an entity or group (other than Parent or Purchaser) will have made and not withdrawn a proposal with respect to a Third Party Acquisition; or (f) by the Company if (i) there will have been a breach of any representation or warranty in the Merger Agreement or the Distribution Agreement on the part of Parent or Purchaser which materially adversely affects (or materially delays) the consummation of the Offer or (ii) there will have been a material breach of any covenant or agreement in the Merger Agreement or the Distribution Agreement on the part of Parent or Purchaser which materially adversely affects (or materially delays) the consummation of the Offer which will not have been cured prior to the earlier of (A) 10 days following notice of such breach or (B) two business days prior to the date on which the Offer expires. Termination Fee. Pursuant to the Merger Agreement, (a) if: (i) Parent or Purchaser terminates the Merger Agreement pursuant to Clause (e)(ii), (iii) or (v) of the immediately preceding paragraph and within 12 months thereafter the Company enters into an agreement with respect to a Third Party Acquisition, or a Third Party Acquisition occurs, involving any party (or any affiliate thereof) (A) with whom the Company (or its agents) had negotiations with a view to a Third Party Acquisition, (B) to whom the Company (or its agents) information with a view to a Third Party Acquisition or (C) who had submitted a proposal or expressed an interest in a Third Party Acquisition, in the case of each of clauses (A), (B) and (C) after the date of the Merger Agreement and prior to such termination; or (ii) Parent or Purchaser terminates the Merger Agreement pursuant to clause (e)(iii) or (v) of the immediately preceding paragraph and, within 12 months thereafter, a Third Party Acquisition will occur involving a Higher Offer (as defined below); or (iii) Parent or Purchaser terminates the Merger Agreement pursuant to Clause (e)(iv) of the immediately preceding paragraph; or (iv) the Company terminates the Merger Agreement pursuant to clause (d)(ii) of the immediately preceding paragraph; then, in each case, the Company will pay to Parent, within one business day following the execution and delivery of such agreement or such occurrence, as the case may be, or simultaneously with such determination pursuant to clause (d)(ii) above, a fee, in cash, of $175 million; provided, that the Company in no event will be obligated to pay more than one such $175 million fee with respect to all such agreements and occurrences and such termination. "Active Negotiations" means negotiations with a Third Party that has proposed a Third Party Acquisition or made an Acquisition Proposal, or with such Third Party's agents or representatives with respect to the substance of such Third Party Acquisition or Acquisition Proposal, but will not include (x) communications in connection with, or constituting, the furnishing of information pursuant to a confidentiality agreement as contemplated by the Merger Agreement or (y) communications that include no more than an explicit bona fide rejection of such proposal and a very brief statement of the reasons therefor. "Third Party Acquisition" means the occurrence of any of the following events: (i) the acquisition of the Company by merger or otherwise by any person (which includes for these purposes a "person" as such term is defined in Section 13(d)(3) of the Exchange Act) or entity other than Parent, the Purchaser or any affiliate thereof (a "Third Party"); (ii) the acquisition by a Third Party of more than 30% of the total assets of the Company and its subsidiaries, taken as a whole; (iii) the acquisition by a Third Party of 30% or more of the outstanding Shares; (iv) the adoption by the Company of a plan of liquidation or the declaration or payment of an extraordinary dividend; or (v) the purchase by the Company or any of its subsidiaries of more than 20% of the outstanding shares. "Higher Offer" means any Third Party Acquisition which reflects a higher value for the Shares than the aggregate value being provided pursuant to the transactions contemplated by the Merger Agreement and the Ancillary Agreements including, without limitation, the shares of Loral Space Common Stock distributed in the Spin-Off. Prior to the termination of the Merger Agreement by the Company pursuant to clause (d)(ii) above, the Board of Directors will provide a reasonable opportunity to a nationally recognized investment banking firm selected by Parent, Purchaser or their designee (the "IB") to evaluate the proposed Third Party Acquisition, to determine whether it is a Higher Offer and to advise the Board of Directors of the Company of the basis for and results of its determination. The Company agrees to cooperate and cause the Company's financial advisors to cooperate with the IB (including, without limitation, providing the IB with full access to all such information which the IB deems relevant and which the IB agrees to keep confidential) to the extent reasonably requested by the IB. The fees and expenses incurred by the IB shall be paid by Parent. Nothing contained in the definitions of "Active Negotiations", "Third Party Acquisitions" or "Higher Offer" will prevent Parent and Purchaser from challenging, by injunction or otherwise, the termination or attempted termination of the Merger Agreement pursuant to clause (d)(ii) above. Pursuant to the Merger Agreement, in the event of the termination and abandonment of the Merger Agreement, the Merger Agreement will become void and have no effect, without any liability on the part of any party or its affiliates, directors, officers or stockholders, other than the provisions relating to the termination fee, fees and expenses, governing law, brokerage fees and commissions, indemnification and confidentiality of information, provided, that a party will not be relieved from liability for any breach of the Merger Agreement. Notwithstanding anything to the contrary contained in the Merger Agreement, upon payment by the Company of the fees and expenses referred to in the Merger Agreement, the Company will be released from all liability thereunder, including any liability for any claims by Parent, the Purchaser or any of their affiliates based upon or arising out of any breach of the Merger Agreement or any Ancillary Agreements. Fees and Expenses. If the Merger Agreement is terminated pursuant to Clause (e)(i) or (e)(ii) above (the "Designated Termination Provisions") or Parent is entitled to receive the $175 million fee under the Merger Agreement, then the Company will reimburse Parent, Purchaser and their affiliates (not later than one business day after submission of statements therefor) for actual documented out-of-pocket fees and expenses, not to exceed $45 million, actually incurred by any of them or on their behalf in connection with the Offer, the proposed Merger and the proposed Spin-Off and the transactions contemplated by the Merger Agreement and the Distribution Agreement (including, without limitation, fees payable to financing sources, investment bankers (including to the IB), counsel to any of the foregoing and accountants), whether incurred prior to or after the date of the Merger Agreement. The Company will in any event pay the amount requested (not to exceed $45 million) within one business day of such request, subject to the Company's right to demand a return of any portion as to which invoices are not received in due course. Except as specifically provided in Section 8.3 of the Merger Agreement and except as otherwise specifically provided in the Distribution Agreement, each party shall bear its own respective expenses incurred in connection with the Merger Agreement, the Offer and the Merger, including, without limitation, the preparation, execution and performance of the Merger Agreement and the Ancillary Agreements and the transactions contemplated thereby, and all fees and expenses of investment bankers, finders, brokers, agents, representatives, counsel and accountants. The following is a summary of certain provisions of the Distribution Agreement. A copy of the Distribution Agreement (with certain Exhibits omitted) is attached hereto as Exhibit (cX3) and is incorporated herein by reference. The following summary is qualified in its entirety by reference to the Distribution Agreement. Pursuant to the Distribution Agreement, the Company and certain subsidiaries of the Company, through a series of transactions, will transfer to Loral Space all of their respective right, title and interest in and to the following assets (such assets, the "Loral Space Assets"): (a) all shares of capital stock or partnership interests, as the case may be, then owned in the Loral Space Companies, (b) the $712,400,000 cash amount being transferred to the Company pursuant to the Distribution Agreement, (c) the rights to the "Loral" name, (d) all rights to receive management fees from certain of the Loral Space Companies, (e) all rights and interests in any prospective domestic or international direct broadcast satellite projects currently under consideration, (f) certain service provider operations related to Globalstar, (g) certain rights and liabilities with respect to certain litigation in which the Company has an interest, (h) certain corporate aircraft, (i) a portion of the leasehold interest in the Company's New York corporate offices, (j) certain FCC license applications, and (k) certain Warrants to be received from Globalstar in connection with the Company's guarantee of certain Globalstar bank indebtedness, and (l) certain other assets described in the Distribution Agreement, in exchange for the issuance by Spinco to the Company and its subsidiaries of a certain amount of Loral Space capital stock. Concurrently with the actions in the immediately preceding sentence, Loral Space will assume and will in due course pay, perform and discharge (or will cause to be assumed and cause in due course to be paid, performed and discharged), all of the various liabilities (the "Loral Space Liabilities") relating to (a) each business and each former business which is or was conducted by Loral Space or a Loral Space Company as of the date of the Distribution or which is or was included within the Loral Space Assets (all such businesses, the "Loral Space Business"), (b) the employees of Loral Space, and (c) certain other liabilities relating to the Loral Space Companies or the Loral Space Business or otherwise. As promptly as practicable after the date of the Distribution Agreement and prior to the Distribution Date, the Company and Loral Space will prepare an Information Statement (which will set forth appropriate disclosure concerning Spinco and the Loral Space Companies, the Loral Space Business, the Spin-Off and certain other matters) and Loral Space will file with the Commission a registration statement on Form 10 (which will include or incorporate by reference the Information Statement). The Company and Loral Space will use their respective reasonable efforts to cause the Form 10 to be declared effective under the Exchange Act or, if either the Company or Parent reasonably determines that the Distribution may not be effected without Common Stock pursuant to the Securities Act of 1933, as amended (the "Securities Act"), the Company shall use its best efforts to cause the Loral Space Common Stock to be registered pursuant to the Securities Act and thereafter effect the Distribution in accordance with the terms of the Distribution Agreement, including, without limitation, by preparing and filing on an appropriate form of registration statement under the Securities Act covering the Loral Space Common Stock and using its best efforts to cause such registration statement to be declared effective. Following the effectiveness of such Form 10 (or registration statement, as the case may be), the Company will mail the Information Statement to the holders of the Company Common Stock. Subject to terms and conditions of the Distribution Agreement, the Company's Board of Directors (or any duly appointed committee thereof) will in its reasonable discretion establish the Spin-Off Record Date and the Distribution Date and any appropriate procedures in connection with the Distribution (subject in each case to the provisions of applicable law) as soon as reasonably practicable following the date of the Distribution Agreement or on such other dates as Parent may reasonably request; provided that (x) the Spin- Off Record Date may not be earlier than the twentieth day following the date on which the Offer is commenced and also may not be earlier than the tenth day following the date on which this Board takes action to establish the Spin-Off Record Date (the "Distribution Declaration Date") and (y) the parties hereto will use their reasonable efforts to cause the Spin-Off Record Date to be established so as to occur immediately prior to the acceptance for payment by the Purchaser of the shares of Common Stock pursuant to the Offer (provided that in no event will the Spin-Off Record Date be established so as to occur as of or at any time after the acceptance for payment by the Purchaser of the shares of common stock pursuant to the Offer); provided further that if all conditions to the Offer have been satisfied or waived prior to the date on which all of the Distribution Conditions (as defined below) have been satisfied (or waived, to the extent expressly permitted by the provisions of the Distribution Agreement), then the Purchaser will be permitted, but not required, to accept for payment at such time the shares of Common Stock pursuant to the Offer notwithstanding the fact that the Distribution Conditions have not been satisfied or waived (provided that prior to such acceptance for payment Purchaser first obtains the consent of the Company, which consent may not be unreasonably withheld). The parties hereto acknowledge and agree that payment of the Distribution will be conditioned on (x) the satisfaction (or waiver, to the extent expressly permitted by the provisions of the Distribution Agreement) of each of the Distribution Conditions on a date which is prior to the fiftieth (50th) day following the Spin-Off Record Date and (y) Parent and Purchaser not having taken any action, on or after the Distribution Declaration Date, to extend or delay the expiration of the Offer to a date which is later than the Spin-Off Record Date. The obligations of each of the Company, its subsidiaries and Spinco under the Distribution Agreement are subject to the satisfaction of the following conditions (the "Distribution Conditions"): (i) the Purchaser will have notified the Company that it is prepared to immediately accept for payment shares of Company Common Stock pursuant to the terms and conditions of the Offer as set forth in Section 15, (ii) the Spin-Off Record Date will have been set by the Company's Board of Directors, (iii) the Form 10 (or any registration statement filed in lieu thereof) will have been declared effective by the Commission, (iv) the Spinco Common Stock will have been accepted for listing or quotation in accordance with the Distribution Agreement, (v) no court order or law will have been enacted, promulgated, issued or entered against any of the parties which (x) prohibits or materially restricts consummation of any of the transactions contemplated by the Distribution Agreement and (y) remains in effect as of the date on which the satisfaction of this condition is determined, (vi) the Company and each of the Retained Subsidiaries will have obtained all consents required to be obtained by the Company as a result of or in connection with the transactions contemplated by the Distribution Agreement in order to avoid a material default under any material contract to or by which the Company, Spinco or any of their respective subsidiaries is a party or may be bound, or otherwise necessary to permit the Company and each of the Retained Subsidiaries to conduct their business in a manner consistent with its past practices, (vii) all consents and approvals of, and notices to and filings with, any governmental entity or any other person or entity arising out of or relating to the consummation of the transactions contemplated by the Distribution Agreement, will have been obtained or made (as the case may be), (viii) the guarantee by the Company of certain bank indebtedness of Globalstar (the "Globalstar Bank Guarantee") will have been amended so that the provisions thereof shall, following the transactions described above (the "Restructuring"), be amended in the manner contemplated pursuant to the Distribution Agreement (with such changes thereto as Parent and the Company may approve prior to the Offer Purchase Date), and (ix) certain merchant banking partnerships affiliated with Lehman Brothers Holdings Inc. (the "Lehman Partnerships") and all other holders of the preferred stock of Loral Aerospace Holdings, Inc. ("Holdings") (if any) will have exchanged all issued and outstanding shares of such preferred stock for shares of capital stock or other equity securities of either Spinco, any Spinco Company or any subsidiary of Spinco. Following the Spin-Off, Spinco will establish a qualified defined benefit pension plan and trust ("Spinco Pension Plan"). Thereafter, the Company will direct the trustees of the trusts under the Loral Corporation Pension Plan and the Retirement Plan of Loral Aerospace Corp. (the "Company Pension Plans") to transfer in cash or in kind, as agreed to by the Company and Spinco, to the trust under the Spinco Pension Plan, an amount determined by the certified actuary of the Company Pension Plans to be equal to, with respect to each such Company Pension Plan, (A) the product of (i) the fair market value of the assets held under such Company Pension Plan as of the last day of the month prior to the month in which the transfer occurs (the "Valuation Date") and (ii) a fraction, the numerator of which is equal to the present value of all accrued benefits under such Company Pension Plan as of the Distribution Date in respect of Spinco Employees and the denominator of which is equal to the present value of all accrued benefits under such Company Pension Plan less (B) the payments made by such Company Pension Plan between the Distribution Date and the date of transfer in respect of Spinco Employees. From the Valuation Date to the date of transfer, the assets to be transferred will be credited with interest at the interest rate available on a 30-day treasury note at the auction date on or immediately preceding the Valuation Date. Following the Distribution Date, Spinco shall cause SSL to establish a trust intended to qualify under Section 501(a) of the Code ("Spinco SSL Trust") and intended to hold the assets of the Retirement Plan of SSL (the "SSL Plan"). Thereafter, the Company shall direct the Trustees of the Loral Master Pension Trust (the "Master Trust") to transfer in cash or in kind as agreed to by SSL and the Company from the Master Trust to the Spinco SSL Trust, the assets held by the Master Trust under the SSL Plan. Upon the transfers described above, Spinco agrees to indemnify and hold harmless the Company, its officers, directors, employees, agents and affiliates from and against any and all Indemnifiable Losses arising out of or related to the Spinco Pension Plan and the SSL Plan, including all benefits accrued by Spinco Employees prior to the Distribution Date under the Company Pension Plans and the SSL Plan. Spinco will assume and be solely responsible for all liabilities and obligations arising under the Company's retiree welfare plans (including retiree medical plans) with respect to Spinco Employees. The Company will retain and be solely responsible for all liabilities and obligations arising under the Company's retiree welfare plans (including retiree medical plans) with respect to Retained Employees. Spinco represents and warrants to the Company that (i) except as expressly provided in the Globalstar Bank Guarantee (as amended pursuant to the Distribution Agreement), neither the Company nor any of the Retained Subsidiaries will, after giving effect to the Restructuring, be liable directly or indirectly, as borrower, surety, guarantor, indemnitor or otherwise, with respect to (and that none of the assets of the Company other than the Spinco Assets (such assets the "Retained Assets") will be bound by or subject to) any of the Spinco Liabilities or any Spinco indebtedness, (ii) there are no intercompany agreements between the Company and the Retained Subsidiaries, on the one hand and Spinco and the Spinco Companies on the other in effect as of the date of the Distribution Agreement, which, either individually or in the aggregate, are materially adverse to (i) the business, properties, operations, prospects, results of operations or condition (financial or otherwise) of the Retained Business or (ii) the ability of the Company or any of the Retained Subsidiaries to perform their respective obligations under the Distribution Agreement, the Tax Sharing Agreement or the Stockholders Agreement, (iii) there are no Spinco Assets which have been used within the Retained Business within one year prior to the date of the Distribution Agreement, other than those Spinco Assets which are listed on the Disclosure Schedule to the Distribution Agreement, (iv) except as set forth in the Disclosure Schedule to the Distribution Agreement neither Spinco nor any Spinco Company will, immediately after giving effect to the Restructuring and the Distribution, own, hold or lease, in whole or in part, any of the assets, properties, licenses and rights which are reasonably necessary to carry on the Retained Business as presently conducted, and (v) prior to, on or shortly after the Distribution Date, GTL or Globalstar (as the case may be) will issue to the Company warrants to acquire equity of GTL or Globalstar (as the case may be), which warrants will be on the terms and conditions described in the December 21, 1995 memorandum from Michael B. Targoff to Enrique Fernandez relating to, among other things, the Globalstar Bank Guarantee and the Globalstar Credit Agreement (the "Globalstar Warrant Memorandum") and shall otherwise be on such terms and conditions as are customary to transactions of a similar nature. Except as otherwise specified by Spinco prior to the Offer Purchase Date, the executive officers of the Company shall be the executive officers of Spinco on and after the Distribution Date. Effective as of the Distribution Date, (a) those Retained Employees who are employed by the Company or any of its subsidiaries immediately prior to the Distribution Date will become employees of the Company in the same capacities as then held by such employees (or in such other capacities as the Company will determine in its sole discretion) and (b) those Spinco Employees, together with those persons whose primary employment is with the Spinco Business, who are employed by the Company or any of its subsidiaries immediately prior to the Distribution Date will become employees of Spinco in the same capacities as then held by such employees (or in such other capacities as Spinco will determine in its sole discretion). Prior to the Spin-Off, the Company will establish a rabbi trust or trusts for the benefit of participants in the Company's Supplemental Executive Retirement Plan ("SERP") and will deposit in such rabbi trust or trusts an amount at least equal to the present value of the accrued benefits under the SERP. This amount is not expected to exceed $11 million. The liabilities for the accrued benefits under the SERP with respect to Spinco Employees, and any assets held in the rabbi trust or trusts relating to such liabilities, will be transferred to Spinco as soon as practicable after the Distribution Date. Each of the parties agree that except as otherwise expressly provided in Article IV of the Distribution Agreement, all existing intercompany agreements in effect immediately prior to the Distribution Date will not be deemed altered, amended or terminated as a result of the Distribution Agreement or the consummation of the transactions contemplated by the Distribution Agreement and will otherwise remain in effect immediately after giving effect to the Restructuring. In addition to any indemnification required by Articles II, VI and VIII of the Distribution Agreement, subject to the terms and conditions set forth therein, from and after the Distribution Date, Spinco shall indemnify, defend and hold harmless the Company, each Retained Subsidiary, the Purchaser and Parent and each of their respective directors, officers, employees, representatives, advisors, agents and affiliates (collectively, the "Parent Indemnified Parties") from, against and in respect of any and all indemnifiable losses of the Parent Indemnified Parties arising out of, relating to or resulting from, directly or indirectly, (i) any misrepresentations or breach of warranty made by or on behalf of Spinco or, on or prior to the Offer Purchase Date, made by or on behalf of the Company which misrepresentation or breach of warranty is contained in the Distribution Agreement or the Stockholders Agreement (as defined in this Section 10), (ii) any breach of any agreement or covenant under the Distribution Agreement or the Stockholders Agreement on the part of Spinco or, on or prior to the Offer Purchase Date, on the part of the Company, (iii) any and all Spinco Liabilities, (iv) the conduct of the Spinco Business or any part thereof on, prior to or following the Distribution Date, (v) any transfer of Spinco Assets to, or assumption of Spinco Liabilities by, Spinco or any Spinco Company in accordance with the Distribution Agreement or otherwise in connection with the Restructuring (other than any costs and expenses which have been expressly assumed by the Company pursuant to the provisions of the Distribution Agreement), (vi) any indemnifiable loss resulting from any claims that any statements or omissions relating to or describing directly or indirectly, Spinco, any Spinco Company, the Spinco Business, any Spinco Asset or any Spinco Liability, and which occur on or prior to the Offer Purchase Date (A) in the Information Statement, the Form 10 or in any registration statement filed pursuant to the Distribution Agreement (in each case other than with respect to any statements or omissions made in reliance upon and in conformity with information furnished in writing by Parent, the Purchaser or their affiliates, representatives or advisors) and other than any statements or omissions which relate solely to the Merger Agreement and the Distribution Agreement and the transactions contemplated thereby), or (B) in any document(s) filed with the Commission by Spinco or any Spinco Company after the date hereof pursuant to either the Securities Act or the Exchange Act (in each case other than with respect to any statements or omissions which relate solely to the Merger Agreement and the Distribution Agreement and the transactions contemplated thereby), which, in the case of either clause (A) or (B) above, are false or misleading with respect to any material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading, (vii) the failure of the Company or Spinco to obtain any final order or other consent or approval of the FCC with respect to any of the transactions contemplated pursuant to either the Distribution Agreement or the Merger Agreement and (viii) any Excluded Indemnifiable Losses (as defined below). Notwithstanding the foregoing, Spinco's indemnification obligations pursuant to the Distribution Agreement will not in any event include any indemnifiable losses arising out of or relating to litigation relating to the Offer and the transactions contemplated thereby, except to the extent of any indemnifiable losses (such indemnifiable losses, the "Excluded Indemnifiable Losses") which the Company is able to demonstrate resulted directly from (a) any statement or omission on the part of Spinco or any of its affiliates in the documents referred to in clause (vi) above or (b) any business activities, assets or liabilities of Spinco, any of the Spinco Companies or the Spinco Business. Notwithstanding Spinco's obligations to indemnify Parent Indemnified Parties described above, Spinco shall be obligated to indemnify the Parent Indemnified Parties only for those indemnifiable losses under clauses (i), (ii) or (vi) of the immediately preceding paragraph as to which the Parent Indemnified Parties have given Spinco written notice thereof on or prior to the third anniversary of the Distribution Date (it being understood that there shall be no corresponding time limitation with respect to any Indemnifiable Losses arising under clauses (iii), (iv), (v), (vii) and (viii) of the immediately preceding paragraph; provided further that claims with respect to breaches of covenants and agreements set forth in the Distribution Agreement or in the Stockholders Agreement will survive for the applicable statute of limitations period. Notwithstanding the foregoing, if on or before the expiration of such indemnification period any Parent Indemnified Party has given notice to Spinco pursuant to the Distribution Agreement of any matter which would be the basis for a claim of indemnification by such Parent Indemnified Party pursuant to the immediately preceding paragraph, such Parent Indemnified Party will have the right after the expiration of such indemnification period to assert or to continue to assert such claim and to be indemnified with respect thereto. In addition to any indemnification required by Articles II, VI and VIII of the Distribution Agreement, subject to the terms and conditions set forth therein, from and after the Distribution Date, the Company will indemnify, defend and hold harmless Spinco, each Spinco Company and each of their respective directors, officers, employees, representatives, advisors, agents and affiliates (collectively, the "Spinco Indemnified Parties") from, against and in respect of any and all indemnifiable losses of the Spinco Indemnified Parties arising out of, relating to or resulting from, directly or indirectly, (i) any breach of the Distribution Agreement or any agreement or covenant set forth in the Distribution Agreement or in the Stockholders Agreement on the part of Parent or the Purchaser or, following the Offer Purchase Date, on the part of the Company, (ii) any and all liabilities of the Company and the Retained Subsidiaries (such liabilities, the "Retained Liabilities"), (iii) the conduct of the businesses of the Company, the Retained Subsidiaries and the Retained Business or any part thereof on, prior to or following the Distribution Date, (iv) any Indemnifiable Loss resulting from any claims that any statements or omissions (A) relating to or describing, directly or indirectly, Parent or the Purchaser, and which occur on or prior to the Offer Purchase Date in any Solicitation/Recommendation Statement on Schedule 14D-9 of the Company filed in connection with the Offer, the Information Statement, the Form 10 or in any registration statement filed pursuant to Section 3.1 or Section 3.3 of the Distribution Agreement (in each case only to the extent of any statements or omissions made in reliance upon and in conformity with information furnished in writing by Parent, the Purchaser or their affiliates, representatives or advisors), (B) in any Tender Offer Statement on Schedule 14D-1 of the Purchaser or Parent filed in connection with the Offer (other than any statements or omissions made in reliance upon and in conformity with information furnished in writing by the Company, and Retained Subsidiary, Spinco, any Spinco Company or any of their respective affiliates, representatives or advisors), or (C) in any other document(s) filed after the date of the Distribution Agreement by Parent or the Purchaser with the Commission pursuant to either the Securities Act or the Exchange Act or the Exchange Act (e.g., statements or omissions made in a Current Report on Form 8-K filed by either Parent or the Purchaser after the date of the Distribution Agreement pursuant to the Exchange Act), which, in the case of either clauses (A), (B) or (C) above, are false or misleading with respect to any material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading and (v) any Indemnifiable Loss arising out of or resulting from litigation relating to the Offer and the transactions contemplated thereby (other than Excluded Indemnifiable Losses). Notwithstanding the foregoing and anything to the contrary in the Distribution Agreement or any other agreement to be entered into pursuant to the Distribution Agreement, the Company shall not be required to indemnify, defend and hold harmless any Spinco Indemnified Party from and against any Indemnifiable Loss resulting from any claims that the statements included in the Information Statement, the Form 10 or in any registration statement filed pursuant to Section 3.1 or Section 3.3 of the Distribution Agreement (in each case other than statements or omissions made in reliance upon and in conformity with information furnished in writing by Parent, the Purchaser or their affiliates, representatives or advisors expressly for use therein) are false or misleading with respect to any material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Notwithstanding the Company's obligations to indemnify the Spinco Indemnified Parties described in the preceding paragraph, the Company will be obligated to indemnify the Spinco Indemnified Parties only for those Indemnifiable Losses under Clause (i) and (iv) of the immediately preceding paragraph as to which the Spinco Indemnified Parties have given the Company written notice thereof on or prior to the expiration of any applicable statute of limitations period (it being understood that there will be no corresponding time limitation with respect to any Indemnifiable Losses arising under clauses (ii) and (iii) of the immediately preceding paragraph). Notwithstanding the foregoing, if on or before the expiration of such indemnification period any Spinco Indemnified Party has given notice to the Company of any matter which would be the basis for a claim of indemnification by such Spinco Indemnified Party pursuant to the immediately preceding paragraph, such Spinco Indemnified Party will have the right after the expiration of such indemnification period to assert or to continue to assert such claim and to be indemnified with respect thereto. The following is a summary of certain provisions of the Tax Sharing Agreement (as defined below). A copy of the Tax Sharing Agreement is attached hereto as Exhibit (c)(5) and is incorporated herein by reference. The following summary is qualified in its entirety by reference to the Tax Sharing Agreement. Pursuant to a tax sharing agreement, to be entered into prior to the consummation of the Offer, between Parent, Purchaser, the Company and Spinco (the "Tax Sharing Agreement"), Parent generally has agreed, among other things, to file all tax returns with respect to, and to pay all taxes imposed upon or attributable to, the Company or the Retained Subsidiaries for all taxable periods, including the taxes incurred in connection with the transfers of the Spinco Assets to Spinco and the Spin-Off Loral Space. Spinco generally has agreed, among other things, to file all tax returns with respect to Loral Space or the Loral Space Spinco Companies for all taxable periods beginning after the Distribution Date and to pay all taxes imposed upon or attributable to Spinco or the Spinco Companies for all taxable periods. The Tax Sharing Agreement will become effective only upon consummation of the Offer. The foregoing summary of the Distribution Agreement and the Tax Sharing Agreement (together, the "Ancillary Agreements") does not purport to be complete and is qualified in its entirety by reference to the text of the Ancillary Agreements, a copy of each of which is filed as an Exhibit to the Schedule 14D-1 and is incorporated herein by reference. The Schedule 14D-1 may be inspected and copies may be obtained from the offices of the Commission in the same manner as set forth in Section 7. The Company has advised Parent that pursuant to the Rights Agreement, on January 7, 1996 the Board of Directors of the Company declared a dividend distribution of one Right for each share of Spinco COMMON STOCK outstanding at the close of business on January 22, 1996 (the "Rights Record Date") and with respect to the Spinco Common Stock issued thereafter until the Rights Distribution Date (as defined below) and, in certain circumstances, with respect to Spinco Common Stock issued after the Distribution Date. Except as set forth below, each Right, when it becomes exercisable, entitles the registered holder to purchase from the Company a unit consisting initially of one one-thousandth of a share (a "Unit") of Series A Preferred Stock, par value $1.00 per share (the "Spinco Rights Preferred Stock"), of Spinco at a Purchase Price of $180 per Unit, subject to adjustment (the "Rights Purchase Price"). The description and terms of the Rights are set forth in the Rights Agreement. Initially, the Rights were and are attached to all certificates representing shares of Spinco Common Stock then outstanding, and no separate certificates evidencing the Rights (the "Rights Certificates") were or have been distributed. The Rights will separate from the Common Stock and a "Rights Distribution Date" will occur upon the earlier of (i) ten days (or such later date as the Spinco Board of Directors shall determine) following public disclosure that a person or group of affiliated or associated persons has become an "Acquiring Person" (as defined below), or (ii) ten business days (or such later date as the Spinco Board shall determine) following the commencement of a tender offer or exchange offer that would result in a person or group becoming an "Acquiring Person". Except as set forth below, an "Acquiring Person" is a person or group of affiliated or associated persons who has acquired beneficial ownership of 20% or more of the outstanding shares of Spinco Common Stock. The term "Acquiring Person" excludes (i) Spinco, (ii) any subsidiary of Spinco, (iii) any employee benefit plan of Spinco or any subsidiary of Spinco or (iv) any person or entity organized, appointed or established by Spinco for or pursuant to the terms of any such plan. Until the occurrence of the Rights Distribution Date, (i) the Rights will be evidenced by the Spinco Common Stock certificates and will be transferred with and only with such Spinco Common Stock certificates, (ii) new Spinco Common Stock certificates issued after the Rights Record Date will contain a notation incorporating the Rights Agreement by reference, and (iii) the surrender for transfer of any certificates for Spinco Common Stock outstanding will also constitute the transfer of the Rights associated with the Spinco Common Stock represented by such certificate. Pursuant to the Rights Agreement, Spinco reserves the right to require prior to the occurrence of a Triggering Event (as defined below) that, upon any exercise of Rights, a number of Rights be exercised so that only whole shares of Spinco Preferred Stock will be issued. As soon as practicable after the occurrence of the Rights Distribution Date, Rights Certificates will be mailed to holders of record of Spinco Common Stock as of the close of business on the Rights Distribution Date and, thereafter, the separate Rights Certificates alone will represent the Rights. Except in certain circumstances specified in the Rights Agreement or as otherwise determined by the Board of Directors of Spinco, only shares of Spinco Common Stock issued prior to the Rights Distribution Date will be issued with Rights. The Rights are not exercisable until the occurrence of the Rights Distribution Date. The Rights will expire at the close of business on January 22, 2006, unless extended or earlier redeemed by Spinco as described below. In the event that, at any time following the Rights Distribution Date, a person becomes an Acquiring Person, each holder of a Right will thereafter have the right to receive, upon exercise of the Right, Spinco Common Stock (or, in certain circumstances, cash, property or other securities of Spinco) having a value equal to two times the exercise price of the Right. Notwithstanding the foregoing, following the occurrence of the event set forth in this paragraph, all Rights that are, or (under certain circumstances specified in the Rights Agreement) were, beneficially owned by any Acquiring Person will be null and void and nontransferable and any holder of any such Right (including any purported transferee or subsequent holder) will be unable to exercise or transfer any such Right. For example, at an exercise price of $200 per Right, each Right not owned by an Acquiring Person (or by certain related parties) following an event set forth in this paragraph would entitle its holder to purchase $400 worth of Spinco Common Stock (or other consideration, as noted above) for $200. Assuming that the Spinco Common Stock had a per share value of $40 at such time, the holder of each valid Right would be entitled to purchase ten shares of Spinco Common Stock for $200. In the event that, at any time following the date on which there has been public disclosure that, or of facts indicating that, a person has become an Acquiring Person (the "Stock Acquisition Date"), (i) Spinco is acquired in a merger or other business combination transaction in which Spinco is not the surviving corporation (other than a merger which follows an offer described in the preceding paragraph), or (ii) 50% or more of Spinco's assets or earning power is sold, mortgaged or transferred, each holder of a Right (except Rights which previously have been voided as set forth above) shall thereafter have the right to receive, upon exercise, common stock of the acquiring company having a value equal to two times the exercise price of the Right. The events set forth in this paragraph and in the preceding paragraph are referred to as the "Triggering Events." The Purchase Price payable, and the number of Units of Spinco Rights Preferred Stock or other securities or property issuable, upon exercise of the Rights are subject to adjustment from time to time to prevent dilution (i) in the event of a stock dividend on, or a subdivision, combination or reclassification of, the Spinco Rights Preferred Stock, (ii) if holders of Spinco Rights Preferred Stock are granted certain rights or warrants to subscribe for Spinco Rights Preferred Stock or convertible securities at less than the current market price of the Spinco Rights Preferred Stock, or (iii) upon the distribution to holders of the Spinco Rights Preferred Stock of evidences of indebtedness or assets (excluding regular quarterly cash dividends) or of subscription rights or warrants (other than those referred to above). With certain exceptions, no adjustment in the Rights Purchase Price will be required until cumulative adjustments amount to at least 1% of the Rights Purchase Price. No fractional Units will be issued and, in lieu thereof, an adjustment in cash will be made based on the market price of the Spinco Rights Preferred Stock on the last trading date prior to the date of exercise. Because of the nature of the Spinco Rights Preferred Stock's dividend and liquidation rights, the value of the one one-thousandth interest in a share of Spinco Rights Preferred Stock purchasable upon exercise of each Right should approximate the value of one share of Spinco Common Stock. Shares of Spinco Rights Preferred Stock purchasable upon exercise of the Rights will not be redeemable. Each share of Spinco Rights Preferred Stock will be entitled to a quarterly dividend payment of 1,000 times the dividend declared per share of Spinco Common Stock. In the event of liquidation, each share of Spinco Rights Preferred Stock will be entitled to a $1.00 preference and, thereafter the holders of the shares of Spinco Rights Preferred Stock will be entitled to an aggregate payment of 1,000 times the aggregate payment made per share of Spinco Common Stock. Each share of Spinco Rights Preferred Stock will have one vote, voting together with the shares of Spinco Common Stock. These rights are protected by customary antidilution provisions. At any time until ten days following the Stock Acquisition Date, Loral Space may redeem the Rights in whole, but not in part, at a price (the "Spinco Redemption Price") of $.0001 per Right (payable in cash, Spinco Common Stock or other consideration deemed appropriate by the Loral Space Board of Directors) by resolution of the Loral Space Board of Directors. The redemption of the Rights may be made effective at such time, on such basis, and with such conditions as the Board of Directors in its sole discretion may establish. Immediately upon such action of the Board of Directors ordering redemption of the Rights, the Rights will terminate and the only right of the holders of Rights will be to receive the Redemption Price. Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of Spinco including, without limitation, the right to vote or to receive dividends. While the distribution of the Rights will not be taxable to stockholders or to Spinco, stockholders may, depending upon the circumstances, recognize taxable income in the event that the Rights become exercisable for Loral Space Common Stock (or other consideration) of Spinco or for common stock of the acquiring company as set forth above. Other than those provisions relating to the principal economic terms of the Rights, any of the provisions of the Rights Agreement may be amended by resolution of Loral Space's Board of Directors. After the Rights Distribution Date, the provisions of the Rights Agreement may be amended by resolution of Loral Space's Board of Directors in order to cure any ambiguity, to make changes which do not adversely affect the interests of holders of Rights (excluding the interests of any Acquiring Person or its affiliates or associates), or to shorten or lengthen any time period under the Rights Agreement; provided, however, that no amendment to adjust the time period governing redemption shall be made at such time as the Rights are not redeemable. Because (i) the Offer is an offer to purchase all of the outstanding Shares and the Board has unanimously determined that the Offer described herein is fair to and in the best interests of the Company's stockholders and (ii) on January 7, 1996, the Board of Directors approved amending the Rights Agreement in accordance with the terms of the Merger Agreement, the acquisition of Shares pursuant to the Offer or the consummation of the Merger will not (a) cause any person to become an Acquiring Person or, (b) cause a Rights Distribution Date or a Stock Acquisition Date to occur or cause or require the distribution of any Rights Certificates to the record holders of Spinco Common Stock or, (c) give rise to a Triggering Event. The following is a summary of certain provisions of the Stockholders Agreement (as defined below). A copy of the Stockholders Agreement (with certain Exhibits omitted) is attached hereto as Exhibit and is incorporated herein by reference. The following summary is qualified in its entirety by reference to the Stockholders Agreement. On or prior to the Distribution Date, the Company and Loral Space will enter into a Stockholders Agreement (the "Stockholders Agreement"), which establishes, among other things, certain conditions with respect to the relationship between Loral Space, on the one hand, and the Company and its affiliates (the "Subject Stockholders"), on the other hand. The Stockholders Agreement limits the ability of the Subject Stockholders, during the term of the Stockholders Agreement, to acquire any voting securities or assets of, or solicit proxies or make a public announcement of a proposal for any extraordinary transaction with respect to, Spinco. The Stockholders Agreement provides that, subject to certain exceptions, the Subject Stockholders are obligated to vote any equity securities of Spinco, at the option of the Subject Stockholders, either (i) as recommended by the Board of Directors or management of Loral Space, or (ii) in the same proportions as the holders of equity securities of Spinco vote their securities. The Stockholders Agreement also limits the ability of the Subject Stockholders to transfer the equity securities of Spinco held by the Subject Stockholders except pursuant to a registered public offering or the provisions of Rule 144 under the Exchange Act or pursuant to certain permitted transfers. The Stockholders Agreement provides that if, within one year following the date thereof, the Subject Stockholders vote against certain business combination transactions, Loral Space shall have the right to purchase from the Subject Stockholders all of the equity securities of Spinco held by the Subject Stockholders at an agreed upon price. The Stockholders Agreement also provides that if, within one year following the date thereof certain transaction occur, the Company shall have the right to purchase from Spinco (including any successor to the rights and obligations of Loral Space) a certain number of shares of Spinco (or such successor) at an agreed upon price. The Stockholders Agreement also provides that in the event of certain transactions, the Subject Stockholders shall have the right to require Loral Space to purchase the GlobalStar Warrants (as defined in the Stockholders Agreement) for an agreed upon price. The Stockholders Agreement further provides that under certain circumstances and subject to certain conditions the Subject Stockholders may require Spinco to register under the Securities Act any Loral Space securities held by the Subject Stockholders. The Stockholders Agreement provides, subject to certain exceptions, that, in the event of a tender offer, if Subject Stockholders wish to sell or transfer any Loral Space securities pursuant to the tender offer the Subject Stockholders must first offer the shares for sale to Loral Space. The term of the Stockholders Agreement will continue until the earlier of (x) the date on which the voting power of the equity securities owned by the Subject Stockholders represent, on a fully-diluted basis, less than five percent (5%) of the total voting power, (y) the seventh anniversary of the date of the agreement, or (z) a change of control in Loral Space. It is anticipated that Parent will enter into an employment agreement with Frank C. Lanza. The agreement will provide for Mr. Lanza to serve as Executive Vice President and co-Chief Operating Officer of Parent for a period commencing with the Effective Time. The terms of the agreement have not yet been determined. 11. PURPOSE OF THE OFFER, THE MERGER AND THE SPIN-OFF; PLANS FOR THE COMPANY. Purpose of the Offer. The purpose of the Offer, the Merger and the Spin-Off is for the Purchaser to acquire control of the entire equity interest of the Retained Business (and to acquire a 20% equity interest in Loral Space). Consummation of the Offer in accordance with its terms and conditions will provide the Purchaser with at least a two-thirds equity interest in the Company. As described above, as a result of the Spin-Off, the Company will continue to own only the Retained Business and a 20% equity interest in Loral Space. The Merger will allow the Purchaser to acquire all outstanding Shares not tendered and purchased pursuant to the Offer. The acquisition of the entire equity interest in the Retained Business and the 20% equity interest in Spinco has been structured as a cash tender offer followed by the Spin-Off and a cash merger in order to provide a prompt and orderly transfer of ownership of the Retained Business and the 20% equity interest in Loral Space from the public stockholders of the Company to Parent and to provide stockholders with cash and Loral Space Shares for all their Shares. The purchase of Shares pursuant to the Offer will increase the likelihood that the Merger will be effected. Except as noted in this Offer to Purchase, neither Parent nor the Purchaser has any present plans or proposals that would result in an extraordinary corporate transaction, such as a merger, reorganization, liquidation, relocation of operations, or sale or transfer of assets, involving the Company or any of its subsidiaries, or any material changes in the Company's corporate structure or business or the composition of its management or personnel. 12. EFFECT OF THE OFFER ON THE MARKET FOR THE SHARES; STOCK EXCHANGE LISTING; REGISTRATION UNDER THE EXCHANGE ACT. The purchase of Shares pursuant to the Offer will reduce the number of Shares that might otherwise trade publicly and may reduce the number of holders of Shares, which could adversely affect the liquidity and market value of the remaining Shares held by stockholders other than the Purchaser. The Purchaser cannot predict whether the reduction in the number of Shares that might otherwise trade publicly would have an adverse or beneficial effect on the market price for or marketability of the Shares or whether it would cause future market prices to be greater or less than the Offer price. Depending upon the number of Shares purchased pursuant to the Offer, the Shares may no longer meet the requirements of the NYSE for continued listing and may, therefore, be delisted from such exchange. According to the NYSE's published guidelines, the NYSE could consider delisting the Shares if, among other things, the number of publicly held Shares (excluding Shares held by officers, directors, their immediate families and other concentrated holdings of 10% or more) were less than 600,000, there were less than 1,200 holders of at least 100 shares or the aggregate market value of the publicly held Shares were less than $5 million. If, as a result of the purchase of Shares pursuant to the Offer, the Shares no longer meet the requirements of the NYSE for continued listing and the listing of Shares on such exchanges is discontinued, the market for the Shares could be adversely affected. If the NYSE were to delist the Shares, it is possible that the Shares would trade on another securities exchange or in the over-the-counter market and that price quotations for the Shares would be reported by such exchange or through NASDAQ or other sources. The extent of the public market for the Shares and availability of such quotations would, however, depend upon such factors as the number of holders and/or the aggregate market value of the publicly held Shares at such time, the interest in maintaining a market in the Shares on the part of securities firms, the possible termination of registration of the Shares under the Exchange Act and other factors. The Shares are currently "margin securities" under the regulations of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"), which has the effect, among other things, of allowing brokers to extend credit on the collateral of the Shares. Depending upon factors similar to those described above regarding listing and market quotations, the Shares might no longer constitute "margin securities" for the purposes of the Federal Reserve Board's margin regulations and, therefore, could no longer be used as collateral for loans made by brokers. The Shares are currently registered under the Exchange Act. Such registration may be terminated if the Shares are not listed on a national securities exchange and there are fewer than 300 holders of record. Termination of the registration of the Shares under the Exchange Act would substantially reduce the information required to be furnished by the Company to holders of Shares and to the Commission and would make certain of the provisions of the Exchange Act, such as the short-swing profit recovery provisions of Section 16(b), the requirement of furnishing a proxy or information statement in connection with stockholder action and the related requirement of an annual report to stockholders and the requirements of Rule 13e-3 under the Exchange Act with respect to "going private" transactions, no longer applicable to the Shares. Furthermore, "affiliates" of the Company and persons holding "restricted securities" of the Company may be deprived of the ability to dispose of such securities pursuant to Rule 144 promulgated under the Securities Act. If registration of the Shares under the Exchange Act were terminated, the Shares would no longer be "margin securities" or eligible for listing on a securities exchange or NASDAQ reporting. It is the current intention of Parent to deregister the Shares after consummation of the Offer if the requirements for termination of registration are met. 13. DIVIDENDS AND DISTRIBUTIONS. If, on or after the date of the Merger Agreement, the Company should (i) split, combine or otherwise change the Shares or its capitalization, (ii) issue or sell any additional securities of the Company or otherwise cause an increase in the number of outstanding securities of the Company (except for Shares issuable upon the exercise of employee stock options outstanding on the date of the Merger Agreement) or (iii) acquire currently outstanding Shares or otherwise cause a reduction in the number of outstanding Shares, then, without prejudice to the Purchaser's rights under Sections 1 and 15, the Purchaser, in its sole discretion, subject to the terms of the Merger Agreement, may make such adjustments as it deems appropriate in the purchase price and other terms of the Offer. If, on or after the date of the Merger Agreement, the Company should declare or pay any dividend on the Shares or make any distribution (including, without limitation, cash dividends, the issuance of additional Shares pursuant to a stock dividend or stock split, the issuance of other securities or the issuance of rights for the purchase of any securities, but excluding any regular quarterly dividend on the Shares of not more than $.08 per share on the dividend and payment dates normally applicable to the Shares) with respect to the Shares, other than Spinco Shares payable or distributable in respect of the Shares in connection with the Spin-Off, that is payable or distributable to stockholders of record on a date prior to the transfer to the name of the Purchaser or its nominee or transferee on the Company's stock transfer records of the Shares purchased pursuant to the Offer, then, without prejudice to the Purchaser's rights under Sections 1 and 15, any such dividend, distribution or right to be received by the tendering stockholders will be received and held by the tendering stockholders for the account of the Purchaser and will be required to be promptly remitted and transferred by each tendering stockholder to the Depositary for the account of the Purchaser, accompanied by appropriate documentation of transfer. Pending such remittance and subject to applicable law, the Purchaser will be entitled to all rights and privileges as owner of any such dividend, distribution or right and may withhold the entire purchase price or deduct from the purchase price the amount or value thereof, as determined by the Purchaser in its sole discretion. 14. EXTENSION OF TENDER PERIOD; AMENDMENT; TERMINATION. The Purchaser expressly reserves the right, in its sole discretion, at any time or from time to time, regardless of whether or not any of the events set forth in Section 15 will have occurred or will have been determined by the Purchaser to have occurred, subject to the terms of the Merger Agreement and applicable rules of the Commission, (i) to extend the period of time during which the Offer is open and thereby delay acceptance for payment of, and the payment for, any Shares, by giving oral or written notice of such extension to the Depositary and (ii) to amend the Offer in any respect by giving oral or written notice of such amendment to the Depositary. In the Merger Agreement, Parent and the Purchaser have agreed not to extend the Expiration Date beyond the twentieth business day following commencement of the Offer unless one or more of the conditions set forth in Section 15 is not satisfied or unless Parent reasonably determines that such extension is necessary to comply with any legal or regulatory requirements relating to the Offer or the Spin-Off. Parent and Purchaser have also agreed in the Merger Agreement, subject to the terms and conditions thereof, to extend the Expiration Date if the Offer would otherwise expire prior to Split-Off Record Date or the expiration or termination of any applicable waiting period under the Antitrust Laws. In the Merger Agreement, the Purchaser expressly reserves the right to amend the terms or conditions of the Offer; provided, that without the consent of the Company, the Purchaser will not amend the terms or conditions of the Offer to change the form of consideration to be paid or decrease the price per Share payable in the Offer, the number of Shares sought in the Offer or to impose conditions to the Offer in addition to those set forth in Section 15 or to amend any other term of the Offer in any manner materially adverse to the holders of Shares. The rights reserved by the Purchaser in this paragraph are in addition to the Purchaser's rights to terminate the Offer pursuant to Section 15. Any extension, amendment or termination will be followed as promptly as practicable by public announcement thereof, the announcement in the case of an extension to be issued no later than 9:00 a.m., New York City time, on the next business day after the previously scheduled Expiration Date in accordance with the public announcement requirements of Rules 14d-4(c) and 14e-1(d) under the Exchange Act. Any reduction in the purchase price pursuant to the Merger Agreement will be considered an amendment to the Offer, and will be followed by the appropriate announcement. Without limiting the obligation of the Purchaser under such Rules or the manner in which the Purchaser may choose to make any public announcement, the Purchaser currently intends to make announcements by issuing a release to the Dow Jones News Service or the Reuters News Service. The Purchaser also reserves the right, in its sole discretion, subject to the terms of the Merger Agreement, in the event any of the conditions specified in Section 15 will not have been satisfied and so long as Shares have not theretofore been accepted for payment, to delay (except as otherwise required by applicable law) acceptance for payment of or payment for Shares or to terminate the Offer and not accept for payment or pay for Shares. If the Purchaser extends the Offer, or if the Purchaser (whether before or after its acceptance for payment of Shares) is delayed in its purchase of or payment for Shares or is unable to pay for Shares pursuant to the Offer for any reason, then, without prejudice to the Purchaser's rights under the Offer, the Depositary may retain tendered shares on behalf of the Purchaser, and such Shares may not be withdrawn except to the extent tendering stockholders are entitled to withdrawal rights as described in Section 4. However, the ability of the Purchaser to delay the payment for Shares which the Purchaser has accepted for payment is limited by Rule 14e-1(c) under the Exchange Act, which requires that a bidder pay the consideration offered or return the securities deposited by or on behalf of holders of securities promptly after the termination or withdrawal of such bidder's offer. If the Purchaser makes a material change in the terms of the Offer or the information concerning the Offer or waives a material condition of the Offer (including the Minimum Condition), the Purchaser will disseminate additional tender offer materials and extend the Offer to the extent required by Rules 14d-4(c) and 14d-6(d) under the Exchange Act. The minimum period during which the Offer must remain open following material changes in the terms of the Offer or information concerning the Offer, other than a change in price or a change in percentage of securities sought, will depend upon the facts and circumstances, including the relative materiality of the terms or information. With respect to a change in price or a change in percentage of securities sought, a minimum ten business day period is generally required to allow for adequate dissemination to stockholders and investor response. If prior to the Expiration Date, the Purchaser should decide to increase the price per Share being offered in the Offer, such increase will be applicable to all stockholders whose Shares are accepted for payment pursuant to the Offer. As used in this Offer to Purchase, "business day" means any day other than Saturday, Sunday or a federal holiday and consists of the time period from 12:01 A.M. through 12:00 Midnight, New York City time as computed in accordance with Rule 14d-l under the Exchange Act. 15. CERTAIN CONDITIONS TO THE OFFER. Notwithstanding any other provision of the Offer, Purchaser shall not be required to accept for payment or pay for, and may delay the acceptance for payment of (whether or not the Shares have theretofore been accepted for payment), or the payment for, any Shares tendered, and may terminate or extend the Offer and not accept for payment any Shares, if: (i) immediately prior to the expiration of the Offer (as extended in accordance with the terms of the Offer), (A) any applicable waiting period under the Antitrust Laws will not have expired or been terminated or any approvals required under the EC Merger Regulation (as defined below) will not have been received, (B) the Spin-Off Record Date for the distribution of shares of Spinco common stock to stockholders of the Company pursuant to the Distribution Agreement will not have been set by the Company's Board of Directors, (C) the public indenture merger opinions will not have been delivered to Purchaser and the applicable public indenture trustees, or (D) the number of Shares validly tendered and not withdrawn when added to the Shares then beneficially owned by Parent does not constitute two-thirds of the Shares then outstanding and represent two-thirds of the voting power of the Shares then outstanding on a fully diluted basis on the date of purchase; OR (ii) on or after the date of the Merger Agreement and prior to the acceptance for payment of Shares, any of the following conditions exist: (a) any of the representations or warranties of the Company contained in the Merger Agreement will not have been true and correct at the date when made or (except for those representations and warranties made as of a particular date which need only be true and correct as of such date) shall cease to be true and correct at any time prior to consummation of the Offer, except where the failure to be so true and correct would not, individually or in the aggregate, have a Material Adverse Effect (as defined in the Merger Agreement); provided, that if any such failure to be so true and correct is curable by the Company through the exercise of its reasonable efforts, then Purchaser may not terminate the Offer under this subsection (a) until 10 business days after written notice thereof has been given to the Company by Parent or Purchaser and unless at such time the matter has not been cured; or (b) any of the representations or warranties of Spinco contained in the Distribution Agreement will not have been true and correct at the date when made or (except for those representations and warranties made as of a particular date which need only be true and correct as of such date) will cease to be true and correct at any time prior to consummation of the Offer, except where the failure to be so true and correct would not individually or in the aggregate, have a Material Adverse Effect; provided, that if any such failure to be so true and correct is curable by Spinco through the exercise of its reasonable efforts, then Purchaser may not terminate the Offer under this subsection (b) until 10 business days after written notice thereof has been given to the Company by Parent or Purchaser and unless at such time the matter has not been cured; or (c) the Company will have breached any of its covenants or agreements contained in the Merger Agreement, except for any such breaches that, individually or in the aggregate, would not have a Material Adverse Effect; provided that, if any such breach is curable by the Company through the exercise of its reasonable efforts, then Purchaser may not terminate the Offer under this subsection (c) until 10 business days after written notice thereof has been given to the Company by Parent or Purchaser and unless at such time the breach has not been cured; or (d) Spinco or the Company will have breached any of its covenants or agreements contained in the Distribution Agreement, except for any such breaches that, individually or in the aggregate, would not have a Material Adverse Effect; provided, that if any such breach is curable by Spinco or the Company through the exercise of its reasonable efforts, then Purchaser may not terminate the Offer under this subsection (d) until 10 business days after written notice thereof has been given to the Company or Spinco, as the case may be, by Parent or Purchaser and unless at such time the breach has not been cured; or (e) there will have been any statute, rule, regulation, judgment, order or injunction promulgated, enacted, entered, enforced or deemed applicable to the Offer, or any other legal action will have been taken, by any state, federal or foreign government or governmental authority or by any U.S. court, other than the routine application to the Offer, the Merger or the Spin-Off of waiting periods under the HSR Act, that presents a substantial likelihood of (1) making the acceptance for payment of, or the payment for, all of the Shares illegal or otherwise prohibiting, restricting or significantly delaying consummation of the Offer, (2) imposing material limitations on the ability of Purchaser or Parent to acquire or hold or to exercise any rights of ownership of the Shares, or effectively to manage or control the Retained Business, the Company, the Retained Subsidiaries, Purchaser or any of their respective affiliates, which individually or in the aggregate could constitute a Significant Adverse Effect; or (f) any fact or circumstance exists or will have occurred that has a (g) there will have occurred (1) any general suspension of trading in, or limitation on prices for, securities on the NYSE, (2) the declaration of a banking moratorium or any suspension of payments in respect of banks in the United States (whether or not mandatory), (3) the commencement of a war, armed hostilities or other international or national calamity directly or indirectly involving the United States and having a Material Adverse Effect or materially adversely affecting (or materially delaying) the consummation of the Offer, (4) any limitation or proposed limitation (whether or not mandatory) by any U.S. governmental authority or agency, or any other event, that materially adversely affects generally the extension of credit by banks or other financial institutions, (5) from the date of the Merger Agreement through the date of termination or expiration of the Offer, a decline of at least 25% in the Standard & Poor's 500 Index or (6) in the case of any of the situations described in clauses (1) through (5) inclusive, existing at the date of the commencement of the Offer, a material acceleration, escalation or worsening thereof; or (h) any person (which includes a "person" as such term is defined in Section 13(d)(3) of the Exchange Act) other than Purchaser, any of its affiliates, or any group of which any of them is a member will have acquired beneficial ownership of more than 20% of the outstanding Shares or will have entered into a definitive agreement or an agreement in principle with the Company with respect to a tender offer or exchange offer for any Shares or merger, consolidation or other business combination with or involving the Company or any of its subsidiaries; or (i) prior to the purchase of Shares pursuant to the Offer, the Board of Directors of the Company will have withdrawn or modified (including by amendment of the Schedule 14D-9) in a manner adverse to Purchaser its approval or recommendation of the Offer, the Merger Agreement, the Merger or the Spin-Off, will have recommended to the Company's stockholders another offer, will have authorized the redemption of the Rights (whether or not in accordance with Section 6.1(k) of the Merger Agreement) after the Company has received an Acquisition Proposal, or will have adopted any resolution to effect any of the foregoing which, in the sole judgment of Purchaser in any such case, and regardless of the circumstances (including any action or omission by Purchaser) giving rise to any such condition, makes it inadvisable to proceed with such acceptance for payment; or (j) the Merger Agreement will have been terminated in accordance with its (k) the Spin-Off Record Date will not have occurred; or (l) the conditions to the Spin-Off will not have been satisfied or (iii) Parent and Purchaser will not have secured financing on terms reasonably acceptable to Parent to finance the purchase of all of the Shares at the Merger Price and to consummate the transactions contemplated by the Merger Agreement and the Ancillary Agreements; provided, that the condition set forth in this clause (iii) will be a condition to Purchaser's obligations with respect to the Offer only if (A) the Offer has not been consummated on or before April 30, 1996, (B) Parent has not taken any significant action outside of the ordinary course of business, which prevents Parent from obtaining sufficient financing to purchase all of the Shares at the Merger Price and to consummate the transactions contemplated by the Merger Agreement and the Ancillary Agreements and (C) Parent and Purchaser are in substantial compliance with their respective material obligations under Sections 6.4, 6.5 and 6.6 of the Merger Agreement. The foregoing conditions are for the sole benefit of Purchaser and may be asserted by Purchaser regardless of the circumstances giving rise to such conditions, or may be waived by Purchaser in whole or in part at any time and from time to time in its sole discretion; provided, that the condition set forth in clause (ii)(j) above may be waived or modified only by the mutual consent of Purchaser and the Company. 16. CERTAIN LEGAL MATTERS; REGULATORY APPROVALS. Except as described in this Section 16, based on a review of publicly available filings by the Company with the Commission and other publicly available information concerning the Company, neither Parent nor the Purchaser is aware of any license or regulatory permit that appears to be material to the business of the Company and its subsidiaries, taken as a whole, that might be adversely affected by the acquisition of Shares by the Purchaser or Parent pursuant to the Offer, the Merger or otherwise or of any approval or other action by any governmental, administrative or regulatory agency or authority, domestic or foreign, that would be required prior to the acquisition of Shares by the Purchaser or Parent pursuant to the Offer, the Merger or otherwise. Should any such approval or other action be required, Parent and the Purchaser currently contemplate that it will be sought. While the Purchaser does not currently intend to delay the acceptance for payment of Shares tendered pursuant to the Offer pending the outcome of any such matter, there can be no assurance that any such approval or other action, if needed, would be obtained or would be obtained without substantial conditions or that adverse consequences might not result to the business of the Company or Parent or that certain parts of the business of the Company or Parent might not have to be disposed of in the event that such approvals were not obtained or any other actions were not taken. The Purchaser's obligation under the Offer to accept for payment and pay for Shares is subject to certain conditions, including conditions relating to the legal matters discussed in this Section 16. See Section 15. State Takeover Statutes. The Company is incorporated under the laws of the State of New York. Section 912 of the NYBCL prohibits certain "business combinations" (defined to include mergers and consolidations) involving a New York corporation and an "interested shareholder" (defined generally as a person who is the beneficial owner of 20% or more of the outstanding voting stock of such New York corporation) for a period of five years following the date on which such interested shareholder became such (such date, a "stock acquisition date") unless such business combination or the purchase of stock made by such interested shareholder is approved by the board of directors of such New York corporation prior to such interested shareholder's stock acquisition date or certain other statutory conditions have been met. At a meeting on January 7, 1996, the Board of Directors approved the Merger Agreement, the Merger, the Offer and the Purchaser's purchase of Shares pursuant to the Offer. Accordingly, the provisions of Section 912 of the NYBCL have been satisfied with respect to the Offer and the Merger and such provisions will not delay the consummation of the Merger. Article 16 of the NYBCL also requires a bidder for shares of a New York corporation to file a registration statement with the attorney general and satisfy certain disclosure requirements. Parent and the Purchaser have filed such a registration statement and this Offer to Purchase sets forth the information required to be disclosed pursuant to Article 16 of the NYBCL. A number of other states have adopted "takeover" statutes that purport to apply to attempts to acquire corporations that are incorporated in such states, or whose business operations have substantial economic effects in such states, or which have substantial assets, security holders, employees, principal executive offices or places of business in such states. In Edgar v. MITE Corporation, the Supreme Court of the United States invalidated on constitutional grounds the Illinois Business Takeover Act, which, as a matter of state securities law, made takeovers of corporations meeting certain requirements more difficult. However, in CTS Corp. v. Dynamics Corp. of America, the Supreme Court held that a state may, as a matter of corporate law and, in particular, those laws concerning corporate governance, constitutionally disqualify a potential acquiror from voting on the affairs of a target corporation without prior approval of the remaining stockholders, provided that such laws were applicable under certain conditions, in particular, that the corporation has a substantial number of stockholders in the state and is incorporated there. The Company, directly or through subsidiaries, conducts business in a number of states throughout the United States, some of which have enacted "takeover" statutes. The Purchaser does not know whether any of these statutes will, by their terms, apply to the Offer, and has not complied with any such statutes other than those adopted by the State of New York. To the extent that certain provisions of these statutes purport to apply to the Offer, the Purchaser believes that there are reasonable bases for contesting such statutes. If any person should seek to apply any state takeover statute, the Purchaser would take such action as then appears desirable, which action may include challenging the validity or applicability of any such statute in appropriate court proceedings. If it is asserted that one or more takeover statutes apply to the Offer, and it is not determined by an appropriate court that such statute or statutes do not apply or are invalid as applied to the Offer, the Purchaser might be required to file certain information with, or receive approvals from, the relevant state authorities, and the Purchaser might be unable to purchase or pay for Shares tendered pursuant to the Offer, or be delayed in continuing or consummating the Offer. In such case, the Purchaser may not be obligated to accept for payment or pay for Shares tendered. See Section 15. Antitrust. Under the HSR Act, certain acquisitions may not be consummated unless information has been furnished to the FTC and the Antitrust Division and certain waiting period requirements have been satisfied. The Offer and the acquisition of Shares pursuant to the Merger Agreement are subject to the HSR Act. Parent expects to file a Notification and Report Form with respect to the Offer on or before January 19, 1996. Under the provisions of the HSR Act applicable to the Offer, the purchase of Shares under the Offer may not be consummated until the expiration of a 15- calendar day waiting period following the filing by Parent. Accordingly, if Parent files its HSR Notification and Report Form on January 19, 1996, the waiting period with respect to the Offer will expire at 11:59 p.m., New York City time, on February 3, 1996, unless Parent receives a request for additional information or documentary material, or the Antitrust Division and the FTC terminate the waiting period prior thereto. If, within such 15-day waiting period, either the Antitrust Division or the FTC requests additional information or material from Parent concerning the Offer, the waiting period will be extended and would expire at 11:59 p.m., New York City time, on the tenth calendar day after the date of substantial compliance by Parent with such request. Only one extension of the waiting period pursuant to a request for additional information is authorized by the HSR Act. Thereafter, such waiting period may be extended only by court order or with the consent of Parent. The Purchaser will not accept for payment Shares tendered pursuant to the Offer unless and until the waiting period requirements imposed by the HSR Act with respect to the Offer have been satisfied. See Section 15. No separate HSR Act waiting period requirements with respect to the Merger Agreement will apply, so long as the 15-day waiting period expires or is terminated. Thus, all Shares will be acquired pursuant to the Offer at the close of the 15-day waiting period or on the tenth calendar day after the date of substantial compliance with a request for additional information (assuming all other conditions to the Offer have been satisfied or waived in accordance with the provisions thereof). The FTC and the Antitrust Division frequently scrutinize the legality under the antitrust laws of transactions such as the Purchaser's acquisition of Shares pursuant to the Offer and the Merger Agreement. At any time before or after the Purchaser's acquisition of Shares, the Antitrust Division or the FTC could take such action under the antitrust laws as it deems necessary or desirable in the public interest, including seeking to enjoin the acquisition of Shares pursuant to the Offer or otherwise or seeking divestiture of Shares acquired by the Purchaser or divestiture of substantial assets of Parent or its subsidiaries. Private parties and state attorneys general may also bring legal action under the antitrust laws under certain circumstances. Based upon an examination of publicly available information relating to the businesses in which Parent and the Company are engaged, Parent and the Purchaser believe that the acquisition of Shares by the Purchaser will not violate the antitrust laws. Nevertheless, there can be no assurance that a challenge to the Offer or other acquisition of Shares by the Purchaser on antitrust grounds will not be made or, if such a challenge is made, of the result. See Section 15 for certain conditions to the Offer, including conditions with respect to litigation and certain governmental actions. EC Merger Regulation. According to the Company 10-K, the Company may conduct substantial operations within the European Community (the "EC") and certain of the individual member states of the EC. The EC Merger Regulation requires that notices of concentrations with a "community dimension" be provided to the EC Commission for review and approval prior to being put into effect. The Offer will be deemed to have a "community dimension" if the combined aggregate worldwide annual revenues of both the Company and the Purchaser exceeds ECU 5 billion, if the community- wide annual revenues of each of the Company and the Purchaser exceed ECU 250 million, and if both the Company and the Purchaser do not receive more than two-thirds of their respective community-wide revenues from one and the same member state. Based upon information contained in the Company 10-K, the Purchaser believes that the Offer may be considered to have a "community dimension" if the Offer falls within the EC Merger Regulation, the EC Commission, as opposed to individual member states, has exclusive jurisdiction to review it, subject to certain exceptions. Under the EC Merger Regulation, a concentration that meets the foregoing guidelines requires the filing of a notice in a prescribed form with the EC Commission. This filing must normally be made within seven days of the earlier of the announcement of a public bid, the conclusion of the relevant agreement or acquisition of a controlling interest, although extensions of time are sometimes granted. Transactions subject to the filing requirements of the EC Merger Regulation are suspended automatically until three weeks after receipt of the notice. The EC Commission may extend the suspension period for such period as it finds necessary to make a final decision on the legality of the transaction. In the case of a public bid, the bidder may acquire shares of the target company during the suspension period, but may not vote such shares until after the end of the period unless the EC Commission grants permission to do so in order to permit the bidder to maintain the full value of its investment. The EC Commission must decide whether to initiate proceedings within one month after the receipt of the notice, subject to certain extensions for EC holidays or if an individual member state has requested a referral of the transaction. If proceedings are initiated, the EC Commission must reach a decision in the proceedings within four months of the commencement of the proceedings. If the EC Commission fails to reach a decision within either of these time periods the transactions will be deemed to be compatible with the common market. If the EC Commission declares the Offer to be not compatible with the common market, it may prevent the consummation of the transaction, order a divestiture if the transaction has already been consummated or impose conditions or other obligations. In the event that the transaction is found not to be subject to the EC Merger Regulation, various national merger control regimes of the member states may apply, and it may be necessary to obtain approvals from such national authorities. There can be no assurance that a challenge to the Offer will not be made pursuant to the EC Merger Regulation and if such a challenge is made, what the outcome will be, or, alternatively, if the concentration does not meet the aforementioned guidelines and does not require the filing of a notice with the EC Commission, what the outcome will be pursuant to the merger regulations of one or more of the various member states. FCC Regulation. The Communications Act of 1934, as amended (the "Communications Act"), requires prior approval by the FCC of the assignment or transfer of control of any radio or satellite license or licensee, or the assignment or transfer of any rights arising under any such license. The FCC distinguishes between pro forma transfers and assignments, in which ultimate ownership and control are not substantially changed and for which applications are processed on an expedited basis, and "substantial" assignments and transfers of control, which trigger an opportunity for public comment and receive a more comprehensive review by the FCC. Applications must be filed with the FCC seeking approval of both pro forma and substantial assignments and transfers. The Communications Act requires the FCC to find that the proposed transfer or assignment would serve the public interest, convenience and necessity as a prerequisite to granting approval. The FCC may also require that the applicant demonstrate that it possesses the requisite legal, financial, technical and other qualifications to operate the licensed facilities before it will approve the assignment or transfer. The FCC assesses, as part of the process of considering applications proposing assignments or transfers of control of FCC licenses or licensees, certain information with respect to officers, directors and stockholders of the entity to which control is to be transferred. The Offer and acquisition of Shares pursuant to the Merger Agreement will result in substantial assignments of, and transfers of control over, certain private radio licenses used internally by the Company in connection with its defense electronics and systems integration business. Such assignments and FCC approval. The public-comment period, however, will not be triggered because these licenses are private radio licenses. Moreover, in the case of private radio licenses, special temporary authorizations possibly may be obtained to allow the Offer and acquisition of Shares to close even if the FCC has not yet granted its approval of the underlying private radio transfer applications. In addition, based on publicly available information, Parent and Purchaser believe that the Spin-Off will result in a pro forma assignment of, and transfer of control over, certain licenses and authorizations issued by the FCC to the Company and its subsidiaries in connection with their telecommunications and space systems business, which will require prior FCC approval. There can be no assurance that challenge to the Offer or the Spin- Off will not be made pursuant to the Communications Act, and if such challenge were made, what the outcome would be. Commission Approval of Information Statement. The Company intends to file the Information Statement with the Commission as part of a registration statement of the Spinco Shares under the Exchange Act. The Company may not distribute the Information Statement or the Spinco Shares until the Commission has reviewed such registration statement and declared it effective. Margin Rules. The Purchaser and Parent believe that the requirements of the margin regulations promulgated by the Federal Reserve Board are not applicable to the financing of the Offer and the Merger. Short-Form Merger. Section 905 of the NYBCL would permit the Merger to occur without a vote of the Company's shareholders (a "short-form merger") if the Purchaser were to acquire at least 90% of the outstanding Shares in the Offer. 17. FEES AND EXPENSES. Parent and the Purchaser have engaged Bear Stearns to act as financial advisor to Parent in connection with the proposed acquisition of the Company and as Dealer Manager in connection with the Offer. Parent has agreed to pay Bear Stearns a fee of $5 million as compensation for its services to date as financial advisor to Parent and an additional fee of $20 million upon the consummation of the purchase by Parent or Purchaser of more than 50% of the capital stock of the Company for a total fee of $25 million. If Parent or Purchaser receives recovery of expenses or any other similar fee pursuant to the Merger Agreement, then Parent shall pay Bear Stearns immediately upon receipt of such expenses an additional fee of $20 million. The Purchaser also has agreed to reimburse Bear Stearns for its expenses, including reasonable counsel fees and to indemnify it against certain liabilities and expenses, including certain liabilities under the federal securities laws. The Purchaser has retained Morrow & Co. to act as the Information Agent and First Chicago Trust Company of New York to act as the Depositary in connection with the Offer. The Information Agent may contact holders of Shares by mail, telephone, telex, facsimile, telegraph and personal interview and may request brokers, dealers, commercial banks, trust companies and other nominees to forward the Offer material to beneficial owners. The Information Agent and Depositary each will receive reasonable and customary compensation for their services, will be reimbursed for certain reasonable out-of-pocket expenses and will be indemnified against certain liabilities and expenses in connection therewith, including certain liabilities under the federal securities laws. The Depositary has not been retained to make solicitations or recommendations in connection with the Offer. Neither the Purchaser nor Parent will pay any fees or commissions to any broker or dealer or other persons for soliciting tenders of Shares pursuant to the Offer (other than the fees of the Dealer Manager and the Information Agent). Brokers, dealers, commercial banks and trust companies will be reimbursed by the Purchaser for reasonable expenses incurred by them in forwarding material to their customers. 18. MISCELLANEOUS. The Purchaser is not aware of any jurisdiction in which the making of the Offer is not in compliance with applicable law. If the Purchaser becomes aware of any jurisdiction in which the making of the Offer would not be in compliance with applicable law, the Purchaser will make a good faith effort to comply with any such law. If, after such good faith effort, the Purchaser cannot comply with any such law, the Offer will not be made to (nor will tenders be accepted from or on behalf of) the holders of Shares residing in such jurisdiction. In those jurisdictions where securities or blue sky laws require the Offer to be made by a licensed broker or dealer, the Offer is being made on behalf of the Purchaser by the Dealer Manager or one or more registered brokers or dealers which are licensed under the laws of such jurisdiction. NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY REPRESENTATION ON BEHALF OF THE PURCHASER OR PARENT NOT CONTAINED IN THIS OFFER TO PURCHASE OR IN THE LETTER OF TRANSMITTAL AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED. The Purchaser has filed with the Commission the Schedule 14D-1 pursuant to Rule 14d-3 under the Exchange Act, furnishing certain additional information with respect to the Offer, and may file amendments thereto. The Schedule 14D-l and any amendments thereto, including exhibits, may be inspected and copies may be obtained at the same places and in the same manner as set forth in Section 7 (except they will not be available at the regional offices of the Commission). DIRECTORS AND EXECUTIVE OFFICERS OF PARENT The name, business address, present principal occupation or employment and five-year employment history of each director and executive officer of Parent and certain other information are set forth below. Unless otherwise indicated below, the address of each director and officer is c/o 6801 Rockledge Drive, Bethesda, Maryland 20817. No information is provided in the right-hand column where the individual has occupied the position indicated in the middle column for the past five years and holds no outside directorships. Unless otherwise indicated, each occupation set forth opposite an individual's name refers to employment with Parent. All directors and officers listed below are citizens of the United States. Parenthetical years indicate the year the individual was elected or appointed a director of Lockheed Corporation or Martin Marietta Corporation (which were combined into Lockheed Martin Corporation in the first quarter of 1995). The name, business address, present principal occupation or employment and five-year employment history of each director and executive officer of Purchaser and certain other information are set forth below. Unless otherwise indicated below, the address of each director and officer is c/o 6801 Rockledge Drive, Bethesda, Maryland 20817. Unless otherwise indicated, each occupation set forth opposite an individual's name refers to employment with Parent. Parenthetical years indicate the year the individual was elected or appointed to the position or office. All directors and officers listed below are citizens of the United States. CERTAIN INFORMATION ABOUT PARENT REQUIRED BY NEW YORK LAW Parent provides assistance to eligible employees participating in study programs leading to an undergraduate or an advanced degree. Such study programs must be consistent with Parent's business goals and objectives and applicable to the employee's field of work. Parent may limit the reimbursement of the academic costs of tuition. Parent may reimburse job applicants for reasonable and actual interview expenses, and may reimburse new and existing employees for reasonable and actual travel and relocation expenses in accordance with the provisions of corporate policy. Parent supports a broad spectrum of public interest activities through a gifts and grants program, with emphasis on recognized agencies in such fields as health, education, civic affairs, and cultural activities. Individual companies are authorized to make community contributions out of their operating funds. Parent sponsors a number of retirement plans that cover substantially all employees. Defined benefit plans for salaried and certain hourly employees provide benefits based on employees' years of service and compensation, either on a final or career average basis. Defined benefit plans for other hourly employees generally provide benefits of stated amounts for specified periods of service. Certain health care and life insurance benefits are provided to eligible retirees by Parent. For recently retired participants, the health benefits generally provide for cost sharing through participant contributions and copayments. For certain groups of employees who recently retired there is an annual limit on the Corporation's contribution per participant. STOCK OPTION AND AWARD PLANS Under Parent's 1995 Omnibus Performance Award Plan (the "Plan"), employees of Parent may be granted stock-based incentive awards, including options to purchase common stock, stock appreciation rights, restricted stock or other stock-based incentive awards. Cash-based incentive awards such as performance units may also be awarded. These awards may be granted singly or in combination with other awards. To date, Parent has awarded stock options under the Plan. The options to purchase its common stock were granted at a price equal to the market value at the date of grant. These options become exercisable in two approximately equal annual increments in multiples of 100 on the first and second anniversary dates of such grants and expire 10 years from such date. The Plan allows Parent to provide financing for purchases, subject to certain conditions, by interest-bearing notes payable to Parent. The Letter of Transmittal, certificates for Shares and any other required documents should be sent or delivered by each shareholder of the Company or his broker, dealer, commercial bank or other nominee to the Depository at one of its addresses set forth below. The Depositary for the Offer is: FIRST CHICAGO TRUST COMPANY OF NEW YORK By Mail: By Hand or Overnight Courier: Tenders & Exchanges Tenders & Exchanges P.O. Box 2564 14 Wall Street, Suite 4680--Loral Jersey City, New Jersey 07303-2564 New York, New York 10005 Any questions or requests for assistance or additional copies of this Offer to Purchase, the Letter of Transmittal and the Notice of Guaranteed Delivery may be directed to the Information Agent or the Dealer Manager at their respective telephone numbers and locations listed below. You may also contact your broker, dealer, commercial bank or trust company or nominee for assistance concerning the Offer. The Information Agent for the Offer is: 909 Third Avenue, 20th Floor New York, New York 10022 Call Toll Free: (800) 566-9058 Banks and Brokerage Firms, please call: (800) 662-5200 The Dealer Manager for the Offer is: BEAR, STEARNS & CO. INC. New York, New York 10167 Call toll free: (800) 726-9849	SC 14D1	EX-99.(A)(1)	1996-01-12T00:00:00	1996-01-12T17:26:30
0000950168-96-000038	0000950168-96-000038_0001.txt	COLLINS & AIKMAN COMPLETES ACQUISITION OF MANCHESTER PLASTICS Charlotte, North Carolina -- January 3, 1996, -- Collins & Aikman Corporation (NYSE:CKC) announced today that it has completed the acquisition of Larizza Industries, Inc., whose sole operating unit is Manchester Plastics, for a purchase price of approximately $144 million. In addition, approximately $40 million of Larizza debt was extinguished. The acquisition and related fees and expenses have been financed with a $197 million credit facility arranged by Chemical Bank. Mr. Thomas E. Hannah, Chief Executive Officer of Collins & Aikman, commented, "The acquisition of Manchester advances Collins & Aikman's automotive growth strategy by adding a broad range of molded plastic components to our existing market leading automotive interior lines. A strong book of future business is currently expected to increase Manchester's sales per North America build from $12 presently to nearly $20 per vehicle by the end of the decade." Mr. Hannah added, "The Manchester acquisition also complements the other dimension of our automotive growth strategy which is to develop European production capabilities for both existing and new product lines." Manchester Plastics, a maker of automotive door panels, headrests, floor console systems and instrument panel components, is the sole operating Inc., which has been renamed Manchester Plastics, Inc. Manchester is a leading designer and manufacturer of high quality plastics-based components and systems used in the interior of automobiles, light trucks, sport utility vehicles and minivans. It serves the North American automakers from eight manufacturing plants in the United States and Canada. Edward W. Wells will continue as president of Manchester Plastics and will report to Mr. Hannah. Collins & Aikman Corporation is a leader in each of its three business segments. In Automotive Products, it is the largest supplier of interior textile trim products to the North American auto industry. In Interior Furnishings, it is the largest manufacturer of residential upholstery fabrics and a leading manufacturer of specified contract carpet products. In Wallcoverings, it is the largest producer of residential wallpaper in the United States. Within these three segments, the Company holds a number one or a number two position in each of its eight major product lines, which together approximate more than 80% of its total net sales.	SC 13D/A	EX-4	1996-01-12T00:00:00	1996-01-11T17:34:38
0000950005-96-000006	0000950005-96-000006_0000.txt	/ X / QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended November 30, 1995 / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from __________ to __________ (Exact name of Registrant as specified in its charter) (State or other jurisdiction (I.R.S. employer of incorporation or organization) identification no.) (Address, including zip code, of Registrant's principal executive offices and telephone 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 _____ The number of shares outstanding of the Registrant's Common Stock on December 31, 1995 was 10,193,893 shares. The Exhibit Index is located on page 13. Page 1 of 15 pages. PART I - FINANCIAL INFORMATION Item 1. Financial Statements 3 Condensed Consolidated Balance Sheets at November 30, 1995 and February 28, 1995 4 Condensed Consolidated Statements of Income for the Three Months and Nine Months Ended November 30, 1995 and 1994 5 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended November 30, 1995 and 1994 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 13 PART I - FINANCIAL INFORMATION The condensed consolidated interim financial statements included herein have been prepared by Integrated Systems, Inc. (the "Company"), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Although certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, the Company believes that the disclosures made are adequate to make the information presented not misleading. It is suggested that the condensed consolidated interim financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended February 28, 1995. The February 28, 1995 condensed consolidated balance sheet data was derived from the audited financial statements, but does not include all disclosures required by generally accepted accounting principles. The accompanying condensed consolidated interim financial statements have been prepared in all material respects in conformity with the standards of accounting measurements set forth in Accounting Principles Board Opinion No. 28 and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to summarize fairly the financial position, results of operations, and cash flows for the periods indicated. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year. Prior to fiscal 1996, the Company's fiscal year was reported on a 52/53-week period ending on the last Saturday in February of each year. Accordingly, quarterly periods did not necessarily end on the last day of a calendar month. Beginning in fiscal 1996, the Company's fiscal year end is the last day in February and quarterly periods will end on the last day of a calendar month. The effect of this change was not material to the Company's financial statements for the three and nine-month periods ended November 30, 1995. For clarity of presentation herein, all fiscal periods are described as ending on a calendar month-end. Cash and cash equivalents $ 10,162 $ 7,144 Marketable securities, current 16,192 6,472 Accounts receivable, net 17,100 14,156 Deferred income taxes 852 1,153 Other current assets 2,334 2,757 Total current assets 46,640 31,682 Marketable securities, noncurrent 19,590 22,299 Property and equipment, net 3,578 2,584 Intangible assets, net 1,994 5,466 Total assets $ 72,592 $ 62,458 Accounts payable $ 2,222 $ 1,741 Accrued payroll and related expenses 2,124 2,110 Other accrued liabilities 3,491 3,097 Income taxes payable 2,852 1,952 Total current liabilities 18,155 14,967 Common Stock, no par value, 25,000 shares authorized: 10,190 and 9,494 shares issued and outstanding at November 30, 1995 and February 28, 1995, Unrealized holding gain (loss) on marketable Total shareholders' equity 53,986 47,291 Total liabilities and shareholders' equity $ 72,592 $ 62,458 The accompanying notes are an integral part of these condensed consolidated financial statements. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Cash flows from operating activities: Net income $ 3,714 $ 3,625 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,260 2,667 Write-down of intangible assets 3,083 -- Changes in assets and liabilities: Other current assets 424 (333) Accounts payable, accrued payroll and other accrued liabilities 889 (166) Income taxes payable 900 208 Other assets and liabilities 168 (139) Net cash provided by operating activities 9,893 3,959 Cash flows from investing activities: Purchases of marketable securities, net (6,261) (339) Additions to property and equipment, net (2,080) (1,577) Capitalized software development costs (285) (467) Net cash paid in acquisitions -- (1,750) Net cash used in investing activities (9,126) (4,333) Cash flows from financing activities: Proceeds from exercise of common stock options and purchases under the employee stock purchase plan 2,251 1,467 Repurchase of common stock -- (1,094) Net cash provided by financing activities 2,251 373 Net increase (decrease) in cash and cash equivalents 3,018 (1) Cash and cash equivalents at beginning of period 7,144 8,021 Cash and cash equivalents at end of period $ 10,162 $ 8,020 Supplemental disclosure of noncash investing and financing activities: Unrealized gain (loss) on marketable securities $ 750 $ (812) The accompanying notes are an integral part of these condensed consolidated financial statements. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Information for the three and nine months ended November 30, 1995 and 1994 is unaudited) 1. Summary of Significant Accounting Policies The condensed consolidated financial statements include the accounts of Integrated Systems, Inc. and its majority owned subsidiaries, after elimination of all significant intercompany accounts and transactions, and should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended February 28, 1995. These condensed consolidated financial statements do not include all disclosures normally required by generally accepted accounting principles. The Company incurs certain costs to develop computer software to be licensed or otherwise marketed to customers. Costs that are required to be capitalized under Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed" ("SFAS No. 86") were $285,000 in the first nine months of fiscal 1996 compared to $467,000 in the same period of the previous year. Such costs are being amortized using the greater of the amount computed using the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product, or on a straight-line basis over three years. Amortization for the three and nine months ended November 30, 1995 was $229,000 and $690,000, respectively, compared to $200,000 and $393,000, respectively, for the same periods of the previous year. Earnings per share is computed using the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares result from the assumed exercise of outstanding stock options that have a dilutive effect when applying the treasury stock method. On October 31, 1995, the Company acquired TakeFive Software GmbH, an Austrian corporation ("TakeFive"), in a share exchange reorganization, by issuing 435,990 shares of Common Stock in exchange for 97% of the shares of TakeFive. The business combination was accounted for as a pooling of interests and the results of operations for the nine months ended November 30, 1995 have been restated to include those of TakeFive for the period. Revenues and net income for TakeFive for the nine months ended November 30, 1995 were $3.2 million and $0.6 million, respectively. The prior year's results have not been restated as those of TakeFive were insignificant. Prior to the business combination, TakeFive was in the business of developing, marketing and supporting software tools used in software development. The Company intends to continue the business of TakeFive and operate TakeFive as an independent subsidiary. In connection with the business combination, $3.6 million of merger related costs and expenses were charged to operations in the third quarter of fiscal 1996. The merger costs and expenses include approximately $0.5 million of direct transaction costs and a $3.1 million write-down of previously capitalized intangible assets related to a prior acquisition whose product offering will be replaced by the use of TakeFive products. Following the end of the third quarter, the Company announced that it has signed a definitive agreement to acquire privately-held Doctor Design, Inc. ("DDI"), a California corporation. DDI is a developer of multimedia hardware, software and application specific integrated circuit technology. In connection with this transaction, the Company will issue common stock in exchange for DDI stock. Although the number of shares has not yet been determined, the total value of the transaction is estimated to be approximately $17.5 million. The acquisition is expected to close by the end of January 1996 and will be accounted for as a pooling of interests. Following the end of the third quarter, the Company acquired certain technology and related assets to enhance pSOSystem product offerings for approximately $3.2 million plus additional cash payments contingent upon the achievement of certain sales levels of the acquired products over the next three years. The Company expects that the results for the fourth quarter and the full fiscal year ending February 29, 1996, will include a charge for the write-off of in-process research and development associated with this acquisition. The amount of the charge has not yet been determined. 6. Statement of Financial Accounting Standards No. 123 The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") in October 1995. This accounting standard permits the use of either a fair value based method or the current Accounting Principals Board Opinion 25, "Accounting for Stock Issued to Employees" ("APB 25") when accounting for stock-based compensation arrangements. Companies that do not follow the new fair value based method will be required to disclose pro forma net income and earnings per share computed as if the fair value based method had been applied. The disclosure provisions of SFAS No. 123 are effective for fiscal years beginning after December 15, 1995. Management has not determined if it will adopt the fair value based method of accounting for stock-based compensation arrangements nor the impact of SFAS No. 123 on the Company's Consolidated Financial Statements. Item 2. Management's Discussion and Analysis of Financial Condition and Results The following information should be read in conjunction with the condensed consolidated interim financial statements and the notes thereto included in Item 1 of this Quarterly Report and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's Annual Report on Form 10-K for the year ended February 28, 1995, as filed with the Securities and Exchange Commission on May 26, 1995. The following tables set forth for the periods indicated the percentage of total revenue represented by each line item in the Company's condensed consolidated statements of income and the percentage change from the comparative prior period in each line item: Three Months Ended Three Months Ended 1995 1994 1995 compared to 1994 Revenue: Product licenses 68% 65% 43% Maintenance and renewals 15 17 16 Engineering services 17 18 31 Total revenue 100 100 36 Cost of product licenses revenue 11 10 55 Cost of maintenance and renewals revenue -- -- (12) Cost of engineering services revenue 11 11 39 Marketing and sales 35 40 21 Research and development 15 16 27 General and administrative 8 7 59 Amortization of intangible assets 1 1 (57) Merger related expenses 20 -- N/M Total costs and expenses 101 85 61 Income (loss) from operations (1) 15 (105) Interest and other income 3 4 16 Income before income taxes 2 19 (84) Provision for income taxes 1 6 (84) Net income 1% 13% (84)% Nine Months Ended Nine Months Ended 1995 1994 1995 compared to 1994 Revenue: Product licenses 69% 63% 52% Maintenance and renewals 15 19 10 Engineering services 16 18 29 Total revenue 100 100 40 Cost of product licenses revenue 11 10 56 Cost of maintenance and renewals revenue 1 1 (38) Cost of engineering services revenue 12 12 46 Marketing and sales 37 40 29 Research and development 16 16 40 General and administrative 8 7 56 Amortization of intangible assets 1 3 (60) Merger related expenses 7 -- N/M Total costs and expenses 93 89 46 Income from operations 7 11 (7) Interest and other income 4 4 33 Income before income taxes 11 15 2 Provision for income taxes 4 5 2 Net income 7% 10% 2% The Company's revenue is derived from the licensing of its products, related maintenance and license renewals, and engineering services. Total revenue in the third quarter of fiscal 1996 of $18,426,000 increased 36% compared to the third quarter of fiscal 1995, while total revenue for the first nine months of fiscal 1996 of $50,648,000 increased 40% compared to the first nine months of fiscal 1995. These increases were due to growth in all revenue categories. Product licenses revenue increased by 43% in the third quarter of fiscal 1996 compared to the third quarter of fiscal 1995 and 52% for the first nine months of fiscal 1996 compared to the first nine months of fiscal 1995, due to growth in both the real-time product line and the MATRIXx product line. Real-time product licenses revenue for the three and nine months ended November 30, 1995 includes revenues of TakeFive Software GmbH. The Company acquired TakeFive Software GmbH on October 31, 1995. The business combination has been accounted for as a pooling of interests and, accordingly, the results of operations for the three and nine months ended November 30, 1995 include those of TakeFive Software GmbH. The prior year comparative results have not been restated as those of TakeFive Software GmbH were insignificant. Total maintenance and renewals revenue increased by 16% over the prior year's third quarter and by 10% over the prior year's first nine months due to increased customer base. Engineering services revenue over these periods increased by 31% and 29%, respectively, due to increases in the number and size of contracts. The Company's real-time product licenses, maintenance and renewals revenue increased 44% in the third quarter of fiscal 1996 compared to the same quarter of the prior fiscal year and by 63% in the first nine months of fiscal 1996 compared to the same period of the prior fiscal year. Contributing to revenue growth of the real-time product family was the introduction of new products and sales related to TakeFive Software GmbH, which the Company acquired in the third quarter of fiscal 1996. MATRIXx product licenses, maintenance and renewals revenue increased 25% in the third quarter of fiscal 1996 compared to the third quarter of fiscal 1995 and 14% in the first nine months of fiscal 1996 compared to the first nine months of fiscal 1995, due mostly to the introduction of new products. Domestic product licenses, maintenance and renewals revenue increased by 40% between the comparative quarterly periods and 29% between the comparative nine-month periods, while international product licenses, maintenance and renewals revenue increased by 33% and 66%, respectively. The percentage of the Company's total revenue from customers located internationally was 33% in the third quarter of fiscal 1996 and 35% in the first nine months of fiscal 1996, compared to 34% in the third quarter of fiscal 1995 and 29% in the first nine months of fiscal 1995. The Company's cost of product licenses revenue as a percentage of total revenue increased to 11% in both the three and nine-month periods of fiscal 1996 compared to 10% in the comparative periods of fiscal 1995. This increase was due in part to an increase in the amortization of capitalized research and development expenditures with releases of new products and an increase in royalty and other third party software costs. The cost of maintenance and renewals revenue as a percentage of total revenue was not significant in the third quarter and first nine months of fiscal 1996 and fiscal 1995. The cost of engineering services revenue as a percentage of engineering services revenue increased in both the three and nine-month periods due primarily to changes in contract mix. Marketing and sales expenses increased 21% and 29% between the comparative three and nine-month periods, respectively, primarily as a result of the Company's continuing efforts to strengthen its sales, support and service organization, both domestically and overseas, as well as an increase in volume-related sales expenses. Marketing and sales expenses decreased from 40% to 35% of total revenue and from 40% to 37% of total revenue for the three and nine-month comparative period, respectively. Sales and marketing expenses as a percentage of revenue are expected to be higher for the whole of fiscal 1996 as the Company continues to build its sales and marketing infrastructure, particularly in Japan and the rest of Asia. Research and development expenses increased by 27% and 40%, respectively, between the quarterly and nine-month comparative periods. These increases were primarily the result of increased activity associated with bringing several significant products to market, including increased personnel and consulting expenses. Costs that are required to be capitalized under Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed" ("SFAS No. 86") were $50,000 in the third quarter of fiscal 1996 compared to $75,000 in the third quarter of fiscal 1995 and $285,000 in the first nine months of fiscal 1996 compared to $467,000 in the first nine months of fiscal 1995. The amount capitalized represents approximately 2% of total research and development expenditures for the third quarter of fiscal 1996 compared to 3% for the third quarter of fiscal 1995, and 3% for the first nine months of fiscal 1996 compared to 7% for the first nine months of fiscal 1995. The amount of research and development expenditures capitalized in a given time period depends upon the nature of the development performed and, accordingly, amounts capitalized may vary from period to period. Capitalized costs are being amortized using the greater of the amount computed using the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product, or on a straight-line basis over three years. Amortization for the three months ended November 30, 1995 was $229,000 compared to $200,000 for the three months ended November 30, 1994, and $690,000 for the nine months ended November 30, 1995 compared to $393,000 for the nine months ended November 30, 1994. General and administrative expenses increased 59% between the three-month comparative periods and 56% between the nine-month comparative periods due mostly to increased headcount. General and administrative expenses increased slightly as a percentage of total revenue. Amortization of intangible assets in the third quarter of fiscal 1996 and for the nine months ended November 30, 1995 has decreased from the prior year quarter and comparative nine-month period as certain assets and deferred compensation related to the acquisition of Software Components Group, Inc. in the second quarter of fiscal 1992 became fully amortized in fiscal 1995. In conjunction with the merger with TakeFive Software GmbH, the Company incurred merger related expenses of $3.6 million consisting of approximately $0.5 million of direct transaction costs and a $3.1 million write-down of previously capitalized intangible assets related to a prior acquisition whose product offering will be replaced by the use of TakeFive products. The Company's interest and other income increased by $73,000 between the three-month comparative periods and $425,000 between the nine-month comparative periods due primarily to an increase in cash and marketable securities. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") in October 1995. This accounting standard permits the use of either a fair value based method or the current Accounting Principals Board Opinion 25, "Accounting for Stock Issued to Employees" ("APB 25") when accounting for stock-based compensation arrangements. Companies that do not follow the new fair value based method will be required to disclose pro forma net income and earnings per share computed as if the fair value based method had been applied. The disclosure provisions of SFAS No. 123 are effective for fiscal years beginning after December 15, 1995. Management has not determined if it will adopt the fair value based method of accounting for stock-based compensation arrangements nor the impact of SFAS No. 123 on the Company's Consolidated Financial Statements. Risk Factors That May Affect Future Results of Operations The Company believes that in the future, its results of operations could be impacted by factors such as delays in shipment of the Company's new products and major new versions of existing products, declining product prices and margins, market acceptance of new products and upgrades, growth in the marketplace in which it operates, competitive product offerings and adverse changes in general economic conditions in any of the countries in which the Company does business. The Company's performance may also be adversely affected by the ability of its suppliers to provide competitive products. During the last twelve months, the Company's competitors have continued to make a variety of product announcements and offerings. The Company continues to release new versions of its product lines and the successful acceptance of these products will play a key role in future growth. The impact of any of these factors is difficult to predict or forecast. The Company's recent acquisitions have not been fully integrated into the Company. Delays or problems in this integration could significantly impact the Company's quarterly or annual results. Furthermore, newly discovered problems with these acquisitions could affect Company performance. During the quarter, one of the Company's major competitors announced that it intends to be acquired by a company with significantly more resources. The Company expects that this acquisition will make the embedded software market more competitive. Due to the risk factors noted above, the Company's future earnings and stock price may be subject to significant volatility, particularly on a quarterly basis. Any shortfall in revenue or earnings from levels expected by securities analysts could have an immediate and significant adverse effect on the trading price of the Company's common stock in any given period. Additionally, the Company often does not learn of such shortfalls until late in the fiscal quarter, or even after the quarter is over, which could result in an even more immediate and adverse effect on the trading price of the Company's common stock. The trading prices of many high technology companies' stocks, including the stock of the Company, are at or near their historical highs and reflect price/earnings ratios substantially above historical norms. There can be no assurance that the trading price of the Company's stock will remain at or near its current level. Finally, the Company participates in a highly dynamic industry, which often results in significant volatility of the Company's common stock price. Consequently, the purchase or holding of the Company's stock involves a high degree of risk. The Company funds its operations principally through cash flows from operations. As of November 30, 1995, the Company had $45,944,000 of cash, cash equivalents and marketable securities. This represents an increase of $10,029,000 from February 28, 1995. During fiscal 1995, the Company announced that the Board of Directors authorized the Company to repurchase up to an additional 500,000 shares of common stock for cash, from time-to-time at market prices, pursuant to a repurchase program announced in September 1992. In fiscal 1995, under this program, the Company repurchased 125,000 shares of common stock for $1,094,000. The Company believes that cash flows from operations, together with existing cash balances and available borrowings, will be adequate to meet the Company's cash requirements for working capital, capital expenditures and stock repurchases for the next twelve months and the foreseeable future. Net cash provided by operating activities during the nine months ended November 30, 1995 totaled $9,893,000 compared to $3,959,000 in the nine months ended November 30, 1994. The increase in net cash provided by operating activities was primarily due to increased net income and the write-down of intangible assets. Net cash used in investing activities totaled $9,126,000 in the first nine months of fiscal 1996 compared to $4,333,000 in the first nine months of fiscal 1995. The increase in net cash used in investing activities was due primarily to net purchases of marketable securities. Net cash provided by financing activities during the nine months ended November 30, 1995 totaled $2,251,000 compared to $373,000 for the nine months ended November 30, 1994. The increase was due to increased proceeds from the exercise of common stock options and purchases under the Employee Stock Purchase Plan and due to use of funds in fiscal 1995 resulting from the repurchase of common stock for $1,094,000. The Company expects that it will be able to sustain its level of expenditures on property and equipment and fund operational needs for the next twelve months and the foreseeable future, from cash flow from operations. PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K The following exhibit is filed herewith: 27.00 Financial Data Schedule 15 (b) Reports on Form 8-K. A Form 8-K was filed by the Registrant on November 15, 1995 in conjunction with the acquisition of TakeFive Software GmbH. Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: January 11, 1996 INTEGRATED SYSTEMS, INC. President and Chief Executive Officer	10-Q	10-Q	1996-01-12T00:00:00	1996-01-11T21:07:00
0001002241-96-000001	0001002241-96-000001_0000.txt	Lexington SmallCap Value Fund, Inc. P.O. Box 1515 / Park 80 West Plaza Two, Saddle Brook, New Jersey 07663 A NO-LOAD MUTUAL FUND WHOSE INVESTMENT OBJECTIVE IS LONG-TERM CAPITAL APPRECIATION. THE FUND WILL SEEK TO ACHIEVE ITS INVESTMENT OBJECTIVE THROUGH INVESTMENT IN COMMON STOCKS AND EQUIVALENTS OF COMPANIES DOMICILED IN THE UNITED STATES WITH A MARKET CAPITALIZATION OF LESS THAN $1 BILLION. Lexington SmallCap Value Fund, Inc. (the "Fund") is a no-load open-end diversified management investment company. The Fund's principal investment objective is long term capital appreciation. Shareholders may invest, reinvest or redeem shares at any time without charge or penalty. Lexington Management Corporation ("LMC") is the Investment Adviser of the Fund. Capital Technology, Inc. ("CTI") is the Fund's Sub-Adviser. Lexington Funds Distributor, Inc. ("LFD") is the Distributor of shares of the Fund. This Prospectus concisely sets forth information about the Fund that you should know before investing. It should be read and retained for future reference. A Statement of Additional Information dated January 2, 1996, which provides a further discussion of certain areas in this Prospectus and other matters that may be of interest to some investors, has been filed with the Securities and Exchange Commission and is incorporated herein by reference. For a free copy, call the appropriate telephone number above or write to the address listed above. Mutual fund shares are not deposits or obligations of (or endorsed or guaranteed by) any bank, nor are they federally insured or otherwise protected by the Federal Deposit Insurance Corporation ("FDIC"), the Federal Reserve Board or any other agency. Investing in mutual funds involves investment risks, including the possible loss of principal, and their value and return will fluctuate. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. Investors Should Read and Retain this Prospectus for Future Reference (as a percentage of average net assets) (net of reimbursement): Total Fund Operating Expenses......................................... 1.75% Example: 1 year 3 years You would pay the following expenses on a $1,000 investment, assuming (1) 5% annual return and (2) redemption at the end of each period..................... $18 $55 The purpose of the foregoing table is to assist an investor in understanding the various costs and expenses that an investor in the Fund will bear indirectly. LMC has agreed to voluntarily limit the total expenses of the Fund (excluding interest, taxes, brokerage, and extraordinary expenses but including management fee and operating expenses) to an annual rate of 1.75% of the Fund's average net assets. (For more complete descriptions of the various costs and expenses, see "Investment Adviser, Sub-Adviser, Distributor and Administrator" below.) The Expenses and Example (except the 12b-1 fees) appearing in the table above are based on the Fund's estimated expenses for the current fiscal year. The 12b-1 fees shown in the table reflect the maximum amount which may be paid under the Distribution Plan. See "Distribution Plan." The Example shown in the table above should not be considered a representation of past or future expenses and actual expenses may be greater or less than those shown. The percentages stated in this Fee Table are net of reimbursement. Total Operating Expenses absent expense reimbursements are predicted to be 2.50%, 2.00% and 1.75% of the Fund's average net assets, respectively, for the first, second and third years of operations. The Fund is an open-end diversified management investment company. It is called a no-load Fund because its shares are sold without a sales charge. INVESTMENT OBJECTIVE, POLICIES AND RISK FACTORS Lexington SmallCap Value Fund (the "Fund") is an open-end, diversified management investment company. The Fund's investment objective is to seek long-term capital appreciation. The Fund will seek to obtain its objecitve through investment in common stocks and equivalents of companies domiciled in the United States with a market capitalization of less than $1 billion which the Sub-Adviser believes offer exceptional relative value and attractive prices. Production of income is incidental to this objective. The Fund's portfolio will be invested primarily in equities listed on stock exchanges or traded in over-the-counter markets in the U.S. The Fund may invest in Canadian or other foreign domiciled companies whose shares trade in U.S. dollar denominated markets. The Fund will seek to achieve its objective through investment in a diversified portfolio of securities that will consist of all types of common stocks and equivalents (the following constitute equivalents: warrants, options and convertible debt securities). There is no assurance that the Fund will be able to achieve its investment objective. Except for defensive or liquidity purposes, the Fund will invest substantially all (at least 90%) of its assets in small companies domiciled in the U..S which have market capitalization (based on aggregate market value of outstanding shares) between $20 million and $1 billion at the time of investment. The remainder of its assets (no more than 10%) may be invested in securities of companies with market capitalizations below $20 million; above $1,000,000,000; domiciled outside the U.S. if its shares trade in U.S. markets in dollar denominations; in American Depository Shares or Receipts ("ADR's" or "ADS's"), real estate investment trusts ("REIT's) and/or in cash and equivalent securities. The Fund does not currently intend to invest in securities which, at the time of purchase, are not readily marketable; in securities of foreign issuers denominated in foreign currencies; or in futures contracts. The Fund will not engage in short-selling activities, leverage or portfolio hedging techniques. At any time the Sub-Adviser deems it advisable for temporary defensive or liquidity purposes, the Fund may hold all its assets in cash or cash equivalents and invest in, or hold unlimited amounts of, debt obligations of the United States government or its political subdivisions, and money market instruments including repurchase agreements with maturities of seven days or less and Certificates of Deposit. The Fund's investment portfolio may include repurchase agreements with banks and dealers in U.S. Government securities. A repurchase agreement involves the purchase by the Fund of an investment contract from a bank or a dealer in U.S. Government securities which contract is secured by debt securities whose value is equal to or greater than the value of the repurchase agreement including the agreed upon interest. The agreement provides that the institution will repurchase the underlying securities at an agreed upon time and price. The total amount received on repurchase would exceed the price paid by the Fund, reflecting an agreed upon rate of interest for the period from the date of the repurchase agreement to the settlement date, and would not be related to the interest rate on the underlying securities. The difference between the total amount to be received upon the repurchase of the securities and the price paid by the Fund upon their acquisition is accrued daily as interest. If the institution defaults on the repurchase agreement, the Fund will retain possession of the underlying securities. In addition, if bankruptcy proceedings are commenced with respect to the seller, realization on the collateral by the Fund may be delayed or limited and the Fund may incur additional costs. In such case the Fund will be subject to risks associated with changes in the market value of collateral securities. The Fund intends to limit repurchase agreements to transactions with institutions believed by the Sub-Adviser to present minimal credit risk. The Fund's overall approach to investing in small capitalization value stocks is based upon research performed by its Sub-Adviser which shows that extremely undervalued companies offer potential for high returns over time and excellent diversification versus other domestic equity investment styles. This strategy may under-emphasize widely followed, institutional favorites and result in holdings of stocks with little "Wall Street" or outside research coverage. Advantages of investing in distressed and/or neglected issues based on internal, fundamental research include: * low valuations that offer some downside protection * lack of institutional ownership that results in return streams not highly correlated with market indices * potential for upside surprises that is increased as stocks exceed minimal expectations and are "discovered" by other investors * low transaction costs based solely on best execution rather than research commitments. The companies in which the Fund intends to invest will generally have the following characteristics: * a market capitalization of less than $1 billion * a high relative ratio of revenue per share to stock price * a low relative ratio of price to book value per share * a positive cash flow and other measures of financial stability * a low stock price relative to historical levels. By following these criteria, the Fund intends to select securities which can have enhanced appreciation prospects and may provide investment returns superior to the market as a whole. However, the market value of these companies' securities tends to be volatile and in the past offered greater potential for gain as well as loss than securities of larger capitalization companies. Special Considerations. An investor should be aware that investment in small capitalization issuers carry more risk than issuers with market capitalization greater than $1 billion. Generally, small companies rely on limited product lines, financial resources, and business activities that may make them more susceptible to setbacks or downturns. In addition, the stock of such companies may be more thinly traded. As a result, in order to sell this type of security the Fund may need to dispose of such securities over a long period and accordingly, the performance of small capitalization issuers may be more volatile. Investments by the Fund of up to 10% of its total assets in the common stock of foreign companies which are traded in the United States or in ADR's or ADS's may involve considerations and risks that are different in certain respects from an investment in securities of U.S. companies. Such risks include the effect of currency fluctuations on the value of Fund shares, the imposition of withholding taxes on interest or dividends, possible adoption of foreign governmental restrictions on repatriation of income or capital investment, or other adverse political or economic developments. Additionally, it may be more difficult to enforce the rights of a security holder against a foreign company. There may be delays in settling securities transactions in certain foreign markets and information about the operations of foreign companies may be more difficult to obtain and evaluate. With respect to the Fund's investment in debt securities, there is no requirement that all such securities be rated by a recognized rating agency. However, it is the policy of the Fund that investments in debt securities, whether rated or unrated, will be made only if they are, in the opinion of the Sub-Adviser, of equivalent quality to "investment grade" securities. "Investment grade" securities are those rated within the four highest quality grades as determined by Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's Corporation ("Standard & Poor's"). Securities rated Aaa by Moody's and AAA by Standard & Poor's are judged to be of the best quality and carry the smallest degree of risk. Securities rated Baa by Moody's and BBB by Standard & Poor's lack high quality investment characteristics and, in fact, have speculative characteristics as well. Debt securities are interest-rate sensitive; therefore their value will tend to decrease when interest rates rise and increase when interest rates fall. Such increase or decrease in the value of longer-term debt instruments as a result of interest rate movement will be larger than the increase or decrease in value of shorter-term debt instruments. The Statement of Additional Information contains a complete description of the Fund's restrictions and any additional information on policies relating to the investment of its assets and its activities. Although the Fund does not generally intend to invest for the purpose of seeking short-term profits, the Fund's investments may be changed when circumstances warrant, without regard to the length of time a particular security has been held. It is expected that the Fund will have an annual portfolio turnover rate that will generally not exceed 100%. A 100% turnover rate would occur if all the Fund's portfolio investments were sold and either repurchased or replaced within a year. A high turnover rate (100% or more) results in correspondingly greater brokerage commissions and other transactional expenses which are borne by the Fund. High portfolio turnover may result in the realization of net short-term capital gains by the Fund which, when distributed to shareholders, will be taxable as ordinary income. See "Tax Matters." The business affairs of the Fund are managed under the direction of its Board of Directors. There are currently nine Directors (of whom six are non-affiliated persons) who meet four times each year. The Statement of Additional Information contains additional information regarding the directors and officers of the Fund. The Fund is managed by a portfolio management team. The lead managers are Robb W. Rowe, CFA and Dennis J. Hamilton, CFA of Capital Technology, Inc. ("CTI"), the Sub-Advisor . Both Mr. Rowe and Mr. Hamilton are Chartered Financial Analysts and members of the Association for Investment Management & Research and the North Carolina Society of Financial Analysts. Robb Rowe is President and principal shareholder of CTI. He is responsible for the Fund's overall investment strategy. Mr. Rowe joined CTI in 1982 after being Vice President and Regional Manager of AG Becker Co. He is a graduate of Ripon College and has an MBA from the University of Chicago in 1971. Mr. Rowe's investment management career began over 20 years ago. Dennis Hamilton is Vice President and Portfolio Manager of CTI. He is responsible for issue selection and the day to day investment activities of the Fund. Mr. Hamilton joined CTI in 1994 after being a Principal at Mercer Investment Consulting, Inc. He has also served as Director of Pension Investment for several multi-billion corporate pension funds and was President and Chief Investment Officer of Western Reserve Capital Management, Inc., an SEC registered investment advisor. He is an Honors graduate of Colgate University and earned an MBA from Harvard Business School in 1971. Mr. Hamilton's investment management career began over 24 years ago. INVESTMENT ADVISER, SUB-ADVISER, DISTRIBUTOR AND ADMINISTRATOR The Fund has entered into an investment advisory contract with Lexington Management Corporation ("LMC"), P.O. Box 1515, Park 80 West Plaza Two, Saddle Brook, New Jersey 07663. LMC provides investment advice and in general conducts the management and investment program of the Fund under the supervision and control of the Directors of the Fund. LMC has entered into a sub-advisory contract with CTI, McMullen Creek Office Center, P.O. Box 472428, Charlotte, North Carolina 28247, under which CTI will provide the Fund with investment advice and management of the Fund's investment program. Lexington Funds Distributor, Inc. ("LFD"), a registered broker dealer, is the Fund's distributor. LMC, established in 1938, currently manages over $3.5 billion in assets. LMC serves as investment adviser to other investment companies and private and institutional investment accounts. Included among these clients are persons and organizations which own significant amounts of capital stock of LMC's parent. The clients pay fees which LMC considers comparable to the fees paid by similarly served clients. CTI was founded in Charlotte, North Carolina in 1977 and invests exclusively in domestic smaller capitalization stocks. CTI currently manages assets both small and mid cap growth and value styles for primarily institutional clients. As compensation for its services, the Fund pays LMC a monthly management fee at the annual rate of 1.00% of the average daily net assets. This fee is higher than that paid by most other investment companies. However, it is not necessarily greater than the management fee of other investment companies with objectives and policies similar to this Fund. LMC will pay CTI an annual sub-advisory fee of .50% of the Fund's average daily net assets. The sub-advisory fee will be paid by LMC, not the Fund. See "Investment Adviser and Distributor" in the Statement of Additional Information. LMC has agreed to voluntarily limit the total expenses of the Fund (excluding interest, taxes, brokerage, and extraordinary expenses but including the management fee and operating expenses) to an annual rate of 1.75% of the Fund's average daily net assets through April 30,1996 or such later date to be determined by LMC. LMC also acts as administrator to the Fund and performs certain administrative and internal accounting services, including but not limited to, maintaining general ledger accounts, regulatory compliance, preparation of financial information for semiannual and annual reports, preparing registration statements, calculating net asset values, producing shareholder communications and supervision of the custodian, transfer agent and provides facilities for such services. The Fund shall reimburse LMC for its actual cost in providing such services, facilities and expenses. LMC and LFD are wholly-owned subsidiaries of Lexington Global Asset Managers, Inc., a Delaware corporation with offices at 80 Maiden Lane, New York, New York 10038. Descendants of Lunsford Richardson, Sr., their spouses, trusts and other related entities have a majority voting control of outstanding shares of Lexington Global Asset Managers, Inc. See "Investment Adviser and Distributor" in the Statement of Additional Information. Initial Investment-Minimum $1,000. By Mail: Send a check payable to Lexington SmallCap Value Fund, Inc., along with a completed New Account Application to State Street Bank and Trust Company (the "Agent"). See the back cover of this Prospectus for the Agent's address. Subsequent Investments-Minimum $50. By Mail: Send a check payable to Lexington SmallCap Value Fund, Inc., to the Agent, accompanied by either the detachable form which is part of the confirmation of a prior transaction or a letter indicating the dollar amount of the investment and identifying the Fund, account number and registration. Broker-Dealers: You may invest in shares of the Fund through broker-dealers who are members of the National Association of Securities Dealers, Inc., and other financial institutions and who have selling agreements with LFD. Broker-dealers and financial institutions who process such purchase and sale transactions for their customers may charge a transaction fee for these services. The fee may be avoided by purchasing shares directly from the Fund. The Open Account: By investing in the Fund, a shareholder appoints the Agent, as his agent, to establish an open account to which all shares purchased will be credited, together with any dividends and capital gain distributions which are paid in additional shares (see "Dividend, Distribution and Reinvestment Policy"). Stock certificates will be issued for full shares only when requested in writing. Unless payment for shares is made by certified or cashier's check or federal funds wire, certificates will not be issued for 30 days. In order to facilitate redemptions and transfers, most shareholders elect not to receive certificates. After an Open Account is established, payments can be provided for by "Lex-O-Matic" or other authorized automatic bank check program accounts (checks drawn on the investor's bank periodically for investment in the Fund). A shareholder may arrange to make additional purchases of shares automatically on a monthly or quarterly basis with the Automatic Investing Plan, "Lex-O-Matic". investments of $50 or more are automatically deducted from a checking account on or about the 15th day of each month. The institution must be an Automated Clearing House (ACH) member. Should an order to purchase shares of a fund be cancelled because your automated transfer does not clear, you will be responsible for any resulting loss incurred by that fund. The shareholder reserves the right to discontinue the Lex-O-Matic program provided written notice is given ten days prior to the scheduled investment date. Further information regarding this service can be obtained from Lexington by calling 1-800-526-0056. On payroll deduction accounts administered by a employer and on payments into qualified pension or profit sharing plans and other continuing purchase programs, there are no minimum purchase requirements. Purchase Price: The purchase price will be the net asset value per share of the Fund next determined after receipt by the Agent of a completed New Account Application in proper form. Determination of Net Asset Value: The net asset value of Fund shares is determined at the official closing time of the New York Stock Exchange each day that such Exchange is open for trading. In determining net asset value, portfolio securities listed on a national securities exchange are valued at their sales price on such exchange as of such time; if no sales price is reported, the mean of the last bid and asked price is used. For over-the-counter securities the mean of the latest bid and asked prices is used. Securities for which there are no current bid and asked prices, and any other assets of the Fund for which there is no readily available market value, shall be valued by Fund management in good faith under the direction of the Fund's Board of Directors. Repurchase agreements and certificates of deposit are stated at amortized cost. In order to determine net asset value per share, the aggregate value of portfolio securities is added to the value of the Fund's other assets, such as cash and receivables; the total of the assets thus obtained, less liabilities, is then divided by the number of shares outstanding. Terms of Offering: If an order to purchase shares is cancelled because the investor's check does not clear, the purchaser will be responsible for any loss incurred by the Fund. To recover any such loss the Fund reserves the right to redeem shares owned by the purchaser, seek reimbursement directly from the purchaser and may prohibit or restrict the purchaser in placing future orders in any of the Lexington Funds. The Fund reserves the right to reject any order, and to waive or lower the investment minimums with respect to any person or class of persons, including shareholders of the Fund's special investment programs. An order to purchase shares is not binding on the Fund until it has been confirmed by the Agent. Account Statements: The Agent will send shareholders either purchasing or redeeming shares of the Fund, a confirmation of the transaction indicating the date the purchase or redemption was accepted, the number of shares purchased or redeemed, the purchase or redemption price per share, and the amount purchased or redemption proceeds. A statement is also sent to shareholders whenever a distribution is paid, or when a change in the registration, address, or dividend option occurs. Shareholders are urged to retain their account statements for tax purposes. By Mail: Send to the Agent (see the back cover of this Prospectus for the address): (1) a written request for redemption, signed by each registered owner exactly as the shares are registered including the name of the Fund, account number and exact registration; (2)stock certificates for any shares to be redeemed which are held by the shareholder; (3) signature guarantees, when required, and (4) the additional documents required for redemptions by corporations, executors, administrators, trustees, and guardians. Redemptions by mail will not become effective until all documents in proper form have been received by the Agent. If a shareholder has any questions regarding the requirements for redeeming shares, he should call the Fund at the toll free number on the back cover prior to submitting a redemption request. If a redemption request is sent to the Fund in New Jersey, it will be forwarded to the Agent and the effective date of redemption will be the date received by the Agent. Checks for redemption proceeds will normally be mailed within seven days. However, the Fund will only mail redemption checks upon clearance of the purchase payment. Signature Guarantee: Signature guarantees are required in connection with (a) redemptions by mail involving $10,000 or more; (b) all redemptions by mail, regardless of the amount involved, when the proceeds are to be paid to someone other than the registered owners; (c) changes in instructions as to where the proceeds of redemptions are to be sent, and (d) share transfer requests. The Agent requires that the guarantor be either a commercial bank which is a member of the Federal Deposit Insurance Corporation, a trust company, a savings and loan association, a savings bank, a credit union, a member firm of a domestic stock exchange, or a foreign branch of any of the foregoing. A notary public is not an acceptable guarantor. With respect to redemption requests submitted by mail, the signature guarantees must appear either: (a) on the written request for redemption, (b) on a separate instrument of assignment ("stock power") specifying the total number of shares to be redeemed, or (c) on all stock certificates tendered for redemption and, if shares held by the Agent are also being redeemed, on the letter or stock power. Redemption Price: The redemption price will be the net asset value per share of the Fund next determined after receipt by the Agent of a redemption request in proper form (see "Determination of Net Asset Value" in the Statement of Additional Information). The right of redemption may be suspended (a) for any period during which the New York Stock Exchange is closed or the Securities and Exchange Commission ("SEC") determines that trading on the Exchange is restricted, (b) when there is an emergency as determined by the SEC as a result of which it is not reasonably practicable for the Fund to dispose of securities owned by it or to determine fairly the value of its net assets, or (c) for such other periods as the SEC may by order permit for the protection of shareholders of the Fund. Due to the proportionately high cost of maintaining smaller accounts, the Fund reserves the right to redeem all shares in an account with a value of less than $500 (except retirement plan accounts) and mail the proceeds to the shareholder. Such right reserved by the Fund pertains to circumstances in which the value of shares falls below the stated threshold due to redemptions, and not due to market fluctuations. Shareholders will be notified before these redemptions are to be made and will have 30 days to make an additional investment to bring their accounts up to the required minimum. Transfer: Shares of the Fund may be transferred to another owner. A signature guarantee of the registered owner is required on the letter of instruction or accompanying stock power. Systematic Withdrawal Plan: Shareholders may elect to withdraw cash in fixed amounts from their accounts at regular intervals. The minimum investment to establish a Systematic Withdrawal Plan is $10,000. If the proceeds are to be mailed to someone other than the registered owner, a signature guarantee is required. Group Sub-Accounting: To minimize recordkeeping by fiduciaries, corporations, and certain other investors, the minimum initial investment may be waived. Shares of the Fund may be exchanged for shares of the following Lexington Funds on the basis of relative net asset value per share next determined at the time of the exchange. In the event shares of one or more of these funds being exchanged by a single investor have a value in excess of $500,000, the shares of the Fund will not be purchased until the fifth business day following the redemption of the shares being exchanged in order to enable the redeeming fund to utilize normal securities settlement procedures in transferring the proceeds of the redemption to the Fund. Exchanges may not be made until all checks in payment for the shares to be exchanged have been cleared. The Lexington Funds currently available for exchange are: LEXINGTON GLOBAL FUND, INC. (NASDAQ Symbol: LXGLX) LEXINGTON WORLDWIDE EMERGING MARKETS FUND, INC. (NASDAQ Symbol: LEXGX) LEXINGTON INTERNATIONAL FUND, INC. (NASDAQ Symbol: LEXIX)/Shares of the Fund are not presently available for sale in Vermont or Missouri. LEXINGTON CROSBY SMALL CAP ASIA GROWTH FUND, INC. LEXINGTON CORPORATE LEADERS TRUST FUND (NASDAQ Symbol: LEXCX) LEXINGTON GROWTH AND INCOME FUND, INC. (NASDAQ Symbol: LEXRX) LEXINGTON SMALLCAP VALUE FUND, INC. LEXINGTON GOLDFUND, INC. (NASDAQ Symbol: LEXMX) LEXINGTON CONVERTIBLE SECURITIES FUND. (NASDAQ Symbol: CNCVX) Shares of the Fund are not presently available for sale in Vermont. LEXINGTON GNMA INCOME FUND, INC. (NASDAQ Symbol: LEXNX) LEXINGTON RAMIREZ GLOBAL INCOME FUND (NASDAQ Symbol: LEBDX) LEXINGTO MONEY MARKET TRUST (NASDAQ Symbol: LMMXX) LEXINGTON TAX FREE MONEY FUND, INC. (NASDAQ Symbol: LTFXX) Shareholders in any of these funds may exchange all or part of their shares for shares of one or more of the other funds, subject to the conditions described herein. The Exchange Privilege enables a shareholder in any of these funds to acquire shares in a fund with a different investment objective when the shareholder believes that a shift between funds is an appropriate investment decision. Shareholders contemplating an exchange should obtain and review the prospectus of the fund to be acquired. If an exchange involves investing in a Lexington Fund not already owned and a new account has to be established, the dollar amount exchanged must meet the initial investment of the Fund being purchased. If, however, an account already exists in the Fund being bought, there is a $500 minimum exchange required. Shareholders must provide the account number of the existing account. Any exchange between mutual funds is, in effect, a redemption of shares in one Fund and a purchase in the other Fund. Shareholders should consider the possible tax effects of an exchange. TELEPHONE EXCHANGE PROVISIONS-Exchange instructions may be given in writing or by telephone. Telephone exchanges may only be made if a Telephone Authorization form has been previously executed and filed with LFD. Telephone exchanges are permitted only after a minimum of 7 days have elapsed from the date of a previous exchange. Exchanges may not be made until all checks in payment for the shares to be exchanged have been cleared. Telephonic exchanges can only involve shares held on deposit at the Agent; shares held in certificate form by the shareholder cannot be included. However, outstanding certificates can be returned to the Agent and qualify for these services. Any new account established with the same registration will also have the privilege of exchange by telephone in the Lexington Funds. All accounts involved in a telephonic exchange must have the same registration and dividend option as the account from which the shares were transferred and will also have the privilege of exchange by telephone in the Lexington Funds in which these services are available. By checking the box on the New Account Application authorizing telephone exchange services, a shareholder constitutes and appoints LFD, distributor of the Lexington Group of Mutual Funds as the true and lawful attorney to surrender for redemption or exchange any and all non-certificated shares held by the Agent in account(s) designated, or in any other account with the Lexington Funds, present or future, which has the identical registration with full power of substitution in the premises, authorizes and directs LFD to act upon any instruction from any person by telephone for exchange of shares held in any of these accounts, to purchase shares of any other Lexington Fund that is available, provided the registration and mailing address of the shares to be purchased are identical to the registration of the shares being redeemed, and agrees that neither LFD, the Agent, nor the Fund(s) will be liable for any loss, expense or cost arising out of any requests effected in accordance with this authorization which would include requests effected by imposters or persons otherwise unauthorized to act on behalf of the account. LFD, the Agent and the Fund, will employ reasonable procedures to confirm that instructions communicated by telephone are genuine and if they do not employ reasonable procedures they may be liable for any losses due to unauthorized or fraudulent instructions. The following identification procedures may include, but are not limited to, the following: account number, registration and address, taxpayer identification number and other information particular to the account. In addition, all exchange transactions will take place on recorded telephone lines and each transaction will be confirmed in writing by the Fund. LFD reserves the right to cease to act as attorney subject to the above appointment upon thirty (30) days' written notice to the address of record. If other than an individual, it is certified that certain persons have been duly elected and are now legally holding the titles given and that the said corporation, trust, unincorporated association, etc. is duly organized and existing and has power to take action called for by this continuing Authorization. Exchange Authorization forms, Telephone Authorization forms and prospectuses of the other funds may be obtained from LFD. This exchange offer is available only in states where shares of the fund being acquired may legally be sold and may be modified or terminated at any time by the Fund. Broker-dealers who process exchange orders on behalf of their customers may charge a fee for their services. Such fee may be avoided by making requests for exchange directly to the Fund or Agent. For further information concerning Telephone Exchange Provisions, please see the Statement of Additional Information. The Fund offers a Prototype Pension and Profit Sharing Plan, including a Keogh Plan, IRA's, SEP-IRA's and IRA Rollover Accounts, 401(k) Plans, Section 457 Deferred Compensation Plans and 403(b)(7) Plans. Plan support services are available through the Shareholder Services Department of LMC at 1-800-526-0056. (See "Tax-Sheltered Retirement Plans" in the Statement of Additional DIVIDEND, DISTRIBUTION AND REINVESTMENT POLICY The Fund intends to declare or distribute a dividend from its net investment income and/or net capital gain income to shareholders annually or more frequently if necessary in order to comply with distribution requirements of the Code to avoid the imposition of regular Federal income tax, and if applicable, a 4% excise tax. Any dividends and distribution payments will be reinvested at net asset value, without sales charge, in additional full and fractional shares of the Fund unless and until the shareholder notifies the Agent in writing that he wants to receive his payments in cash. This request must be received by the Agent at least seven days before the dividend record date. Upon receipt by the Agent of such written notice, all further payments will be made in cash until written notice to the contrary is received. An account of such shares owned by each shareholder will be maintained by the Agent. Shareholders whose accounts are maintained by the Agent will have the same rights as other shareholders with respect to shares so registered (see "How to Purchase Shares-The Open Account"). The Board of Directors of the Fund has adopted a Distribution Plan (the "Plan") in accordance with Rule 12b-1 under the Investment Company Act of 1940, after having concluded that there is a reasonable likelihood that the Plan will benefit the Fund and its shareholders. The Plan provides that the Fund may pay distribution fees, including payments to the Distributor, at an annual rate not to exceed 0.25% of its average daily net assets for distribution services. Distribution payments will be made as follows: The Fund either directly or through the Adviser, may make payments periodically (i) to the Distributor or to any broker-dealer (a "Broker") who is registered under the Securities Exchange Act of 1934 and a member in good standing of the National Association of Securities Dealers, Inc. and who has entered into a Selected Dealer Agreement with the Distributor, (ii) to other persons or organizations ("Servicing Agents") who have entered into shareholder processing and service agreements with the Adviser or with the Distributor, with respect to Fund shares owned by shareholders for which such Broker is the dealer or holder of record or such servicing agent has a servicing relationship, or (iii) for expenses associated with distribution of Fund shares, including the compensation of the sales personnel of the Distributor; payments of no more than an effective annual rate of 0.25%, or such lesser amounts as the Distributor determines appropriate. Payments may also be made for any advertising and promotional expenses relating to selling efforts, including but not limited to the incremental costs of printing prospectuses, statements of additional information, annual reports and other periodic reports for distribution to persons who are not shareholders of the Fund; the costs of preparing and distributing any other supplemental sales literature; costs of radio, television, newspaper and other advertising; telecommunications expenses, including the cost of telephones, telephone lines and other communications equipment, incurred by or for the Distributor in carrying out its obligations under the Distribution Agreement. LMC, at no additional cost to the Fund, may pay to Shareholder Service Agents, additional amounts from past profits for administrative services. The Fund intends to qualify as a regulated investment company by satisfying the requirements under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), including requirements with respect to diversification of distribution of income and sources of income. It is the Fund's policy to distribute to shareholders all of its investment income (net of expenses) and any capital gains (net of capital losses) so that, in addition to satisfying the distribution requirement of Subchapter M, the Fund will not be subject to federal income tax or the 4% excise tax. Distributions by the Fund of its net investment income and the excess, if any, of its net short-term capital gain over its net long-term capital loss are taxable to shareholders as ordinary income. These distributions are treated as dividends for federal income tax purposes, but in any year only a portion thereof (which cannot exceed the aggregate amount of qualifying dividends from domestic corporations received by the Fund during the year) may qualify for the 70% dividends-received deduction for corporate shareholders. Because the Fund's investment income may include interest and dividends from foreign corporations and the Fund may have short-term capital gains, less than 100% of the ordinary income dividends paid by the Fund may qualify for the dividends-received deduction. Distributions by the Fund of the excess, if any, of its net long-term capital gain over its net short-term capital loss are designated as capital gain dividends and are taxable to shareholders as long-term capital gains, regardless of the length of time the shareholder held his shares. Distributions to shareholders will be treated in the same manner for federal income tax purposes whether received in cash or reinvested in additional shares of the Fund. In general, distributions by the Fund are taken into account by the shareholders in the year in which they are made. However, certain distributions made during January will be treated as having been paid by the Fund and received by the shareholders on December 31 of the preceding year. A statement setting forth the federal income tax status of all distributions made or deemed made during the year will be sent to shareholders promptly after the end of each year. Shareholders purchasing shares of the Fund just prior to the ex-dividend date will be taxed on the entire amount of the dividend received, even though the net asset value per share on the date of such purchase reflected the amount of such dividend. Any loss realized upon a taxable disposition of shares within six months from the date of their purchase will be treated as a long-term capital loss to the extent of any capital gain dividends received on such shares. All or a portion of any loss realized upon a taxable disposition of shares of the Fund may be disallowed if other shares of the Fund are purchased within 30 days before or after such disposition. Under the back-up withholding rules of the Code, certain shareholders may be subject to 31% withholding of federal income tax on distributions and redemption payments made by the Fund. In order to avoid this back-up withholding, a shareholder must provide the Fund with a correct taxpayer identification number (which for most individuals is their Social Security number) or certify that it is a corporation or otherwise exempt from or not subject to back-up withholding. The new account application included with this Prospectus provides for shareholder compliance with these certification requirements. The foregoing discussion of federal income tax consequences is based on tax laws and regulations in effect on the date of this Prospectus, and is subject to change by legislative or administrative action. As the foregoing discussion is for general information only, a prospective shareholder should also review the more detailed discussion of federal income tax considerations relevant to the Fund that is contained in the Statement of Additional Information. In addition, each prospective shareholder should consult with his own tax adviser as to the tax consequences of investments in the Fund, including the application of state and local taxes which may differ from the federal income tax consequences described above. ORGANIZATION AND DESCRIPTION OF COMMON STOCK The Fund is an open-end, diversified management investment company organized as a corporation under the laws of the State of Maryland on August 29, 1995 and has authorized capital of 1,000,000,000 shares of common stock, par value $.001 of which 500,000,000 have been designated the Lexington SmallCap Value Fund Series. Each share of common stock has one vote and shares equally with other shares of the same series in dividends and distributions when and if declared by the Fund and in the Fund's net assets belonging to such series upon liquidation. All shares, when issued, are fully paid and nonassessable. There are no preemptive, conversion or exchange rights. Fund shares do not have cumulative voting rights and, as such, holders of at least 50% of the shares voting for Directors can elect all Directors and the remaining shareholders would not be able to elect any Directors. The Company will not normally hold annual shareholder meetings except as required by Maryland General Corporation Law or the Investment Company Act of 1940. However, meetings of shareholders may be called at any time by the Secretary upon the written request of shareholders holding in the aggregate not less than 25% of the outstanding shares, such request specifying the purposes for which such meeting is to be called. In addition, the Directors will promptly call a meeting of shareholders for the purpose of voting upon the question of removal of any Director when requested to do so in writing by the recordholders of not less than 10% of the Fund's outstanding shares. The Fund will assist shareholders in any such communication between shareholders and Directors. The Fund will calculate performance on a total return basis for various periods. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends paid by the Fund. Dividends are comprised of net realized capital gains and net investment income. Performance will vary from time to time and past results are not necessarily representative of future results. It should be remembered that performance is a function of portfolio management in selecting the type and quality of portfolio securities and is affected by operating expenses. Comparative performance information may be used from time to time in advertising or marketing of the Fund's shares, including data from Lipper Analytical Services, Inc. or major market indices such as the Dow Jones Industrial Average Index, Russell 2000, Standard & Poor's 500 Composite Stock Price Index. Such comparative performance information will be stated in the same terms in which the comparative data and indices are stated. CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT Chase Manhattan Bank, N.A., 1211 Avenue of the Americas, New York, New York 10036 has been retained to act as the Custodian for the Funds' portfolio securities and other assets. State Street Bank and Trust Company, 225 Franklin Street, Boston, Massachusetts 02110, is the transfer agent and dividend disbursing agent for the Fund. Neither Chase Manhattan Bank, N.A. nor State Street Bank and Trust Company have any part in determining the investment policies of the Fund or in determining which portfolio securities are to be purchased or sold by the Fund or in the declaration of dividends and distributions. Kramer, Levin, Naftalis, Nessen, Kamin & Frankel, 919 Third Avenue, New York, New York 10022 will pass upon legal matters for the Fund in connection with the shares offered by this Prospectus. KPMG Peat Marwick LLP, 345 Park Avenue, New York, New York 10154, has been selected as independent auditors for the Fund for the fiscal year ending December 31, 1996. This prospectus omits certain information contained in the registration statement filed with the SEC. Copies of the registration statement, including items omitted herein, may be obtained from the SEC by paying the charges prescribed under its rules and regulations. The Statement of Additional Information included in such registration statement may be obtained without charge from the Fund. The Code of Ethics adopted by each of the Adviser, Sub-Adviser and the Fund prohibits all affiliated personnel from engaging in personal investment activities which compete with or attempt to take advantage of the Fund's planned portfolio transactions. The objective of each Code of Ethics is that the operations of the Adviser, Sub-Adviser and Fund be carried out for the exclusive benefit of the Fund's shareholders. All organizations maintain careful monitoring of compliance with the Code of Ethics. Additional portfolios may be created from time to time with investment objectives and policies different from those of the Fund. In addition, the Directors may, subject to any necessary regulatory approvals, create more than one class of shares in the Fund, with the classes being subject to different charges and expenses and having such other different rights as the Directors may prescribe. No person has been authorized to give any information or to make any representation other than those contained in this Prospectus, and information or representations not herein contained, if given or made, must not be relied upon as having been authorized by the Fund. This Prospectus does not constitute an offer or solicitation in any jurisdiction in which such offering may not lawfully be made. P.O. Box 1515/Park 80 West Plaza Two P.O. Box 1515/Park 80 West Plaza Two All shareholder requests for services of any kind should be sent to: STATE STREET BANK AND TRUST COMPANY c/o National Financial Data Services Description of the Fund.............................. 2 Investment Objective, Policies and Risk Factors...... 2 Management of the Fund............................... 4 How to Purchase Shares............................... 5 How to Redeem Shares................................. 6 Dividend, Distribution and Reinvestment Policy....... 9 Organization and Description of Common Stock......... 10 Counsel and Independent Auditors..................... 11 L E X I N G T O N (filled box) Small cap stocks (filled box) No sales charge (filled box) No redemption fee P R O S P E C T U S LEXINGTON SMALLCAP VALUE FUND, INC. This Statement of Additional Information, which is not a prospectus, should be read in conjunction with the current prospectus of Lexington SmallCap Value Fund (the "Fund"), dated January 2, 1996, and as it may be revised from time to time. To obtain a copy of the Fund's prospectus at no charge, please write to the Fund at P.O. Box 1515/Park 80 West - Plaza Two, Saddle Brook, New Jersey 07663 or call the following toll-free numbers: Lexington Management Corporation ("LMC") is the Fund's Investment Adviser. Capital Technology, Inc. ("CTI") is the Fund's Sub-Adviser. Lexington Funds Distributor, Inc. is the Fund's Distributor. Investment Objective and Policies............................................ 2 Management of the Fund....................................................... 3 Investment Adviser, Sub-Adviser, Distributor and Administrator............... 6 Portfolio Transactions and Brokerage Commissions............................. 7 Determination of Net Asset Value............................................. 7 Lexington SmalICap Value Fund (the "Fund") is an open-end, diversified management investment company. The Fund's investment objective is to seek long-term capital appreciation. The Fund will seek to achieve its investment objective through investment in common stocks and equivalents primarily of companies domiciled in the United States with a market capitalization of less than $1 billion which the Sub-Adviser believes offers exceptional relative value and attractive prices. Production of income is incidental to this objective. The Fund's portfolio will be invested primarily in equities listed on stock exchanges or traded in over-the-counter markets in the U.S. The fund may invest in Canadian or other foreign domiciled companies whose shares trade in U.S. dollar denominated markets. The Fund will seek to achieve its objective through investment in a diversified portfolio of securities that will consist of all types of common stocks and equivalents (the following constitute equivalents: warrants, options, and convertible debt securities). There is no assurance that the Fund will be able to achieve its investment objective. Under normal market conditions, the Fund will invest substantially all (at least 90%) of its assets in small companies domiciled in the U.S. which have market capitalization (based on aggregate market value of outstanding shares) between $20 million and $1 billion at the time of investment. The remainder of its assets (no more than 10%) may be invested in securities of companies with market capitalizations below $20 million; above $1,000,000,000.; domiciled outside the U.S. if its shares trade in U.S. markets in dollar denominations; in American Depository Shares or Receipts ("ADR's" or "ADS's"), real estate investment trusts ("REIT's") and/or in cash and equivalent securities. The Fund does not intend to invest in securities which, at the time of purchase, are not readily marketable; in securities of foreign issuers denominated in foreign currencies; or in futures contracts. The Fund will not engage in short-selling activities, leveraging or portfolio hedging techniques. The Fund's overall approach to investing in small capitalization value stocks is based on research performed by its Sub-Adviser which shows that extremely undervalued companies offer potential for high returns over time and excellent diversification versus other domestic equity investment styles. This strategy may under-emphasize widely followed, institutional favorites and result in holdings of stocks with little "Wall Street" or outside research coverage. Advantages of investing in distressed and/or neglected issues based on internal, fundamental research include: * low valuations that offer some downside protection * lack of institutional ownership that results in return streams not highly correlated with market indices * potential for upside surprises that is increased as stocks exceed minimal expectations and are "discovered" by other investors * low transaction costs based solely on best execution rather than research commitments. The companies in which the Fund intends to invest will generally have the following characteristics: * a market capitalization of less that $1 billion * a high relative ratio of revenue per share to stock price * a low relative ratio of price to book value per share * a positive cash flow and other measures of financial stability * a low stock price relative to historical levels. By following these criteria, the Fund intends to select securities which can have enhanced appreciation prospects and may provide investment returns superior to the market as a whole. However, the market value of these companies' securities tends to be volatile and in the past offered greater potential for gain as well as loss than securities of larger capitalization companies. Special Considerations. An investor should be aware that investment in small capitalization issuers carry more risk than issuers with market capitalization greater than $1 billion. Generally, small companies rely on limited product lines, financial resources, and business activities that may make them more susceptible to setbacks or downturns. In addition, the stock of such companies may be more thinly traded. Accordingly, the performance of small capitalization issuers may be more volatile. Investments by the Fund of up to 10% of its total assets in the common stock of foreign companies which are traded in the United States or in ADR's may involve considerations and risks that are different in certain respects from an investment in securities of U.S. companies. Such risks include the effect of currency fluctuations on the value of Fund shares, the imposition of withholding taxes on interest or dividends, possible adoption of foreign governmental restrictions on repatriation of income or capital investment, or other adverse political or economic developments. Additionally, it may be more difficult to enforce the rights of a security holder against a foreign company. There may be delays in settling securities transactions in certain foreign markets and information about the operations of foreign companies may be more difficult to obtain and evaluate. With respect to the Fund's investment in debt securities, there is no requirement that all such securities be rated by a recognized rating agency. However, it is the policy of the Fund that investments in debt securities, whether rated or unrated, will be made only if they are, in the opinion of the Sub-Adviser, of equivalent quality to "investment grade" securities. "Investment grade" securities are those rated within the four highest quality grades as determined by Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's Corporation ("Standard & Poor's"). Securities rated Aaa by Moody's and AAA by Standard & Poor's are judged to be of the best quality and carry the smallest degree of risk. Securities rated Baa by Moody's and BBB by Standard & Poor's lack high quality investment characteristics and, in fact, have speculative characteristics as well. Debt securities are interest-rate sensitive; therefore their value will tend to decrease when interest rates rise and increase when interest rates fall. Such increase or decrease in the value of longer-term debt instruments as a result of interest rate movement will be larger than the increase or decrease in the value of shorter-term debt instruments. Although the Fund does not generally intend to invest for the purpose of seeking short-term profits, the Fund's investments may be changed when circumstances warrant, without regard to the length of time a particular security has been held. It is expected that the Fund will have an annual portfolio turnover rate that will generally not exceed 100%. A 100% turnover rate would occur if all the Fund's portfolio investments were sold and either repurchased or replaced within a year. A high turnover rate (100% or more) results in correspondingly greater brokerage commissions and other transactional expenses which are borne by the Fund. High portfolio turnover may result in the realization of net short-term capital gains by the Fund which, when distributed to shareholders, will be taxable as ordinary income. See "Tax Matters." The Directors and executive officers of the Fund and their principal occupations are set forth below: (d)ROBERT M. DEMICHELE, President and Director. P.O. Box 1515, Saddle Brook, N.J. 07663. Chairman and Chief Executive Officer, Lexington Management Corporation; Chairman and Chief Executive Officer, Lexington Funds Distributor, Inc.; President and Director, Lexington Global Asset Managers, Inc.; Director, Reinsurance Corporation of New York; Director, Unione Italiana Reinsurance; Vice Chairman of the Board of Trustees, Union College; Director, Continental National Corporation; Director, The Navigator's Group, Inc.; Chairman, Lexington Capital Management, Inc.; Chairman, LCM Financial Services, Inc.; Director, Vanguard Cellular Systems Inc.; Chairman of the Board, Market Systems Research, Inc. and Market Systems Research Advisors, Inc. (registered investment advisers): Trustee, Smith Richardson Foundation. (d)BEVERLEY C. DUER, Director, 340 East 72nd Street, New York, N.Y. 10021. Private Investor. Formerly, Manager of Operations Research Department-CPC International, Inc. (d)BARBARA R. EVANS, Director, 5 Fernwood Road, Summit, N.J. 07901. Private Investor. Prior to May, 1989, Assistant Vice President and Securities Analyst, Lexington Management Corporation; prior to March 1987, Vice President-Institutional Equity Sales, L.F. Rothschild, Unterberg, Towbin. (d)LAWRENCE KANTOR, Vice President and Director. P.O. Box 1515, Saddle Brook, N.J. 07663. Managing Director, General Manager and Director, Lexington Management Corporation; Executive Vice President and Director, Lexington Funds Distributor, Inc.; Executive Vice President and General Manager-Mutual Funds, Lexigton Global Asset Managers, Inc. (d)DONALD B. MILLER, Director. 10725 Quail Covey Road, Boynton Beach, FL 33436. Chairman, Horizon Media, Inc.; Trustee, Galaxy Funds; Director, Maguire Group of Connecticut; prior to January 1989, President, Director and C.E.O., Media General Broadcast Services (advertising firm). (d)MARGARET W. RUSSELL. Director. 55 North Mountain Avenue, Montclair, N.J. 07042. Private Investor. Formerly, Community Affairs Director, Union Camp Corporation. (d)PHILIP C. SMITH, Director. 87 Lord's Highway, Weston, Connecticut 06883. Private Investor; Director, Southwest Investors Income Fund, Inc., Government Income Fund, Inc., U.S. Trend Fund, Inc., Investors Cash Reserve and Plimony Fund, Inc. (d)FRANCIS A. SUNDERLAND, Director. 309 Quito Place, Castle Pines, Castle Rock, Colorado 80104. Private Investor. ROBB W. ROWE, CFA, Vice President and Portfolio Manager. P.O. Box 472428, Charlotte, N.C. 28247. President, Capital Technology, Inc. DENNIS J. HAMILTON, CFA, Vice President and Portfolio Manager. P.O. Box 472428, Charlotte, N.C. 28247. Vice President, Capital Technology, Inc. Prior to October, 1994, Principal, William M. Mercer Asset Planning, Inc. (d)LISA CURCIO, Vice President and Secretary. P.O. Box 1515, Saddle Brook, N.J. 07663. Senior Vice President and Secretary, Lexington Management Corporation; Vice President and Secretary, Lexington Funds Distributor, Inc.; Secretary, Lexington Global Asset Managers, Inc. (d)RICHARD M. HISEY, CFA, Vice President and Treasurer. P. O. Box 1515, Saddle Brook, N.J. 07663. Managing Director, Director and Chief Financial Officer, Lexington Management Corporation; Chief Financial Officer, Vice President and Director, Lexington Funds Distributor, Inc.; Chief Financial Off., Market Systems Research Advisors, Inc.; Executive Vice President & Chief Financial Officer, Lexington Global Asset Managers, Inc. (d)RICHARD LAVERY, CLU ChFC, Vice President. P.O. Box 1515, Saddle Brook, N.J. 07663. Senior Vice President, Lexington Management Corporation; Vice President, Lexington Funds Distributor, Inc. (d)JANICE CARNICELLI, Vice President. P.O. Box 1515, Saddle Brook, N.J. 07663. (d)CHRISTIE CARR, Assistant Treasurer P.O. Box 1515, Saddle Brook, N.J. 07663. Prior to October 1992, Senior Accountant. KPMG Peat Marwick LLP. (d)SIOBHAN GILFILLAN, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663. (d)THOMAS LUEHS, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663. Prior to November 1993, Supervisor of Investment Accounting, Alliance Capital Management. (d)SHERI MOSCA, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663. (d)ANDREW PETRUSKI, Assistant Treasurer. P.O. Box 1515, Saddle Brook, 07663. Prior to May 1994, Supervising Senior Accountant, NY Life Securities. Prior to December 1990, Senior Accountant Dreyfus Corporation. (d)PETER CORNIOTES, Assistant Secretary. P.O. Box 1515, Saddle Brook, N.J. 07663. Assistant Vice President, Lexington Management Corporation. Assistant Secretary, Lexington Funds Distributor, Inc. (d)ENRIQUE J. FAUST, Assistant Secretary. P.O. Box 1515, Saddle Brook, N.J. 07663. Prior to March 1994, Blue Sky Compliance Coordinator, Lexington Management Corporation. *"Interested person" and/or "Affiliated person" of LMC or CT as defined in the Investment Company Act of 1940, as amended. (d)Messrs. Corniotes, DeMichele, Duer, Faust, Hisey, Kantor, Lavery, Luehs, Miller, Petruski, Preston, Smith and Sunderland and Mmes. Carnicelli, Carr, Curcio, Evans, Gilfillan, Mosca and Russell hold similar offices with some or all of the other investment companies advised and/or distributed by LMC and LFD. Directors not employed by the Fund or its affiliates receive an annual fee of $800 and a fee of $160 for each meeting attended plus reimbursement of expenses for attendance at regular meetings. The Board does not have any audit, nominating or compensation committees. The Fund's investment objective, as described under "Investment Objective and Policies" and the following investment restrictions are matters of fundamental policy which may not be changed without the affirmative vote of the lesser of (a) 67% or more of the shares of the Fund present at a shareholders' meeting at which more than 50% of the outstanding shares are present or represented by proxy or (b) more than 50% of the outstanding shares. Under these investment restrictions: (1) the Fund will not issue any senior security (as defined in the 1940 Act), except that (a) the Fund may enter into commitments to purchase securities in accordance with the Fund's investment program, including reverse repurchase agreements, foreign exchange contracts, delayed delivery and when-issued securities, which may be considered the issuance of senior securities; (b) the Fund may engage in transactions that may result in the issuance of a senior security to the extent permitted under applicable regulations, interpretation of the 1940 Act or an exemptive order; (c) the Fund may engage in short sales of securities to the extent permitted in its investment program and other restrictions; (d) the purchase or sale of futures contracts and related options shall not be considered to involve the issuance of senior securities; and (e) subject to fundamental restrictions, the Fund may borrow money as authorized by the 1940 Act. (2) The Fund will not borrow money, except that (a) the Fund may enter into certain futures contracts and options related thereto; (b) the Fund may enter into commitments to purchase securities in accordance with the Fund's investment program, including delayed delivery and when-issued securities and reverse repurchase agreements; (c) for temporary emergency purposes, the Fund may borrow money in amounts not exceeding the value of its total assets at the time when the loan is made; (d) The Fund may pledge its portfolio securities or receivables or transfer or assign or otherwise encumber them in an amount not exceeding one-third of the value of its total assets; and (e) for purposes of leveraging, the Fund may borrow money from banks (including its custodian bank), only if, immediately after such borrowing, the value of the Fund's assets, including the amount borrowed, less its liabilities, is equal to at least 300% of the amount borrowed, plus all outstanding borrowings. If at any time, the value of the Fund's assets fails to meet the 300% asset coverage requirement relative only to leveraging, the Fund will, within three days (not including Sundays and holidays), reduce its borrowings to the extent necessary to meet the 300% test. The Fund has no intention at this time of engaging in these activities or investing in the securities. (3) The Fund will not act as an underwriter of securities except to the extent that, in connection with the disposition of portfolio securities by the Fund, the Fund may be deemed to be an underwriter under the provisions of the 1933 Act. (4) The Fund will not purchase real estate, interests in real estate or real estate limited partnership interests except that, to the extent appropriate under its investment program, the Fund may invest in securities secured by real estate or interests therein or issued by companies, including real estate investment trusts, which deal in real estate or interests therein. (5) The Fund will not make loans, except that, to the extent appropriate under its investment program, the Fund may (a) purchase bonds, debentures or other debt securities, including short-term obligations, (b) enter into repurchase transactions and (c) lend portfolio securities provided that the value of such loaned securities does not exceed one-third of the Fund's total assets. (6) The Fund will not invest in commodity contracts, except that the Fund may, to the extent appropriate under its investment program, purchase securities of companies engaged in such activities, may enter into transactions in financial and index futures contracts and related options, may engage in transactions on a when-issued or forward commitment basis, and may enter into forward currency contracts. (7) The Fund will not concentrate its investments in any one industry, except that the Fund may invest up to 25% of its total assets in securities issued by companies principally engaged in any one industry. The Fund considers foreign government securities and supranational organizations to be industries. This limitation, however, will not apply to securities issued or guaranteed by the U.S. Government, its agencies and instrumentalities. (8) The Fund will not purchase securities of an issuer, if (a) more than 5% of the Fund's total assets taken at market value would at the time be invested in the securities of such issuer, except that such restriction shall not apply to securities issued or guaranteed by the United States government or its agencies or instrumentalities; or (b) such purchases would at the time result in more than 10% of the outstanding voting securities of such issuer being held by the Fund . In addition to the above fundamental restrictions, the Fund has undertaken the following non-fundamental restrictions, which may be changed in the future by the Board of Directors, without a vote of the shareholders of the Fund: (1) The Fund will not participate on a joint or joint-and-several basis in any securities trading account. The "bunching" of orders for the sale or purchase of marketable portfolio securities with other accounts under the management of the investment adviser or sub-adviser to save commissions or to average prices among them is not deemed to result in a securities trading account. (2) The Fund may purchase and sell futures contracts and related options under the following conditions: (a) the then-current aggregate futures market prices of financial instruments required to be delivered and purchased under open futures contracts shall not exceed 30% of the Fund's total assets, at market value; and (b) no more than 5% of the assets, at market value at the time of entering into a contract, shall be committed to margin deposits in relation to futures contracts. The Fund has no intention at this time of engaging in these activities or investing in the securities. (3) The Fund will not make short sales of securities, other than short sales "against the box," or purchase securities on margin except for short-term credits necessary for clearance of portfolio transactions, provided that this restriction will not be applied to limit the use of options, futures contracts and related options, in the manner otherwise permitted by the investment restrictions, policies and investment programs of the Fund. The Fund has no intention at this time of engaging in these activities or investing in the securities. (4) The Fund will not purchase securities of an issuer if to the Fund's knowledge, one or more of the Directors or officers of the Fund or LMC individually owns beneficially more than 0.5% and together own beneficially more than 5% of the securities of such issuer nor will the Fund hold the securities of such issuer. (5) The Fund will not purchase the securities of any other investment company, except as permitted under the 1940 Act. (6) The Fund will not, except for investments which, in the aggregate, do not exceed 5% of the Fund's total assets taken at market value, purchase securities unless the issuer thereof or any company on whose credit the purchase was based has a record of at least three years continuous operations prior to the purchase. (7) The Fund will not invest for the purpose of exercising control over or management of any company. (8) The Fund will not purchase warrants except in units with other securities in original issuance thereof or attached to other securities, if at the time of the purchase, the Fund's investment in warrants, valued at the lower of cost or market, would exceed 5% of the Fund's total assets. Warrants which are not listed on a United States securities exchange shall not exceed 2% of the Fund's net assets. For these purposes, warrants attached to units or other securities shall be deemed to be without value. (9) The Fund will not invest more than 15% of its total assets in illiquid securities. Illiquid securities are securities that are not readily marketable or cannot be disposed of promptly within seven days and in the usual course of business without taking a materially reduced price. Such securities include, but are not limited to, time deposits and repurchase agreements with maturities longer than seven days. Securities that may be resold under Rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended, shall not be deemed illiquid solely by reason of being unregistered. The Investment Adviser shall determine whether a particular security is deemed to be liquid based on the trading markets for the specific security and other factors. The Fund has no intention at this time of engaging in these activities or investing in the securities. (10) The Fund will not purchase interests in oil, gas, mineral leases or other exploration programs; however, this policy will not prohibit the acquisition of securities of companies engaged in the production or transmission of oil, gas or other materials. The percentage restrictions referred to above are to be adhered to at the time of investment and are not applicable to a later increase or decrease in percentage beyond the specified limit resulting from change in values or net assets. Pursuant to an undertaking made to a state administrator, loans of portfolio securities (as stated under fundamental investment restriction #5) must be fully collateralized at no less than 100% and marked to market daily. INVESTMENT ADVISER, SUB-ADVISER, DISTRIBUTOR AND ADMINISTRATOR Lexington Management Corporation ("LMC"), P.O. Box 1515, Saddle Brook, New Jersey 07663 is the investment adviser to the Fund pursuant to an Investment Management Agreement dated September 14, 1995, (the "Advisory Agreement"). Lexington Funds Distributor, Inc. ("LFD") is the distributor of Fund shares pursuant to a Distribution Agreement dated May 16, 1995, (the "Distribution Agreement"). LMC has entered into a Sub-Advisory contract with Capital Technology, Inc. under which CTI will provide the Fund with investment advice and management of the Fund's investment program. LMC makes recommendations to the Fund with respect to its investments and investment policies. These agreements were approved by the Fund's Board of Directors (including a majority of the Directors who were not parties to either the Advisory Agreement, Sub-Advisory Agreement or the Distribution Agreement or "interested persons" of any such party) on September 14, 1995. LMC also acts as administrator to the Fund and performs certain administrative and accounting services, including but not limited to, maintaining general ledger accounts, regulatory compliance, preparation of financial information for semiannual and annual reports, preparing registration statements, calculating net asset values, shareholder communications and supervision of the custodian, transfer agent and provides facilities for such services. The Fund shall reimburse LMC for its actual cost in providing such services, facilities and expenses. LMC's investment advisory fee will be reduced for any fiscal year by any amount necessary to prevent Fund expenses from exceeding the most restrictive expense limitations imposed by the securities laws or regulations of those states or jurisdictions in which the Fund's shares are registered or qualified for sale. Currently, the most restrictive of such expense limitation would require LMC to reduce its fee so that ordinary expenses (excluding interest, taxes, brokerage commissions and extraordinary expenses) for any fiscal year do not exceed 2.5% of the first $30 million of the Fund's average daily net assets, plus 2.0% of the next $70 million, plus 1.5% of the Fund's average daily net excess of $100 million. LMC has agreed to voluntarily limit the total expenses of the Fund (excluding interest, taxes, brokerage, and extraordinary expenses but including the management fee and operating expenses) to an annual rate of 1.75% of the Fund's average net assets through April 30, 1996 or such later date to be determined by LMC. LFD pays the advertising and sales expenses related to the continuous offering of Fund shares, including the cost of printing prospectuses, proxies and shareholder reports for persons other than existing shareholders. The Fund furnishes LFD, at printer's overrun cost paid by LFD, such copies of its prospectus and annual, semi-annual and other reports and shareholder communications as may reasonably be required for sales purposes. The Advisory Agreement, Sub-Advisory Agreement, the Distribution Agreement and the Administrative Services Agreement are subject to annual approval by the Fund's Board of Directors and by the affirmative vote, cast in person at a meeting called for such purpose, of a majority of the Directors who are not parties either to the Advisory Agreement, Sub-Advisory Agreement of the Distribution Agreement, as the case may be, or "interested persons" of any such party. Either the Fund or LMC may terminate the Advisory Agreement and the Fund or LFD may terminate the Distribution Agreement on 60 days' written notice without penalty. The Advisory Agreement terminates automatically in the event of assignment, as defined in the Investment Company Act of 1940. As compensation for its services, the Fund pays LMC a monthly management fee at the annual rate of 1.00% of the average daily net assets. This fee is higher than that paid by most other investment companies. However, it is not necessarily greater than the management fee of other investment companies with objectives and policies similar to this Fund. LMC will pay CTI an annual sub-advisory fee of 0.50% of the Fund's average daily net assets. The sub-advisory fee will be paid by LMC, not the Fund. See "Investment Adviser and Distributor" in the Statement of Additional Information. LMC as owner of the registered service mark "Lexington" will sublicense to the Fund to include the word "Lexington" as part of its corporate name subject to revocation by LMC in the event that the Fund ceases to engage LMC or its affiliate as investment adviser or distributor. In that event the Fund will be required upon demand of LMC to change its name to delete the word "Lexington" therefrom. LMC shall not be liable to the Fund or its shareholders for any act or omission by LMC, its officers, directors or employees or any loss sustained by the Fund or its shareholders except in the case of willful misfeasance, bad faith, gross negligence or reckless disregard of duty. LMC and LFD are wholly owned subsidiaries of Lexington Global Asset Managers, Inc., a publicly traded corporation. Descendants of Lunsford Richardson, Sr., their spouses, trusts and other related entities have a majority voting control of outstanding shares of Lexington Global Asset Managers, Inc. CTI was founded in Charlotte, North Carolina in 1977 and has invested exclusively in domestic smaller capitalization stocks since then. CTI currently manages assets both small and mid cap growth and value styles for primarily institutional clients. Of the directors, officers or employees ("affiliated persons") of the Fund, Messrs. Corniotes, DeMichele, Faust, Hisey, Kantor, Lavery, Luehs, and Petruski and Mmes. Carnicelli, Carr, Curcio, Gilfillan and Mosca (see "Management of the Fund"), may also be deemed affiliates of LMC and LFD by virtue of being officers, directors or employees thereof. PORTFOLIO TRANSACTIONS AND BROKERAGE COMMISSIONS The Fund's primary policy is to execute all purchases and sales of portfolio instruments at the most favorable prices consistent with best execution, considering all of the costs of the transaction including brokerage commissions. This policy governs the selection of brokers and dealers and the market in which a transaction is executed. Consistent with this policy, the Rules of Fair Practice of the National Association of Securities Dealers, Inc., and such other policies as the Directors may determine, LMC and CTI may consider sales of shares of the Fund and of the other Lexington Funds as a factor in the selection of broker-dealers to execute the Fund's portfolio transactions. The research that is used for security selection is 100% internal. CTI evaluates publicly available data and generates original research. CTI believes that by generating original research, CTI can maintain its objectivity and avoid the tendency to move in tandem with the prevailing sentiment of the investment community. DETERMINATION OF NET ASSET VALUE The Fund calculates net asset value as of the close of normal trading on the New York Stock Exchange (currently 4:00 p.m., Eastern time, unless weather, equipment failure or other factors contribute to an earlier closing time) each business day. It is expected that the New York Stock Exchange will be closed on Saturdays and Sundays and on New Year's Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. See the Prospectus for the further discussion of net asset value. The Fund has adopted a Distribution Plan (the "Plan") in accordance with Rule 12b-1 under the Investment Company Act of 1940, which provides that the Fund may pay distribution fees including payments to the Distributor, at an annual rate not to exceed 0.25% of its average daily net assets for distribution services. Distribution payments will be made as follows: The Fund either directly or through the Adviser, may make payments periodically (i) to the Distributor or to any broker-dealer (a "Broker") who is registered under the Securities Exchange Act of 1934 and a member in good standing of the National Association of Securities Dealers, Inc. and who has entered into a Selected Dealer Agreement with the Distributor, (ii) to other persons or organizations ("Servicing Agents") who have entered into shareholder processing and service agreements with the Adviser or with the Distributor, with respect to Fund shares owned by shareholders for which such Broker is the dealer or holder of record or such servicing agent has a servicing relationship, or (iii) for expenses associated with distribution of Fund shares, including the compensation of the sales personnel of the Distributor; payments of no more than an effective annual rate of 0.25%, or such lesser amounts as the Distributor determines appropriate. Payments may also be made for any advertising and promotional expenses relating to selling efforts, including but not limited to the incremental costs of printing prospectuses, statements of additional information, annual reports and other periodic reports for distribution to persons who are not shareholders of the Fund; the costs of preparing and distributing any other supplemental sales literature; costs of radio, television, newspaper and other advertising; telecommunications expenses, including the cost of telephones, telephone lines and other communications equipment, incurred by or for the Distributor in carrying out its obligations under the Distribution Agreement. Quarterly, in each year that this Plan remains in effect, the Fund's Treasurer shall prepare and furnish to the Directors of the Fund a written report, complying with the requirements of Rule 12b-1, setting forth the amounts expended by the Fund under the Plan and purposes for which such expenditures were made. The Plan shall become effective upon approval of the Plan, the form of Selected Dealer Agreement and the form of Shareholder Service Agreement, by the majority votes of both (a) the Fund's Directors and the Qualified Directors (as defined below), cast in person at a meeting called for the purpose of voting on the Plan and (b) the outstanding voting securities of the Fund, as defined in Section 2(a)(42) of the 1940 Act. The Plan shall remain in effect for one year from its adoption date and may be continued thereafter if this Plan and all related agreements are approved at least annually by a majority vote of the Directors of the Fund, including a majority of the Qualified Directors cast in person at a meeting called for the purpose of voting on such Plan and agreements. This Plan may not be amended in order to increase materially the amount to be spent for distribution assistance without shareholder approval. All material amendments to this Plan must be approved by a vote of the Directors of the Fund, and of the Qualified Directors (as hereinafter defined), cast in person at a meeting called for the purpose of voting thereon. The Plan may be terminated at any time by a majority vote of the Directors who are not interested persons (as defined in Section 2(a)(19) of the 1940 Act) of the Fund and have no direct or indirect financial interest in the operation of the Plan or in any agreements related to the Plan (the "Qualified Directors") or by vote of a majority of the outstanding voting securities of the Fund, as defined in Section 2(a)(42) of the 1940 Act. While this Plan shall be in effect, the selection and nomination of the "non-interested" Directors of the Fund shall be committed to the discretion of the Qualified Directors then in office. Exchange instructions may be given in writing or by telephone. Telephone exchanges may only be made if a Telephone Authorization form has been previously executed and filed with LFD. Telephone exchanges are permitted only after a minimum of seven (7) days have elapsed from the date of a previous exchange. Exchanges may not be made until all checks in payment for the shares to be exchanged have been cleared. Telephonic exchanges can only involve shares held on deposit at State Street Bank and Trust Company (the "Agent"); shares held in certificate form by the shareholder cannot be included. However, outstanding certificates can be returned to the Agent and qualify for these services. Any new account established with the same registration will also have the privilege of exchange by telephone in the Lexington Funds. All accounts involved in a telephonic exchange must have the same registration and dividend option as the account from which the shares were transferred and will also have the privilege of exchange by telephone in the Lexington Funds in which these services are available. By checking the box on the New Account Application authorizing telephone exchange services, a shareholder constitutes and appoints LFD, distributor of the Lexington Group of Mutual Funds, as the true and lawful attorney to surrender for redemption or exchange any and all non-certificate shares held by the Agent in account(s) designated, or in any other account with the Lexington Funds, present or future which has the identical registration, with full power of substitution in the premises, authorizes and directs LFD to act upon any instruction from any person by telephone for exchange of shares held in any of these accounts, to purchase shares of any other Lexington Fund that is available, provided the registration and mailing address of the shares to be purchased are identical to the registration of the shares being redeemed, and agrees that neither LFD, the Agent, or the Fund(s) will be liable for any loss, expense or cost arising out of any requests effected in accordance with this authorization which would include requests effected by impostors or persons otherwise unauthorized to act on behalf of the account. LFD reserves the right to cease to act as attorney subject to the above appointment upon thirty (30) days written notice to the address of record. If the shareholder is an entity other than an individual, such entity may be required to certify that certain persons have been duly elected and are now legally holding the titles given and that the said corporation, trust, unincorporated association, etc. is duly organized and existing and has the power to take action called for by this continuing authorization. Exchange Authorizations forms, Telephone Authorization forms and prospectuses of the other funds may be obtained from LFD. LFD has made arrangements with certain dealers to accept instructions by telephone to exchange shares of the Fund or shares of one of the other Lexington Funds at net asset value as described above. Under this procedure, the dealer must agree to indemnify LFD and the funds from any loss or liability that any of them might incur as a result of the acceptance of such telephone exchange orders. A properly signed Exchange Authorization must be received by LFD within 5 days of the exchange request. LFD reserves the right to reject any telephone exchange request. In each such exchange, the registration of the shares of the Fund being acquired must be identical to the registration of the shares of the Fund being exchanged. Any telephone exchange orders so rejected may be processed by mail. This exchange offer is available only in states where shares of the Fund being acquired may legally be sold and may be modified or terminated at any time by the Fund. Broker-dealers who process exchange orders on behalf of their customers may charge a fee for their services. Such fee may be avoided by making requests for exchange directly to the Fund or Agent. The Fund makes available a variety of Prototype Pension and Profit Sharing plans including a 401(k) Plan and a 403(b)(7} Plan. Plan services are available by contacting the Shareholder Services Department of the Distributor at 1-800-526-0056. INDIVIDUAL RETIREMENT ACCOUNT ("IRA"): Individuals may make tax deductible contributions to their own Individual Retirement Accounts established under Section 408 of the Internal Revenue Code (the "Code"). Married investors filing a joint return neither of whom is an active participant in an employer sponsored retirement plan, or who have an adjusted gross income of $40,000 or less ($25,000 or less for single taxpayers) may continue to make a $2,000 ($2,500 for spousal IRAs) annual deductible IRA contribution. For adjusted gross incomes above $40,000 ($25,000 for single taxpayers, the IRA deduction limit is generally phased out ratably over the next $10,000 of adjusted gross income, subject to a minimum $200 deductible contribution. Investors who are not able to deduct a full $2,000 ($2,250 spousal) IRA contribution because of the limitations may make a nondeductible contribution to their IRA to the extent a deductible contribution is not allowed. Federal income tax on accumulations earned on nondeductible contributions is deferred until such time as these amounts are deemed distributed to an investor. Rollovers are also permitted under the Plan. The disclosure statement required by the Internal Revenue Service ("IRS") is provided by the Fund. The minimum initial investment to establish a tax-sheltered plan is $250. Subsequent investments are subject to a minimum of $50 for each account. SELF-EMPLOYED RETIREMENT PLAN (HR-10): Self-employed individuals may make tax deductible contributions to a prototype defined contribution pension plan or profit sharing plan. There are, however, a number of special rules which apply when self-employed individuals participate in such plans. Currently purchase payments under a self-employed plan are deductible only to the extent of the lesser of (i) $30,000 or (ii) 25% of the individuals earned annual income (as defined in the Code) and in applying these limitations not more than $200,000 of "earned income" may be taken into account. CORPORATE PENSION AND PROFIT SHARING PLANS: The Fund makes available a Prototype Defined Contribution Pension Plan and a Prototype Profit Sharing Plan. All purchases and redemptions of Fund shares pursuant to any one of the Fund's tax sheltered plans must be carried out in accordance with the provisions of the Plan. Accordingly, all plan documents should be reviewed carefully before adopting or enrolling in the Plan. Investors should especially note that a penalty tax of 10% may be imposed by the IRS on early withdrawals under corporate, Keogh or IRA plans. It is recommended by the IRS that an investor consult a tax adviser before investing in the Fund through any of these plans. An investor participating in any of the Fund's special plans has no obligation to continue to invest in the Fund and may terminate the Plan with the Fund at any time. Except for expenses of sales and promotion, executive and administrative personnel, and certain services which are furnished by LMC, the cost of the plans generally is borne by the Fund; however, each IRA Plan account is subject to an annual maintenance fee of $12.00 charged by the Agent. The following is only a summary of certain additional tax considerations generally affecting the Fund and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the Fund or its shareholders, and the discussions here and in the Prospectus are not intended as substitutes for careful tax planning. Qualification as a Regulated Investment Company The Fund has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the Fund is not subject to federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the Fund made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. In addition to satisfying the Distribution Requirement, a regulated investment company must: (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock or securities) and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months the "Short-Short Gain Test"). However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or futures thereon). Because of the Short-Short Gain Test, the Fund may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the Fund from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the Fund at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income that is attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. In general, gain or loss recognized by the Fund on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased by the Fund at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued during the period of time the Fund held the debt obligation. In addition, under the rules of Code Section 988, gain or loss recognized on the disposition of a debt obligation denominated in a foreign currency or an option with respect thereto (but only to the extent attributable to changes in foreign currency exchange rates), and gain or loss recognized on the disposition of a foreign currency forward contract, futures contract, option or similar financial instrument, or of foreign currency itself, except for regulated futures contracts or non-equity options subject to Code Section 1256 (unless the Fund elects otherwise), will generally be treated as ordinary income or loss. In general, for purposes of determining whether capital gain or loss recognized by the Fund on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (1) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used; (2) the asset is otherwise held by the Fund as part of a "straddle" (which term generally excludes a situation where the asset is stock and Fund grants a qualified covered call option (which, among other things, must not be deep-in-the-money) with respect thereto); or (3) the asset is stock and the Fund grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (1) above. In addition, the Fund may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain recognized by the Fund on the lapse of, or any gain or loss recognized by the Fund from a closing transaction with respect to, an option written by the Fund will be treated as a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of an option written by the Fund will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the Fund may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Transactions that may be engaged in by the Fund (such as regulated futures contracts, certain foreign currency contracts, and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contracts have not terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. Any capital gain or loss for the taxable year with respect to Section 1256 contracts (including any capital gain or loss arising as a consequence of the year-end deemed sale of such contracts) is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss. A Fund, however, may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the Fund that are not Section 1256 contracts. The IRS has held in several private rulings (and Treasury Regulations now provide) that gains arising from Section 1256 contracts will be treated for purposes of the Short-Short Gain Test as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. The Fund may purchase securities of certain foreign investment funds or trusts which constitute passive foreign investment companies ("PFICs") for federal income tax purposes. If the Fund invests in a PFIC, it may elect to treat the PFIC as a qualifying electing fund (a "QEF") in which event the Fund will each year have ordinary income equal to its pro rata share of the PFIC's ordinary earnings for the year and long-term capital gain equal to its pro rata share of the PFIC's net capital gain for the year, regardless of whether the Fund receives distributions of any such ordinary earning or capital gain from the PFIC. If the Fund does not (because it is unable to, chooses not to or otherwise) elect to treat the PFIC as a QEF, then in general (1) any gain recognized by the Fund upon sale or other disposition of its interest in the PFIC or any excess distribution received by the Fund from the PFIC will be allocated ratably over the Fund's holding period of its interest in the PFIC, (2) the portion of such gain or excess distribution so allocated to the year in which the gain is recognized or the excess distribution is received shall be included in the Fund's gross income for such year as ordinary income (and the distribution of such portion by the Fund to shareholders will be taxable as an ordinary income dividend, but such portion will not be subject to tax at the Fund level), (3) the Fund shall be liable for tax on the portions of such gain or excess distribution so allocated to prior years in an amount equal to, for each such prior year, (i) the amount of gain or excess distribution allocated to such prior year multiplied by the highest tax rate (individual or corporate) in effect for such prior year plus (ii) interest on the amount determined under clause (i) for the period from the due date for filing a return for such prior year until the date for filing a return for the year in which the gain is recognized or the excess distribution is received at the rates and methods applicable to underpayments of tax for such period, and (4) the distribution by the Fund to shareholders of the portions of such gain or excess distribution so allocated to prior years (net of the tax payable by the Fund thereon) will again be taxable to the shareholders as an ordinary income dividend. Under recently proposed Treasury Regulations the Fund can elect to recognize as gain the excess, as of the last day of its taxable year, of the fair market value of each share of PFIC stock over the Fund's adjusted tax basis in that share ("mark to market gain"). Such mark to market gain will be included by the Fund as ordinary income, such gain will not be subject to the Short-Short Gain Test, and the Fund's holding period with respect to such PFIC stock commences on the first day of the next taxable year. If the Fund makes such election in the first taxable year it holds PFIC stock, the Fund will include ordinary income from any mark to market gain, if any, and will not incur the tax described in the previous paragraph. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it had been incurred in the succeeding year. In addition to satisfying the requirements described above, the Fund must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of the Fund's taxable year, at least 50% of the value of the Fund's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of other issuers (as to which the Fund has not invested more than 5% of the value of the Fund's total assets in securities of such issuer and as to which the Fund does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the Fund controls and which are engaged in the same or similar trades or businesses. Generally, an option (call or put) with respect to a security is treated as issued by the issuer of the security not the issuer of the option. If for any taxable year the Fund does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable to the shareholders as ordinary dividends to the extent of the Fund's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall: (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year; and (2) exclude foreign currency gains and losses incurred after October 31 of any year (or after the end of its taxable year if it has made a taxable year election) in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The Fund intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that the Fund may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. The Fund anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for federal income tax purposes, but they generally should not qualify for the 70% dividends-received deduction for corporate shareholders. A Fund may either retain or distribute to shareholders its net capital gain for each taxable year. The Fund currently intends to distribute any such amounts. If net capital gain is distributed and designated as a capital gain dividend, it will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the Fund prior to the date on which the shareholder acquired his shares. Conversely, if the Fund elects to retain its net capital gain, the Fund will be taxed thereon (except to the extent of any available capital loss carryovers) at the 35% corporate tax rate. If the Fund elects to retain its net capital gain, it is expected that the Fund also will elect to have shareholders of record on the last day of its taxable year treated as if each received a distribution of his pro rata share of such gain, with the result that each shareholder will be required to report his pro rata share of such gain on his tax return as long-term capital gain, will receive a refundable tax credit for his pro rata share of tax paid by the Fund on the gain, and will increase the tax basis for his shares by an amount equal to the deemed distribution less the tax credit. Ordinary income dividends paid by the Fund with respect to a taxable year will qualify for the 70% dividends-received deduction generally available to corporations (other than corporations, such as S corporations, which are not eligible for the deduction because of their special characteristics and other than for purposes of special taxes such as the accumulated earnings tax and the personal holding company tax) to the extent of the amount of qualifying dividends received by the Fund from domestic corporations for the taxable year. A dividend received by the Fund will not be treated as a qualifying dividend (1) if it has been received with respect to any share of stock that the Fund has held for less than 46 days (91 days in the case of certain preferred stock), excluding for this purpose under the rules of Code Section 246(c)(3) and (4): (i) any day more than 45 days (or 90 days in the case of certain preferred stock) after the date on which the stock becomes ex-dividend and (ii) any period during which the Fund has an option to sell, is under a contractual obligation to sell, has made and not closed a short sale of, is the grantor of a deep-in-the-money or otherwise nonqualified option to buy, or has otherwise diminished its risk of loss by holding other positions with respect to, such (or substantially identical) stock; (2) to the extent that the Fund is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property; or (3) to the extent the stock on which the dividend is paid is treated as debt-financed under the rules of Code Section 246A. Moreover, the dividends-received deduction for a corporate shareholder may be disallowed or reduced (1) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of the Fund or (2) by application of Code Section 246(b) which in general limits the dividends-received deduction to 70% of the shareholder's taxable income (determined without regard to the dividends-received deduction and certain other items). Since an insignificant portion of the Fund will be invested in stock of domestic corporations, the ordinary dividends distributed by the Fund will not qualify for the dividends-received deduction for corporate shareholders. Alternative minimum tax ("AMT") is imposed in addition to, but only to the extent it exceeds, the regular tax and is computed at a maximum marginal rate of 28% for noncorporate taxpayers and 20% for corporate taxpayers on the excess of the taxpayer's alternative minimum taxable income ("AMTI") over an exemption amount. In addition, under the Superfund Amendments and Reauthorization Act of 1986, a tax is imposed for taxable years beginning after 1986 and before 1996 at the rate of 0.12% on the excess of a corporate taxpayer's AMTI (determined without regard to the deduction for this tax and the AMT net operating loss deduction) over $2 million. For purposes of the corporate AMT and the environmental superfund tax (which are discussed above), the corporate dividends-received deduction is not itself an item of tax preference that must be added back to taxable income or is otherwise disallowed in determining a corporation's AMTI. However, corporate shareholders will generally be required to take the full amount of any dividend received from the Fund into account (without a dividends-received deduction) in determining its adjusted current earnings, which are used in computing an additional corporate preference item (i.e., 75% of the excess of a corporate taxpayer's adjusted current earnings over its AMTI (determined without regard to this item and the AMT net operating loss deduction)) includable in AMTI. Investment income that may be received by the Fund from sources within foreign countries may be subject to foreign taxes withheld at the source. The United States has entered into tax treaties with many foreign countries which entitle the Fund to a reduced rate of, or exemption from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the amount of the Fund's assets to be invested in various countries is not known. If more than 50% of the value of the Fund's total assets at the close of its taxable year consist of the stock or securities of foreign corporations, the Fund may elect to "pass through" to the Fund's shareholders the amount of foreign taxes paid by the Fund. If the Fund so elects, each shareholder would be required to include in gross income, even though not actually received, his pro rata share of the foreign taxes paid by the Fund, but would be treated as having paid his pro rata share of such foreign taxes and would therefore be allowed to either deduct such amount in computing taxable income or use such amount (subject to various Code limitations) as a foreign tax credit against federal income tax (but not both). For purposes of the foreign tax credit limitation rules of the Code, each shareholder would treat as foreign source income his pro rata share of such foreign taxes plus the portion of dividends received from the Fund representing income derived from foreign sources. No deduction for foreign taxes could be claimed by an individual shareholder who does not itemize deductions. Each shareholder should consult his own tax adviser regarding the potential application of foreign tax credits. Distributions by the Fund that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the Fund will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the Fund (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the Fund reflects undistributed net investment income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the Fund, distributions of such amounts will be taxable to the shareholder in the manner described above, although such distributions economically constitute a return of capital to the shareholder. Ordinarily, shareholders are required to take distributions by the Fund into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the Fund) on December 31 of such calendar year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The Fund will be required in certain cases to withhold and remit to the U.S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the IRS for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the Fund that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the Fund in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the Fund within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the Fund will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) (discussed above in connection with the dividends-received deduction for corporations) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the Fund is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the Fund is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends paid to a foreign shareholder will be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate) upon the gross amount of the dividend. Furthermore, such a foreign shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate) on the gross income resulting from the Fund's election to treat any foreign taxes paid by it as paid by its shareholders, but may not be allowed a deduction against this gross income or a credit against this U.S. withholding tax for the foreign shareholder's pro rata share of such foreign taxes which it is treated as having paid. Such a foreign shareholder would generally be exempt from U.S. federal income tax on gains realized on the sale of shares of the Fund, capital gain dividends and amounts retained by the Fund that are designated as undistributed capital gains. If the income from the Fund is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends, and any gains realized upon the sale of shares of the Fund will be subject to U.S. federal income tax at the rates applicable to U.S. Citizens or domestic corporations. In the case of foreign noncorporate shareholders, the Fund may be required to withhold U.S. federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the Fund with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the Fund, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting investment in the Fund. For the purpose of quoting and comparing the performance of the Fund to that of other mutual funds and to other relevant market indices in advertisements or in reports to shareholders, performance may be stated in terms of total return. Under the rules of the Securities and Exchange Commission ("SEC rules"), funds advertising performance must include total return quotes calculated according to the following formula: P(l + T)n = ERV Where: P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof). Under the foregoing formula, the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five and ten year periods or a shorter period dating from the effectiveness of the Fund's Registration Statement. In calculating the ending redeemable value, all dividends and distributions by the Fund are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. Any recurring account charges that might in the future be imposed by the Fund would be included at that time. The Fund may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the performance of the Fund with other measures of investment return. For example, in comparing the Fund's total return with data published by Lipper Analytical Services, Inc., or with the performance of the Standard and Poor's 500 Stock Index or the Russell 2000, the Fund calculates its aggregate total return for the specified periods of time assuming the investment of $10,000 in Fund shares and assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial value of the investment from the ending value and by dividing the remainder by the beginning value. Shareholders will receive reports at least semi-annually showing the Fund's holdings and other information. In addition, shareholders will receive annual financial statements audited by KPMG Peat Marwick LLP, the Fund's independent auditors. To the Shareholders and Directors of Lexington SmallCap Value Fund, Inc.: We have audited the accompanying statement of assets and liabilities of Lexington SmallCap Value Fund, Inc. (the "Fund") as of October 27, 1995. This financial statement is the responsibility of the Fund's management. Our responsibility is to express an opinion on this financial statement based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the statement of assets and liabilities is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the statement of assets and liabilities. 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 statement of assets and liabilities referred to above presents fairly, in all material respects, the financial position of Lexington SmallCap Value Fund, Inc. as of October 27, 1995 in conformity with generally accepted accounting principles. LEXINGTON SMALLCAP VALUE FUND, INC. Statement of Assets and Liabilities Deferred organization and registration expenses (Note 2)........... 50,000 Payable to Lexington Management Corporation (Note 2)............... $ 50,000 NET ASSETS applicable to 10,000 outstanding shares of common stock, $.001 par value per share, respectively............................ $100,000 Common stock - at par value, $.001 per share, issued and outstanding 10,000 (Note 1)......................... $ 10 Additional Paid in Capital......................................... 99,990 NET ASSET VALUE offering and redemption price per share (1) The Lexington SmallCap Value Fund, Inc. (the "Fund") was formed on August 29, 1995 as a Maryland Corporation. The Fund has had no operations through October 27, 1995 other than matters relating to its organization and registration as a diversified, open-end investment company under the Investment Company Act of 1940 and the sale and issuance of 10,000 shares of its common stock to the Lexington Management Corporation at an aggregate purchase price of $100,000 to provide the initial capital of the Fund. (2) Organization and initial offering expenses are to be borne by the Fund and were advanced by Lexington Management Corporation (LMC). It is estimated that such expenses will not exceed $50,000 and will be amortized from the date operations commence over a period which it is expected that a benefit will be realized, not to exceed five years. The Fund will reimburse LMC for such expenses when the Fund's assets exceed $20 million or when the Fund has completed one year of operations, whichever occurs first. Lexington Management Corporation has agreed that in the event that any of the initial 10,000 shares are redeemed during the period of amortization of the Fund's organizational expenses, the redemption proceeds will be reduced by any such unamortized organizational expenses in the same proportion as the number of initial shares being redeemed bears to the number of initial shares (10,000) outstanding at the time of redemption. (3) The Fund intends to comply in its initial year and thereafter with the requirements of the Internal Revenue Code necessary to qualify as a regulated investment company and as such will not be subject to federal income taxes on otherwise taxable income (including net realized capital gains) which is distributed to shareholders.	497	497	1996-01-12T00:00:00	1996-01-12T15:44:56
0000950152-96-000077	0000950152-96-000077_0003.txt	1.1 The purpose of this Plan is to provide additional compensation as an incentive to Key Executives upon whose efforts the continued successful and profitable operations of the Corporation and its subsidiaries are largely dependent, and to insure the continued availability of their services to the Corporation. For purposes of this Plan: 2.1 "Adjusted Consolidated Income" means the Corporation's consolidated income before provisions for income taxes and minority interests and before deduction of the Bonus, as shown on the consolidated statement of income contained in the Corporation's annual report to stockholders. 2.2 "Adjusted Income Portion Points" mean the points awarded to Key Executives by the Committee with respect to the Adjusted Income Portion of the Bonus as described in Section 5.1. 2.3 "Beginning of the Year Stockholders' Equity" means the stockholders' equity at the end of the preceding Year, as shown on the consolidated balance sheet contained in the Corporation's annual report to stockholders. 2.4 "Board" means the board of directors of the Corporation. 2.5 "Bonus" means any bonus awarded to a Key Executive pursuant to the Plan. 2.6 "Committee" means the Incentive Bonus Committee appointed under Section 3.1 to administer the Plan. 2.7 "Common Shares" mean the common shares of the Corporation. 2.8 "Corporation" means Durametallic Corporation. 2.9 "Disability" means a mental or physical illness or condition rendering a Key Executive incapable of performing his normal duties with the Corporation for a period of six months. 2.10 "Key Executive" means an employee of the Corporation who is selected by the Committee to participate in the Plan. 2.11 "Long Term Portion Points" mean the points awarded to Key Executives by the Committee with respect to the Long Term Portion of the Bonus as described in Section 5.1. 2.12 "Partial Bonus" means an amount obtained by multiplying the Bonus that the Key Executive would have received if he had been employed for a full Year by a ratio equal to the calendar days prior to the employment termination date over the total calendar days in the Year. 2.13 "Plan" means this Executive Incentive Bonus Plan, as amended. 2.14 "Retirement" means retirement as defined in the Corporation's R. D. Hall Employee Stock Ownership Plan, as it may from time to time be amended. 2.15 "Return on Equity" means an amount obtained by dividing the Corporation's consolidated net income, as shown on the consolidated statement of income, by consolidated stockholders' equity as of the end of the preceding Year, as shown on the consolidated balance sheet contained in the Corporation's annual report to stockholders. 2.16 "Return on Equity Bonus Amount" means an amount calculated each Year according to the following schedule: For purposes of calculating Return on Equity Bonus Amounts under this section, Return on Equity amounts shall be rounded to the nearest whole percentage. 2.17 "Year" means the fiscal year of the Corporation ending December 31. 3.1 The Board shall, appoint an Incentive Bonus Committee which shall serve at the pleasure of the Board. The President shall be an EX OFFICIO member of the Committee but shall have no voting rights. The Committee is authorized to construe, interpret and administer the Plan and may from time to time adopt such rules and regulations for the administration of the Plan as it may deem appropriate. No voting member of the Committee shall be eligible to receive a Bonus under the Plan for any period during which he served as a member of the Committee. All decisions and selections made by the Committee shall be final and binding upon all parties. No member of the Committee shall be liable for any action or determination made in good faith with respect to the Plan. 3.2 The selection of employees to receive Bonuses and the determination of the number of points to be awarded to each Key Executive shall be entirely within the discretion of the Committee. 4.1 As soon as practicable after the beginning of each Year, the Committee shall select employees eligible to participate in the Plan and determine the number of Adjusted Income Portion Points and Long Term Portion Points to be awarded to each Key Executive for that Year. In making such selections, the Committee shall consider the recommendations of management. 4.2 The Committee shall notify each Key Executive of his selection as a participant in the Plan, the number of Adjusted Income Portion Points and Long Term Portion Points awarded to him and the total number of Adjusted Income Portion Points and Long Term Portion Points awarded to Key Executives for that Year. 4.3 The selection of an employee to be a Key Executive for a particular Year shall not constitute him a Key Executive for another Year unless he is selected to be a Key Executive for such other Year. 5.1 The Bonus shall consist of an Adjusted Income Portion and a Long Term Portion as computed below. Each Key Executive shall be entitled to receive the same percentage of the total Adjusted Income Portion as his Adjusted Income Portion Points are to the total Adjusted Income Portion Points of all Key Executives and the same percentage of the total Long Term Portion as his Long Term Portion Points are to the total Long Term Portion Points of all Key Executives. 5.2 The Adjusted Income Portion of the Bonus for each Year shall be an amount equal to five percent (5%) of the balance remaining after deducting eight percent (8%) of the Beginning of the Year Stockholders' Equity from the Adjusted Consolidated Income. 5.3 The Long Term Portion of the Bonus for each Year shall be an amount equal to the sum of the Return on Equity Bonus Amounts for the last five Years. 5.4 The Corporation's independent public accountants shall determine and report to the Committee the amount available for the Plan for each Year as promptly after the close of such Year as practicable following completion of their review and audit of the accounts of the Corporation for the purpose of certification of the financial statements appearing in the annual report to shareholders for the Year. This Plan refers to the date that the Corporation receives the accountant's report as the "Determination Date." METHOD AND TIME OF PAYMENT OF BONUS 6.1 The Corporation shall pay the Adjusted Income Portion of the Bonus in cash. The Corporation shall distribute the Adjusted Income Portion as soon as possible after the Determination Date. 6.2 The Corporation shall pay the Long Term Portion of the Bonus fifty percent (50%) in cash and fifty percent (50%) in Common Shares. The Corporation shall pay the cash portion of the Long Term Portion in annual installments of twenty-five percent (25%), the first installment payable the Year following the Year the Corporation selects the employee as a Key Executive and the remaining installments payable in each of the succeeding three Years. The Corporation shall pay the first cash installment within ninety (90) days after the Determination Date. The Corporation shall pay each subsequent cash installment within one hundred fifty (150) days of the beginning of each succeeding year. 6.3 The Corporation shall pay the Common Share portion of the Long Term Portion of the Bonus as soon as possible after the Corporation has determined the market value of the Common Shares as set forth in Section 7.2. The Corporation shall issue in the name of the Key Executive all of the Common Shares payable under the Long Term Portion of the Bonus. All of the Common Shares (the "Restricted Stock") shall be subject to the restrictions set forth in Section 8.6. 7.1 Common Shares to be delivered in partial payment of Bonuses shall be made available from authorized and unissued stock of the Corporation. 7.2 The Common Share portion of the Long Term Portion of the Bonus shall consist of the number of Common Shares having an aggregate market value, determined within ninety (90) days of the Determination Date, equal to fifty percent (50%) of the Key Executive's share of the Long Term Portion as determined under Section 5.1. If payment of Common Shares would require the delivery of a fractional share, then in lieu of the fractional share the Corporation shall pay to the Key Executive the cash value thereof. Market value shall be determined by independent appraisers or such other valuation methods as the Corporation may from time to time adopt. 7.3 The Key Executive shall represent and warrant that he is acquiring the Common Shares for his own account and investment and without any intention to resell, or distribute the Common Shares. The Key Executive shall agree not to resell or distribute the Common Shares except upon the conditions as the Corporation may reasonably specify to insure compliance with federal and state securities laws. The Key Executive shall execute an agreement in the form of EXHIBIT A, or such other form as the Committee may from time to time adopt. 7.4 (a) Any certificate issued under this Plan and representing Common Shares which are Restricted Stock shall bear the following legend: The Corporation has not registered these shares under federal and state securities laws. The holder of these shares may not sell or otherwise transfer the shares unless the sale or other transfer is (A) registered or exempt from registration under federal and applicable state securities laws and (B) in accordance with an agreement with the company dated [insert date of employee's letter agreement] a copy of which is on file with the Corporation. Under the agreement, the shares represented by this certificate are subject to forfeiture upon the occurrence of certain events. (b) Any certificate issued under this Plan and representing Common Shares which, by the terms of Section 8.6 and the written agreement described in Section 7.3 hereof, are no longer subject to a termination of rights and interests as Restricted Stock shall bear the following legend: The Corporation has not registered these shares under federal and state securities laws. The holder of these shares may not sell or otherwise transfer the shares unless the sale or other transfer is (a) registered or exempt from registration under federal and applicable state securities laws and (b) in accordance with an agreement with the Corporation dated [insert date of employee's letter agreement], a copy of which is on file with the Corporation. 8.1 A Key Executive whose employment terminates by dismissal for cause or who voluntarily terminates his employment shall forfeit all rights to any Bonus for the Year in which he terminates employment, any unpaid Bonus awarded for the Year prior to the Year in which he terminates employment, and any unpaid cash installments of the Long Term Portion of any Bonus awarded in any previous Year. As set forth in Section 8.6, the termination of employment shall also terminate the Key Executive's right to and interest in any Restricted Stock the Key Executive has received. For purposes of this Plan, "cause" shall include conviction of a crime involving moral turpitude, neglect of duties, incompetence, disobedience of reasonable directives of the Board, or activities in direct competition with the Corporation or in aid of its competitors, or any other activities which operate to the detriment of the Corporation. 8.2 A Key Executive whose employment terminates after the end of any Year in which he was designated a Key Executive, but before the Bonus for the Year is paid, because of death, Disability, Retirement, or any other reason except for dismissal for cause or voluntary termination, shall be entitled to the Bonus for the prior Year and shall be entitled to continue to receive any unpaid cash installments of the Long Term Portion of any Bonus awarded in any previous Year. The Corporation shall pay the Bonus to the Key Executive in the same manner as if he were still employed, or in the event of death, in the same manner as if he were living, PROVIDED, that the Corporation shall pay the Long Term Portion of the Bonus entirely in cash. 8.3 A Key Executive whose employment terminates during a Year in which he was designated a Key Executive because of death, Disability, Retirement, or any other reason except for dismissal for cause or voluntary termination, shall be entitled to a Partial Bonus for the Year. The Corporation shall pay the Bonus to the Key Executive in the same manner as if he were still employed, or in the event of death in the same manner as if he were living, provided, that the Corporation shall pay the Long Term Portion of the Bonus entirely in cash. 8.4 The Corporation shall reallocate among the remaining Key Executives on a pro rata basis any bonus forfeited or reduced pursuant to Section 8.1 or Section 8.3, PROVIDED, that any unpaid installments of the Long Term Portion of any Bonus awarded for any Year prior to the Year of termination, which unpaid installments are forfeited pursuant to Section 8.1, shall not be reallocated nor inure to the benefit of any other Key Executives. 8.5 Each Key Executive may file a written notice with the Committee designating a beneficiary or beneficiaries to receive any Bonus payable pursuant to Section 8.2 or Section 8.3 at the death of the Key Executive. The Key Executive may change the designation from time to time; provided, however, that any change shall not be effective until received in writing by the Committee. If no beneficiary has been designated or survives the Key Executive, any such Bonus shall be paid to the estate of the Key Executive. 8.6 Each award of Restricted Stock under this Plan shall be subject to the following terms and conditions. The agreement referenced in Section 7.3 shall contain these terms and conditions. (a) EMPLOYMENT. The Corporation shall award Restricted Stock on the condition that the Key Executive remain in the employ of the Corporation, or one or more of its subsidiaries, for a period of three (3) years following the date of the award of the Restricted Stock (the "Restricted Period"). This condition shall not affect the right of the Corporation or any subsidiary to terminate the Key Executive's employment at any time for any reason. An award of Restricted Stock in any Year shall not affect the length of the Restricted Period which applies to previously awarded Restricted Stock. (b) TERMINATION OF RIGHTS AND INTERESTS. In the event the Corporation terminates the Key Executive's employment for cause (as defined in Section 8.1), the Key Executive voluntarily terminates his or her employment or a Transfer (as defined in Section 8.6(d)) occurs or is proposed to occur during a Restricted Period (collectively referred to as a "Terminating Event"), the Key Executive's rights to and interests in the shares of Restricted Stock the subject of the Restricted Period shall terminate as of the date of Terminating Event and the Key Executive shall promptly surrender to the Corporation those shares of Restricted Stock as to which the Key Executive's rights and interests have terminated. (c) DEATH OR NORMAL RETIREMENT. In the event employment terminates during a Restricted Period by reason of death, Disability or Retirement, or the Corporation terminates employment without cause, the Key Executive's right to all of the Key Executive's Restricted Stock the subject of the Restricted Period shall vest as of the date that the employment terminates and the Key Executive may then transfer the Restricted Stock free of the restrictions under this Plan, except for those restrictions that Section 7.3 describes. (d) TRANSFER RESTRICTIONS. The Key Executive may not sell, assign, exchange, transfer, pledge or otherwise dispose of the shares of Restricted Stock during the applicable Restricted Period other than to the Corporation pursuant to Section 8.6(b) or by will or by the laws of descent or distribution. If the Key Executive sells, assigns, exchanges, pledges, transfers or otherwise voluntarily or involuntarily disposes of or attempts to take any such action to dispose of any shares of Restricted Stock during the Restricted Period applicable to the shares, or if the shares of Restricted Stock are subject to any attachment, garnishment, lien, execution of judgment or other involuntary transfer during an applicable Restricted Period (collectively referred to as a "Transfer"), except as provided above in Section 8.6(b), the Key Executive's rights to and interests in the Restricted Stock the subject of the Restricted Period shall terminate as set forth in Section 8.6(b), the Key Executive shall promptly surrender to the Corporation those Shares of Restricted Stock and any Transfer of Shares the subiect of the Restricted Period shall be void and not binding on the Corporation. The Key Executive shall grant the Corporation a security interest in the Restricted Stock and shall authorize the Corporation to retain during the Restricted Period the certificates which evidence the Restricted Stock. (e) SHAREHOLDER RIGHTS. During the Restricted Period applicable to any Restricted Stock, the Key Executive shall have all rights of a shareholder with respect to the Restricted Stock the subject of the Restricted Period including (i) the right to vote any shares at shareholders' meetings, (ii) the right to receive, without restriction, all cash dividends paid on the Restricted Stock, and (iii) the right to participate with respect to the Restricted Stock in any stock dividend, stock split, recapitalization, or other adjustment in the Common Shares of the Corporation or any merger, consolidation or other reorganization involving an increase, decrease or adjustment in the Common Shares of the Corporation. Any new, additional or different shares or other security received by the Key Executive pursuant to the stock dividend, stock split, recapitalization or reorganization shall be subject to the same terms, conditions and restrictions as those relating to the Restricted Stock for which the shares were received. 9.1 The Board may from time to time amend, suspend, or terminate, in whole or in part, any or all of the provisions of this Plan, effective as of the beginning of any Year commencing after the date of adoption of such action by the Board; provided, that no such action shall affect the rights of any Key Executive or the operation of this Plan with respect to any Bonus to which the Key Executive may have become entitled hereunder prior to the effective date of the action. 10.1 Neither the action of the Corporation in establishing this Plan nor any action taken by it or the Committee shall be construed as giving any Key Executive the right to be retained in the employ of the Corporation. 10.2 The expense of administering this Plan shall be borne by the Corporation. 10.3 The effective date of this amended Plan shall be January 1, 1993. For purposes of calculating the Long Term Portion of the Bonus under Section 5.3, the Corporation shall use the results of the Corporation's operations for the five Years ending December 31, 1992. I understand that Durametallic Corporation (the "Corporation") has chosen me as a Key Executive under the Corporation's Executive Incentive Bonus Plan, as amended (the "Plan"). A portion of my Bonus is payable in shares of Common Stock of the Corporation (the "Shares"). I agree that any Shares which I will receive under the Plan or have received under the Plan prior to any amendment (the "Restricted Stock") are subject to the terms and conditions of this letter, and the Shares and my rights under this letter are subject to the terms, conditions and definitions of the Plan which are incorporated herein by reference. I agree that as of the date of this letter, the Corporation has awarded to me Shares under the Plan. (a) CONTINUED EMPLOYMENT. I agree that any Restricted Stock awarded to me will be subject to the condition that I remain in the employ of the Corporation or one or more of its subsidiaries for three (3) years from the date that the Restricted Stock is issued to me (the three year period applicable to each Share is referenced herein as a "Restricted Period"). Neither this condition nor the award or the Restricted Stock shall impose upon the Corporation or any subsidiary any obligation to retain me in their employ for any given period or upon any specific terms of employment. I acknowledge that, except as the Corporation or one of its subsidiaries may otherwise agree in a signed written agreement, approved by its board of directors, my employment is "at will" and terminable by me or the Corporation at any time and for any reason. (b) TERMINATION OF RIGHTS AND INTERESTS. In the event the Corporation or any subsidiary terminates my employment for cause (as defined in Section 8.1 of the Plan), I voluntarily terminate my employment or a Transfer (as defined below) occurs or is proposed to occur during a Restricted Period (collectively referred to as a "Terminating Event"), all my rights to and interests in the Shares of Restricted Stock the subject of the Restricted Period shall immediately terminate as of the date of the Terminating Event and I shall promptly surrender to the Corporation those Shares of Restricted Stock in which my rights and interests have terminated. (c) DEATH OR NORMAL RETIREMENT. In the event my employment terminates during a Restricted Period by reason of death, Disability or Retirement, or the Corporation terminates my employment without cause, my right to all of my Restricted Stock the subject of the Restricted Period shall vest as of the date that my employment terminates and I may then transfer the Restricted Stock free of the restrictions under the Plan, except for those restrictions that Section 7.3 of the Plan describes or as set forth in this Agreement. (d) TRANSFER RESTRICTIONS. I may not sell, assign, exchange, transfer, pledge or otherwise dispose of the Shares of Restricted Stock during the applicable Restricted Period other than to the Corporation pursuant to Paragraph (b) above or by will or by the laws of descent or distribution. If I sell, assign, exchange, pledge, transfer or otherwise voluntarily or involuntarily dispose of or attempt to take any such action to dispose of the Restricted Stock during the Restricted Period applicable to the Shares, or if the Shares of Restricted Stock are subject to any attachment, garnishment, lien, execution of judgment or other involuntary transfer during an applicable Restricted Period (collectively referred to as a "Transfer"), except as provided above in Paragraph (b), my rights to and interests in the Restricted Stock the subject of the Restricted Period shall terminate as set forth in Paragraph (b) above, I shall promptly surrender to the Corporation those Shares of Restricted Stock and any Transfer of Shares the subiect of the Restricted Period shall be void and not binding on the Corporation. I hereby grant the Corporation a security interest in the Restricted Stock and authorize the Corporation to retain during the applicable Restricted Period the certificates which evidence the Restricted Stock. (e) SHAREHOLDER RIGHTS. During the Restricted Period, I shall have all rights of a shareholder with respect to the Restricted Stock the subject of the Restricted Period including (i) the right to vote any Shares at shareholders' meetings, (ii) the right to receive, without restriction, all cash dividends paid on the Restricted Stock, and (iii) the right to participate with respect to the Restricted Stock in any stock dividend, stock split, recapitalization, or other adjustment in the Common Shares of the Corporation or any merger, consolidation or other reorganization involving an increase, decrease or adjustment in the Common Shares of the Corporation. Any new, additional or different Shares or other security received by me pursuant to the stock dividend, stock split, recapitalization or reorganization shall be subject to the same terms, conditions and restrictions as those relating to the Restricted Stock for which the Shares were received. (1) For Shares which are not Restricted Stock subject to a termination of rights and interests upon a Transfer, I hereby grant the Corporation the option to purchase the Shares in the event (i) I desire to sell, assign, exchange, transfer or otherwise disclose of all or any portion of the Shares pursuant to a bona fide offer or (ii) the Shares are subject to an involuntary transfer. (A) I shall give written notice to the Corporation of any proposed voluntary transfer. The written notice shall specify the number of Shares I desire to transfer, the name, address, and telephone number of the proposed transferee, the proposed price and other terms of the transfer (the "Offer"). The Corporation shall have the right to purchase the number of Shares which are the subject of the Offer upon the terms and conditions contained in the Offer. The Corporation's option shall be exercisable for thirty (30) days following receipt of the written notice. The Corporation shall exercise its option by written notice to me. If the Corporation does not exercise its option, I agree that I shall have a period of sixty (60) days after the expiration of Corporation's option to transfer the Shares to the proposed transferee named in the notice, on terms no more favorable and at a price not less than those stated in the notice. (B) The Corporation's option to purchase any Shares which are the subject of an involuntary transfer shall be exercisable for thirty (30) days following the Corporation's receipt of notice of the involuntary transfer. The purchase price for the Shares shall be their market value as of the date of the involuntary transfer. The Corporation shall exercise the option by written notice to any successor(s) in interest. Market value shall be determined by independent appraisers or such other valuation methods as may from time to time be adopted by the Corporation. (2) For Shares which are not Restricted Stock subject to a termination of rights and interests upon my employment termination, I hereby grant the Corporation the option to purchase the Shares upon termination of my employment by the Corporation or any of its subsidiaries for any reason whatsoever, including the employer's termination, my voluntary termination, death, Disability, or Retirement. The purchase price for the Shares shall be their market value as of the date of option shall be exercisable for thirty (30) days following my employment termination date. The Corporation shall exercise its option by written notice to me or my successor(s) in interest. Market value shall be determined by independent appraisers or such other valuation methods as may from time to time be adopted by the Corporation. In consideration of being chosen as a Key Executive, I hereby represent and warrant to the Corporation that I am acquiring the Shares for my own account for investment, and without any view or present intention of reselling or engaging in any other distribution thereof. In particular, but without limiting the foregoing, I warrant that I am not acquiring the Shares wholly or partly for the benefit of or pursuant to any understanding or agreement with, any other person or persons. I further agree that I will not sell, assign, encumber or otherwise transfer or offer for sale any of the Shares except (a) pursuant to effective registration and qualification under all applicable federal or state securities laws; or (b) in such circumstances that, in the opinion of counsel for the Corporation, such registration or qualification is not required, I may sell or otherwise transfer without violating any federal or state securities laws, and the sale or transfer is consistent with my investment representation. I agree that the stock certificate or certificates to be issued to me may bear an appropriate legend reflecting the foregoing restrictions on transfer. In the event any provision of law or the regulations of any stock exchange upon which the common stock of the Corporation may be listed shall at any time in the future be changed so as to require any different or additional legend with respect to such investment undertaking, I further agree to deliver to the Corporation the certificates evidencing the Shares so that the Corporation may amend or supplement the legend thereon in accordance with the laws or regulations. I further agree that the Corporation may give appropriate stop transfer instructions to any transfer agent or registrar of the Corporation's common stock (including the Corporation as its own transfer agent), to give effect to the foregoing investment representations and restrictions. I further agree that in the event I attempt any sale or other disposition of the Shares in violation of the foregoing representations or restrictions, the Corporation may refuse to register the transfer.	S-8 POS	EX-4.6	1996-01-12T00:00:00	1996-01-12T11:23:00
0000070668-96-000005	0000070668-96-000005_0000.txt	INFORMATION REQUIRED IN PROXY STATEMENT Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 Filed by the registrant X Filed by a party other than the registrant ___ ___ Soliciting material pursuant to Rule 14a-11(c) or Rule 14a-12 (Name of Registrant as Specified in Its Charter) (Name of Person(s) Filing Proxy Statement) Payment of filing fee (Check appropriate box): X $125 per Exchange Act Rule 0-11(c)(l)(ii), 14a-6(i), or 14a- 6(j)(2). ___ $500 per each party to the controversy pursuant to Exchange Act Rule 14a-6(i)(3). ___ Fee computed on table below per Exchange Act rules 14a-6(i)(4) and 0-11. (1) Title of each class of securities to which transaction applies: (2) Aggregate number of securities to which transactions applies: (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act rule 0-11: (4) Proposed maximum aggregate value of transaction: ___ Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the form or schedule and the date of its filing (2) Form, schedule or registration statement no.: 550 Route 202-206, P.O. Box 760 NOTICE OF ANNUAL MEETING OF SHAREHOLDERS The Annual Meeting of Shareholders of NUI Corporation will be held at One Elizabethtown Plaza, Union, New Jersey, on Tuesday, March 12, 1996 at 10:30 A.M. for the following purposes: 1. To elect three (3) directors for three-year terms expiring 2. To ratify the appointment, by the Board of Directors, of Arthur Andersen LLP as independent public accountants for the fiscal year ending September 30, 1996; 3. To approve the NUI Corporation 1996 Stock Option and Stock Award Plan, as described in the accompanying proxy 4. To approve the NUI Corporation 1996 Employee Stock Purchase Plan, as described in the accompanying proxy statement; 5. To approve the NUI Corporation 1996 Stock Purchase Plan for Outside Directors, as described in the accompanying proxy 6. To transact such other business as may properly be brought before the Annual Meeting, or any adjournment thereof. Only shareholders of record at the close of business on January 26, 1996 shall be entitled to notice of, and to vote at, the Annual Meeting or any adjournment thereof. By Order of the Board of Directors YOUR VOTE IS IMPORTANT. YOU ARE URGED TO SIGN, DATE AND RETURN THE ENCLOSED PROXY CARD AS PROMPTLY AS POSSIBLE TO ENSURE ITS ARRIVAL IN TIME FOR THE MEETING. PLEASE USE THE ACCOMPANYING POSTAGE-PAID ENVELOPE. Convenient parking is available in the immediate vicinity for shareholders attending the meeting. Directions to the meeting site are included on the back cover. 550 Route 202-206, P.O. Box 760 This Proxy Statement is being furnished to shareholders in connection with the solicitation by the Board of Directors of NUI Corporation, a New Jersey corporation (hereinafter called the "Company" or "NUI") of proxies to be voted at the Annual Meeting of Shareholders to be held on Tuesday, March 12, 1996, at 10:30 a.m., local time, and at any adjournment or postponement thereof (the "Annual Meeting"). This Proxy Statement and the accompanying form of proxy are first being mailed to shareholders on or about February 2, 1996. Record Date, Shareholders Entitled to Vote and Vote Required Only shareholders of record of the Company"s Common Stock, no par value (the "Common Stock") at the close of business on January 26, 1996 are entitled to notice of and to vote at the Annual Meeting. As of January 26, 1996 there were outstanding 9,201,237 shares of Common Stock entitled to notice of and to vote at the Annual Meeting. These shares were held by 6,956 shareholders of record. The presence of a majority of the outstanding shares of Common Stock, either in person or by proxy, is necessary to constitute a quorum at the Annual Meeting. Each holder of Common Stock is entitled to one vote for each share held. In accordance with the Company's By-Laws, the affirmative vote of the holders of a plurality of the shares of Common Stock represented in person or by proxy and voting at the Annual Meeting is required to elect the three directors to the Board of Directors. The affirmative vote of the holders of a majority of the shares of the Common Stock represented in person or by proxy and voting at the Annual Meeting is required to ratify the appointment of Arthur Andersen LLP as the Company's independent public accountants and to approve the adoption of the 1996 Stock Option and Stock Award Plan, the 1996 Employee Stock Purchase Plan and the 1996 Stock Purchase Plan for Outside Directors. Solicitation, Revocation and Voting of Proxies This solicitation is made on behalf of the Board of Directors of the Company. The cost of soliciting these proxies will be borne by the Company. In addition to solicitation by mail, directors, officers and employees of the Company and its subsidiaries may solicit proxies for the Annual Meeting from the Company"s shareholders personally or by telephone or telegram without additional remuneration. The Company will also provide persons, firms, banks and companies holding shares in their names or in the names of nominees, which in such cases are beneficially owned by others, proxy material for transmittal to such beneficial owners and will reimburse such record owners for their expenses related to such transmittal. The Company has retained the firm of D.F. King & Co. to assist in the solicitation of proxies at a cost of $5,500, plus expenses. The form of proxy enclosed is for use at the Annual Meeting. Any proxy given pursuant to this solicitation may be revoked at any time prior to its use by delivering a written notice of revocation or a duly executed proxy bearing a later date to the Secretary of the Company at the above address, or by attending the Annual Meeting and voting in person. All shares represented by valid proxies will be voted at the Annual Meeting in the manner indicated on the proxies. If no contrary instructions are indicated, such proxies will be voted FOR the election of each of the nominees to the Board of Directors, FOR the appointment of Arthur Andersen LLP as independent public accountants for the fiscal year ending September 30, 1996, FOR the approval of the 1996 Stock Option and Stock Award Plan, FOR the approval of the 1996 Employee Stock Purchase Plan and FOR the 1996 Stock Purchase Plan for Outside Directors. The By-Laws of the Company provide that the Board of Directors shall consist of not less than eight nor more than 25 directors. Pursuant to action taken by the Board of Directors, the number of directors has been fixed at eight. The By-Laws also provide that the Board of Directors shall be divided into three classes with directors in each class serving three-year terms. Approximately one-third of the Board of Directors is elected each year. Robert W. Kean, Jr., having reached the Board"s mandatory retirement age of 72 during his most recent term, has retired from the Board and is not standing for re- election at the Annual Meeting. It is the intention of the persons named as proxies to vote in favor of Calvin R. Carver, Vera King Farris and John Winthrop as directors of the Company for three-year terms expiring at the 1999 Annual Meeting of Shareholders or until their successors are elected and shall qualify, unless otherwise directed by the shareholder. Messrs. Carver and Winthrop were last elected to the Board at the 1993 Annual Meeting of Shareholders. Dr. Farris was elected to the Board in May, 1994 to fill an existing vacancy. While it is not anticipated that any of the nominees will be unable to serve, if any nominee is unable or declines to serve as a director at the time of the Annual Meeting, proxies will be voted for any nominee designated by the Board of Directors to fill the vacancy. The By-Laws of the Company provide that specific advance notification and information requirements must be satisfied in order for a shareholder to nominate any individual for election to the Board. As of the date of this Proxy Statement, no such nominations had been made. Set forth below is information concerning the age, current term, committee memberships, the period served as a director and business experience during the past five years with respect to each director nominee: Photo of Calvin R. Carver, age 70 Calvin R. Current term expires in 1996 Carver Member of the Audit, Executive and Investment Mr. Carver has served as a director of the Company since 1969 (except for four months ended March 1982). Mr. Carver served as Executive Vice President of the Company until his retirement in 1986. He is also a director and Treasurer of Penn-Jersey Pipe Line Co. Photo of Dr. Vera King Farris, age 55 Dr. Vera Current term expires in 1996 King Farris Member of the Compensation Committee Dr. Farris has served as a director of the Company since May 1994. She is President of The Richard Stockton College of New Jersey. She also serves as a director of Flagstar Companies, Inc. and on the boards of numerous educational and civic organizations. Photo of John Winthrop, age 59 John Current term expires in 1996 Winthrop Member of the Audit and Investment Committees Mr. Winthrop has served as a director since 1978. Mr. Winthrop is President of John Winthrop & Co., Inc. and a partner of Winthrop Melhado Flynn (both investment management firms). He also serves as a director of the American Farmland Trust and several mutual funds, including certain Alliance Capital Funds and the Pioneer Funds. Set forth below is information concerning the age, current term, committee memberships, the period served as director and business experience during the past five years for those members of the Board of Directors whose current term extends beyond 1996: Photo of James J. Forese, age 59 James J. Current term expires in 1997 Forese Member of the Audit, Executive and Compensation Mr. Forese has served as a director of the Company since 1978. Since January, 1996 Mr. Forese has served as Executive Vice President and Chief Operating Officer of Alco Standard Corp. From October, 1993 through December, 1995 he served as General Manager of Customer Financing for International Business Machines Corporation ( IBM ) and as Chairman of IBM Credit Corporation. From 1990 through 1995 he held the additional position of Vice President-Finance of IBM. Mr. Forese also serves as a director of American Management Systems, Inc. and Lexmark International, Inc. Photo of John Kean, age 66 John Kean Current term expires in 1998 Chairman of the Board of Directors Member of the Executive Committee Mr. Kean has served as a director since 1969. He served as Chief Executive Officer of the Company from 1969 until his retirement in April, 1995, holding the positions of Chairman of the Board since October, 1994 and President from 1969 until October, 1994. Mr. Kean is also a director of E'Town Corporation and its subsidiary, Elizabethtown Water Company. Photo of John Kean, Jr., age 38 John Current term expires in 1998 Kean, Jr. President and Chief Executive Officer Member of the Executive Committee Mr. Kean has served as a director since 1995. Since April, 1995 he has served as President and Chief Executive Officer of the Company. From October, 1994 through March, 1995 he served as President and Chief Operating Officer. He served as Executive Vice President of the Company from January 1992 to September 1994 and as Executive Vice President of Elizabethtown Gas Company from March 1993 to September 1994. Prior to March, 1993 he served as Chief Financial Officer of the Company. Photo of Dr. Bernard S. Lee, age 61 Dr. Bernard S. Current term expires in 1998 Lee Member of the Audit and Compensation Committees Dr. Lee has served as director since 1992. He is Chief Executive Officer and President of the Institute of Gas Technology. Dr. Lee is also a director of Peerless Mfg. Co., Energy Biosystems Corp. and National Fuel Gas Company. Photo of R. Van Whisnand, age 51 R. Van Current term expires in 1997 Whisnand Member of the Compensation, Executive and Investment Mr. Whisnand has served as a director since 1982. Since March, 1995 he has served as a principal of Fox Asset Management (investment management) and prior thereto he served as a partner in Combined Capital Management (investment management). Committees and Meetings of the Board of Directors The Board of Directors holds regular meetings every other month and special meetings as necessary from time to time. During fiscal year 1995, the Board of Directors held eight meetings and Board members attended, in the aggregate, 94% of the total number of meetings of the Board and Committees of the Board on which the directors served. No member of the Board attended fewer than 75% of the aggregate of meetings of the Board and meetings of Committees on which such director served. The Board has an Executive, Audit, Compensation and Investment Committee and does not have a Nominating Committee. Information on the Committees of the Board is set forth below. The Executive Committee has the authority (with certain exceptions) to take such actions as the Board of Directors is authorized to take. The Committee does not hold regularly scheduled meetings, but remains on call. The Committee held no meetings during fiscal year 1995. The current members of the Executive Committee are Calvin R. Carver, James J. Forese, John Kean (Chairman), John Kean, Jr., Robert W. Kean, Jr. and R. Van Whisnand. The Audit Committee has the responsibility to review and approve the scope of the annual audit; to recommend to the Board the appointment of independent public accountants; to review and approve the annual internal audit program and review the findings of internal audits; to review with the independent public accountants the adequacy of the Company"s systems and internal controls; and to review any non- audit services provided by the independent public accountants. The Committee met four times during fiscal year 1995. The Current members of the Audit Committee are Calvin R. Carver, James J. Forese (Chairman), Bernard S. Lee and John Winthrop. The Investment Committee has the responsibility to oversee the investment of assets held by the Company"s retirement plans and savings and investment plans. The Committee selects investment managers, establishes guidelines under which they operate and reviews their performance. The Committee met four times during fiscal year 1995. The current members of the Investment Committee are Calvin R. Carver (Chairman), John Kean, Robert W. Kean, Jr. and John Winthrop. The Compensation Committee has the responsibility to review and make recommendations to the Board of Directors regarding the annual salaries and cash bonuses to be paid the officers of the Company and its divisions and subsidiaries; to review, and make recommendations to the Board concerning, the Company"s executive compensation policies, practices and objectives; and to administer the Company"s 1988 Stock Plan and make grants and awards under the Plan, establishing vesting and other criteria applicable to any such grants and awards. The Committee met three times in fiscal year 1995. For additional information on the role and activities of the Committee, please see Compensation Committee Report on Executive Compensation located later in this Proxy Statement. The current members of the Compensation Committee are Vera King Farris, James J. Forese, Bernard S. Lee and R. Van Whisnand (Chairman). The compensation program for directors is closely aligned with the Company's long-term goals for performance and the enhancement of shareholder value. Each non-employee director of the Company (with the exception of John Kean) is paid a retainer fee pursuant to the Company"s 1988 Stock Plan that consists of a deferred grant of shares of Common Stock. The number of shares of Common Stock credited to the accounts of such non-employee directors is determined by dividing $12,000 by the closing price of the Common Stock on the date of the annual organization meeting of the Board. Directors who Chair Board Committees (with the exception of John Kean) receive an additional deferred grant of Common Stock with a value of $2,500 on the date of grant. On each Common Stock dividend payment date, the accounts of these non-employee directors are credited with an additional number of shares equal to the number of shares which could have been purchased on that date if the directors" shares had actually been issued and the dividends reinvested at the closing price on such date. The shares of Common Stock credited to a director under the 1988 Stock Plan are issued upon the termination of the director"s service as a member of the Board. As of September 30, 1995, the total deferred grants for non-employee directors provide for the issuance of 19,005 shares of Common Stock, an increase of 4,995 shares during fiscal year 1995. In addition to these retainers, non-employee directors (with the exception of John Kean) are paid $600 for attendance at each regular or special meeting of the Board of Directors and any Committee thereof. The Company entered into an agreement, dated March 24, 1995, with John Kean, who retired as Chief Executive Officer of the Company effective April 1, 1995. The Agreement has a three-year term and expires on March 31, 1998. Under the Agreement, Mr. Kean is providing consulting services to the Company for up to 110 hours each calendar month. The Agreement requires Mr. Kean to devote sufficient time and effort to perform such duties as may be assigned by the Company or the Board of Directors from time to time. The Agreement also provides that during the term of the Agreement, if Mr. Kean remains a director, he shall hold the position of Chairman of the Board. In consideration of the services rendered under the Agreement, the Company provides Mr. Kean with an annual fee of $150,000 and office space, clerical support, expense reimbursement and life, health and medical coverages similar to those previously provided to him when he was an employee of the Company. Other than this annual fee and the benefits provided for under the Agreement, Mr. Kean does not receive any additional compensation for serving on the Board or Committees of the Board of the Company, its divisions or subsidiaries. The Agreement will terminate automatically in the event of Mr. Kean"s death and may be terminated by the Company for cause or if Mr. Kean should become disabled. Mr. Kean may terminate the Agreement for Good Reason (as defined in the Agreement) following a change in control of the Company, upon the impairment of his health or upon thirty days prior written notice. Upon a change in control of the Company, the Agreement is automatically extended for three years following such change in control. In addition, if, following a change in control the Agreement is terminated by Mr. Kean for Good Reason or by the Company (or its successor) other than as a result of Mr. Kean"s disability or for cause, Mr. Kean shall be entitled to receive (i) an amount equal to the amounts which would have otherwise been paid to him if the Agreement had remained in effect through its term, (ii) the continuation of benefits through the term of the Agreement and(iii) an amount, if necessary, in order to offset the impact of the application of any excise tax imposed upon the value of such payments and benefits under the Internal Revenue Code. Calvin R. Carver currently serves as a director of the Company"s Elizabethtown Gas Company division and is paid an annual retainer of $1,000 and $450 for each Board and Committee meeting attended. The Company has in effect a retirement plan for directors. To be eligible for retirement benefits under the Plan, a director must have served as a director for at least ten years, with a minimum of five years of service as a non-employee of the Company or any of its subsidiaries. An eligible participant in the Plan will be paid, upon retirement at or after age 70, an annual retirement benefit for life equal to the value of the annual Board retainer in effect at the time of the director"s retirement, subject to a minimum annual benefit of $8,000. Compensation Committee Interlocks and Insider Participation Proxy disclosure rules require the Company to report certain relationships involving the Company in which members of the Compensation Committee have a direct or indirect material interest. Also required is disclosure of interlocking relationships among Compensation Committee members and those executive officers of the Company, if any, who also serve as members of compensation committees or executive officers at other companies. The purpose of these requirements is to allow shareholders to assess the independence of the Company"s Compensation Committee members in making executive compensation decisions and recommendations. While the Company has had transactions with companies and firms with which certain members of the Compensation Committee are, or at some point during fiscal year 1995 were, affiliated as an officer and/or director, there are no reportable relationships in which members of the Committee have a direct or indirect material interest. In addition, there are no interlocking relationships of the nature described above involving members of the Compensation Committee. Some companies and firms with which certain directors are or during fiscal year 1995 were affiliated as an officer and/or director had transactions in the ordinary course of business with the Company during fiscal year 1995 and similar transactions are expected to occur in the future. Except as discussed in next paragraph, none of these directors had a direct or indirect material interest in such transactions. The companies or firms involved in these transactions and the related directors are: Alliance Capital Management (John Winthrop) E"Town Corporation and Elizabethtown Water Company (John Kean and Robert W. Kean, Jr.), Fox Asset Management (R. Van Whisnand), Institute for Gas Technology (Bernard S. Lee), International Business Machines Corporation (James J. Forese), KCS Energy, Inc. (John Kean, Jr.) and Penn-Jersey Pipeline Company (Mr. Carver). In August 1987, Elizabethtown Gas Company entered into an Agreement of Lease with Liberty Hall Joint Venture for the occupancy of approximately 160,000 square feet of a 200,000 square foot office building in Union, New Jersey. On December 9, 1987, the predecessor to the New Jersey Board of Public Utilities authorized the acceptance of this agreement subject to certain conditions. The Joint Venture participants are Cali Liberty Hall Associates (a New Jersey general partnership) and a Kean family trust of which John Kean and Stewart B. Kean are trustees. All negotiations relative to the lease were conducted between Elizabethtown Gas Company and Cali Liberty Hall Associates. No person involved with the Kean family trust participated in such discussions. The annual base rent is approximately $2.5 million through 1994, $2.9 million from 1995 through 1999, $3.3 million from 2000 through 2004, and $3.7 million from 2005 through 2009. John Kean is the father of John Kean, Jr. and the cousin of retiring director Robert W. Kean, Jr. THE BOARD OF DIRECTORS RECOMMENDS THAT SHAREHOLDERS VOTE FOR THE ELECTION OF THE DIRECTOR NOMINEES LISTED ABOVE. The accounting firm of Arthur Andersen LLP, 1345 Avenue of the Americas, New York, N.Y. 10105 has been selected by the Board of Directors, upon recommendation of its Audit Committee, to serve as independent public accountants for the Company and its subsidiaries for the fiscal year ending September 30, 1996. This firm has served as auditors for the Company since 1969. It is expected that representatives of Arthur Andersen LLP will be present at the Annual Meeting. They will have the opportunity to make a statement and will be available to respond to appropriate questions. THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE APPOINTMENT OF ARTHUR ANDERSEN LLP AND RECOMMENDS THAT SHAREHOLDERS VOTE FOR THE RATIFICATION OF THIS APPOINTMENT. In the event of an insufficient number of votes to ratify this appointment, the Board of Directors will reconsider its decision. APPROVAL OF THE 1996 STOCK OPTION AND STOCK AWARD PLAN On November 28, 1995, the Board of Directors unanimously adopted, subject to shareholder approval at the Annual Meeting and such regulatory approvals as may be necessary, the NUI Corporation 1996 Stock Option and Stock Award Plan (the 1996 Stock Plan ). If approved by shareholders (subject to regulatory approval), the 1996 Stock Plan will provide for the granting of stock options, stock appreciation rights and other stock awards in order to facilitate the attraction, retention and motivation of key employees to participate in the long-term growth and financial success of the Company. Shares Reserved Under the 1996 Stock Plan The number of shares of Common Stock with respect to which grants and awards may be made under the 1996 Stock Plan is 250,000, subject to adjustment in the event of stock dividends, stock splits, combinations of shares, recapitalizations or other changes in the outstanding Common Stock. The shares issuable under the 1996 Stock Plan may be drawn from either authorized but previously unissued shares of Common Stock or from reacquired shares of Common Stock, including shares purchased by the Company on the open market or held as treasury shares. Material Features of the 1996 Stock Plan The following description of the material features of the 1996 Stock Plan is qualified in its entirety by reference to the full text of the Plan that is attached to this Proxy Statement as Exhibit A. The 1996 Stock Plan will be administered by a Committee designated by the Board of Directors (the Committee ) and composed of at least three members, each of whom shall be a disinterested person within the meaning of Rule 16b-3 of the Securities Exchange Act of 1934 and an outside director within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended from time to time (the Code ). Currently, the Compensation Committee serves as the Committee. The Committee shall have, among other powers, the power to interpret, waive, amend, and establish rules and regulations for the 1996 Stock Plan. The Committee shall have the sole and complete authority to grant to eligible participants one or more grants or awards, including incentive stock options, nonqualified stock options, stock appreciation rights, bonuses payable in stock and restricted stock, or any combination thereof. The Committee shall have the sole discretion to determine the amount of any such grants or awards, subject to the condition that no participant shall receive grants or awards with respect to more than 50,000 of the 250,000 shares reserved for issuance under the 1996 Stock Plan. The Committee shall also have the sole authority to establish such vesting periods and/or performance based goals that must be attained in order for the participant to be able to exercise any stock option or stock appreciation right or to obtain ownership of shares subject to the a restricted stock award. All stock options, stock appreciation rights and restricted stock awards shall be subject to agreements which shall be approved by the Committee. The Agreements shall set forth the terms and conditions of any such grants and awards and the conditions, if any, that must be satisfied by participants in order to obtain the benefits of the grants or awards. The Committee may, in its discretion, provide in the Agreements that in the event of a change in control of the Company, outstanding awards will vest, become immediately exercisable or payable or have all restrictions lifted. All grants and awards are non-transferable. The 1996 Stock Plan also provides for the payment of annual retainers to non-employee members of the Board of Directors for their service as members of the Board and for service as the Chair of a Board Committee in the form of deferred grants of Common Stock.. The Company"s 1988 Stock Plan provides for the payment of Board and Committee retainers in this same manner. The number of shares of stock to be allocated to a non-employee director"s account every year is determined by dividing the annual Board retainer (plus the annual Committee Chair retainer, if applicable) by the fair market value of the Common Stock on the date of the organization meeting of the Board. Currently, the annual Board retainer for non-employee directors is $12,000 and the annual Committee Chair retainer is $2,500. In addition to these shares, the accounts of non-employee directors are credited on each Common Stock dividend payment date with that number of additional shares that could have been purchased on the accrued shares in the account had the shares actually been issued to the director and the dividends on those shares been reinvested. The number of shares accrued to a director are issued upon the termination of the director"s service as a member of the Board. As described earlier in this Proxy Statement under Compensation of Directors , the Company has a Consulting Agreement with John Kean, Chairman of the Board. Under the Agreement, he receives no Board or Committee Chair retainers. Accordingly, although he is a non-employee director, he will not be a participant under the 1996 Stock Plan during the term of the Consulting Agreement. Under the 1996 Stock Plan, key salaried employees, including officers, of the Company, its divisions and subsidiaries are eligible to receive grants and awards under the 1996 Stock Plan. There are approximately thirty such officers. The determination of those employees who shall be eligible to receive grants and awards is determined by the Committee, in its sole discretion. Amendments Permitted to the 1996 Stock Plan Without Shareholder The Board of Directors may amend, alter or discontinue the 1996 Stock Plan at any time, provided that no amendment, alteration or discontinuation shall be made which would impair the rights of any holder of a grant or award without the participant"s written consent, or which, without shareholder approval, would (i) increase the maximum number of shares of Common Stock with respect to which grants and awards may be made (except for permitted adjustments applicable to changes in the outstanding Common Stock), (ii) decrease the exercise price for options below 100% of the fair market value of the Common Stock on the date of grant (except for permitted adjustments arising as a result of changes in the outstanding Common Stock), (iii) materially change the class of persons eligible to receive grant and awards, (iv) extend the duration of the 1996 Stock Plan, or (v) materially increase in any other way the benefits accruing to Discussion of Federal Income Tax Consequences Set forth below is a summary of the federal income tax consequences relating to grants and awards under the 1996 Stock Plan. The Plan has been designed to meet the requirements of Section 162(m) of the Code. No taxable income is recognized by the optionee upon the grant or exercise of an incentive stock option ( ISO ) that meets the requirements of Section 422 of the Code. However, the exercise of an ISO may result in alternative minimum tax liability for the optionee. If no disposition of shares issued to an optionee pursuant to the exercise of an ISO is made by the optionee within two years from the date of grant or within one year after the date of exercise, then upon sale of such shares, any amount realized in excess of the exercise price (the amount paid for the shares) will be taxed to the optionee as a long-term capital gain and any loss sustained will be a long-term capital loss, and no deduction will be allowed to the Company for federal income tax purposes. If shares of Common Stock acquired upon the exercise of an ISO are disposed of prior to the expiration of the two-year and one-year holding periods described above (a disqualifying disposition ), generally the optionee will recognize ordinary income in the year of disposition in an amount equal to the excess (if any) of the fair market value of the shares on the date of exercise (or, if less, the amount realized on the arm"s length sale of such shares) over the exercise price of the underlying options, and the Company will be entitled to deduct such amount. Any gain realized from the shares in excess of the amount taxed as ordinary income will be taxed as capital gain and will not be deductible by the Company. An ISO will not be eligible for the tax treatment described above if it is exercised more than three months following termination of employment, except in certain cases where the ISO is exercised after the death or permanent and total disability of the optionee. If an ISO is exercised at a time when it no longer qualifies for the tax treatment described above, the option is treated as an nonqualified stock option ( NQO ). No taxable income is recognized by the optionee at the time an NQO is granted under the 1996 Stock Plan. Generally, on the date of exercise of an NQO, ordinary income is recognized by the optionee in an amount equal to the difference between the exercise price and the fair market value of the shares on the date of exercise, and the Company receives a tax deduction for the same amount. Upon disposition of the shares acquired, an optionee generally recognizes the appreciation or depreciation on the shares after the date of exercise as either short-term or long-term capital gain or loss depending on how long the shares have been held. If the stock received upon exercise of an option or stock appreciation right is subject to a substantial risk of forfeiture, the income and the deduction, if any, associated with such award may be deferred in accordance with the rules described below for restricted stock. No income will be recognized by an optionee in connection with the grant of a stock appreciation right ( SAR ). When the SAR is exercised, the optionee will generally be required to include as taxable ordinary income in the year of such exercise an amount equal to the amount of cash received and the fair market value of any stock received. The Company will generally be entitled to a deduction equal to the amount includable as ordinary income by such optionee. A recipient of restricted stock generally will be subject to tax at ordinary income rates on the excess of the fair market value of the stock (measured at the time the stock is either transferable or is no longer subject to forfeiture) over the amount, if any, paid for such stock. However, a recipient who elects under Section 83(b) of the Code within 30 days of the date of issuance of the restricted stock to be taxed at the time of issuance of the restricted stock will recognize ordinary income on the date of issuance equal to the fair market value of the shares of restricted stock at the time (measured as if the shares were unrestricted and could be sold immediately), minus any amount paid for such stock. If the shares subject to such election are forfeited, the recipient will be entitled to a capital loss for tax purposes only for the amount paid for the forfeited shares, not the amount recognized as ordinary income as a result of the Section 83(b) election. The holding period to determine whether the recipient has long-term or short-term capital gain or loss upon sale of shares begins when the forfeiture period expires (or upon issuance of the shares, if the recipient elected immediate recognition of income under Section 83(b) of the Code). New Plan Benefits Under the 1996 Stock Plan On November 28, 1995 the Committee made grants of restricted Common Stock to selected key employees of the Company, including the officers listed in the Summary Compensation Table (with the exception of John Kean), which require that the Company achieve specific goals for earnings per share growth during each of the next four fiscal years in order for the recipients to receive all of the shares of Common Stock granted. Ownership of the shares will vest 50% after two years, 25% after the third year and 25% after the fourth year, subject to the condition that the performance objectives have been attained. In order for the recipients to receive all of the shares granted, the Company must achieve a 15% growth in earnings per share during each of the next four fiscal years. A reduced number of the granted shares will be earned if earnings per share growth equals 7% to 14.9%; and if during any year of the performance period a minimum of 7% earnings per share growth is not obtained, a certain portion of the granted shares will be forfeited. The Committee has the authority to make downward adjustments to these performance goals if it deems such adjustments appropriate. The following table sets forth the value and number of shares of restricted stock which have been granted by the Board of Directors, subject to shareholder and regulatory approval of the 1996 Stock Plan. All of these grants are subject to the terms described above and carry a risk of forfeiture in the event that the performance objectives are not met. Name and Position Dollar Value ($)(1) Number of and Former CEO -0- -0- President and CEO $243,750 15,000 Chief Technology Officer 49,237 3,030 as a Group 795,453 48,951 as a Group 262,632 16,162 (1) Dollar values are based upon a Common Stock market price of $16.25 per share, which was the closing price of the Common Stock on the date immediately prior to the date of grant. Approval of the 1996 Stock Plan requires the affirmative vote of the holders of a majority of the shares represented at the Meeting. In addition, the regulatory commissions in the six states in which the Company operates must also approve the 1996 Stock Plan, which approvals have been requested. Broker non-votes will not be treated as shares present or represented and entitled to vote at the Annual Meeting. The Board of Directors believes that the approval of the 1996 Stock Plan is in the best interests of the Company since it will facilitate the attraction, retention and motivation of key employees and is consistent with the Board"s compensation philosophy of aligning the interests of the Company"s employees with the interests of shareholders. In addition, the Plan will maintain the Company"s ability to fully deduct its performance-based compensation under Section 162(m) of the Code. THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE 1996 STOCK PLAN AND RECOMMENDS THAT YOU VOTE FOR APPROVAL OF THE 1996 STOCK PLAN. Proxies solicited by management will be voted FOR this proposal unless a vote against this proposal or abstention is specifically indicated. APPROVAL OF 1996 EMPLOYEE STOCK PURCHASE PLAN On January 23, 1996 the Board of Directors unanimously adopted, subject to shareholder approval at the Annual Meeting and such regulatory approvals as may be necessary, the NUI Corporation 1996 Employee Stock Purchase Plan (the Employee Plan ). The Employee Plan is designed to encourage employees to increase their ownership interest in the Company and to motivate them to exert their maximum efforts toward the success of the Company. The Employee Plan is one of several initiatives undertaken by the Board of Directors in order to align the interests of the Company"s employees with the interests of shareholders. If approved by shareholders (subject to regulatory approvals), the Employee Plan will provide for employees of the Company and its subsidiaries to purchase shares of the Company"s Common Stock on a monthly basis through payroll deductions, at a purchase price equal to the lesser of (i) 85% of the fair market value at the beginning of the month, or (ii) 85% of the fair market value at the end of the month. All employees who have been employed with the Company or one of its divisions or subsidiaries for at least six months will initially be eligible for participation in the Employee Plan. Accordingly, approximately 1,000 employees will initially be eligible. Shares Reserved Under the Employee Plan The number of shares of Common Stock which may be purchased under the Employee Plan is 140,000, subject to adjustment in the event of stock dividends, stock splits, combinations of shares, recapitalizations or other changes in the outstanding Common Stock. Shares will be isued during forty-four monthly purchase periods commencing in May, 1996. The shares issuable under the Employee Plan may be drawn from either authorized but previously unissued shares of Common Stock or from reacquired shares of Common Stock, including shares purchased by the Company on the open market or held as treasury shares. Material Features of the Employee Plan The following description of the material features of the Employee Plan is qualified in its entirety by reference to the full text of the Employee Plan that is included as Exhibit B to this Proxy Statement. The Employee Plan is administered by a Committee designated by the Board of Directors (the Committee ) and comprised of at least three directors, each of whom shall be a disinterested person within the meaning of Rule 16b-3 of the Securities Exchange Act of 1934 and an outside director within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended from time to time (the Code ). Currently, the Compensation Committee serves as this Committee. Employees eligible to participate in the Employee Plan consist of all employees of the Company or any subsidiary of the Company who have been employed for at least six months and who regularly work at least twenty hours per week ( Participants ). Participants shall be entitled to designate a percentage of their base salary ranging from one percent (1%) to a maximum of ten percent (10%) to be withheld from their pay in order to purchase shares of the Company"s Common Stock. There will be regular monthly offering periods beginning in May, 1996. In order to be eligible to participate in a monthly offering period, enrollment and payroll deduction forms must be filed by a specified date. Once enrolled, a Participant will continue to be enrolled in subsequent offering periods at the percentage of pay selected until the Participant either elects a different rate by filing appropriate forms or withdraws from the Employee Plan. As of the last business day of every month, the agent for the Employee Plan will credit to the account of the Participant the number of whole shares of Common Stock derived by dividing the total amount withheld from the Participant"s pay during the month by the lesser of (i) 85% of the fair market value of the Common Stock on the first business day of the month, and (ii) 85% of the fair market value of the Common Stock on the last business day of the month. For purposes of the Employee Plan, the fair market value of the Common Stock on a particular day shall be the mean between the highest and lowest prices at which the Common Stock is traded on a national securities exchange or, if there is no sale on such exchange on such date, the mean between the bid and asked prices on such exchange at the close of the market on such date, or if the market is closed on such date, the nearest prior trading day. Fractional shares will not be issued and any amounts remaining at the end of a monthly purchase period will be held for the purchase of Common Stock in the next monthly purchase period. Participants will receive periodic reports, no less frequently than quarterly, indicating the amount of the Participants" payroll deductions during the preceding period, the amount of those deductions applied to purchase shares of Common Stock of the Company, the purchase price in effect for each monthly purchase period, the number of shares purchased and the amount of deductions, if any, carried over to the next period. A Participant may withdraw payroll deductions credited to the Participant"s account under the Employee Plan if the amounts have not already been used to purchase Common Stock by giving at least ten days prior written notice. The cash balance will then be paid to the Participant and no further payroll deductions will be made from the Participant"s pay during such offering. Withdrawal from an offering will not affect a Participant"s eligibility to participate in subsequent offerings. Participants are required to hold shares acquired under the Employee Plan for at least six months. A violation of this requirement will result in a six month suspension of the Participant from eligibility to participate in the Employee Plan. Participants do not have the right to assign or transfer their rights to purchase Common Stock under the Employee Plan. No employee will be permitted to purchase Common Stock under the Employee Plan if such employee, immediately after the purchase, would own stock possessing 5% or more of the combined voting power or value of all classes of stock of the Company. In addition, no employee will be able to purchase Common Stock having a value in excess of $25,000 during any one calendar year. In the event that the outstanding shares of Common Stock of the Company have been increased, decreased, changed into or been exchanged for a different number or kind of shares of Company securities through reorganization, merger, recapitalization, reclassification, stock split, reverse stock split or similar transaction, the Committee may make appropriate adjustments to the number and/or kind of shares subject to a current offering and may also make appropriate adjustments to the number and/or kind of shares which may be offered under the Employee Plan. The Board of Directors has the authority to terminate or amend the Employee Plan at any time, provided that the Board may not, without the approval of the shareholders of the Company, increase the maximum number of shares which may be issued under the Employee Plan (except as set forth in the immediately preceding paragraph), amend the requirements as to the employees eligible to participate in the Employee Plan or permit members of the Committee to participate in the Employee Plan. The Employee Plan shall become effective upon the approval of shareholders and obtaining such regulatory approvals as may be necessary and it will terminate upon the earlier to occur of termination by the Board of Directors or the issuance of all shares subject to the Employee Plan. Tax Consequences of the Employee Plan The Employee Plan is intended to qualify as an employee stock purchase plan under Section 423 of the Internal Revenue Code of 1986, as amended from time to time (the "Code"). Under present law, a Participant will not be deemed to have received any compensation for Federal income tax purposes at either the start of the monthly purchase period or subsequent purchase of Common Stock at the end of the monthly period. Participants will recognize taxable income in the year in which there is a disposition of the Common Stock purchased under the Employee Plan. If the Common Stock is not disposed of until at least two years after the start date of the monthly purchase period in which the Common Stock was acquired (a qualifying disposition ), the Participant will realize ordinary income in the year of the qualifying disposition equal to the lesser of (i) the amount by which the fair market value of the Common Stock on the date of the qualifying disposition exceeds the purchase price, or (ii) 15% of the fair market value of the Common Stock on the start date of the monthly purchase period in which the Common Stock was acquired. The amount of ordinary income will be added to the basis in the stock and any additional gain recognized upon the qualifying disposition will be a long-term capital gain. If the fair market value on the date of the qualifying disposition is less than the purchase price paid for the stock, no ordinary income will be recognized and any loss recognized will be a long-term capital loss. If the Common Stock is disposed of at any time within two years of the start date of the monthly purchase period during which it was acquired (a disqualifying disposition), the Participant will recognize ordinary income in the year of the disqualifying disposition equal to the amount by which the fair market value of the Common Stock on the purchase date exceeded the purchase price. The amount of the ordinary income will be added to the basis in the stock, and any resulting gain or loss recognized upon the disposition will be a capital gain or loss. The capital gain or loss will be long-term if the stock has been held for more than one year. If the Participant disposes of the Common Stock acquired under the Employee Plan in a disqualifying disposition, the Company will be entitled to a deduction for Federal income tax purposes in an amount equal to the ordinary income recognized by the Participant. The Company is not entitled to any deduction when the stock is disposed of in a qualifying disposition. The deductibility of capital losses realized by Participants upon disposition may be limited by the Code. Although the Tax Reform Act of 1986 eliminated the special long-term capital gain deduction so that the entire gain on disposition of stock acquired under the Employee Plan will be taxed at ordinary income tax rates, 1990 amendments to the Code have made 28% the maximum tax rate applicable to net long-term capital gains. New Plan Benefits Under the Employee Plan Because participation in the Employee Plan will vary from employee to employee and levels of participation among Participants will also vary, it is not possible to determine the value of benefits which may be obtained by executive officers and other employees under the Employee Plan. Approval of the Employee Plan requires the affirmative vote of the holders of a majority of the shares represented at the Annual Meeting. In addition, the regulatory commissions of the six states in which the Company operates must also approve the Employee Plan, and such approvals have been requested. Broker non-votes will not be treated as shares present or represented and entitled to vote at the Annual Meeting. The Board of Directors believes that the approval of the Employee Plan is in the best interests of the Company since it will provide an incentive for the Company"s employees to increase their ownership in the Company and to enhance shareholder value through improved Company performance. THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE EMPLOYEE PLAN AND RECOMMENDS THAT YOU VOTE FOR APPROVAL OF THE EMPLOYEE PLAN. Proxies solicited by management will be voted FOR this proposal unless a vote against this proposal or abstention is specifically indicated. APPROVAL OF 1996 STOCK PURCHASE PLAN On January 23, 1995 the Company"s Board of Directors unanimously approved the NUI Corporation 1996 Stock Purchase Plan for Outside Directors (the "Director Plan"). The Director Plan is designed to encourage outside members of the Board of Directors to increase their ownership interest in the Company"s Common Stock. The Director Plan is one of several initiatives undertaken by the Board in order to further align the interests of the Company"s management and Board with the interests of shareholders. If approved by shareholders (subject to regulatory approvals), the Director Plan will provide to outside directors of the Company an option to purchase up to 1,500 shares of Common Stock per year at a purchase price equal to 85% of the fair market value of the Common Stock on the date of the exercise of the option. All non-employee directors of the Company will be eligible to participate in the Director Plan; the Company currently has eight non- employee directors, and following this Annual Meeting there will be seven non-employee directors. Shares Reserved Under the Director Plan The number of shares of Common Stock with respect to which options may be granted under the Director Plan is 70,000, subject to adjustment in the event of stock dividends, stock splits, combinations of shares, recapitalizations or other changes in the outstanding Common Stock. The shares issuable under the Director Plan may be drawn from either authorized but previously unissued shares of Common Stock or shares purchased by the Company on the open market or held as treasury shares. Material Features of the Director Plan The following description of the Director Plan is qualified in its entirety by reference to the text of the Director Plan, which is included as Exhibit C to this Proxy Statement. Under the Director Plan, as of the date of the first meeting of the Board of Directors of the Company immediately following the Annual Meeting of Shareholders each year (the Annual Grant Date ) each non- employee director of the Company (a Participant ) shall automatically be granted an option to purchase up to 1,500 shares of the Company"s Common Stock, which will be exercisable immediately. Each option shall have a term commencing on the Annual Grant Date and expiring on the next succeeding Annual Grant Date. Accordingly, at no time will a Participant have outstanding options to purchase more than 1,500 shares of Common Stock and all options must be exercised within a roughly one year period or they will expire. Each option may be exercised in whole or in part at any time. An option may be exercised by delivery of a written notification of exercise to the Secretary of the Company, accompanied by payment of the exercise price for the number of shares to be purchased. The date upon which the Secretary receives both an exercise notification and payment of the exercise price is the Exercise Date . Additionally, at any time up to and including an Annual Grant Date, a director may elect to have all Board and/or Committee attendance fees to be paid to the director during the next succeeding year to be utilized for the purpose of automatically exercising the director"s option for the number of shares which could be purchased on the date of the meeting(s) at which such fee(s) are payable. The date of the meetings at which Board and/or Committee attendance fees are earned by such a director is the Automatic Exercise Date . The exercise price at which shares of Common Stock subject to outstanding options may be purchased shall 85% of the fair market value of the Common Stock on the Exercise Date or Automatic Exercise Date, as applicable. For purposes of the Director Plan, the fair market value of the Common Stock on a particular day shall be the mean between the highest and lowest prices at which the Common Stock is traded on a national securities exchange or, if there is no sale on such exchange on such date, the mean between the bid and asked prices on such exchange at the close of the market on such date, or if the market is closed on such date, the nearest prior trading day. Fractional shares will not be issued and any amounts remaining following the exercise or partial exercise of the option shall be returned to the Participant, unless the purchase was as the result of an automatic exercise using Board and/or Committee attendance fees, in which event all amounts remaining following such an exercise shall be retained and be credited to the Participant"s account. All shares purchased upon the exercise or partial exercise of an option shall be issued to the Participant as promptly as practicable following the Exercise Date or Automatic Exercise Date, as applicable, or, if requested by the Participant, shall be credited to the Participant"s account in NUI Direct, the Company"s dividend reinvestment and stock purchase plan. Options which are not exercised by the next succeeding Annual Grant Date will be forfeited, and all shares which are subject to such forfeited options will be returned to the number of shares which are available for future option grants under the Director Plan. The Director Plan shall be administered by the Compensation Committee of the Board of Directors (the Committee), which is authorized to interpret and establish rules and procedures governing the Director Plan. In the event that the outstanding shares of Common Stock of the Company have been increased, decreased, changed into or been exchanged for a different number or kind of shares of Company securities through reorganization, merger, recapitalization, reclassification, stock split, reverse stock split or similar transaction, the Committee may make appropriate adjustments to the exercise price and the number and/or kind of shares subject to outstanding options and may also make appropriate adjustments to the number and/or kind of shares which may be offered under the Director Plan. Amendments Permitted to the Director Plan Without Shareholder Approval The Board of Directors may amend, alter or discontinue the Director Plan at any time, provided that no amendment, alteration or discontinuation shall be made which would impair the rights of any holder of an option without the Participant"s written consent, or which, without shareholder approval, would (i) increase the maximum number of shares of Common Stock with respect to which options may be awarded (except for permitted adjustments discussed in the immediately preceding paragraph), (ii) decrease the exercise price for options (except for permitted adjustments arising as a result of changes in the outstanding Common Stock), (iii) materially change the class of persons eligible to participate in the Director Plan, (iv) extend the duration of the Director Plan, or (v) materially increase in any other way the benefits accruing to Participants The Director Plan shall become effective upon the approval of shareholders and obtaining all required regulatory approvals and it shall terminate upon the earlier to occur of termination by the Board of Directors or the lack of shares available for option grants. Tax Consequences of the Director Plan The options granted to Participants under the Director Plan are nonqualified options ( NQO ) for Federal income tax purposes. No taxable income is recognized by the optionee at the time an NQO is granted under the Director Plan. Generally, on the date of exercise of an NQO, ordinary income is recognized by the optionee in an amount equal to the difference between the exercise price and the fair market value of the shares on the date of exercise, and the Company receives a tax deduction for the same amount. Upon disposition of the shares acquired, an optionee generally recognizes the appreciation or depreciation on the shares after the date of exercise as either short- term or long-term capital gain or loss depending on how long the shares have been held. New Plan Benefits Under the Director Plan The benefits which directors will obtain under the Director Plan in a given annual period will depend upon the number of shares purchased upon the exercise of options and the fair market value of the Common Stock on the date of exercise. Accordingly, it is not possible to determine the number of shares which may be purchased under the Director Plan on an annual basis. However, the following table sets forth the benefits which would have been realized by directors if the Director Plan had been in effect during 1995 and all eligible directors had fully exercised their options. Individuals Covered Dollar Value ($)(1) Number of (1) This figure represents the aggregate value of the discount on the purchase price for shares acquired upon the exercise of options. For purposes of this table, it is assumed that all non-employee directors on March 14, 1995 (the date of the first Board of Directors Meeting following the Annual Meeting of Shareholders) were granted an option to purchase 1,500 shares of Common Stock at 85% of the fair market value on the exercise date. It is further assumed that all options were exercised at an average purchase price of $14.13, which is 85% of the closing price of $16.625 for the Common Stock on September 29, 1995. Approval of the Director Plan requires the affirmative vote of the holders of a majority of the shares represented at the Annual Meeting. In addition, the regulatory commissions of the six states in which the Company operates must also approve the Director Plan, and such approvals have been requested. Broker non-votes will not be treated as shares present or represented and entitled to vote at the Annual Meeting. The Board believes that the Director Plan is in the best interests of the Company since it will provide an incentive for the Company"s directors to increase their ownership interest in the Company. THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE DIRECTOR PLAN AND RECOMMENDS THAT YOU VOTE FOR APPROVAL OF THE DIRECTOR PLAN. Proxies solicited by management will be voted FOR this proposal unless a vote against this proposal or abstention is specifically indicated. OWNERSHIP OF VOTING SECURITIES BY CERTAIN Security Ownership of Certain Beneficial Owners. The Company"s management is aware of two shareholders, John Kean and Stewart B. Kean, who own beneficially more than five percent of the Company"s Common Stock. Name and Address of Percent Beneficial Owner Number of Shares of Class John Kean 509,013 (1) 5.5% Stewart B. Kean 709,034 (2) 7.7% (1) Includes 135,389 shares over which Mr. John Kean has sole voting and investment power and 373,624 shares over which Mr. Kean has shared voting and investment power as a co-trustee under various trusts for the benefit of members of the Kean family. (2) Includes (a) 335,410 shares over which Mr. Stewart B. Kean has sole voting and investment power, and (b) 373,624 shares over which Mr. Kean has shared voting and investment power as a co-trustee under various trusts for the benefit of members of the Kean family. Security Ownership of Management. The following table shows, as of December 31, 1995, the number and percent of the shares of Common Stock beneficially owned by each director, each executive officer listed in the Summary Compensation Table and all directors and executive officers of the Company as a group: Title of Beneficial Number of Percent of Class Owner Shares (1)(2) Class Common Stock Calvin R. Carver 122,855(3) 1.3% Vera King Farris 1,497 * James J. Forese 3,342 * John Kean 509,013 (4) 5.5% John Kean, Jr. 56,025 (6) * Robert W. Kean, Jr. 121,387 (5) 1.3% Bernard S. Lee 4,362 * R. Van Whisnand 3,342 * Frank T. Bahniuk 5,405 * Lyle C. Motley, Jr. 1,032 * Richard J. O"Neill 2,867 * Robert P. Kenney 21,102 * David P. Vincent 27,009 * as a group 951,993 10.3% (1) Includes the following number of shares of Common Stock issuable to non-employee directors upon termination of Board service in payment for their annual Board retainers, as follows: Messers. Carver, Forese and Whisnand, 3,192 shares each; Messrs. Robert Kean and Winthrop, 2,908 shares each; Dr. Lee, 2,362 shares; Dr. Farris, 1,250 shares; and all directors as a group, 19,005 shares; and (b) shares of restricted stock, as follows: John Kean, Jr., 7,675 shares, Kenney, 8,925 shares, Vincent, 6,775 shares, and all directors and officers as a group, 50,005 shares. Also includes shares that are subject to currently exercisable stock options, as follows: John Kean, Jr., 5,000 shares; David P. Vincent, 4,800 shares; and all Directors and officers as a group, 9,800 shares. (2) Except as noted, each beneficial owner indicated has sole voting and investment power with respect to the shares indicated next to such person's name. (3) Includes 600 shares with respect to which Mr. Carver disclaims beneficial ownership. (4) Includes 135,389 shares over which Mr. Kean has sole voting and investment power and 373,624 shares over which Mr. Kean has shared voting and investment power as a co-trustee under various trusts for the benefit of members of the Kean family. (5) Includes 114,482 shares with respect to which Mr. Kean has shared voting and investment power. (6) Includes 17,263 shares with respect to which Mr. Kean shares voting and investment power. The following information is provided with respect to each executive officer of the Company. Officers are elected annually at the first meting of the Board of Directors following the Annual Meeting of Shareholders. There are no arrangements or understandings between any officer and any other person pursuant to which the officer was selected. John Kean, Jr., age 38 President and Chief Executive Officer Since April, 1995 Mr. Kean has served as President and Chief Executive Officer of the Company. From October, 1994 through March, 1995 he served as President and Chief Operating Officer. From March, 1993 to September, 1994 he served as Executive Vice President of Elizabethtown Gas Company. Prior thereto, he served as Chief Financial Officer of the Company. He held the additional position of Executive Vice President of the Company from January 1992 to September 1994. Frank T. Bahniuk, age 58 Mr. Bahniuk has served as Senior Vice President of the Company since August 1994. Prior thereto, he served as Senior Vice President of Elizabethtown Gas Company. Michael J. Behan, age 49 Vice President - External Affairs Mr. Behan has served as Vice President since March 1993, and prior thereto he served as Assistant Vice President. Mr. Behan is also President of Natural Gas Services, Inc., a subsidiary of the Company. Robert P. Kenney, age 61 Mr. Kenney has served as President and Chief Executive Officer of Elizabethtown Gas Company since 1991. He is also Chairman of the Board of Utility Billing Services, Inc., a subsidiary of the Company. Stephen M. Liaskos, age 44 Mr. Liaskos has served as Controller since September, 1995. From 1992 until September, 1995 he served as an independent financial and accounting consultant and prior thereto he served as Vice President and Controller of Metallgesellschaft Corp. Robert F. Lurie, age 38 Mr. Lurie has served as Treasurer since February 1994. Prior thereto he served as Director of the Office of Public Finance for the Treasury Department of the State of New Jersey. Lyle C. Motley, Jr., age 54 Mr. Motley has served as President of the Southern Division since April, 1995. From March, 1992 through March, 1995 he served as President, and prior thereto as Executive Vice President, of Pennsylvania and Southern Gas Company, which was acquired by the Company in April, 1994. Richard J. O"Neill, age 56 Human Resources and Administrative Officer Mr. O"Neill has served as Human Resources and Administrative Officer since October, 1995. From April, 1995 through September, 1995 he served as Senior Vice President, and prior thereto as Group Vice President, of Elizabethtown Gas Company. James R. Van Horn, age 39 Mr. Van Horn has served as General Counsel and Secretary since June, 1995. Prior thereto he served as Senior Vice President, General Counsel and Secretary of Citizens First Bancorp, Inc. and Citizens First National Bank of New Jersey. David P. Vincent, age 52 Mr. Vincent has served as Chief Technology Officer since October, 1995. From April through September, 1995 he served as a Senior Vice President of Elizabethtown Gas Company. From March, 1993 through March, 1995 he served as Executive Vice President and Chief Financial Officer of the Company and prior thereto he served as Executive Vice President of the Company. Compensation Committee Report on Executive Compensation The Compensation Committee of the Board of Directors (the "Committee") is comprised of four independent, non-employee directors. The Committee has the general responsibility of making recommendations to the Board concerning the Company"s executive compensation policies, practices and objectives. The Committee makes recommendations to the Board concerning base salary levels and cash bonus awards for the officers of the Company, its divisions and subsidiaries and it administers the Company"s 1988 Stock Plan, making grants and awards under the Plan to selected key employees in its discretion. In addition, the Committee is responsible for administering and making grants and awards under the 1996 Stock Option and Stock Award Plan (the 1996 Stock Plan ), which is being presented for shareholder approval at this Annual Meeting. In discharging its responsibilities, the Committee draws upon various resources, including but not limited to the varied business experiences and knowledge of Committee members and independent directors in the area of executive compensation and the advice of independent compensation experts. These resources allow the Committee to stay abreast of current trends and developments in executive compensation and provide valuable guidance to the Committee in making decisions and recommendations to the Board of Directors. The Committee strongly believes that the executive compensation program should be designed to align the interests of management closely with the interests of shareholders and to tie overall compensation levels to the performance of the Company and the achievement of long-term and short-term goals and objectives. The Committee also recognizes the importance of a strong executive compensation program to attracting and retaining qualified executives. Accordingly, the program is designed to: * Provide short-term incentives for personal and Company performance through the payment of cash bonuses; * Provide long-term incentives for enhancing shareholder value through equity-based compensation which is earned only upon the achievement of specific Company performance goals; and * Provide the Company with the ability to attract, motivate and retain key executives who are critical to the success of the Company through the payment of competitive base salaries, the opportunity to earn incentive compensation and through the provision of a competitive benefits package. The components of the Company's executive compensation program are base salary, annual cash bonuses, long-term incentive compensation and various benefits. Long-term compensation is comprised of grants and awards under the Company's 1988 Stock Plan (and, subject to shareholder approval, the 1996 Stock Plan), pursuant to which the Committee may make stock awards and grants of restricted stock, stock options and stock appreciation rights. The benefits provided to executives include medical, retirement and savings plans which are available to employees generally and supplementary medical and retirement plans that are not available to employees generally. Consistent with the Committee"s overall objective of aligning the interests of management with the interests of shareholders and providing an incentive for the enhancement of shareholder value, the Committee recommended, and the Board of Directors approved, the 1996 Stock Plan. The 1996 Stock Plan is subject to the approval of shareholders at this Annual Meeting and such regulatory approvals as may be necessary (See Proposal Number 3 in this Proxy Statement). Under the 1996 Stock Plan, the Committee has the discretion to establish specific performance criteria which must be satisfied in order for grants and awards to be earned. On November 28, 1995 the Committee made grants of restricted Common Stock to officers of the Company, including the officers listed in the Summary Compensation Table (with the exception of John Kean), which require that the Company achieve specific goals for earnings per share growth during each of the next four fiscal years in order for the recipients to receive all of the shares of Common Stock granted. Ownership of the shares will vest 50% after two years, 25% after the third year and 25% after the fourth year, subject to the condition that the performance objectives have been attained. In order for the recipients to receive all of the shares granted, the Company must achieve a 15% growth in earnings per share during each of the next four fiscal years. A reduced number of the granted shares will be earned earnings per share growth is 7% to 14.9%; and if during any year of the performance period a minimum of 7% earnings per share growth is not obtained, a certain portion of the granted shares will be forfeited. The Committee has the authority to make downward adjustments to these performance goals if it deems such adjustments appropriate. In establishing recommendations to be made to the Board of Directors for increases in base salary and for cash bonuses for the Company"s executives, including the Chief Executive Officer, for fiscal year 1995, the Committee considered a number of factors, including various measures of the Company"s financial performance, relative both to historical Company performance and the performance of other natural gas distribution companies. The Committee also considered management"s achievement of a number of goals during the year. These factors were considered collectively, with no specific weight given to each factor. The general conclusion of the Committee after this evaluation was that on an overall basis salary increases should be in line with the average level of executive raises nationwide and cash bonus payments should be significantly reduced from the levels granted in prior years. The compensation paid to John Kean, Jr., President and Chief Executive Officer of the Company, with respect to fiscal year 1995 is set forth in the Summary Compensation Table. Mr. Kean"s salary increased by approximately 24% in 1995 from the salary he received in 1994. This increase is the result of the significant increase in responsibility assumed by Mr. Kean during fiscal year 1995. In October, 1994 he became President and Chief Operating Officer of the Company and in April, 1995 he assumed the position of Chief Executive Officer of the Company. Mr. Kean"s base salary remains below the average base salary of Chief Executive Officers at companies in the natural gas distribution industry with revenues comparable to the Company"s revenue level. For the second consecutive year Mr. Kean was not awarded a cash bonus. The Committee believes that this action was appropriate in light of the financial performance of the Company and is not a reflection on the individual performance of Mr. Kean. In order to provide a long-term incentive to Mr. Kean to continue to improve upon the financial performance of the Company and enhance shareholder value, the Committee awarded him 15,000 shares of restricted Common Stock. The restricted stock was granted pursuant to the 1996 Stock Plan, discussed above, which is being presented for shareholder approval at this Annual Meeting. The vesting and Company performance criteria which must be satisfied for Mr. Kean to obtain ownership of these shares is set forth above. This restricted stock award is consistent with the Committee"s objective of aligning the interests of management with the interests of shareholders. The Committee believes that the Company"s executive compensation program is well structured to provide maximum incentive to executives to continually improve upon the financial performance of the Company; to attract, retain and motivate key officers; and to enhance shareholder wealth. Members of the Compensation Committee The graph below reflects the performance of the Company"s Common Stock during the past five fiscal years and compares that performance with the performance of a borad market index, the S&P 500 and the performance of an industry index during that same period of time. The industry index is an index of natural gas distribution companies prepared by Edward D. Jones and Co. The chart below tracks the performance of an investment of $100 on October 1, 1990 and assumes the reinvestment of dividends. Measurement Period Gas S&P 500 (Fiscal Year Covered) NUI Corp. Utilities Index Measurement Pt. 9/30/90 100.0 100.0 100.0 FYE 9/30/91 130.1 118.8 131.0 FYE 9/30/92 203.3 145.2 145.4 FYE 9/30/93 166.4 181.5 164.2 FYE 9/30/94 179.3 162.0 170.2 FYE 9/30/95 173.4 164.2 220.6 Annual Compensation, Long-Term Compensation and All Other Compensation The following table summarizes the compensation paid to the two individuals who served as the Company"s Chief Executive Officer during fiscal year 1995, the four other most highly compensated officers and one officer who served as an executive officer during the year but was not an executive officer at the conclusion of the year. Name and Year Salary Bonus Restrict All Principal ($) ($) ed Stock Other John Kean 1995 $137,550 -0- --- -0- Chairman of the 1994 272,450 -0- --- $27,985 $67,729 Board; Chief 1993 261,325 115,700 --- 110,025 12,906 John Kean, Jr. 1995 $221,200 -0- --- $243,750 $ 6,389 President and 1994 177,800 -0- --- $100,050 6,842 Executive 1993 167,600 58,000 --- $ 72,450 7,019 Robert P. Kenney 1995 $208,025 $20,980 --- $108,257 $ 9,342 President - 1994 200,275 -0- --- $ 82,800 7,283 Division 1993 188,500 65,100 --- 77,775 7,685 Frank T. Bahniuk 1995 $147,675 $12,000 --- $61,912 $10,609 Senior Vice 1994 139,150 23,600 --- 5,655 10,097 Gas Supply 1993 132,875 32,200 --- 9,765 Richard J. 1995 $124,025 $12,000 --- $52,032 $ 8,576 Human Resources 1994 $119,475 20,400 --- -0- 8,481 Administrative 1993 114,125 28,140 --- -0- 6,176 Lyle C. Motley, 1995 117,644 15,000 --- $78,146 $ 6,643 Jr. President- 1994 37,008 -0- --- 2,828 2,338 David P. Vincent 1995 $165,400 -0- --- $49,237 $ 8,445 Chief Technology 1994 163,700 -0- --- 59,513 6,427 Chief Financial 1993 156,700 $51,400 --- 57,188 5,562 (1) If no figure appears in the Other Annual Compensation column, the dollar value of perquisites paid to each of the named executive officers does not exceed the lesser of $50,000 or 10% of the total of annual salary and bonus for the named executive officer. (2) John Kean retired from the Company effective April 1, 1995 and compensation information for Mr. Kean relates to the period from October 1, 1994 through March 31, 1995. Mr. Motley joined the Company on April 19, 1994 and compensation information for Mr. Motley in 1994 relates to the period of April 19 - September 30, 1994. Although Mr. Vincent did not serve as an executive officer of the Company at the end of fiscal year 1995, compensation information appears in this table because he served as an executive officer (Chief Financial Officer ) during the fiscal year and because of his level of compensation. (3) The restricted stock awards for 1995 are subject to shareholder and regulatory approval of the NUI Corporation 1996 Stock Option and Stock Award Plan. The number of shares of restricted stock granted to the named executive officers is as follows: John Kean - 0;, John Kean, Jr. - 15, 000; Robert P. Kenney - 6,662; Frank T. Bahniuk - 3810; Richard J. O"Neill - 3202; Lyle C. Motley, Jr. - 4,809; and David P. Vincent - 3030. These shares will vest over a four year period as follows: 50% after two years, 25% after three years and 25% after four years. In order for recipients to receive the granted shares, specific performance goals must be achieved by the Company. Set forth below is information on current outstanding restricted stock (not including the 1995 grants) for the named executive officers. Prior to full vesting, the recipients receive dividends on these shares and have voting rights with respect to these shares. Name Date of Number of Value on Shares Date John 1/23/92 7,000 $11,637 700 1/23/96 11/23/92 1,400 $23,275 700 11/23/95 11/22/93 2,800 $46,550 1,400 11/22/95 11/22/94 6,900 $114,712 3,450 11/22/96 Robert P. 1/23/92 850 $14,131 700 1/23/96 11/23/92 1,700 $28,262 850 11/23/95 11/22/93 3,200 53,200 1,600 11/23/95 11/22/94 4,540 75,477 2,270 11/22/96 Frank T. 11/22/94 390 $6,484 195 11/22/96 J. Lyle C. 11/22/94 195 $3,242 98 11/22/96 David P. 1/23/92 650 $10,806 650 1/23/96 Vincent 11/23/92 1,250 $20,781 625 11/23/95 11/22/93 2,300 $38,237 1,150 11/22/95 11/22/94 580 9,642 290 11/22/96 (4) Includes the following amounts representing the employer match under qualified savings plans during fiscal year 1995: John Kean - $2,850; John Kean, Jr. - $4,725; Frank T. Bahniuk - $4,589, Robert P. Kenney - $4,725; Richard J. O"Neill - $3,902; Lyle C. Motley, Jr. - $5,882; and David P. Vincent - $4,725. Also includes the following amounts representing the value of group life insurance premiums paid during fiscal year 1995; John Kean - $1,404; John Kean, Jr. - $264; Robert P. Kenney - $2,808; Frank T. Bahniuk - $1,800; Richard J. O"Neill - $1,800; Lyle C. Motley, Jr. - $761; and David P. Vincent - $1,152. Includes the following amounts paid to the named executive officers during fiscal year 1995 with respect to Company"s medical expense reimbursement plan, which provides officers with supplemental medical coverage: John Kean - $599; John Kean, Jr. - $1,400; Robert P. Kenney - $1,809; Frank T. Bahniuk - $4,200; Richard J. O"Neill - $2,874; and David P. Vincent - $2,568. For John Kean, this figure also includes $450 in directors fees received from Elizabethtown Gas Company and $62,426 paid to Mr. Kean for unused vacation upon his retirement from the Company. Options and Stock Appreciation Rights No options or Stock Appreciation Rights (SARs) were granted during fiscal year 1995 to any of the executive officers listed in the Summary Compensation Table and no outstanding options or SARs were repriced in the most recent fiscal year. Aggregated Option/SAR Exercises in 1995 Fiscal Year Option and SAR Values as of September 30, 1995 Name Shares Value Number of Securities Value of Acquired Realized Underlying Unexercised Unexercised on ($) Options/SARs at FY-End In-the- John -- -- 5,000/-- --- Kean, Jr. David -- -- 4,800/-- $4,104 (1) The market value of the Common Stock as of September 30, 1995 was $16.625. Mr. Kean has an option to purchase 5,000 shares at a per share exercise price of $17.625, so these options are not in-the- money. Mr. Vincent has an option to purchase 4,800 shares at a per share exercise price of $15.77. No long-term incentive plan awards were granted or paid out in fiscal year 1995 to any of the executive officers listed in the Summary Compensation Table. The executive officers of the Company, other than participants in theCIty Gas Company of Florida and the Pennsylvania and Southern Gas Company Plans, earn retirement benefits that may be payable under three separate plans: (1) the Company"s Retirement Plan, a funded plan in which more than 70% of the Company's employees are eligible to participate; (2) the ERISA Excess Benefits Plan, an unfunded plan that is designed to provide benefits for those participants in the Retirement Plan for whom benefits are reduced by reason of the limita- tions imposed under Section 415 of the Internal Revenue Code of 1986, as amended from time to time (the "Code"); and (3) the Supplemental Retirement Benefits Plan, an unfunded plan that provides additional benefits to certain key executive employees, including those listed in the Summary Compensation Table. While participants in the Retirement Plan and the ERISA Excess Benefits Plan become vested in their entitlement to benefits under vesting requirements established under the Employee Retirement Income Security Act of 1974, participants in the Supplemental Retirement Benefits Plan are eligible to receive benefits from the plan only if they reach retirement age while working for the Company. The Retirement Plan, which is funded entirely by the Company, provides that a participant retiring at or after age 65 will receive an annual retirement benefit equal in amount (when calculated as a life annuity with two years certain) to 1-1/2% of the participant's final average compensation (the average of the highest sixty consecutive months base salary) multiplied by the number of years of credited service. Benefits payable to participants in the Retirement Plan may be reduced by reason of the limitations imposed under Section 415 of the Code. The ERISA Excess Benefits Plan will pay the difference between the amount payable to the participant under the Retirement Plan and the amount the participant would have been paid but for the limitations pursuant to Section 415 of the Code. Benefits under this plan are subject to the same terms and conditions as the benefits payable to the participant under the NUI Retirement Plan. The unfunded Supplemental Retirement Benefits Plan provides that each eligible employee who reaches retirement age while working for the Companymay receive an annual retirement benefit equal in amount (when calculated as a life annuity with two years certain) to 2% of the participant's final average total compensation (the average of the highest sixty consecutive months" earnings, including cash bonuses earned) multiplied by the number of years of credited service up to a maximum of 60%. Benefits otherwise payable under the unfunded Supplemental Retirement Benefits Plan are reduced by amounts payable under the Retirement Plan and the ERISA Excess Benefits Plan. The following table shows the maximum aggregate annual retirement benefits payable from all three plans at normal retirement age for various levels of final average compensation and years of service, assuming payment of benefits in the form of a life annuity with a two year certain. Renumeration 10 Years 20 Years 30 Years 40 Years $50,000 $10,000 $20,000 $30,000 $30,000 100,000 20,000 40,000 60,000 60,000 150,000 30,000 60,000 90,000 90,000 200,000 40,000 80,000 120,000 120,000 250,000 50,000 100,000 150,000 150,000 300,000 60,000 120,000 180,000 180,000 350,000 70,000 140,000 210,000 210,000 400,000 80,000 160,000 240,000 240,000 450,000 90,000 180,000 270,000 270,000 Average annual compensation utilized for formula purposes includes salary and bonus as reported on the "Summary Compensation Table." The benefit amounts shown in the preceding table are not subject to any deduction for Social Security benefits or other offset amounts. The number of years of service now credited under the NUI Retirement Plan for the participants listed in the "Summary Compensation Table" is as follows: John Kean, Jr., 10 years; Robert P. Kenney, 26 years; Frank T. Bahniuk, 6 years; Richard J. O"Neill, 25 years; and David P. Vincent, 9 years. John Kean retired effective April 1, 1995 with 39 years of credited service under the plan; his average annual compensation for purposes of the plan is $_______. City Gas Company Pension Plan. The non-bargaining-unit employees of City Gas Company of Florida ( CGF ) are eligible to participate in the CGF Plan which, generally, is the plan that was in effect when the CGF was acquired in 1988. TheCGF Plans, including the CGF Pension Plan and Trust which is funded entirely by the Company, provide that a participant retiring at or after age 65 will receive an annual retirement benefit equal in amount (when calculated as a life annuity with two years certain) to 1-1/4% of the participant's final average compensation (the average of the highest sixty consecutive months payroll compensation in the last ten years of the participant's service are subject to report on Internal Revenue Service Form W-2) multiplied by the number of years of credited service. Benefits payable to participants in the CGF Plan may be reduced by reason of the limitations imposed under Section 415 of the Code, which as of the date of this Proxy Statement limit the participant's eligible final average compensation to $150,000. The following table shows the maximum aggregate annual retirement benefit payable at normal retirement age for various levels of final average compensation and years of service, assuming the election of retirement allowance payable as a life annuity with two years certain: 10 Years 20 Years 30 Years 40 Years $50,000 $6,250 $12,500 $18,750 $25,000 100,000 12,500 25,000 37,500 50,000 150,000 18,750 37,500 56,250 75,000 200,000 18,750 37,500 56,250 75,000 Average annual compensation utilized for formula purposes includes salary, bonus, the value of restricted stock grants and payments for unused vacation as reduced by reason of the limitations imposed under Section 415 of the Code. The benefit amounts shown in the preceding table are not subject to deduction for Social Security benefits or other offset amounts. Lyle C. Motley, Jr. became a participant in the CGF Plan effective January 1, 1996. Prior thereto, he had been a participant in the Pennsylvania and Southern Gas Company ( P&S ) Retirement Plan, discussed below. Pennsylvania & Southern Pension Plan - The Company also maintains the Pennsylvania & Southern Gas Company Retirement Plan (the P&S Plan). The P & S Plan, which is funded entirely by the Company, provides that a participant retiring at or after age 65 will receive an annual retirement benefit equal in amount to 1% of final average compensation subject to Social Security taxes, plus 1.55% of the participant"s final average compensation which is in excess of this level, multiplied by years of credited service, up to a maximum of thirty-five years. The following table shows the maximum aggregate annual retirement benefit payable at normal retirement age for various levels of final average compensation and years of service: Remuneration Years Years Years Years $50,000 $6,250 $12,500 $18,750 $25,000 100,000 12,500 25,000 37,500 50,000 150,000 18,750 37,500 56,250 75,000 200,000 18,750 37,500 56,250 75,000 Final annual compensation utilized for formula purposes includes salary and bonus payments and as reduced by reason of the limitations imposed under Section 415 of the Internal Revenue Code, which as of the date of this Proxy Statement limit the participant's annual average compensation for formula purposes to $150,000. Lyle C. Motley, Jr. has 14 years of credited service under the P&S Plan; his average compensation for purposes of the Plan is $______. Certain key employees of the Company, including the executives listed in the Summary Compensation Table (with the exception of John Kean) have entered into Change in Control Agreements with the Company which provide for the employees to receive certain payments and benefits in the event of a change in control of the Company (as defined in the Agreements) and subsequent termination of employment. A covered employee becomes entitled to the payments and benefits provided for in the Agreement if, within thirty-six months after the change in control, the Company (or its successor) terminates the employee other than for cause or as a result of the employee"s death or disability or the employee terminates his or her employment for Good Reason (as defined in the Agreement). The payments to which the covered employee will be entitled in such a termination event include a payment equal to either (i) three times the employee"s annual base salary plus three times the highest incentive compensation award received by the employee during the preceding thirty-six months, or (ii) two times the employee"s annual base salary plus two times the highest incentive award received by the employee during the preceding twenty-four months. The level at which an employee is covered differs among the covered officers, but all executives listed in the Summary Compensation Table, with the exception of John Kean, have Agreements providing for payments at the three times level described in (i) above. In addition, the Agreements provide that following termination of employment the officer will continue to participate in all employee benefit plans in which the officer was eligible to participate on the date of termination; all incentive awards not yet paid would be payable; the spread between the exercise price and the higher of the highest bid price during the twelve months preceding termination or the highest price per share paid in connection with any change in control would be payable in cash in lieu of stock issuable upon the exercise of stock options. All Change in Control Agreements, with the exception of the Agreement with John Kean, Jr., provide that in the event that any payment or benefit received under the Agreement would be an excess parachute payment (within the meaning of Section 280G(b)(1) of the Internal Revenue Code of 1986, as amended from time to time), then the present value of all payments to be received under the Agreement shall be reduced to an amount which maximizes payments but does not result in the payment of an excess parachute payment. The Agreement with John Kean, Jr. provides that if any payments are subject to the excise tax imposed by Section 4999 of the Internal Revenue Code as a result of an excess parachute payment, then the Company (or its successor) shall gross-up the payments to be made to him so that the net amount shall be equal to the payments prior to the payment of any excise tax and any income taxes on the gross-up payment. John Kean is employed as a consultant pursuant to an agreement which provides for him to receive certain payments and benefits in the event that the agreement is terminated following a change in control of the Company. The details of this agreement are discussed under Compensation of Directors in this Proxy Statement. Except as set forth above, the Company is not party to any other employment, change in control or termination agreements. The Board of Directors does not intend to present any other business at the Annual Meeting, and is not aware of any business to be presented by others. However, if other matters are properly presented for a vote, the proxies will be voted upon such matters in accordance with the judgment of the persons acting under the proxy. The Annual Report of the Company for the fiscal year ended September 30, 1995 has previously been mailed to shareholders, who are referred to such report for financial and other information about the Company. The Company will furnish without charge a copy of its most recent Annual Report on Form 10-K as filed with the Securities and Exchange Commission to any beneficial owner of the Company"s shares upon receipt of a written request from such person. Please direct all such requests to James R. Van Horn, General Counsel and Secretary, 550 Route 202-206, P.O. Box 760, Bedminster, New Jersey 07921-0760. Shareholders are entitled to submit proposals for consideration at the Company"s 1997 Annual Meeting. Shareholders who desire to submit a proposal to be considered for inclusion in the Proxy Statement relating to that meeting must satisfy certain informational and stock ownership requirements established by the Securities and Exchange Commission and submit such proposal to the Secretary of the Company at 550 Route 202-206, P.O. Box 760, Bedminster, New Jersey 07921-0760 no later than September 30, 1996. By Order of the Board of Directors 1996 STOCK OPTION AND STOCK AWARD PLAN Purpose. The purpose of the NUI Corporation 1996 Stock Option and Stock Award Plan (the "Plan") is to maintain the ability of NUI Corporation (the "Company") and its subsidiaries to attract and retain highly qualified and experienced employees and directors and to give such employees and directors a continued proprietary interest in the success of the Company and its subsidiaries. Pursuant to the Plan, eligible employees will be provided the opportunity to participate in the enhancement of shareholder value through the grants of options, stock appreciation rights, awards of restricted stock, bonuses payable in stock, or any combination thereof. Eligible directors will participate through awards of restricted stock as set forth in Section 8. Employees and directors who participate or become eligible to participate in the Plan from time to time are referred to collectively herein as "Participants." The term "subsidiary" as used in the Plan shall mean any present or future corporation which is or would be a "subsidiary corporation" of the Company as the term is defined in Section 424(f) of the Internal Revenue Code of 1986, as amended from time to time (the "Code"). Administration of the Plan. The Plan shall be administered by a committee (the "Committee") which is appointed from time to time by the Board of Directors of the Company (the "Board"). The Committee shall consist of three (3) or more members of the Board, each of whom shall be a "disinterested person" within the meaning of Rule 16b-3 of the Securities Exchange Act of 1934 (the "Exchange Act") and an "outside director" within the meaning of Section 162(m) of the Code. A majority of the members of the Committee shall constitute a quorum. The majority vote of the members of the Committee present at a meeting at which a quorum is present shall be required for the Committee to take action under the Plan. In administering the Plan, the Committee may adopt rules and regulations for carrying out the Plan. The interpretation and decision made by the Committee with regard to any question arising under the Plan shall be final and conclusive on Participants. The Committee shall determine the Participants to whom, and the time or times at which, grants or awards shall be made and the number of shares, stock appreciation rights or other grants or awards to be made under the Plan, and the terms and conditions of such options, grants and awards, including the periods for which options will be outstanding. Each grant or award made pursuant to the Plan shall be evidenced by an Option Agreement or Award Agreement (the "Agreement"). No person shall have any rights under any option, restricted stock or other award granted under the Plan unless and until the person to whom such option, restricted stock or other award shall be granted shall have executed and delivered an Agreement to the Company. The Committee shall prescribe the form of all Agreements. A fully executed counterpart of the Agreement shall be provided to both the Company and the recipient of the grant or award. Shares of Stock Subject to the Plan. The maximum number of shares of the voting common stock of the Company, no par value (the "Common Stock"), that may be optioned or awarded under the Plan is 250,000 shares, subject to adjustment as provided in Section 14 hereof. No Participant shall receive, over the term of the Plan, awards of restricted stock, awards in the form of stock appreciation rights or options, whether incentive stock options or options other than incentive stock options, to purchase more than an aggregate of 50,000 shares of Common Stock. Any shares subject to an option which for any reason expires or is terminated unexercised and any restricted stock which is forfeited may again be optioned or awarded under the Plan; provided, however, that forfeited shares shall not be available for further awards if the Participant has realized any benefits of ownership from such shares. Shares subject to the Plan may be either authorized and unissued shares or issued shares repurchased or otherwise acquired by the Company or its subsidiaries. Eligibility. Key salaried employees, including officers, of the Company and its divisions and subsidiaries are eligible to be granted options, restricted stock and other awards under the Plan and to have their bonuses payable in restricted stock. The employees who shall receive awards or options under the Plan, and the criteria to be used in determining the award to be made, shall be determined from time to time by the Committee, in its sole discretion, from among those eligible, which may be based upon information furnished to the Committee by the Company's management, and the Committee shall determine, in its sole discretion, the number of shares to be covered by each award and option granted to each employee selected. Certain non-employee directors of the Company are also eligible to participate in the Plan in accordance with Section 8. Duration of the Plan. No award or option may be granted under the Plan after more than ten years from the earlier of the date the Plan is adopted by the Board or the date the Plan is approved by the shareholders of the Company, but awards or options theretofore granted may have exercise or vesting periods which extend beyond that date. Terms and Conditions of Stock Options. Options granted under the Plan may be either incentive stock options, as defined in Section 422 of the Code, or options other than incentive stock options. Each option shall be subject to all the applicable provisions of the Plan, including the following terms and conditions, and to such other terms and conditions not inconsistent therewith as the Committee shall determine: (a) The option price per share shall be determined by the Committee. However, the option price per share shall not be less than 100% of the fair market value of a share of Common Stock at the time the option is granted. For purposes of the Plan, fair market value shall be the mean between the highest and lowest prices at which the Common Stock is traded on a national securities exchange on the relevant date; provided, however, if there is no sale of the Common Stock on such exchange on such date, fair market value shall be the mean between the bid and asked prices on such exchange at the close of the market on such date. (b) Each option shall be exercisable pursuant to the attainment of such performance goals, and/or during such period ending not later than ten years from the date it was granted, as may be determined by the Committee and stated in the Agreement. In no event may an option be exercised more than 10 years from the date the option was granted. (c) An option shall not be exercisable with respect to a fractional share of Common Stock or with respect to the lesser of fifty (50) shares or the full number of shares then subject to the option. No fractional shares of Common Stock shall be issued upon the exercise of an option. If a fractional share of Common Stock shall become subject to an option by reason of a stock dividend or otherwise, the optionee shall not be entitled to exercise the option with respect to such fractional share. (d) Each option shall state whether it will or will not be treated as an incentive stock option. (e) Each option will be deemed exercised on the day written notice specifying the number of shares to be purchased, accompanied by payment in full including, if required by law, applicable taxes, is received by the Company. Payment, except as provided in the Agreement (i) in United States dollars by check or bank draft, or (ii) by tendering to the Company shares of Common Stock already owned for at least six months by the person exercising the option, which may include shares received as the result of a prior exercise of an option, and having a fair market value, as determined in accordance with Section 6(a), on the date on which the option is exercised equal to the cash exercise price applicable to such option, (iii) by a combination of United States dollars and shares of Common Stock valued as aforesaid. No optionee shall have any rights to dividends or other rights of a shareholder with respect to shares of Common Stock subject to his or her option until he or she has given written notice of exercise of such option and paid in full for such shares. (f) Notwithstanding the foregoing, the Committee may, in its sole discretion, include in the grant of an option the right of a grantee (hereinafter referred to as a "stock appreciation right") to elect, in the manner described below, in lieu of exercising his or her option for all or a portion of the shares of Common Stock covered by such option, to relinquish his or her option with respect to any or all of such shares and to receive from the Company a payment equal in value to (x) the fair market value, as determined in accordance with Section 6(a), of a share of Common Stock on the date of such election, multiplied by the number of shares as to which the grantee shall have made such election, less (y) the exercise price for that number of shares of Common Stock for which the grantee shall have made such election under the terms of such option. A stock appreciation right shall be exercisable at the time the tandem option is exercisable, and the "expiration date" for the stock appreciation right shall be the expiration date for the tandem option. A grantee who makes such an election shall receive payment in the sole discretion of the Committee (i) in cash equal to such excess; or (ii) in the nearest whole number of shares of Common Stock having an aggregate fair market value, as determined in accordance with Section 6(a) as of the date of election, which is not greater than the cash amount calculated in (ii) above; or (iii) a combination of (i) and (ii) above. A stock appreciation right may be exercised only when the amount described in (x) above exceeds the amount described in (y) above. An election to exercise stock appreciation rights shall be deemed to have been made on the day written notice of such election, addressed to the Committee, is received by the Company. An option or any portion thereof with respect to which a grantee has elected to exercise a stock appreciation right shall be surrendered to the Company and such option shall thereafter remain exercisable according to its terms only with respect to the number of shares as to which it would otherwise be exercisable, less the number of shares with respect to which stock appreciation rights have been exercised. The grant of a stock appreciation right shall be evidenced by an Agreement. The Agreement evidencing stock appreciation rights shall be personal and will provide that the stock appreciation rights will not be transferable by the grantee otherwise than by will or the laws of descent and distribution and that they will be exercisable, during the lifetime of the grantee, only by him or her. (g) Except as provided in the applicable Agreement, an option may be exercised only if at all times during the period beginning with the date of the granting of the option and ending on the date of such exercise, the grantee was an employee of either the Company (or of a division) or subsidiary of the Company or of another corporation referred to in Section 421(a)(2) of the Code. The Agreement shall provide whether, and to what extent, an option may be exercised after termination of continuous employment, but any such exercise shall in no event be later than the termination date of the option. If the grantee should die, or become permanently disabled as determined by the Committee at any time when the option, or any portion thereof, shall be exercisable, the option will be exercisable within a period provided for in the Agreement, by the optionee or person or persons to whom his or her rights under the option shall have passed by will or by the laws of descent and distribution, but in no event at a date later than the termination of the option. The Committee may require medical evidence of permanent disability, including medical examinations by physicians selected by it. (h) Each option by its terms shall be personal and shall not be transferable by the optionee otherwise than by will or by the laws of descent and distribution as provided in Section 6(g) above. During the lifetime of an optionee, the option shall be exercisable only by the optionee. In the event any option is exercised by the executors, administrators, heirs or distributees of the estate of a deceased optionee as provided in Section 6(g) above, the Company shall be under no obligation to issue Common Stock thereunder unless and until the Company is satisfied that the person or persons exercising the option are the duly appointed legal representative of the deceased optionee's estate or the proper legatees or distributees thereof. (i) Notwithstanding any intent to grant incentive stock options, an option will not be considered an incentive stock option to the extent that such option, together with any previously granted incentive stock options, permits the exercise for the first time in any calendar year for the purchase of more than $100,000 in fair market value of Common Stock (determined at the time of grant). (j) No incentive stock option shall be granted to an employee who owns or would be treated as owning by attribution under Code Section 424(d) immediately before the grant of such option, directly or indirectly, stock possessing more than 10% of the total combined voting power of all classes of stock of the Company. This restriction shall not apply if, (i) at the time such incentive stock option is granted, the option price is at least 110% of the fair market value of the shares of Common Stock subject to the option, as determined in accordance with Section 6(a) on the date of grant, and (ii) the incentive stock option by its terms is not exercisable after the expiration of five years from the date of its grant. (k) An option and any Common Stock received upon the exercise of an option shall be subject to such other transfer restrictions and/or legending requirements as are specified in the applicable Agreement. Terms and Conditions of Restricted Stock Awards. Awards of restricted stock under the Plan shall be subject to all the applicable provisions of the Plan, including the following terms and conditions, and to such other terms and conditions not inconsistent therewith, as the Committee shall determine: (a) Awards of restricted stock may be in addition to or in lieu of option grants. (b) Awards may be conditioned on the attainment of particular performance goals based on criteria established by the Committee at the time of each award of restricted stock. During a period set forth in the Agreement (the "Restriction Period"), the recipient shall not be permitted to sell, transfer, pledge, or otherwise encumber the shares of restricted stock; except that such shares may be used, if the Agreement permits, to pay the option price pursuant to any option granted under the Plan, provided an equal number of shares delivered to the optionee shall carry the same restrictions as the shares so used. (c) Shares of restricted stock shall become free of all restrictions if during the Restriction Period, (i) the recipient dies, (ii) the recipient's employment terminates by reason of permanent disability, as determined by the Committee, (iii) the recipient retires after attaining both 59-1/2 years of age and five years of continuous service with the Company and/or a division or subsidiary, or (iv) if provided in the Agreement, there is a "change in control" of the Company (as defined in such Agreement). The Committee may require medical evidence of permanent disability, including medical examinations by physicians selected by it. (d) Unless and to the extent otherwise provided in the Agreement, shares of restricted stock shall be forfeited and revert to the Company upon the recipient's termination of employment during the Restriction Period for any reason other than death, permanent disability, as determined by the Committee, retirement after attaining both 59-1/2 years of age and five years of continuous service with the Company and/or a subsidiary or division, or, to the extent provided in the Agreement, a "change in control" of the Company (as defined in such Agreement), except to the extent the Committee, in its sole discretion, finds that such forfeiture might not be in the best interests of the Company and, therefore, waives all or part of the application of this provision to the restricted stock held by such recipient. (e) Stock certificates for restricted stock shall be registered in the name of the recipient but shall be appropriately legended and returned to the Company by the recipient, together with a stock power endorsed in blank by the recipient. The recipient shall be entitled to vote shares of restricted stock and shall be entitled to all dividends paid thereon, except that dividends paid in Common Stock or other property shall also be subject to the same restrictions. (f) Restricted stock shall become free of the foregoing restrictions upon expiration of the applicable Restriction Period and the Company shall then deliver to the recipient Common Stock certificates evidencing such stock. (g) Restricted Stock and any Common Stock received upon the expiration of the restriction period shall be subject to such other transfer restrictions and/or legending requirements as are specified in the applicable Agreement. Terms and Conditions of Deferred Restricted Stock Grants for Non-Employee Directors. (a) For purposes of this Plan, a "non-employee director" is a member of the Board who is not a full-time employee of the Company, or one of its or subsidiaries. Non-employee directors will receive benefits under the Plan only as provided in this Section 8. A non-employee director shall receive his or her director's retainer then paid by the Company to its directors in deferred restricted stock credits rather than cash. Such credits shall not be funded, but shall exist solely as a deferred restricted stock account on the books of the Company to reflect the number of shares of Common Stock (including fractional shares to 5 decimal places) which could have been purchased from time to time with the earned amount of such retainer at 100% of fair market value. Fair market value shall be determined on the first day of each participating director's directorship for the year with respect to which such retainer is credited. Whenever a cash dividend is paid with respect to Common Stock, each non-employee director's deferred restricted stock account shall be credited with the number of shares of Common Stock (including fractional shares to 5 decimal places) which could have been purchased on the applicable dividend payment date at 100% of fair market value on such date, based upon the per share cash dividend multiplied by the number of shares of Common Stock then credited to such director's account. Any stock dividend shall also be credited to each non- employee director's deferred restricted stock account (including fractional shares to 5 decimal places). (b) Upon termination of his or her directorship for any reason, the non-employee director (or his or her designated beneficiary) shall receive the number of whole shares of Common Stock then credited to his or her account (but not any fractional shares). Any fractional share credits remaining in the account shall thereupon be canceled. Such shares shall be restricted in accordance with this Section 8. (c) With respect to shares of restricted stock granted pursuant to this Section 8, the Restriction Period shall end on the later of (i) the date that such non-employee director ceases to serve on the Board, or (ii) the date such non-employee director would otherwise be permitted to sell such restricted stock under Section 16(b) of the Exchange Act. The Committee shall not modify the term of the Restriction Period with respect to shares of restricted stock granted pursuant to this Section 8. Bonuses Payable in Stock. In lieu of cash bonuses otherwise payable under the Company's or applicable division's or subsidiary's compensation practices to employees eligible to participate in the Plan, the Committee, in its sole discretion, may determine that such bonuses shall be payable in Common Stock or partly in Common Stock and partly in cash. Such bonuses shall be in consideration of services previously performed and as an incentive toward future services and shall consist of shares of Common Stock subject to such terms as the Committee may determine in its sole discretion. The number of shares of Common Stock payable in lieu of a bonus otherwise payable shall be determined by dividing such bonus amount by the fair market value of one share of Common Stock on the date the bonus is payable, with fair market value determined as of such date in accordance with Section 6(a). Change in Control. Each Agreement may, in the sole discretion of the Committee, provide that any or all of the following actions may be taken upon the occurrence of a change in control (as defined in the Agreement) with respect to the Company: (i) acceleration of time periods for purposes of vesting in, or realizing gain from, or exercise of any outstanding option or stock appreciation right or shares of restricted stock awarded (ii) offering to purchase any outstanding option or stock appreciation right or shares of restricted stock made pursuant to this Plan from the holder for its equivalent cash value, as determined by the Committee, as of the date of the change in control; or (iii) making adjustments or modifications to outstanding options or stock appreciation rights or with respect to restricted stock as the Committee deems appropriate to maintain and protect the rights and interests of the Participants following such change in control, provided, however, that the exercise period of any option may not be extended beyond 10 years from the date of grant. Transfer, Leave of Absence. For purposes of the Plan: (a) a transfer of an employee from the Company to a division or subsidiary of the Company, whether or not incorporated, or vice versa, or from one division or subsidiary of the Company to another, and (b) a leave of absence, duly authorized in writing by the Company or a subsidiary or division of the Company, shall not be deemed a termination of employment. Rights of Employees. (a) No person shall have any rights or claims under the Plan except in accordance with the provisions of the Plan and each Agreement. (b) Nothing contained in the Plan an Agreement shall be deemed to give any employee the right to continued employment by the Company or its divisions or subsidiaries. Withholding Taxes. The Company shall require a payment from a Participant to cover applicable withholding for income and employment taxes upon the happening of any event pursuant to the Plan which requires such withholding. The Company reserves the right to offset such tax payment from any funds which may be due the Participant from the Company or its subsidiaries or divisions or, in its discretion, to the extent permitted by applicable law, to accept such tax payment through the delivery of shares of Common Stock owned by the Participant or by utilizing shares of the Common Stock which were to be delivered to the Participant pursuant to the Plan, having an aggregate fair market value, determined as of the date of payment, equal to the amount of the payment due. Adjustments. In the event of stock dividends, stock splits, recapitalizations, mergers, consolidations, combinations, exchanges of shares, spin-offs, liquidations, reclassifications or other similar changes in the capitalization of the Company, the number of shares of Common Stock available for grant under this Plan shall be adjusted appropriately by the Board, and, where deemed appropriate, the number of shares covered by outstanding stock options and stock appreciation rights outstanding and the number of shares of restricted stock outstanding, and the option price of outstanding stock options, shall be similarly adjusted. If another corporation or other business entity is acquired by the Company, and the Company has assumed outstanding employee option grants under a prior existing plan of the acquired entity, similar adjustments are permitted at the discretion of the Committee. In the event of any other change affecting the shares of Common Stock available for awards under the Plan, such adjustment, if any, as may be deemed equitable by the Committee, shall be made to preserve the intended benefits of the Plan giving proper effect to such event. (a) The Plan shall be unfunded. The Company shall not be required to establish any special or separate fund or to make any other segregation of assets to assure the issuance of share or the payment of cash upon exercise of any option or stock appreciation right under the Plan. Proceeds from the sale of shares of Common Stock pursuant to options granted under this Plan shall constitute general funds of the Company. The expenses of the Plan shall be borne by the Company. (b) The Committee may, at any time and from time to time after the granting of an option or the award of restricted stock or bonuses payable in Common Stock hereunder, specify such additional terms, conditions and restrictions with respect to such option or stock as may be deemed necessary or appropriate to ensure compliance with any and all applicable laws, including, but not limited to, the Code, federal and state securities laws and methods of withholding or providing for the payment of required taxes. (c) If at any time the Committee shall determine in its discretion that the listing, registration or qualification of shares of Common Stock upon any national securities exchange or under any state or federal law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, the sale or purchase of shares of Common Stock hereunder, no option or stock appreciation right may be exercised or restricted stock or stock bonus may be transferred in whole or in part unless and until such listing registration, qualification, consent or approval shall have been effected or obtained, or otherwise provided for, free of any conditions not acceptable to the Committee. (d) By accepting any benefit under the Plan, each Participant and each person claiming under or through such Participant shall be conclusively deemed to have indicated his acceptance and ratification, and consent to, any action taken under the Plan by the Committee, the Company or the Board. (e) The Plan shall be governed by and construed in accordance with the laws of the State of New Jersey. (f) Committee members exercising their functions under this Plan are serving as directors of the Company and they shall therefore be entitled to all rights of indemnification and advancement of expenses accorded directors of the Company. (a) Any liability of the Company or a subsidiary of the Company to any Participant with respect to any option or award shall be based solely upon contractual obligations created by the Plan and Agreement. (b) Neither the Company nor a division or subsidiary of the Company, nor any member of the Committee or the Board, nor any other person participating in any determination of any question under the Plan, or in the interpretation, administration or application of the Plan, shall have any liability to any party for any action taken or not taken in connection with the Plan, except as may expressly be provided by statute. Amendments and Termination. The Board may, at any time, amend, alter or discontinue the Plan; provided, however, no amendment, alteration or discontinuation shall be made which would impair the rights of any holder of an award of restricted stock, option, stock appreciation rights or stock bonus theretofore granted, without his or her written consent, or which, without the written approval of the shareholders would: (a) except as provided in Section 14, increase the maximum number of shares of Common Stock which may be issued under the Plan; (b) except as provided in Section 14, decrease the option price of an option (and related stock appreciation rights, if any) to less than 100% of the fair market value, as determined in accordance with Section 6(a) of a share of Common Stock on the date of the granting of the option (and related stock appreciation rights, if any); (c) materially change the class of persons eligible to receive an award of restricted stock or options or stock appreciation rights (d) extend the duration of the Plan; or (e) materially increase in any other way the benefits accruing to Participants. Duration. The Plan shall be adopted by the Board and approved by a majority of the Company's shareholders, which approval must occur within the period ending twelve months after the date the Plan is adopted. Subject to the approval of the Plan by shareholders, grants and awards may be made under the Plan between the date of its adoption and the approval of the Plan by shareholders. The Plan shall terminate upon the earlier of the following dates or events to occur. (a) upon the adoption of a resolution of the Board terminating (b) the date all shares of Common Stock subject to the Plan are purchased according to the Plan's provisions; or (c) ten years from the date of adoption of the Plan by the Board. No such termination of the Plan shall adversely affect the rights of any Participant hereunder and all options or stock appreciation rights previously granted and restricted stock and stock bonuses awarded hereunder shall continue in force and in operation after the termination of the Plan, except as they may be otherwise terminated in accordance with the terms of the Plan. Other Compensation Plans. The Plan shall not be deemed to preclude the implementation by the Company or its divisions or subsidiaries of other compensation plans which may be in effect from time to time, nor adversely affect any rights of Participants under any other compensation plans of the Company or its divisions or subsidiaries. Non-Transferability. No right or interest in any award granted under the Plan shall be assignable or transferable, except as set forth in the Plan and required by law, and no right or interest of any participant in any award shall be liable for, or subject to, any lien, obligation or liability except as set forth in the Plan or as required by law. NUI CORPORATION EMPLOYEE STOCK PURCHASE PLAN The NUI Corporation Employee Stock Purchase Plan (the "Plan") is intended to provide a method whereby employees of NUI Corporation, its subsidiary corporations and divisions (hereinafter collectively referred to, unless the context otherwise requires, as the "Company") will have an opportunity to acquire a proprietary interest in the Company through the purchase of shares of the voting common stock of the Company, no par value (the "Common Stock"). It is the intention of the Company to have the Plan qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code of 1986, as amended (the "Code"). The provisions of the Plan shall be construed in a manner consistent with the requirements of the Code. "Base Pay" shall mean regular earnings excluding payments for overtime, shift premium, bonuses and other special payments, commissions and marketing or other incentive payments. "Board" shall mean the Board of Directors of NUI Corporation. Committee. "Committee" shall mean the individuals described in Article XI. "Employee" shall mean any person who is customarily employed on a full-time or part-time basis by the Company and is regularly scheduled to work more than 20 hours per week and whose customary employment is for more than 5 months in any calendar year. "Subsidiary Corporation" shall mean any corporation which at any time (i) would be a "subsidiary corporation" of NUI Corporation as that term is defined in Section 424 of the Code and (ii) is designated as a participating subsidiary in the Plan by the Committee. ARTICLE III - ELIGIBILITY AND PARTICIPATION Any Employee who shall have completed one hundred eighty (180) consecutive days of employment and shall be employed by the Company on the date his or her participation in the Plan is to become effective shall be eligible to participate in offerings under the Plan which commence on or after such one hundred eighty day period has concluded. For purposes of participation in the Plan, a person on leave of absence shall be deemed to be an Employee for the first 180 days of such leave of absence. An Employee's employment shall be deemed to have terminated at the close of business on the 180th day of a leave of absence unless the Employee shall have returned to regular full- time or part-time employment (as the case may be) prior to the close of business on such 180th day. Notwithstanding any provisions of the Plan to the contrary, no Employee shall be granted an option pursuant to the Plan (an "Option"): (a) if immediately after the grant the Employee would own Common Stock, and/or hold outstanding options (including Options under the Plan) to purchase Common Stock possessing 5% or more of the total combined voting power or value of all classes of stock of the Company (for purposes of this paragraph, the rules of Section 424(d) of the Code shall apply in determining stock ownership of an Employee); or (b) which gives him or her rights to purchase stock under all Employee stock purchase plans of the Company and any parent or Subsidiary Corporation to accrue at a rate which exceeds $25,000 in fair market value of the stock (determined at the time such Option is granted) for each calendar year in which such Option is outstanding, all as set forth in Reg. 1.423-2 promulgated under the Code. An eligible Employee may become a participant in the Plan either by completing an authorization for a payroll deduction on the form provided by the Committee and filing it with the Committee on or before the filing date set by the Committee, which date shall be prior to the Offering Commencement Date for an Offering (as such terms are defined below). Payroll deductions for a participant shall commence on the first Offering Commencement Date after his or her authorization for a payroll deduction becomes effective and shall end on the termination of the Plan or the participant's earlier termination of participation. The Plan will be implemented by forty-four monthly offerings of Common Stock (each an "Offering"), beginning on the 1st day of each month (commencing with May, 1996) in each of the years 1996, 1997, 1998 and 1999, each Offering terminating on the final day of such month. Each Offering shall be for 3,181 shares of Common Stock, plus any unissued shares from the prior Offerings. In no event may an Option granted under the Plan be exercised after 27 months from the date of grant. ARTICLE V -- DEDUCTIONS AND PAYMENTS At the time a participant files an authorization for payroll deduction, he or she shall elect to have deductions made from pay on each payday during the time he or she is a participant in an Offering at the rate of a whole number percentage from 1% to 10% of Base Pay in effect at the Offering Commencement Date of such Offering. In the case of a part-time hourly Employee, such Employee's Base Pay during an Offering shall be determined by multiplying such Employee's hourly rate of pay in effect on the Offering Commencement Date by the number of regularly scheduled hours of work for such Employee during such Offering. All payroll deductions made for a participant shall be credited to his or her account under the Plan. A participant may discontinue participation in the Plan as provided in Article VIII, but no other change can be made during an Offering and, specifically, a participant may not alter the payroll deduction percentage for that Offering. If a participant goes on a leave of absence, such participant shall have the right to elect no less than 10 days prior to such leave, on forms supplied by the Committee: (a) to withdraw the balance in his or her account pursuant to Section 8.01, (b) to discontinue contributions to the Plan but remain a participant in the Plan, or (c) to remain a participant in the Plan during such leave of absence. ARTICLE VI -- GRANTING OF OPTION On the Offering Commencement Date of each Offering, a participating Employee shall be deemed to have been granted an Option to purchase a maximum number of shares of Common Stock equal to 10 % of Base Pay during such Offering divided by 85% of the market value of the Common Stock determined as provided in Section 6.02. An Employee's Base Pay during the period of an Offering shall be his or her normal monthly rate of pay (as in effect on the last day prior to the applicable Offering Commencement Date) provided that, a part time hourly Employee's Base Pay shall be determined in accordance with Section 5.01. The Option price of Common Stock purchased with payroll deductions made during any Offering shall be the lower of: (a) 85% of the mean between the highest and lowest prices at which the Common Stock is traded on a national securities exchange on the Offering Commencement Date or, if there is no sale on such exchange on such date, the mean between the bid and asked prices on such exchange at the close of the market on such date, or if the market is closed on such date, the nearest prior trading day; or (b) 85% of the mean between the highest and lowest prices at which the Common Stock is traded on a national securities exchange on the day which the Option is exercised, or, if there is no sale on such exchange on such date, the mean between the bid and asked prices on such exchange at the close of the market on such date, or if the market is closed on such date, the nearest prior trading day. If the Common Stock is not listed on a national securities exchange on any of the aforesaid dates for which prices are to be determined, then the Option price shall be 85% of fair market value of the Common Stock on that date, as determined by the Committee. ARTICLE VII -- EXERCISE OF OPTION Unless a participant gives written notice to the Company as hereinafter provided, his or her Option for the purchase of stock with payroll deductions and/or direct payments made during any Offering will be deemed to have been exercised automatically on the last business day of each calendar month after the Offering Commencement Date (but in no event prior to the approval of this Plan by the shareholders of NUI Corporation and such regulatory bodies as may be necessary) for the purchase of the number of full shares of Common Stock which the accumulated payroll deductions and direct payments in his or her account at that time will purchase at the applicable Option price. Any excess remaining in the participant's account after exercise because of the non-issuance of fractional shares will be carried in the account to the next Offerings. Any other excess will be returned to the participant, without interest. If a participant violates Section 7.04, any excess remaining in his or her account shall be returned to the participant, without interest. Fractional shares will not be issued under the Plan and any accumulated payroll deductions which would have been used to purchase fractional shares and which remain in the participant's account on the final Offering Termination Date will be returned to the participant, without interest. (a) During the lifetime of a participant, his or her right to exercise an Option granted under the Plan shall be exercisable only by such optionee or, if then permitted under Section 16 of the Securities Exchange Act of 1934, as amended, or regulations thereunder, pursuant to a qualified domestic relations order as defined in the Internal Revenue Code and regulations thereunder (a ""QDRO") and shall not be assignable or transferable by such optionee other than by will or the laws of descent and distribution or, it then permitted by Section 16, pursuant to a QDRO. (b) Any transfer of Common Stock purchased by the exercise of an Option granted under the Plan shall comply with all applicable restrictions and holding periods set forth in Rule 16b-3 promulgated under Section 16 of the Securities of the Securities Exchange Act of 1934, as amended and any other requirements imposed by law. Common Stock purchased by a participant shall not be transferred by him or her during the period commencing on the date of purchase and ending six months and one day thereafter. Any transfer in violation of this Section 7.04 shall cause the termination of such participant's Option for the remainder of the then current Offering and for the next following six (6) Offerings. As promptly as practicable after the close of each Offering, the Company will deliver to each participant the certificates representing Common Stock purchased upon exercise of his or her Option or evidence that such shares are maintained on behalf of the participant in book share form with the agent for the Plan. A participant may withdraw amounts credited to his or her account under the Plan which have not theretofore been used to purchase Common Stock by giving written notice to the Committee at least 10 business days prior to the last pay day of a month. All of the cash balance credited to the participant's account will be paid to him or her promptly after receipt of such notice of withdrawal, and no further payroll deductions will be made from his or her pay during such Offering. A participant's withdrawal from any Offering will bar him or her from participating in the three (3) subsequent Offerings. Upon termination of the participant's employment for any reason, including retirement, but excluding death, any amounts credited to his or her account will be returned to the participant, without interest. Termination of Employment Due to Death. Upon termination of the participant's employment because of death, his or her beneficiary (as defined in Section 12.01) shall be entitled to receive the remaining cash balance credited to the participant's account under the Plan as of the date of the A participant while on leave of absence, subject to the election made by such participant pursuant to Section 5.04, shall continue to be a participant in the Plan. A participant who has been on leave of absence for more than 180 days and who therefore is no longer an Employee for purposes of the Plan shall not be entitled to participate in any Offering commencing after the 180th day of such leave of absence. No interest will be paid or allowed on any money paid into the Plan or credited to the account of any participant. ARTICLE X -- COMMON STOCK The maximum number of shares of Common Stock which shall be issued under the Plan, subject to adjustment as provided in Section 12.04 shall be 3,181 shares in each monthly Offering, not to exceed an aggregate of 140,000 shares for all Offerings. Shares unissued in an Offering may be added to the shares offered in any subsequent Offering until sold. If the total number of shares for which Options are exercised in any Offering exceeds the maximum number of shares available for sale under the applicable Offering, the Company shall make a pro rata allocation of any remaining shares available for delivery and distribution pursuant to such Offering in as nearly a uniform manner as shall be practicable and as it shall determine to be equitable, and the balance credited to the account of each participant under the Plan shall be returned as promptly as possible. Participant's Interest in Option Stock. The participant will have no interest in stock covered by his or her Option until such Option has been exercised. Stock delivered to a participant under the Plan will be registered in the name of the participant. If at any time the Company shall determine in its discretion that the listing, registration or qualification of shares of Common Stock upon any securities exchange or under any state or federal law, or the consent or approval of any governmental regulatory body is necessary or desirable as a condition of, or in connection with, the sale or purchase of shares of Common Stock hereunder, no Option may be exercised unless and until such listing registration, qualification, consent or approval shall have been effected or obtained, or otherwise provided for, free of any conditions not acceptable to the Company. 10.04. Regulatory Approval and Compliance. The Company shall not be required to issue any certificate or certificates for Common Stock upon the exercise of an Option granted under the Plan or to record as a holder of record of Common Stock the name of the individual exercising an Option under the Plan or his or her transferee, without obtaining to the complete satisfaction of the Committee the approval of all regulatory bodies deemed necessary by the Committee and without complying, to the Committee's complete satisfaction, with all rules and regulations under federal, state, or local law deemed applicable by the Committee. The Plan shall be administered by the Committee which is appointed from time to time by the Board. The Committee shall consist of three (3) or more members of the Board, each of whom shall be a "disinterested person" within the meaning of Rule 16b-3 of the Securities Exchange Act of 1934 and an "outside director" within the meaning of Section 162(m) of the Code. A majority of the members of the Committee shall constitute a quorum. A majority vote of the members of the Committee present at a meeting at which a quorum is present shall be required for the Committee to take action under the Plan. Subject to the express provisions of the Plan, the Committee shall have full authority to interpret and construe the Plan, to adopt rules and regulations for administering the Plan, and to make all other determinations deemed necessary or advisable for administering the Plan. The Committee's determination on the foregoing matters shall be conclusive. Rules Governing the Administration of the Committee The Board may from time to time appoint members of the Committee in substitution for or in addition to members previously appointed and may fill vacancies, however caused, in the Committee. The Committee may select one of its members as its Chairman and shall hold its meetings at such times and places and in such manner as it shall deem advisable. The Committee may correct any defect or omission or reconcile any inconsistency in the Plan, in the manner and to the extent it shall deem desirable, subject to applicable law. Any decision or determination reduced to writing and signed by a majority of the members of the Committee shall be as fully effective as if it had been made by a majority vote at a meeting duly called and held. The Committee may appoint a secretary and shall make such rules and regulations for the conduct of its business as it shall deem advisable. A participant may file a written designation of a beneficiary who is to receive any Common Stock and/or cash remaining in the participant's Plan account following the participant's death. Such designation of beneficiary may be changed by the participant at any time by written notice to the Committee. Upon the death of a participant and upon receipt by the Committee of proof of identify and existence at the participant's death of a beneficiary validly designated by him under the Plan, the Committee shall deliver such Common Stock and/or cash to the beneficiary. In the event of the death of a participant where there is no beneficiary validly designated under the Plan who is living at the time of such participant's death, the Committee shall deliver such Common Stock and/or cash to the participant's personal representative, or if no such representative has been appointed (to the knowledge of the Committee), the Committee in its discretion, may deliver such Common Stock and/or cash to the spouse or to any one or more dependents of the participant as the Committee may designate. No beneficiary, prior to the death of the participant by whom he or she has been designated, shall acquire any interest in the Common Stock or cash credited to the participant under the Plan. Prior to exercise of Options, all payroll deductions received or held by the Company under this Plan may be used by the Company for any corporate purpose and the Company shall not be obligated to segregate such payroll deductions. Adjustment Upon Changes in Capitalization. (a) If, while any Options are outstanding, the outstanding shares of Common Stock have been increased, decreased, changed into, or been exchanged for a different number or kind of shares of securities of NUI Corporation through reorganization, merger, recapitalization, reclassification, stock split, reverse stock split or similar transaction, appropriate adjustments may be made by the Committee in the number and/or kind of shares which are subject to purchase under outstanding Options and on the Option exercise price or prices applicable to such outstanding Options. In addition, in any such event, the number and/or kind of shares which may be offered in the offering described in Article IV shall also be appropriately adjusted. No adjustments shall be made for stock dividends. For the purposes of this section, any distribution of Common Stock to shareholders in an amount aggregating 5% or more of the outstanding shares of Common Stock shall be deemed a stock split and any distributions of Common Stock aggregating less than 5% of the outstanding shares of Common Stock shall be deemed a stock dividend. (b) Upon the dissolution or liquidation of NUI Corporation, or upon a reorganization, merger or consolidation of NUI Corporation with one or more corporations as a result of which NUI Corporation is not the surviving corporation, or upon a sale of substantially all of its property or stock to another corporation, or a sale or spin off of a division or a Subsidiary Corporation, the affected holder of each Option then outstanding under the Plan will thereafter be entitled to receive at the next date for the exercise of such Option, for each share of Common Stock as to which such Option would have been exercised, as nearly as reasonably may be determined, the cash, securities and/or property which a holder of one share of the Common Stock was entitled to receive upon and at the time of such transaction. The Board and the Committee shall take such steps in connection with such transactions as the Board and the Committee respectively shall deem necessary to assure that the provisions of this Section 12.03 shall thereafter be applicable, as nearly as reasonably may be determined, in relation to the said cash, securities and/or property as to which the holder of such Option might thereafter The Board shall have complete power and authority to terminate or amend the Plan; provided, however, that the Board shall not, without the approval of the shareholders of the Company (i) increase the maximum number of share of Common Stock which may be issued under any Offering (except pursuant to Section 12.03); (ii) amend the requirements as to the class of Employees eligible to purchase Common Stock under the Plan or to permit the members of the Committee to purchase stock under the Plan. No termination, modification, or amendment of the Plan may adversely affect the rights of any participant under an Option without the consent of all participants. Effective Date. The Plan shall become effective as of January 1, 1996 subject to approval by the required vote of the holders of the Common Stock at a special or annual meeting of the shareholders of NUI Corporation held on or before November 27, 1996 and the approval of such regulatory bodies as may be necessary. If the Plan is not so approved, the Plan shall not become effective and any payroll withholdings shall promptly be returned to the Employees. No Common Stock shall be purchased under the Plan prior to its having been approved by the Company's shareholders. No Employment Rights. The Plan does not, directly or indirectly, create in any Employee or class of Employees any right with respect to continuation or employment by the Company, and it shall not be deemed to interfere in any way with the Company's right to terminate, or otherwise modify, an Employee's employment at any time. The provisions of the Plan shall, in accordance with its terms, be binding upon, and inure to the benefit of, all successors of each Employee participating in the Plan, including, without limitation, such Employee's estate and the executors, administrators or trustees thereof, heirs and legatees, and any receiver, trustee in bankruptcy or representative of creditors of such Employee. 12.08. Indemnification; Limitation of Liability. (a) Committee members exercising their functions under this Plan are serving as directors of NUI Corporation and they shall therefore be entitled to all rights of indemnification and advancement of expenses accorded directors of NUI Corporation. (b) NUI Corporation, any Subsidiary Corporation, and any member of the Committee or the Board, or any other person participating in any determination of any question under the Plan, or in the interpretation, administration or application of the Plan, shall not have any liability to any party for any action taken or not taken in connection with the Plan, except as may expressly be provided by statute. The law of the State of New Jersey will govern all matters relating to this Plan except to the extent it is superseded by the laws of the United States. 1996 STOCK PURCHASE PLAN FOR OUTSIDE DIRECTORS The purpose of the NUI Corporation 1996 Stock Purchase Plan for Outside Directors (the "Plan") is to promote the interests of NUI Corporation (the "Company") and its shareholders by enhancing the ability of the Company to attract and retain the services of knowledgeable nonemployee directors by encouraging such directors to acquire an increased proprietary interest in the Company. SHARES SUBJECT TO THE PLAN Subject to adjustment as provided in Section 7, the total number of shares of the voting common stock of the Company (the "Common Stock") for which options may be granted under the Plan (each an "Option") shall be 70,000. The Common Stock available for issuance upon exercise of Options shall be currently authorized but unissued shares or shares currently held or subsequently acquired by the Company as treasury shares, including shares purchased in the open market or in private transactions. If an Option expires or terminates for any reason without having been exercised in full, the Common Stock subject to but not delivered under such Option may become available for the grant of other Options. No shares delivered to the Company in full or partial payment of an Option purchase price payable pursuant to Section 6.6 shall become available for the grant of other Options. The Plan shall be administered by the Compensation Committee of the Company's Board of Directors (the "Committee"). Subject to the terms of the Plan, the Committee shall have the power to construe the provisions of the Plan, to determine all questions arising thereunder, and to adopt and amend such rules and regulations for administering the Plan as the Committee deems desirable. Each member of the Company's Board of Directors (a "Director") who is not otherwise an employee of the Company or any subsidiary of the Company (an "Eligible Director") shall be eligible to participate in the Plan. All Options shall be nonstatutory Options which are not intended to be qualified under Section 422 of the Internal Revenue Code of 1986, as amended. Each Option granted to an Eligible Director and the issuance of shares thereunder shall be subject to the following terms: Each Option shall be evidenced by an option agreement (an "Agreement") duly executed on behalf of the Company and by the Eligible Director to whom such Option is granted and dated as of the applicable date of grant. Each Agreement shall comply with and be subject to the terms and conditions of the Plan. Any Agreement may contain such other provisions not inconsistent with the Plan as may be determined by the Committee. An Option to purchase 1,500 shares of Common Stock shall be automatically granted each year to each Eligible Director on the date of the first regularly scheduled meeting of the Board of Directors of the Company following the Annual Meeting of Shareholders. The Option exercise price per share for an Option shall be eighty five percent (85%) of the Fair Market Value of the underlying Common Stock on the date the Option is exercised. "Fair Market Value" shall mean the average of the high and low sales prices per share of the Common Stock traded on a national securities exchange on the relevant date or, if no sales were made on such exchange on such date, the mean between the bid and asked prices on such exchange at the close of the market on such date, or if the market is closed on such date, the One hundred percent (100%) of each Option shall vest and become nonforfeitable and exercisable on the date on which the Option is granted. (a) Any Option shall be exercisable in whole or in part at any time, or from time to time, during the Option period by written notice, signed by the person exercising the Option, to the Company accompanied by payment of the Option exercise. The date that both such notice and payment are received by the Secretary of the Company shall be the date of exercise of the Option. No Option may at any time be exercised with respect to a fractional share. (b) An Eligible Director, no later than the date of the first regularly scheduled meeting of the Board of Directors of the Company following the Annual Meeting of Shareholders, may irrevocably authorize the withholding of his or her board attendance and committee fees for the forthcoming year and the application of such fees (when earned) to the exercise of the current year's Option. Payment of the Option exercise price may be made by certified, cashier's, or personal check or by the application of fees pursuant to Section 6.5(b). Any amount paid in exercise of an Option which is in excess of the number of shares then remaining subject to an Option of the optionee shall be returned to the optioner, without interest. Each Option shall expire on the date of the first meeting of the Board of Dir3ectors following the Annual Meeting of Shareholders next succeeding the date of grant, but shall be subject to earlier termination if: (a) the optionee shall cease to serve as a Director for reason other than retirement or disability (each of which is defined below), or death, in which event the then outstanding Options may be exercised only within three months after such termination or on the stated grant expiration date, whichever is earlier, unless such termination of service shall result from removal for cause, in which case all outstanding Options shall immediately (b) the optionee shall cease to serve as a Director because of retirement or disability, in which event then-outstanding Options of such optionee shall expire one year after the date of such termination or on the stated grant expiration date, whichever is earlier. The term "by reason of retirement" shall mean mandatory retirement pursuant to any statute, regulation, by-law or Board of Directors' policy. "Disability" shall mean the inability to perform the duties of a Director by reason of any physical or mental (c) the optionee shall cease to serve as a Director because of death, in which event, the then-outstanding Options of such optionee shall expire one year after the date of death of such optionee or on the stated grant expiration date, whichever is earlier. Exercise of a deceased optionee's Options shall be by his or her personal representative or by a person or persons whom the optionee had designated in a writing filed with the Company, or, if no designation had been made, by the person or persons to whom the optionee's rights have passed by will or the laws of descent and distribution. (a) During the lifetime of an optionee, his or her right to exercise an Option granted under the Plan shall be exercisable only by such optionee or, if then permitted under Section 16 of the Securities Exchange Act of 1934, as amended, or regulations thereunder, pursuant to a qualified domestic relations order as defined in the Internal Revenue Code and regulations thereunder (a "QDRO") and shall not be assignable or transferable by such optionee other than by will or the laws of descent and distribution or, if then permitted by Section 16, pursuant to a QDRO. (b) Any transfer of Common Stock purchased by the exercise of an Option granted under the Plan shall comply with all applicable restrictions and holding periods set forth in Rule 16b-3 promulgated under Section 16 of the Securities of the Securities Exchange Act of 1934, as amended and any other requirements imposed by law. 6.9.1 Limitation as to Shares. Neither an optionee nor an optionee's successor or successors in interest shall have any right as a stockholder of the Company with respect to any Common Stock subject to an Option granted to such person until the date of exercise. 6.9.2 Limitation as to Directorship. Neither the Plan, nor the granting of an Option, nor any other action taken pursuant to the Plan shall constitute or be evidence of any agreement or understanding, express or implied, that an Eligible Director has a right to continue as a Director for any period of time or at any particular rate or compensation. 6.10 Regulatory Approval and Compliance The Company shall not be required to issue any certificate or certificates for Common Stock upon the exercise of an Option granted under the Plan or to record as a holder of record of Common Stock the name of the individual exercising an Option under the Plan or his or her transferee, without obtaining to the complete satisfaction of the Committee the approval of all regulatory bodies deemed necessary by the Committee and without complying, to the Committee's complete satisfaction, with all rules and regulations under federal, state, or local law deemed applicable by the Committee. In the event of stock dividends, stock splits, recapitalizations, mergers, consolidations, combinations, exchanges of shares, spin-offs, liquidations, reclassifications or other similar changes in the capitalization of the Company, the number and class of shares available for grant under the Plan shall be adjusted proportionately and the number and class of shares covered by outstanding Options and the option price shall be similarly adjusted. All costs and expenses of the adoption and administration of the Plan shall be borne by the Company and none of such expenses shall be charged to any optionee. EFFECTIVE DATE AND DURATION OF THE PLAN The Plan shall be effective immediately following approval by the Company's shareholders and such regulatory bodies as may be required; provided, however, that grants may be made prior to the effective date if such grants are made subject to such approvals. The Plan shall continue in effect until there are no longer any Options which may be granted under the Plan or it is terminated by action of the Board or the Company's shareholders, but such termination shall not affect the terms of any then outstanding Options. (a) Committee members exercising their functions under this Plan are serving as directors of the Company and they shall therefore be entitled to all rights of indemnification and advancement of expenses accorded directors of the Company. (b) The Company and any member of the Committee or the Board, or any other person participating in any determination of any question under the Plan, or in the interpretation, administration or application of the Plan, shall not have any liability to any party for any action taken or not taken in connection with the Plan, except as may expressly be provided by statute. The validity, interpretation and administration of the Plan and of any rules, regulations, determinations or decisions made thereunder, and the rights of any and all persons having or claiming to have any interest therein or thereunder, shall be determined in accordance with the laws of the State of New Jersey. TERMINATION AND AMENDMENT OF THE PLAN The Company's Board of Directors may amend, terminate or suspend the Plan at any time, in its sole and absolute discretion; provided, however, that if required to qualify the Plan under Rule 16b-3 promulgated under Section 16 of the Securities Exchange Act of 1934, as amended, no amendment shall be made more than once every six months that would change the amount, price or timing of Options granted under the Plan, other than to comport with changes in the Internal Revenue Code of 1986, as amended, or the rules and regulations promulgated thereunder, provided, further, that if required to qualify the Plan under Rule 16b-3, no amendment that would do any of the following shall be made without the approval of the Company's shareholders: (a) materially increase the number of shares that may be issued (b) materially modify the requirements as to eligibility for participation in the Plan; or (c) otherwise materially increase the benefits accruing to participants under the Plan. THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS The undersigned hereby appoints John Kean, John Kean, Jr. and James R. Van Horn, or any one of them, with full power of substitution, attorneys, agents and proxies to vote on behalf of the undersigned at the Annual Meeting of Shareholders of NUI Corporation to be held on March 12, 1996 at 10:30 a.m. or any adjournment thereof: This proxy when property executed will be voted in the manner directed herein by the undersigned shareholder. If no direction is made, this proxy will be voted FOR with respect to Items 1, 2, 3, 4, and 5. 1. ELECTION OF DIRECTORS: Calvin R. Carver, Vera King Farris For all nominees WITHHOLD Instruction: To withhold listed above AUTHORITY authority to vote for (except as marked to vote for individual nominee, to the contrary) all nominees strike line through the nominee's name. 2. TO RATIFY THE APPOINTMENT OF ARTHUR ANDERSEN & CO. AS THE COMPANY'S INDEPENDENT PUBLIC ACCOUNTANTS. 3. APPROVAL OF 1996 STOCK OPTION AND STOCK AWARD PLAN. 4. APPROVAL OF 1996 EMPLOYEE STOCK PURCHASE PLAN. 5. APPROVAL OF 1996 STOCK PURCHASE PLAN FOR OUTSIDE DIRECTORS. 6. In their discretion, the Proxies are authorized to vote upon such other business as may properly come before the meeting. _____ day of _____, 1996. Please Check here if you (Please date) plan to attend the Annual Please sign exactly as name appears hereon. When shares are held by joint tenants, both should sign. When signing as an attorney, executor, administrator, trustee, or guardian, please give full title as such. If a corporation, please sign in full corporate name by President or other authorized officer. If a partnership, please sign in partnership name by authorized person. PLEASE MARK, SIGN, DATE AND RETURN THIS PROXY CARD PROMPTLY USING THE ENCLOSED PREPAID ENVELOPE. BOXES SO THAT DATA PROCESSING EQUIPMENT WILL RECORD YOUR VOTES"	PRE 14A	PRE 14A	1996-01-12T00:00:00	1996-01-12T15:17:56
0000912057-96-000459	0000912057-96-000459_0000.txt	AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 12, 1996 THE SECURITIES ACT OF 1933 (Exact name of Registrant as specified in its charter) 6001 INDIAN SCHOOL ROAD, N.E., SUITE 530 (Address, including zip code, and telephone number, including area code, of VICE PRESIDENT OF LEGAL AFFAIRS, SECRETARY AND GENERAL COUNSEL 6001 INDIAN SCHOOL ROAD, N.E., SUITE 530 (Name, address, including zip code, and telephone number, including area code, APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT. If the only securities being registered on this Form are being offered pursuant to dividend or interest reinvestment plans, please check the following If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. / / If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier registration statement for the same offering. / / If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. / / (1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457 under the Securities Act of 1933, as amended. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED JANUARY 12, 1996 % SENIOR SUBORDINATED NOTES DUE 2006 The % Senior Subordinated Notes due 2006 (the "Notes") are being offered (the "Offering") by Horizon/CMS Healthcare Corporation ("Horizon" or the "Company"). Interest on the Notes will be payable semi-annually in arrears on and of each year, commencing , 1996. The Company will not be required to make mandatory redemption or sinking fund payments with respect to the Notes. The Notes will be redeemable at the option of the Company, in whole or in part, at any time on or after , 2001, at the redemption prices set forth herein, plus accrued and unpaid interest to the date of redemption. Upon a Change of Control (as defined herein), each holder of Notes may require the Company to purchase all or a portion of such holder's Notes at 101% of the principal amount thereof, plus accrued and unpaid interest to the date of purchase. The Notes will be general unsecured senior subordinated obligations of the Company, subordinated in right of payment to all existing and future Senior Debt (as defined herein) of the Company, including indebtedness pursuant to the Credit Facility (as defined herein), and will be structurally subordinated to all indebtedness of the Company's subsidiaries. At November 30, 1995, on a pro forma basis after giving effect to the Offering, the Company would have had approximately $422.2 million of Senior Debt outstanding (including $45.3 million of letters of credit issued under the Credit Facility), and the Notes would have been structurally subordinated to approximately $19.2 million of indebtedness of the Company's subsidiaries, excluding guarantees by certain of such subsidiaries of indebtedness under the Credit Facility. See "Use of Proceeds" and "Description of Notes." SEE "RISK FACTORS" BEGINNING ON PAGE 8 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION WITH AN INVESTMENT IN THE NOTES OFFERED HEREBY. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. (1) PLUS ACCRUED INTEREST, IF ANY, FROM THE DATE OF ISSUANCE. (2) THE COMPANY HAS AGREED TO INDEMNIFY THE UNDERWRITERS (AS DEFINED HEREIN) AGAINST CERTAIN LIABILITIES, INCLUDING LIABILITIES UNDER THE SECURITIES ACT OF 1933, AS AMENDED. SEE "UNDERWRITING." (3) BEFORE DEDUCTING EXPENSES PAYABLE BY THE COMPANY, ESTIMATED TO BE $ . The Notes are offered by the several Underwriters subject to prior sale, when, as and if delivered to and accepted by them, and subject to various prior conditions, including their right to reject any order in whole or in part. It is expected that delivery of the Notes will be made in New York, New York on or about , 1996. J. P. MORGAN SECURITIES INC. IN CONNECTION WITH THE OFFERING OF THE NOTES, THE UNDERWRITERS MAY OVER- ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICES OF THE NOTES OFFERED HEREBY AT LEVELS ABOVE THOSE THAT MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND FINANCIAL STATEMENTS (INCLUDING THE NOTES THERETO) INCLUDED ELSEWHERE IN THIS PROSPECTUS OR INCORPORATED HEREIN BY REFERENCE. UNLESS THE CONTEXT INDICATES OTHERWISE, THE TERMS "COMPANY" AND "HORIZON" REFER TO HORIZON/CMS HEALTHCARE CORPORATION AND ITS SUBSIDIARIES. AS USED HEREIN, A "FISCAL" YEAR MEANS A YEAR ENDING ON MAY 31. The Company is a leading provider of post-acute health care services, including specialty health care services and long-term care services, principally in the Midwest, Southwest and Northeast regions of the United States. At January 1, 1996, Horizon provided specialty health care services through 37 acute rehabilitation hospitals in 16 states (2,065 beds), 57 specialty hospitals and subacute care units in 17 states (1,875 beds), 145 outpatient rehabilitation clinics in 19 states and 2,686 rehabilitation therapy contracts in 35 states. At that date, Horizon provided long-term care services through 119 owned or leased facilities (14,793 beds) and 147 managed facilities (16,448 beds) in a total of 19 states. Other medical services offered by the Company include pharmacy, laboratory, Alzheimer's care, physician management, non-invasive medical diagnostic, home respiratory, home infusion therapy and hospice care. For the six months ended November 30, 1995, the Company derived 50% of its revenues from private sources, 32% from Medicare and 18% from Medicaid. Post-acute care is the provision of a continuum of care to patients for the twelve month period following discharge from an acute care hospital. Post-acute care services that the Company provides include: (a) inpatient and outpatient rehabilitative services; (b) subacute care; (c) long-term care; (d) contract rehabilitation therapy services; (e) pharmacy and related services; (f) clinical laboratory services; (g) non-invasive medical diagnostic services; (h) home respiratory supplies and services; (i) home infusion supplies and services; and (j) institutional hospice care. Horizon's integrated post-acute health care system is intended to provide continuity of care for its patients and enable payors to contract with one provider to provide for virtually all of the patient's needs during the period following discharge from an acute care facility. In response to current health care reform and ongoing changes in the health care marketplace, Horizon has implemented and continues to implement a strategy of extending the continuum of services offered by the Company beyond traditional long-term and subacute care to create a post-acute health care delivery system in each geographic region that it serves. The Company's strategy is designed to improve its profit margins, occupancy levels and payor mix. Continued implementation of this strategy will require the following: LEVERAGING EXISTING FACILITIES. Horizon intends to continue to use its rehabilitation, long-term care and subacute care facilities as platforms to provide a cost-effective continuum of post-acute care to managed care, private and government payors. This allows Horizon to provide its services to the increasing number of patients who continue to require rehabilitation, subacute care or long-term care after being discharged from hospitals. EXPANDING SPECIALTY HEALTH CARE SERVICES OFFERED. The Company believes that by providing a broad range of cost effective services it meets the needs of managed care and other payors. As a result, the Company has experienced and expects to continue to experience increased patient volumes in, and revenues derived from, its facilities. CROSS-SELLING BROAD SERVICE OFFERING. In response to payors' demands for a broad range of services, the Company intends to cross-sell the variety of services provided by its business units. The Company has begun to market aggressively its pharmacy services, various therapies and other medical services to its existing and newly acquired operations. CONCENTRATING OPERATIONS IN TARGETED GEOGRAPHIC AREAS. To realize operating efficiencies, economies of scale and growth opportunities, Horizon intends to continue to concentrate its operations in clusters of operating units in selected geographic areas. DEVELOPING REHABILITATION NETWORKS. Horizon intends to develop rehabilitation networks by concentrating its outpatient rehabilitation clinics in geographic locations where regional coverage, combined with the ability to provide multiple services in concert with existing acute rehabilitation, subacute and long-term care facilities, will strengthen its position with managed care payors. EXPANDING THROUGH ACQUISITIONS. Horizon intends to continue to expand its operations through the acquisition in select geographic areas of long-term care facilities and providers of specialty health care services. Management believes that such acquisitions provide opportunities to realize operating efficiencies, particularly through (a) margin improvements from enhanced utilization of rehabilitation therapies and other specialty medical services; (b) the expansion of Horizon's institutional pharmacy services into new facilities and new markets; (c) the consolidation of corporate overhead; (d) the potential to increase business by providing a full range of care to managed care providers who desire "one stop shopping;" (e) the ability to increase capacity and margins by offering higher margin and higher acuity services to patients in Company owned or operated subacute and long-term care facilities; (f) the potential to increase patient volume by expanding the continuum of care of each acquired entity on a stand-alone basis; and (g) the potential for improved buying power with respect to suppliers. The Company was incorporated under Delaware law on July 29, 1986. The Company's principal executive office is located at 6001 Indian School Road, N.E., Suite 530, Albuquerque, New Mexico 87110 and its telephone number is (505) 881-4961. The Company acquired Continental Medical Systems, Inc. ("CMS") on July 10, 1995. The purchase price, paid in shares of Common Stock of the Company, was $393.9 million (based on the market value of such shares on that date). CMS is one of the nation's largest providers of comprehensive inpatient and outpatient medical rehabilitation services and contract rehabilitation therapy services. In November 1995, the Company announced its agreement to acquire Pacific Rehabilitation & Sports Medicine, Inc. ("Pacific Rehab") for approximately 2.8 million shares of Common Stock of the Company (which had a market value of approximately $62.0 million on the day preceding such announcement). The acquisition is expected to be consummated in the first quarter of 1996. Pacific Rehab operates 72 outpatient rehabilitation clinics. In December 1995, the Company announced that it had finalized a contract to manage the operations of 134 long-term care facilities (14,757 beds) in Texas, Michigan and Oklahoma which are operated under long-term leases by Texas Health Enterprises, Inc., HEA of Michigan, Inc., and HEA of Oklahoma, Inc. (collectively, the "HEA Group"). The Company began managing these facilities on January 1, 1996 under a management contract between a subsidiary of Horizon and the HEA Group, which has an initial term of ten years. Horizon will receive a management fee equal to 6.5% of the annual gross revenues generated from the operation of the HEA Group facilities which, in the aggregate, for the year ended December 31, 1995 had approximate revenues of $220.0 million. The Company has made available a $30.0 million credit line for, among other things, the working capital and capital improvement requirements of the facilities covered by the management contract. See "Recent Developments." The following summary historical statement of operations data for the fiscal years ended May 31, 1991 through May 31, 1995 have been derived from Horizon's consolidated financial statements, as restated for the merger with CMS, which was accounted for as a pooling of interests. The summary historical financial data as of November 30, 1995 and for the six months ended November 30, 1994 and 1995 have been derived from the unaudited financial statements of Horizon, as restated for the merger with CMS. The following summary pro forma financial information has been derived from and should be read in conjunction with the unaudited pro forma financial information and notes thereto included elsewhere in this Prospectus. (SEE FOOTNOTES ON FOLLOWING PAGE) (1) To give effect to (i) the acquisition of the peopleCARE Heritage group and the consummation of certain other insignificant acquisitions; (ii) the retirement of certain senior subordinated notes; (iii) the Offering; and (iv) the pending acquisition of Pacific Rehab, as though all such transactions occurred on June 1, 1994. (2) To give effect to (i) the retirement of certain senior subordinated notes; (ii) the Offering; and (iii) the pending acquisition of Pacific Rehab, as though all such transactions occurred on June 1, 1995. (3) Special and settlement charges represent the following items by period (for historical fiscal year unless otherwise indicated): (i) 1992 -- reflects $1,000 of merger expenses incurred in connection with an acquisition accounted for as a pooling of interests and $3,319 related to a terminated merger agreement; (ii) 1993 -- reflects the write-down of certain rehabilitation facility development costs and merger expenses incurred in connection with an acquisition accounted for as a pooling of interests and expenses of subsequently integrating the acquired companies' operations; (iii) 1994 -- related to the impairment of selected rehabilitation hospital division assets of $50,244, the costs associated with the consolidation of contract therapy companies and losses related to the termination of certain relationships in the contract therapy business of approximately $22,842 and the costs related to the reduction of corporate office work force and other restructuring costs of $1,748; (iv) 1995 historical and pro forma -- reflects the effect of a revision in the Company's estimate of contract therapy receivables from third party payors of $18,377, costs of $13,500 incurred in connection with the settlement of pending litigation and related contract terminations and costs of $5,045 related to restructuring actions taken at contract therapy companies; (v) six months ended November 30, 1994 -- reflects the effect of a revision in the Company's estimate of contract therapy receivables from third party payors; and (vi) historical and pro forma six months ended November 30, 1995 -- reflects the write-off of $6.7 million in transaction costs incurred in completing the CMS merger, the $44.9 million of costs of combining and restructuring the merged companies and the $11.9 million write-down of assets expected to be divested during fiscal 1996. (4) Includes an extraordinary loss of $22,075, net of tax, recognized on the purchase of certain senior subordinated notes at a premium. (5) Adjusted EBITDA consists of earnings (loss) before minority interests, income taxes, cumulative effect of accounting change and extraordinary item plus interest, depreciation and amortization and special and settlement charges. Adjusted EBITDA is included because management believes that certain investors find it to be a useful tool for measuring a company's ability to service its debt. Adjusted EBITDA does not represent cash flow from operations, as defined by generally accepted accounting principles, and should not be considered as a substitute for net earnings as an indicator of the Company's operating performance or cash flow as a measure of liquidity. The Company also believes that the ratio of Adjusted EBITDA to interest expense is an accepted measure of debt service ability; however, such ratio should not be considered as a substitute for the ratio of earnings to fixed charges as a measure of debt service ability. (6) For purposes of computing the ratio of earnings to fixed charges (a) earnings consist of (i) earnings (loss) before minority interests, income taxes, cumulative effect of accounting change and extraordinary items and (ii) fixed charges net of capitalized interest and (b) fixed charges consist of (i) interest expense on indebtedness, including capitalized interest; (ii) amortization of debt issuance costs; and (iii) a portion of rental expense which, in the judgement of management, represents an appropriate interest factor. Earnings were insufficient to cover fixed charges in fiscal 1994 in the approximate amount of $15,034. (7) As adjusted to reflect the Offering and the application of the net proceeds therefrom. (8) As adjusted to reflect (i) the retirement of certain senior subordinated notes; (ii) the Offering; and (iii) the pending acquisition of Pacific Rehab. PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY, IN ADDITION TO THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS, THE FOLLOWING FACTORS BEFORE PURCHASING THE NOTES OFFERED HEREBY. The Company has had and will continue to have substantial indebtedness and debt service obligations. At November 30, 1995, on a pro forma basis after giving effect to the Offering, the Company would have had total outstanding long-term indebtedness (including the current portion thereof) of $613.6 million, total assets of $1,458.0 million and stockholders' equity of $627.7 million. In addition, the Company would have had $435.5 million of additional borrowing capacity under the Credit Facility. The Company also has substantial obligations under operating leases. For the six months ended November 30, 1995, the Company's lease expense was approximately $42.9 million. See "Capitalization," "Selected Financial Information" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company's ability to pay principal and interest on the Notes is dependent on the Company's future operating performance, which is itself dependent on a number of factors, many of which are beyond the Company's control, including prevailing economic conditions and financial, business, regulatory and other factors affecting the Company's business and operations. There can be no assurance that the Company's future performance will not be adversely affected by such economic conditions and financial, business, regulatory and other factors. The degree to which the Company is leveraged could have important consequences to the holders of the Notes, including: (i) a significant portion of the Company's cash flow from operations must be dedicated to the payment of interest on its indebtedness and principal repayment obligations and will not be available to the Company for its operations, capital expenditures, acquisitions or other purposes; (ii) the Company's leverage may affect the Company's flexibility in planning for, and reacting to, changes in its business, including possible acquisition activities; (iii) the Company's ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes may be limited; and (iv) the Company's borrowings under its Credit Facility are at variable rates of interest, which could result in higher interest expense in the event of an increase in interest rates. See "Description of Notes" and "Description of Certain Indebtedness." The Notes will be unsecured and subordinated in right of payment to all existing and future Senior Debt of the Company, including all indebtedness under the Credit Facility. By reason of such subordination, in the event of the insolvency, liquidation or other reorganization of the Company or if the Senior Debt is otherwise accelerated, the assets of the Company will be available to pay obligations on the Notes only after all Senior Debt has been paid in full. As a result, there may not be sufficient assets remaining to pay amounts due on any or all of the Notes then outstanding. Additional indebtedness, including Senior Debt, may be incurred by the Company and its subsidiaries from time to time, subject to the terms of the Indenture and the then outstanding indebtedness of the Company. At November 30, 1995, on a pro forma basis after giving effect to the Offering, the Notes would have been subordinated to approximately $422.2 million of Senior Debt of the Company (including $45.3 million of letters of credit issued under the Credit Facility). See "Description of Notes." The Notes will be structurally subordinated to indebtedness of the Company's subsidiaries, including guarantees by certain of such subsidiaries of indebtedness under the Credit Facility. At November 30, 1995, there would have been outstanding approximately $19.2 million of indebtedness of the Company's subsidiaries, excluding the guarantees by certain of those subsidiaries of indebtedness under the Credit Facility. DEPENDENCE UPON OPERATIONS OF SUBSIDIARIES A substantial portion of the tangible assets of the Company is held by its subsidiaries, and a substantial portion of the Company's operating revenues is derived from operations of its subsidiaries. Therefore, the Company's ability to pay interest and principal when due to holders of the Notes is dependent in part the receipt of sufficient funds from its direct and indirect subsidiaries. The ability of the Company's subsidiaries to pay dividends to the Company may be limited by the terms of the agreements governing such subsidiaries' indebtedness. LIMITATIONS IMPOSED BY CERTAIN INDEBTEDNESS The documents governing the indebtedness of the Company and its subsidiaries expected to be outstanding upon consummation of the Offering (including the Notes and the Credit Facility) will contain significant covenants that limit the ability of the Company and its subsidiaries to engage in various transactions and, in certain cases, require satisfaction of specified financial performance criteria. In addition, under each of the foregoing documents, the occurrence of any of certain specified events (including, without limitation, failure to comply with the foregoing covenants, material inaccuracies of representations and warranties, certain defaults under or acceleration of other indebtedness and events of bankruptcy or insolvency) would, in certain cases after notice and grace periods, constitute an event of default permitting acceleration of the indebtedness covered by such document. The limitations imposed by the documents governing the outstanding indebtedness of the Company and its subsidiaries are substantial, and failure to comply with them could have a material adverse effect on the Company and its subsidiaries. See "Description of Notes" and "Description of Certain Indebtedness." FUNDING OF CHANGE OF CONTROL OFFER AND ASSET SALE OFFER The Credit Facility currently prohibits the Company from purchasing any Notes or certain other indebtedness subordinated to the indebtedness under the Credit Facility, and also provides that certain change of control events with respect to the Company and asset sales would constitute a default thereunder. Any future credit agreements or other agreements relating to Senior Debt to which the Company becomes a party may contain similar restrictions and provisions. If a Change of Control or an Asset Sale (as defined herein) occurs at a time when the Company is prohibited from purchasing Notes, the Company could seek the consent of its lenders to the purchase of Notes or could attempt to refinance the indebtedness that contains such prohibition. If the Company does not obtain such a consent or repay such indebtedness, the Company will remain prohibited from purchasing Notes. In such case, the Company's failure to purchase tendered Notes would constitute an event of default under the Indenture which would, in turn, constitute a default under the Credit Facility. In such circumstances, the subordination provisions in the Indenture would likely restrict payments to the holders of Notes. See "Description of Notes." Since its inception in 1986, Horizon has rapidly expanded both the size and the diversity of its operations through (i) strategic mergers and acquisitions such as the acquisition of CMS and the pending acquisition of Pacific Rehab, (ii) the acquisition of or agreements to manage long-term care facilities including Greenery Rehabilitation Group, Inc., the peopleCARE Heritage group and the HEA Group, (iii) the development of specialty hospitals and subacute care units and (iv) the acquisition and development of other specialty health care businesses. Growth through acquisition entails certain risks in that acquired operations could be subject to unanticipated business uncertainties or legal liabilities. Horizon seeks to minimize these risks through investigation and evaluation of the operations proposed to be acquired and through transaction structure and indemnification. In addition, each such business combination presents the risk that currently unanticipated difficulties may arise in integrating the operations of the combined entities. Moreover, such business combinations present the risk that the synergies expected from the combined operations may not be realized. The various risks associated with the integration of recent and future acquisitions and the subsequent performance of such acquired operations may adversely affect Horizon's results of operations. In addition, the ability of Horizon to acquire additional operations depends upon its ability to identify appropriate acquisition candidates and to obtain appropriate financing and personnel. REIMBURSEMENT BY THIRD PARTY PAYORS For fiscal years 1993, 1994, and 1995, Horizon derived approximately 33%, 34% and 28%, respectively, of its revenues from Medicare, and 14%, 14% and 17%, respectively, of its revenues from Medicaid (excluding certain out-of-state Medicaid revenues). Changes in the mix of patients among different types of private pay sources and among private pay sources, Medicare and Medicaid can revenues and profitability of Horizon's operations. Moreover, there are increasing pressures from many payor sources to control health care costs and to limit increases in reimbursement rates for medical services. There can be no assurance that payments under governmental and third party payor programs will remain at levels comparable to present levels or that Horizon will continue to attract and retain private pay patients or maintain its current payor or revenue mixes. In attempts to limit the federal budget deficit, there have been, and Horizon expects that there will continue to be, a number of proposals to limit Medicare and Medicaid reimbursement for certain services. Horizon cannot now predict whether any of these pending proposals will be adopted or, if adopted and implemented, what effect such proposals would have on Horizon. REIMBURSEMENT RATES FOR CONTRACT THERAPY SERVICES In April 1995, the Health Care Financing Administration ("HCFA") issued a memorandum to its Medicare fiscal intermediaries as a guideline to assess costs incurred by inpatient providers relating to payment of occupational and speech language pathology services furnished under arrangements that include contracts between therapy providers and inpatient providers. While not binding on the fiscal intermediaries, the memorandum suggested certain rates to assist the fiscal intermediaries in making annual "prudent buyer" assessments of speech and occupational therapy rates paid by inpatient providers. In light of the fluid nature of the circumstances surrounding the memorandum, Horizon cannot now determine whether HCFA will continue to recommend the rates suggested in the memorandum or whether such rates will be used by HCFA as a basis for developing a salary equivalency based reimbursement system for speech and occupational therapy services. There can be no assurance that actions ultimately taken by HCFA with regard to reimbursement rates for such services will not adversely affect the Company's results of operations. During 1995, various Congressional legislators introduced reform proposals that are intended to control health care costs, to improve access to medical services for uninsured individuals and to balance the federal budget by the year 2002. Certain of these budgetary proposals have been passed by both Houses of Congress, including passage of the resultant committee bills. These proposals included reduced rates of growth in the Medicare and Medicaid programs and proposals to block grant funds to the states to administer the Medicaid program. These proposals were included in the 1995 budget reconciliation act, which the President of the United States has vetoed. In January 1996, the President presented his own plan to balance the federal budget by 2002. Discussions are continuing between members of the House of Representatives, members of the Senate and the President to devise a balanced budget plan. While these proposals do not, at this time, appear to affect Horizon adversely in any material respect, significant changes in reimbursement levels under Medicare or Medicaid and changes in applicable governmental regulations could significantly affect the future results of operations of Horizon. There can be no assurance that future legislation, health care or budgetary, or other changes in the administration or interpretation of governmental health care programs will not adversely effect the results of operations of Horizon. The federal government and the governments of all states in which Horizon operates regulate various aspects of its business. There can be no assurance that federal or state governments will not impose additional restrictions on its activities that might adversely affect its business. The operation of Horizon's long-term care facilities and certain segments of its specialty health care services and the provision of these services are subject to federal, state and local licensure and certification laws. These facilities and segments are subject to periodic inspection by governmental and other authorities to assure compliance with the various standards established for continued licensure under state law, certification under the Medicare and Medicaid programs and participation in the Veteran's Administration program. To the extent that Certificates of Need or other similar approvals are required for expansion of Horizon's operations, Horizon could be adversely affected by the failure or inability to obtain such approvals, by changes in the standards applicable to approvals and by possible delays and expenses associated with obtaining approvals. The failure to obtain, retain or renew any required regulatory approvals, licenses or certifications could prevent Horizon from being reimbursed for or offering its services or could adversely affect its operations, financial performance and ability to expand. A wide array of Medicare/Medicaid fraud and abuse provisions applies to long-term care facilities, other specialty health care facilities, pharmacies and clinical laboratories. Penalties for violations of these federal laws include exclusion from participation in the Medicare/Medicaid programs, asset forfeitures, civil penalties and criminal penalties. The Office of Inspector General ("OIG") of the Department of Health and Human Services, the Department of Justice and other federal agencies interpret these fraud and abuse provisions liberally and enforce them aggressively. Members of both the House of Representatives and the Senate have proposed various pieces of legislation to expand significantly the federal government's involvement in curtailing fraud and abuse and to increase the monetary penalties for violations of these provisions. ABSENCE OF A PUBLIC MARKET FOR THE NOTES There is no existing market for the Notes and there can be no assurance as to the liquidity of any market that may develop for the Notes, the ability of holders of the Notes to sell their Notes or the price at which holders would be able to sell their Notes. Future trading prices of the Notes will depend on many factors, including, among other things, prevailing interest rates, the Company's operating results and the market for similar securities. The Company has been advised by the Underwriters that, subject to applicable laws and regulations, the Underwriters currently intend to make a market in the Notes after the consummation of the Offering, although they are not obligated to do so and may discontinue any market-making activities with respect to the Notes at any time without notice. The Company operates in a highly competitive industry. The Company's facilities generally operate in communities that are also served by similar facilities operated by others. Some competing facilities are located in buildings that are newer than those operated by the Company and provide services not offered by the Company. In addition, some facilities are operated by nonprofit organizations or government agencies supported by endowments, charitable contributions, tax revenues and other resources not available to the Company. Some acute care hospitals that provide long-term care, subacute care and rehabilitative services are also a potential source of competition to the Company. In each area of services provided by the Company, some of its competitors have greater financial and other resources and longer operating histories than the Company. There can be no assurance that the Company will not encounter increased competition in the future that would adversely affect the Company's results of operations. See "Business -- Competition." The success and growth strategy of Horizon are dependent in part on its ability to attract and retain competent individuals with training and experience in marketing, nursing, therapy and other clinical or operating disciplines. Such persons are in high demand and often are subject to competing offers. In past years, the health care industry has experienced nursing and therapy personnel shortages. There can be no assurance that Horizon will be able to attract and retain the qualified clinical or operating personnel necessary for its business and planned growth. A future lack of such personnel could adversely affect results of operations of Horizon. Horizon acquired CMS on July 10, 1995 by means of a merger pursuant to which CMS became a wholly owned subsidiary of Horizon. The purchase price, paid in shares of Common Stock of the Company, was approximately $393.9 million (based on the market value of such shares on that date). The acquisition was accounted for as a pooling of interests. CMS is one of the nation's largest providers of comprehensive inpatient and outpatient medical rehabilitative services, operating 37 free-standing rehabilitation hospitals, providing outpatient rehabilitation at more than 140 locations, managing 13 inpatient rehabilitation units for general acute care hospitals and providing contract rehabilitation therapy services. As a result, Horizon now has an increased and significant clinical and market presence in each of the medical rehabilitation industry's three principal sectors: inpatient rehabilitation care, outpatient rehabilitation care and contract rehabilitation therapies. See "Business -- Services." In November 1995, Horizon announced its agreement to acquire Pacific Rehab through the issuance of approximately 2.8 million shares of Common Stock of Horizon (which had a market value of approximately $62.0 million on the day preceding such announcement). As of September 30, 1995, Pacific Rehab had $21.4 million of debt outstanding. The acquisition, which will be accounted for as a pooling of interests, is expected to be consummated in the first quarter of 1996. The acquisition of Pacific Rehab will significantly expand Horizon's presence in the outpatient rehabilitation clinic marketplace by adding 72 clinics to the Company's existing operations. Consummation of the acquisition is subject to certain conditions, and there can be no assurance that those conditions will be satisfied. In December 1995, the Company announced that it had finalized a contract to manage the operations of 134 long-term care facilities (14,757 beds) in Texas, Michigan and Oklahoma which are operated under long-term leases by the HEA Group. The Company began managing these facilities on January 1, 1996 under a contract between a subsidiary of Horizon and the HEA Group, which has an initial term of ten years. Horizon will receive a management fee equal to 6.5% of the annual gross revenues generated from the operation of the HEA Group facilities, which, in the aggregate, for the year ended December 31, 1995 had revenues of approximately $220.0 million. Under certain circumstances, the management fee can increase to 7.5% of the annual gross revenues. The Company has made available a $30.0 million credit line to provide for, among other things, the working capital and capital improvement requirements of the managed facilities. The credit line bears interest at 75 basis points over the Company's effective cost of borrowing under the Credit Facility, is secured by substantially all the assets of the HEA Group and is repayable out of the cash flow of the operations of the facilities, among other sources. The net proceeds to be received by the Company from the sale of the Notes offered hereby, after deducting underwriting discounts and commissions and expenses related to the Offering, are estimated to be $194.0 million. The Company will use all of the net proceeds from the Offering to repay a portion of the indebtedness outstanding under the Credit Facility. As of November 30, 1995, the indebtedness outstanding under the Credit Facility was $463.2 million. As of November 30, 1995, the effective annual interest rate on the indebtedness outstanding under the Credit Facility was 7.2%. For further information regarding the terms, including the interest rates applicable to borrowings thereunder, of the Credit Facility, see "Description of Certain Indebtedness." The following table sets forth the consolidated capitalization of the Company as of November 30, 1995 and as adjusted to reflect the Offering and the application of the net proceeds therefrom as described under "Use of Proceeds." The following selected historical statement of operations data as of and for the periods ended May 31, 1991 through May 31, 1995 have been derived from Horizon's consolidated financial statements, as restated for the merger with CMS, which was accounted for as a pooling of interests. The selected historical financial data as of November 30, 1995 and for the six months ended November 30, 1994 and 1995 have been derived from the unaudited financial statements of Horizon, as restated for the merger with CMS. The following selected pro forma financial information has been derived from and should be read in conjunction with the unaudited pro forma financial information and notes thereto included elsewhere in this Prospectus. (SEE FOOTNOTES ON FOLLOWING PAGE) (1) To give effect to (i) the acquisition of the peopleCARE Heritage group and the consummation of certain other insignificant acquisitions; (ii) the retirement of certain senior subordinated notes; (iii) the Offering; and (iv) the pending acquisition of Pacific Rehab, as though all such transactions occurred on June 1, 1994. (2) To give effect to (i) the retirement of certain senior subordinated notes; (ii) the Offering; and (iii) the pending acquisition of Pacific Rehab, as though all such transactions occurred on June 1, 1995. (3) Special and settlement charges represent the following items by period (for historical fiscal year unless otherwise indicated): (i) 1992 -- reflects $1,000 of merger expenses incurred in connection with an acquisition accounted for as a pooling of interests and $3,319 related to a terminated merger agreement; (ii) 1993 -- reflects the write-down of certain rehabilitation facility development costs and merger expenses incurred in connection with an acquisition accounted for as a pooling of interests and expenses of subsequently integrating the acquired companies' operations; (iii) 1994 -- related to the impairment of selected rehabilitation hospital division assets of $50,244, the costs associated with the consolidation of contract therapy companies and losses related to the termination of certain relationships in the contract therapy business of approximately $22,842 and the costs related to the reduction of corporate office work force and other restructuring costs of $1,748; (iv) 1995 historical and pro forma -- reflects the effect of a revision in the Company's estimate of contract therapy receivables from third party payors of $18,377, costs of $13,500 incurred in connection with the settlement of pending litigation and related contract terminations and costs of $5,045 related to restructuring actions taken at contract therapy companies; (v) six months ended November 30, 1994 -- reflects the effect of a revision in the Company's estimate of contract therapy receivables from third party payors; and (vi) historical and pro forma six months ended November 30, 1995 -- reflects the write-off of $6.7 million in transaction costs incurred in completing the CMS merger, the $44.9 million of costs of combining and restructuring the merged companies and the $11.9 million write-down of assets expected to be divested during fiscal 1996. (4) Includes an extraordinary loss of $22,075, net of tax, recognized on the purchase of certain senior subordinated notes at a premium. (5) Adjusted EBITDA consists of earnings (loss) before minority interests, income taxes, cumulative effect of accounting change and extraordinary item plus interest, depreciation and amortization and special and settlement charges. Adjusted EBITDA is included because management believes that certain investors find it to be a useful tool for measuring a company's ability to service its debt. Adjusted EBITDA does not represent cash flow from operations, as defined by generally accepted accounting principles, and should not be considered as a substitute for net earnings as an indicator of the Company's operating performance or cash flow as a measure of liquidity. The Company also believes that the ratio of Adjusted EBITDA to interest expense is an accepted measure of debt service ability; however, such ratio should not be considered as a substitute for the ratio of earnings to fixed charges as a measure of debt service ability. (6) For purposes of computing the ratio of earnings to fixed charges (a) earnings consist of (i) earnings (loss) before minority interests, income taxes, cumulative effect of accounting change and extraordinary items and (ii) fixed charges net of capitalized interest and (b) fixed charges consist of (i) interest expense on indebtedness, including capitalized interest; (ii) amortization of debt issuance costs; and (iii) a portion of rental expense which, in the judgement of management, represents an appropriate interest factor. Earnings were insufficient to cover fixed charges in 1994 in the approximate amount of $15,034. (7) As adjusted to reflect the Offering and the application of the net proceeds therefrom. (8) As adjusted to reflect (i) the retirement of certain senior subordinated notes; (ii) the Offering; and (iii) the pending acquisition of Pacific Rehab. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table sets forth certain statements of operations data expressed as a percentage of total operating revenues: SIX MONTHS ENDED NOVEMBER 30, 1995 COMPARED TO SIX MONTHS ENDED NOVEMBER 30, Total operating revenues increased approximately $88.7 million, or 11.3%, for the six months ended November 30, 1995 compared to the corresponding period in 1994. The growth in total operating revenues is primarily attributable to (i) the increase in the number of long-term care and specialty health care facilities operated by the Company, (ii) the increase in occupancy in facilities operated by the Company and (iii) the increase in Medicare, Medicaid and private and other rates received by the Company. For the six months ended November 30, 1995, the Company added seven long-term care and specialty health care facilities, representing 121 additional beds. Occupancy for the six months ended 1995 decreased to 86% compared to 88% in 1994 as a result of acquisitions with lower occupancy rates than those experienced in Horizon's other facilities. The Company's blended reimbursement rate increased 2.0% compared to 1994. Cost of services increased approximately $55.1 million, or 9.1%, for the six months ended November 30, 1995 compared to the corresponding period in 1994. The increase in cost of services is primarily attributable to the growth in the number of long-term care facilities, specialty hospitals and subacute units operated by the Company, as well as expansion of the Company's specialty health care services and programs. As a percentage of total operating revenues, cost of services declined to 76.1% from 77.7% in 1994, due largely to increased revenues from higher margin businesses. Administrative and general expenses increased $2.2 million, or 5.6%, for the six months ended November 30, 1995 compared to the corresponding period in 1994. As a percentage of operating revenues, administrative and general expenses declined to 4.8% from 5.1% in 1994. The decline in the expense margin is attributable to the Company's continued success in controlling these costs and to overhead reductions realized in the CMS merger. Facility lease expense increased $3.4 million, or 8.6%, for the six months ended November 30, 1995 compared to the corresponding period in 1994. The increase in facility lease expense is attributable to the increase in the number of leased facilities operated in 1995. As a percentage of total operating revenues, facility lease expense declined to 4.9% from 5.0% in 1994. Depreciation and amortization increased $2.1 million, or 7.7%, for the six months ended November 30, 1995 compared to the corresponding period in 1994. As a percentage of total operating revenues, depreciation and amortization declined to 3.4% from 3.5% in 1994. The increase in depreciation and amortization is attributable to the growth in the number of facilities owned in 1995 as well as the impact of capital expenditures made. Interest expense declined $2.1 million, or 7.9%, for the six month period ended November 30, 1995 compared to the corresponding period in 1994. The decline in interest expense is primarily attributable to the retirement of substantially all of the Senior Subordinated Notes (as hereinafter defined) of CMS, utilizing proceeds from the Credit Facility which bears interest at a substantially lower rate. The Company recorded a $63.5 million special charge in the six months ended November 30, 1995. The special charge resulted primarily from (i) the write-off of transaction costs of $6.7 million which had been incurred in completing the CMS merger, (ii) the approval by management of the Company of restructuring costs of $44.9 million related to efforts to combine and restructure the operations of the Company and CMS and (iii) the $11.9 million write down of assets expected to be divested during fiscal 1996. On September 26, 1995, the Company completed a tender offer and consent solicitation for two issues of publicly held indebtedness of CMS (together, the "Senior Subordinated Notes"). The Company purchased $118.7 million in principal amount of 10 3/8% Senior Subordinated Notes due 2003 at 109.25% plus a consent fee of 1.05% and $137.5 million in principal amount of 10 7/8% Senior Subordinated Notes due 2002 at 109.0% plus a consent fee of 0.75%. The Company paid $289.5 million to retire the Senior Subordinated Notes, including principal, premiums, accrued interest, consent fees and other related costs. As a result of the tender, the Company recorded an extraordinary charge related to the loss on the retirement of the Senior Subordinated Notes, including the write-off of related deferred discount, swap cancellation and financing costs, of approximately $22.1 million, net of tax, in the second quarter of fiscal 1996. YEAR ENDED MAY 31, 1995 COMPARED TO YEAR ENDED MAY 31, 1994 Total operating revenues increased $243.2 million, or 17.6%, for fiscal 1995 as compared with fiscal 1994. The majority of this increase is the result of the Company's expansion, both through acquisitions and internally, since May 31, 1994. Greenery Rehabilitation Group, Inc. ("Greenery"), which was acquired in February 1994, contributed $130.7 million of operating revenues in fiscal 1995 as compared to $46.2 million contributed during the three and one-half months Greenery was owned by the Company in fiscal 1994. peopleCARE, which was acquired in July 1994, contributed $78.3 million of operating revenues in fiscal 1995. During fiscal 1995, the Company also completed other acquisitions resulting in the addition of approximately 4,000 long-term care beds, a skilled nursing center, two sleep diagnostic clinics, two home respiratory providers and two medical diagnostic services companies. In addition, the Company entered into management contracts involving approximately 1,020 long-term care beds. Increases in Medicare, Medicaid and private pay rates also had a positive impact on revenues. The average increase in rates per patient day across all payor types was approximately 8.8%, resulting in an increase in revenues of $37.2 million. The average occupancy of the Company's facilities remained essentially flat at 88% and, as a consequence, had little or no effect on operating revenues. Cost of services and administrative and general expenses increased $161.8 million, or 14.7%, and $22.4 million, or 37.3%, respectively, in fiscal 1995 from fiscal 1994. These increases are due primarily to the increase in the number of long-term care facilities, specialty hospitals and subacute care units operated by the Company, as well as the costs associated with the expansion of specialty health care services and programs. As a percentage of total operating revenues, cost of services declined to 77.6% from 79.5% in fiscal 1994 due largely to increased revenues from higher margin businesses. Administrative and general expenses, as a percentage of total operating revenues, increased to 5.1% from 4.3% in fiscal 1994 due, in large part, to increased overhead in the contract therapy division. Facility lease expense and depreciation and amortization increased approximately $12.8 million, or 18.5%, and $8.4 million, or 17.3%, respectively, for the same period. This increase is directly related to the increased number of facilities operated in fiscal 1995. As percentages of total operating revenues, facility lease expense and depreciation and amortization remained essentially flat at 5.0% and 3.5%, respectively, compared with fiscal 1994. Interest expense increased $8.6 million, or 19.5%, in fiscal 1995 from fiscal 1994. This increase is due primarily to the following factors: (i) increased borrowings to finance an increase in the Company's average investment in owned facilities due in large part to the Greenery merger late in fiscal 1994 and the peopleCARE acquisition early in fiscal 1995, (ii) capital lease interest associated with the six peopleCARE leased facilities, (iii) assumption of $54.8 million of Greenery bonds late in fiscal 1994 and (iv) increased borrowings under the Company's then existing credit facility in connection with other acquisitions during fiscal 1995. The increased interest expense was partially offset by the retirement of $85.2 million of the Senior Subordinated Notes during fiscal 1995. The Company recorded special charges during the second, third, and fourth quarters of fiscal 1995 of $13.4 million, $5.0 million and $5.0 million, respectively. The second and fourth quarter special charges reflect the effect of a revision in the Company's estimate of accounts receivable from third party payors at its CMS Therapies, Inc. subsidiary. The third quarter special charge reflects the costs of eliminating management and staff positions, office lease terminations and certain other costs of the changes implemented during the third quarter at CMS Therapies, Inc. For further information, see Note 7 of Notes to Consolidated Financial Statements. During the fourth quarter of fiscal 1994, a special charge of $74.8 million was recorded resulting from the implementation of a plan to streamline operations and improve productivity by restructuring the Company into major operating businesses, flattening the management organization structure, writing down certain assets and, where appropriate, divesting unproductive assets. The special charge comprised several items, including (i) the impairment of assets at eight rehabilitation hospitals, divestiture of two rehabilitation hospitals, closure of a select group of outpatient locations and miscellaneous other related charges ($50.2 million), (ii) the consolidation of certain contract therapy companies, the exit from certain markets and businesses and losses related to the termination of certain business relationships ($22.8 million) and (iii) the reduction of the work force at the Company's corporate office and transaction costs related to the plan ($1.8 million). On September 27, 1995, the Company settled certain pending litigation, terminated a number of contracts with the other party to the litigation, and obtained releases of claims and potential claims relating to the litigation and the terminated contracts. In consideration for the settlement, contract terminations and releases, the Company paid cash and delivered a warrant to purchase Horizon/CMS stock. At May 31, 1995, the Company accrued $12.8 million of expenses and wrote down $0.7 million of accounts receivable to record the cash payment, warrant valuation, receivable write-off and other commitments and transaction costs relating to the settlement transaction. YEAR ENDED MAY 31, 1994 COMPARED TO YEAR ENDED MAY 31, 1993 Total operating revenues increased approximately $245.8 million, or 21.6%, for fiscal 1994 as compared with fiscal 1993. The largest portion of such increase was the result of the Company's expansion, both internally and through acquisitions, since May 31, 1993. The expansion of contract therapy services resulted in an increase in operating revenues of $74.0 million, or 23.9%, during fiscal 1994 over fiscal 1993. Net operating revenues attributable to the Company's acute rehabilitation hospitals and contract rehabilitation therapies increased $37.5 million or 7.3% during fiscal 1994 over fiscal 1993. This increase resulted primarily from the four rehabilitation hospitals which were newly opened during fiscal 1994 and a full year's results for those opened in fiscal 1993. Greenery, acquired in February 1994, contributed $46.2 million to revenues in fiscal 1994. As a result of the consummation of the Greenery merger, the Company added the operations of 17 acute rehabilitation and long-term care facilities and three managed facilities. At May 31, 1994 (excluding facilities acquired in the Greenery merger), the Company operated three more long-term care facilities, three more specialty hospitals and three more subacute care units than it did at May 31, 1993. During fiscal 1994, the Company also expanded its institutional pharmacy services, and its clinical laboratory services in Texas. An additional cause of the increase in revenues was increases in Medicare, Medicaid and private pay rates. The average increase in rates per patient day across all payor types was approximately 9.7%, resulting in an increase in operating revenues of $18.8 million. The average occupancy of the Company's facilities remained essentially flat at 89%. Cost of services and administrative and general expenses increased $206.3 million, or 23.1%, and $17.8 million, or 42.2%, respectively, in fiscal 1994 from fiscal 1993. These increases were due primarily to the increase in the number of long-term care facilities, specialty hospitals and subacute care units operated by the Company, as well as the costs associated with the expansion of specialty health care services and programs. As a percentage of total operating revenues, cost of services increased to 79.5% from 78.6% in fiscal 1993 due primarily to the opening of rehabilitation hospitals and associated costs. Administrative and general expenses, as a percentage of total operating revenues, increased to 4.3% from 3.7% in fiscal 1993 due primarily to the opening of rehabilitation hospitals. Facility lease expense and depreciation and amortization increased approximately $4.4 million, or 6.8%, and $14.3 million, or 42.3%, respectively, for the same period. This increase is directly related to the increased number of facilities operated. Greenery accounted for nearly one-half of the increase. As percentages of total operating revenues, facility lease expenses declined to 5.0% from 5.6% in fiscal 1993 while depreciation and amortization increased to 3.5% from 3.0% in fiscal 1993 due to the acquisition of more owned facilities than leased facilities. Interest expense increased $17.4 million, or 64.4%, in fiscal 1994 from fiscal 1993. This increase is related to borrowings under the Company's then-existing credit facility, and the assumption of certain bonds and secured real property indebtedness in connection with facility acquisitions during fiscal 1994. Interest expense was also higher during this period due to a higher average outstanding debt balance and higher average interest rate resulting from the issuance of $350.0 million of Senior Subordinated Notes during fiscal 1993. During the fourth quarter of fiscal 1993, the Company recorded a pre-tax charge of $14.6 million related principally to the write-off of deferred costs for approximately 30 abandoned rehabilitation hospital development projects on which construction had not started. The decision to abandon certain projects and pursue less capital intensive growth than in the past was a result of changes in the Company's rehabilitation hospital development strategy in response to changes in various health care delivery markets. Prior to fiscal 1994, the Company deferred certain costs incurred to obtain government approvals and other expenses related to the development of rehabilitation hospitals. Based on a historical high rate of completion, costs of developing a project were charged to operations only when it was probable that the project would be abandoned. As a result of its change in development strategy, the Company changed its accounting for development costs. Ongoing hospital development costs are now expensed until that time when it is probable that construction will commence. In addition, the Company recorded a pre-tax charge of $2.6 million related to the acquisition and subsequent consolidation of a physician services company. The Company has historically funded its operations and expansion program from cash flows from operating activities and financing activities. Net cash provided by operating activities was $7.4 million, $29.0 million and $10.6 million during each of the three years ended May 31, 1993, 1994 and 1995 and net cash used in operating activities was $(16.8) million and $(8.6) million in the six month periods ended November 30, 1994 and 1995. Net cash provided by financing activities was $262.8 million, $41.9 million and $127.3 million during each of the three years ended May 31, 1993, 1994 and 1995 and was $104.0 million and $76.4 in the six month periods ended November 30, 1994 and 1995. During the three years ended May 31, 1995, the primary application of the Company's cash flows was the Company's program of expansion both internally and through acquisitions. The Company's expansion program requires funds: (i) to acquire assets and to expand and improve existing and newly acquired facilities; (ii) to repay funded indebtedness assumed or otherwise acquired in connection with the acquisitions of facilities and properties; and (iii) to finance the increase in patient care and other accounts receivable resulting from acquisitions. The funds necessary to meet these requirements have been provided principally by the Company's financing and operating activities. Net cash used in investing activities during each of the three years ended May 31, 1993, 1994 and 1995 was $264.7 million, $79.9 million and $158.6 million. Similarly, net cash used in investing activities during the six month periods ended November 30, 1994 and 1995 was $109.2 million and $40.7 million. In each of such periods, the primary uses of cash in investing activities were payments pursuant to acquisition agreements, net of cash acquired, and capital expenditures (acquisitions of property and equipment). During the three years ended May 31, 1995, payments pursuant to acquisition agreements and capital expenditures aggregated $506.0 million which included the following major expenditures: (i) fiscal 1993 -- the acquisition of properties from real estate partnerships ($40.7 million) and the construction and furnishing of new hospitals ($131.2 million); (ii) fiscal 1994 -- the Greenery merger transaction ($7.8 million) and the purchase of long-term care facilities in Massachusetts ($24.0 million) and (iii) fiscal 1995 -- acquisition of peopleCARE ($61.3 million) and other acquisitions ($37.1 million). During the six month periods ended November 30, 1994 and 1995, payments pursuant to acquisition agreements and capital expenditures were $107.8 million and $40.9 million. The largest component of such expenditures was the peopleCARE acquisition which was effected in the first quarter of fiscal 1995. Capital expenditures during these periods were primarily used to fund the Company's internal and external expansion program. For fiscal 1996, the Company has budgeted for capital expenditures in the range of $35.0-$45.0 million. At November 30, 1995, the Company's working capital was $329.8 million, including cash and cash equivalents of $26.4 million. This compared with working capital of $284.3 million, including cash and cash equivalents of $40.7 million, at May 31, 1995 and $232.6 million, including cash and cash equivalents of $61.4 million, at May 31, 1994. As indicated above, the Company generated positive cash flow from operations during the three years ended May 31, 1995. During the six month periods ended November 30, 1994 and 1995, these operating activities used $(16.8) million and $(8.6) million in net cash. During the six months ended November 30, 1995, accounts and settlements receivable increased $46.0 million, substantially all of which represents increases generated by existing facilities or generated by new facilities after the date of acquisition and the settlement of cost reports for various periods. At November 30, 1995, the available credit under the Credit Facility was $241.5 million and, on a pro forma basis after giving effect to the Offering, the available credit thereunder would be $435.5 million. See "Use of Proceeds" and "Description of Certain Indebtedness." To the extent that the Company's operations and expansion program require cash expenditures in excess of cash from operations and the amounts available to it under the Credit Facility, management of the Company believes that the Company can obtain the necessary funds through other financing activities, including the issuance and sale of debt and equity in public and private markets. The Company is a leading provider of post-acute health care services, including specialty health care services and long-term care services, principally in the Midwest, Southwest and Northeast regions of the United States. At January 1, 1996, Horizon provided specialty health care services through 37 acute rehabilitation hospitals in 16 states (2,065 beds), 57 specialty hospitals and subacute care units in 17 states (1,875 beds), 145 outpatient rehabilitation clinics in 19 states and 2,686 rehabilitation therapy contracts in 35 states. At that date, Horizon provided long-term care services through 119 owned or leased facilities (14,793 beds) and 147 managed facilities (16,448 beds) in a total of 19 states. Other medical services offered by the Company include pharmacy, laboratory, Alzheimer's care, physician management, non-invasive medical diagnostic, home respiratory, home infusion therapy and hospice care. For the six months ended November 30, 1995, the Company derived 50% of its revenues from private sources, 32% from Medicare and 18% from Medicaid. Post-acute care is the provision of a continuum of care to patients for the twelve month period following discharge from an acute care hospital. Post-acute care services that the Company provides include: (a) inpatient and outpatient rehabilitative services; (b) subacute care; (c) long-term care; (d) contract rehabilitation therapy services; (e) pharmacy and related services; (f) clinical laboratory services; (g) non-invasive medical diagnostic services; (h) home respiratory supplies and services; (i) home infusion supplies and services; and (j) hospice care. Horizon's integrated post-acute health care system is intended to provide continuity of care for its patients and enable payors to contract with one provider to provide for virtually all of the patient's needs during the period following discharge from an acute care facility. In response to current health care reform and ongoing changes in the health care marketplace, Horizon has implemented and continues to implement a strategy of extending the continuum of services offered by the Company beyond traditional long-term and subacute care to create a post-acute health care delivery system in each geographic region that it serves. The Company's strategy is designed to improve its profit margins, occupancy levels and payor mix. Continued implementation of this strategy will require the following: Horizon intends to continue to use its rehabilitation, long-term care and subacute care facilities as platforms to provide a cost-effective continuum of post-acute care to managed care, private and government payors. This allows Horizon to provide its services to the increasing number of patients who continue to require rehabilitation, subacute care or long-term care after being discharged from hospitals. These patients often cannot receive proper care in the home because of the complex monitoring and specialized medical treatment required. Horizon is able to offer these complex medical services at a significantly lower cost than acute care hospitals because its facilities have lower capital and operating costs than acute care hospitals. EXPANDING SPECIALTY HEALTH CARE SERVICES OFFERED The Company believes that by providing a broad range of cost effective services it meets the needs of managed care and other payors. As a result, the Company has experienced and expects to continue to experience increased patient volumes in, and revenues derived from, its facilities. The Company intends to diversify further the specialty services it offers. In response to payors' demands for a broad range of services, the Company intends to cross-sell the variety of services provided by its business units. The Company has begun to market aggressively its pharmacy services, various therapies and other medical services to its existing and newly acquired operations. As a result of these efforts, the Company has achieved significant market positions in large markets, such as Texas and Nevada, where it offers a full continuum of post-acute care through the integration of rehabilitation, subacute, long-term and other medical services. CONCENTRATING OPERATIONS IN TARGETED GEOGRAPHIC AREAS To realize operating efficiencies, economies of scale and growth opportunities, Horizon intends to continue to concentrate its operations in clusters of operating units in selected geographic areas. The Company believes that concentration of its rehabilitation hospitals and long-term care facilities within selected geographic regions (a) provides Horizon with a platform from which it can expand its specialty health care services, (b) enhances the development of stronger local referral sources through concentrated marketing efforts and (c) facilitates the establishment of effective working relationships with the regulatory and legislative authorities in the states in which the Company operates. Horizon intends to develop rehabilitation networks by concentrating its outpatient rehabilitation clinics in geographic locations where regional coverage, combined with the ability to provide multiple services in concert with existing acute rehabilitation, subacute and long-term care facilities, will strengthen its position with managed care payors. The Company believes that these networks better enable it to provide a more complete continuum of care and also establish the Company as a provider of choice for the region or locality. By concentrating its rehabilitation facilities, the Company expects to be better able to negotiate comprehensive rehabilitation contracts and leverage the clinical expertise in an individual market. Horizon intends to continue to expand its operations through the acquisition in select geographic areas of long-term care facilities and providers of specialty health care services. Management believes that such acquisitions provide opportunities to realize operating efficiencies, particularly through (a) margin improvements from enhanced utilization of rehabilitation therapies and other specialty medical services; (b) the expansion of Horizon's institutional pharmacy services into new facilities and new markets; (c) the consolidation of corporate overhead; (d) the potential to increase business by providing a full range of care to managed care providers who desire "one stop shopping;" (e) the ability to increase capacity and margins by offering higher margin and higher acuity services to patients in Company owned or operated subacute and long-term care facilities; (f) the potential to increase patient volume by expanding the continuum of care of each acquired entity on a stand-alone basis; and (g) the potential for improved buying power with respect to suppliers. The post-acute care industry encompasses a broad range of health care services for patients with medically complex needs who can be cared for outside of acute care hospitals. The Company believes that it is well positioned to create a post-acute health care delivery system in each geographic region it serves by capitalizing on favorable industry trends, which include: In response to rapidly rising costs, governmental and private pay sources have adopted cost containment measures that encourage reduced length of stays in acute care hospitals. These third party payors have implemented strong case management and utilization review procedures. In addition, traditional private insurers have begun to limit reimbursement to predetermined "reasonable charges," while managed care organizations such as health maintenance organizations and preferred provider organizations are attempting to limit hospitalization costs by monitoring and reducing hospital utilization and by negotiating discounted rates for hospital services or fixed charges for procedures regardless of length of stay. As a result, average acute care hospital stays have been shortened, and many patients are discharged despite a continuing need for specialty health care services or nursing care. According to the U.S. Bureau of the Census, approximately 1.4% of people 65-74 years of age received care in long-term care facilities in 1990, while 6.1% of people 75-84 years of age and 24.5% of people over age 85 received such care. The U.S. Bureau of the Census estimates that the U.S. population over age 75 will increase from approximately 13 million, or 5.2% of the population, in 1990 to approximately 17 million, or 6.1% of the population, by the year 2000. In particular, the segment of the U.S. population over 85 years of age, which comprises 45-50% of residents at long-term care facilities nationwide, is projected to increase by more than 40%, from approximately 3 million, or 1.2% of the population, in 1990 to more than 4 million, or 1.6% of the population in 2000. The population over age 65 suffers from a greater incidence of chronic illnesses and disabilities than the rest of the population and currently accounts for more than two-thirds of total health care expenditures in the United States. As the number of Americans over age 65 increases, the need for long-term care services is also expected to increase. Advances in medical technology have increased the life expectancy of a growing number of patients who require a high degree of care traditionally not available outside acute care hospitals. For such patients, home health care often is not a viable alternative because of the complexity of medical services and equipment required. As a result, the Company believes that there is an increasing need for care facilities that provide 24 hours-a-day supervision and specialty care at a significantly lower cost than traditional acute care and rehabilitation hospitals. Recently, the industry has been subject to competitive pressures that have resulted in a trend towards consolidation of smaller, local operators into larger, more established regional or national operators. The increasing complexity of medical services, growing regulatory and compliance requirements and increasingly complicated reimbursement systems have resulted in consolidation of small operators who lack the sophisticated management information systems, geographic diversity, operating efficiencies and financial resources to compete effectively. The following table summarizes each of the Company's business units by revenues for the periods indicated: Horizon provides a variety of specialty health care services, including acute rehabilitation, subacute care, rehabilitation therapies (occupational, speech and physical therapies (in both inpatient and outpatient settings) and treatment of traumatic head injury and other neurological impairments), institutional pharmacy services, Alzheimer's care, non-invasive medical diagnostic testing services, home respiratory care services and supplies, and clinical laboratory services. Horizon believes that providing a broad range of specialty health care services and programs enables the Company to attract patients with more complex health care needs. In addition, these services typically generate higher profit margins than long-term care patient services. ACUTE REHABILITATION. At January 1, 1996, Horizon operated 37 freestanding comprehensive acute rehabilitation hospitals with a total of 2,065 licensed acute rehabilitation beds located in 16 states. Generally, these hospitals are located in the same geographic area as Horizon's long-term care or subacute care facilities (including specialty hospitals) and therefore benefit from referrals from such facilities. Many of Horizon's rehabilitation hospitals are operated through joint ventures with local general acute care hospitals, physicians and other investors. Horizon's rehabilitation unit management group operates inpatient and outpatient rehabilitation programs within acute care hospitals. At January 1, 1996, the Company managed 12 rehabilitation units with more than 270 beds in such acute care hospitals. In addition, the Company's freestanding rehabilitation hospitals typically provide on-site outpatient services. SUBACUTE CARE. Horizon provides subacute care to high acuity patients with medically complex conditions who require ongoing, multi-disciplinary nursing and medical supervision and access to specialized equipment and services but who do not require many of the other services provided by an acute care hospital. Horizon's subacute care services include dedicated programs for rehabilitative ventilator care, wound management, general rehabilitation, head trauma/coma stimulation and infusion therapy. The Company's subacute care services are provided through both its specialty hospitals and its subacute care units. Generally, these specialty hospitals and subacute care units are located in separate areas within the physical structures of the Company's long-term care facilities and are supervised by separate nursing staffs employed by the Company. As of January 1, 1996, the Company operated 57 specialty hospitals and subacute care units, including one standalone specialty hospital, with 1,863 beds in 17 states. Horizon believes that private insurance companies and other third party payors, including certain state Medicaid programs, recognize that treating patients requiring subacute care in specialty units such as those operated by Horizon is a cost effective alternative to treatment in acute care hospitals. Horizon believes that it can continue to offer subacute care at rates substantially below those typically charged by acute care hospitals for comparable services. The Company's specialty hospitals are operated under specialty hospital licenses that permit the Company to provide higher acuity services and, as a consequence, to receive higher reimbursement rates than subacute care units which are operated under long-term care facility licenses. It is Horizon's belief that such specialty hospital licenses enhance its marketing efforts to referral sources such as physicians, managed care providers and hospital discharge planners. Once a specialty hospital license has been obtained, the beds so licensed generally can no longer be used for patients who require only basic patient care. Horizon is a party to a number of contracts with commercial insurers and managed care providers and out-of-state enhanced rate Medicaid provider agreements. Horizon believes that these relationships will enable it to improve its reimbursement rates and profit margins. CONTRACT REHABILITATION THERAPIES. Horizon provides a comprehensive range of rehabilitation therapies, including physical, occupational, respiratory (including inpatient and outreach services) and speech therapy services to skilled nursing facilities, general acute care hospitals, schools, home health agencies, inpatient rehabilitation hospitals and outpatient clinics. As of January 1, 1996, Horizon provided these services through approximately 2,686 contracts in 35 states, 184 of which are with Company-operated long-term care facilities, specialty hospitals and subacute facilities, and 2,502 of which are term care facilities, home health agencies, hospitals, outpatient clinics or school systems. The CMS merger has significantly expanded Horizon's presence in the contract rehabilitation therapy marketplace, making Horizon one of the nation's leading providers of these services. OUTPATIENT REHABILITATION. The Company provides rehabilitation therapies to ambulatory patients recovering from industrial injuries, sports-related injuries and other general orthopedic conditions. Horizon's outpatient clinics provide rehabilitation programs dedicated to industrial reconditioning, sports medicine, aquatic therapy, back stabilization, arthritis, osteoporosis, pain management, total joint replacement and general rehabilitation. These services are provided in freestanding outpatient facilities and ambulatory outpatient clinics within institutional settings, as well as by a staff of fully-trained professionals who rehabilitate patients in their own homes. As of January 1, 1996, Horizon provided outpatient services through 145 outpatient rehabilitation clinics in 19 states. The proposed merger with Pacific Rehab will significantly expand Horizon's presence in the outpatient rehabilitation clinic marketplace by adding 72 clinics, many of which are concentrated in major cities. The proposed merger would enable Horizon to consolidate its existing outpatient rehabilitation clinic business with Pacific Rehab's business into a single network of outpatient rehabilitation clinics, with a centralized management and regional marketing structure. This combined structure will enhance the geographic diversity of the two companies. Management of Horizon believes that significant synergies can be realized through the proposed merger. INSTITUTIONAL PHARMACY. Horizon has established a network of 28 regionally located pharmacies in 14 states through which it provides a full range of prescription drugs and infusion therapy services, such as antibiotic therapy, pain management and chemotherapy, to over 38,400 beds in facilities operated by Horizon and by third parties. These pharmacy operations (certain of which are managed by third parties) enable Horizon to generate revenues from services previously provided to Horizon by third-party pharmacy vendors. Of the total beds serviced by Horizon's institutional pharmacies, 20,500 are located in facilities not operated by Horizon. ALZHEIMER'S CARE. Horizon offers a specialized program for persons with Alzheimer's disease through its Alzheimer's centers. At January 1, 1996, this program had been instituted at 25 of Horizon's long-term care facilities, with a total of 816 beds. Each Alzheimer's center is located in a designated wing of a long-term care facility and is designed to address the problems of disorientation experienced by Alzheimer's patients and to help reduce stress and agitation resulting from a short attention span and hyperactivity. Each Alzheimer's center employs a specially trained nursing staff and an activities director and engages a medical director with expertise in the treatment of Alzheimer's disease. The program also provides education and support to the patient's family. Horizon's long-term care facilities provide routine basic patient services to geriatric and other patients with respect to daily living activities and general medical needs. Such basic patient services include daily dietary services, recreational activities, social services, housekeeping and laundry services, pharmaceutical and medical supplies and 24 hours-a-day access to registered nurses, licensed practical nurses and related services prescribed by the patient's physician. At January 1, 1996, Horizon operated 266 long-term care facilities (31,241 beds), of which 46 were owned (6,031 beds) and 73 were leased (8,762 beds), and also managed 147 long-term care facilities (16,448 beds), located in a total of 19 states. PHYSICIAN "LOCUM TENENS." Horizon provides physician locum tenens services to institutional providers and physician practice groups throughout the United States. The Company recruits, credentials and places health care providers in appropriate short-term, long-term or permanent positions in most physician and allied health care specialties. The Company also provides credentialing assistance, recruitment outsourcing, staff planning services and educational programs for physicians and health care executives. NON-INVASIVE MEDICAL DIAGNOSTICS. During fiscal 1994, Horizon began providing non-invasive medical diagnostic testing services by way of mobile units and fixed location operations (generally in acute care hospitals) through a network of physicians and surgeons. These services include cardiovascular (both cardiac imaging and vascular imaging), pelvic and abdominal testing services and sleep diagnostic services. Horizon has recently expanded its diagnostic expertise and the diagnostic markets it serves through acquisitions. CLINICAL LABORATORY SERVICES. In fiscal 1993, Horizon established a comprehensive clinical laboratory, located in Dallas, Texas, to serve the long-term care industry. The clinical laboratory provides bodily fluid testing services to assist in detecting, diagnosing and monitoring diseases. This laboratory has all necessary state regulatory approvals to conduct business in the states in which Horizon currently operates and is certified to receive reimbursement for charges to patients covered by Medicare and Medicaid. At January 1, 1996, the laboratory provided services to approximately 10,000 beds. HOME RESPIRATORY; HOME INFUSION. The Company provides home respiratory care services and supplies to home care patients in Texas, Oklahoma, Arkansas, Louisiana, Tennessee and Kentucky through a physician referral base. The Company employs a fully-trained nursing staff to perform these services, which include the provision of home infusion and intravenous therapies. Supplies provided by the Company include gas and liquid oxygen cylinders, oxygen concentrators and aerosol nebulizers. HOSPICE CARE. Commencing in fiscal 1996, the Company began providing hospice care in Texas to home-bound and institutionalized, terminally ill patients. Hospice care includes the provision of all durable medical equipment, intravenous therapies and pharmaceuticals incident to such care. The Company's operations are organized principally according to the services provided. It is an objective of the Company to delegate operational responsibility to operational managers located within local communities to the extent practicable. Regional managers in each business unit report to business unit managers who, in turn, report to senior management. These managers are supported by a broad range of support services supplied by the Company's corporate and regional staffs. These support services include marketing assistance, training, quality assurance oversight, human resource management, reimbursement expertise, accounting, cash management, legal services and management support. The Company has established standardized operating procedures for its units and monitors the units to assure consistency of operations. The Company's specialty health care operations are organized as follows: ACUTE REHABILITATION. The Company's acute rehabilitation business is supervised by an Executive Vice-President and is organized into three regions each supervised by a divisional president. Acute rehabilitation services are provided in freestanding comprehensive rehabilitation hospitals and provide care in the form of physical, psychological, social and vocational rehabilitative services. Each rehabilitation hospital is supervised by a chief executive officer. Services are provided by a number of different types of health care professionals, predominately physicians specializing in rehabilitation medicine, nurses and physical, speech, occupational, recreation and respiratory therapists, aides and assistants. SUBACUTE CARE. The Company's subacute care operations are organized into two geographic regions, each of which is supervised by a Director of Operations. Each of the subacute care facilities and/or specialty hospitals is supervised by a licensed administrator and a governing board. Each of the subacute care facilities and specialty hospitals employs a Director of Nursing Services, who supervises a staff of registered nurses, licensed practical nurses and nurses' aides. A Medical Director and a staff of resident medical professionals supervise the medical management of all patients. CONTRACT REHABILITATION THERAPIES. The Company's contract rehabilitation therapy operations are organized into eight regional operational divisions, each of which is supervised by a Director of Operations. These regional divisions each recruit, hire, train and supervise the physical, occupational and speech pathology therapists that provide the "hands on" therapy services to the Company's facilities and, to a greater extent, third parties. Each of the Directors of Operations is responsible not only for the productivity of the therapists employed by the Company but also for the compliance with the Company's policies and procedures in billing for services rendered. OUTPATIENT REHABILITATION. Several of the Company's outpatient rehabilitation clinics are operated through the hospital division as ambulatory clinics within a hospital setting (while not necessarily part of the physical structure of the hospital). Other clinics are operated through the contract therapy division as freestanding clinics. In either case, the day to day operations of the clinic are supervised by a therapy manager with general oversight provided by either a hospital administrator or contract therapy regional manager. The acquisition of Pacific Rehab will provide a structure to develop this division more effectively, permitting the consolidation of outpatient services while continuing the extension of hospital programs. The merger will result in the development of five geographic regions, each supervised by a Regional Vice President. These individuals recruit, hire, train and supervise the physical, occupational and speech pathology therapists, as well as the administrative and marketing personnel who operate the outpatient clinics. INSTITUTIONAL PHARMACY SERVICES. The Company's institutional pharmacy business is organized into geographic pharmacy distribution centers in each of the states where the Company provides these services. In each of the pharmacy distribution centers, the Company employs pharmacists to fill prescriptions ordered in each of the facilities with which the Company has contracted. Each of these pharmacy distribution centers also prepare and provide enteral and parenteral supplies as ordered in addition to all legally required pharmaceutical consulting services. These operations are supervised by a Vice President of Pharmacy Services. In addition, the regional managers recruit, hire, train and supervise the pharmacists employed by the Company. The Company's long-term care facilities (including its Alzheimer's centers) are organized into four regions, each of which is supervised by a Vice President of Operations. For every six to twelve centers within each region, a District Director, Quality Assurance Nurse and Dietary Consultant are responsible for monitoring operations. Each facility operated by the Company is supervised by a licensed administrator and employs a Director of Nursing Services, who supervises a staff of registered nurses, licensed practical nurses and nurses' aides. A Medical Director supervises the medical management of all patients. Other personnel include dietary staff, housekeeping, laundry and maintenance staff, activities and social services staff and a business office staff. OTHER SPECIALTY HEALTH CARE OPERATIONS PHYSICIAN "LOCUM TENENS." The Company's locum tenens business is organized into two divisions, physicians and allied health care professionals, each supervised by a division leader. These divisions each recruit, hire, credential, market and provide risk management assistance for the physicians and other health care professionals provided to hospitals, physician practices and managed care payors on a temporary basis. NON-INVASIVE MEDICAL DIAGNOSTICS. The Company's non-invasive medical diagnostic business is headquartered in Albuquerque, New Mexico and is divided into several geographic regions. Each of these regions is supervised by a regional supervisor, who recruits, hires, trains and supervises diagnostic technicians who work either in the Company's hospital-based operations or in the Company's mobile units. The Company also operates one of the largest physician training programs in the medical diagnostic industry. CLINICAL LABORATORY SERVICES. The Company's clinical laboratory operation is based in Dallas, Texas, and is operated by the Vice President of Operations for the clinical laboratory. A Medical Director supervises the testing of samples at the laboratory. When a facility physician orders lab testing for a patient, the necessary samples are drawn at the facility and shipped by overnight delivery service to the Company's clinical laboratory. The ordered tests are completed and the results are transmitted electronically back to the facility. HOME RESPIRATORY; HOME INFUSION. The Company's home respiratory service businesses are organized into four geographic regions, each of which is supervised by a Director of Operations. These regional directors report to the Company's Vice President of Specialty Medical Services. Each regional office recruits, hires, trains, and supervises the nursing staff employed by the Company. HOSPICE CARE. The Company's hospice care business is currently organized into two regional operational offices. Each regional office recruits, hires, trains and supervises the nursing and clergy staff who provide the hospice care. These regional offices are supervised by a director of operations located at the Company's headquarters in Albuquerque, New Mexico. The Company believes that the selection of a post-acute care provider is strongly influenced by advice rendered by physicians, managed care providers and hospital discharge planners. As a result, the Company has focused its marketing efforts at the community level and attempts to identify, develop and maintain relationships with these primary referral sources. These efforts have been supplemented by corporate management which emphasizes the diverse array of services offered by the Company and the significant opportunities for cross-selling these services. Where appropriate, the Company consolidates its marketing efforts to benefit all the facilities in a regional cluster. The Company has implemented a comprehensive program of financial and managerial controls to ensure adequate monitoring of its diverse business units. Financial control is maintained through financial and accounting policies that are established at the corporate level for use at, and with respect to, each facility. The Company's financial reporting system enables it to monitor certain key financial data at each facility, such as payor mix, admissions and discharges, cash collections, net patient care revenues and staffing. Managerial control is maintained through standard operating procedures which establish and promote consistency of operations. All support and development functions are centralized at the Company's headquarters in Albuquerque, New Mexico. This system allows corporate management access to information from any acute rehabilitation hospital, subacute care or long-term care facility in its network on a daily basis and provides for monthly review of results of operations by corporate and regional personnel as well as periodic site visits for more detailed reviews. In addition, payroll information is routinely examined biweekly. Each business unit develops monthly budgets that are then reviewed by corporate management and compared to the prior year's budget and actual results prior to approval. The Company has developed a comprehensive quality assurance program intended to maintain a high standard of care with respect to all of the services it provides to patients. Under the Company's long-term and subacute care quality assurance program, the care and services provided at each facility are evaluated quarterly by a quality assurance team that reports directly to the Company's management and to the administrator of each facility. The long-term and subacute program is comprised of a quality assurance checklist and a patient satisfaction survey and evaluation. The checklist, completed quarterly by the regional quality assurance nurses employed by the Company, provides for ongoing evaluation. Patient satisfaction is evaluated through patient satisfaction surveys. Patients and their families are encouraged to recognize employees who demonstrate outstanding performance. Bonuses paid to long-term and subacute facility administrators are dependent in part upon the rankings of their facilities in these surveys. In order to assist patients and their families in resolving any concerns they may have, the Company has also established a resident advocacy program. The Company has also developed a similar, though more specialized, quality assurance program for its Alzheimer's living centers. Under the Company's acute rehabilitation hospital quality assurance program, the quality of the care and services provided at the hospitals is supervised and evaluated on a continuous basis by a full time quality manager in each hospital. Quality and risk management measures are captured in a hospital-based program throughout the month and summarized results are routinely evaluated against national benchmarks. The corporate office has access to the hospital-based data enabling a coordinated quality assurance effort. Patient surveys are also collected at time of discharge to evaluate patient satisfaction. Patient outcomes are similarly evaluated by corporate management. At January 1, 1996, the Company operated (a) 37 acute rehabilitation hospitals, of which 15 were owned (either directly or through joint venture arrangements) and the balance were leased; (b) ten specialty hospitals; (c) 47 subacute care units; (d) 266 long-term care facilities (including 147 which were operated by the Company under management contracts), of which 119 were owned or leased; (e) 145 outpatient rehabilitation units; and (f) 28 pharmacy units. Information regarding the geographic location of these facilities is provided in the following table: (1) All of such long-term care facilities are managed by the Company under a contract entered into as a part of the Company's acquisition of Greenery Rehabilitation Group, Inc. (2) Includes seven long-term care and subacute care facilities consisting of 810 beds managed by the Company. (3) Includes eight long-term care facilities consisting of 946 beds covered by the Company's management contract with the HEA Group. (4) Includes one long-term care facility consisting of 120 beds managed by the Company. (5) Includes ten long-term care facilities consisting of 1,086 beds covered by the Company's management contract with the HEA Group. Also includes one long-term care facility consisting of 110 beds managed by the Company. (6) Includes 116 long-term care facilities consisting of 12,725 beds covered by the Company's management contract with the HEA Group. Also includes one long-term care facility consisting of 90 beds managed by the Company. The Company derives substantially all of its revenues from private pay patients, non-affiliated long-term care facilities and public funding through the Medicare, Medicaid, Veterans' Administration and other governmental benefit programs. The Company's charges for private pay patients are established by the Company from time to time and the level of such charges is generally not subject to regulatory control. The Company classifies payments from individuals who pay directly for services without government assistance as private pay revenues. The private pay classification includes revenues from sources such as commercial insurers and health maintenance organizations. The Company bills private pay patients and rehabilitation therapy customers (or their insurers or health maintenance organizations) on a monthly basis for services rendered. These billings are due and payable upon receipt. The Company typically receives payments on a current basis from individuals and within 60 to 90 days of billing from commercial insurers and health maintenance organizations. Under the Medicare program and some state Medicaid programs, the Company's acute rehabilitation hospitals, subacute care facilities, specialty hospitals and long-term care facilities are periodically paid in amounts designed to approximate the facilities' reimbursable costs or the applicable payment rate. Actual costs incurred are reported by each facility annually. Such cost reports are subject to audit, which may result in upward or downward adjustment for Medicare payments received. Most of the Company's Medicaid payments are prospective payments intended to approximate costs, and normally no retroactive adjustment is made to such payments. However, under certain of the Company's specialty health care businesses, the Company's Medicare reimbursement is either on a fee screen or fee for service basis. The Company is generally paid for these services within 60 to 90 days. The following table identifies the Company's revenues attributable to each of its revenue sources for the periods indicated below: The Company's long-term care facilities principally compete for patients with other long-term care facilities and, to a lesser extent, with home health care providers and acute care hospitals. In competing for patients, a facility's local reputation is a critical factor. Referrals typically come from acute care hospitals, physicians, religious groups, other community organizations, health maintenance organizations and patients' families and friends. Members of a patient's family generally actively participate in selecting a long-term care facility. Other factors that affect a facility's ability to attract patients include the physical plant condition, the ability to identify and meet particular health care needs in the community, the rates charged for services, and the availability of personnel to provide the requisite care. The primary competitive factors in the rehabilitation services business are quality outcomes and cost efficiency. As managed care companies increase their influence within the markets the Company serves, the Company's competitive position in such markets will increasingly depend on its ability to negotiate provider contracts with organized purchasers of health care services, including health maintenance and preferred provider organizations, medical groups and other third party payors. Competition for acute rehabilitation services includes other inpatient rehabilitation hospitals as well as local acute care hospitals. The Company believes recent cost containment efforts of federal and state governments, health maintenance and preferred provider organizations and other third party payors are designed to encourage more efficient utilization of health care services and have resulted in lower acute care hospital occupancy, motivating some of these acute care hospitals to convert to, or add, specialized post-acute facilities in an attempt to meet patient care needs in a more cost efficient manner. Competition for subacute care patients is increasing by virtue of market entry by other care providers. These market entrants include acute care hospitals, rehabilitation hospitals and other specialty service providers. Important competitive factors include the reputation of the facility in the community, the services offered, the availability of qualified nurses, local physicians and hospital support, physical therapists and other personnel, the appearance of the facility and the cost of services. Competition for contract rehabilitation therapy services comes, primarily, from small locally-based firms. Increasingly, the Company faces competition from inpatient health care providers seeking to insource rehabilitation therapy services. The Company believes it will be able to compete successfully with local firms by maintaining its strong reputation in the local communities and by establishing new relationships through internal expansion and strategic acquisitions. The Company also believes its variety of service delivery settings will allow it to compete successfully for therapists with providers seeking to insource such services. The Company also faces competition in its other specialty health care lines of business: institutional pharmacy services, Alzheimer's care, noninvasive medical diagnostic services and clinical laboratory services. The degree of competition varies depending on local market conditions. Competitive factors include nature and quality of the services offered, timeliness of delivery of services and availability of qualified personnel. A key element of the Company's strategy is to expand through the acquisition of long-term care facilities and specialty medical and related businesses. In making such acquisitions, the Company competes with other providers, some of which may have greater financial resources than the Company. Certain of these providers are operated by not-for-profit organizations and similar businesses that can finance capital expenditures on a tax-exempt basis or receive charitable contributions unavailable to the Company. There can be no assurance that suitable facilities can be located, that acquisitions can be consummated or that acquired facilities can be integrated successfully into the Company's operations. See "Risk Factors -- Competition" and "-- Acquisitions and Expansion." As of January 1, 1996, the Company employed approximately 35,000 persons, and approximately 1,476 or 4% of the Company's employees were covered by collective bargaining contracts. In addition, 424 employees have opted to organize into collective bargaining units and to be covered by collective bargaining agreements in the future. Of the 21 collective bargaining contracts covering the Company's employees, four will expire in calendar year 1996, eight will expire in calendar year 1997 and nine will expire in calendar year 1998. The Company believes it has had good relationships with the unions which represent its employees, but it cannot predict the effect of continued union representation or organizational activities on its future activities. The Company also believes that it has good relationships with its non-union employees. Although the Company believes it is able to employ sufficient personnel to staff its facilities adequately, a shortage of therapists and nurses in key geographic areas could affect the ability of the Company to attract and retain qualified professional health care personnel or could increase the Company's labor costs. The Company competes with other health care providers for both professional and non-professional employees and with non-health care providers for non-professional employees. The directors and executive officers of the Company are as follows: Neal M. Elliott, the Company's President, Chief Executive Officer and Chairman of the Board, has served in those capacities since July 1986. Mr. Elliott, a certified public accountant, worked for Price Waterhouse & Co. prior to joining The Hillhaven Corporation ("Hillhaven") as Controller in 1969. In 1970, Mr. Elliott became Vice President of Finance for Hillhaven and served as such until 1983. From 1983 to 1986, Mr. Elliott served as President of the long-term care group of National Medical Enterprises, Inc., a health care company then affiliated with Hillhaven. Mr. Elliott is a director of LTC Properties, Inc., a real estate investment trust which invests in health care related real estate. Robert A. Ortenzio has been Executive Vice President and a Director of the Company since July 1995. He is also President and Chief Operating Officer of CMS, and has served in those capacities since May 1989 and April 1988, respectively. He joined CMS as a Senior Vice President in February 1986. Prior thereto, he was a Vice President of Rehab Hospital Services Corporation. Mr. Ortenzio is also a director of American Oncology Resources, Inc. and OccuSystems, Inc. Michael A. Jeffries, the Company's Senior Vice President of Operations, has served the Company in such position since June 1989. He became a Director of the Company in January 1992. Mr. Jeffries has 15 years of experience in the long-term health care industry. From 1984 to 1989, he served as Senior Vice President of Operations for the Central Division of Beverly Enterprises, Inc., an operator of long-term health care facilities. From 1983 to 1984, Mr. Jeffries, a certified public accountant, held the positions of Vice President of Operations and Assistant to the President of Beverly Enterprises, Inc. Charles H. Gonzales, the Company's Senior Vice President of Subsidiary Operations, has served in such position since January 1992. He became a Director of the Company in January 1992. From September 1986 to January 1992, Mr. Gonzales, a certified public accountant, served as Senior Vice President of Government Programs for the Company. From June 1984 to September 1986, Mr. Gonzales was National Director of Reimbursement for Hillhaven. Ernest A. Schofield, the Company's Senior Vice President, Treasurer, and Chief Financial Officer, has been with the Company since July 1987. From July 1987 to April 1988, he served as a reimbursement analyst for the Company, from April 1988 to May 1989, he served as Assistant Controller, from May 1989 to November 1990, he served as Vice President and Controller of the Company, and from November 1990 to August 1994 he served as Vice President of Finance. He assumed his present position in September 1994. Prior to joining the Company, Mr. Schofield, a certified public accountant, held various positions in public accounting with Fox & Company and as a partner with Olivas & Company (certified public accounting firms). Scot Sauder, the Company's Vice President of Legal Affairs, Secretary and General Counsel, has been with the Company since September 1993. From September 1993 to September 1994, he served as General Counsel to the Company. From September 1994 through July 1995, he served as Secretary and General Counsel to the Company. Prior to joining the Company, Mr. Sauder, an attorney licensed to practice in Texas and certain federal courts, was associated with Palmer & Palmer, P.C., and was a director of Geary, Glast & Middleton, P.C., and Smith & Underwood, P.C. (law firms). Gerard M. Martin was the controlling shareholder of Greenery Rehabilitation Group, Inc. ("Greenery") and served as Chairman of the Board and Chief Executive Officer of Greenery from 1985 until the consummation of the Greenery merger with the Company in February 1994. He became a Director of the Company in 1994. Mr. Martin is a member of the Board of Trustees of Health and Rehabilitation Properties Trust ("HRP") and a director and controlling shareholder of HRPT Advisors, Inc. (which acts as advisor to HRP). Frank M. McCord is the Chairman and Chief Executive Officer of Cascade Savings Bank in Everett, Washington, a position he has held since March 1990. From 1987 until that date, Mr. McCord served such bank as a member of the Board of Directors and the Executive, Loan and Audit committees. From 1956 to 1986, Mr. McCord, a certified public accountant, was an accountant with KPMG Peat Marwick. He became a Director of the Company in October 1986. Raymond N. Noveck, a certified public accountant, has served as the President of Strategic Systems, Inc., a provider of audiotex health and medical information since January 1990. He became a Director of the Company in July 1987. From July 1989 through December 1989, Mr. Noveck was Senior Vice President of Kimberly Quality Care, a provider of home health care, temporary nursing personnel and related medical services. Prior to that, he was Executive Vice President of Lifetime Corporation, a home health care company, from June 1987 through July 1989. Barry M. Portnoy is a member of the Board of Trustees of HRP and a director and controlling shareholder of HRPT Advisors, Inc. He became a Director of the Company in 1994. Since 1978, Mr. Portnoy has been a partner in the law firm of Sullivan & Worcester, Boston, Massachusetts. Russell L. Carson is a general partner of Welsh, Carson, Anderson & Stowe, a private investment partnership located in New York City which was formed in March 1979 to make investments in small to medium sized companies. He became a Director of the Company in July 1995 and served as a director of CMS from 1986 to 1995. Mr. Carson is also a director of American Oncology Resources, Inc., AMSCO International, Quorum Health Group, Inc., Health Management Systems, Inc., Healthwise of America, Inc. and MedAlliance, Incorporated. Bryan C. Cressey is a founding member of Golder, Thoma, Cressey and Rauner, Inc., a venture capital firm located in Chicago, Illinois, which was established in 1980 to make investments in small to medium sized companies. He became a Director of the Company in July 1995 and served as a director of CMS from 1986 to 1995. Mr. Cressey is also a director of Paging Network, Inc., Cable Design Technologies and Gold Enterprises, Inc. LeRoy S. Zimmerman has been a partner in the law firm of Eckert, Seamans, Cherin & Mellott, located in Harrisburg, Pennsylvania, since 1989. He became a Director of the Company in July 1995 and served as a director of CMS from 1994 to 1995. Mr. Zimmerman was the Attorney General of the Commonwealth of Pennsylvania from 1981 to 1989. Mr. Zimmerman became a director of Super Rite Corporation in January 1995. The Notes will be issued pursuant to the Indenture (the "Indenture") between the Company and , as trustee (the "Trustee"). The terms of the Notes include those stated in the Indenture and those made part of the Indenture by reference to the Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"). The Notes are subject to all such terms, and Holders of Notes are referred to the Indenture and the Trust Indenture Act for a statement thereof. The following summary of certain provisions of the Indenture does not purport to be complete and is qualified in its entirety by reference to the Indenture, including the definitions therein of certain terms used below. A copy of the proposed form of Indenture has been filed as an exhibit to the Registration Statement of which this Prospectus is a part and is available as set forth under "Available Information." The definitions of certain terms used in the following summary are set forth below under "-- Certain Definitions." The Notes will be general unsecured senior subordinated obligations of the Company, subordinated in right of payment to all existing and future Senior Debt of the Company, including Indebtedness pursuant to the Credit Facility. See "-- Subordination." The Notes will be structurally subordinated to Indebtedness of the Company's Subsidiaries, including guarantees by such Subsidiaries of Indebtedness under the Credit Facility. At November 30, 1995, on a pro forma basis after giving effect to the Offering, the principal amount of Senior Debt outstanding would have been approximately $422.2 million (including $45.3 million in letters of credit issued under the Credit Facility) and the principal amount of Indebtedness of the Company's Subsidiaries would have been approximately $19.2 million, excluding guarantees by certain Subsidiaries of Indebtedness under the Credit Facility. The Notes will be limited in aggregate principal amount to $200.0 million and will mature on , 2006. Interest on the Notes will accrue at the rate of % per annum and will be payable semi-annually in arrears on and , commencing on , 1996, to Holders of record on the immediately preceding and . Interest on the Notes will accrue from the most recent date to which interest has been paid or, if no interest has been paid, from the date of original issuance. Interest will be computed on the basis of a 360-day year comprised of twelve 30-day months. Principal, premium, if any, and interest on the Notes will be payable at the office or agency of the Company maintained for such purpose within the City and State of New York or, at the option of the Company, payment of interest may be made by check mailed to the Holders of the Notes at their respective addresses set forth in the register of Holders of Notes. Until otherwise designated by the Company, the Company's office or agency in New York will be the office of the Trustee maintained for such purpose. The Notes will be issued in denominations of $1,000 and integral multiples thereof. The payment of principal of, premium, if any, and interest on the Notes will be subordinated in right of payment, as set forth in the Indenture, to the prior payment in full of all Senior Debt, whether outstanding on the date of the Indenture or thereafter incurred. Upon any distribution to creditors of the Company in a liquidation or dissolution of the Company or in a bankruptcy, reorganization, insolvency, receivership or similar proceeding relating to the Company or its property, an assignment for the benefit of creditors or any marshaling of the Company's assets and liabilities, the holders of Senior Debt will be entitled to receive payment in full in cash or cash equivalents of all Obligations due in respect of such Senior Debt (including interest after the commencement of any such proceeding at the rate specified in the applicable Senior Debt) before the Holders of Notes will be entitled to receive any payment with respect to the Notes, and until all Obligations with respect to Senior Debt are paid in full in cash or cash equivalents, any distribution to which the Holders of Notes would be entitled shall be made to the holders of Senior Debt (except that Holders of Notes may receive securities that are subordinated at least to the same extent as the Notes to Senior Debt and any securities issued in exchange for Senior Debt and payments made from the trust described under "Legal Defeasance and Covenant Defeasance"). The Company also may not make any payment upon or in respect of the Notes (except in such subordinated securities or from the trust described under "Legal Defeasance and Covenant Defeasance") if (i) a default in the payment of the principal of, premium, if any, or interest on Designated Senior Debt occurs and is continuing or (ii) any other default occurs and is continuing with respect to Designated Senior Debt that permits holders of the Designated Senior Debt as to which such default relates to accelerate its maturity and the Trustee receives a notice of such other default (a "Payment Blockage Notice") from the Company or the holders of any Designated Senior Debt. Payments on the Notes may and shall be resumed (a) in the case of a payment default, upon the date on which such default is cured or waived and (b) in case of a nonpayment default (subject to clause (i) of the preceding sentence), the earlier of the date on which such nonpayment default is cured or waived or 179 days after the date on which the applicable Payment Blockage Notice is received, unless the maturity of any Designated Senior Debt has been accelerated. No new period of payment blockage may be commenced unless and until 360 days have elapsed since the receipt by the Trustee of the immediately prior Payment Blockage Notice. No nonpayment default that existed or was continuing on the date of delivery of any Payment Blockage Notice to the Trustee shall be, or be made, the basis for a subsequent Payment Blockage Notice, unless such default shall have been cured for a period of at least 90 consecutive days following the date of delivery of such Payment Blockage Notice. The Indenture will further require that the Company promptly notify holders of Senior Debt if payment of the Notes is accelerated because of an Event of Default. As a result of the subordination provisions described above, in the event of a liquidation or insolvency, Holders of Notes may recover less ratably than creditors of the Company who are holders of Senior Debt. At November 30, 1995, on a pro forma basis after giving effect to the Offering, the principal amount of Senior Debt outstanding would have been approximately $422.2 million (including $45.3 million in letters of credit issued under the Credit Facility). The Indenture will limit, subject to certain financial tests, the amount of additional Indebtedness, including Senior Debt, that the Company and its Subsidiaries may incur. See "Certain Covenants -- Incurrence of Indebtedness and Issuance of Preferred Stock." The Notes will not be redeemable at the Company's option prior to , 2001. Thereafter, the Notes will be subject to redemption at the option of the Company, in whole or in part, upon not less than 30 nor more than 60 days' notice, at the redemption prices (expressed as percentages of principal amount) set forth below, together with accrued and unpaid interest thereon to the applicable redemption date, if redeemed during the twelve-month period beginning on of the years indicated below: If less than all of the Notes are to be redeemed at any time, selection of Notes for redemption will be made by the Trustee in compliance with the requirements of the principal national securities exchange, if any, on which the Notes are listed or, if the Notes are not so listed, on a pro rata basis, by lot or by such other method as the Trustee deems fair and appropriate; PROVIDED that no Notes with a principal amount of $1,000 or less shall be redeemed in part. Notice of redemption shall be mailed by first class mail at least 30 but not more than 60 days before the redemption date to each Holder of Notes to be redeemed at its registered address. If any Note is to be redeemed in part only, the notice of redemption that relates to such Note shall state the portion of the principal amount thereof to be redeemed. A new Note in principal amount equal to the unredeemed portion thereof will be issued in the name of the Holder thereof upon cancellation of the original Note. On and after the redemption date, interest will cease to accrue on Notes or portions thereof called for redemption. Except as set forth below under "Repurchase at the Option of Holders,."the Company is not required to make any mandatory redemption or sinking fund payments with respect to the Notes. REPURCHASE AT THE OPTION OF HOLDERS Upon the occurrence of a Change of Control, each Holder of Notes will have the right to require the Company to repurchase all or any part (equal to $1,000 or an integral multiple thereof) of such Holder's Notes pursuant to the offer described below (the "Change of Control Offer") at an offer price in cash equal to 101% of the aggregate principal amount thereof plus accrued and unpaid interest thereon to the date of purchase (the "Change of Control Payment"). Within ten days following any Change of Control, the Company will mail a notice to each Holder describing the transaction or transactions that constitute the Change of Control and offering to repurchase Notes pursuant to the procedures required by the Indenture and described in such notice. The Company will comply with the requirements of Rule 14e-1 under the Exchange Act and any other securities laws and regulations thereunder to the extent such laws and regulations are applicable in connection with the repurchase of the Notes as a result of a Change of Control. On the Change of Control Payment Date, the Company will, to the extent lawful, (1) accept for payment all Notes or portions thereof properly tendered pursuant to the Change of Control Offer, (2) deposit with the Paying Agent an amount equal to the Change of Control Payment in respect of all Notes or portions thereof so tendered and (3) deliver or cause to be delivered to the Trustee the Notes so accepted together with an Officers' Certificate stating the aggregate principal amount of Notes or portions thereof being purchased by the Company. The Paying Agent will promptly mail to each Holder of Notes so tendered the Change of Control Payment for such Notes, and the Trustee will promptly authenticate and mail (or cause to be transferred by book entry) to each Holder a new Note equal in principal amount to any unpurchased portion of the Notes surrendered; PROVIDED that each such new Note will be in a principal amount of $1,000 or an integral multiple thereof. The Indenture will provide that, prior to complying with the provisions of this covenant, but in any event within 90 days following a Change of Control, the Company will either repay all outstanding Senior Debt or obtain the requisite consents, if any, under all agreements governing outstanding Senior Debt to permit the repurchase of Notes required by this covenant. The Company will publicly announce the results of the Change of Control Offer on or as soon as practicable after the Change of Control Payment Date. The Change of Control provisions described above will be applicable whether or not any other provisions of the Indenture are applicable. Except as described above with respect to a Change of Control, the Indenture does not contain provisions that permit the Holders of the Notes to require that the Company repurchase or redeem the Notes in the event of a takeover, recapitalization or similar restructuring. The Company will not be required to make a Change of Control Offer upon a Change of Control if a third party makes the Change of Control Offer in the manner, at the times and otherwise in compliance with the requirements set forth in the Indenture applicable to a Change of Control Offer made by the Company and purchases all Notes validly tendered and not withdrawn under such Change of Control Offer. The definition of Change of Control includes a phrase relating to the sale, lease, transfer, conveyance or other disposition of "all or substantially all" of the assets of the Company and its Subsidiaries taken as a whole. Although there is a developing body of case law interpreting the phrase "substantially all," there is no precise established definition of the phrase under applicable law. Accordingly, the ability of a Holder of Notes to require the Company to repurchase such Notes as a result of a sale, lease, transfer, conveyance or other disposition of less than all of the assets of the Company and its Subsidiaries taken as a whole to another Person or group may be uncertain. The Indenture will provide that the Company will not, and will not permit any of its Subsidiaries to, engage in an Asset Sale unless (i) the Company (or the Subsidiary, as the case may be) receives consideration at the time of such Asset Sale at least equal to the fair market value (evidenced by a resolution of of Directors set forth in an Officers' Certificate delivered to the Trustee) of the assets or Equity Interests issued or sold or otherwise disposed of and (ii) at least 75% of the consideration therefor received by the Company or such Subsidiary is in the form of cash; PROVIDED that the amount of (x) any liabilities (as shown on the Company's or such Subsidiary's most recent balance sheet) of the Company or any Subsidiary (other than contingent liabilities and liabilities that are by their terms subordinated to the Notes or any guarantee thereof) that are assumed by the transferee of any such assets pursuant to a customary novation agreement that releases the Company or such Subsidiary from further liability and (y) any notes or other obligations received by the Company or any such Subsidiary from such transferee that are immediately converted by the Company or such Subsidiary into cash (to the extent of the cash received), will be deemed to be cash for purposes of this provision; and PROVIDED, FURTHER, that the requirements of this clause (ii) shall not apply to assets having an aggregate book value not exceeding $30.0 million that, as of the date of the Indenture, were held by the Company and its Subsidiaries for sale. Within 360 days after the receipt of any Net Proceeds from an Asset Sale, the Company may apply such Net Proceeds, at its option, (a) to permanently reduce Indebtedness (and, in the case of revolving Indebtedness, to permanently reduce the commitments) under the Credit Facility or other Senior Debt of the Company, (b) to purchase one or more Health Care Facilities or Related Businesses and/or a controlling interest in the Capital Stock of a Person owning one or more Health Care Facilities and/or one or more Related Businesses or (c) to make a capital expenditure or to acquire other tangible assets, in each case, that are used or useful in any business in which the Company is permitted to be engaged pursuant to the covenant entitled "Line of Business." Pending the final application of any such Net Proceeds, the Company may temporarily reduce revolving Indebtedness under the Credit Facility or otherwise invest such Net Proceeds in any manner that is not prohibited by the Indenture. Any Net Proceeds from Asset Sales that are not applied or invested as provided in the preceding sentences of this paragraph will be deemed to constitute "Excess Proceeds." When the aggregate amount of Excess Proceeds exceeds $15.0 million, the Company will be required to make an offer to all Holders of Notes (an "Asset Sale Offer") to purchase the maximum principal amount of Notes that may be purchased out of the Excess Proceeds, at an offer price in cash in an amount equal to 100% of the principal amount thereof plus accrued and unpaid interest thereon to the date of purchase, in accordance with the procedures set forth in the Indenture. To the extent that the aggregate amount of Notes tendered pursuant to an Asset Sale Offer is less than the Excess Proceeds, the Company may use any remaining Excess Proceeds for general corporate purposes. If the aggregate principal amount of Notes surrendered by Holders thereof exceeds the amount of Excess Proceeds, the Trustee shall select the Notes to be purchased on a PRO RATA basis. Upon completion of such Asset Sale Offer, the amount of Excess Proceeds shall be reset at zero. The Credit Facility prohibits the Company from purchasing any Notes and also provides that certain change of control events with respect to the Company and certain asset sales would constitute a default thereunder. Any future credit agreements or other agreements relating to Senior Debt to which the Company becomes a party may contain similar restrictions and provisions. In the event a Change of Control or an Asset Sale occurs at a time when the Company is prohibited from purchasing Notes, the Company could seek the consent of its lenders to the purchase of Notes or could attempt to refinance the borrowings that contain such prohibition. If the Company does not obtain such a consent or repay such borrowings, the Company will remain prohibited from purchasing Notes. In such case, the Company's failure to purchase tendered Notes would constitute an Event of Default under the Indenture which would, in turn, constitute a default under the Credit Facility. In such circumstances, the subordination provisions in the Indenture would likely restrict payments to the Holders of Notes. See "Risk Factors -- Subordination of Notes." The Indenture will provide that the Company will not, and will not permit any of its Subsidiaries to, directly or indirectly: (i) declare or pay any dividend or make any other payment or distribution on account of any Equity Interests of the Company or any of its Subsidiaries (other than (x) dividends or distributions payable in Equity Interests (other than Disqualified Stock) of the Company, (y) dividends or distributions payable to the Company or any Subsidiary of the Company and (z) dividends or distributions by any Subsidiary of the Company payable to all holders of a class of Equity Interests of such Subsidiary on a pro rata basis); (ii) purchase, redeem or otherwise acquire or retire for value any Equity Interests of the Company; (iii) make any principal payment on, or purchase, redeem, defease or otherwise acquire or retire for value any Indebtedness that is PARI PASSU with or subordinated to the Notes, except at the original final maturity thereof or in accordance with the scheduled mandatory redemption or repayment provisions set forth in the original documentation governing such Indebtedness (but not pursuant to any mandatory offer to repurchase upon the occurrence of any event) or (iv) make any Restricted Investment (all such payments and other actions set forth in clauses (i) through (iv) above being collectively referred to as "Restricted Payments", unless: (a) no Default or Event of Default shall have occurred and be continuing or would occur as a consequence thereof; (b) the Company would, at the time of such Restricted Payment and after giving pro forma effect thereto as if such Restricted Payment had been made at the beginning of the applicable four-quarter period, have been permitted to incur at least $1.00 of additional Indebtedness pursuant to the Fixed Charge Coverage Ratio test set forth in the first paragraph of the covenant entitled "Incurrence of Indebtedness and Issuance of Preferred Stock;" and (c) such Restricted Payment, together with the aggregate of all other Restricted Payments made by the Company and its Subsidiaries after the date of the Indenture (excluding Restricted Payments permitted by clauses (ii), (iii) and (iv) of the next succeeding paragraph), is less than the sum of (1) 50% of the Consolidated Net Income of the Company for the period (taken as one accounting period) from the beginning of the first fiscal quarter commencing after the date of the Indenture to the end of the Company's most recently ended fiscal quarter for which internal financial statements are available at the time of such Restricted Payment (or, if such Consolidated Net Income for such period is a deficit, minus 100% of such deficit), PLUS (2) 100% of the aggregate net cash proceeds received by the Company from the issue or sale since the date of the Indenture of Equity Interests of the Company or of debt securities of the Company that have been converted into such Equity Interests (other than Equity Interests (or convertible debt securities) sold to a Subsidiary of the Company and other than Disqualified Stock or debt securities that have been converted into Disqualified Stock), PLUS (3) to the extent that any Restricted Investment that was made after the date of the Indenture is sold for cash or otherwise liquidated or repaid for cash, the lesser of (A) the cash return of capital with respect to such Restricted Investment (less the cost of disposition, if any) and (B) the initial amount of such Restricted Investment, PLUS (4) $10.0 million; PROVIDED that no cash proceeds received by the Company from the issue or sale of any Equity Interests of the Company will be counted in determining the amount available for Restricted Payments under this clause (c) to the extent such proceeds were used to redeem, repurchase, retire or acquire any Equity Interests of the Company pursuant to clause (ii) of the next succeeding paragraph, to defease, redeem or repurchase any PARI PASSU or subordinated Indebtedness pursuant to clause (iii) of the next succeeding paragraph or to repurchase, redeem, acquire or retire any Equity Interests of the Company pursuant to clause (iv) of the next succeeding paragraph. The foregoing provisions will not prohibit the following: (i) the payment of any dividend within 60 days after the date of declaration thereof, if at such date of declaration such payment would have complied with the provisions of the Indenture; (ii) the redemption, repurchase, retirement or other acquisition of any Equity Interests of the Company in exchange for, or out of the net proceeds of, the substantially concurrent sale (other than to a Subsidiary of the Company) of other Equity Interests of the Company (other than Disqualified Stock); (iii) the defeasance, redemption or repurchase of PARI PASSU or subordinated Indebtedness with the net proceeds from an incurrence of Permitted Refinancing Debt or the substantially concurrent sale (other than to a Subsidiary of the Company) of Equity Interests of the Company (other than Disqualified Stock); (iv) the repurchase, redemption or other acquisition or retirement for value of any Equity Interests of the Company held by any member of the Company's or any of the Company's Subsidiaries' management pursuant to any management equity subscription agreement or stock option agreement; PROVIDED that the aggregate price paid for all such repurchased, redeemed, acquired or retired Equity Interests shall not exceed $1.0 million in any twelve-month period plus the aggregate cash proceeds received by the Company during such twelve-month period from any reissuance of Equity Interests by the Company to members of management of the Company and its Subsidiaries; (v) the redemption, repurchase, retirement or other acquisition of Equity Interests of a Permitted Joint Venture; (vi) the incurrence, creation or assumption of any Guarantee of Indebtedness of a Permitted Joint Venture; (vii) the making of any payment pursuant to any Guarantee of Indebtedness of a Permitted Joint Venture; (viii) the payment of non-pro rata dividends or distributions to holders of minority interest in the Equity Interests of Permitted Joint Ventures made in accordance with the terms of the agreements pursuant to which such payments are made in an amount not to exceed $10.0 million in the aggregate in any twelve-month period; (ix) the purchase, redemption or acquisition of the Company's (A) 8 3/4% Convertible Senior Subordinated Notes due 2015 in the principal amount of $20.4 million and (B) 6 1/2% Convertible Subordinated Debentures due 2012 in the principal amount of $5.7 million; (x) acquisitions of Equity Interests of the Company in satisfaction of certain Indebtedness owed to the Company in the outstanding principal amount of $13.0 million in accordance with the terms of such Indebtedness as in effect on the date of the Indenture; and (xi) acquisitions of Equity Interests of the Company in satisfaction of principal and interest on loans made by the Company to enable employees and directors of the Company to exercise options to purchase capital stock of the Company and to pay taxes thereon, which loans in respect of principal, interest and taxes will not exceed $10.0 million in the aggregate prior to maturity of the Notes, PROVIDED, HOWEVER, in the case of clauses (ii) through (xi) of this paragraph, no Default or Event of Default shall have occurred or be continuing at the time of such Restricted Payment or would occur as a consequence thereof. The amount of all Restricted Payments (other than cash) shall be the fair market value (evidenced by a resolution of the Board of Directors set forth in an Officers' Certificate delivered to the Trustee) on the date of the Restricted Payment of the asset(s) proposed to be transferred by the Company or such Subsidiary, as the case may be, pursuant to the Restricted Payment. Not later than the date of making any Restricted Payment, the Company shall deliver to the Trustee an Officers' Certificate stating that such Restricted Payment is permitted and setting forth the basis upon which the calculations required by the covenant "Restricted Payments" were computed, which calculations shall be based upon the Company's latest available financial statements. INCURRENCE OF INDEBTEDNESS AND ISSUANCE OF PREFERRED STOCK The Indenture will provide that the Company will not, and will not permit any of its Subsidiaries to, directly or indirectly, create, incur, issue, assume, Guarantee or otherwise become directly or indirectly liable with respect to (collectively, "incur") any Indebtedness (including Acquired Debt) and that the Company will not issue any Disqualified Stock and will not permit any of the Company's Subsidiaries to issue any shares of preferred stock; PROVIDED, HOWEVER, that the Company may incur Indebtedness or issue shares of Disqualified Stock and any Subsidiary may incur Indebtedness or issue shares of preferred stock, if the Fixed Charge Coverage Ratio for the Company's most recently ended four full fiscal quarters for which internal financial statements are available immediately preceding the date on which such additional Indebtedness is incurred or such Disqualified Stock or preferred stock is issued would have been at least 2.5 to 1, determined on a pro forma basis (including a pro forma application of the net proceeds therefrom), as if the additional Indebtedness had been incurred, or the Disqualified Stock or preferred stock had been issued, as the case may be, at the beginning of such four-quarter period. Notwithstanding the foregoing sentence, in no event shall any Subsidiary of the Company incur any Indebtedness or issue any preferred stock pursuant to the foregoing sentence (other than Indebtedness of a Person existing at the time such Person merges with or into or becomes a Subsidiary of the Company, and Indebtedness assumed in connection with the acquisition of assets from such Person, in each case which Indebtedness was not incurred in connection with, or in contemplation of, such Person merging with or into or becoming a Subsidiary of the Company) unless (i) the aggregate principal amount of outstanding Indebtedness of all the Company's Subsidiaries that was incurred pursuant to the foregoing sentence, PLUS (ii) the aggregate liquidation preference of outstanding preferred stock of all of the Company's Subsidiaries that was issued pursuant to the foregoing sentence, does not exceed at any time $75.0 million. The foregoing provisions will not apply to: (i) the incurrence by the Company or any Subsidiary of Indebtedness and letters of credit pursuant to the Credit Facility (with letters of credit being deemed to have a principal amount equal to the maximum potential liability of the Company or the relevant Guarantor thereunder), in a maximum principal amount not to exceed $750.0 million, LESS the aggregate amount of all Net Proceeds of Asset Sales applied to permanently reduce Indebtedness (and the commitments) thereunder pursuant to the covenant entitled "Asset Sales"; (ii) the incurrence by the Company or any Subsidiary of Indebtedness represented by the Notes; (iii) the incurrence by the Company or any Subsidiary of the Existing Indebtedness; (iv) the incurrence by the Company or any Subsidiary of Permitted Refinancing Debt; (v) the incurrence by the Company or any Subsidiary of intercompany Indebtedness between or among the Company and any of its Subsidiaries; PROVIDED, HOWEVER, that (a) any such Indebtedness of the Company (other than Indebtedness of the Company to a Permitted Joint Venture arising in the ordinary course of business as a result of the Company's cash concentration system) is expressly subordinate to the payment in full of all Obligations with respect to the Notes and (b)(1) any subsequent issuance or transfer (other than for security purposes) of Equity Interests that result in any such Indebtedness being held by a Person other than the Company or a Subsidiary of the Company and (2) any sale or other transfer (other than for security purposes) of any such Indebtedness to a Person that is not either the Company or a Subsidiary shall be deemed, in each case, to constitute an incurrence of such Indebtedness by the Company or such Subsidiary, as the case may be; (vi) the incurrence by the Company or any Subsidiary of Hedging Obligations with respect to any Indebtedness that is permitted by the terms of the Indenture to be outstanding; and (vii) the incurrence by the Company or any Subsidiary of Indebtedness (in addition to Indebtedness permitted by any other clause of this paragraph) in an aggregate principal amount (or accreted value, as applicable) at any time outstanding not to exceed $100.0 million. The Indenture will provide that the Company will not, and will not permit any of its Subsidiaries to, directly or indirectly, create, incur, assume or suffer to exist any Lien on any property or asset now owned or hereafter acquired, or on any income or profits therefrom or assign or convey any right to receive income therefrom, except Permitted Liens. DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING SUBSIDIARIES The Indenture will provide that the Company will not, and will not permit any of its Subsidiaries to, directly or indirectly, create or otherwise cause or suffer to exist or become effective any encumbrance or restriction on the ability of any Subsidiary to: (i)(a) pay dividends or make any other distributions to the Company or any of its Subsidiaries (1) on its Capital Stock or (2) with respect to any other interest or participation in, or measured by, its profits, or (b) pay any Indebtedness owed to the Company or any of its Subsidiaries; (ii) make loans or advances to the Company or any of its Subsidiaries; or (iii) transfer any of its properties or assets to the Company or any of its Subsidiaries, except for such encumbrances or restrictions existing under or by reasons of (a) Existing Indebtedness; (b) the Credit Facility, as in effect on the date of the Indenture, and any amendments, modifications, restatements, renewals, increases, supplements, refundings, replacements or refinancings thereof, PROVIDED that such encumbrances or restrictions contained in such amendments, modifications, restatements, renewals, increases, supplements, refundings, replacements or refinancings are not materially less favorable to the Holders of Notes than those contained in the Credit Facility, as in effect on the date of the Indenture; (c) the Indenture and the Notes; (d) applicable law; (e) any instrument governing Indebtedness or Capital Stock of a Person acquired by the Company or any of its Subsidiaries, as in effect at the time of acquisition (except to the extent such Indebtedness was incurred in connection with, or in contemplation of, such acquisition), which encumbrance or restriction is not applicable to any Person, or the properties or assets of any Person, other than the Person, or the property or assets of the Person, so acquired, PROVIDED that, in the case of Indebtedness, such Indebtedness was permitted by the terms of the Indenture to be incurred; (f) by reason of customary non-assignment provisions in leases entered into in the ordinary course of business and consistent with past practices; (g) purchase money obligations for property acquired in the ordinary course of business that impose restrictions of the nature described in clause (iii) above on the property so acquired; (h) Permitted Refinancing Debt, PROVIDED that the restrictions contained in the agreements governing such Permitted Refinancing Debt are not materially less favorable to the Holders of Notes than those contained in the agreements governing the Indebtedness being refinanced; (i) other Indebtedness permitted by the terms of the Indenture to be aggregate amount not to exceed $5.0 million at any time outstanding; or (j) agreements entered into in the ordinary course of business in connection with Permitted Joint Ventures that impose restrictions of the nature described in clauses (ii) and (iii) above on the property of such Permitted Joint Ventures. MERGER, CONSOLIDATION, OR SALE OF ASSETS The Indenture will provide that the Company may not consolidate or merge with or into (whether or not the Company is the surviving entity), or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of its properties or assets in one or more related transactions to, another corporation, Person or entity unless (i) the Company is the surviving corporation or entity or the Person formed by or surviving any such consolidation or merger (if other than the Company) or to which such sale, assignment, transfer, lease, conveyance or other disposition shall have been made is a corporation organized or existing under the laws of the United States, any state thereof or the District of Columbia; (ii) the entity or Person formed by or surviving any such consolidation or merger (if other than the Company) or the entity or Person to which such sale, assignment, transfer, lease, conveyance or other disposition will have been made assumes all the Obligations of the Company under the Notes and the Indenture pursuant to a supplemental indenture in form reasonably satisfactory to the Trustee; (iii) immediately after such transaction, no Default or Event of Default exists; and (iv) except in the case of a merger of the Company with or into a Subsidiary, the Company or the entity or Person formed by or surviving any such consolidation or merger, or to which such sale, assignment, transfer, lease, conveyance or other disposition will have been made (A) will have Consolidated Net Worth immediately after the transaction equal to or greater than the Consolidated Net Worth of the Company immediately preceding the transaction and (B) will, at the time of such transaction after giving pro forma effect thereto as if such transaction had occurred at the beginning of the applicable four-quarter period, be permitted to incur at least $1.00 of additional Indebtedness pursuant to the Fixed Charge Coverage Ratio test set forth in the first paragraph of the covenant entitled "Incurrence of Indebtedness and Issuance of Preferred Stock." The Indenture will provide that the Company will not, and will not permit any of its Subsidiaries to, make any payment to, or sell, lease, transfer or otherwise dispose of any of its properties or assets to, or purchase any property or assets from, or enter into or make or amend any contract, agreement, understanding, loan, advance or guarantee with, or for the benefit of, any Affiliate (each of the foregoing, an "Affiliate Transaction"), unless (i) such Affiliate Transaction is on terms that are no less favorable to the Company or such Subsidiary than those that would have been obtained in a comparable transaction by the Company or such Subsidiary with an unrelated Person and (ii) the Company delivers to the Trustee (a) with respect to any Affiliate Transaction or series of related Affiliate Transactions involving aggregate consideration in excess of $5.0 million, a resolution of the Board of Directors set forth in an Officers' Certificate certifying that such Affiliate Transaction complies with clause (i) above and that such Affiliate Transaction has been approved by a majority of the disinterested members of the Board of Directors and (b) with respect to any Affiliate Transaction or series of related Affiliate Transactions involving aggregate consideration in excess of $10.0 million, an opinion as to the fairness to the Company or such Subsidiary of such Affiliate Transaction from a financial point of view issued by an accounting, appraisal or investment banking firm of national standing; PROVIDED, HOWEVER, that (a) any employment agreement entered into by the Company or any of its Subsidiaries or employee compensation and other benefit arrangements in the ordinary course of business and consistent with the past practice of the Company or such Subsidiary and the payment of reasonable and customary fees to the directors of the Company or any Subsidiary who are not employees of the Company or any Affiliate, (b) Affiliate Transactions between or among the Company and/or its Subsidiaries, (c) Restricted Payments and Permitted Investments that are permitted by the provisions of the Indenture described above under the covenant entitled "Restricted Payments," and (d) the continued performance of existing arrangements with Affiliates on the terms described in the most recent proxy statement filed by the Company, in each case, shall not be deemed Affiliate Transactions. The Indenture will provide that the Company will not incur, create, issue, assume, guarantee or otherwise become liable for any Indebtedness that is subordinate or junior in right of payment to any Senior Debt and senior in any respect in right of payment to the Notes. The Company will not, and will not permit any Subsidiary to, engage to any material extent in any business other than the ownership, operation and management of Health Care Facilities and Related Businesses. The Indenture will provide that, whether or not required by the rules and regulations of the Securities and Exchange Commission (the "Commission"), so long as any Notes are outstanding, the Company will furnish to the Holders of Notes (i) all quarterly and annual financial information that would be required to be contained in a filing with the Commission on Forms 10-Q and 10-K if the Company were required to file such Forms, including a "Management's Discussion and Analysis of Financial Condition and Results of Operations" and, with respect to the annual information only, a report thereon by the Company's certified independent accountants and (ii) all current reports that would be required to be filed with the Commission on Form 8-K if the Company were required to file such reports. In addition, whether or not required by the rules and regulations of the Commission, the Company will file a copy of all such information and reports with the Commission for public availability (unless the Commission will not accept such a filing) and make such information available to securities analysts and prospective investors upon request. EVENTS OF DEFAULT AND REMEDIES The Indenture will provide that each of the following constitutes an Event of Default: (i) default for 30 days in the payment when due of interest on the Notes (whether or not prohibited by the subordination provisions of the (ii) default in payment when due of principal or premium, if any, on the Notes at maturity, upon redemption or otherwise (whether or not prohibited by the subordination provisions of the Indenture); (iii) failure by the Company to comply with the provisions described under the covenants entitled "Change of Control," or "Merger, Consolidation (iv) failure by the Company for 60 days after notice to comply with its other agreements in the Indenture or the Notes; (v) default under any mortgage, indenture or instrument under which there may be issued or by which there may be secured or evidenced any Indebtedness for money borrowed by the Company or any of its Subsidiaries (or the payment of which is guaranteed by the Company or any of its Subsidiaries) whether such Indebtedness or Guarantee now exists, or is created after the date of the Indenture, which default (a) is caused by a failure to pay when due principal of or premium, if any, or interest on such Indebtedness prior to the expiration of the grace period provided in such Indebtedness on the date of such default (a "Payment Default") or (b) results in the acceleration of such Indebtedness prior to its express maturity and, in each case, the principal amount of any such Indebtedness, together with the principal amount of any other such Indebtedness under which there has been a Payment Default or the maturity of which has been so accelerated, aggregates $20.0 million or more; (vi) failure by the Company or any of its Subsidiaries to pay final judgments aggregating in excess of $20.0 million, which judgments are not stayed within 60 days after their entry; and (vii) certain events of bankruptcy or insolvency with respect to the Company or any of its Significant Subsidiaries. If any Event of Default occurs and is continuing, the Trustee or the Holders of at least 25% in principal amount of the then outstanding Notes may declare all the Notes to be due and payable immediately. Notwithstanding the foregoing, in the case of an Event of Default arising from certain events of bankruptcy or insolvency with respect to the Company, any Significant Subsidiary or any group of Subsidiaries that, taken together, would constitute a Significant Subsidiary, all outstanding Notes will become due and payable without further action or notice. Holders of the Notes may not enforce the Indenture or the Notes except as provided in the Indenture. Subject to certain limitations, Holders of a majority in principal amount of the then outstanding Notes may direct the Trustee in its exercise of any trust or power. In the case of any Event of Default occurring by reason of any willful action (or inaction) taken (or not taken) by or on behalf of the Company with the intention of avoiding payment of the premium that the Company would have had to pay if the Company then had elected to redeem the Notes pursuant to the optional redemption provisions of the Indenture, an equivalent premium shall also become and be immediately due and payable to the extent permitted by law upon the acceleration of the Notes. If an Event of Default occurs prior to , 2001 by reason of any willful action (or inaction) taken (or not taken) by or on behalf of the Company with the intention of avoiding the prohibition on redemption of the Notes prior to , 2001, then the premium specified in the Indenture shall also become immediately due and payable to the extent permitted by law upon the acceleration of the Notes. The Holders of a majority in aggregate principal amount of the Notes then outstanding, by notice to the Trustee, may on behalf of the Holders of all of the Notes waive any existing Default or Event of Default and its consequences under the Indenture, except a continuing Default or Event of Default in the payment of interest or premium on, or principal of, the Notes. The Trustee may withhold from Holders of the Notes notice of any continuing Default or Event of Default (except a Default or Event of Default relating to the payment of principal or interest) if it determines that withholding notice is in such Holders' interest. The Company is required to deliver to the Trustee annually a statement regarding compliance with the Indenture, and the Company is required upon becoming aware of any Default or Event of Default to deliver to the Trustee a statement specifying such Default or Event of Default. NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS No director, officer, employee, incorporator or stockholder of the Company, as such, shall have any liability for any Obligations of the Company under the Notes or the Indenture or for any claim based on, in respect of, or by reason of, such Obligations or their creation. Each Holder of Notes by accepting a Note waives and releases all such liability. The waiver and release are part of the consideration for issuance of the Notes. Such waiver may not be effective to waive liabilities under the federal securities laws and it is the view of the Commission that such a waiver is against public policy. LEGAL DEFEASANCE AND COVENANT DEFEASANCE The Company may, at its option and at any time, elect to have all of its obligations discharged with respect to the outstanding Notes ("Legal Defeasance") except for (i) the rights of Holders of outstanding Notes to receive payments in respect of the principal of, premium, if any, and interest on such Notes when such payments are due from the trust referred to below, (ii) the Company's obligations with respect to the Notes concerning issuing temporary Notes, registration of Notes, mutilated, destroyed, lost or stolen Notes and the maintenance of an office or agency for payment and money for security payments held in trust, (iii) the rights, powers, trusts, duties and immunities of the Trustee, and the Company's obligations in connection therewith and (iv) the Legal Defeasance provisions of the Indenture. In addition, the Company may, at its option and at any time, elect to have the obligations of the Company released with respect to certain covenants that are described in the Indenture ("Covenant Defeasance") and thereafter any omission to comply with such obligations shall not constitute a Default or Event of Default with respect to the Notes. In the event Covenant Defeasance occurs, certain events (not including non-payment and certain events of bankruptcy or insolvency) described under "Events of Default" will no longer constitute an Event of Default with respect to the Notes. In order to exercise either Legal Defeasance or Covenant Defeasance, (i) the Company must irrevocably deposit with the Trustee, in trust, for the benefit of the Holders of the Notes, cash in U.S. dollars, non-callable Government Securities, or a combination thereof, in such amounts as will be sufficient, in the opinion of a nationally recognized firm of independent public accountants, to pay the principal of, premium, if any, and interest on the outstanding Notes on the stated maturity or on the applicable redemption date, as the case may be, and the Company must specify whether the Notes are being defeased to maturity or to a particular redemption date; (ii) in the case of Legal Defeasance, the Company shall have delivered to the Trustee an opinion of counsel in the United States reasonably acceptable to the Trustee confirming that (A) the Company has received from, or there has been published by, the Internal Revenue Service a ruling or (B) since the date of the Indenture, there has been a change in the applicable federal income tax law, in either case to the effect that, and based thereon such opinion of counsel shall confirm that, the Holders of the outstanding Notes will not recognize income, gain or loss for federal income tax purposes as a result of such Legal Defeasance and will be subject to federal income tax on the same amounts, in the same manner and at the same times as would have been the case if such Legal Defeasance had not occurred; (iii) in the case of Covenant Defeasance, the Company shall have delivered to the Trustee an opinion of counsel in the United States reasonably acceptable to the Trustee confirming that the Holders of the outstanding Notes will not recognize income, gain or loss for federal income tax purposes as a result of such Covenant Defeasance and will be subject to federal income tax on the same amounts, in the same manner and at the same times as would have been the case if such Covenant Defeasance had not occurred; (iv) no Default or Event of Default shall have occurred and be continuing on the date of such deposit (other than a Default or Event of Default resulting from the borrowing of funds to be applied to such deposit) or insofar as Events of Default from bankruptcy or insolvency events are concerned, at any time in the period ending on the 91st day after the date of deposit; (v) such Legal Defeasance or Covenant Defeasance will not result in a breach or violation of, or constitute a default under any material agreement or instrument (other than the Indenture) to which the Company or any of its Subsidiaries is a party or by which the Company or any of its Subsidiaries is bound; (vi) the Company must have delivered to the Trustee an opinion of counsel to the effect that after the 91st day following the deposit, the trust funds will not be subject to the effect of any applicable bankruptcy, insolvency, reorganization or similar laws affecting creditors' rights generally; (vii) the Company must deliver to the Trustee an Officers' Certificate stating that the deposit was not made by the Company with the intent of preferring the Holders of Notes over the other creditors of the Company with the intent of defeating, hindering, delaying or defrauding creditors of the Company or others; and (viii) the Company must deliver to the Trustee an Officers' Certificate and an opinion of counsel, each stating that all conditions precedent provided for relating to the Legal Defeasance or the Covenant Defeasance have been complied with. A Holder may transfer or exchange Notes in accordance with the Indenture. The Registrar and the Trustee may require a Holder, among other things, to furnish appropriate endorsements and transfer documents and the Company may require a Holder to pay any taxes and fees required by law or permitted by the Indenture. The Company is not required to transfer or exchange any Note selected for redemption. Also, the Company is not required to transfer or exchange any Note for a period of 15 days before a selection of Notes to be redeemed. The registered Holder of a Note will be treated as the owner of it for all purposes. Except as provided in the next two succeeding paragraphs, the Indenture or the Notes may be amended or supplemented with the consent of the Holders of at least a majority in principal amount of the Notes then outstanding (including, without limitation, consents obtained in connection with a purchase of, or tender offer or exchange offer for, Notes), and any existing default or compliance with any provision of the Indenture or the Notes may be waived with the consent of the Holders of a majority in principal amount of the then outstanding Notes (including consents obtained in connection with a purchase of, or tender offer or exchange offer for Notes). Without the consent of each Holder affected, however, an amendment or waiver may not (with respect to any Note held by a non-consenting Holder): (i) reduce the principal amount of Notes whose Holders must consent to an amendment, supplement or waiver; (ii) reduce the principal of or change the fixed maturity of any Note or alter the provisions with respect to the redemption or repurchase of the Notes (other than provisions relating to the covenant entitled "Asset Sales"); (iii) reduce the rate of or change the time for payment of interest on any Notes; (iv) waive a Default or Event of Default in the payment of principal of or premium, if any, or interest on the Notes (except a rescission of acceleration of the Notes by the Holders of at least a majority in aggregate principal amount of the Notes and a waiver of the payment default that resulted from such acceleration); (v) make any Note payable in money other than that stated in the Notes; (vi) make any change in the provisions of the Indenture relating to waivers of past Defaults or the rights of Holders of Notes to receive payments of principal or premium of or interest on the Notes; (vii) waive a redemption or repurchase payment with respect to any Note; (viii) waive the obligation to make any Change of Control Offer; or (ix) make any change in the foregoing amendment and waiver provisions. In addition, any amendment to the provisions of Article 10 of the Indenture (which relate to subordination) will require the consent of the Holders of at least 75% in aggregate principal amount of the Notes then outstanding if such amendment would adversely affect the rights of Holders of Notes. Notwithstanding the foregoing, without the consent of any Holder of Notes, the Company and the Trustee may amend or supplement the Indenture or the Notes to cure any ambiguity, defect or inconsistency, to provide for uncertificated Notes in addition to or in place of certificated Notes, to provide for the assumption of the Company's obligations to Holders of the Notes in the case of a merger or consolidation, to make any change that would provide any additional rights or benefits to the Holders of the Notes or that does not adversely affect the legal rights under the Indenture of any such Holder, or to comply with requirements of the Commission in order to effect or maintain the qualification of the Indenture under the Trust Indenture Act. The Indenture contains certain limitations on the rights of the Trustee, should the Trustee become a creditor of the Company, to obtain payment of claims in certain cases, or to realize on certain property received in respect of any such claim as security or otherwise. The Trustee will be permitted to engage in other transactions with the Company; however, if the Trustee acquires any conflicting interest, it must eliminate such conflict within 90 days, apply to the Commission for permission to continue as Trustee or resign. The Holders of a majority in principal amount of the then outstanding Notes will have the right to direct the time, method and place of conducting any proceeding for exercising any remedy available to the Trustee, subject to certain exceptions. The Indenture provides that in case an Event of Default shall occur (which shall not be cured), the Trustee will be required, in the exercise of its power, to use the degree of care of a prudent man in the conduct of his own affairs. Subject to such provisions, the Trustee will be under no obligation to exercise any of its rights or powers under the Indenture at the request of any Holder of Notes, unless such Holder shall have offered to the Trustee security and indemnity satisfactory to it against any loss, liability or expense. Anyone who receives this Prospectus may obtain a copy of the Indenture without charge by writing to the Company, 6001 Indian School Road, N.E., Suite 530, Albuquerque, New Mexico, 87110, Attention: Corporate Secretary. Set forth below are certain defined terms used in the Indenture. Reference is made to the Indenture for a full disclosure of all such terms, as well as any other capitalized terms used herein for which no definition is provided. "ACQUIRED DEBT" means, with respect to any specified Person, (i) Indebtedness of any other Person existing at the time such other Person merges with or into or becomes a Subsidiary of such specified Person, including Indebtedness incurred in connection with, or in contemplation of, such other Person merging with or into or becoming a Subsidiary of such specified Person, and (ii) Indebtedness secured by a Lien encumbering any asset acquired by such specified Person. "AFFILIATE" of any specified Person means any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For purposes of this definition, "control" (including, with correlative meanings, the terms "controlling," "controlled by" and "under common control with"), as used with respect to any Person, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of such Person, whether through the ownership of voting securities, by agreement or otherwise; PROVIDED that beneficial ownership of 10% or more of the voting securities of a Person shall be deemed to be control. "ASSET SALE" means (i) the sale, lease, conveyance or other disposition of any assets (excluding by way of a sale and leaseback) other than in the ordinary course of business (PROVIDED that the sale, lease, conveyance or other disposition of all or substantially all of the assets of the Company and its Subsidiaries taken as a whole will be governed by the provisions of the Indenture described above under the covenant entitled "Change of Control" and/or the provisions described above under the covenant entitled "Merger, Consolidation or Sale of Assets" and not by the provisions of the Asset Sale covenant), and (ii) the issue or sale by the Company or any of its Subsidiaries of Equity Interests of any of the Company's Subsidiaries, in the case of either clause (i) or (ii), whether in a single transaction or a series of related transactions (a) that have a fair market value in excess of $5.0 million or (b) for net proceeds in excess of $5.0 million. Notwithstanding the foregoing, (i) a transfer of assets by the Company to a Wholly Owned Subsidiary or by a Wholly Owned Subsidiary to the Company or to another Wholly Owned Subsidiary, (ii) an issuance of Equity Interests by a Wholly Owned Subsidiary to the Company or to another Wholly Owned Subsidiary, (iii) transfers of assets which transfers constitute Permitted Investments, (iv) a Restricted Payment that is permitted by the covenant described above under the covenant entitled "Restricted Payments", and (v) an issuance of Equity Interests by a Permitted Joint Venture in the ordinary course of business, in each case, will not be deemed to be Asset Sales. "ATTRIBUTABLE DEBT" in respect of a sale and leaseback means, at the time of determination, the present value (discounted at the rate of interest implicit in such transaction, determined in accordance with GAAP or, in the event that such rate of interest is not reasonably determinable, discounted at the rate of interest borne by the Notes) of the obligation of the lessee for net rental payments during the remaining term of the lease included in such sale and leaseback (including any period for which such lease has been extended or may, at the option of the lessor, be extended). "CAPITAL LEASE OBLIGATION" means, at the time any determination thereof is to be made, the amount of the liability in respect of a capital lease that would at such time be so required to be capitalized on the balance sheet in accordance with GAAP. "CAPITAL STOCK" means, (i) in the case of a corporation, corporate stock, (ii) in the case of an association or business entity, any and all shares, interests, participations, rights or other equivalents (however designated) of corporate stock, (iii) in the case of a partnership, partnership interests (whether general or limited) and (iv) any other interest or participation that confers on a Person the right to receive a share of the profits and losses of, or distributions of assets of, the issuing Person. "CASH EQUIVALENTS" means (i) United States dollars, (ii) securities issued or directly and fully guaranteed or insured by the United States government or any agency or instrumentality thereof having maturities of not more than one year from the date of acquisition, (iii) certificates of deposit and eurodollar time deposits with maturities of one year or less from the date of acquisition, bankers' acceptances with maturities not exceeding one year and overnight bank deposits, in each case with any domestic commercial bank having capital and surplus in excess of $500 million and a Keefe Bank Watch Rating of "B" or better, (iv) repurchase obligations with a term of not more than seven days for underlying securities of the types described in clauses (ii) and (iii) above entered into with any financial institution meeting the qualifications specified in clause (iii) above, (v) commercial paper having the highest rating obtainable from Moody's Investors Service, Inc. or Standard & Poor's Corporation and in each case maturing within one year after the date of acquisition and (vi) bank deposits with any domestic commercial bank which are generally withdrawn within 5 days as part of the Company's cash concentration system. "CHANGE OF CONTROL" means the occurrence of any of the following: (i) any sale, lease, transfer, conveyance or other disposition (other than by way of merger or consolidation) in one or a series of related transactions, of all or substantially all of the assets of the Company and its Subsidiaries taken as a whole to any "person" (as defined in Section 13(d)(3) of the Exchange Act) or "group" (as defined in Sections 13(d)(3) and 14(d)(2) of the Exchange Act), (ii) the adoption of a plan for the liquidation or dissolution of the Company, (iii) the Company consolidates with, or merges with or into, another "person" (as defined above) in a transaction or series of related transactions in which the Voting Stock of the Company is converted into or exchanged for cash, securities or other property, other than any transaction where (A) the outstanding Voting Stock of the Company is converted into or exchanged for (1) Voting Stock (other than Disqualified Stock) of the surviving or transferee corporation and/or (2) cash, securities and other property in an amount which could be paid by the Company as a Restricted Payment under the Indenture and (B) the "beneficial owners" (as defined in Rule 13d-3 under the Exchange Act) of the Voting Stock of the Company immediately prior to such transaction own, directly or indirectly, not less than 40% of the total Voting Stock of the surviving or transferee corporation immediately after such transaction, (iv) the consummation of any transaction or series of related transactions (including, without limitation, by way of merger or consolidation) the result of which is that any "person" (as defined above) or "group" (as defined above) becomes the "beneficial owner" (as defined above) of more than 40% of the Voting Stock of the Company or (v) the first day on which a majority of the members of the Board of Directors of the Company are not Continuing Directors. "CMS" means Continental Medical Systems, Inc., a Delaware corporation, and a Wholly Owned Subsidiary of the Company. "CONSOLIDATED NET INCOME" means, with respect to any Person for any period, the aggregate of the Net Income of such Person and its Subsidiaries for such period, on a consolidated basis, determined in accordance with GAAP; PROVIDED, HOWEVER, that (i) the Net Income (but not loss) of any Person that is not a Subsidiary or that is accounted for by the equity method of accounting shall be included only to the extent of the amount of dividends or distributions paid to the referent Person or a Wholly Owned Subsidiary thereof, (ii) the Net Income of any Subsidiary shall be excluded to the extent that the declaration or payment of dividends or similar distributions by that Subsidiary of that Net Income is not, at the date of determination, permitted without any prior governmental approval (which has not been obtained) or, directly or indirectly, by operation of the terms of its charter or any agreement, instrument, judgment, decree, order, statute, rule or governmental regulation applicable to that Subsidiary or its stockholders, (iii) the Net Income of any Person acquired after the date of the Indenture in a pooling of interests transaction for any period prior to the date of such acquisition shall be excluded, and (iv) the cumulative effect of a change in accounting principles shall be excluded. "CONSOLIDATED NET WORTH" means, with respect to any Person as of any date, the sum of (i) the consolidated equity of the common stockholders of such Person and its consolidated Subsidiaries as of such date plus (ii) the respective amounts reported on such Person's balance sheet as of such date with respect to any series of preferred stock (other than Disqualified Stock) that by its terms is not entitled to the payment of dividends unless such dividends may be declared and paid only out of net earnings in respect of the year of such declaration and payment, but only to the extent of any cash received by such Person upon issuance of such preferred stock, less (x) all write-ups (other than write-ups resulting from foreign currency translations and write-ups of tangible assets of a going concern business made within 12 months after the acquisition of such business) subsequent to the date of the Indenture in the book value of any asset owned by such Person or a consolidated Subsidiary of such Person, (y) all investments as of such date in unconsolidated Subsidiaries and in Persons that are not Subsidiaries (except, in each case, Permitted Investments), and (z) all unamortized debt discount and expense and unamortized deferred charges as of such date, all of the foregoing determined in accordance with GAAP. "CONSOLIDATED TOTAL ASSETS" means, with respect to any Person as of any date, the consolidated total assets of such Person and its consolidated Subsidiaries as reported on the most recent consolidated balance sheet of such Person as of such date, determined in accordance with GAAP. "CONTINUING DIRECTORS" means, as of any date of determination, any member of the Board of Directors of the Company who (i) was a member of such Board of Directors on the date of the Indenture or (ii) was nominated for election or elected to such Board of Directors with the approval of a majority of the Continuing Directors who were members of such Board at the time of such nomination or election. "CREDIT FACILITY" means that certain amended and restated credit agreement, dated as of September 26, 1995, by and among the Company, CMS, NationsBank of Texas, N.A., as agent, and the lenders party thereto, including any related notes, guarantees, collateral documents, instruments and agreements executed in connection therewith, and in each case as amended, modified, extended, renewed, refunded, replaced or refinanced from time to time. "DEFAULT" means any event that is or with the passage of time or the giving of notice or both would be an Event of Default. "DESIGNATED SENIOR DEBT" means (i) so long as the Company has any Obligation under the Credit Facility, the Credit Facility and (ii) thereafter, any other Senior Debt of the Company the principal amount of which is $75.0 million or more and that has been designated by the Company as "Designated Senior Debt." "DISQUALIFIED STOCK" means any Capital Stock which, by its terms (or by the terms of any security into which it is convertible or for which it is exchangeable), or upon the happening of any event, matures or is mandatorily redeemable, pursuant to a sinking fund obligation or otherwise, or redeemable at the option of the holder thereof, in whole or in part, on or prior to date on which the Notes mature. "EBITDA" means, with respect to any Person for any period, the Consolidated Net Income of such Person for such period plus (i) an amount equal to any extraordinary loss plus any net loss realized in connection with an Asset Sale (to the extent such losses were deducted in computing such Consolidated Net Income), plus (ii) provision for taxes based on income or profits of such Person and its Subsidiaries for such period, to the extent that such provision for taxes was included in computing such Consolidated Net Income, plus (iii) consolidated interest expense of such Person and its Subsidiaries for such period, whether paid or accrued and whether or not capitalized (including, without limitation, amortization of original issue discount, non-cash interest payments, the interest component of any deferred payment obligations, the interest component of all payments associated with Capital Lease Obligations, commissions, discounts and other fees and charges incurred in respect of letter of credit or bankers' acceptance financings, and net payments (if any) pursuant to Hedging Obligations), to the extent that any such expense was deducted in computing such Consolidated Net Income, plus (iv) depreciation, amortization (including amortization of goodwill and other intangibles but excluding amortization of prepaid cash expenses that were paid in a prior period) and other non-cash charges (excluding any such non-cash charge to the extent that it represents an accrual of or reserve for cash charges in any future period or amortization of a prepaid cash expense that was paid in a prior period) of such Person and its Subsidiaries for such period to the extent that such depreciation, amortization and other non-cash charges were deducted in computing such Consolidated Net Income, in each case, on a consolidated basis and determined in accordance with GAAP. Notwithstanding the foregoing, the provision for taxes on the income or profits of, and the depreciation and amortization and other non-cash charges of, a Subsidiary of the referent Person shall be added to Consolidated Net Income to compute EBITDA only to the extent (and in same proportion) that the Net Income of such Subsidiary was included in calculating the Consolidated Net Income of such Person and only if a corresponding amount would be permitted at the date of determination to be paid as a dividend to the Company by such Subsidiary without prior approval (that has not been obtained) required, pursuant to the terms of its charter and all agreements, instruments, judgments, decrees, orders, statutes, rules and governmental regulations applicable to that Subsidiary or its stockholders. "EQUITY INTERESTS" means Capital Stock and all warrants, options or other rights to acquire Capital Stock (but excluding any debt security that is convertible into, or exchangeable for Capital Stock). "EXISTING INDEBTEDNESS" means Indebtedness of the Company and its Subsidiaries (other than Indebtedness under the Credit Facility) in existence on the date of the Indenture until such amounts are repaid. "FIXED CHARGES" means, with respect to any Person for any period, the sum of (i) the consolidated interest expense of such Person and its Subsidiaries for such period, whether paid or accrued (including, without limitation, amortization of original issue discount, non-cash interest payments, the interest component of any deferred payment obligations, the interest component of all payments associated with Capital Lease Obligations, commissions, discounts and other fees and charges incurred in respect of letter of credit or bankers' acceptance financings, and net payments (if any) pursuant to Hedging Obligations), (ii) the consolidated interest expense of such Person and its Subsidiaries that was capitalized during such period, (iii) any interest expense on Indebtedness of another Person that is Guaranteed by such Person or one of its Subsidiaries or secured by a Lien on assets of such Person or one of its Subsidiaries (whether or not such Guarantee or Lien is called upon) and (iv) the product of (a) all cash dividend payments (and non-cash dividend payments in the case of a Person that is a Subsidiary) on any series of preferred stock of such Person, times (b) a fraction, the numerator of which is one and the denominator of which is one minus the then current combined federal, state and local statutory tax rate of such Person, expressed as a decimal, in each case, on a consolidated basis and in accordance with GAAP. "FIXED CHARGE COVERAGE RATIO" means with respect to any Person for any period, the ratio of the EBITDA of such Person for such period to the Fixed Charges of such Person for such period. If the Company or any of its Subsidiaries incurs, assumes, Guarantees or redeems any Indebtedness (other than revolving credit borrowings) or issues or redeems preferred stock subsequent to the commencement of the period for which the Fixed Charge Coverage Ratio is being calculated but on or prior to the date on which the event for which the calculation of the Fixed Charge Coverage Ratio is made (the "Calculation Date"), then the Fixed Charge Coverage Ratio shall be calculated giving pro forma effect to such incurrence, assumption, Guarantee or redemption of Indebtedness, or such issuance or redemption of preferred stock, as if the same had occurred at the beginning of the applicable four-quarter reference period. In addition, for purposes of making the computation referred to above, (i) acquisitions that have been made by the Company or any of its Subsidiaries, including through mergers or consolidations and including any related financing transactions, during the four-quarter reference period or subsequent to such reference period and on or prior to the Calculation Date shall be deemed to have occurred on the first day of the four-quarter reference period and EBITDA for such reference period shall be calculated without giving effect to clause (iii) of the proviso set forth in the definition of Consolidated Net Income, (ii) the EBITDA attributable to discontinued operations, as determined in accordance with GAAP, and operations or businesses disposed of prior to the Calculation Date, shall be excluded, and (iii) the Fixed Charges attributable to discontinued operations, as determined in accordance with GAAP, and operations or businesses disposed of prior to the Calculation Date, shall be excluded, but only to the extent that the obligations giving rise to such Fixed Charges will not be obligations of the referent Person or any of its Subsidiaries following the Calculation Date. "GAAP" means generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity as may be approved by a significant segment of the accounting profession of the United States, which are in effect from time to time. "GOVERNMENT SECURITIES" means direct obligations of, or obligations guaranteed by, the United States of America for the payment of which guarantee or obligations the full faith and credit of the United States is pledged. "GUARANTEE" means a guarantee (other than by endorsement of negotiable instruments for collection in the ordinary course of business), direct or indirect, in any manner, of all or any part of any Indebtedness. "HEALTH CARE FACILITY" means a long-term care facility, acute rehabilitation facility, subacute care facility, outpatient rehabilitation clinic, institutional pharmacy, Alzheimer's center or such other facility that is used or useful in the provision of health care services. "HEDGING OBLIGATIONS" means, with respect to any Person, the obligations of such Person under (i) interest rate swap agreements, interest rate cap agreements and interest rate collar agreements and (ii) other agreements or arrangements designed to protect such person against interest rate exposure. "INDEBTEDNESS" means, with respect to any Person, any indebtedness of such Person, whether or not contingent, in respect of borrowed money or evidenced by bonds, notes, debentures or similar instruments or letters of credit (or reimbursement agreements in respect thereof) or representing Capital Lease Obligations or the balance deferred and unpaid of the purchase price of any property or representing any Hedging Obligations, except any such balance that constitutes an accrued expense or trade payable, if and to the extent any of the foregoing indebtedness (other than letters of credit and Hedging Obligations) would appear as a liability upon a balance sheet of such Person prepared in accordance with GAAP, as well as all Attributable Debt of such Person and indebtedness of others secured by a Lien on any asset of such Person (whether or not such indebtedness is assumed by such Person) and, to the extent not otherwise included, the Guarantee by such Person of any indebtedness of any other Person. "INVESTMENTS" means, with respect to any Person, all investments by such Person in other Persons (including Affiliates) in the forms of direct or indirect loans (including Guarantees or other obligations), advances or capital contributions (excluding commission, travel and similar advances to officers and employees made in the ordinary course of business), purchases or other acquisitions for consideration of Indebtedness, Equity Interests or other securities, together with all items that are or would be classified as investments on a balance sheet prepared in accordance with GAAP; PROVIDED that an acquisition of assets, Equity Interests or other securities by the Company for consideration consisting of common equity securities of the Company shall not be deemed to be an Investment. If the Company or any Subsidiary of the Company sells or otherwise disposes of any Equity Interests of any direct or indirect Subsidiary of the Company such that, after giving effect to any such sale or disposition, such Person is no longer a Subsidiary of the Company, the Company shall be deemed to have made an Investment on the date of any such sale or disposition equal to the fair market value of the Equity Interests of such Subsidiary not sold or disposed of. "LIEN" means, with respect to any asset, any mortgage, lien, pledge, charge, security interest or encumbrance of any kind in respect of such asset, whether or not filed, recorded or otherwise perfected under applicable law (including any conditional sale or other title retention agreement, any lease in the nature thereof, any option or other agreement to sell or give a security interest in and any filing of or agreement to give any financing statement under the Uniform Commercial Code (or equivalent statutes) of any jurisdiction). "NET INCOME" means, with respect to any Person, the net income (loss) of such Person, determined in accordance with GAAP and before any reduction in respect of preferred stock dividends, excluding, however, (i) any gain (but not loss), together with any related provision for taxes on such gain (but not loss), realized in connection with (a) any Asset Sale or (b) the disposition of any securities by such Person or any of its Subsidiaries or the extinguishment of any Indebtedness of such Person or any of its Subsidiaries and (ii) any extraordinary or nonrecurring gain (but not loss), together with any related provision for taxes on such extraordinary or nonrecurring gain (but not loss). "NET PROCEEDS" means the aggregate cash proceeds received by the Company or any of its Subsidiaries in respect of any Asset Sale (including, without limitation, any cash received upon the sale or other disposition of any non-cash consideration received in any Asset Sale), net of the direct costs relating to such Asset Sale (including, without limitation, legal, accounting and investment banking fees, and sales commissions) and any relocation expenses incurred as a result thereof, taxes paid or payable as a result thereof (after taking into account any available tax credits or deductions and any tax sharing arrangements), amounts required to be applied to the repayment of Indebtedness secured by a Lien on the asset or assets that were the subject of such Asset Sale and any reserve for adjustment in respect of the sale price of such asset or assets established in accordance with GAAP. "OBLIGATIONS" means any principal, interest, penalties, fees, indemnifications, reimbursements, damages and other liabilities payable under the documentation governing any Indebtedness. "PERMITTED INVESTMENTS" means (i) any Investments in or for the benefit of the Company or a Wholly Owned Subsidiary of the Company, (ii) any Investments in Cash Equivalents, (iii) any Investments by the Company or any Subsidiary of the Company in a Person if, as a result of such Investment, (a) such Person becomes a Wholly Owned Subsidiary of the Company or (b) such Person is merged, amalgamated with or into, or transfers or conveys substantially all of its assets to, or is liquidated into, the Company or a Wholly Owned Subsidiary of the Company, (iv) any Investments made as a result of the receipt of non-cash consideration from an Asset Sale that was made pursuant to and in compliance with the covenant entitled "Asset Sales," (v) any Investments in Permitted Joint Ventures or in a Person which, as a result of such Investment, becomes a Permitted Joint Venture; and (vi) any other Investments in any Person having an aggregate fair market value (measured on the date each such Investment was made and without giving effect to subsequent changes in value), which when taken together with all other Investments made pursuant to this clause (vi) that are at the time outstanding, does not exceed the greater of (x) $35.0 million or (y) 5% of the Consolidated Total Assets of the Company. "PERMITTED JOINT VENTURE" means any Subsidiary engaged in the ownership, operation and management of Health Care facilities and Related Businesses. "PERMITTED LIENS" means (i) Liens securing Senior Debt; (ii) Liens in favor of the Company, (iii) Liens on property of a Person existing at the time such Person is merged into or consolidated with the Company or any Subsidiary of the Company or such Person becomes a Subsidiary of the Company, PROVIDED, that such Liens (x) were not incurred in connection with, or in contemplation of, such merger or consolidation and (y) do not extend to any assets other than those of the Person merged into or consolidated with the Company or such Subsidiary; (iv) Liens on property existing at the time of acquisition thereof by the Company or any Subsidiary of the Company; PROVIDED that such Liens were not incurred in connection with, or in contemplation of, such acquisition and do not extend to any assets of the Company or any of its Subsidiaries other than the property so acquired; (v) Liens to secure the performance of statutory obligations, surety or appeal bonds or performance bonds, or landlords', carriers', warehousemen's, mechanics', suppliers', materialmen's or other like Liens, in any case incurred in the ordinary course of business and with respect to amounts not yet delinquent or being contested in good faith by appropriate process of law, if a reserve or other appropriate provision, if any, as is required by GAAP shall have been made therefor; (vi) Liens existing on the date of the Indenture; (vii) Liens for taxes, assessments or governmental charges or claims that are not yet delinquent or that are being contested in good faith by appropriate proceedings promptly instituted and diligently concluded; PROVIDED that any reserve or other appropriate provision as shall be required in conformity with GAAP shall have been made therefor; (viii) Liens to secure Capital Lease Obligations, mortgage financings or purchase money obligations permitted by clause (vii) of the second paragraph of the covenant entitled "Incurrence of Indebtedness and Issuance of Preferred Stock" covering only the assets acquired with such Indebtedness; (ix) Liens incurred in the ordinary course of business of the Company or any Subsidiary of the Company with respect to obligations not constituting Indebtedness for borrowed money that do not exceed $5.0 million in the aggregate at any one time outstanding; (x) Liens securing Indebtedness incurred to refinance Indebtedness that has been secured by a Lien permitted under the Indenture; PROVIDED that (a) any such Lien shall not extend to or cover any assets or property not securing the Indebtedness so refinanced and (b) the refinancing Indebtedness secured by such Lien shall have been permitted to be incurred under the covenant entitled "Incurrence of Indebtedness and Issuance of Preferred Stock;" (xi) Liens securing Obligations under the Credit Facility are Hedging Obligations to any lender under the Credit Facility permitted under the Indenture; and (xii) Liens in respect of deposits in connection with workers' compensation, unemployment insurance, old age pensions or other social security or retirement benefits legislation in respect of employees of the Company and its Subsidiaries. "PERMITTED REFINANCING DEBT" means any Indebtedness of the Company or any Subsidiary issued in exchange for, or the net proceeds of which are used to extend, refinance, renew, replace, defease or refund other Indebtedness of the Company or any of its Subsidiaries permitted by the Indenture to be incurred; PROVIDED that: (i) the principal amount (or accreted value, if applicable) of such Permitted Refinancing Debt does not exceed the principal amount (or accreted value, if applicable) of the Indebtedness so extended, refinanced, renewed, replaced, defeased or refunded (plus the amount of reasonable expenses incurred in connection therewith); (ii) such Permitted Refinancing Debt has a final maturity date later than the final maturity date of, and has a Weighted Average Life to Maturity equal to or greater than the Weighted Average Life to Maturity of, the Indebtedness being extended, refinanced, renewed, replaced, defeased or refunded; (iii) if the Indebtedness being extended, refinanced, renewed, replaced, defeased or refunded is subordinated in right of payment to the Notes, such Permitted Refinancing Debt has a final maturity date later than the final maturity date of, and is subordinated in right of payment to, the Notes on terms not materially less favorable to the Holders of Notes as those contained in the documentation governing the Indebtedness being extended, refinanced, renewed, replaced, defeased or refunded; and (iv) such Permitted Refinancing Debt is incurred either by the Company or by the Subsidiary who is the obligor on the Indebtedness being extended, refinanced, renewed, replaced, defeased or refunded. "RELATED BUSINESS" means the business conducted by the Company and its Subsidiaries as of the date of the Indenture and any and all health care service businesses that in the good faith judgment of the Board of Directors of the Company are materially related businesses. "RESTRICTED INVESTMENT" means an Investment other than a Permitted Investment. "SENIOR DEBT" means (i) Obligations of the Company under the Credit Facility and (ii) any other Indebtedness permitted to be incurred by the Company under the terms of the Indenture, unless the instrument under which such other Indebtedness is incurred expressly provides that it is on a parity with or subordinated in right of payment to the Notes. Notwithstanding anything to the contrary in the foregoing, Senior Debt will not include (w) any liability for federal, state, local or other taxes, (x) any Indebtedness of the Company to any of its Subsidiaries or other Affiliate (PROVIDED, that in no event will the Credit Facility be construed as Indebtedness within the scope of this clause (x) by virtue of Continental Medical Systems, Inc. being a co-borrower under the Credit Facility), (y) any trade payables or (z) any Indebtedness to the extent that such Indebtedness is incurred in violation of the Indenture. "SIGNIFICANT SUBSIDIARY" means any Subsidiary that would be a "significant subsidiary" as defined in Article 1, Rule 1-02 of Regulation S-X, promulgated pursuant to the Act, as such Regulation is in effect on the date hereof. "SUBSIDIARY" means, with respect to any Person, (i) any corporation, association or other business entity of which (x) at least 50% of the total voting power of shares of Capital Stock entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time owned or controlled, directly or indirectly, by such Person or one or more of the other Subsidiaries of that Person (or a combination thereof) and (y) such Person, directly or indirectly, has the right to elect a majority of the members of the board of directors, managers or trustees either as a result of the ownership or control of more than 50% of the total voting power of shares of Capital Stock entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof or pursuant to a shareholders agreement or other voting agreement and (ii) any partnership (a) the sole general partner or the managing general partner of which is such Person or a Subsidiary of such Person or (b) the only general partners of which are such Person or one or more Subsidiaries of such Person (or any combination thereof). "VOTING STOCK" means any class or classes of Capital Stock pursuant to which the holders thereof have the general voting power under ordinary circumstances to elect at least a majority of the board of directors, managers or trustees of any Person (irrespective of whether or not, at the time, stock of any other class or classes shall have, or might have, voting power by reason of the happening of any contingency). "WEIGHTED AVERAGE LIFE TO MATURITY" means, when applied to any Indebtedness at any date, the number of years obtained by dividing (i) the then outstanding principal amount of such Indebtedness into (ii) the total of the product obtained by multiplying (a) the amount of each then remaining installment, sinking fund, serial maturity or other required payment of principal, including payment at final maturity, in respect thereof, by (b) the number of years (calculated to the nearest one-twelfth) that will elapse between such date and the making of such payment. "WHOLLY OWNED SUBSIDIARY" of any Person means a Subsidiary of such Person all of the outstanding Capital Stock or other ownership interests of which (other than directors' qualifying shares) shall at the time be owned by such Person or by one or more Wholly Owned Subsidiaries of such Person or by such Person and one or more Wholly Owned Subsidiaries of such Person. The following summarizes the material terms of the Credit Facility. The summary is not a complete description of the Credit Facility. Copies of the material agreements relating thereto have been filed with the Commission and the description set forth below is qualified in its entirety by reference to such agreements. In July 1995, the Company and CMS entered into the Credit Facility with a consortium of banks. The amount available for borrowing by either borrower thereunder is $750.0 million, including a $70.0 million letter of credit sub-facility. Interest on borrowings under the Credit Facility is computed at a rate equal to either the Alternate Base Rate or the Adjusted LIBOR Rate plus 0.625% to 1.25% per annum, depending on the maintenance of certain specified financial ratios. The Alternate Base Rate is equal to the greater of the prime rate or the federal funds effective rate plus 0.5%. The agreement relating to the Credit Facility: (a) requires the Company to maintain certain financial ratios, (b) restricts the Company's ability to enter into capital leases beyond certain specified amounts, (c) prohibits transactions with affiliates not at arm's length, (d) allows the Company to make only permitted investments, (e) restricts certain indebtedness, liens, dispositions of property and issuances of securities and (f) prohibits a change in control or a fundamental change in the business of the Company except under certain limited circumstances. The Credit Facility also restricts payment of dividends by the Company to an amount which may not exceed 20% of the Company's net income for the prior fiscal year. Any such payment is subject to continued compliance by the Company with the financial ratio covenants contained in the agreement. The agreement expires in June 2000, unless extended, is secured by a pledge of the stock and intercompany notes of all material subsidiaries of the Company and is guaranteed by certain of such subsidiaries. At November 30, 1995, the indebtedness outstanding under the Credit Facility was $463.2 million. After giving pro forma effect to the Offering and the use of the net proceeds therefrom, indebtedness outstanding under the Credit Facility at November 30, 1995 would have been $269.2 million. The Company and CMS used the funds borrowed under the Credit Facility principally (i) to fund acquisitions and capital expenditures ($84.7 million) and (ii) to fund the tender offer and consent solicitation by the Company for the outstanding 10 3/8% and 10 7/8% Senior Subordinated Notes of CMS ($289.5 million). The Company intends to use funds available under the Credit Facility for general corporate purposes, including acquisitions. Subject to the terms and conditions set forth in the Underwriting Agreement (the "Underwriting Agreement") among the Company and the underwriters named below (the "Underwriters"), the Company has agreed to sell to each of the Underwriters, and each of the Underwriters has severally agreed to purchase, the respective principal amounts of Notes set forth opposite its name below, at the public offering price set forth on the cover page of this Prospectus, less the underwriting discount: The Underwriting Agreement provides that the obligations of the Underwriters are subject to certain conditions. The nature of the Underwriters' obligations is such that the Underwriters are committed to purchase all of the Notes if any of the Notes are purchased by them. The Underwriters have advised the Company that they propose initially to offer the Notes directly to the public at the public offering price set forth on the cover page of this Prospectus, and to certain dealers at such price less a concession not in excess of % of the principal amount. The Underwriters may allow, and such dealers may reallow, a discount not in excess of % of the principal amount of the Notes to certain other dealers. After the initial public offering, the public offering price and other selling terms may be changed by the Underwriters. The Company has agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended, or to contribute to payments the Underwriters may be required to make in respect thereof. From time to time, each of the Underwriters (or in certain circumstances an affiliate thereof) performs investment banking, commercial banking or other financial services for the Company in return for customary fees. The validity of the Notes offered hereby will be passed upon for the Company by Vinson & Elkins L.L.P., Houston, Texas. Certain legal matters in connection with the Notes will be passed upon for the Underwriters by Latham & Watkins, New York, New York. The consolidated financial statements of Horizon/CMS Healthcare Corporation at May 31, 1995 and 1994 and for each of the three years in the period ended May 31, 1995, included in this Prospectus and elsewhere in this Registration Statement, have been audited by Arthur Andersen LLP, independent accountants, as set forth in their reports thereon which, as to the years 1995, 1994, and 1993, are based in part on the reports of Ernst & Young LLP and Price Waterhouse LLP, independent accountants. The financial statements referred to above have been included in this Prospectus and elsewhere in this Registration Statement in reliance upon said reports given upon the authority of said firms as experts in accounting and auditing. The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files reports and other information with the Securities and Exchange Commission (the "Commission"). Reports, proxy statements and other information filed by the Company can be inspected and copied at the public reference facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's Regional Offices at 13th Floor, Seven World Trade Center, New York, New York 10048 and Suite 1400, Northwestern Atrium Center, 500 West Madison Street, Chicago, Illinois 60621-2511. Copies of such material can be obtained by mail from the Public Reference Branch of the Commission at 450 West Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. In addition, reports, proxy statements and other information concerning the Company may be inspected at the office of the New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005. This Prospectus constitutes a part of a Registration Statement on Form S-3 (herein, together with all amendments and exhibits, referred to as the "Registration Statement") which the Company has filed with the Commission under the Securities Act. This Prospectus omits certain of the information contained in the Registration Statement in accordance with the rules and regulations of the Commission. Reference is hereby made to the Registration Statement and related exhibits for further information with respect to the Company and the Notes. Statements contained herein concerning the provisions of any document are not necessarily complete and, in each instance, reference is made to the copy of the document filed as an exhibit to the Registration Statement or otherwise filed with the Commission. Each such statement is qualified in its entirety by such reference. INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following documents, which have been filed with the Commission pursuant to the Exchange Act, are incorporated herein by reference: (1) Annual Report on Form 10-K for the year ended May 31, 1995, as amended by Amendment No. 1 on Form 10-K/A dated October 3, 1995; (2) Quarterly Report on Form 10-Q for the quarter ended August 31, 1995; (3) Current Reports on Form 8-K dated June 23, 1995 (as amended by Amendment No. 1 on Form 8-K/A dated August 8, 1995); July 25, 1995; July 25, 1995 (as amended by Amendment No. 1 on Form 8-K/A dated September 25, 1995 and Amendment No. 2 on Form 8-K/A dated September 26, 1995); November 20, 1995; and November 21, 1995; (4) Registration Statement on Form 8-A dated March 17, 1987, as amended by Amendment No. 1 on Form 8-A/A dated June 23, 1994 and Amendment No. 2 on Form 8-A/A dated September 22, 1994; and (5) Registration Statement on Form 8-A dated September 16, 1994. All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of this Prospectus and prior to the termination of the offering of the Notes shall be deemed to be incorporated by reference in this Prospectus and to be a part hereof from the date of filing of such documents. Any statement contained in a document incorporated or deemed to be incorporated by reference herein shall be deemed to be modified or superseded for purposes of this Prospectus to the extent that a statement contained herein or in any other subsequently filed document which also is or is deemed to be incorporated by reference herein modifies or supersedes such statement. Any such statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of this Prospectus. The Company will provide without charge to each person to whom a copy of this Prospectus is delivered, upon the written or oral request of such person, a copy of any or all of the documents which are incorporated by reference herein, other than exhibits to such documents (unless such exhibits are specifically incorporated by reference into such documents). Requests should be directed to Ernest A. Schofield, Senior Vice President, Treasurer, and Chief Financial Officer, at the Company's principal executive offices. INDEX TO HISTORICAL FINANCIAL STATEMENTS REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Horizon/CMS Healthcare Corporation: We have audited the accompanying consolidated balance sheets of Horizon/CMS Healthcare Corporation (formerly, Horizon Healthcare Corporation) (a Delaware corporation) and subsidiaries (Note 1) as of May 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended May 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of Continental Medical Systems, Inc. and subsidiaries ("CMS"), a company acquired during fiscal 1996 in a transaction accounted for as a pooling-of-interests, as discussed in Notes 1 and 18. Such statements are included in the consolidated financial statements of Horizon/CMS Healthcare Corporation and reflect total operating revenues of 79.6 percent in 1993, and total assets and total operating revenues of 65.4 and 73.0 percent, respectively in 1994, and 49.3 percent and 60.7 percent, respectively in 1995, of the related consolidated totals. Those statements were audited by other auditors whose report has been furnished to us and our opinion, insofar as it relates to amounts included for CMS, is based solely upon the reports of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of the other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Horizon/CMS Healthcare Corporation and subsidiaries as of May 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended May 31, 1995, in conformity with generally accepted accounting principles. To the Board of Directors and Stockholders of Horizon/CMS Healthcare Corporation: We have audited the consolidated balance sheets of Continental Medical Systems, Inc. and subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended June 30, 1995 (not presented separately herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements of Continental Medical Systems, Inc. and subsidiaries for the year ended June 30, 1993, were audited by other auditors whose report dated August 10, 1993, on those statements included an explanatory paragraph that described the change in the Company's method of accounting for development costs and the adoption of the provisions of Statement of Financial Accounting Standards No. 115, which are discussed in Notes 8 and 11, respectively, to the consolidated financial statements. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 1995 and 1994 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Continental Medical Systems, Inc. and subsidiaries at June 30, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the two years in the period ended June 30, 1995, in conformity with generally accepted accounting principles. August 3, 1995, except for Note 6 and Note 19 for which the date is September 26, 1995; Note 14 for which the date is September 12, 1995; and Note 20 for which the date is To the Board of Directors of Continental Medical Systems, Inc. We have audited the consolidated balance sheet of Continental Medical Systems, Inc. and its subsidiaries as of June 30, 1993 and the related consolidated statements of income, stockholders' equity and cash flows for the year then ended (not presented separately herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statments are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements audited by us present fairly, in all material respects, the financial position of Continental Medical Systems, Inc. and its subsidiaries at June 30, 1993 and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. We have not audited the consolidated financial statements of Continental Medical Systems, Inc. for any period subsequent to June 30, 1993. As discussed in Notes 8 and 11 to the consolidated financial statements, in fiscal 1993 the Company changed its method of accounting for development costs and adopted the provisions of Statement of Financial Accounting Standards No. 115. MAY 31, 1995 AND 1994 The accompanying notes are an integral part of these balance sheets. FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 The accompanying notes are an integral part of these statements. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 The accompanying notes are an integral part of these statements. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 The accompanying notes are an integral part of these statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Horizon/CMS Healthcare Corporation (formerly, Horizon Healthcare Corporation) and its subsidiaries (collectively, the Company) is a leading provider of post-acute health care services. The Company's long-term care facilities provide skilled nursing care and basic patient services with respect to daily living and general medical needs. The Company also provides comprehensive medical rehabilitation programs and services in each of the rehabilitation industry's three principal sectors -- inpatient rehabilitation care, outpatient rehabilitation care and contract therapy. The Company also provides other specialty health care services to its long-term care and rehabilitation facilities and outside parties. Such specialty health care services include licensed specialty hospital services and subacute units, institutional pharmacy services, physician locum tenens, Alzheimer's care, non-invasive medical diagnostic testing services, home respiratory care services, clinical laboratory services and management and managed care services to physicians and other providers. Substantially all of these services are within the post-acute health care market and, accordingly, the Company operates within a single industry segment. Subsequent to year end, in connection with the merger of a wholly owned subsidiary of the Company with Continental Medical Systems, Inc. (CMS), the Company changed its name to Horizon/CMS Healthcare Corporation (Note 18). As discussed in Note 18, the accompanying financial statements have been restated to include the accounts and operations of CMS for all periods prior to the merger. These restated financial statements include the financial position of CMS as of June 30, 1995 and 1994 and the results of operations of CMS for each of the three years in the period ended June 30, 1995. The consolidated financial statements include the accounts of the Company and its 50% or greater owned subsidiaries which the Company controls. All significant intercompany accounts and transactions have been eliminated in consolidation. Investments in affiliates, which are included in other assets in the accompanying consolidated balance sheets, in which the Company owns 20% or more and limited partnerships are carried on the equity basis which approximates the Company's equity in underlying net book value. Other investments are stated at cost. Operating revenues include net patient care and other revenues. Net patient care revenues are recorded at established billing rates or at the amount realizable under agreements with third-party payors, primarily Medicaid and Medicare. Revenues under third-party payor agreements in certain states are subject to examination and retroactive adjustments, and amounts realizable may change due to periodic changes in the regulatory environment. Provisions for estimated third-party payor settlements are provided in the period the related services are rendered. Differences between the amounts accrued and subsequent settlements are recorded in operations in the year of settlement. A significant portion of the Company's revenue is derived from patients under the Medicaid and Medicare programs. There have been and the Company expects that there will continue to be a number of proposals to limit Medicare and Medicaid reimbursement for long-term and rehabilitative care services. The Company cannot predict at this time whether any of these proposals will be adopted or, if adopted and implemented, what effect such proposals would have on the Company. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Operating revenues also include interest, management fees and other revenues which are not material to total operating revenues. For purposes of the accompanying consolidated statements of cash flows, the Company considers its highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Property and equipment is stated at the lower of cost or net realizable value. Depreciation is recorded using the straight-line method over the estimated useful lives of the assets (buildings -- 30 to 40 years; equipment -- 3 to 20 years). Maintenance and repairs are charged to expense as incurred. Major renewals or improvements are capitalized. The carrying values of long-lived assets are reviewed if the facts and circumstances suggest that an item may be impaired. If this review indicates that a long-lived asset will not be recoverable, as determined based on the future undiscounted cash flows of the asset, the Company's carrying value of the long-lived asset is reduced to fair value. Goodwill has resulted from various acquisitions made by the Company. In connection with acquisitions accounted for as purchases, the excess of the total acquisition cost over the fair value of the net assets acquired has been recorded as goodwill. Goodwill is amortized on the straight-line basis over a period of 15 to 40 years. The Company evaluates the realizability of goodwill quarterly based upon expectations of undiscounted future cash flows of the related assets. The Company files a consolidated federal income tax return for all 80% or more owned subsidiaries. Separate returns are filed for all subsidiaries owned less than 80%. On June 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (FAS 109), "Accounting for Income Taxes." The adoption of FAS 109 changes the Company's method of accounting for income taxes from the deferred method (APB Opinion No. 11) to an asset and liability approach. The asset and liability approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. Workers' compensation coverage is effected through deductible insurance policies and qualified self insurance plans which vary by the states in which the Company operates. Provisions for estimated settlements are provided in the period of the related coverage and are determined on a case by case basis plus an amount for incurred but not reported claims. Differences between the amounts accrued and subsequent settlements are recorded in operations in the period of settlement. Earnings per share is calculated based upon the weighted-average number of common shares and common equivalent shares outstanding during each period. Common equivalent shares include stock purchase warrants and options. Earnings per common and common equivalent share is based upon 47,850,000 shares in 1995, 37,078,000 shares in 1994, and 32,248,000 shares in 1993. Earnings per common share-assuming full dilution is based upon 47,857,000 shares in 1995, 40,051,000 shares in 1994 and 36,941,000 shares in 1993, including the effect of convertible subordinated notes. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Notes receivable consists of the following: Property and equipment owned and held under capital lease is stated at cost and consists of the following: Accrued expenses is comprised of the following: NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Long-term debt consists of the following: On March 16, 1995, the Company completed a $250,000 revolving credit loan agreement with the Boatmen's National Bank of St. Louis, as agent for a group of banks (the "Boatmen's Facility"). The Boatmen's Facility, which replaced the revolving loan agreement outstanding at May 31, 1994 was drawn in the amount of $104,750 at May 31, 1995. This facility bears interest at either the Adjusted Corporate Base Rate plus up to .25% (9.0% at May 31, 1995) or at the Adjusted London Interbank Offered Rate (LIBOR) rate plus 0.5 to 1.25% (7.0 to 7.0625% at May 31, 1995), both as defined in the credit agreement. The average interest rate on amounts outstanding under the Boatmen's Facility was 7.68% at May 31, 1995. This facility: (a) requires the Company to maintain certain financial ratios, (b) restricts the Company's ability to enter into capital leases beyond certain specified amounts, (c) prohibits transactions with affiliates not at arm's length, (d) allows the Company to make only permitted investments, (e) restricts certain indebtedness, liens, dispositions of property and issuances of securities and (f) prohibits a change in control or a fundamental change in the business of the Company except under certain limited circumstances. The Boatmen's Facility also restricts the payment of dividends by the Company to an amount which shall not exceed 25% of the Company's net income for the prior fiscal year, and any such payment is subject to continued compliance by the Company with the financial ratio covenants contained in the credit agreement. This facility further provides that any event or occurrence that would have a material adverse effect on the Company's ability to repay the loans or to perform its obligations under the loan documents will constitute an event of default under this facility. Certain subsidiaries of the Company have guaranteed the obligations of the Company under the Boatmen's Facility. The Boatmen's Facility expires on March 31, 1998 and is secured by a pledge of the stock of all subsidiaries of the Company and certain accounts receivable of the Company. The amount of such accounts receivable collateral was approximately $102,200 at May 31, 1995. Prior to the merger, at May 31, 1995, the Company was also party to a credit facility with Citibank, N.A., as agent for a group of several banks (the "Citibank Facility"). At May 31, 1995, $34,000 had been drawn on this facility. The Citibank Facility provided up to $235,000 in a revolving line of credit, of which up to $45,000 was available in the form of letters of credit. The Citibank Facility provided for a revolving loan period NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) through December 31, 1996 and the subsequent conversion of the revolving loan into a term loan. At the Company's option, the interest rate on any loan under the Citibank Facility was based on the LIBOR rate or a base rate as specified in the agreement as adjusted for a margin. At May 31, 1995, the weighted average interest rate for all borrowings under the Citibank Facility was 8.02%. In July 1995, in connection with the merger with CMS, the Company and CMS entered into a new facility with NationsBank of Texas, N.A., as agent for a group of banks, (the "NationsBank Facility") that replaced the Boatmen's and Citibank Facilities and combined the amount available for borrowing at $485,000. The aggregate principal amount was divided between the Company and CMS in the amounts of $250,000 and $235,000, respectively. The terms of the NationsBank Facility are substantially consistent with those of the Boatmen's Facility except that accounts receivable are no longer required as collateral and the interest component has been revised. Under the NationsBank Facility, interest is computed at a rate equal to either, as selected by the Company, the Alternate Base Rate or the Adjusted LIBOR rate plus 0.625% to 1.25% per annum, depending on the maintenance of specified financial ratios. The Alternate Base Rate is equal to the greater of the prime rate or the federal funds effective rate plus .5%. The agreement expires in June 2000. Simultaneous with the tender offer for the 10 3/8% and 10 7/8% Senior Subordinated Notes discussed below, in September 1995 the NationsBank Facility was amended and restated to increase the facility from $485,000 to $750,000, of which $70,000 is available in the form of letters of credit, and to remove the division between the Company and CMS. On August 17, 1992, the Company issued 10 7/8% Senior Subordinated Notes due 2002 ("10 7/8% Notes") in the amount of $200,000 in a public offering in which the Company received net proceeds of $192,500. The 10 7/8% Notes were priced at 99.25%, to yield 11% annually to maturity. On March 16, 1993 the Company issued its 10 3/8% Senior Subordinated Notes due 2003 ("10 3/8% Notes") in the amount of $150,000 in a private placement in which the Company received net proceeds of $144,586. The 10 3/8% Notes were priced at 99.22% to yield 10 1/2% annually to maturity. The 10 3/8% Notes were subsequently registered in a registered exchange offer. Of the difference between the face amount of each issue of the Notes and the net proceeds of the offerings, $2,664 represented original issue discount. The remaining $10,250 represented various issuance costs and is recorded within other intangible assets and is amortized over the life of the notes. The 10 7/8% Notes are subject to redemption at any time on or after August 15, 1997, at specified redemption prices plus accrued interest. The 10 3/8% Notes are subject to redemption at any time on or after April 1, 1998, at specified redemption prices plus accrued interest. The indentures for the Notes contain certain covenants which limit the ability to incur additional indebtedness, provide guarantees and pay cash dividends. During fiscal 1995, the Company purchased $85,206 principal amount of its 10 7/8% and 10 3/8% Notes, (collectively its "Senior Subordinated Notes" or "Subordinated Debt"), at a discount in a series of open market transactions. On September 26, 1995, the Company completed a tender offer and consent solicitation for the Senior Subordinated Notes. Tenders and consents were obtained from the holders of 99.8% of the $118,800 10 3/8% Notes and holders of 97.5% of the $146,100 10 7/8% Notes. The 10 3/8% Notes were redeemed at 109.25% plus a consent fee of 1.05% and the 10 7/8% Notes were redeemed at 109.0% plus a consent fee of .75%. The Company paid $289,500 to retire the Notes, including principal, premium, consent fee and other related costs. As a result of the tender, the Company will record an extraordinary charge related to the loss on the retirement of the Senior Subordinated Notes, including the write-off of related deferred discount, swap cancellation and financing costs, of approximately $22,100, net of tax, in the second quarter of fiscal 1996. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The Senior Subordinated Notes were retired with funds drawn on the NationsBank Facility. Aggregate draws, including letters of credit, under the amended credit facility after retirement of the Senior Subordinated Notes was approximately $490,000. In order to reduce the impact of changes in interest rates on its long-term debt, the Company, during fiscal 1994 and 1993, entered into four, seven year, interest rate swap agreements with notional amounts of $25,000 each which mature in 1999 and 2000 and which provide for receipt of yields of between 5.16% and 6.65% and payment of a six month LIBOR yield. On September 12, 1995, these interest rate swap agreements were terminated at a cost of $3,540, in connection with the tender offer for the Senior Subordinated Notes discussed above. On February 14, 1992, the Company issued $57,500 of 6.75% convertible subordinated notes (the "6.75% Notes") due February 1, 2002. The 6.75% Notes were convertible at any time prior to maturity into shares of common stock of the Company at a conversion price of $12.00 per share, subject to adjustment in certain events. Interest on the 6.75% Notes was payable semi-annually on each February 1 and August 1, commencing August 1, 1992. During the year ended May 31, 1992, the Company redeemed $3,230 of 6.75% Notes at approximately 80% of par value, resulting in a gain of $475, net of allocable deferred financing costs of approximately $140. During the third quarter of fiscal 1994, the remaining $54,270 of 6.75% Notes were converted into the Company's common stock at the conversion price stated above. In connection therewith, approximately $1,900 of deferred financing costs and $500 of conversion costs were offset against additional paid-in capital at the time of conversion. In connection with the merger of Greenery Rehabilitation Group, Inc. (Greenery) into the Company (discussed in Note 15), the Company assumed the obligations under Greenery's 6 1/2% convertible subordinated notes and 8 3/4% convertible senior subordinated notes, par value of $26,631 and $28,150, respectively, at February 11, 1994. These obligations were recorded at their fair market value under purchase accounting, resulting in a discount on the 6 1/2% convertible subordinated notes of $2,663. The 6 1/2% convertible subordinated notes are due June 2011 and are convertible into common stock of the Company at a price of $69.32 per share. These notes may be redeemed in whole or in part at 103 1/4% of par, plus accrued interest, declining annually to par on June 15, 1996. Commencing June 15, 1996, the Company is obligated to retire 5% of the issue amount annually to maturity. The 8 3/4% convertible senior subordinated notes are due 2015 and are convertible into common stock of the Company at a price of $54.00 per share. The Company may redeem the notes, in whole or in part at 106.125% of par, plus accrued interest, declining annually to par on April 1, 2000. Commencing April 1, 2000, the Company is required to retire 5% of the original issue amount annually to maturity. The notes are senior to the 6 1/2% debentures, but will be subordinated to any future senior indebtedness. During the fourth quarter of fiscal 1994, the Company redeemed $15,520 of the 6 1/2% convertible subordinated notes and $7,244 of the 8 3/4% convertible senior subordinated notes. The Company recorded a gain of approximately $734, net of the write-off of $1,552 debt discount recorded under purchase accounting and income taxes of approximately $480. During 1995, the Company repurchased $4,800 of the 6 1/2% convertible subordinated notes and $506 of the 8 3/4% convertible senior subordinated notes. The Company recorded a gain of approximately $613, net of the write-off of $480 debt discount recorded under purchase accounting and income taxes of approximately $401. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The approximate aggregate maturities of long-term debt are as follows: In November 1987, a 7 3/4% convertible subordinated debenture was sold to the Company's vice chairman. This $2,000 debenture is convertible into shares of common stock at a conversion price of $8.56 per share. Simultaneously, the Company loaned the vice chairman $2,000 to purchase the debenture. The loan is evidenced by a promissory note bearing interest at 7 3/4%, payable on the maturity date of the debenture or earlier to the extent that the debenture is converted. At May 31, 1995, $1,000 is outstanding on the note. The Company has noncancelable operating leases primarily for facilities and equipment. Certain leases provide for purchase and renewal options of 5 to 15 years, contingent rentals primarily based on operating revenues and the escalation of lease payments coincident with increases in certain economic indexes. Contingent rent expense for the years ended May 31, 1995, 1994 and 1993 was approximately $6,346, $6,198 and $7,662, respectively. Future minimum payments under noncancelable operating leases are as follows: The Company is contingently liable for annual lease payments of approximately $2,570 for leases on facilities sold. In addition, the Company is contingently liable for annual lease payments of $6,200 for leases on managed facilities. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The Company leases seven facilities from an affiliate of two directors of the Company. During fiscal 1995, a previously leased facility was purchased by the Company. The aggregate lease expense for these facilities for the years ended May 31, 1995, 1994 and 1993 was approximately $15,900, $5,501, and $903, respectively. Future minimum lease commitments related to these facilities are as follows: The Company has been party to various contracts with Commercial Construction Company, Inc. ("CCI") for the construction of new rehabilitation hospitals to be owned and operated by the Company. CCI is wholly owned by the son of the Company's vice-chairman and brother of an executive vice-president of the Company. In addition, the Company purchases other development and maintenance services, equipment, furniture and supplies for its rehabilitation hospitals through CCI and its affiliates. The Company also leases certain clinic and office space in the greater Harrisburg, PA area under leases with various partnerships, of which the vice-chairman of the Company and an executive vice-president are partners. Also, the Company leases certain office space located in the greater Harrisburg, PA area from a director of the Company and partner of a law firm which provides legal services to the Company. In fiscal 1995, 1994, and 1993, the Company made payments to these related parties aggregating approximately $7,401, $16,950, and $75,220, respectively. Of these payments, $2,292, $7,189, and $66,204, were recorded in property and equipment for fiscal 1995, 1994, and 1993, respectively, and $5,109, $9,761, and $9,016 were charged to cost of services for fiscal 1995, 1994, and 1993, respectively. As of May 31, 1995, future commitments under outstanding contracts with CCI and its affiliates were $3,475 plus reimbursement of certain personnel costs. In addition, the Company leases its corporate office space located in Albuquerque, NM from certain officers and directors. The lease is classified as an operating lease and provides for minimum annual rents of $535. The lease expires on July 31, 2001. (7) SPECIAL CHARGE AND CHANGE IN ACCOUNTING PRINCIPLE During the second, third and fourth quarters of fiscal 1995, special pre-tax charges of $13,398, $5,045 and $4,979 were recorded, respectively. The second and fourth quarter special charges reflect the effect of a revision in the Company's estimate of receivables from third party payors at its CMS Therapies, Inc. subsidiary. The third quarter special charge reflects the costs of eliminating management and staff positions, office lease terminations and certain other costs of the changes implemented during the third quarter at CMS Therapies, Inc. At May 31, 1995, the $4,085 balance of the third quarter special charge is included within accrued expenses. The Company received various adjustments upon the final settlement of its 1991 and 1992 CMS Therapies, Inc. home office cost reports and other CMS Therapies, Inc. 1992 cost reports. As a result of the settlements, which was the Company's first indication that adjustments to its estimates would be required, the Company performed a detail analysis of its estimated third party settlements for all open cost reports. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (7) SPECIAL CHARGE AND CHANGE IN ACCOUNTING PRINCIPLE (CONTINUED) Upon completion of its analysis during the second quarter of fiscal 1995, and subsequent revision in the fourth quarter of fiscal 1995, the Company recorded the second and fourth quarter special charges to reflect the revision in the Company's estimated third party settlements. During the fourth quarter of fiscal 1994, a special pre-tax charge of $74,834 was recorded. The special charge resulted from the approval by the Company's board of directors of several measures to streamline operations and improve productivity by restructuring the Company into major operating businesses, flattening the management organization structure, writing down certain assets and, where appropriate, divesting of unproductive assets. The Company began working on the proposed plan during the fiscal 1994 third quarter as a result of market changes the Company was experiencing. The special charge comprised several items including the impairment of selected assets in the Company's hospital division, the costs associated with the consolidation of its contract therapy companies, the losses related to the termination of certain business relationships in the contract therapy business and certain other costs of the restructuring program. At May 31, 1995, the remaining balance in the special charge is approximately $6,656, (excluding the write down of assets which are reflected as a reduction of the related asset account), which is included within accrued expenses. The components of the special charge are as follows: Approximately $50,244 of the special charge was associated with the impairment of assets at eight rehabilitation hospitals, divestiture of two rehabilitation hospitals, closure of a select group of outpatient locations and the accrual of amounts for certain future noncancellable commitments. The impaired assets were identified in accordance with the Company's policy and based upon a review of the facts and circumstances related to the assets and a determination that the assets would not be recoverable, as determined based upon the future undiscounted cash flows resulting from the assets. The impairment loss was measured as the difference between the carrying amount of the assets and their fair value as determined by independent appraisals. Approximately $12,042 of the charge is related to the consolidation of certain contract therapy companies into CMS Therapies, Inc. and the exit from certain markets and businesses. This consolidation process involved the closure of offices, relocation and severance of personnel and elimination of duplicative processes. Approximately $10,800 of the charge is related to the writedown of uncollectible receivables pertaining to the termination of certain business relationships at CMS Therapies, Inc. During the second quarter of fiscal 1994, the Company exited business arrangements in which it provided therapists to unrelated Medicare certified agencies which in turn supplied those therapists to non-Medicare certified skilled nursing facilities. For a variety of business reasons, including, among others, the Health Care Financing Administration's announced intentions to increase their review of the reasonableness of the charges billed by the agencies to the Medicare program, the Company exited those relationships and, in many instances, began to provide the same services directly to Medicare patients upon termination of the contracts with the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (7) SPECIAL CHARGE AND CHANGE IN ACCOUNTING PRINCIPLE (CONTINUED) termination of the contracts, the Company continued to assess the collectibility of the agency receivables and, due to deteriorating business relations and declining financial condition of the agencies, it was determined a write-down of these receivables was required as of May 31, 1994. The remainder of the charge, $1,748, was to reduce the corporate office work force and provide for transaction costs to execute the plan. During the fourth quarter of fiscal 1993 the Company recorded a pre-tax charge of $14,556 related principally to the write-off of deferred costs for approximately 30 abandoned rehabilitation hospital development projects for which construction had not started. The decision to write-down or abandon certain projects and pursue less capital-intensive growth than in the past was a result of changes in the Company's rehabilitation hospital development strategy in response to changes in various health care delivery markets. Previously, the Company had deferred certain costs incurred to obtain government approvals and other expenses related to the development of rehabilitation hospitals. Based on a historically high rate of completion, costs of developing a project were charged to operations only when it was determined that the project would be abandoned. As a result of the change in development strategy, the Company changed its accounting for development costs. Hospital development costs are expensed until that time when it is probable that construction will commence. Additionally, costs of $2,598 related to the merger with Kron Medical Corporation ("Kron") and Kron's subsequent consolidation with the Company's other physician services company, CompHealth, were charged to expense in the third quarter of fiscal 1993. On September 27, 1995, the Company settled certain pending litigation, terminated a number of contracts with the other party to the litigation and obtained releases of claims and potential claims relating to the subject matter of the litigation and the terminated contracts. As consideration for the settlement, contract terminations and releases, the Company paid cash and delivered a warrant to purchase the Company's common stock. At May 31, 1995, the Company accrued $12,800 of expenses and wrote down $700 of receivables to record the cash payment, warrant valuation, receivable write-offs and other commitments and transaction costs of the settlement transaction. During fiscal 1995, the Company recognized a gain of $2,571 ($4,172 less related tax effect of $1,601) relating to open market purchases at a discount of its subordinated debt and its 8 3/4% and 6 1/2% convertible subordinated notes. During fiscal 1994, the Company recognized a gain of $734 ($1,214 less related tax effect of $480) relating to open market purchases of its 8 3/4% and 6 1/2% convertible subordinated notes at a discount. On June 1, 1993, the Company adopted FAS 109 through retroactive restatement of its financial statements from June 1, 1990. The adoption did not have a material effect on the Company's financial condition or results of operations. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The provision for income taxes consists of the following: The differences between the total tax expense from operations and the income tax expense using the statutory federal income tax rate (35 percent) were as follows: The components of the net deferred tax assets and liabilities are as follows: NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) As a result of business combinations during the years ended May 31, 1995 and 1994, net deferred income tax assets of $4,238 and $14,724, respectively, and related valuation allowances of $0 and $3,051, respectively, were recorded. The Company has regular tax net operating loss carryforwards of approximately $8,470 which are currently subject to separate return year limitations and expire in years 2007 and 2008. In addition, the Company also has an alternative minimum tax credit carryforward of $1,207 which is available for utilization indefinitely. At May 31, 1995, the Company has an estimated $500 capital loss carryforward, primarily as a result of certain restructuring transactions. The loss is only available to offset future capital gain income and will expire in fiscal 1998. The valuation allowance is the result of: (1) separate return loss carryforward limitations; (2) the uncertain state tax benefits from states requiring separate return filings or with no or limited loss carryover provisions; and (3) limitations on the Company's ability to absorb capital losses in the five year carryforward period. The valuation allowance decreased by $800 during fiscal 1995 primarily as a result of capital loss utilization. In November and December 1994, the Company completed the sale of 5,558,790 shares of its common stock, including the sale of 643,333 shares held by certain stockholders. Net proceeds of approximately $119,600 were used to repay outstanding debt under the revolving credit loan agreement and to fund acquisitions. During 1995 the Company issued 1,847,899 shares of common stock in connection with certain acquisitions. As discussed in Note 5, the Company converted $54,270 of its 6 3/4% convertible subordinated notes into 4,522,500 shares of the Company's common stock during the third quarter of 1994. The conversion price was $12 per share. During 1994, the Company issued 2,828,968 shares of common stock in connection with certain acquisitions. In October 1993, the Company completed a common stock offering of 4,025,000 shares. Net proceeds of approximately $58,200 were used to repay outstanding debt under the revolving credit loan agreement and to fund acquisitions. There are 500,000 shares of authorized but unissued shares of $.001 preferred stock. On September 12, 1994, the board of directors of the Company declared a dividend of one preferred share purchase right (a "Right." for each outstanding share of the Company's common stock held of record on September 22, 1994, and approved the further issuance of Rights with respect to all shares of the Company's common stock that are subsequently issued. Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of series A junior participating preferred stock, par value $.001 per share of the Company, at a price of $110 per one one-thousandth of a share, subject to adjustment. Until the occurrence of certain events, the Rights are not exercisable, will be evidenced by the certificates for the Company's common stock and will not be transferable apart from the Company's common stock. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The Company had 100,000 stock purchase warrants outstanding at May 31, 1995, for the purchase of common shares. These warrants, priced at $2.50, were exercised subsequent to year end. The Company has a nonqualified employee stock option plan and a directors' stock option plan that provide the Company the ability to grant to employees and outside directors the option to purchase shares of common stock of the Company at the market value of the stock at the option grant date. Accordingly, no compensation is recorded in the accompanying consolidated financial statements for the options granted. All options granted under the employee plan and directors' plan expire ten years after grant, are non-transferable and are exercisable only during or immediately following the period the individual is employed by the Company or is a current member of the board of directors, subject to certain exceptions for death or disability. One-third of each option is exercisable on each of the first, second and third anniversary dates following the date of grant. The Company also had the following stock compensation plans at May 31, 1995: the 1986 stock option plan (1986 Plan), the 1989 non-qualified stock option agreement, the 1989 non-employee directors' stock option plan, the 1992 CEO stock option plan (1992 Plan), the 1993 non-qualified stock option plan (1993 Plan), and the 1994 stock option plan (1994 Plan). Options outstanding at May 31, 1995, are at prices ranging from $9.73 to $40.47 per share, as adjusted for the Exchange Rate (as defined below). As options are granted at exercise prices which represent the fair market value of the stock at the date of grant, no compensation expense has been recorded for these awards. Options become exercisable in four to seven annual installments commencing on the first anniversary of the date of grant, and expire between October 1995 and August 2003, five to ten years from the date of grant. The 1994 plan was adopted in August 1993, which authorized options of 809,550 shares, as adjusted for the Exchange Rate. In May 1993, the 1993 Plan was adopted which authorized options of 539,700 shares, as adjusted for the Exchange Rate. Officers and directors were not eligible to receive options under the 1993 Stock Option Plan. In May 1993, options, exercisable at the market price on the date of grant ($20.38 per share, as adjusted for the Exchange Rate), were granted to substantially all CMS employees holding outstanding options with exercise prices higher than such current market price. The number of shares subject to the options granted to each employee was equal in number to the shares covered by options previously granted to such employee at higher exercise prices. The new options were granted subject to each employee's agreement to cancel their previously granted options for an equal number of shares at the higher exercise prices. The term, vesting rate and other provisions of the new options were otherwise identical to the options canceled. As a result, options on 1,802,159 shares with exercise prices per share ranging from $24.09 to $42.39 per share, as adjusted for the Exchange Rate, were canceled and the same number of new options were granted at an exercise price of $20.38 per share, as adjusted for the Exchange Rate. During fiscal 1993, the Company loaned the vice-chairman $4,548 for the exercise of stock options and the payment of the resulting income taxes, and loaned an executive vice-president of the Company $530 for the payment of income taxes resulting from the exercise of stock options. The tax loans were authorized under the 1986 Plan, and the remaining loan was authorized by the board of directors. The loans are repayable upon demand with interest payable monthly at the IRS' applicable federal rate, adjusted semi-annually on January 1 and July 1. The loan for the exercise of stock options is included as a deduction from stockholders' equity. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The following information is a summary of the stock option activity under the plans as adjusted for a three-for-two stock split paid November 15, 1991 on CMS common stock and the exchange of .5397 shares (the "Exchange Rate") of CMS common stock for each share of the Company's common stock in connnection with the CMS merger: The Company also has an employee stock purchase plan (Plan). The Plan allows substantially all full-time employees to contribute up to five percent of their compensation for the purchase of the Company's common stock at 85 percent of market value at the date of purchase. For the year ended May 31, 1995, 16,352 shares of the Company's stock had been purchased under the Plan. In connection with the Greenery merger, the Company issued to one of the Company's directors a five year option to purchase 125,000 shares of the Company's common stock at $17 per share. This option was exercised during 1995 and the shares, along with approximately 50,000 shares of additional common stock, were converted to treasury stock in consideration for reduction of amounts due to the Company under the terms of a note receivable. The total number of shares allocated, granted and outstanding pursuant to the Company's employee and directors' stock option plans and employee stock purchase plan together with other shares issued or allocated for issuance to employees and directors pursuant to option, incentive or similar plans, may not exceed 10 percent of the total number of shares authorized for issuance at the time of the allocation or grant. The Company has deferred compensation plans for selected employees and directors. These plans, which are not required to be funded by the Company, allow eligible employees to defer portions of their current compensation up to 10%. The Company then matches up to 4% of the employee's deferred compensation. Employee contributions are vested immediately. Employer contributions vest on a graduated basis, with full vesting achieved at the end of six years or seven years, depending upon the plan. The Company contributed approximately $261, $254 and $157 to these plans for the years ended May 31, 1995, 1994 and 1993, respectively. The Company also has 401(k) savings plans available to substantially all employees who have been with the Company for more than six months. Employees may defer up to 15% or 20% of their salary, depending upon the plan, subject to the maximum permitted by law. The Company matches a portion of the employee's contribution, which may be discretionary, depending upon the plan. Employee contributions are vested immediately. Employer contributions vest on a graduated basis, with full vesting achieved at the end of five or seven years, depending upon the plan. The Company contributed approximately $1,890, $1,377 and $979 to these plans for the years ended May 31, 1995, 1994 and 1993, respectively. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the Years Ended May 31, 1995, 1994 and 1993 (Dollars in thousands, except per share amounts) In addition, the Company also has a profit-sharing plan to which it may make contributions at its discretion. The Company has not made any contributions to this plan. The Company may terminate any of the above plans at any time. (13) SUPPLEMENTAL CASH FLOW INFORMATION Significant non-cash operating, investing and financing activities for fiscal 1995, 1994 and 1993 were as follows: - The issuance of 1,776,924 shares of common stock in connection with acquisitions in which net assets of approximately $22,030 were acquired, - The acceptance of 175,041 shares of treasury stock for payment of a note, - The assumption of long-term debt of $19,900 in connection with - The assumption of obligations under capital lease of $48,600 in connection with acquisitions. - The conversion of $54,270 of 6.75% convertible subordinated notes into the - The issuance of 2,213,976 shares of common stock in connection with acquisitions in which net assets of approximately $16,573 were acquired, - The assumption of long-term debt of $19,300 in connection with - The issuance of common stock and payment of cash for the purchase of Medical Management Associates, Inc. in which net liabilities of approximately $857 were assumed. - The receipt of notes receivable of $8,150 and cash for the sale of net Cash paid for interest for the years ended May 31, 1995, 1994 and 1993 was approximately $54,351, $44,852 and $14,743, respectively. Cash paid for income taxes, net of refunds, for the years ended May 31, 1995, 1994 and 1993 was approximately $19,236, $12,848 and $32,006, respectively. (14) FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of the Company's financial instruments at May 31, 1995 are as follows: NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (14) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) The carrying amount of cash and cash equivalents approximates fair value due to the short maturity of these instruments. The fair value of notes receivable was estimated by discounting the future cash flows using current rates available to similar borrowers under similar circumstances. The fair value of marketable equity securities and other short-term investments is based on quoted market prices. It is not practicable to estimate the fair value of the Company's other investments, which comprise certain equity investments because of the lack of a quoted market price, and the inability to estimate fair value without incurring excessive costs. The fair value of the Company's long-term debt, excluding capital leases, was estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The fair values of interest rate swaps and interest rate collars are the estimated amounts that the Company would receive or pay to terminate the swap agreements, taking into account current interest rates. On September 12, 1995, these interest rate swap agreements were terminated at a cost of $3,540. The market value of the outstanding convertible subordinated notes at May 31, 1995 of $25,344 included in the long-term debt amount above is a function of both the conversion feature and the underlying debt instrument. It is impracticable to allocate the market value between these two components, however, the market value is not representative of the amounts that would be currently required to retire the debt obligation. In July 1994, the Company acquired peopleCARE, a 13 facility long-term care company located in Texas. Consideration given for the acquisition included the issuance of approximately 449,000 shares of the Company's common stock, valued at approximately $10,000, assumption of capital lease obligations of approximately $48,600 for six facilities, and cash payment of approximately $56,000 for fee simple title to seven facilities. The Company acquired Advanced Cardiovascular Technology, Inc. (ACT), a non-invasive medical diagnostic company, in April 1994. In connection with this acquisition, the Company issued 163,976 new shares of common stock at $25 per share. The terms of the acquisition provide for the issuance of up to 204,985 additional shares of common stock if certain earning levels are achieved by March 31, 1997. Of these contingent shares, 160,000 were issued into escrow at closing and remained in escrow at May 31, 1995. This contingent consideration has not been recorded as of May 31, 1995. In March 1994, the Company acquired all of the outstanding stock of Medical Management Associates, Inc. ("MMA"), for $1,500 in cash relating to certain non-compete agreements and 349,456 shares of the Company's common stock. The acquisition was accounted for by the purchase method of accounting. Pursuant to the acquisition agreement, additional shares of the Company's common stock may be issued over the next two years, subject to the achievement of certain pre-tax earnings levels. In February 1994, the Company completed its merger of Greenery Rehabilitation Group, Inc. ("Greenery") into the Company. Pursuant to the merger, the Company issued approximately 2,050,000 shares of its common stock, valued at approximately $48,000, and assumed approximately $58,000 in debt for all of the outstanding shares of Greenery common stock. This merger added the operations of 17 rehabilitation and skilled nursing facilities and 3 managed facilities to the Company's operations. Subsequent to fiscal year end, on June 19, 1995, the Company announced plans to dispose of eight long-term care facilities. Six of the facilities to be disposed of were among the 17 acquired in the Greenery merger during fiscal 1994. The decision to sell the facilities was based upon financial, regulatory and operational considerations. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The following unaudited pro forma financial information reflects the combined results of operations, as restated for the merger with CMS (see Note 18), for the years ended May 31, 1995 and 1994 as if the material acquisitions during the period, Greenery and peopleCARE, had been consummated on June 1, 1993: The unaudited pro forma information is not necessarily indicative either of the results of operations that would have occurred had the acquisitions taken place at the beginning of fiscal 1994 or of future results of operations of the combined companies. Prior to fiscal 1992, the Company acquired 80% of the outstanding stock of Communi-Care/ProRehab, Inc. ("Communi-Care") and on July 1, 1992 acquired the remaining 20% of the outstanding stock. The initial purchase price was approximately $5,654, paid in cash and the Company's common stock. The purchase price for the remaining 20% of the outstanding stock was approximately $4,831, paid in cash and the Company's common stock. As additional purchase price under the purchase agreement, cash and common stock totaling $8,322, $8,589, and $2,504 was paid during fiscal 1995, 1994 and 1993, respectively. During fiscal 1995 and 1994, the Company made various other acquisitions which individually and in the aggregate were insignificant. Pursuant to other acquisitions consummated prior to fiscal 1993, cash and common stock totaling $1,920 and $2,162 was paid during fiscal 1994 and 1993, respectively. No payments were made during fiscal 1995 relating to these acquisitions. Contingent payments estimated under all of the Company's acquisition agreements may be paid in cash and the Company's common stock through fiscal 1997. These amounts are subject to adjustment based upon the achievement of certain earnings levels and are not expected to be material. The Company was contingently liable for letters of credit aggregating $40,898 and $38,557 at May 31, 1995 and 1994, respectively. The letters of credit, which reduce the availability under the credit agreement, were used in lieu of lease deposits for facilities operated by the Company and for deposits under various workers' compensation programs. Under annual employment agreements with three senior officers, the Company is committed to pay minimum annual salaries totaling $1,215, subject to certain covenants. In addition, the employment agreements provide for annual retirement benefits and disability benefits equal to a maximum of 50 percent of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (16) COMMITMENTS AND CONTINGENCIES (CONTINUED) each officer's base salary. The retirement benefits vest in equivalent increments over 10 years and the disability benefits terminate upon retirement or age 65. Further, an annual death benefit is payable to the surviving spouse or minor children equal to one-half of the vested retirement benefit at the time of the officer's death. Amounts recorded for the annual retirement and disability benefits have been included in other accrued liabilities in the accompanying consolidated financial statements. In addition and in connection with the Greenery merger, the Company has entered into a seven year consulting agreement with one of the Company's directors for which the Company has agreed to pay annual consulting fees of $175. In fiscal 1994, the Company agreed to fund life insurance premiums for certain of its senior officers. As of May 31, 1995, such advances totaled approximately $1,162 and are reflected in other assets in the accompanying consolidated financial statements. These advances will be repaid to the Company by the officers' estates upon the earlier of cancellation of the policies or death of the officers. In connection with the Greenery merger, the Company has committed to manage three Connecticut facilities for an affiliate of two directors of the Company. The Company is committed to manage these facilities for up to five years, subject to the affiliate's right to terminate sooner at any time with 90 days notice. Under the terms of one of the Company's facility lease agreements, the Company has the option to purchase the facility and the lessor has the option to require the Company to purchase the facility should the Company fail to exercise the purchase option for $5,500 at the end of the lease term (August 1, 1998). The Company has purchased usage of a Cessna/Citation III aircraft from AMI Aviation II, L.L.C., a Delaware limited liability company ("AMI II"). The Company's chief executive officer owns 99% of the membership interests of AMI II. Under the aircraft usage agreement, the Company will purchase a minimum of 20 hours usage per month for $45 per month for a five year period, and will pay certain amounts per hour for usage over 20 hours in a month plus a monthly maintenance reserve. The Company believes that the amounts payable under this agreement are comparable to those it would pay to other third party vendors of similar aircraft services. The Company has notes receivable and other investments, related to its divestiture of its free-standing long-term care facilities totaling $17,843 including notes receivable of $14,834 from Renaissance Healthcare Corporation ("RHC"), a long-term care company owned and operated by former employees of the Company. Repayment of those amounts are dependent upon the cash flows of the individual companies. Collateral on certain notes receivable and investments aggregating $4,709 consists of first or second mortgages, personal guarantees and pledges of certain other assets. Certain notes receivable from RHC aggregating $13,134 reflect future installment sales obligations under which the Company holds title to the sold assets until all payments are made. The Company has a working capital loan commitment of $3,000 to RHC of which $1,700 was used at May 31, 1995 and is included in the above amounts. The Company guarantees payment throughout the term of a bond issue to an economic development authority of amounts due and payable by the owner of a long-term care facility previously managed by the Company. The outstanding bonds total approximately $6,064 at May 31, 1995. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (16) COMMITMENTS AND CONTINGENCIES (CONTINUED) During fiscal 1995, certain operating facilities and office locations of the Company were visited or contacted by representatives of the U.S. Justice Department for the purpose of interviewing certain of its employees and reviewing certain documents. The Company cooperated with the Justice Department inquiries. The Company's management is not aware of any Company practices of the type covered by the Justice Department inquiries, or otherwise, that are not in compliance with the rules and regulations applicable to its operations. While the Company is unable to predict what effect, if any, these inquiries will have on the Company's business, the Company is of the opinion that their ultimate disposition will not have a material adverse effect upon its consolidated financial position. The Company is subject to legal proceedings and claims which have arisen in the ordinary course of its business and have not been finally adjudicated or settled, which include among other items malpractice claims covered under the Company's insurance policy. Additionally, in the normal course of business, the Company has amounts due to or from the Medicare program, the Medicaid program and other third party payors which it believes are reasonable estimates. However, additional changes to these estimates in the future may be appropriate based on facts and circumstances which arise. Ultimately, the amounts due to or from third party payors may be adjusted by these third party payors upon final settlement. The Company is unable to estimate the likelihood or potential amounts of any such settlements or adjustments. (17) ADOPTION OF NEW ACCOUNTING PRINCIPLE In fiscal 1993 the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Upon issuance of this statement, the Company reviewed the provisions of the new statement and concluded that the statement compelled the write-down to fair value of a long-term investment being held to maturity as a result of the impairment of the investment using a discounted cash flow analysis. Prior to the issuance of this statement, the asset was carried at historical cost which is expected to be recovered upon maturity. In applying this statement, the Company recognized a $5,000 write-down to fair value of the long-term investment. The cumulative effect of this change in accounting principle, on an after-tax basis, was $3,204. On July 6, 1995, the stockholders of the Company and CMS approved the merger of one of the Company's wholly-owned subsidiaries with CMS. Under the terms of the merger agreement, CMS stockholders received .5397 of a share of the Company's common stock for each outstanding share of CMS's common stock. Accordingly, the Company issued approximately 20.9 million shares of common stock, valued at approximately $393.9 million based on the closing price of the Company's common stock on July 10, 1995, for all the outstanding shares of CMS's common stock. Additionally, outstanding options to acquire CMS's common stock were converted at the Exchange Rate to options to acquire 3.8 million shares of the Company's common stock. CMS provides comprehensive medical rehabilitation programs and services with a significant presence in each of the rehabilitation industry's three principal sectors -- inpatient rehabilitation care, outpatient rehabilitation care and contract therapy. The merger qualifies as a tax-free reorganization and was accounted for as a pooling of interests. Accordingly, the accompanying financial statements have been restated to include the accounts and operations of CMS for all periods prior to the merger. These periods include the financial position of CMS as of June 30, 1995 and 1994 and the results of operations of CMS for each of the three years in the period ended June 30, 1995. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Separate results of the Company and CMS for the three years in the period ended May 31, 1995 are as follows: As a result of the combination with CMS, the Company revised the accounting policies and financial presentation of each of the previously separate companies. The effect of these changes did not have a material effect on the operating results or financial position of the Company. A reconciliation of total operating revenues and net earnings of the Company as previously reported to the amounts presented above and included in the accompanying financial statements is as follows: NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (19) QUARTERLY FINANCIAL DATA (UNAUDITED) The following is a summary of the unaudited quarterly results of operations: (a) Includes $13,398 pre-tax special charge related to a revision in the Company's estimate of receivables from third party payors at its CMS Therapies, Inc. subsidiary. (b) Includes $5,045 pre-tax special charge related to eliminations of management and staff positions, office lease terminations and certain other costs of changes implemented during the third quarter at CMS Therapies, Inc. (c) Includes a $2,497 extraordinary gain (net of related taxes of $1,555) relating to open market purchases of its subordinated debt and its 8 3/4% and 6 1/2% convertible subordinated notes at a discount. (d) Includes a $4,979 pre-tax special charge related to a revision in the Company's estimate of receivables from third party payors at its CMS Therapies, Inc. subsidiary and $13,500 pre-tax settlement charge related to a contract dispute. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (19) QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED) (e) Includes a $74 extraordinary gain (net of related taxes of $46) related to open market purchases of its subordinated debt and its 8 3/4% and 6 1/2% convertible subordinated notes at a discount. (f) Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share in fiscal year 1994 does not equal the total computed for the fiscal year. (g) Includes $74,834 pre-tax special charge related to the impairment of selected assets of the Company's hospital division, the costs associated with the consolidation of its contract therapy companies, the losses related to the termination of certain relationships in the contract therapy business and certain other costs of restructuring. (h) Includes a $734 extraordinary gain (net of related taxes of $480) related to open market purchases of its 8 3/4% and 6 1/2% convertible subordinated notes at a discount. INDEX TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS HORIZON/CMS HEALTHCARE CORPORATION AND SUBSIDIARIES INTRODUCTION TO UNAUDITED PRO FORMA The unaudited pro forma balance sheet as of November 30, 1995 gives effect to (i) the Offering and (ii) the proposed acquisition by merger of Pacific Rehab which will be accounted for as a pooling of interests, as if these transactions had occurred on November 30, 1995. Such adjustments are more fully described in the notes to the unaudited pro forma balance sheet. The unaudited pro forma statement of operations for the six months ended November 30, 1995 gives effect to (i) the retirement of certain senior subordinated notes, (ii) the Offering and (iii) the proposed acquisition by merger of Pacific Rehab which will be accounted for as a pooling of interests, as if these transactions had occurred on June 1, 1995. Such adjustments are more fully described in the notes to the unaudited pro forma statement of operations. The unaudited pro forma statement of operations for the year ended May 31, 1995 gives effect to (i) the acquisition of peopleCARE in July 1994 and certain other insignificant acquisitions effected during the period, (ii) the retirement of certain senior subordinated notes, (iii) the Offering and (iv) the proposed acquisition by merger of Pacific Rehab which will be accounted for as a pooling of interests, as if these transactions had occurred on June 1, 1994. Such adjustments are more fully described in the notes to the unaudited pro forma statement of operations. The following pro forma financial information may not necessarily reflect the financial condition or results of operations of Horizon, or of the companies on a combined basis, which would have actually resulted had the transactions referred to above occurred as of the date and for the periods indicated or reflect the future earnings of Horizon. HORIZON/CMS HEALTHCARE CORPORATION AND SUBSIDIARIES UNAUDITED PRO FORMA BALANCE SHEET AS OF NOVEMBER 30, 1995 See Notes to Unaudited Pro Forma Balance Sheet. HORIZON/CMS HEALTHCARE CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED PRO FORMA BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (a) Estimated Medicare and Medicaid settlements of Horizon, which have been reported separately in Horizon's historical balance sheets, have been reclassified to accounts receivable for purposes of presentation in the unaudited pro forma balance sheet. (b) To record deferred financing costs incurred in connection with the Offering. (c) To record the Offering. (d) To record the repayment of borrowings under the Credit Facility with net proceeds of the Offering. (e) Pacific Rehab goodwill, which has been classified as a portion of other intangible assets on Pacific Rehab's historical balance sheets, has been reclassified to a separate line item for purposes of presentation in the unaudited pro forma balance sheet. (f) To record estimated expenses related to effecting the Pacific Rehab merger. (g) In connection with the proposed merger with Pacific Rehab, each share of Pacific Rehab common stock will be converted into .3483 of one share of Horizon common stock. Accordingly, adjustments have been recorded to reflect the issuance of 2,787 shares of Horizon common stock, par value $.001 per share, upon conversion of the 8,002 shares of Pacific Rehab common stock, par value $.01 per share, outstanding at September 30, 1995. HORIZON/CMS HEALTHCARE CORPORATION AND SUBSIDIARIES UNAUDITED PRO FORMA STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED NOVEMBER 30, 1995 See Notes to Unaudited Pro Forma Statement of Operations. HORIZON/CMS HEALTHCARE CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED PRO FORMA STATEMENT OF OPERATIONS (a) The pro forma earnings per share amounts for the six months ended November 30, 1995 reflect additional weighted average shares of 2,947 relating to the issuance of Horizon common stock in connection with the Pacific Rehab merger. (b) During the first quarter of fiscal 1996, the Company completed a tender offer for $118,700 of its 10 3/8% senior subordinated notes and $137,500 of its 10 7/8% senior subordinated notes. The tender was completed using funds borrowed under the Company's Credit Facility. Accordingly, an adjustment for $152 has been recorded to eliminate historical amortization expense on deferred financing costs related to the retired notes for the six months ended November 30, 1995. (c) Adjustments have been recorded to eliminate interest expense related to the retirement of the 10 3/8% and 10 7/8% senior subordinated notes and record additional interest expense related to borrowings under the Credit Facility, as follows: (d) An effective tax rate of 40% has been applied to all pro forma transactions, except with respect to data for Pacific Rehab for which the actual effective tax rate has been maintained. (e) An adjustment for $300 has been recorded to reflect additional amortization expense on $6,000 of deferred financing costs amortized over 10 years incurred in connection with the Offering. (f) In connection with the Offering, adjustments have been recorded to eliminate interest expense related to the repayment of the Credit Facility and to record additional interest expense incurred on the Notes: (g) Interest income and other expenses of Pacific Rehab, which have been reported separately in Pacific Rehab's historical statements of operations, have been reclassified to total operating revenues and cost of services, respectively, for purposes of presentation in the unaudited pro forma statement of operations. (h) Facility leases expense of Pacific Rehab, which has been reported as cost of services on Pacific Rehab's historical statements of operations, has been reclassified to facility leases for purposes of presentation in the unaudited pro forma statement of operations. HORIZON/CMS HEALTHCARE CORPORATION AND SUBSIDIARIES UNAUDITED PRO FORMA STATEMENT OF OPERATIONS FOR THE YEAR ENDED MAY 31, 1995 See Notes to Unaudited Pro Forma Statement of Operations. HORIZON/CMS HEALTHCARE CORPORATION AND SUBSIDIARIES NOTES TO UNADUTIED PRO FORMA STATEMENT OF OPERATIONS (a) The pro forma earnings per share amounts for the year ended May 31, 1995 reflect additional weighted average shares of 2,593 and 798 relating to the issuance of Horizon common stock in connection with the Pacific Rehab merger, and the peopleCARE and certain other acquisitions, respectively. (b) The historical financial information reported for peopleCARE includes certain de minimis amounts which were not acquired or assumed by Horizon in connection with this acquisition. Therefore, adjustments have been recorded to eliminate interest and other operating revenues of $33 for the year ended May 31, 1995 and cost of services expense of $35 for the year ended May 31, 1995 associated with the predecessor entity operations which were not acquired by Horizon. (c) An adjustment of $50 has been recorded to eliminate distributions to peopleCARE's prior owners for the year ended May 31, 1995. (d) An adjustment for $921 has been recorded to eliminate historical lease expense in connection with certain other acquisitions for the year ended May 31, 1995. (e) An adjustment for $682 has been recorded to depreciation and amortization to reflect the additional costs associated with the certain other acquisitions for the year ended May 31, 1995. (f) Adjustments have been recorded to depreciation and amortization expense to reflect the purchase of seven facilities and capital lease of six facilities in connection with the peopleCARE acquisition for the year ended May 31, 1995, as follows: (g) The peopleCARE acquisition purchase price included the payment of $55,616 in cash, which was funded from Horizon's line of credit, for seven facilities. As a result of the acquisition Horizon also entered into a capital lease for six facilities formerly owned by peopleCARE. Accordingly, interest expense has been adjusted as follows for the year ended May 31, 1995: (h) An adjustment for $1,424 has been recorded to reflect interest expense on long-term debt incurred to fund certain other acquisitions for the year ended May 31, 1995. (i) An effective tax rate of 40% has been applied to all pro forma transactions except, with respect to Pacific Rehab, for which the actual effective tax rate has been maintained. HORIZON/CMS HEALTHCARE CORPORATION AND SUBSIDIARIES NOTES TO UNADUTIED PRO FORMA STATEMENT OF OPERATIONS (CONTINUED) (j) An adjustment for $896 has been recorded to eliminate historical amortization expense on deferred financing costs related to the retired notes for the year ended May 31, 1995. (k) During the first quarter of fiscal 1996, the Company completed a tender offer for $118,700 of its 10 3/8% senior subordinated notes and $137,500 of its 10 7/8% senior subordinated notes. The tender was completed using funds borrowed under the Company's Credit Facility. Accordingly, adjustments have been recorded to eliminate interest expense related to the retirement of the 10 3/8% and 10 7/8% senior subordinated notes and record additional interest expense related to borrowings under the Credit Facility, as follows: (l) An adjustment for $600 has been recorded to reflect additional amortization expense on $6,000 of deferred financing costs amortized over 10 years incurred in connection with the Offering. (m) In connection with the Offering, adjustments have been recorded to eliminate interest expense related to the repayment of the Credit Facility and to record additional interest expense on the Notes. (n) Interest income and other expenses of Pacific Rehab, which have been reported separately in Pacific Rehab's historical statements of operations, have been reclassified to total operating revenues and cost of services, respectively, for purposes of presentation in the unaudited pro forma condensed statements of operations. (o) Facility leases expense of Pacific Rehab, which has been reported as cost of services on Pacific Rehab's historical statements of operations, has been reclassified to facility leases for purposes of presentation in the unaudited pro forma statement of operations. NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER, DEALER OR AGENT. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH AN OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. J. P. MORGAN SECURITIES INC. INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION* The expenses of issuance and distribution of the securities are estimated to be: * All amounts are estimates except for the Registration Fee and the NASD listing fee. ** To be filed by amendment. ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS Under Section 145 of the General Corporation Law of the State of Delaware (the "DGCL"), a Delaware corporation has the power, under specified circumstances, to indemnify its directors, officers, employees and agents in connection with threatened, pending or completed actions, suits or proceedings, whether civil, criminal, administrative or investigative (other than an action by or in right of the corporation), brought against them by reason of the fact that they were or are such directors, officers, employees or agents, against expenses, judgments, fines and amounts paid in settlement actually and reasonably incurred in any such action, suit or proceeding. Article XIV of the Company's Restated Certificate of Incorporation together with Article IX of its Bylaws provide for indemnification of each person who is or was made a party to any actual or threatened civil, criminal, administrative or investigative action, suit or proceeding because such person is or was an officer or director of the Company or is a person who is or was serving at the request of the Company as a director, officer, employee or agent of another corporation or of a partnership, joint venture trust or other enterprise, including service relating to employee benefit plans, to the fullest extent permitted by the DGCL as it existed at the time the indemnification provisions of the Company's Restated Certificate of Incorporation and the Bylaws were adopted or as may be thereafter amended. Article IX of the Company's Bylaws and Article XIV of its Restated Certificate of Incorporation expressly provide that they are not the exclusive methods of indemnification. Article IX of the Bylaws and Article XIV of the Company's Restated Certificate of Incorporation also provide that the Company may maintain insurance, at its own expense, to protect itself and any director, officer, employee or agent of the Company or of another entity against any expense, liability or loss, regardless of whether the Company would have the power to indemnify such person against such expense, liability or loss under the DGCL. Section 102(b)(7) of the DGCL provides that a certificate of incorporation may contain a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director (i) for any breach of the director's duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the DGCL (relating to liability for unauthorized acquisitions or redemptions of, or dividends on, capital stock) or (iv) for any transaction from which the director derived an improper personal benefit. Article XI of the Company's Restated Certificate of Incorporation contains such a provision. * To be filed by Amendment. The undersigned Registrant hereby undertakes: (1) That, for purposes of determining any liability under the Securities Act of 1933, each filing of the Registrant's annual report pursuant to section 13(a) or section 15(d) of the Securities Exchange Act of 1934 that is incorporated by reference in the Registration Statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona tide offering (2) That, for purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of a registration statement in reliance upon Rule 430A and contained in the form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of the Registration Statement as of the time it was declared effective; and (3) That, for the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. The undersigned registrant hereby undertakes to deliver or cause to be delivered with the prospectus, to each person to whom the prospectus is sent or given, the latest annual report to security holders that is incorporated by reference in the prospectus and furnished pursuant to and meeting the requirements of Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of 1934; and, where interim financial information required to be presented by Article 3 of Regulation S-X is not set forth in the prospectus, to deliver or cause to be delivered, to each person to whom the prospectus is sent or given, the latest quarterly report that is specifically incorporated by reference in the prospectus to provide such interim financial information. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Albuquerque, State of New Mexico, on the 12th day of January, 1996. By /s/ ERNEST A. SCHOFIELD KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Ernest A. Schofield, Scot Sauder and Sean Dailey or any of them, his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Registration Statement, and to file the same with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and ratifying and confirming all that said attorney-in-fact and agent or his substitute or substitutes may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities indicated on the dates indicated. /s/ NEAL M. ELLIOTT President, Chief January 12, 1996 Neal M. Elliott Chairman of the Board of /s/ FRANK M. MCCORD Director January 12, 1996 /s/ RAYMOND N. NOVECK Director January 12, 1996 /s/ MICHAEL A. JEFFRIES Director January 12, 1996 /s/ CHARLES H. GONZALES Director January 12, 1996 * To be filed by Amendment.	S-3	S-3	1996-01-12T00:00:00	1996-01-12T16:57:32
0000912057-96-000444	0000912057-96-000444_0000.txt	U.S. SECURITIES AND EXCHANGE COMMISSION [ X ] ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Fee Required) FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1995 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required) (Name of small business issuer in its charter) (State or other jurisdiction of (I.R.S. Employer Identification No.) 1444 SANTA ANITA AVENUE, SOUTH EL MONTE, CALIFORNIA 91733 (Address of principal executive offices) (Zip code) ISSUER'S TELEPHONE NUMBER: (818) 442-3141 SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT Title of Each Class on Which Registered Common stock, par value $.10 American Stock Exchange, Inc. SECURITIES REGISTERED UNDER SECTION 12 (g) OF THE EXCHANGE ACT: NONE Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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. Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ X ] State issuer's revenues for its most recent fiscal year: $10,053,000 Gross As of the close of business on November 30, 1995, the aggregate market value of Lee Pharmaceuticals common stock held by nonaffiliates was $1,643,436. State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. Common stock, par value $.10; 4,135,162 shares outstanding as of the close of business on January 5, 1996. DOCUMENTS INCORPORATED BY REFERENCE: NONE ITEM 1. DESCRIPTION OF BUSINESS. Lee Pharmaceuticals is engaged in the research, development, purchase, manufacture, and marketing of consumer personal care products and professional dental products, all of which are targeted for the improved well-being of the human body. The Company's business is directed to two main areas: (a) the development and marketing of a range of consumer products including nail extenders and strengtheners, depilatories, feminine hygiene products and over-the-counter drug items and (b) the manufacture and sale of materials and supplies for use in the professional dental health field. For all years presented, revenues, operating results and identifiable assets of the consumer products group were in excess of 90% of total company operations. Lee Pharmaceuticals' executive offices are located at 1444 Santa Anita Avenue, South El Monte, California 91733, and its telephone number is (818) 442-3141. The Company was incorporated in April 1971 as a California corporation. The Company's consumer products line consists primarily of a variety of artificial fingernail extenders and related fingernail products. In addition, the Company manufactures and sells hair removal and related feminine products, antacid tablets, nasal care products, infant items and a variety of over-the-counter drug products. The Company's product lines have been developed internally, particularly in the case of fingernail products, and by outside product line acquisitions. In fiscal years 1993 and 1994, the research and development capability of Lee Pharmaceuticals generated several new product entries, including Lee Press-On Body Tattoos, Lee Brush-On Nail Bleach, Lee Nail Whitener and the Lee Fancy Fingers Nail Jewelry Kit. In addition, the consumer products line of the Company was further diversified by the acquisition of seven products from other manufacturers, including six over-the-counter drug products and Sundance, a line of skin care products. In fiscal year 1995, the research and development capability of Lee Pharmaceuticals generated several new product entries, including a new product line -- Lee Press-On Nails - Professional Salon Style in fourteen high fashion nail colors plus a nail extender product line known as Lee Elegant Edge Nail Tip kits. In addition, there was further diversification of the Company's consumer products line by the acquisition of products from other manufacturers, including aloe vera skin care products, a line of men's after shave lotions, infant care items and additional over-the-counter drug products. Consumer products are sold nationally, principally through major retail drug, food and discount department store chains. Retail distribution is primarily accomplished through a network of independent general merchandise sales representatives. All lines are advertised in a variety of media, including television, magazines and newspapers. The Consumer Products Division of Lee Pharmaceuticals operates in a highly competitive environment. In the area of fingernail extension, Lee Pharmaceuticals competes with five to six companies of similar size and financial resources. Competition in the depilatory product category is intense, but competitors are not as numerous as in the artificial fingernail field. The acquisition of Zip Wax and Bikini Bare brands of hair removal products has given Lee Pharmaceuticals two major brands in this category sub-segment. Lee Pharmaceuticals continues to expand its product line via a combination of acquisitions and in-house research and development activity. The consumer products line today is dominated by nail extension, nail treatment, and nail decor products, but it now includes depilatory products, wax hair removal products, feminine deodorant products, a nailbiting deterrent product, nasal care items, over-the-counter drug products, skin care products and men's fragrance products. The Company's consumer products line today is no longer restricted solely to the volatilities of the cosmetics business. The Company's consumer products are regulated by the Food and Drug Administration. The regulations deal principally with consumer safety and with the effectiveness of the products for the purposes for which they are proposed to be used. For many years, the cosmetic regulations were applied only in cases of adulteration or misbranding. Under the Fair Packaging and Labeling Act (1966), the FDA has moved to require new labeling data as to ingredients in cosmetics. The Company believes that all its cosmetic products are manufactured and sold in compliance with the laws of each state and that no pre-marketing clearance of its products is required from any state. The Company maintains a comprehensive data file on each of its consumer products and believes that it would be able to apply for any required clearances expeditiously if data were ever required for its cosmetic products. To the extent the Company's products are marketed in foreign countries, foreign laws are applicable as well as FDA regulations which control export of cosmetics. To date, where regulations have been established by foreign ministries of health which differ from those established in the United States, the Company has been able to make acceptable substitutions. As a result, marketing of the products has not been significantly impeded by foreign regulations. Material Safety Data Sheets (MSDS) are available on all its consumer finished products. The MSDS's are supplied to the Company's customers. All products for export shipped by air or sea which contain listed hazardous materials meet United Nations Standards as of January 1991. The requirements are based on the U.N.'s performance-oriented packaging (POP) specifications found in the "Transport of Dangerous Goods" commonly called "The Orange Book". From its inception in 1971 through 1995, the Company at various times introduced dental products designed to satisfy specific material or supply requirements of the practicing dental professional and of the orthodontic and endodontic specialist. Its dental product line consists of a variety of restorative materials (filling materials, core build up materials, fissure sealants, etc.), splints, orthodontic brackets, Maryland bridge adhesives, and enamel and dentin bonding materials and related products. In 1991, the Company licensed the right to certain patents and technology developed by the American Dental Association Health Foundation through research it sponsored at the Paffenbarger Center for Excellence in Dental Research at the National Institute of Technology and Standards for fabricating dental inserts and inlays of special formulas of beta quartz. The Company has been marketing nine shapes and sizes, and is now introducing twenty-six more sizes and shapes which are intended to offer the dentist several new classes of restorations between amalgam and composite restorations on the one hand, and laboratory inlays on the other hand. These new beta quartz designs are intended to permit the dentist to prepare inlays in one visit, directly at the chairside, without the need for time consuming impressions, or the need for expensive laboratory work. DENTAL MARKETING IN THE UNITED STATES The Company markets its dental, orthodontic and endodontic products in the United States through telephone solicitation, direct mail, advertisement in trade journals, attendance at conventions, and dental dealers. The Company plans and executes its own marketing programs, prepares its own technical literature, produces its own clinical and marketing films, and regularly displays its dental products at conventions throughout the country. DENTAL MARKETING OUTSIDE THE UNITED STATES The Company markets dental products outside the United States through foreign dental distributors who either solicit individual dentists and orthodontists and sell the Company's products to them directly for use in the treatment of their patients, or sell through local dealers whom they engage to sell the Company's products on their behalf. The Company plans and executes its own international marketing programs and regularly displays its dental products at international conventions. The dental preventive and restorative materials industry is highly competitive, and the Company's market share in the total industry is insignificant. The Company competes with larger corporations which have greater financial resources and believes other companies may enter this field. The Company's principal competitors are 3M Dental Division, a division of 3M; Kerr, a division of Sybron; L. D. Caulk Co., a division of Dentsply; and Unitek, a division of 3M. The principal methods of competition are in the area of product performance, technical assistance provided to the customer, and price. Dental materials are classified as devices under the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act. All the dental device products marketed by the Company were registered as devices with the FDA at the mandatory time (December 31, 1977). All new devices marketed after May 28, 1976, must be processed under the FDA premarketing notification regulation (510 k) for determination of equivalency to preenactment devices, or the product must be submitted as a new device which requires providing considerable extra test data. The Safe Medical Devices Act (SMDA) became law on November 28, 1990, requiring all serious injuries and serious illness contributed to or caused by medical devices to be reported to distributors, manufacturers and the FDA. SMDA also requires all premarket submissions to the FDA to contain adequate information on safety and effectiveness. As required by the FDA, the Company observes certain procedures and policies in the manufacture, quality control, and after-sale monitoring of performance for its products. Although the various criteria to be used by the FDA in regulating devices have not been finalized, the Company believes that all of its products and procedures comply with all current and anticipated device regulations. Over half the Company's products fall into the FDA's Class II classification which requires that those products must meet certain performance standards. The Company believes that all affected products meet all current performance standards. For those products placed in Class II, final marketing approval from the FDA is contingent on final acceptance of the Panel's findings and on development of standards (in large part being done by the American Dental Association). It is expected that, based upon current available information, most of the Company's products will meet the standards currently anticipated; for the products that do not meet the standards, the Company will have to submit adequate data directly to the FDA. Failure to gain approval by the FDA could impede the marketing of these devices to the point of removal from the market until such time as clearance is obtained. To the extent the Company's products are marketed in foreign countries, the Company believes it has complied with the laws of such countries, and with the FDA regulations which control export of devices. It is anticipated that compliance with the FDA regulations will ensure compliance also with applicable foreign laws and regulations, although certain foreign countries could develop more restrictive laws and regulations that could impede the Company's ability to market its dental products in foreign countries. The Company believes that all its dental products are manufactured and sold in compliance with the laws of each state and country to whom the Company exports and that no premarketing clearance of its products is required from any state. The Materials Transportation Bureau administers the Hazardous Materials Regulation, effective July 7, 1975. It has been ascertained that those dental products and components marketed by the Company which fall within the provisions of the regulations are brought into compliance by proper labeling and/or filing for exemptions. The Company believes that it is in full compliance with all bureau regulations applicable to its products and that compliance with these regulations will not significantly impede the marketing of its products. FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES (except Canada). . . . . . . . . . $1,161 $781 $880 The Company conducts a research program to enhance its present products and to develop new products. The members of the research staff devote a majority of their time to development of new products and to production in the areas of quality control and technical assistance. As needed, clinical research on products is also done under contract with dental schools and clinics. The Company follows the policy of expensing all research and development costs when incurred. During the years ended September 30, 1995, 1994 and 1993, the Company spent approximately $186,000, $289,000 and $248,000, respectively, on research activities relating to the development of new products or the improvement of existing products. The raw materials used by the Company in the manufacture of most of its dental and consumer products are obtained from commercial sources where they are presently available in sufficient quantities and are refined by the Company as needed for use in its products. The Company generally carries sufficient amounts of raw materials inventory to meet the delivery requirements of customers. The Company has adopted the policy of making patent disclosures on its products and of filing applications for patents on the products or on aspects of their manufacture or use when appropriate. The Company owns forty U.S. patents, and owns the rights in a number of other U. S. patent applications pending. A U.S. patent on sculptured nails has been granted. There are currently ten foreign patents held by the Company. In addition, one design patent has been granted for a nail buffer and for artificial nails. There is no assurance that any of the patent applications will be granted or that, if granted, the Company will be afforded any competitive advantages thereby. The Company believes that, while patent protection is desirable in certain areas, it is not essential; therefore, certain foreign patents have been abandoned as not necessary to the interest of the Company. In addition to the forty patents noted above, which apply to dental and consumer products, the Company has been assigned three U.S. patents which relate to general epoxy chemistry. Two of these may be used by the Epoxylite Corporation for other than medical and dental products without the payment of any royalty or other consideration. United States trademarks for the major dental products have been granted. Additional trademarks for other products have been applied for, both in the U. S. and in foreign countries. Trademarks for certain minor products, or in countries with minor market potential, have been abandoned as not necessary to the interest of the Company. The Company has the right to use the name "Epoxylite" in connection with the marketing and sale of its medical and dental products and owns the trademark "Epoxylite" in medical and dental categories. The Epoxylite Corporation owns the trademark "Epoxylite" in all other categories. The trademark "Epoxylite" is registered for medical and dental classifications in the U.S., Canada, Mexico, England, France, and numerous other countries. The Company owns, or applications are pending for, trademarks for the names under which each of its principal products is marketed. The Company is registered with the federal and State of California FDA agencies as a manufacturer and distributor of Drugs, Medical Devices and Cosmetics. The Company is also registered as a waste generator with the Environmental Protection Agency (EPA). ENVIRONMENTAL PROTECTION REGULATION AND LITIGATION The Company believes that its manufacturing facilities are operated in compliance with all federal, state and local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. The Company owns a manufacturing facility located in South El Monte, California. The California Regional Water Quality Control Board (The "RWQCB"), has alleged that the soil and shallow groundwater at the site are contaminated. On August 12, 1991, the Board issued a "Cleanup and Abatement Order" directing the Company to conduct further testing and cleanup the site. The Company did not complete the testing, and in June, 1992, the RWQCB requested that the EPA evaluate the contamination and take appropriate action. At the EPA's request, Ecology & Environment, Inc. conducted an investigation of soil and groundwater on the Company's property. Ecology & Environment Inc.'s Final Site Assessment Report, which was submitted to the EPA in June, 1994, did not rule out the possibility that some of the contamination originated onsite, and resulted from either past or current operations on the property. While the Company may be liable for all or part of the costs of remediating the contamination on its property, the remediation cost is not known at this time. The EPA has not taken any further action in this matter, but may do so in the future. The Company and nearby property owners are in the process of engaging a consultant to perform a site investigation with respect to soil and shallow groundwater contamination. Based upon proposals received to date, the Company currently estimates the cost to perform the site investigation to be $175,000. Accordingly, while recognizing it may be jointly and severally liable for the entire cost, the accompanying financial statements include the proportionate amount ($87,500) which the Company believes is its liability for a site investigation. The tenants of nearby properties upgradient have sued the Company alleging that hazardous materials from the Company's property caused contamination on the properties leased by the tenants. The Company does not believe there is any basis for the allegations and is vigorously defending the lawsuit. The case name is DEL RAY INDUSTRIAL ENTERPRISES, INC. v. ROBERT MALONE, ET AL., Los Angeles County Superior Court, Northwest District, commenced August 21, 1991. In this action, the plaintiff alleges environmental contamination by defendants of its property, and seeks a court order preventing further contamination and monetary damages. The Company does not believe there is any basis for the allegations and is vigorously defending the lawsuit. The Company's South El Monte manufacturing facility is also located over a large area of possibly contaminated regional groundwater which is part of the San Gabriel Valley Superfund site. The Company has been notified that it is a potentially responsible party ("PRP") for the contamination. The cost of any cleanup of the groundwater is not known at this time. In September 1992, EPA announced that the levels of contamination in the Whittier Narrows area of the Superfund site were sufficiently low and that it was not planning a cleanup at this time, but rather would continue to monitor the groundwater for an indefinite period. The Company's property is adjacent to the Whittier Narrows area. Except as described above, it is not clear what action the EPA will take with respect to the Company's property. In August, 1995, the Company was informed that the EPA entered into an Administrative Order on Consent with Cardinal Industrial Finishes ("Cardinal") for a PRP lead remedial investigation and feasibility study (the "Study") which, the EPA states, will both characterize the extent of groundwater contamination in South El Monte and analyze alternatives to control the spread of contamination. The Company and others have entered into the South El Monte Operable Unit Site Participation Agreement with Cardinal pursuant to which, among other things, Cardinal will contract with an environmental firm to conduct the Study. The Study is anticipated to take eighteen to twenty-four months. The Company's share of the cost of the Study is currently $15,000 which has been accrued for in the accompanying financial statements. The City of South El Monte, the city in which the Company has it's manufacturing facility, is located in the San Gabriel Valley. The San Gabriel Valley has been declared a Superfund site. The 1995 Water Quality Control Plan issued by the California Regional Water Quality Control Board states that the primary groundwater basin pollutants in the San Gabriel Valley are volatile organic compounds from industry, nitrates from subsurface sewage disposal and past agricultural activities. In addition, the Plan noted that hundreds of underground storage tanks leaking gasoline and other toxic chemicals have existed in the San Gabriel Valley. The California Department of Toxic Substance Control have declared large areas of the San Gabriel Valley to be environmentally hazardous and subject to cleanup work. The Company believes the City of South El Monte does not appear to be located over any of the major plumes. However, the EPA recently announced it is studying the possibility that, although the vadose soil and groundwater, while presenting cleanup problems, there may be a contamination by DNAPs (dense non-aqueous phase liquids), i.e., "sinkers", usually chlorinated organic cleaning solvents. The EPA has proposed to drill six "deep wells" throughout the City of South El Monte at an estimated cost of $1,400,000. The EPA is conferring with SEMPOA (South El Monte Property Owners Association) as to cost sharing on this project. SEMPOA has obtained much lower preliminary cost estimates. The outcome cost and exact scope of this are unclear at this time. The Securities and Exchange Commission has issued a formal order of investigation concerning certain matters, including the Company's environmental liabilities. The Company is cooperating with the investigation. Currently, the Company does not have any reliable information on the likely cleanup costs of its property. Thus, it cannot determine the extent, if any, of its share of liability for any such cleanup costs. The Company has been seeking reimbursement of costs from its insurance carriers, who have denied reimbursement of costs, based on their review and analysis of the insurance policies, the history of the site, the nature of the claims and current court decisions in such cases. During the last several years, several state, local and federal agencies have finalized or proposed regulations relating to hazardous materials. These include Los Angeles County Hazardous Materials Business Plan, California and federal OSHA "right to know" laws, EPA "community right to know" laws and Extremely Hazardous Substance Regulations, Los Angeles County's program for monitoring and closing underground tanks, the California Safe Drinking and Toxic Enforcement Act of 1986 (Prop 65), California Connelly-Sterling Toxic Hot Spots Information Act and AQMD's New Source of Carcinogenic Air Contaminants (Rule 1401). The Company believes it is in compliance with these regulations that are in effect and is anticipating it will be in compliance with those of these acts yet to be finalized. The Company's work force of 92 presently includes 27 permanent employees, both salaried and hourly, and 65 personnel leased through employment agencies. The Company is not dependent upon any one supplier for any important raw material item. Most raw material items are commodities and readily available in the market. In most instances, the Company utilizes two or more suppliers to furnish raw materials as needed. Sources are believed to be sufficient to satisfy current and anticipated needs. Demand for the Company's principal product line is not seasonal. The depilatory line of products is, however, generally seasonal, with demand significantly higher during the spring and summer months. Although the Company does not believe that it is dependent upon any one customer or distributor, a customer accounted for 7% and 10% of the Company's net revenues during fiscal 1995 and 1994, respectively. No other customer accounted for 10% or more of the Company's net revenues for those fiscal years. Backlog is not a significant factor in the Company's business. Most orders are filled immediately and in any event, are cancelable under certain conditions. There are no material contracts with distributors. Consumer Products Division returns must include proof of purchase, sales receipt and a written explanation of the reason for the return. The Company generally provides credits for replacement of product, however, on occasion it may provide a cash refund. In addition, discontinued or overstocked items may be returned once the customer receives a computer printed "return authorization" and "shipping labels" for full case stock of factory fresh product to be sent freight prepaid to the Company's warehouse. The customer will not receive credit for additional merchandise that may have been added to the return. Also, the Company issues a damaged merchandise allowance of 1/2 of 1% visibly deducted on each and every invoice from the total net value of that invoice in lieu of accepting returns of damaged merchandise. Finally, only 20% of the original merchandise order of custom packed assortments is subject to return. The Company's sales return policy for the Dental Division, is as follows: "products returned to Lee Pharmaceuticals for credit must be sent postage paid and within 90 days of purchase". Defective merchandise can be replaced free of charge at any time prior to the date of expiration. Excessively used or improperly stored merchandise is not eligible for replacement. ITEM 2. DESCRIPTION OF PROPERTIES. The Company occupies, through ownership or lease, ten buildings on contiguous lots in South El Monte, California. The Company owns the following: 1428 Santa Anita Avenue 12,000 Chemical processing and filling The Company leases the following: (1) This property is treated as a sale leaseback agreement between the Company and one of its directors (former Chairman). The monthly lease payments were set at the currently prevailing rates in the area at the time the leases were written. (2) The Company entered into a sublease agreement, effective January 15, 1996, which expires November 30, 2000. The gross annual rental income is $57,250. The tenant occupies 13,000 square feet of the total 15,000 square footage. In June 1998, the subleasee will commence occupancy of the entire 15,000 square footage and the monthly rent will be adjusted accordingly. The sublease includes a cost of living adjustment in June 1998. All of the Company's business segments use the properties owned or leased by the Company except for 1470 Santa Anita Avenue (available for subleasing) and 1445 Lidcombe Avenue which was vacated in August 1995 and subleased effective November 8, 1995. The Company has a right of first refusal to acquire most of the buildings which it leases. The Company believes that its existing facilities are adequate to enable it to continue to produce its products at their present volume together with any moderate increases thereto. In the ordinary course of its business, the Company is involved from time to time in litigation. In the opinion of management of the Company none of the litigation currently pending will have a material effect on its business or financial condition. See Item I -- "Applicable to all segments -- Environmental protection regulation and litigation" (including the SEC formal investigation) for additional information concerning certain litigation and an investigation by the Securities and Exchange Commission. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS. Lee Pharmaceuticals' common stock has been traded on the American Stock Exchange since October 24, 1973. For the two most recent fiscal years, its shares have closed at high and low trading prices as follows: FY 1995 1Q $ .9375 $ .4375 FY 1994 1Q $3.5000 $1.6250 The Company does not currently meet the guidelines for continued listing of the Company's Common Stock on the American Stock Exchange. No assurances can be given that the Company's Common Stock will continue to be traded on the American Stock Exchange. The Company is exploring the possibility of moving the trading of its stock to the over the counter market. There were approximately 894 shareholders of record of the Company's common stock as of the close of business on September 30, 1995. The Company has not paid any cash dividends and has no present intention of paying cash dividends in the foreseeable future. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS. FISCAL YEARS ENDED SEPTEMBER 30, 1995 AND SEPTEMBER 30, 1994 Net revenues decreased during fiscal 1995 by $1,730,000 or 16% when compared to fiscal 1994. The decrease in net revenues was the result of lower sales volume of the Company's nail extender products. The decline in sales revenue was caused by lower competitive pricing, contracting inventory levels and customer consolidations by the retailers. The Company's percentage of sales returns to gross revenues was basically constant when comparing fiscal 1995 and 1994. New product launches and brand acquisitions accounted for approximately 6% of the total net revenues for fiscal 1995. As noted under "Description of Business -- Consumer Products Segment" the Company has pursued a policy of diversifying its product line and has increasingly emphasized lower priced products. The overall economic recession had some effect on the down turn in the Company's sales volume in fiscal 1995. Cost of sales as a percentage of gross revenues increased during fiscal 1995 when compared to fiscal year 1994. The increased cost of sales percentage (47% versus 41%) is attributed to bulk sales of slow moving finished goods at lower than normal gross margins. Also the Company's charge to cost of sales to increase the inventory obsolescence allowance amounted to $485,000 or approximately 500 basis points of the fiscal year cost of sales percentage increase (47% versus 41%). Selling and advertising expenses decreased $1,047,000 or 20% when comparing fiscal year 1995 and 1994. The cost reductions occurred in several major expense classifications, namely: 1) decrease in payroll and related fringe benefits due to cutbacks of personnel, 2) decline in advertising promotion costs, 3) lower manufacturer representative commissions (lower sales volume) and 4) lower consulting and amortization expenses. Research and development expenses decreased $103,000 (36%) to $186,000 for 1995, as compared to $289,000 at September 30, 1994. A reduction in personnel and related fringe benefit costs explains the reduction in expenditures. The recent Company trend has been in the direction of brand acquisitions rather than extensive internal research and development. General and administrative expenses remained constant when comparing fiscal year 1995 and 1994. When comparing fiscal year 1995 and 1994, the following key expense categories decreased; salaries and wages plus related fringe benefits ($152,000), legal ($27,000), and insurance ($17,000). The reduction in expenses were offset primarily by increases for an environmental cleanup accrual ($102,500) and a write off of an affiliate receivable ($83,000). Working capital was $1,260,000 at September 30, 1995, as compared with $3,042,000 at September 30, 1994. The ratio of current assets to current liabilities was 1.3 to 1 at September 30, 1995 and 2.0 to 1 at September 30, 1994. The decrease in working capital during fiscal 1995 primarily resulted from a decrease in inventory levels ($962,000) as a result of scrapping excess packaging components. Also, the Company's accounts payable and payables due to related parties increased $358,000 and $223,000, respectively. The decrease in current ratio during 1995 compared to 1994 resulted primarily from: 1) a real estate bank loan (approximately $289,000) which becomes due in March 1996, 2) the increase in inventory obsolescence allowance of $485,000 and 3) the recognition and recording of the remaining current portion ($660,000) of the long term liabilities related to prior brands acquisitions. Accounts and notes payable (current) increased ($935,000) from 1994 to 1995. Accounts payable as a percentage of total costs and expenses increased to 16% from 11% when comparing fiscal years 1995 versus 1994. The accounts receivable turnover has remained relatively constant when comparing fiscal year 1995 and 1994. In fiscal 1995, the Company received additional cash advances from the Company's Chairman. The additional borrowing was obtained for the continued payment to suppliers. The Company extended the repayment terms of several notes prior to their maturity during fiscal 1995. Customer consolidations, as expected, materialized in fiscal 1995 and will, no doubt, continue in fiscal 1996. Management continues to face lower retail store inventory levels and expanded computerization (EDI - electronic data interchange) in the field. The Company has an accumulated deficit of $4,805,000. The Company's recurring losses from operations and inability to generate sufficient cash flow from normal operations to meet its obligations as they came due raise substantial doubt about the Company's ability to continue as a going concern. The Company's ability to continue in existence is dependent upon future developments, including obtaining additional financing and achieving a level of profitable operations sufficient to enable it to meet its obligations as they become due. In order to increase its working capital, the Company developed the following financial plan. The Company has taken steps to conserve cash by reducing its occupied facility square footage by 25% since August 1995. The lease on a 7,000 square foot facility was canceled by paying a six (6) month advance rent buyout. Two other facilities were vacated and will be subleased during fiscal 1996. One subleasee took occupancy of a building in November of 1995, and the second building will be occupied in January 1996. The amount of rental income will be slightly less than the Company's current monthly rent expense related to these buildings. The total annualized economic savings via the lease buyout and rental income on the two buildings is approximately $133,000. Additionally, the Company is conducting a review of its inventory and is diligently working to reduced the amount of working capital tied up in inventory. The Company reduced its gross inventory level during fiscal 1995 by approximately $477,000, exclusive of material scrapped from inventory. Plus, the Company is reviewing proposals from finance companies regarding the possibility of them making a loan secured by the Company's accounts receivable, inventory and equipment. The Company is hopeful that this funding will be available should the need arise. Also, the renegotiation of the Company's real estate loan ($289,000) which matures in March, 1996 is underway. No assurances can be given that the Company's efforts in this regard will be successful. The Company does not believe that inflation had a significant impact on its operations during fiscal years 1995 and 1994. All schedules not filed or included herein are omitted either because they are not applicable or not required, or the required information is included in the financial statements or notes thereto. 9300 WILSHIRE BOULEVARD, SUITE 480 I have audited the accompanying balance sheet of Lee Pharmaceuticals as of September 30, 1995 and the related statements of operations, changes in stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. My responsibility is to express an opinion on these financial statements based on my audit. The financial statements of Lee Pharmaceuticals for the period ending September 30, 1994 were audited by other auditors whose report thereon dated December 6, 1994 expressed an unqualified opinion on those statements. I conducted my audit in accordance with generally accepted auditing standards. Those standards require that I plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. I believe that my audit provides a reasonable basis for my opinion. In my opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Lee Pharmaceuticals as of September 30, 1995, and the results of its operations and its cash flows for the year then ended, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1 to the financial statements, the Company's recurring losses from operations and inability to generate sufficient cash flow from normal operations raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Notes 1 and 15. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern. As discussed in Note 10 to the financial statements, the Company is involved in various matters involving environmental cleanup issues. The Company is presently planning and/or participating in remedial cost studies and has made the appropriate provision in the financial statements for the cost of these studies. However, the ultimate outcome of these matters cannot presently be determined. Accordingly, no provision for any loss that may result from the resolution of these matters has been made in the accompanying financial statements. We have audited the statements of operations, changes in stockholders' equity, and cash flows of Lee Pharmaceuticals for the year ended September 30, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements presentations. 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 results of operations and cash flows of Lee Pharmaceuticals for the year ended September 30, 1994, in conformity with generally accepted accounting principles. As discussed in Note 10 to the financial statements, the Company is involved in various matters involving environmental cleanup issues. The ultimate outcome of these matters cannot presently be determined. Accordingly, no provision for any loss that may result from the resolution of these matters has been made in the accompanying financial statements. 139 South Beverly Drive, Suite 204 Beverly Hills, CA 90212 Tel: (310) 274-7541 Fax: (310) 274-1015 Accounts receivable, less allowance for doubtful accounts of $141,000 and sales returns allowance of $243,000......... 1,331,000 PROPERTY, PLANT AND EQUIPMENT, AT COST (Notes 5 and 6F): Less accumulated depreciation and amortization................ 6,519,000 NET PROPERTY, PLANT AND EQUIPMENT........................... 587,000 INTANGIBLE AND OTHER ASSETS, net of accumulated amortization of $2,558,000 (Notes 3, 6F and 8)............................. 3,127,000 Note payable to bank (Note 5)................................. $ 289,000 Notes payable, other (Note 8)................................. 165,000 Current portion - royalty agreements (Note 2)................. 743,000 Due to related parties (Note 7)............................... 388,000 Deferred income (Note 7)...................................... 65,000 LONG-TERM NOTES PAYABLE TO RELATED PARTIES (Note 6)............. 3,346,000 LONG-TERM PAYABLE - royalty agreements, less current portion $743,000 (Note 2)..................................... 1,525,000 DEFERRED INCOME (Note 7)........................................ 273,000 COMMITMENTS AND CONTINGENCIES (Note 10) STOCKHOLDERS' DEFICIENCY (Notes 11 and 13): Common stock, $.10 par value; authorized 7,500,000 shares; issued and outstanding, 4,135,162 shares.................... 413,000 Accumulated deficit (Note 1).................................. (4,805,000) The accompanying notes are an integral part of the financial statements. FOR THE YEARS ENDED SEPTEMBER 30, Cost of sales.................................. 4,762,000 4,884,000 Selling and advertising........................ 4,077,000 5,124,000 General and administrative..................... 1,110,000 1,114,000 Research and development....................... 186,000 289,000 TOTAL COSTS AND EXPENSES......................... 10,135,000 11,411,000 GAIN ON SALE OF BUILDINGS AND OTHER (Note 7)..... 65,000 67,000 NET LOSS......................................... $(1,282,000) $ (663,000) PER SHARE: Net loss....................................... $ (.31) $ (.16) The accompanying notes are an integral part of the financial statements. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY) FOR THE YEARS ENDED SEPTEMBER 30, The accompanying notes are an integral part of the financial statements. FOR THE YEARS ENDED SEPTEMBER 30, CASH FLOWS FROM OPERATING ACTIVITIES: Adjustments to reconcile net loss to net cash provided by operating activities: Amortization of intangibles.................... 245,000 216,000 (Gain) on disposal of property, plant Change in operating assets and liabilities: (Increase) decrease in accounts receivable..... (398,000) 696,000 Decrease (increase) in inventories............. 962,000 (42,000) Decrease (increase) in other current assets.... 278,000 (420,000) Increase in accounts payable................... 358,000 180,000 Increase (decrease) in accounts payable, Increase in note payable bank.................. 289,000 -- Increase in notes payable - other.............. 65,000 100,000 (Decrease) in customer advances and deposits... (26,000) (109,000) (Decrease) in accrued salaries and wages....... (48,000) (10,000) (Decrease) in other accrued liabilities........ (170,000) (122,000) Increase in accrued royalties.................. 83,000 -- (Decrease) in deferred income.................. (65,000) (189,000) Net cash provided by (used in) operating CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, plant and equipment..... (98,000) (300,000) Proceeds from sale of equipment................ 26,000 1,000 Acquisition of product brands.................. (552,000) (101,000) Net cash (used in) investing activities...... (624,000) (400,000) CASH FLOWS FROM FINANCING ACTIVITIES: Payments on bank loans......................... (296,000) (7,000) Proceeds from notes payable to related party... 193,000 510,000 Net cash (used in) provided by financing NET INCREASE (DECREASE) IN CASH.................. 17,000 (186,000) Cash, beginning of year.......................... 106,000 292,000 Cash, end of year................................ $ 123,000 $ 106,000 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid (refunded) during the year for: Interest....................................... $ 138,000 $ 181,000 The accompanying notes are an integral part of the financial statements. NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company manufactures and markets consumer products to national and regional retailers of varying financial strength. The Company also manufactures and sells dental products to dental service providers principally in the United States. For all years presented, sales, operating results and identifiable assets of the consumer products group were in excess of 87% of total company operations. The financial statements have been prepared assuming that the Company will continue as a going concern. The Company has an accumulated deficit of $4,805,000. The Company's recurring losses from operations and inability to generate sufficient cash flow from normal operations to meet its obligations as they came due raise substantial doubt about the Company's ability to continue as a going concern. The Company's ability to continue in existence is dependent upon future developments, including obtaining additional financing and achieving a level of profitable operations sufficient to enable it to meet its obligations as they become due. Management's plans in regard to these matters are described in Note 15 -- "Subsequent Events." The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern. Inventories are stated at the lower of average cost or market using the first-in, first-out method. Property, plant and equipment are depreciated using the straight-line method over estimated useful lives of three to ten years for machinery and equipment and building improvements and thirty-one years for the building. Leasehold improvements are amortized over the shorter of the estimated useful lives of the assets or the related lease term. The excess of acquisition costs over the fair value of certain assets acquired is being amortized over forty years. Covenants not to compete are being amortized over three to five years, which is the term of the related agreements. Amortization is provided using the straight-line method. Environmental expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. The Company's proportionate share of the liabilities are recorded when environmental remediation and/or cleanups are probable, and the costs can be reasonably estimated. See Note 10 -- "Assessment for environmental cleanup." The Company had one major customer with sales volume approximating 7% and 10% of the Company's net revenues for the years ending September 30, 1995 and 1994, respectively. The amount due from the customer was $118,000 and $278,000 at September 30, 1995 and 1994, respectively, and is included in accounts receivable in these financial statements. Financial instruments which potentially subject the Company to concentrations of credit risk consist of cash and trade receivables. The Company places its cash with high credit quality financial institutions. At times such investments may be in excess of the FDIC limit. In regards to trade receivables, the risk is limited due to the large number of customers comprising the customer base, and the dispersion in different industries and geographies. Net loss per share is based on the weighted average number of common shares outstanding which were 4,135,162 in 1995 and 1994. Common stock equivalents (common stock options) for fiscal 1995 and 1994 were not considered in the net loss per share computations since the effect was anti-dilutive. The Company has experienced recurring losses from operations. Management plans to fund any potential additions to the deficit by borrowing from various sources. See Note 15 -- "Subsequent Events." NOTE 2 - CHANGE IN ACCOUNTING POLICY The Company has changed its method of accounting for royalty agreements in connection with brand acquisitions. Minimum royalty obligations that are fixed and certain in amount are "grossed up" and recorded as liabilities. The related intangible assets acquired are amortized over the life of the royalty agreement. This change which is a grossing up of assets and liabilities, in equal amounts, has no effect on the statements of operations. Certain reclassifications have been made in the Statement of Cash Flows for the year ending September 30, 1994 to make the statement comparable to the September 30, 1995 presentation. NOTE 3 - INTANGIBLE ASSETS The Company acquired certain product lines in 1995 (See Note 14) and prior years. Certain amounts related to these acquisitions were allocated to intangible assets. Included in intangible and other assets at September 30, 1995 are the following intangible assets: Covenants not to compete 1,388,000 Inventories consist of the following at September 30, 1995: NOTE 5 - NOTE PAYABLE TO BANK Note payable to bank, secured by a deed on land and building, requires monthly payment of $3,900, including interest at the bank's reference rate plus 2%, maturing March 1996. At September 30, 1995, the interest rate was 13.75%. The note is guaranteed by the former Chairman of the Company. The Company is going through the renegotiations with the bank regarding this real estate loan. See Note 15 -- "Subsequent Events." NOTE 6 - NOTES PAYABLE - RELATED PARTIES The Company's Chairman retired in April 1995. The above referenced notes B, C, D, G, H and M are payable to the Company's retired officer. At September 30, 1995, the Company was committed to the following minimum principal payments. NOTE 7 - RELATED PARTY TRANSACTIONS In 1991, the Company sold and leased back two of its operating facilities in a transaction with its Chairman. An initial gain was recognized and a deferred gain was recorded which is to be amortized over the term of the two leases which expire November 2000. The amount of deferred gain recognized during 1995 and 1994 was $65,000. During the fiscal year ending September 30, 1995, the total interest expensed to related parties (Note 6) was $291,000 out of which $66,000 was paid and $318,000 was accrued as of September 30, 1995. There were no consulting fees charged by the Chairman's firm during fiscal year ending September 30, 1995. During fiscal year 1995 the Company paid the $38,000, which was payable as of September 30, 1994. In April 1995, the Chairman retired. He will continue as a director of the Company. The Chairman (thru April 1995) is a majority shareholder with a freight consulting firm. During the fiscal year ending September 30, 1994, the Chairman's firm provided the Company with analysis of freight shipments and development of expert system type computer programs for traffic management. The total consulting fees approximated $113,000 for the year ended September 30, 1994. The Company's primary agent for purchasing television advertising is Western International Media Corp. (WIMC) whose President and Chief Executive Officer, Dennis F. Holt, was a Director of the Company during 1995. Agency and advertisement expenses in connection with (WIMC) were $204,000 and $61,000 for the years ended September 30, 1995 and 1994, respectively. Amounts owed to WIMC by the Company at September 30, 1995 were $153,000. See Note 15 -- "Subsequent Events." NOTE 8 - NOTES PAYABLE - OTHER NOTE 9 - FOURTH QUARTER RESULTS The Company increased its fourth quarter, ended September 30, 1995, unaudited operating loss by $601,000 due primarily to: 1) increased inventory obsolescence allowance of $355,000, 2) accrual for estimated environmental remediation costs of $102,500 and 3) a write off of an affiliate receivable of approximately $83,000. The fourth quarter ended September 30, 1995 operating loss (including the above) was approximately $885,000. NOTE 10 - COMMITMENTS AND CONTINGENCIES At September 30, 1995, the Company was committed to its former Chairman and to others under noncancelable operating leases for land and buildings requiring minimum annual rentals as follows: Generally, the leases provide that maintenance, insurance and a portion of property taxes are to be paid by the Company. The Company also has a right of first refusal to acquire most of the buildings which it leases. The Company's rental expense for the years ended September 30, 1995 and 1994 was $552,000 and $547,000, respectively. The amount of rent paid to the Company's former Chairman was $147,000 and $105,000 for the years ended September 30, 1995 and 1994, respectively. The Company owns a manufacturing facility located in South El Monte, California. The California Regional Water Quality Control Board (The "RWQCB"), has alleged that the soil and shallow groundwater at the site are contaminated. On August 12, 1991, the Board issued a "Cleanup and Abatement Order" directing the Company to conduct further testing and cleanup the site. The Company did not complete the testing, and in June, 1992, the RWQCB requested that the EPA evaluate the contamination and take appropriate action. At the EPA's request, Ecology & Environment, Inc. conducted an investigation of soil and groundwater on the Company's property. Ecology & Environment Inc.'s Final Site Assessment Report, which was submitted to the EPA in June, 1994, did not rule out the possibility that some of the contamination originated onsite, and resulted from either past or current operations on the property. While the Company may be liable for all or part of the costs of remediating the contamination on its property, the remediation cost is not known at this time. The EPA has not taken any further action in this matter, but may do so in the future. The Company and nearby property owners are in the process of engaging a consultant to perform a site investigation with respect to soil and shallow groundwater contamination. Based upon proposals received to date, the Company currently estimates the cost to perform the site investigation to be $175,000. Accordingly, while recognizing it may be jointly and severally liable for the entire cost, the accompanying financial statements include the proportionate amount ($87,500) which the Company believes is its liability for a site investigation. The tenants of nearby properties upgradient have sued the Company alleging that hazardous materials from the Company's property caused contamination on the properties leased by the tenants. The Company does not believe there is any basis for the allegations and is vigorously defending the lawsuit. The case name is DEL RAY INDUSTRIAL ENTERPRISES, INC. v. ROBERT MALONE, ET AL., Los Angeles County Superior Court, Northwest District, commenced August 21, 1991. In this action, the plaintiff alleges environmental contamination by defendants of its property, and seeks a court order preventing further contamination and monetary damages. The Company does not believe there is any basis for the allegations and is vigorously defending the lawsuit. The Company's South El Monte manufacturing facility is also located over a large area of possibly contaminated regional groundwater which is part of the San Gabriel Valley Superfund site. The Company has been notified that it is a potentially responsible party ("PRP") for the contamination. The cost of any cleanup of the groundwater is not known at this time. In September 1992, EPA announced that the levels of contamination in the Whittier Narrows area of the Superfund site were sufficiently low and that it was not planning a cleanup at this time, but rather would continue to monitor the groundwater for an indefinite period. The Company's property is adjacent to the Whittier Narrows area. Except as described above, it is not clear what action the EPA will take with respect to the Company's property. In August, 1995, the Company was informed that the EPA entered into an Administrative Order on Consent with Cardinal Industrial Finishes ("Cardinal") for a PRP lead remedial investigation and feasibility study (the "Study") which, the EPA states, will both characterize the extent of groundwater contamination in South El Monte and analyze alternatives to control the spread of contamination. The Company and others have entered into the South El Monte Operable Unit Site Participation Agreement with Cardinal pursuant to which, among other things, Cardinal will contract with an environmental firm to conduct the Study. The Study is anticipated to take eighteen to twenty-four months. The Company's share of the cost of the Study is currently $15,000 which has been accrued for in the accompanying financial statements. The City of South El Monte, the city in which the Company has it's manufacturing facility, is located in the San Gabriel Valley. The San Gabriel Valley has been declared a Superfund site. The 1995 Water Quality Control Plan issued by the California Regional Water Quality Control Board states that the primary groundwater basin pollutants in the San Gabriel Valley are volatile organic compounds from industry, nitrates from subsurface sewage disposal and past agricultural activities. In addition, the Plan noted that hundreds of underground storage tanks leaking gasoline and other toxic chemicals have existed in the San Gabriel Valley. The California Department of Toxic Substance Control have declared large areas of the San Gabriel Valley to be environmentally hazardous and subject to cleanup work. The Company believes the City of South El Monte does not appear to be located over any of the major plumes. However, the EPA recently announced it is studying the possibility that, although the vadose soil and groundwater, while presenting cleanup problems, there may be a contamination by DNAPs (dense non-aqueous phase liquids), i.e., "sinkers", usually chlorinated organic cleaning solvents. The EPA has proposed to drill six "deep wells" throughout the City of South El Monte at an estimated cost of $1,400,000. The EPA is conferring with SEMPOA (South El Monte Property Owners Association) as to cost sharing on this project. SEMPOA has obtained much lower preliminary cost estimates. The outcome cost and exact scope of this are unclear at this time. The Securities and Exchange Commission has issued a formal order of investigation concerning certain matters, including the Company's environmental liabilities. The Company is cooperating with the investigation. Currently, the Company does not have any reliable information on the likely cleanup costs of its property. Thus, it cannot determine the extent, if any, of its share of liability for any such costs. The Company has been seeking reimbursement of costs from its insurance carriers, who have denied reimbursement of costs, based on their review and analysis of the insurance policies, the history of the site, the nature of the claims and current court decisions in such cases. The Company has been named as a defendant in, or is otherwise a party to, several other lawsuits, claims and legal proceedings arising out of the conduct of its business, including those related to commercial transactions and other safety matters. While the ultimate results of these lawsuits and other proceedings against the Company cannot be predicted with certainty, after considering all relevant facts and the opinion of outside counsel, management of the Company believes such matters will not have a material effect on the financial position of the Company. NOTE 11 - STOCK OPTIONS Under the Company's 1985 Employee Incentive Stock Option Plan, as amended, common stock options may be granted to officers and other key employees for the purchase of up to a total of 580,000 shares of common stock of the Company at a price per share equal to its fair market value on the date of grant. Options expire five years from the date of grant, are contingent upon continued employment and become exercisable in equal installments during each of the three years beginning eighteen months after the date of grant. The following table sets forth the number of shares under option and the related option prices at September 30, 1994 and 1995: Outstanding at September 30, 1993 462,000 $1.25 -- $4.13 Granted 204,000 $1.31 -- $1.44 Canceled (94,000) $3.75 -- $4.13 Outstanding at September 30, 1994 572,000 $1.25 -- $4.13 Canceled (270,000) $1.25 -- $2.07 Outstanding at September 30, 1995 467,000 $0.50 -- $1.31 At September 30, 1995, 204,000 shares are eligible to be exercised and 113,000 shares are available for future grants under the plan. The 1987 Stock Option Plan was adopted by the Board of Directors on January 4, 1988 and was approved by the Company's shareholders on March 8, 1988. This Stock Option Plan provides for the granting of options to the Company's outside directors for the purchase of a total of 50,000 shares of common stock of the Company at a price per share equal to the fair market value on the date of grant. Options expire five years from the date of grant and become exercisable in equal installments during each of the three years beginning eighteen months after the date of grant. At September 30, 1995, options to purchase 50,000 shares were outstanding and 12,000 shares are eligible to be exercised at a price of $1.31 per share. NOTE 12 - INCOME TAXES As of September 30, 1995, the Company had net operating loss carryforwards of approximately $5,700,000 for Federal and $3,300,000 for California which for tax purposes can be used to offset future Federal and California income taxes. The differences in the state carryforwards relate primarily to the treatment of loss carryforwards and depreciation of property, plant and equipment. The carryforwards expire from 2003 through 2010. NOTE 13 - EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST The Company established an Employee Stock Ownership Plan and Trust ("Plan"). The Plan is a tax-qualified employee stock ownership plan which is designed to invest primarily in the common stock of the Company for the benefit of the employees and their beneficiaries. The benefits provided by the Plan are paid for entirely by the Company. The Company contributions are used to purchase the common stock of the Company which is credited to the individual accounts maintained for each participant. For each twelve-consecutive-month period of employment, employees receive a one-year period of service credit. After three years of service employees have a 20% vested interest in their accounts under the Plan, increasing at a rate of 20% per year with full vesting occurring at seven years of service. The Plan consists of a stock bonus plan, ("Plan A") and a money purchase pension plan, ("Plan B"). Under Plan A, the Company's Board of Directors annually determines the amount to be contributed to the Plan. The contribution by the Company for any single plan year (October 1 through September 30) cannot exceed fifteen percent (15%) of the total compensation paid to Plan participants for the year. Plan B requires an automatic contribution equal to ten percent (10%) of participant compensation each Plan Year. The Company did not make any contributions (expense) related to Plan A for the year ending September 30, 1995 or September 30, 1994. Effective June 30, 1993, Plan B was canceled; therefore, there was no contribution under Plan B for the year ended September 30, 1995 or for the period October 1, 1993 through September 30, 1994. All participants under Plan B became 100% vested on July 1, 1993 due to the cancelation of Plan B. Effective September 30, 1995, Plan A was canceled. All participants under Plan A became 100% vested on September 30, 1995 due to the cancelation of Plan A. On October 1, 1993, the Company purchased certain assets related to an over-the-counter (OTC) personal care product, from Medtech Laboratories, Inc. of Jackson, Wyoming for $100,000. In addition, the Company signed a licensing and royalty agreement to pay Rumson Laboratories, Inc. of Red Bank, New Jersey a royalty based on net sales of the acquired brand. The agreement expires on September 30, 1999. According to the agreement the Company paid $50,000 in cash as an initial license fee. In addition, the annual royalty payment is $100,000 per year. The aggregate royalty over the six (6) year period totals $600,000. The total of $650,000 for royalty and license fee will be expensed over the terms of the agreement. On August 31, 1994, the Company entered into an agreement to purchase certain assets of the "WATE-ON-R-" and "SUPER WATE-ON-R-" line of nutritional products from The Fleetwood Company for approximately $67,000 in cash. In addition, the Company remitted $100,000 to the seller which was due upon closing. A royalty agreement was entered into whereby the Company is required to remit approximately $6,900 per month for thirty-six months. The royalty amount is to be expensed over the length of the agreement which terminates on August 31, 1999. On August 31, 1994, the Company entered into an agreement to purchase certain assets of the Aloe E and Aloe 99 line of aloe vera products from Alivio Products, Inc. for approximately $50,000 in cash. A royalty agreement was entered into whereby the Company is required to remit $120,000 which is payable over a twelve month period commencing on September 30, 1994 and continuing on the last of each month for the next eleven (11) months. On June 15, 1995, the Company purchased certain assets of the Brush 'n Floss-R- product which is a patented device to facilitate tooth flossing from Sundance Healthcare Products, Inc. for approximately $24,000 cash. The purchase price ($24,000) includes a $20,000 prepayment of a five year royalty which is being expensed monthly commencing July, 1995. On June 30, 1995, the Company purchased certain assets of the Baby Gasz-TM- and Baby Gumz-TM- brand of baby products from Reinhard Labs, Inc. for approximately $73,000 cash. The Company signed a consulting agreement whereby the Company prepaid the three (3) year consulting fee ($60,000) which is included in the $73,000 purchase price. The consulting fee is expensed monthly commencing July 1, 1995 thru June 30, 1998. The royalty agreement is for a period of five (5) years, commencing July 1, 1995, and is based on 10% of net sales. The royalty payments are payable thirty (30) days after each calendar quarter. On August 10, 1995, the Company purchased certain assets of the XS-R- line of hangover relief/over indulgence products from Barnett Laboratories, Inc. for approximately $129,000. In addition, the Company signed a consulting agreement to pay Barnett Laboratories, Inc. $75,000. The Company is required to remit $5,000 per month, commencing on September 1, 1995, plus accrued interest at 10%. The payments will continue for the next fifteen (15) months. The royalty agreement covers a period of sixty-four and two-thirds (64 2/3) months, commencing August 10, 1995, and is payable thirty (30) days after each quarter. The royalty agreement is based on 25% of net sales. NOTE 15 - SUBSEQUENT EVENTS In order to increase its working capital, the Company developed the following financial plan. The Company has taken steps to conserve cash by reducing its occupied facility square footage by 25% since August 1995. The lease on a 7,000 square foot facility was canceled by paying a six (6) month advance rent buyout. Two other facilities were vacated and will be subleased during fiscal 1996. One subleasee took occupancy of a building in November 1995 and the second building will be occupied in January 1996. The amount of rental income will be slightly less than the Company's current monthly rent expense related to these buildings. The total annualized economic savings via the lease buyout and rental income on the two buildings is approximately $133,000. Additionally, the Company is conducting a review of its inventory and is diligently working to reduce the amount of working capital tied up in inventory. The Company reduced its gross inventory level during fiscal 1995 by approximately of material scrapped from inventory. Plus, the Company is reviewing proposals from finance companies regarding the possibility of them making a loan secured by the Company's accounts receivable, inventory and equipment. The Company is hopeful that this funding will be available should the need arise. Also, the renegotiation of the Company real estate loan ($289,000) which matures in March, 1996 is underway. Effective October 12, 1995, Mr. Holt resigned from the Company's Board of Directors. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. As previously reported in a Current Report on Form 8-K, on September 27, 1995, the Board of Directors of Lee Pharmaceuticals authorized, effective September 27, 1995, (1) the termination of the engagement of Meir & Meir as independent auditors for Lee Pharmaceuticals for the fiscal year ended September 30, 1995 and (2) the engagement of Jeffery, Corrigan & Shaw, 245 South Los Robles Avenue, Suite 400, Pasadena, California 91101-2894, as independent auditors for Lee Pharmaceuticals for fiscal 1995. Jeffery, Corrigan & Shaw was engaged as the Company's principal independent auditors on September 29, 1995. During the fiscal year ended September 30, 1994 and through September 27, 1995 there were no disagreements with Meir & Meir on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to the satisfaction of Meir & Meir would have caused them to make reference in connection with their report to the subject matter. The Company had been informed by Meir & Meir that information had come to their attention that made them conclude that the scope of the audit should be expanded to include an expert opinion regarding the environmental issues the Company is involved with. The finding of such expert may materially impact the fairness or reliability of the previously issued audit reports or the underlying financial statements, or the financial statements to be issued covering the fiscal periods subsequent to the date of the most recent audited financial statements (including information that might preclude the issuance of an unqualified report). The request by Meir & Meir to include the expert opinion in the fiscal 1995 audit was not the basis for the Company's change in independent accountants. Prior to such firm's engagement, Jeffery, Corrigan & Shaw was not consulted by the Company (or anyone acting on its behalf) regarding (1) either the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on Lee Pharmaceuticals' financial statements or (2) any matter that was either the subject of a "disagreement" of a "reportable event" as such terms are defined in Regulation S-K promulgated by the Securities and Exchange Commission. As previously reported in a Current Report on Form 8-K, on October 27, 1995, the Board of Directors of Lee Pharmaceuticals authorized, effective October 27, 1995, (1) the termination of the engagement of Jeffery, Corrigan & Shaw as independent auditors for Lee Pharmaceuticals for the fiscal year ended September 30, 1995 and (2) the engagement of George Brenner, CPA, 9300 Wilshire Boulevard, Suite 480, Beverly Hills, California 90212, as independent auditor for Lee Pharmaceuticals for fiscal 1995. George Brenner, CPA was engaged as the Company's principal independent auditor on October 27, 1995. In connection with its activities for the period September 27, 1995, (the date Jeffery, Corrigan & Shaw was engaged), through October 27, 1995, there were no disagreements on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to the satisfaction of Jeffrey, Corrigan & Shaw would have caused them to make reference in connection with their report to the subject matter. Jeffrey, Corrigan & Shaw was unable to proceed with the audit engagement because of its failure to obtain the insurance it believed was necessary. Prior to such firm's engagement, George Brenner, CPA was not consulted by the Company (or anyone acting on its behalf) regarding (1) either the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on Lee Pharmaceuticals' financial statements or (2) any matter that was either the subject of a "disagreement" of a "reportable event" as such terms are defined in Regulation S-K promulgated by the Securities and Exchange Commission. ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE ACT. Directors are elected to serve until the next annual stockholders' meeting or until their respective successors have been elected and qualified or as otherwise provided in the bylaws. Set forth below for the current directors and executive officers are their ages, principal occupations during the past five years, and the period during which they have served as a director or officer of the Company. (1) None of the companies named, other than the Company, is a parent, subsidiary or other affiliate of the Company. Ronald G. Lee is the son of Dr. Henry L. Lee. The following table sets forth information with respect to remuneration paid by the Company to the executive officers of the Company with total annual salary and bonus of at least $100,000 for services in all capacities while acting as officers and directors of the Company during the fiscal years ended September 30, 1995, 1994 and 1993. (1) Includes reimbursement of medical and dental expenses not covered by the Company's insurance plan of $1,294 and $8,116, respectively, in 1994 and 1993, and non-cash fringe benefits of $475, $1,734 and $1,058, respectively, in 1995, 1994 and 1993. (2) Includes reimbursement of medical and dental expenses not covered by the Company's insurance plan of $5,081, $713 and $4,383, respectively, in 1995, 1994 and 1993 and non cash fringe benefits of $653, $3,171 and $1,081, respectively, in 1995, 1994 and 1993. (3) The Company granted 55,000 stock options on January 24, 1994 which had an option price of $1.44 at the date of grant. (4) The Company granted 80,000 stock options on May 8, 1995 which had an option price of $.50 at the date of grant and 55,000 stock options on January 24, 1994 which had an option price of $1.31 at the date of grant. (5) The Company granted 51,500 stock options on May 8, 1995 which had an option price of $.50 at the date of grant and 55,000 stock options on January 24, 1994 which had an option price of $1.31 at the date of grant. (6) Amount represents the fair market value of Company shares purchased and/or forfeitures in the Company's Employee Stock Ownership Plan and Trust. There were no shares purchased and/or forfeitures in the Company's Employee Stock Ownership Plan and Trust in 1995. (7) Amount represents the fair market value of Company shares purchased and/or forfeitures in the Company's Employee Stock Ownership Plan and Trust of $0 in 1995, $349 in 1994 and $22,177 in 1993 and life insurance policy with an annual premium of $0 in 1995, $1,560 in 1994 and $2,287 in 1993. (8) Amount represents the fair market value of Company shares purchased and/or forfeitures in the Company's Employee Stock Ownership Plan and Trust of $0 in 1995, $311 in 1994 and $22,177 in 1993 and life insurance policy with an annual premium of $0 in 1995, $2,417 in 1994 and $3,392 in 1993. Dr. Henry Lee's participation in the Company's Employee Stock Ownership Plan and Trust ("Plan") terminated when he retired. Subsequent distribution of the 66,286 shares and $9,058 cash was made after September 30, 1995. He elected to take all cash which was $39,380 net after mandatory (22%) withholding taxes. Each of the directors of the Company who is not employed by the Company receives a director's fee of $750 for each quarter and $500 for each meeting of the Board of Directors attended. OPTION GRANTS IN LAST FISCAL YEAR AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST The Company established an Employee Stock Ownership Plan and Trust ("Plan") effective December 1, 1985. The Plan is a tax-qualified employee stock ownership plan which is designed to invest primarily in the common stock of the Employer for the benefit of the employees and their beneficiaries. The benefits provided by the Plan are paid for entirely by the Employer. The Employer contributions are used to purchase the common stock of the Employer, which is credited to the individual accounts maintained for each participant. In addition to providing an opportunity for employees to participate in the Employer's growth through stock ownership and to provide funds for employees' retirement, the Plan is designed to be available as a technique of corporate finance to the Employer. All employees who had completed at least a six-month period of service with the Employer as of the effective date of this Plan (December 1, 1985) became participants in the Plan as of such date. Every other employee will become a participant in the Plan as of the first day of the month coinciding with or next following the date upon which he completes a six-month period of service provided that he is employed by the Employer on such date. The Employer makes contributions only on behalf of the participants who are employed by it on the last day of each Plan year, September 30. Contributions made on behalf of the employees will not be taxable to them until the time benefits are actually paid to them. Effective October 1, 1989, the Plan consists of two (2) parts: Plan A, a stock bonus plan, and Plan B, a money purchase pension plan. The Company's Board of Directors determines the amount to be contributed annually to Plan A up to a maximum of fifteen percent (15%) participant compensation for the Plan year (October 1 through September 30). The contribution under Plan B is a non-discretionary amount equal to ten percent (10%) of participant compensation for the Plan year. The contribution by the Company to the Trust for any single Plan year cannot exceed twenty-five percent (25%) of the total compensation paid to Plan participants for the year. Company contributions are allocated to each Participant's Company Contribution Account in the proportion that his compensation for the Plan year bears to the total compensation paid to all participants for the Plan year. Forfeitures which arise under Plan A are allocated to the accounts of the other participants at the end of the Plan year during which the forfeitures arise due to termination of employment in the same manner as Company contributions are allocated. Forfeitures which arise under Plan B are used to offset the Company's required contribution under Plan B. The term "vested" as applied in the context of employee benefit plans refers to that portion of a participant's accounts which has become nonforfeitable because the participant has accrued a certain number of period-of-service credits. If a participant reaches normal retirement age (age 65), becomes permanently disabled, dies or retires at age 65, his interest in his accounts becomes immediately 100% vested, i.e. nonforfeitable. The Plan has been amended to conform with the requirements of the Tax Reform Act of 1986 and effective October 1, 1989, the vesting schedule of the Plan is as follows: PERIOD OF SERVICE VESTED PERCENTAGE Less than 3 years 0% The following tabulation shows the interest in the Plan and vesting percentages of the officers who are named in the Cash Compensation Table and all executive officers as a group as of September 30, 1995. NAME COMMON STOCK AMOUNT PERCENTAGE Henry L. Lee 66,286 $9,058 100% Theo. H. Dettlaff 52,549 $11,504 100% Ronald G. Lee 52,083 $11,172 100% All executive officers 194,371 $36,872 100% as a group (4 persons) The Company's former Chairman's participation in the Plan terminated when he retired. The distribution of his participation in the Plan was made after September 30, 1995. He elected to take all cash which totaled $39,380, net after mandatory (22%) withholding taxes. Effective July 1, 1993, the plan was amended for a second time. On June 30, 1993 Plan B was canceled; therefore, all participants became 100% vested, in Plan B only, effective July 1, 1993. No contribution was made to Plan A or B for the period October 1, 1993 through September 30, 1994. Effective September 30, 1995, Plan A was canceled. All participants under Plan A became 100% vested on September 30, 1995 due to the cancelation of Plan A. No contribution was made to Plan A or B for the period October 1, 1994 through September 30, 1995. In connection with the termination of Plan A, the Company wrote off the Employee Stock Ownership Plan and Trust receivable as of September 30, 1995. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth the persons who, as of November 30, 1995, were known to the Company to be beneficial owner of more than five percent of the Company's Common Stock: (1) Includes 28,000 shares of the Company's common stock which Dr. Lee holds as trustee for the benefit of certain family members. He has the right to vote such shares but otherwise disclaims beneficial ownership. The following table sets forth the ownership of the Company's Common Stock by its directors and its named executive officers and all executive officers and directors as a group. (1) Includes shares held under the Plan. (2) Includes shares subject to options exercisable at or within 60 days after December 31, 1995. (3) Includes 28,000 shares of the Company's common stock which Dr. Lee holds as trustee for the benefit of certain family members. He has the right to vote such shares but otherwise disclaims beneficial ownership. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Dennis Holt, a Director of the Company during 1995, is an owner, president and chief executive officer of Western International Media Corp., a company which purchases radio and television time on behalf of advertisers. During the fiscal year ended September 30, 1995 and 1994, the Company purchased approximately $204,000 and $61,000, respectively, of television time from Western International Media Corp. to advertise its products. Western International Media Corp. realized a commission of approximately $19,000 and $3,000 from the purchase of such time during fiscal years ended September 30, 1995 and 1994, respectively. In addition, Mr. Holt received a direct remuneration from the Company of $2,000 and $3,000 during fiscal year 1995 and 1994, respectively, as a Director's fee. Effective October 12, 1995, Mr. Holt resigned from the Board of Directors. The information regarding borrowings from and sale and leaseback transactions between the Company and it's Chairman of the Board which is contained in Item 6 and Note 7 of Notes to Financial Statements is incorporated herein by this reference. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. The following exhibits have been or are being filed herewith, and are numbered in accordance with Item 601 of Regulation S-B: The following exhibits are filed herewith: 10.17 - Promissory notes which were amended in January 1995 evidencing advances by the Registrant's officers 10.18 - Promissory notes evidencing advances made by the 10.19 - Promissory notes which were amended in July 1995 evidencing advances made to the Registrant 10.20 - Royalty agreement dated August 31, 1994, between Lee Pharmaceuticals and The Fleetwood Company, regarding a brand acquisition. 10.21 - Royalty agreement dated October 4, 1988, between Lee Pharmaceuticals and Roberts Proprietaries, Inc., regarding a brand acquisition. The following exhibits have previously been filed by the Company: 3.1 - Articles of Incorporation, as amended (1) 3.4 - By-laws, as amended December 20, 1977 (2) 3.5 - Amendment of By-laws effective March 14, 1978 (2) 3.6 - Amendment to By-laws effective November 1, 1980 (3) 10.1 - Qualified Stock Option Plan including forms of grant (4) 10.2 - 1985 Employee Incentive Stock Option Plan (5) 10.3 - Description of bonus agreements between the Registrant 10.4 - Lease dated December 1, 1990, for the premises located at 1470 Santa Anita Avenue, South El Monte, California (6) 10.5 - Lease dated April 16, 1990, for the premises located at 1425 and 1427 Lidcombe Avenue, South El Monte, California (6) 10.6 - Lease dated April 16, 1990, for the premises located at 1434 Santa Anita Avenue, South El Monte, California (6) 10.7 - Lease dated April 16, 1990, for the premises located at 1460 Santa Anita Avenue, South El Monte, California (6) 10.8 - Lease dated April 16, 1990, for the premises located at 1457 Lidcombe, South El Monte, California (6) 10.9 - Lease dated April 16, 1990, for the premises located at 1500 Santa Anita Avenue, South El Monte, California (6) 10.10 - Lease dated April 16, 1990, for the premises located at 1516 Santa Anita Avenue, South El Monte, California (6) 10.11 - Lease dated March 1, 1991, for the premises located at 1444 Santa Anita Avenue, South El Monte, California (6) 10.12 - Lease dated March 1, 1991, for the premises located at 1445 Lidcombe Avenue, South El Monte, California (7) 10.13 - Promissory notes which were amended in September 1992 evidencing advances by the Registrant's officers and 10.14 - Promissory notes which were amended in September 1994 evidencing advances by the Registrant's officers and 10.15 - Promissory notes evidencing advances made to the Registrant's officers and directors (9) 10.16 - Promissory notes evidencing advances made to the (1) Filed as an Exhibit of the same number with the Company's Form S-1 Registration Statement filed with the Securities and Exchange Commission on February 5, 1973 (Registrant No. 2-47005), and incorporated herein by reference. (2) Filed as Exhibits 3.4, 3.5 and 13.18 with the Company's Form 10-K Annual Report for the fiscal year ended September 30, 1978, filed with the Securities and Exchange Commission in December 1978 and incorporated herein by reference. (3) Filed as an Exhibit of the same number with the Company's Form 10-K Annual Report for the fiscal year ended September 30, 1979, filed with the Securities and Exchange Commission in December 1979 and incorporated herein by reference. (4) Filed as Exhibit 5.1 with the Company's Form 10-K Annual Report for the fiscal year ended September 30, 1973, filed with the Securities and Exchange Commission in December 1973 and incorporated herein by reference. (5) Filed as Exhibits 13.27 and 13.28 with the Company's Form 10-K Annual Report for the fiscal year ended September 30, 1986, filed with the Securities and Exchange Commission in December 1986 and incorporated herein by reference. (6) Filed as Exhibit 13.31 with the Company's Form 10-K Annual Report for the fiscal year ended September 30, 1990, filed with the Securities and Exchange Commission in December 1990 and incorporated herein by reference. (7) Filed as Exhibit 13.32 with the Company's Form 10-K Annual Report for the fiscal year ended September 30, 1991, filed with the Securities and Exchange Commission in December 1991 and incorporated herein by reference. (8) Filed as Exhibit 13.33 with the Company's Form 10-K Annual Report for the fiscal year ended September 30, 1992, filed with the Securities and Exchange Commission in December 1992 and incorporated herein by reference. (9) Filed as Exhibit 13.34 with the Company's Form 10-K Annual Report for the fiscal year ended September 30, 1994, filed with the Securities and Exchange Commission in December 1994 and incorporated herein by reference. (b) Reports on Form 8-K: A current report on From 8-K dated September 27, 1995 reporting Item 4 (Changes in Registrant's Certifying Accountant) was filed on October 3, 1995. A current report on Form 8-K dated October 27, 1995 reporting Item 4 (Changes in Registrant's Certifying Accountant) was filed on November 2, 1995. In accordance with 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. Date: January 12, 1996 RONALD G. LEE In accordance with the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: January 12, 1996 RONALD G. LEE (Principal Executive Officer) and Director Date: January 12, 1996 HENRY L. LEE, JR. Henry L. Lee, Jr. Date: January 12, 1996 THEO. H. DETTLAFF Date: January 12, 1996 WILLIAM M. CALDWELL IV Date: January 12, 1996 MICHAEL L. AGRESTI (Principal Financial and Accounting Officer)	10KSB40	10KSB40	1996-01-12T00:00:00	1996-01-12T14:39:28
0000912057-96-000444	0000912057-96-000444_0002.txt	$250,000 South El Monte, California December 23, 1994 For value received, Lee Pharmaceuticals promises to pay Henry L. Lee, Jr. or order, at South El Monte, California the sum of TWO HUNDRED AND FIFTY THOUSAND DOLLARS, with interest from December 23, 1994, on unpaid principal at the rate of Imperial Bank Prime Rate per cent per annum; principal payable on June 30, 1998. Interest shall be calculated on the basis of the unpaid principal balance daily, based on a 365 day year, actual day month, payable monthly. Principal and interest shall be payable in lawful money of the United States. If action be instituted on this note, I promise to pay such sum as the Court may fix as attorney's fees. This note is unsecured. December 27, 1994 RONALD G. LEE Date Lee Pharmaceuticals - Ronald G. Lee December 27, 1994 MICHAEL L. AGRESTI Date Lee Pharmaceuticals - Michael L. Agresti $38,000 South El Monte, California April 12, 1995 For value received, Lee Pharmaceuticals promises to pay Ronald G. Lee or order, at South El Monte, California the sum of THIRTY-EIGHT THOUSAND DOLLARS, with interest from February 17, 1995 on unpaid principal at the rate of Imperial Bank Prime Rate per cent per annum; principal payable on March 21, 1997. Interest shall be calculated on the basis of the unpaid principal balance daily, based on a 365 day year, actual day month, payable semi-annually (August 17 and February 17). Principal and interest shall be payable in lawful money of the United States. If action be instituted on this note, I promise to pay such sum as the Court may fix as attorney's fees. This note is secured by the product brand Aloe E and Aloe 99. February 17, 1995 RONALD G. LEE Date Lee Pharmaceuticals - Ronald G. Lee February 17, 1995 MICHAEL L. AGRESTI Date Lee Pharmaceuticals - Michael L. Agresti	10KSB40	EX-10.18	1996-01-12T00:00:00	1996-01-12T14:39:28
0000950147-96-000014	0000950147-96-000014_0000.txt	[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended November 30, 1995 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Exact name of registrant as specified in its charter) (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 7001 N. Scottsdale Road, Suite 2050 85253 (Address of principal executive offices) (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class of Common Stock December 29, 1995 PART I. FINANCIAL INFORMATION Page Consolidated Balance Sheets as of November 30, 1995 Consolidated Statements of Income for the three and six months ended November 30, 1995 and 1994......................4 Consolidated Statements of Cash Flows for the six months ended November 30, 1995 and 1994..........................5 Notes to unaudited Consolidated Financial Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..............................9 Item 6. Exhibits and Reports on Form 8-K..................................14 CONTINENTAL HOMES HOLDING CORP. AND SUBSIDIARIES Homebuilding: Cash and cash equivalents $ 18,745 $ 12,848 Homes, lots and improvements in production 309,735 291,331 Property and equipment, net 2,472 2,456 Prepaid expenses and other assets 23,533 20,516 Excess of cost over related net Mortgage banking: Mortgage loans held for sale 17,756 17,593 Mortgage loans held for long-term Total assets $ 411,294 $ 386,833 Accounts payable and other liabilities $ 47,019 $ 39,405 Notes payable, senior and convertible debt 216,267 198,814 Deferred income taxes 2,742 2,048 Mortgage banking: Issued - None -- -- Common stock, $.01 par value: Issued - 7,080,900 shares 71 71 Treasury stock, at cost - 130,685 and Capital in excess of par value 59,610 59,610 Total stockholders' equity 120,556 110,479 equity $ 411,294 $ 386,833 The accompanying notes to consolidated financial statements are an integral part of these unaudited consolidated balance sheets. CONTINENTAL HOMES HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Cash flows from operating activities: Net income $ 10,539 $ 7,608 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,649 1,325 Increase (decrease) in deferred income taxes 694 (637) Homes, lots and improvements in production (18,404) (45,590) Prepaid expenses and other assets (894) (6,544) Accounts payable and other liabilities 6,652 (2,006) Net cash provided (used) by operating activities 2,302 (35,332) Cash flows from investing activities: Net additions of property and equipment (371) (310) Cash paid for Heftler Realty Co., net of cash acquired -- (15,498) Net cash used by investing activities (371) (15,808) Cash flows from financing activities: Increase (decrease) in notes payable to financial Retirement of bonds payable (789) (2,315) Retirement of Convertible Subordinated Notes (33,250) -- Issuance of Convertible Subordinated Notes 72,475 -- Stock options exercised 230 46 Net cash provided by financing activities 3,966 35,326 Net increase (decrease) in cash 5,897 (15,814) Cash at beginning of period 12,848 28,809 Cash at end of period $ 18,745 $ 12,995 Supplemental disclosures of cash flow information: Cash paid during the period for: Interest, net of amounts capitalized $ 4,029 $ 3,502 Income taxes $ 6,495 $ 7,218 Supplemental schedule of non-cash investing and financing activities: On November 18, 1994, the Company acquired Heftler Realty Co. As a result of the acquisition, the Company recorded additional assets of $51,116,000 (primarily homes, lots and improvements in production) and liabilities of $22,616,000 (primarily notes payable to financial institutions). The accompanying notes to consolidated financial statements are an integral part of these unaudited consolidated statements. CONTINENTAL HOMES HOLDING CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Basis of Presentation The consolidated financial statements include the accounts of Continental Homes Holding Corp. and its subsidiaries ("Company"). In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the Company's financial position, results of operations and cash flows for the periods presented. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the related disclosures contained in the Company's annual report on Form 10-K for the year ended May 31, 1995, filed with the Securities and Exchange Commission. The results of operations for the three and six months ended November 30, 1995 are not necessarily indicative of the results to be expected for the full year. The Company follows the practice of capitalizing for its homebuilding operations certain interest costs incurred on land under development and homes under construction. Such capitalized interest is included in cost of home sales when the units are delivered. The Company capitalized such interest in the amount of $8,101,000 and $6,211,000 and expensed as a component of cost of goods sold $7,594,000 and $4,806,000 in the six months ended November 30, 1995 and 1994, respectively. CONTINENTAL HOMES HOLDING CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 3. Notes Payable, Senior and Convertible Subordinated Debt Notes payable, senior and convertible subordinated debt for homebuilding consist of: 12% senior notes, due 1999, net of premium of $1,267 and $1,430 $ 111,267 $ 111,430 due 2002, net of discount of $-0- (1) On November 30, 1995 the Company deposited funds with the trustee in satisfaction of the 6-7/8% convertible subordinated notes, due 2002. The notes were redeemed on December 11, 1995. In connection with the redemption of the notes, the Company will record, in the third quarter of fiscal 1996, an extraordinary loss, net of taxes of approximately $859,000 due to the write-off of unamortized discount and debt issuance costs. The summary of the components of interest, net is as follows: Three months ended Six months ended homebuilding ................. $ 1,427 $ 1,367 $ 2,661 $ 2,454 homebuilding ................. (122) (59) (207) (208) $ 1,305 $ 1,308 $ 2,454 $ 2,246 banking ...................... $ 644 $ 532 $ 1,368 $ 1,048 banking ...................... (665) (648) (1,334) (1,337) $ (21) $ (116) $ 34 $ (289) Note 5. Acquisition of Heftler Realty Co. (the "Acquisition") On November 18, 1994, the Company completed the acquisition of 100% of the Common Stock of Heftler Realty Co. ("Heftler"), a Miami, Florida homebuilder, for $29.2 million in cash. The acquisition was accounted for by the results of operations of Heftler included beginning November 1, 1994. The excess of cost over related net assets acquired is being amortized over ten years using the straight-line method. The following unaudited pro forma combined financial data give effect to the Aquisition as if it had occurred on the first day of the period. This pro forma information has been prepared utilizing the historical consolidated financial statements of the Company and Heftler. The pro forma financial data is provided for comparative purposes only and does not purport to be indicative of the results which would have been obtained if the Acquisition had been effected during the period presented. The pro forma financial information is based on the purchase method of accounting for the Acquisition and reflects adjustments to record the profit of acquired inventories, amortize the excess purchase price over the underlying value of net assets acquired, record the additional interest on acquisition indebtedness assumed and adjust income taxes for the pro forma adjustments. Earnings per common share 1.05 CONTINENTAL HOMES HOLDING CORP. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND The following table sets forth, for the periods indicated, unit activity, average sales price and revenue from home sales for the Company: Quarters ended Six months ended Units delivered 1,028 734 2,057 1,560 Average sales price $ 131,696 $ 131,022 $ 130,447 $ 129,019 sales (000's) $ 135,384 $ 96,170 $ 268,330 $ 201,270 from prior year 40.8% 9.7% 33.3% 22.3% Change due to volume 40.1% (.5)% 31.9% 10.7% sales price .7% 10.2% 1.4% 11.6% The volume increase in the quarter and six months ended November 30, 1995 compared to the same periods during fiscal 1995 resulted from improved sales in each market during the fourth quarter of fiscal 1995 and the first quarter of fiscal 1996. The Company believes that relatively low interest rates and the economic strength in certain of its markets contributed to improved sales. The following table summarizes information related to the Company's backlog at the dates indicated: Phoenix 937 $117,972 617 $ 80,021 Texas 421 46,539 278 30,157 South Florida 116 16,738 109 14,991 Denver 130 27,284 91 16,644 Southern California 88 21,401 50 14,096 Total backlog 1,692 $229,934 1,145 $155,909 Average price per unit $ 136 $ 136 The increase in backlog at November 30, 1995 resulted from improved sales in each individual market during the six months ended November 30, 1995. The aggregate sales value of new contracts signed increased 56% in the six months ended November 30, 1995 as a result of the aforementioned improved sales to $294,769,000 representing 2,256 homes (including $14,317,000 in South Florida representing 103 homes) as compared with $188,771,000 representing 1,437 homes (including $1,133,000 in South Florida representing 7 homes) for the six months ended November 30, 1994. Sales in South Florida were included from November 1, 1994. Gross profit from homes sales was 18.4% for the three months ended November 30, 1995 compared to 17.8% for the corresponding fiscal 1995 period. Gross profit from home sales was 18.4% for the six months ended November 30, 1995 compared to 18.2% for the six months ended November 30, 1994. In connection with the acquisitions in Texas and South Florida, the Company capitalized a portion of the purchase price and includes such capitalized purchase price in the cost of homes sales when the related units are delivered (purchase accounting adjustments). Gross profits from home sales, exclusive of purchase accounting adjustments were 18.5% and 18.5% for the quarter and six months ended November 30, 1995, respectively, compared to 18.4% and 18.7% for the quarter and six months ended November 30, 1994, respectively. The increase in total SG&A expense for the quarter and six months ended November 30, 1995 compared to the quarter and six months ended November 30, 1994 was due to the addition of the South Florida operations during the second quarter of fiscal 1995. The first six months of fiscal 1996 included $1,485,000 of SG&A expenses from South Florida compared with $362,000 during the first six months of fiscal 1995. Additionally, the Company experienced higher variable marketing costs (sales commissions, advertising and model furniture amortization) due to the increase in the number of homes delivered, higher salaries, and higher customer service costs. SG&A expenses for each home delivered were $14,661 and $14,560 in the second quarter of fiscal 1996 and 1995, respectively and $14,598 and $13,978 in the first six months of fiscal 1996 and 1995, respectively. The Company capitalizes certain SG&A expenses for homebuilding. Accordingly, total SG&A costs incurred for homebuilding were $16,861,000 and $33,841,000 for the three and six months ended November 30, 1995 compared to $12,057,000 and $24,717,000 for the corresponding fiscal 1995 period. The Company capitalizes certain interest costs for its homebuilding operations and includes such capitalized interest in cost of home sales when the related units are delivered. Accordingly, total interest incurred by the Company was $5,447,000 and $10,762,000 for the three and six months ended November 30, 1995 respectively compared to $4,356,000 and $8,665,000 for the three and six months ended November 30, 1994, respectively. Interest, net for homebuilding was $1,305,000 and $1,308,000 for the three months ended November 30, 1995 and 1994, respectively. For the six month period ended November 30, 1995, interest, net for homebuilding was $2,454,000 compared with $2,246,000 for the six months ended November 30, 1994. The increase in interest incurred for the quarter and the six months ended November 30, 1995 compared to the same periods of the previous year, was due to higher debt levels which resulted primarily from the Heftler acquisition. The Company's pre-tax profit from homebuilding for the six months ended November 30, 1995 was $16,991,000 compared to $12,575,000 for the corresponding period ended November 30, 1994. Pre-tax profit increased in the first six months of fiscal 1996 due primarily to improved results in Texas and Southern California partially offset by a decline in Phoenix results and the negative impact from the inclusion of South Florida results. South Florida's pre-tax loss was caused by weather related delays in the opening of a new subdivision and delays in the municipalities issuing permits. These delays resulted in fewer deliveries from South Florida through October 1995. The Company's mortgage banking operations are conducted through its wholly-owned subsidiary CH Mortgage Company ("CHMC"). The following table summarizes operating information for the Company's mortgage banking operations: Quarters ended Six months ended Number of loans originated 685 468 1,361 1,016 Loan origination fees $ 641 $ 448 $ 1,286 $ 965 marketing gains 1,225 645 2,478 1,445 Other revenue 44 156 205 319 Total revenues 1,910 1,249 3,969 2,729 expenses 1,261 1,090 2,696 2,291 mortgage banking 649 159 1,273 438 Interest, net (21) (116) 38 (289) mortgage banking $ 670 $ 275 $ 1,235 $ 727 Revenues and general and administrative expenses from mortgage banking increased in the quarter and six months ended November 30, 1995 primarily as a result of an increase in the percentage of Phoenix and Texas homebuyers utilizing the Company's mortgage banking operations. Additionally, revenues increased due to higher servicing release premiums received on the sale of servicing. The Company sold approximately $47,705,000 in servicing rights from the servicing portfolio, which amount represents the majority of the portfolio, in January 1996. Net income was $10,539,000 ($1.52 per share, $1.30 fully diluted) for the six months ended November 30, 1995 compared to $7,608,000 ($1.09 per share, $.99 fully diluted) for the period ended November 30, 1994. The Company's financing needs depend primarily upon sales volume, asset turnover, land acquisition and inventory balances. The Company has financed, and expects to continue to finance, its working capital needs through funds generated by operations and borrowings. Funds for future land acquisitions and construction costs are expected to be provided primarily by cash flows from operations and future borrowings as permitted under the 12% Senior Note Indenture. At November 30, 1995, the Company had unsecured lines of credit from two lenders for aggregate borrowings (excluding mortgage warehouse lines) of up to $20,000,000, guaranteed a $10,000,000 secured line of credit for one of its subsidiaries and, subject to available collateral, a $5,000,000 revolving purchase money line. Additionally, the Company assumed $55 million of credit facilities ($15 million of which are unsecured) in connection with the Texas and Florida acquisitions. At November 30, 1995, there was $30,000,000 outstanding in the aggregate under these credit lines. The Company's revolving lines of credit bear interest at rates ranging from LIBOR plus 2-1/4% to prime plus 1%. The Company believes that amounts generated from operations and such additional borrowings will provide funds adequate to finance its homebuilding activities and meet its debt service requirements. The Company does not have any significant current commitments for capital expenditures. CHMC has a warehouse line of credit for $25,000,000 which is guaranteed by the Company. Pursuant to the warehouse line of credit, the Company issues drafts to fund its mortgage loans. The amount represented by a draft is drawn on the warehouse line of credit when the draft is presented for payment. At November 30, 1995, the amount outstanding under the warehouse line of credit and the amount of funding drafts that had not been presented for payment was $6,379,000. The Company believes that this line is sufficient for its mortgage banking operations. On November 18, 1994, the Company acquired all of the outstanding capital stock of Heftler for $29.2 million in cash. On September 19, 1995, the Company entered into an agreement with Kathleen and Robert Wade (the "Wades"), former Co-Chief Executive Officer and President, respectively, whereby the Company has a right to buy and the Wades have the right to sell, from now until January 19, 1996, up to 488,000 shares of the Wades' Continental Homes Holding Corp. Common Stock at $20.50 per share. In January 1996, the Company agreed to allow the Wades to sell a portion of the 488,000 shares at a price per share above $20.50 and to cancel the Company's rights to buy such shares. In consideration therefore, the Wades agreed to cancel their right to sell such shares to the Company and to deliver to the Company 50% of the excess over $20.50 received by the Wades for each share sold. On November 10, 1995, the Company completed the sale of $75,000,000 principal amount of its 6-7/8% Convertible Subordinated Notes due November 2002. On December 5, 1995 the Company sold an additional $11,250,000 of such notes. The net proceeds were used as follows: (i) approximately $33,250,000 was used to redeem the Company's 6-7/8% Convertible Subordinated Notes due March 2002, (ii) approximately $33,156,000 was used to reduce temporarily outstanding amounts under certain of the Company's revolving lines of credit which were incurred for working capital purposes, and (iii) approximately $6,631,000 was used to reduce temporarily outstanding amounts under the Company's warehouse line of credit. In connection with the redemption of the notes, the Company will record, in the third quarter of fiscal 1996, an extraordinary loss, net of taxes of approximately $859,000 due to the write-off of unamortized discount and debt issuance costs. The Convertible Notes are immediately convertible into shares of the Company's common stock at a rate of 42.105 shares for each $1,000 principal amount of Convertible Notes. CONTINENTAL HOMES HOLDING CORP. AND SUBSIDIARIES Item 6. Exhibits and Reports on Form 8-K 4.1 Indenture dated as of November 1, 1995 between the Company and Manufacturers and Traders Trust Company, as Trustee. 10.1 Modification Agreement dated as of December 1, 1995 between Bank One, Arizona NA ("BOAZ") and CHMC. 10.2 Amended and Restated Replacement Revolving Line of Credit Promissory Note by CHMC in favor of BOAZ in the principal amount of $25,000,000. 10.3 Sixth Modification Agreement dated November 26, 1995 between BOAZ and Milburn Investments, Inc. 10.4 Amended and Restated Loan Agreement dated November 30, 1995 between BOAZ and the Company. 10.5 Amended and Restated Promissory Note dated November 30, 1995 by the Company in favor of BOAZ in the principal amount of $15,000,000. 11.0 Statement Re Computation of Per Share Earnings. (b) Reports on Form 8-K: There were no reports on Form 8-K filed for the three months ended November 30, 1995. CONTINENTAL HOMES HOLDING CORP. AND SUBSIDIARIES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: January 11, 1996 By: /s/ Kenda B. Gonzales Date: January 11, 1996 By: /s/ Donald R. Loback 4.1 Indenture dated as of November 1, 1995 between the Company and Company, as Trustee. 10.1 Modification Agreement dated as of December 1, 1995 between Bank One, Arizona NA ("BOAZ") and CHMC. 10.2 Amended and Restated Replacement Revolving Line of Credit Promissory Note by CHMC in favor of BOAZ in $25,000,000. 10.3 Sixth Modification Agreement dated November 26, 1995 between BOAZ and Milburn Investments, Inc. 10.4 Amended and Restated Loan Agreement dated November 30, 1995 between BOAZ and the Company. 10.5 Amended and Restated Promissory Note dated November 30, 1995 by the Company in favor of BOAZ in the principal amount of $15,000,000. 11.0 Statement Re Computation of Per Share Earnings.	10-Q	10-Q	1996-01-12T00:00:00	1996-01-12T16:40:21
0000711402-96-000007	0000711402-96-000007_0000.txt	VOTE BY PHONE CONFIRMATION LETTER (Shareholder name & address of record) PUTNAM CALIFORNIA INTERMEDIATE TAX EXEMPT FUND Meeting of Shareholders March 7, 1996 Account: Shares: Votes Received: (list proposal as on proxy card) In connection with the above-referenced Meeting of Shareholders, this notice will confirm that your shares have been voted as indicated above in accordance with your telephone instructions. If any of the information is incorrect, please call 1-800-735- 3428 immediately, and in any event no later than 5:00 P.M. Eastern Daylight Time, on March 6, 1996. Thank you for your cooperation. Putnam California Intermediate Tax Exempt Fund This script provides information to the shareholder and solicits their vote by phone, to be confirmed by written confirmation. Good Morning/Afternoon/Evening. May I please speak with (name of shareholder)? I am representing Putnam Investments in Boston. I am calling in connection with the upcoming shareholder meeting for Putnam California Intermediate Tax Exempt Fund. To verify that I am speaking with the shareholder of record, may I confirm that you are (name of shareholder of record) and that your address of record is (address of record)? (If the person is unwilling to confirm this information, thank them for their time and terminate the call.) We noted that we have not yet received your proxy card. Do you have any questions regarding the proposal being presented at the meeting that I can clarify for you? (If there are questions regarding the proposal, please refer to the Q & A attached.) Would you like to vote by phone? (If not, ask the shareholder if they would like another proxy card, thank them for their time and terminate the call. If so, We previously sent you a letter describing our procedures for voting your shares by telephone. I will now paraphrase the proxy card so that you can provide us with your voting instructions. The proxy card generally states the following: By authorizing your shares to be voted at the meeting you are approving George Putnam, Hans H. Estin, and Robert E. Patterson, and each of them separately, proxies, with power of substitution, and authorizing them to represent and vote your shares, at the meeting of shareholders of Putnam California Intermediate Tax Exempt Fund, on March 7, 1996, at 2:00 p.m., Boston time, and at any adjournments thereof. When properly authorized, this proxy will be voted in the manner directed by the shareholder. In their discretion, the proxies are authorized to vote upon such other matters as may properly come before the meeting. The proxy card requests your vote on the following proposal, for which the Trustees are recommending a vote in favor. That proposal is to: Approve an Agreement and Plan of Reorganization providing for the transfer of all of the assets of Putnam California Intermediate Tax Exempt Fund (which we'll call the "Intermediate Fund") to Putnam California Tax Exempt Income Fund (which we'll call the "Income Fund") in exchange for shares of the Income Fund and the assumption by the Income Fund of all of the liabilities of the Intermediate Fund, and the distribution of such shares to the shareholders of the Intermediate Fund in complete liquidation of the Intermediate Fund. How would you like to vote on this proposal? Would you like to vote for the proposal, against the proposal, or would you like to abstain from voting on this proposal? I will now repeat your instructions: You voted: (For, Against, Abstained from) the proposal to approve the Agreement and Plan of Reorganization. Thank you. We will be sending you a written confirmation of your vote. Please call us if the information on the confirmation is incorrect. Q&A FOR PUTNAM CALIFORNIA INTERMEDIATE TAX EXEMPT FUND On approximately December 29, 1995, a proxy statement was sent to shareholders of Putnam California Intermediate Tax Exempt Fund. Listed below are answers to the questions and concerns shareholders are likely to have regarding the merger proposal for this fund, followed by answers and information regarding each issue. 1. WHAT IS BEING PROPOSED? The Trustees of the Trust have approved the merger of your fund, Putnam California Intermediate Tax Exempt Fund, into Putnam California Tax Exempt Income Fund. The merger provides for the transfer of all of the assets of your fund to Putnam California Tax Exempt Income Fund in exchange for shares of that fund. It also provides for the assumption by Putnam California Tax Exempt Income Fund of all of the liabilities of your fund. The merger will result in the liquidation of your fund, followed by the distribution of Putnam California Tax Exempt Income Fund shares to Putnam California Intermediate Tax Exempt Fund shareholders. 2. WHAT WILL HAPPEN TO MY SHARES OF THE PUTNAM CALIFORNIA INTERMEDIATE TAX EXEMPT FUND? If the merger is approved, your shares will, in effect, be exchanged at net asset value and on a tax-free basis for shares of Putnam California Tax Exempt Income Fund. 3. WHEN WOULD THE MERGER OCCUR? If approved by the shareholders at their March 7, 1996 meeting, it is expected that the merger would occur as soon as possible after that time. 4. WHY ARE THE TRUSTEES PROPOSING THE MERGER? The Trustees of the Trust recommend approval of the merger (i) the merger offers shareholders of the Putnam California Intermediate Tax Exempt Fund an opportunity to pursue similar investment objectives in a significantly larger fund with greater economies of scale that may result in lower expenses over the longer-term, and (ii) the merger offers shareholders the option of owning shares of a mutual fund with greater investment flexibility, given the substantial asset size of Putnam California Tax Exempt Income Fund. 5. HOW DO THE INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS OF THE TWO FUNDS COMPARE? While the merger would combine two funds with very similar overall investment strategies, Putnam California Tax Exempt Income Fund can be expected to have a higher portfolio dollar- weighted average maturity and duration. Both funds seek a high level of current income exempt from federal income tax and California personal income tax. The proxy statement contains a detailed comparison of the investment policies and risks associated with investments in Putnam California Tax Exempt Income Fund. 6. HOW DO THE RISKS OF INVESTING IN THE FUNDS COMPARE? As discussed in the prospectus/proxy statement, because the funds share similar investment objectives and policies, the risks of an investment in each fund are similar, except that the investments in longer-term fixed income securities of the Putnam California Tax Exempt Income Fund increases sensitivity to changes in interest rates, and the Putnam California Tax Exempt Income Fund currently holds slightly larger investments in securities rated below investment-grade. These lower-rated securities made up 6.35% of that fund's portfolio as of September 30, 1995, while as of that date Putnam California Intermediate Tax Exempt Fund had no investments in such securities. 7. HOW DO THE MANAGEMENT FEES AND OTHER EXPENSES OF THE TWO FUNDS COMPARE, AND WHAT ARE THEY ESTIMATED TO BE FOLLOWING THE MERGER? As shown in the table in the proxy statement, although the funds currently have identical management fee schedules, the Putnam California Intermediate Tax Exempt Fund did not pay management fees for the past fiscal year due to a voluntary expense limitation currently in effect. In addition, Putnam Management assumed certain of the Putnam California Intermediate Tax Exempt Fund's other expenses pursuant to this voluntary expense limitation. In the absence of this expense limitation, management fees and other expenses for the Putnam California Intermediate Tax Exempt Fund would be significantly higher than the corresponding expenses for the Putnam California Tax Exempt Income Fund. This difference in expense levels results largely from the relative sizes of the two funds. 8. ARE THERE ANY FEDERAL INCOME TAX CONSEQUENCES AS A RESULT OF THE PROPOSED MERGER? No. As a result of the merger, no gain or loss will be recognized by the Putnam California Intermediate Tax Exempt Fund or its shareholders for federal income tax purposes. 9. DO THE DISTRIBUTION POLICIES OF THE TWO FUNDS DIFFER? No. Each of the Funds distributes any net investment income at least monthly and any net realized capital gains at least annually. (If shareholder holds certificated shares, add the following: Putnam California Tax Exempt Income Fund will not permit any Putnam California Intermediate Tax Exempt Fund shareholder holding certificates for Putnam California Intermediate Tax Exempt Fund shares at the time of the merger to receive cash dividends or other distributions, receive certificates for Merger Shares, exchange Merger Shares for shares of other investment companies managed by Putnam Management, or pledge or redeem Merger Shares until those certificates for Putnam California Intermediate Tax Exempt Fund shares have been surrendered, or, in the case of lost certificates, an adequate surety bond has been posted. If a shareholder is not for that reason permitted to receive cash dividends or other distributions on Merger Shares, the Putnam California Tax Exempt Income Fund will pay all such dividends and distributions in additional shares, notwithstanding any election the shareholder may have made previously to receive dividends and distributions on Putnam California Intermediate Tax Exempt Fund shares in cash.) 10. DO THE PROCEDURES FOR PURCHASING, REDEEMING AND EXCHANGING SHARES OF THE TWO FUNDS DIFFER? No. The procedures for purchasing and redeeming shares of Putnam California Intermediate Tax Exempt Fund and shares of Putnam California Tax Exempt Income Fund, and for exchanging such shares of each fund for shares of other Putnam funds, are identical. The funds have different front-end sales charges, contingent deferred sales charge schedules and distribution fees. Putnam California Intermediate Tax Exempt Fund currently offers two classes of shares and Putnam California Tax Exempt Income Fund currently offers three classes of shares. Shares of both funds may be purchased either through investment dealers which have sales agreements with Putnam Mutual Funds Corp. or directly through Putnam Mutual Funds at prices based on net asset value, plus varying sales charges, depending on the class and number of shares purchased. Reinvestment of distributions by the funds are made at net asset value for all classes of shares. Any day the New York Stock Exchange is open, shares of both funds may be redeemed at net asset value, either directly to a fund or through an investment dealer. After a ten-day holding period, shares of either fund may be exchanged for shares of the same class of certain other Putnam Funds. 11. WILL THE NUMBER OF SHARES I OWN CHANGE? Yes, but the total value of the shares of the Putnam California Tax Exempt Income Fund you receive will be equal in value to the total value of the shares of the Putnam California Intermediate Tax Exempt Fund that you hold at the time of the merger. Even though the net asset value per share of each fund is different, the total value of a shareholder's holdings will not change as a result of the merger. 12. HOW WILL I BE NOTIFIED OF THE OUTCOME OF THE MERGER? If the proposed merger is approved by shareholders, you will receive confirmation after the reorganization is completed, indicating your new account number. If the merger is not approved, shareholders will be notified, and the results of the meeting will be provided in the next annual report of the Putnam California Intermediate Tax Exempt Fund. You will continue to own shares of the Fund and receive statements regarding your account.	DEFA14A	DEFA14A	1996-01-12T00:00:00	1996-01-12T16:39:37
0000065103-96-000003	0000065103-96-000003_0000.txt	Under the Securities Exchange Act of 1934 (Title of Class of Securities) Check the following box if a fee is being paid with this statement.[X] (A fee is not required only if the filing person: (1) has a previous statement on file reporting beneficial ownership of more than five percent of the class of securities described in Item 1; and (2) has filed no amendment subsequent thereto reporting beneficial ownership of five percent or less of such class.) (See Rule 13d-7). The remainder of this cover page shall be filled out for a reporting person's initial filing on this form with respect to the subject class of securities, and for any subsequent amendment containing information which would alter the disclosures provided in a prior cover page. The information required in the remainder of this cover page shall not be deemed to be "filed" for the purpose of Section 18 of the Securities Exchange Act of 1934 ("Act") or otherwise subject to the liabilities of that section of the Act but shall be subject to all other provisions of the Act (however, see the Notes). 1. NAME OF REPORTING PERSON S.S. or I.R.S. IDENTIFICATION NO. OF ABOVE PERSON Merrill Lynch & Co., Inc. 2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP Joint Filing 4. CITIZENSHIP OR PLACE OF ORGANIZATION NUMBER OF SHARES BENEFICIALLY OWNED BY EACH REPORTING PERSON WITH 9. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 10. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (9) EXCLUDES CERTAIN SHARES* 11. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW 9 12. TYPE OF REPORTING PERSON* SEE INSTRUCTION BEFORE FILING OUT! 1. NAME OF REPORTING PERSON S.S. or I.R.S. IDENTIFICATION NO. OF ABOVE PERSON 2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP Joint Filing 4. CITIZENSHIP OR PLACE OF ORGANIZATION NUMBER OF SHARES BENEFICIALLY OWNED BY EACH REPORTING PERSON WITH 9. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 10. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (9) EXCLUDES CERTAIN SHARES* 11. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW 9 12. TYPE OF REPORTING PERSON* SEE INSTRUCTION BEFORE FILING OUT! 1. NAME OF REPORTING PERSON S.S. or I.R.S. IDENTIFICATION NO. OF ABOVE PERSON 2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP Joint Filing 4. CITIZENSHIP OR PLACE OF ORGANIZATION NUMBER OF SHARES BENEFICIALLY OWNED BY EACH REPORTING PERSON WITH 9. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 10. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (9) EXCLUDES CERTAIN SHARES* 11. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW 9 12. TYPE OF REPORTING PERSON* SEE INSTRUCTION BEFORE FILING OUT! 1. NAME OF REPORTING PERSON S.S. or I.R.S. IDENTIFICATION NO. OF ABOVE PERSON Merrill Lynch Asset Management, L.P. 2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP Joint Filing 4. CITIZENSHIP OR PLACE OF ORGANIZATION NUMBER OF SHARES BENEFICIALLY OWNED BY EACH REPORTING PERSON WITH 9. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 10. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (9) EXCLUDES CERTAIN SHARES* 11. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW 9 12. TYPE OF REPORTING PERSON* SEE INSTRUCTION BEFORE FILING OUT! 1. NAME OF REPORTING PERSON S.S. or I.R.S. IDENTIFICATION NO. OF ABOVE PERSON Merrill Lynch Growth Fund for Investment & Retirement 2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP Joint Filing 4. CITIZENSHIP OR PLACE OF ORGANIZATION NUMBER OF SHARES BENEFICIALLY OWNED BY EACH REPORTING PERSON WITH 9. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 10. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (9) EXCLUDES CERTAIN SHARES* 11. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW 9 12. TYPE OF REPORTING PERSON* SEE INSTRUCTION BEFORE FILING OUT! ITEM 1 (a) Name of Issuer: ITEM 1 (b) Address of Issuer's Principal Executive Offices: 363 North Sam Houston Parkway East ITEM 2 (a) Name of Persons Filing: Merrill Lynch & Co., Inc. Merrill Lynch Group, Inc.. Princeton Services, Inc. Merrill Lynch Asset Management, L.P. Merrill Lynch Growth Fund for Investment & Retirement ITEM 2 (b) Address of Principal Business Office or, if none, Residence: Merrill Lynch & Co., Inc. World Financial Center, North Tower New York, New York 10281 World Financial Center, North Tower New York, New York 10281 Merrill Lynch Asset Management, L.P. Merrill Lynch Growth Fund for Investment & Retirement See Item 4 of Cover Pages ITEM 2 (d) Title of Class of Securities: ITEM 2 (e) CUSIP NUMBER: Merrill Lynch & Co., Inc. ("ML&Co."), Merrill Lynch Group, Inc. ("ML Group") and Princeton Services, Inc. ("PSI") are parent holding companies, in accordance with (S) 240.13d-1(b) (ii) (G). Merrill Lynch Asset Management, L.P. (d/b/a) Merrill Lynch Asset Management ("MLAM") is an investment adviser registered under (S) 203 of the Investment Advisers Act of 1940. Merrill Lynch Growth Fund for Investment & Retirement (the "Fund") is an investment company registered under Section 8 of the Investment Company Act of 1940. See Item 9 of Cover Pages. Pursuant to (S) 240.13d-4, ML&Co., ML Group, PSI and MLAM (the "Reporting Persons") disclaim beneficial ownership of the securities of Autodesk, Inc. (the "Company") referred to herein, and the filing of this Schedule 13G shall not be construed as an admission that the Reporting Persons are, for the purposes of Section 13(d) or 13(g) of the Securities Exchange Act of 1934, the beneficial owner of any securities of the Company covered by this statement. See Item 11 of Cover Pages (c) Number of shares as to which such person has: (i) sole power to vote or to direct the vote: See Item 5 of Cover Pages (ii) shared power to vote or to direct the vote: See Item 6 of the Cover Pages (iii) sole power to dispose of or to direct the disposition of: See Item 7 of Cover Pages (iv) share power to dispose of or direct the disposition of: See Item 8 of Cover Pages ITEM 5 Ownership of Five Percent or Less of a Class. ITEM 6 Ownership of More than Five Percent on Behalf of Another Person. MLAM is an investment adviser registered under Section 203 of the Investment Advisers Act of 1940 and acts as an investment adviser to investment companies registered under Section 8 of the Investment Company Act of 1940. With respect to securities held by those investment companies, several persons have the right to receive, or the power to direct the receipt of dividends from or the proceeds from the sale of, such securities. Merrill Lynch Growth Fund for Investment & Retirement, Inc., a reporting person on this Schedule 13G for which MLAM serves as investment adviser, has an interest that relates to more than 5% of the class of securities reported herein. No other person has an interest that relates to more than 5% of the class of securities reported herein. ITEM 7 Identification and Classification of the Subsidiary Which Acquired the Security Being Reported on by the Parent Holding Company. ITEM 8 Identification and Classification of Members of the Group. ITEM 9 Notice of Dissolution of Group. By signing below each of the undersigned certifies that, to the best of their knowledge and belief, the securities referred to above were acquired in the ordinary course of business and were not acquired for the purpose of and do not have the effect of changing or influencing the control of the issuer of such securities and were not acquired in connection with or as a participant in any transaction having such purpose or effect. After reasonable inquiry and to the best of my knowledge and belief, each of the undersigned certifies that the information set forth in this statement is true, complete and correct. Merrill Lynch & Co, Inc. Signed pursuant to a power of attorney, dated November 17, 1995, included as Exhibit B to this Schedule 13G. Signed pursuant to a power of attorney, dated November 17, 1995, included as Exhibit C to this Schedule 13G. * Signed pursuant to a power of attorney, dated November 30, 1995, included as Exhibit D to this Schedule 13G. Merrill Lynch Asset Management, L.P. By: Princeton Services, Inc. (General Partner) Merrill Lynch Growth Fund for Investment & Retirement ** Signed pursuant to a power of attorney, dated November 30, 1995, included as Exhibit E to this Schedule 13G. *** Signed pursuant to a power of attorney, dated November 22, 1995, included as Exhibit F to this Schedule 13G. EXHIBIT A TO SCHEDULE 13G ITEM 7 DISCLOSURE RESPECTING SUBSIDIARIES Three of the persons filing this report, Merrill Lynch & Co., Inc., a Delaware corporation with its principal place of business at World Financial Center, North Tower, 250 Vesey Street, New York, New York ("ML&Co."), Merrill Lynch Group, Inc., a Delaware corporation with its principal place of business at World Financial Center, North Tower, 250 Vesey Street, New York, New York ("ML Group"), and Princeton Services, Inc. a Delaware corporation with its principal place of business at 800 Scudders Mill Road, Plainsboro, New Jersey, ("PSI") are parent holding companies pursuant to (S)240 13d-1(b) (1) (ii) (G). The relevant subsidiaries of Merrill Lynch & Co. are ML Group and PSI, which is the general partner of Merrill Lynch Asset Management, L.P. (d/b/a) Merrill Lynch Asset Management ("MLAM"). The relevant subsidiary of Merrill Lynch Group is PSI. ML Group, a wholly-owned direct subsidiary of ML&Co., may be deemed to be the beneficial owner of 11.6% of the common stock of Newfield Exploration Co. (the "Company") by virtue of its control of its wholly-owned subsidiary, PSI. PSI, a wholly-owned direct subsidiary of ML Group, may be deemed to be the beneficial owner of 11.6% of the common stock of the Company by virtue of its being the general partner of MLAM. MLAM, a Delaware limited partnership with its principal place of business at 800 Scudders Mill Road, Plainsboro, New Jersey, is an investment adviser registered under Section 203 of the Investment Advisers Act of 1940. MLAM may be deemed to be the beneficial owner of 11.6% of the common stock of the Company by virtue of its acting as investment adviser to several investment companies registered under Section 8 of the Investment Company Act of 1940. One registered investment company advised by MLAM, Merrill Lynch Growth Fund for Investment and Retirement (the "Fund"), is the beneficial owner of 11.6% of the common stock of the Company. Pursuant to (S)240.13d-4, ML & Co., ML Group, PSI, MLAM and the Fund disclaim beneficial ownership of the securities of the Company, and the filing of this Schedule 13G shall not be construed as an admission that any such entity is, for the purposes of Section 13(d) or 13(g) of the Securities Exchange Act of 1934, the beneficial owner of any securities of the Company. The undersigned, Merrill Lynch & Co., Inc. (the "Corporation"), a corporation duly organized under the laws of the State of Delaware, with its principal place of business at World Financial Center, North Tower, New York, New York, 10281, does hereby make, constitute and appoint Richard B. Alsop, Richard D. Kreuder, Andrea Lowenthal, Gregory T. Russo, or any other individual from time to time elected or appointed as Secretary or an Assistant Secretary of the Corporation, acting severally, each of whose address is Merrill Lynch & Co., Inc., World Financial Center, North Tower, New York, New York 10281, as its true and lawful attorneys-in-fact, for it and in its name, place and stead (i) to execute on behalf of the Corporation and cause to be filed and/or delivered, as required under Section 13(d) of the Securities Exchange Act of 1934 (the "Act") and the regulations thereunder, any number, as appropriate, of original, copies, or electronic filings of the Securities and Exchange Commission Schedule 13D or Schedule 13G Beneficial Ownership Reports (together with any amendments and joint filing agreements under Rule 13d-1(f)(1) of the Act, as may be required thereto) to be filed and/or delivered with respect to any equity security (as defined in Rule 13d-1(d) under the Act) beneficially owned by the undersigned and which must be reported by the undersigned pursuant to Section 13(d) of the Act and the regulations thereunder, (ii) to execute on behalf of the Corporation and cause to be filed and/or delivered, any number, as appropriate, of original copies or electronic filings of any forms (inclu- ding, without limitation, Securities and Exchange Commission Form 3, 4 and 5) required to be filed pursuant to Section 16(a) of the Act and the regulations thereunder, and (iii) generally to take such other actions and perform such other things necessary to effectuate the foregoing as fully in all respects as if the undersigned could do if personally present. This Power of Attorney shall remain in effect until revoked, in writing, by the undersigned. IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney this 17th day of November, 1995. MERRILL LYNCH & CO., INC. By: /s/ David H. Komansky Title: President and Chief Operating Officer The undersigned, Merrill Lynch Group, Inc. (the "Corporation"), a corporation duly organized under the laws of the State of Delaware, with its principal place of business at World Financial Center, North Tower, New York, New York, 10281, does hereby make, constitute and appoint Richard B. Alsop, Richard D. Kreuder, Andrea Lowenthal, Gregory T. Russo, or any other individual from time to time elected or appointed as Secretary or an Assistant Secretary of the Corporation, acting severally, each of whose address is Merrill Lynch & Co., Inc., World Financial Center, North Tower, New York, New York 10281, as its true and lawful attorneys-in-fact, for it and in its name, place and stead (i) to execute on behalf of the Corporation and cause to be filed and/or delivered, as required under Section 13(d) of the Securities Exchange Act of 1934 (the "Act") and the regulations thereunder, any number, as appropriate, of original, copies, or electronic filings of the Securities and Exchange Commission Schedule 13D or Schedule 13G Beneficial Ownership Reports (together with any amendments and joint filing agreements under Rule 13d-1(f)(1) of the Act, as may be required thereto) to be filed and/or delivered with respect to any equity security (as defined in Rule 13d-1(d) under the Act) beneficially owned by the undersigned and which must be reported by the undersigned pursuant to Section 13(d) of the Act and the regulations thereunder, (ii) to execute on behalf of the Corporation and cause to be filed and/or delivered, any number, as appropriate, of original copies or electronic filings of any forms (inclu- ding, without limitation, Securities and Exchange Commission Form 3, 4 and 5) required to be filed pursuant to Section 16(a) of the Act and the regulations thereunder, and (iii) generally to take such other actions and perform such other things necessary to effectuate the foregoing as fully in all respects as if the undersigned could do if personally present. This Power of Attorney shall remain in effect until revoked, in writing, by the undersigned. IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney this 17th day of November, 1995. By: /s/ Rosemary T. Berkery Title: Vice President and Director The undersigned, Princeton Services Inc., a corporation duly organized under the laws of the State of Delaware, with its principal place of business at 800 Scudders Mill Road, Plainsboro, New Jersey 08536 does hereby make, constitute and appoint Richard B. Alsop, Andrea Lowenthal, Richard D. Kreuder, Gregory T. Russo, or Dauna R. Williams, acting severally, each of whose address is Merrill Lynch & Co., Inc., World Financial Center, North Tower, New York, New York 10281, as its true and lawful attorneys-in-fact, for it and in its name, place and stead to execute and cause to be filed and/or delivered, as required under Section 13(d) of the Securities Exchange Act of 1934 (the "Act") and the regulations thereunder, any number, as appropriate, of original, copies, or electronic filings of the Securities and Exchange Commission Schedule 13D or Schedule 13G Beneficial Ownership Reports (together with any amendments and joint filing agreements under Rule 13d-1(f) (1) of the Act, as may be required thereto) to be filed and/or delivered with respect to any equity security (as defined in Rule 13d-1(d) under the Act) beneficially owned by the undersigned and which must be reported by the undersigned pursuant to Section 13(d) of the Act and the regulations thereunder, and generally to take such other actions and perform such other things necessary to effectuate the foregoing as fully in all respects as if the undersigned could do if personally present. This Power of Attorney shall remain in effect until revoked, in writing, by the undersigned. IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney this 30th day of November, 1995. By: /s/ Philip L. Kirstein Title: Director, Senior Vice President The undersigned, Merrill Lynch Asset Management, L.P. d/b/a Merrill Lynch Asset Management, a Limited Partnership duly organized under the laws of the State of Delaware, with its principal place of business at 800 Scudders Mill Road, Plainsboro, New Jersey 08536 does hereby make, constitute and appoint Richard B. Alsop, Andrea Lowenthal, Richard D. Kreuder, Gregory T. Russo, or Dauna R. Williams, acting severally, each of whose address is Merrill Lynch & Co., Inc., World Financial Center, North Tower, New York, New York 10281, as its true and lawful attorneys-in-fact, for it and in its name, place and stead to execute and cause to be filed and/or delivered, as required under Section 13(d) of the Securities Exchange Act of 1934 (the "Act") and the regulations thereunder, any number, as appropriate, of original, copies, or electronic filings of the Securities and Exchange Commission Schedule 13D or Schedule 13G Beneficial Ownership Reports (together with any amendments and joint filing agreements under Rule 13d-1(f) (1) of the Act, as may be required thereto) to be filed and/or delivered with respect to any equity security (as defined in Rule 13d-1(d) under the Act) beneficially owned by the undersigned and which must be reported by the undersigned pursuant to Section 13(d) of the Act and the regulations thereunder, and generally to take such other actions and perform such other things necessary to effectuate the foregoing as fully in all respects as if the undersigned could do if personally present. This Power of Attorney shall remain in effect until revoked, in writing, by the undersigned. IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney this 30th day of November, 1995. Merrill Lynch Asset Management, L.P. d/b/a Merrill Lynch Asset Management By: Princeton Services, Inc., General Partner By: /s/ Philip L. Kirstein Title: Director, Senior Vice President The undersigned, Merrill Lynch Growth Fund for Investment and Retirement, Inc., a corporation dully organized under the laws of the State of Massachusetts, with its principal place of business at 800 Scudders Mill Road, Plainsboro, New Jersey 08536 does hereby make, constitute and appoint Richard B. Alsop, Andrea Lowenthal, Richard D. Kreuder, Gregory T. Russo, or Dauna R. Williams, acting severally, each of whose address is Merrill Lynch & Co., Inc., World Financial Center, North Tower, New York, New York 10281, as its true and lawful attorneys-in-fact, for it and in its name, place and stead to execute and cause to be filed and/or delivered, as required under Section 13(d) of the Securities Exchange Act of 1934 (the "Act") and the regulations thereunder, any number, as appropriate, of original, copies, or electronic filings of the Securities and Exchange Commission Schedule 13D or Schedule 13G Beneficial Ownership Reports (together with any amendments and joint filing agreements under Rule 13d-1(f) (1) of the Act, as may be required thereto) to be filed and/or delivered with respect to any equity security (as defined in Rule 13d-1(d) under the Act) beneficially owned by the undersigned and which must be reported by the undersigned pursuant to Section 13(d) of the Act and the regulations thereunder, and generally to take such other actions and perform such other things necessary to effectuate the foregoing as fully in all respects as if the undersigned could do if personally present. This Power of Attorney shall remain in effect until revoked, in writing, by the undersigned. IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney this 22nd day of November, 1995. MERRILL LYNCH GROWH FUND FOR INVESTMENT AND RETIREMENT, INC.	SC 13G	SC 13G	1996-01-12T00:00:00	1996-01-12T15:24:22
0000912057-96-000420	0000912057-96-000420_0000.txt	As filed with the Securities and Exchange Commission on January 12, 1996 THE SECURITIES ACT OF 1933 (Exact name of registrant as specified in its charter) (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) (Address of Principal Executive Offices) (Zip Code) (Full title of the plan) Chairman, President and Chief Executive Officer Richey Electronics, Inc. (Name, address, including zip code, and telephone number, including area code, (1) Pursuant to Rule 457(h), these prices are estimated solely for the purpose of calculating the registration fee and are based upon the average of the high and low sales prices of the Registrant's Common Stock on NASDAQ on January 10, 1996. There are also registered hereunder such additional indeterminate number of shares as may be issued as a result of the antidilution provisions of the Plan. INFORMATION REQUIRED IN THE SECTION 10(A) PROSPECTUS The documents containing information specified by Part I of this Form S-8 Registration Statement (the "Registration Statement") have been or will be sent or given to participants in the plan listed on the cover of the Registration Statement (the "Plan") as specified in Rule 428(b)(1) promulgated by the Securities and Exchange Commission (the "Commission") under the Securities Act of 1933, as amended (the "Securities Act"). Such documents are not being filed with the Commission but constitute (along with the documents incorporated by reference into the Registration Statement pursuant to Item 3 of Part II hereof), a prospectus that meets the requirements of Section 10(a) of the Securities Act. INFORMATION REQUIRED IN THE REGISTRATION STATEMENT ITEM 3. INCORPORATION OF DOCUMENTS BY REFERENCE The following documents filed with the Commission are incorporated herein by reference: (1) The Annual Report on Form 10-K of Richey Electronics, Inc., a Delaware corporation (the "Company"), for the fiscal year ended December 31, 1994. (2) The Company's Quarterly Reports on Form 10-Q dated March 31, 1995, June 30, 1995 and September 29, 1995. (3) The Company's Current Reports on Form 8-K, dated November 20, 1995 and on Form 8-K dated January 4, 1996. (4) The description of the Common Stock ("Common Stock"), of the Company contained in the Company's Amended Registration Statement on Form 8-A/A. All documents subsequently filed by the Company pursuant to Sections 13(a), 13(c), 14 and 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act"), as amended, prior to termination of the offering of the Common Stock pursuant to this Registration Statement shall be deemed to be incorporated by reference in this Registration Statement and to be a part hereof from the date of the filing of such documents. ITEM 4. DESCRIPTION OF SECURITIES ITEM 5. INTERESTS OF NAMED EXPERTS AND COUNSEL ITEM 6. INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 145 of the Delaware General Corporation Law (the "Delaware Law") generally permits indemnification of officers, directors, employees and agents of a Delaware corporation against expenses (including attorneys' fees) incurred in the defense or settlement of a derivative action or third-party action, provided there is a determination by a disinterested quorum of the directors or independent legal counsel or a majority vote of a quorum of the stockholders that the person seeking indemnification acted in good faith and in a manner reasonably believed to be in or not opposed to the best interests of the corporation and, in the case of a criminal proceeding, had no reasonable cause to believe his or her conduct was unlawful. Such indemnification is expressly prohibited, however, in respect of a derivative action in which such person is adjudged liable for negligence or misconduct in the performance of his or her duty to the corporation unless and only to the extent approved by the court. The Delaware Law requires indemnification when the person being indemnified has successfully defended the action on the merits or otherwise. Expenses incurred by an officer or director in defending an action may be paid in advance, under the Delaware Law, if such director or officer undertakes to repay such amounts if it is ultimately determined that he or she is not entitled to indemnification. In addition, the Delaware Law authorizes a corporation's purchase of indemnity insurance for the benefit of its officers, directors, employees and agents whether or not the corporation would have the power to indemnify against the liability covered by the policy. The Delaware Law permits a Delaware corporation to provide indemnification in excess of that provided in the statutes. The Delaware Law does not require authorizing provisions in the certificate of incorporation and does not contain express prohibitions on indemnification in certain circumstances; limitations on indemnification may be imposed by a court, however, based on principles of public policy. The Bylaws of the Company contain provisions requiring indemnification of directors and officers to the maximum extent permitted by the Delaware Law. ITEM 7. EXEMPTION FROM REGISTRATION CLAIMED 4.1 Certificate of Incorporation of Richey Electronics, Inc. (Incorporated by reference to the Registration Statement on Form S-1, filed January 7, 1994) 4.2 Bylaws of Richey Electronics, Inc. (Incorporated by reference to the Registration Statement on Form S-1, 23.1 Consent of McGladrey & Pullen, LLP (a) The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) To include any prospectus required by section 10(a)(3) of the (ii) To reflect in the prospectus any facts or events arising after the effective date of the Registration Statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration (iii) To include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement; PROVIDED, HOWEVER, that paragraphs (a)(1)(i) and (a)(1)(ii) do not apply if the information required to be included in a post-effective amendment by those paragraphs is contained in periodic reports filed by the registrant pursuant to Section 13 or Section 15(d) of the Exchange Act that are incorporated by reference in the Registration Statement. (2) That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (b) The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act, each filing of the registrant's annual report pursuant to Section 13(a) or Section 15(d) of the Exchange Act (and, where applicable, each filing of an employee benefit plan's annual report pursuant to Section 15(d) of the Exchange Act) that is incorporated by reference in the Registration Statement shall be deemed to be a new Registration Statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (c) Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. Pursuant to the requirements of the Securities Act of 1933, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-8 and has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in the County of Los Angeles, State of California on the date indicated below. Date: January 11, 1996 By: /s/ WILLIAM C. CACCIATORE Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the date indicated. /s/ WILLIAM C. CACCIATORE Chairman of the Board, January 11, 1996 William C. Cacciatore Executive Officer /s/ RICHARD N. BERGER Vice President, Chief January 11, 1996 Richard N. Berger Treasurer and Secretary /s/ C. DON ALVERSON Executive Vice President- January 11, 1996 /s/ NORBERT W. ST. JOHN Executive Vice President- January 11, 1996 /s/ DONALD I. ZIMMERMAN Director January 11, 1996 4.1 Certificate of Incorporation of Richey Electronics, Inc. (Incorporated by reference to the Registration Statement on Form S-1, filed January 7, 1994) 4.2 Bylaws of Richey Electronics, Inc. (Incorporated by reference to the Registration Statement on Form S-1, 23.1 Consent of McGladrey & Pullen, LLP.	S-8	S-8	1996-01-12T00:00:00	1996-01-11T20:50:16
0000897101-96-000010	0000897101-96-000010_0000.txt	U.S. SECURITIES AND EXCHANGE COMMISSION [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 1995 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE EXCHANGE ACT FOR THE TRANSITION PERIOD FROM _________ TO _________ (Name of small business issuer in its charter) (State or other jurisdictio (I.R.S. Employer incorporation or organizatio Identification No.) (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER (612) 378-3053 Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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. The number of shares of the registrant's Common Stock, $.01 par value, outstanding at January 5, 1996, was 8,099,885. HEALTH OUTCOMES MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets - November 30, 1995 and February 28, 1995. Condensed Consolidated Statements of Operations Three and nine months ended November 30, 1995 and 1994. Consolidated Statements of Cash Flows Nine months ended November 30, 1995 and 1994. Notes to Consolidated Financial Statements - November 30, 1995. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Item 4 - Submission of Matters to a Vote of Securities Holders. Item 6 - Exhibits and Reports on Form 8-K. PART 1 - FINANCIAL INFORMATION Item 1 - Financial Statements HEALTH OUTCOMES MANAGEMENT, INC. & SUBSIDIARIES Cash and cash equivalents $ 30,253 22,795 Trade receivables, less allowance for doubtful accounts of $26,250 at November 30, 1995 and $25,000 at February 28, 1995 190,611 262,742 Other current assets 840 5,497 Total current assets 264,422 304,263 Property and equipment, at cost (note 2): Office and computer equipment 654,416 593,658 Less accumulated depreciation and amortization (459,289) (385,898) Net property and equipment 195,127 207,760 Capitalized computer software, net of accumulated amortization of $83,676 at November 30, 1995 and $62,757 at February 28, 1995 -- 20,919 Purchased computer software, net of accumulated amortization of $126,597 at November 30, 1995 and $118,472 at February 28, 1995 9,195 9,028 Non-compete covenant, net of accumulated amortization of $67,500 at November 30, 1995 and $45,000 at February 28, 1995 82,500 105,000 Total assets $ 551,244 646,970 The accompanying notes are an integral part of the financial statements. portion (note 3) -- 6,123 current portion (note 3) -- 60,000 under capital leases 60,101 48,187 Deferred revenue, current portion 200,187 115,676 Accrued payroll taxes 19,206 107,662 Other current liabilities 33,985 36,760 Total current liabilities 469,220 731,393 Obligation under capital leases, excluding Common stock--$.01 par value. Authorized at November 30, 1995 and 7,949,385 outstanding at February 28, 1995 80,999 79,494 Additional paid-in capital 4,565,719 4,532,309 Total stockholders' deficit (14,555) (196,983) Total liabilities and stockholders' deficit $ 551,244 646,970 The accompanying notes are an integral part of the financial statements. The accompanying notes are an integral part of the financial statements. HEALTH OUTCOMES MANAGEMENT, INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Nine months ended November 30, Cash flows from operating activities: Net income $ 147,513 $ 78,269 Adjustments to reconcile net income to cash provided by (used in) operating activities: Provision for losses on accounts receivable 28,680 (1,685) Payments in stock 3,650 -- Changes in operating assets and liabilities, net of acquisition of Applied Micro Management Decrease in trade receivables 43,451 95,645 Decrease (increase) in prepaid expenses (29,489) 36,520 Decrease (increase) in other current assets 4,657 (665) Increase (decrease) in accounts payable (136,614) 15,217 Increase (decrease) in deferred revenue 84,511 (429,847) Increase (decrease) in accrued compensation (64,630) 13,488 Decrease in accrued payroll taxes (88,456) -- Increase (decrease) in other current liabilities (2,775) 67,599 Cash provided by operating activities 122,717 122,719 Cash flows from investing activities: Cash paid for acquisition -- (22,500) Cash flows used in investing activities (48,253) (54,744) Cash flows from financing activities: Principal payments under capital lease obligations (32,148) (34,399) Repayment of bank loans assumed in the Applied Micro Management, Inc. acquisition (6,123) (10,041) Net repayment to officer (60,000) (57,000) Repurchase of preferred stock -- (50,000) Proceeds from issuance of common stock 31,265 53,330 Cash flows used in financing activities (67,006) (67,975) Increase in cash and cash equivalents 7,458 0 Cash and cash equivalents at beginning of period 22,795 0 Cash and cash equivalents at end of period $ 30,253 $ 0 Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 21,257 $ 26,531 The accompanying notes are an integral part of the financial statements. HEALTH OUTCOMES MANAGEMENT, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The unaudited financial statements presented herein include the accounts of Health Outcomes Management, Inc. and Subsidiaries after elimination of material intercompany accounts and transactions. These statements do not include all of the information and note disclosures required by generally accepted accounting principles. These statements should be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-KSB for the year ended February 28, 1995. In the opinion of management such financial statements include all adjustments, consisting of only normal recurring adjustments, necessary to summarize fairly the Company's financial position and results of operations. The results of the three and nine month periods ended November 30, 1995, may not be indicative of the results that may be expected for the year ending February 29, 1996. Property and equipment, at cost, consist of the following: Property under capitalized leases $ 310,006 Notes payable to officer totaling $60,000 that were outstanding at February 28, 1995, were paid in full as of March 1, 1995. In August 1993, the Company assumed a $31,223 note payable related to the acquisition of certain assets of Applied Micro Management. This note payable was paid in full as of August 3, 1995. The Company capitalizes software production costs after technological feasibility has been established and prior to general release to clients. On August 17, 1993, the Company completed the acquisition of the client list and certain assets of Applied Micro Management (AMM) of Belleville, Illinois. The Company issued to AMM 450,000 shares of its restricted common stock, assumed a note payable for $31,223 and paid $24,112 in cash to complete the transaction. The terms of the acquisition also required the payment of additional cash and the issuance of additional stock depending upon the number of former AMM clients converting to the Company's Assurance Long-Term Care SystemTM. The purchase method of accounting was used. During June 1994, the Company paid an additional $22,500 in cash and issued an additional 100,000 shares of its restricted common stock to AMM. The cash payment and issuance of the Company's restricted common stock was in accordance with the additional compensation provisions of the Company's agreement with AMM in which the Company acquired the client list and certain assets of AMM. On April 21, 1995, the Company signed a twelve (12) month Master License Agreement with AmeriSource Health Corporation (AmeriSource) of Malvern, PA for the Company's Assurance Community Pharmaceutical Care SystemTM. Pursuant to the terms of the agreement, the Company granted to AmeriSource an exclusive license to market and license the software system to retail pharmacies throughout the United States directly or through its affiliate, Pharmacy Care Management Group (PCMG). As consideration for the Company granting these rights to AmeriSource, the Company received $200,000 cash upon signing the agreement. As further consideration, AmeriSource agreed to license a minimum specified number of new retail pharmacies over the term of the agreement in order to maintain the exclusive status of the Master License Agreement. Additional provisions of the agreement provide for the payment of monthly license and support fees to the Company for each retail pharmacy licensing the software. The Company changed its Corporate name to Health Outcomes Management, Inc., from Data Med Clinical Support Services, Inc. The Company's Shareholders ratified the name change at the Company's Annual Meeting held on September 21, 1995. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND FOR THE THIRD QUARTER ENDED NOVEMBER 30, 1995, COMPARED WITH THE THIRD QUARTER ENDED NOVEMBER 30, 1994: REVENUE. Revenue for the third quarter ended November 30, 1995, increased by $26,362 to $792,488, a 3.4% increase when compared to the prior year third quarter revenue of $766,126. Revenues for the current period were primarily from revenues generated by the Company's Assurance Long-Term Care SystemTM, Assurance Community Pharmaceutical Care SystemTM and Assurance Homecare SystemTM. The Company experienced revenue increases from ongoing software support fees, license fees and training fees when compared to the prior year period. Support fee revenue increased by approximately $101,000 or 32.5%. This increase was due in part to an increase in the number of pharmaceutical care clients and former clients of Applied Micro Management that converted to the Company's Assurance products. The Company also experienced revenue increases in licensing fees, primarily from its Assurance Community Pharmaceutical Care SystemTM and its Assurance Homecare SystemTM. Total license fee revenues increased by approximately $90,000 or 68.6% when compared to the prior year period. Revenues from training fees increased by approximately 62% when compared to the prior year period. This was primarily due to additional retail pharmacists training on the Company's Assurance Community Pharmaceutical Care SystemTM. Revenue from sales of services related to client network capabilities decreased by approximately $33,000 or 52.9% due to no new conversions of former Applied Micro Management clients upgrading their network capabilities. Consulting fee revenue decreased by $174,000 or 95.6% when compared to the prior year period. This was the result of the Company's largest client switching from payment of a monthly retainer to recognizing revenue based on actual homecare systems licensed and trained. The effects of inflation on the Company's revenue and operating results were not significant. COSTS AND EXPENSES. Total costs and expenses incurred during the quarter ended November 30, 1995, including interest, depreciation and amortization expense, increased by approximately $24,000 or 3.1% when compared to the prior year period. Compensation, benefits and payroll taxes increased by 7.7% when compared to the prior year period. The increase in payroll expenses continues to be modest when compared to previous quarters as the Company has been able to delay hiring additional staff. Administrative expenses such as telephone expense and equipment maintenance increased by approximately $34,000 when compared to the prior year period. Equipment maintenance expense increased by approximately $12,000 as a result of the Company's continuing efforts to upgrade and maintain internal computer equipment. Education and seminars expense increased by approximately $8,300 as the Company focuses on educating employees in new software languages and tools for its next generation of software. Commissions expense paid to commissioned sales representatives decreased by approximately 10.9% due to the decrease in commissionable software license fees. Training expense has decreased by approximately $11,300 when compared to the prior year period. In the prior year period, the Company had non-recurring remote training site expenses associated with the conversion of former clients of Applied Micro Management. Interest expense decreased by approximately $3,600 or 36.4% when compared to the prior year period. This decrease was partially due to reduced borrowing needs from an officer of the Company. Notes payable to officer were fully paid on March 1, 1995. Depreciation and amortization expense, including amortization of covenants and other intangibles, decreased by approximately $4,300 or 8.4% during the current year period when compared to the prior year period. This decrease was primarily due to the end of the amortization period for part of the Company's purchased computer software. This decrease was partially offset by increased depreciation expense associated with the purchase and lease of new computer equipment and furniture. FOR THE NINE MONTH PERIOD ENDED NOVEMBER 30, 1995, COMPARED WITH THE NINE MONTH PERIOD ENDED NOVEMBER 30, 1994: REVENUE. Revenue for the nine month period ended November 30, 1995, was $2,427,559 down $21,232 or 0.9% when compared to the prior year period revenue of $2,448,791. Revenues for the current period were primarily from revenues generated by the Company's Assurance Long-Term Care SystemTM, Assurance Community Pharmaceutical Care SystemTM and Assurance Homecare SystemTM. The Company experienced substantial revenue increases from ongoing software support fees and training fees when compared to the prior year period. Revenues from training fees increased by approximately $185,000 or 135.8% when compared to the prior year period. This was primarily due to retail pharmacists training on the Company's Assurance Community Pharmaceutical Care SystemTM. This increase was partially offset by a decrease in training revenue derived from the Company's other products including the long-term care system. Support fee revenue increased by approximately $249,000 or 28.0% when compared to the prior year period. This increase was due in part to an increase in the number of homecare clients, pharmaceutical care clients and former clients of Applied Micro Management that converted to the Company's Assurance product. Non-recurring revenue, primarily license fees, received from former Applied Micro Management clients in last year's nine month period ending November 30, 1994, was approximately $570,000. As a result of no new conversions, license fee revenues decreased by 15.4%. To achieve special discounted license rights, these clients had to complete training by September 1994. This decrease in licensing fee revenue was partially offset by an approximately $229,000 increase in the licensing revenue from the Company's homecare and pharmaceutical care systems. Other revenue increased by approximately 144.3% due in part to the amortization of a lump sum payment received for a long term contract. Revenue from sales of services related to client network capabilities decreased by approximately $150,000 or 70.6%. This decrease can be attributed to no new conversions of former Applied Micro Management clients upgrading network capabilities when compared to the prior period. Consulting fee revenue decreased by $355,000 or 64.8% when compared to the prior year period. This was the result of the Company's largest client switching from payment of a monthly retainer to recognizing revenue based on actual homecare systems licensed and trained. The effects of inflation on the Company's revenue and operating results were not significant. COSTS AND EXPENSES. Total costs and expenses incurred during the nine month period ended November 30, 1995, including interest, depreciation and amortization expense, decreased by approximately $90,000 or 3.8% when compared to the prior year period. Total costs excluding interest, depreciation and amortization expense increased by approximately $30,200 or 1.4%. This small increase in costs and expenses is the result of the Company's cost containment goals. Compensation, benefits and payroll taxes increased by 6.1% when compared to the prior year period. The increase in payroll expenses has slowed when compared to previous periods. Administrative expenses, such as telephone expense, equipment maintenance and accounting and legal, increased by approximately 7.6% when compared to the prior year period. Equipment maintenance expense increased by approximately $7,400 or 54.8% as a result of the Company's continuing efforts to upgrade and maintain internal computer equipment. Education and seminars expense increased by approximately $9,600 as the Company focuses on educating employees in new software languages and tools for its next generation of software. Rent expense increased by approximately $7,200 when compared to the prior year period. The increased rent and occupancy costs were due to the addition of new office space at the Company's corporate headquarters. This increase was partially offset by the cessation of rent expense for the Belleville, IL office. This office was closed in the prior year period. Commissions expense paid to commissioned sales representatives decreased by approximately 26.2% when compared to the prior year period. This decrease is primarily due to the decrease in commissionable software license fees. Travel and training expenses decreased by approximately $46,700 when compared to the prior year period. In the prior year period, the Company had non-recurring travel obligations and remote training site expenses associated with the conversion of former clients of Applied Micro Management. Outside consultant expenses decreased by $18,800 or 11.2%. During the prior year period, the Company utilized outside consultant services as it assumed additional responsibilities from another company in connection with the Company's agreement with OPTION Care, Inc. The utilization of these outside consultant services has decreased. Interest expense decreased by approximately $5,300 or 19.9% when compared to the prior year period. This decrease was partially due to reduced borrowing needs from an officer of the Company. Notes payable to officer were fully paid on March 1, 1995. Depreciation and amortization expense, including amortization of covenants and other intangibles, decreased by approximately $116,000 or 46.7% during the current year period when compared to the prior year period. This decrease was primarily due to the expiration of the write-off period for certain assets and intangibles related to the acquisition of certain assets of Applied Micro Management, Inc. This decrease was partially offset by increased depreciation expense associated with the purchase and lease of new computer equipment and furniture. WORKING CAPITAL. The Company had a working capital deficit of ($204,798) at November 30, 1995, compared to a deficit of ($427,130) at February 28, 1995; an improvement of $222,332. This decrease in working capital deficit can be attributed primarily to the Company recording net income of $147,513 for the nine month period ended November 30, 1995. The Company's negative working situation continues. Improved capital availability and the ability to continue operations will ultimately depend on strong sales performances of the Company's Assurance Long-Term Care SystemTM and the Assurance Community Pharmaceutical Care SystemTM. There can be no assurance that sales results will improve and that the Company will experience continued profitable operations. ADDITIONAL CAPITAL REQUIREMENTS. Management believes that the Company may require additional financing of up to $100,000 during the balance of fiscal 1996 if sales expectations are not met. Management believes that the Company will be able to meet its short term cash needs for 1996 without any external financing or cost reductions. Notes payable to officer outstanding as of February 28, 1995, were fully paid off on March 1, 1995. Item 4 - Submission of Matters to a Vote of Securities Holders At the Annual Meeting of the stockholders of the Company held on September 21, 1995, the stockholders elected to the Board of Directors those nominees as listed in the proxy statement. Those individuals are William A. Peter, Jr., Michael J. Frakes, Robert J. Cipolle and Jerry L. Hoganson. These individuals constitute the entire Board of Directors of the Company. The stockholders also ratified an amendment to the Company's articles of incorporation to change the name of the Corporation to "Health Outcomes Management, Inc." No other matters were submitted to a vote of the security holders. Item 6 - Exhibits and Reports on Form 8-K 3(a) Amendment to the Articles of Incorporation of Health Outcomes Management, Inc. 3(b) Amendment to the Articles of Incorporation of HO Management, Inc. 11 Schedule showing calculation of earnings per share. (b) Reports on Form 8-K Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: January 9, 1996 By: /s/ William A. Peter, Jr. William A. Peter, Jr. Date: January 9, 1996 By: /s/ Russell Jackson 3(a) Amendment to the Articles of Incorporation of Health Outcomes Management, Inc. 3(b) Amendment to the Articles of Incorporation of HO Management, Inc. 11 Schedule showing calculation of earnings per share.	10QSB	10QSB	1996-01-12T00:00:00	1996-01-12T15:15:06
0000899243-96-000019	0000899243-96-000019_0001.txt	THIS ASSET PURCHASE AGREEMENT (the "Agreement"), is made and entered into as of December 29, 1995, by and among NORTH AMERICAN TECHNOLOGIES GROUP, INC., a Delaware corporation ("NATK"), GAIA TECHNOLOGIES, INC., a Texas corporation and wholly-owned subsidiary of NATK ("Sub"), GAIA HOLDINGS, INC., a Delaware corporation ("Gaia Holdings") formerly known as GAIA Technologies, Inc., THOR VENTURES, L.C., a Texas limited liability company ("Thor Ventures"), and THOR INDUSTRIES, INC., a Texas corporation ("Thor Industries;" collectively with Thor Ventures and Gaia Holdings, the "Seller"). The parties hereto wish to provide for the purchase by Sub and sale by Seller of substantially all of the assets and business of Seller (other than certain "Excluded Assets," as defined herein), such that subsequent to such purchase and sale, Sub will have acquired and can operate such assets and businesses as a going concern, on the terms and conditions set forth in this Agreement, and certain other matters as described herein. NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: PURCHASE AND SALE OF ASSETS; CERTAIN RELATED MATTERS 1.1 PURCHASE AND SALE OF PURCHASED ASSETS. Subject to the terms and conditions of this Agreement, and on the basis and in reliance on the representations, warranties, covenants and agreements set forth in this Agreement, at the Closing (as defined below), Seller shall sell, transfer, convey, assign and deliver to Sub, and Sub shall purchase from Seller, as a going concern, all of the "Purchased Assets," as such term is defined in Section 1.3 hereof. 1.2. PURCHASE PRICE. In exchange for Seller's sale, transfer, conveyance, assignment and delivery of the Purchased Assets, and subject to the terms and conditions of this Agreement, and on the basis and in reliance on the representations, warranties, covenants and agreements set forth in this Agreement, at the Closing, Sub shall: (a) pay or cause to be paid to Seller an aggregate amount equal to $2,450,000 (the "Cash/Note Portion of the Purchase Price"), of which: (i) an amount equal to approximately $500,000 will be paid in the form of forgiving the principal amount of the $500,000 Loan (the "$500,000 Loan"), an additional amount will be paid in the form of forgiving the principal amount drawn down as of the Closing on the $600,000 Loan (the "$600,000 Loan") (and no deductions from the Cash/Note Portion of the Purchase Price shall be made to reflect a forgiveness of any interest that may be due on either the $500,000 Loan, the $600,000 Loan or otherwise), as such terms are defined in that certain Promissory Note, Security Agreement and First Option to Purchase Certain Assets (the "$2,100,000 Note"), dated as of September 29, 1995, in the principal amount of $2,100,000 issued by Seller in favor of NATK, and an additional $24,500 shall be deducted therefrom to represent Seller's portion of the Audit Fees (as defined in Section 4.1), and (ii) the remaining balance of the Cash/Note Portion of the Purchase Price will be paid at the Closing (the "Closing Payment"), at the option of NATK, either (x) wholly in cash or (y) partially in cash and the remainder thereof by the issuance at the Closing of a 90-day promissory note (the "90 Day Note") issued jointly and severally by Sub and NATK, in the principal amount equal to the non-cash portion of the Closing Payment. Such 90 Day Note shall be in the form of EXHIBIT E, attached hereto and made a part hereof. (b) cause to be issued and delivered to Seller an aggregate of 1,666,667 shares (the "NATK Shares") of common stock, par value $.001 per share, of NATK ("NATK Common Stock"), which shares shall be issued in the names and denominations set out in Section 2.2(b)(ii) hereof, subject to the escrow provisions set out in Escrow Agreement (as defined below); (c) grant to those parties named therein those rights set forth in that certain Gaia/Thor Royalty Agreement, substantially in the form of EXHIBIT A, attached hereto and made a part hereof (the "Gaia/Thor Royalty Agreement"); (d) grant to those parties named therein those rights set forth in that certain Gaia-TieTek License Agreement, substantially in the form of EXHIBIT B, attached hereto and made a part hereof (the "Gaia-TieTek License Agreement"); (e) forgive, or otherwise assume and discharge Seller (to the satisfaction of Seller) from any liability (including without limitation any liability for payments of principal or interest) under or with respect to, the $500,000 Loan, the $600,000 Loan and the $1,000,000 Loan (as defined below in the $2,100,000 Note, the "$1,000,000 Loan"), if any, such forgiveness, assumption and/or discharge to be evidenced in a writing mutually acceptable to the parties; provided, however, that if any interest or other payments shall have been made with respect to any of the $500,000 Loan, the $600,000 Loan or the $1,000,000 Loan prior to the Closing, then at the Closing the aggregate amount of such payments shall be repaid to Seller, or otherwise accounted for in a manner mutually acceptable to the parties. 1.3 THE PURCHASED ASSETS AND THE EXCLUDED ASSETS. (a) Purchased Assets. The assets to be purchased and sold at the Closing (the "Purchased Assets") shall consist of all of the assets and business (other than the Excluded Assets specified in Section 1.3(b) below) owned by Seller of every kind, character and description, whether tangible, real, personal or located, whether carried on the books of Seller or not carried in such books due to having been expensed, fully depreciated or otherwise. The Purchased Assets shall include without limitation the following (except in each such case, as are expressly included in the Excluded Assets): (i) all technologies, know-how, patents, service marks, copyrights, trademarks, tradenames and similar intellectual property rights and assets including without limitation those identified or referred to on SCHEDULE 1.3(A) attached hereto and made a part hereof; (ii) all accounts receivable and or other rights to receive payment owing to Seller ("Accounts Receivable") on the Closing Date (as defined below), including without limitation those listed on SCHEDULE 1.3(A); (iii) all of the inventories of products, work-in-progress, supplies and materials owned by Seller on the Closing Date ("Inventory"), including without limitation the Inventory listed on SCHEDULE 1.3(A), which Schedule classifies the Inventory by category, quantity and item description; (iv) all tangible personal property owned by Seller, including without limitation furniture, fixtures, tools, machinery and equipment, computers, computer software, data bases, computer disks, drives and other data storage equipment and information, telephone systems, file cabinets and desks (collectively, "Tangible Personal Property"); (v) all of Seller's rights in, to and under all contracts of Seller, including without limitation those identified on SCHEDULE 1.3(A); (vi) all of Seller's rights in, to and under all leases of tools, furniture, machinery, equipment and other items of tangible personal property entered into prior to the date hereof, all of which leases are (vii) to the extent transferable or assignable by their express terms or the terms of any law relating thereto, all franchises, licenses, permits, certificates, approvals and other government authorizations necessary or appropriate to own and operate the Purchased Assets, including without limitation the exclusive right to use any and all trade marks, tradenames, service marks, copyrights and similar rights relating to the business of Seller, including among others the names, "GAIA Technologies," "Hard Goods," and "Leaky Pipe;" (viii) all of the Company's rights in, to and under all warranties and (ix) all rights in, to and under each contract, agreement, purchase order, work order and commitment involving Seller, including without limitation those listed on SCHEDULE 1.3(A) attached hereto and made a part hereof; (x) all cash and cash equivalents on hand and in banks; (xi) all prepaid expenses, prepaid insurance, deposits and other similar (xii) all books and records owned by Seller, including without limitation all customer lists, credit records, computer records, contracts, leases, sales representation agreements, sales agency agreements, marketing and advertising materials, operating manuals, rental or lease payment record, purchase orders, schedules of assets correspondence with vendors, books of account, files, papers, books, and all other public and confidential business records (collectively, the "Business Records"), whether in hard copy form or electronically or magnetically stored; (xiii) all rights, claims, lawsuits and choses in action against third parties relating to the Purchased Assets arising out of transactions occurring prior to the Closing Date (excluding the Retek Judgment, as referred to on Schedule 1.3(b) hereto); (xiv) all rights in, to and under all representations, warranties, covenants and guaranties made or provided by third parties with respect to (xv) all goodwill of the business of Seller and the items identified in provided, however, that to the extent the assignment of any lease, claim, right, benefit, warranty, service contract, commitment, or other contract, agreement, purchase order, work order or other commitment referred to in this Section 1.3(a) shall require the consent of another party other than Seller or an affiliate of a Seller, this Agreement shall not constitute an assignment thereof if an attempted assignment would constitute a breach thereof, and in lieu thereof Seller shall cooperate with Sub, and shall use its best efforts to cause the affiliates of Seller to cooperate, as appropriate, in any reasonable arrangement designed to provide to Sub the benefits thereunder. Except as specifically listed on any Schedule referred to in this Section 1.3(a), all of such Purchased Assets shall be delivered free and clear of any liens, claims, pledges, security interests or encumbrances of any kind, except (i) liens for current taxes not yet due or payable and (ii) claims and liens imposed by law and incurred in the ordinary course of business for obligations not yet due to carriers and materialmen. (b) Excluded Assets. Seller shall not sell, convey, assign, transfer or deliver to Sub at the Closing, and Sub shall not be obligated to purchase (or make any payments or otherwise discharge any liability or obligation of Seller with respect to), those assets owned by Seller or any of them that are identified on SCHEDULE 1.3(B), attached hereto and made a part hereof (the "Excluded Assets"). As used herein, the term, "Purchased Assets" shall not include any of the Excluded Assets, and to the extent that any item or asset is identified both in Section 1.3(a) as a Purchased Asset and in this Section 1.3(b) as an Excluded Asset, such item shall constitute an Excluded Asset for all purposes. 1.4 ASSUMED LIABILITIES. At the Closing, Sub shall assume and agree to pay or perform only those obligations and liabilities of Seller expressly set forth in this Section 1.4 (the "Assumed Liabilities"). Except for the Assumed Liabilities, Sub shall not assume or be deemed to have assumed and shall not be responsible for any other obligation or liability of Seller, direct or indirect, known or unknown, choate or inchoate, absolute or continent, including without limitation any and all obligations regarding any foreign, Federal, state or local income, sales, use, franchise or other tax liabilities, and Seller shall indemnify and hold Sub harmless from all such liabilities and costs incurred by Sub and arising out of or attributable to any such liabilities, all in accordance with Article VI hereof. The Assumed Liabilities are: (a) The accounts payable of Seller arising in the ordinary course of business (and not incurred in violation of any law or in breach of any duty) that are listed on SCHEDULE 1.4 hereto, but only in the amounts set forth on such Schedule ("Accounts Payable") and excluding all reserves for contingent (b) The capitalized lease obligations listed on SCHEDULE 1.4, if any, arising on or after the Closing (and not incurred in violation of any law or in breach of any duty) (collectively, the "Lease Obligations"), but excluding all (c) All other liabilities and claims against Seller incurred by Seller in the ordinary course of business as of the Closing Date that both relate exclusively to the Purchased Assets and are listed on SCHEDULE 1.4 but only in the amounts set forth on such Schedule and excluding all reserves for contingent (d) The obligations or liabilities of Seller that relate to the Purchased Assets and exclusively to periods, events or circumstances after the Closing Date (and not to events or circumstances occurring prior to the Closing Date, except as described in SECTION 1.4) with respect to such Purchased Assets; provided, however, that: (i) each of such obligations or liabilities shall be on the same terms and conditions as are in effect prior to and on the Closing Date; (ii) Sub shall assume no obligation or liability in, to or under any contract, agreement, purchase order or lease that is not specifically referenced on any Schedule referred to in Section 1.3 and (iii) Sub assumes no obligation or liability in, to or under any illegal agreement, illegal lease or illegal purchase order, or any obligation or liability, the performance of which would be illegal. 1.5 ALLOCATION OF PURCHASE PRICE. Seller and Sub agree that for Federal income tax purposes the values of the Purchased Assets and the Assumed Liabilities shall be the Purchase Price ("Tax Purchase Price"). The allocation of such values shall be based on a joint determination, made in good faith, of the fair market values of the Purchased Assets and Assumed Liabilities, and such allocation is intended by the parties to comply with Section 1060 of the Internal Revenue Code of 1986, as amended (the "Code"), and the regulations thereunder. Such allocation will be determined by Sub, insofar as possible, in accordance with generally accepted accounting principles. Notwithstanding anything provision of this Agreement or any document to be executed in connection herewith that may suggest otherwise, the parties acknowledge and agree that substantially all of the value of the Purchased Assets and Assumed Liabilities rests with those Purchased Assets and Assumed Liabilities acquired or to be acquired by Sub from Gaia Holdings. In connection therewith, any portion of the Cash/Note Portion of the Purchase Price, the NATK Shares or the other consideration provided in connection with the purchase of the Purchased Assets that is being paid or delivered to any party other than Gaia Holdings is being so paid at the request and instruction of Gaia Holdings. Seller and Sub shall prepare within two weeks of the Closing Date and timely file the applicable Form 8594 with their respective Federal income tax returns for the taxable year that includes the Closing Date. The parties agree to use the allocation set forth on the agreed-to allocation in all returns and reports filed with the taxing authorities. Each party shall take no action inconsistent with the allocation reported on the Form 8594. If the Internal Revenue Service, or any other taxing authority, challenges the allocation of the Purchase Price, the party whose return is being examined shall promptly notify the other party and shall promptly keep the other party fully informed regarding all developments with respect to the allocation of the Tax Purchase Price. 2.1 CLOSING AND CLOSING DATE. The closing ("Closing") of the purchase and sale of the Purchased Assets and the related transactions shall take place at the offices of counsel for Seller, Crain, Caton & James, 909 Fannin Street, 33rd Floor, Houston, Texas 77010-1079, at 10:00 a.m., local time, on December 29, 1995, or at such other time and place and on such other date as the parties hereto shall agree, but in no event shall such date be later than January 31, 1996, unless such date is extended by the mutual written agreement of the parties hereto. The date of the Closing is referred to herein as the "Closing Date." 2.2 CLOSING TRANSACTIONS. At the Closing: (i) Bills of Sale. Each of the parties thereto shall execute and deliver to the other party thereto a Bill of Sale and Assignment, substantially in the forms of EXHIBITS C-1, C-2 and C-3, attached hereto and made a part hereof (the "Bills of Sale"); and (ii) Assignment of Patents. Seller shall execute and deliver that certain Assignment of Patents, substantially in the form of EXHIBIT D, attached hereto and made a part hereof (the "Assignment of Patents"); (i) The Closing Payment. Sub shall issue and deliver by certified check or wire transfer an amount equal to cash portion of the Closing Payment, if any, to the party or parties as Gaia Holdings shall instruct it. If the Closing Payment is not paid in full in cash, as contemplated by the provisions of Section 1.2(a) hereof, NATK and Sub shall issue the 90 Day Note as contemplated by Section 1.2 (a) hereof. The remainder of the Cash/Note Portion of the Purchase Price shall be applied as contemplated by (ii) NATK Stock. NATK shall issue four certificates representing the NATK Shares, in the names and number of shares as set forth below: GAIA Holdings, Inc. 222,223 (Pledged Shares) Thor Ventures, L.C. 444,444 (Pledged Shares) The 222,223 NATK Shares and the 444,444 NATK Shares identified above as the "Pledged Shares" are sometimes collectively referred to herein as the Pledged Shares." At the Closing, NATK shall deliver to the Escrow Agent the certificates representing the Pledged Shares pursuant to the Escrow Agreement, and shall deliver to Gaia Holdings, the certificate representing the 333,333 Shares and to Thor Ventures, the certificate representing the (iii) Re-delivery of Promissory Notes. NATK shall re-deliver to Seller the $2,100,000 Note marked "CANCELED;" (c) Crosstie Business Related Matters. (i) NATK, TieTek (as defined below), each of Messrs. Aldrich and Sullivan, and J. Denny Bartell shall execute and deliver that certain Crosstie Purchase Option and Loan Agreement, dated as of December 29, 1995 (the "Crosstie Purchase Option Agreement"), and the Crosstie Note (as defined in the Crosstie Purchase Option Agreement); (ii) Seller shall cause to be delivered to the Escrow Agent named in the Escrow Agreement the certificates representing shares of capital stock of TIETEK, Inc., a Texas corporation ("TieTek"), then held by NATK, as pledgee of such shares, pursuant to the provisions of the Escrow Agreement; and (iii) NATK, Sub, Seller, TieTek, the owners of all of the outstanding shares of capital stock of TieTek, and the party named therein as the Escrow Agent (the "Escrow Agent") shall execute and deliver that certain Escrow Agreement, substantially in the form of EXHIBIT G, attached hereto and made a part hereof (the "Escrow Agreement"), relating to the Pledged Shares and the TieTek Shares as described or referred to in the Escrow (d) Other License and Royalty Related Matters. Sub shall execute and deliver the Gaia/Thor Royalty Agreement and the Gaia-TieTek License Agreement; (e) Employment Agreements, Retek Equipment Purchase Option Matters and (i) Each of Sub and William Aldrich ("Aldrich") shall execute and deliver that certain Employment Agreement substantially in the form of EXHIBIT H, attached hereto and made a part hereof (the "Aldrich Employment Agreement"), and each of NATK and Aldrich shall execute and deliver the Stock Option Agreement attached as an exhibit thereto; (ii) Each of Sub and Dr. Henry W. Sullivan ("Sullivan") shall execute and deliver that certain Employment Agreement substantially in the form of EXHIBIT I, attached hereto and made a part hereof (the "Sullivan Employment Agreement"), and each of NATK and Sullivan shall execute and deliver the Stock Option Agreement attached as an exhibit thereto; and (iii) Gaia Holdings and Sub shall execute and deliver that certain Option Agreement, substantially in the form of EXHIBIT J, attached hereto and made a part hereof (the "Retek Equipment Purchase Option"). 3.1. REPRESENTATIONS AND WARRANTIES OF NATK AND THE SUB. NATK and Sub represent and warrant, jointly and severally, to Seller those matters set forth on EXHIBIT K, attached hereto and made a part hereof. 3.2 REPRESENTATIONS AND WARRANTIES OF SELLER. Each of the Sellers represent and warrant, jointly and severally, to NATK and the Sub those matters set forth on EXHIBIT L, attached hereto and made a part hereof. Each of the covenants of NATK and Sub or either of them contained in this Article IV shall be deemed joint and several covenants and agreements of NATK and Sub. Each of the covenants of Seller or any of them contained in this Article IV shall be deemed joint and several covenants and agreements of all of the Sellers. 4.1 AUDIT. The approximately $49,000 of fees and expenses ("Audit Fees") incurred in connection with the preparation of certain audited financial statements of Seller (or one or more of them) by NATK's independent auditors shall be divided and paid 50% by NATK and 50% by Seller; provided, however, that Seller's portion thereof shall be paid by the deduction of the Cash/Note Portion of the Purchase Price (with such amount first being deducted from the principal amount of the 90-day Note, if any), as provided in Section 1.2(a) hereof. 4.3 CORPORATE ACTION. At or before the Closing, Seller shall cause to occur all corporate action necessary on behalf of any of them to effect the purchase and sale of the Purchased Assets and the other transactions contemplated by this Agreement to occur at or before the Closing. At or before the Closing, NATK and Sub shall cause to occur all corporate action necessary on behalf of any of them to effect the purchase and sale of the Purchased Assets and the other transactions contemplated by this Agreement to occur at or before the Closing. (a) Confidentiality of NATK-Related Information. With respect to information concerning NATK, Sub or any transaction proposed by this Agreement that is or has been made available to Seller, whether before or after the date hereof, Seller agrees that it shall hold such information in strict confidence, shall not use such information except for the sole purpose of evaluating the transactions proposed hereby and shall not disseminate or disclose any of such information other than to its directors, officers, employees, shareholders, affiliates, agents and representatives who need to know such information for the sole purpose of evaluating the transactions proposed hereby (each of whom shall be informed by Seller of the confidential nature of such information and directed by Seller in writing to treat such information confidentially) and shall not use (or permit any of its directors, officers, employees, shareholders, affiliates, agents or representatives to use) such information to the detriment (detriment to be determined by NATK) of NATK, its directors, officers, employees or shareholders. If the obligations of the parties under this Agreement are terminated pursuant to the provisions of this Agreement, Seller shall immediately return all such information, all copies thereof and all information prepared by Seller based upon the same, upon NATK's request. The above limitations on use, dissemination and disclosure shall not apply to information that (i) is learned by Seller from a third party entitled to disclose it; (ii) becomes known publicly other than through Seller or any party who received the same through Seller; (iii) is required by law or court order to be disclosed by Seller; or (iv) is disclosed with the express prior written consent thereto of NATK. Seller shall undertake all reasonable steps to ensure that the secrecy and confidentiality of such information will be maintained in accordance with the provisions of this Section 4.4(a). (b) Confidentiality of Seller-Related Information. With respect to information concerning Seller or any transaction proposed by this Agreement that is made available to NATK, whether before or after the date hereof, NATK agrees that it shall hold such information in strict confidence, shall not use such information except for the sole purpose of evaluating the transactions proposed hereby and shall not disseminate or disclose any of such information other than to its directors, officers, employees, shareholders, affiliates, agents and representatives who need to know such information for the sole purpose of evaluating the transaction proposed hereby (each of whom shall be informed by NATK of the confidential nature of such information and directed by NATK in writing to treat such information confidentially) and shall not use (or permit any of its directors, officers, employees, shareholders, affiliates, agents or representatives to use) such information to the detriment (detriment to be determined by Seller) of Seller, its directors, officers, employees or shareholders. If the obligations of the parties under this Agreement are terminated pursuant to provisions of this Agreement, NATK shall immediately return all such information, all copies thereof and all information prepared by NATK based upon the same, upon Seller's request. The above limitations on use, dissemination and disclosure shall not apply to information that (i) is learned by NATK from a third party entitled to disclose it; (ii) becomes known publicly other than through NATK or any party who received the same through NATK; (iii) is required by law or court order to be disclosed by NATK; or (iv) is disclosed with the express prior written consent thereto of Seller. NATK shall undertake all reasonable steps to ensure that the secrecy and confidentiality of such information will be maintained in accordance with the provisions of this Section 4.4(b). (c) Nondisclosure. Neither of the parties hereto shall disclose to the public or to any third party the existence of this Agreement or the transactions as described herein or any other material non-public information concerning or relating to the other party hereto, other than with the express prior written consent of the other party hereto, except as may be required by law or court order or to enforce the rights of such disclosing party under this Agreement, in which event the contents of any proposed disclosure shall be discussed with the other party before release; provided, however, that notwithstanding anything to the contrary contained in this letter, either party may disclose this letter to any of its directors, officers, employees, shareholders, affiliates, agents and representatives who need to know such information for the sole purpose of evaluating the transactions proposed hereby, and to any party whose consent is required in connection with any such proposed transaction. The parties anticipate issuing a mutually acceptable, joint press release announcing the Closing of the purchase and sale of the Purchased Assets and the related transactions. 4.6 CONSENTS. NATK, Sub and each Seller shall cooperate and use their best efforts to obtain, prior to the Closing, all licenses, permits, consents, approvals, authorizations, qualifications and orders of governmental authorities and parties to contracts with any Seller as are necessary for the consummation of the transactions contemplated by this Agreement; provided, however, that the parties shall not be required to seek the consent, approval or authorization of the landlords under, or otherwise amend the written agreements relating to, the lease agreements pursuant to which any Seller leases any real or personal property. 4.7 FILINGS. NATK, Sub and each Seller shall, as promptly as practicable, make any required filings and any other required submissions, under any law, statute, order rule or regulation with respect to the transactions contemplated by this Agreement and shall cooperate with each other with respect to the foregoing. 4.8 ALL REASONABLE EFFORTS. Subject to the terms and conditions of this Agreement and to the fiduciary duties and obligations of the board of directors or similar group governing NATK, Sub and each Seller, each of the parties to this Agreement shall use all reasonable efforts to take, or cause to be taken, all action and to do, or cause to be done, all things necessary, proper or advisable under applicable laws and regulations, or to remove any injunctions or other impediments or delays, legal or otherwise, as soon as reasonably practicable, to consummate the transactions contemplated by this Agreement. 4.9 PUBLIC ANNOUNCEMENTS. NATK and Seller shall consult with each other before issuing any press release or otherwise making any public statements with respect to this Agreement or the other transactions contemplated by this Agreement and shall not issue any other press release or make any other public statement relating to the same without prior consultation with the other parties, except as may be required by law or, with respect to NATK, by obligations pursuant to any listing agreement with an national securities exchange. Notwithstanding the foregoing or anything in this Agreement to the contrary, NATK may inform its financial advisors and placements agents, any of NATK's investors or potential investors, and any purchaser representative or other advisor of any such investor or potential investor of the progress of the transactions contemplated by this Agreement and the proposed terms and conditions of this Agreement. 4.10 NOTIFICATION OF CERTAIN MATTERS. Seller shall give prompt notice to NATK, and NATK shall give prompt notice to Seller, of (a) the occurrence or non- occurrence of any event, the occurrence or non-occurrence of which would cause any of its representations or warranties in this Agreement to be untrue or inaccurate in any material respect at or prior to the Closing and (b) any material failure of Seller, on the one hand, or NATK or the Sub, on the other hand, as the case may be, to comply with or satisfy any covenant, condition or agreement to be complied with or satisfied by it under this Agreement; provided, however, the delivery of any notice pursuant to this Section shall not limit or otherwise affect the remedies available to the party receiving such notice under this Agreement. 4.11 EXPENSES. Except as otherwise expressly provided herein (including without limitation the provisions of Section 4.1 hereof), all costs and expenses incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the party incurring such expenses whether or not the transactions contemplated hereby are consummated. Seller shall pay any and all fees and expenses that may be due McKenna & Company or any of its affiliates in connection with any of the transactions contemplated by this Agreement. 4.12. REGISTRATION RIGHTS. (a) Conditional Right to Piggyback. Subject to the provisions and conditions of this Section 4.12, if NATK (sometimes referred to in this Section as the "Company") proposes to register shares of NATK Common Stock under the Securities Act of 1933, as amended (the "Securities Act"), and if the registration form to be used may be used for the registration of the shares of NATK Common Stock to be received by Seller in connection with the purchase and sale of the Assets as provided in Section 1.2(b) of this Agreement (the "Newly Issued Shares") (such registration event being referred to herein as a "Piggyback Registration"), NATK shall, as promptly as reasonably practical, give written notice to each of the holders of such Newly Issued Shares (the "Shareholders") and will include in such Piggyback Registration, subject to the allocation provisions below, all Newly Issued Shares with respect to which NATK has received written requests (from the Shareholders owning of record such Newly Issued Shares) for inclusion within 20 days after NATK's mailing of such notice. The rights granted to the Seller under this Section 4.12(a) shall be exerciseable by any of them only during the period beginning six (6) months following the Closing Date and ending three (3) years and six (6) months after the Closing Date (the "Registration Rights Period"). The term "Newly Issued Shares" shall include any Pledged Shares that are released or to be released from the pledge thereof pursuant to the Crosstie Note during the Registration Rights Period. (b) Demand Registration. During the Registration Rights Period and only if NATK does not then have a registration statement filed with the Securities and Exchange Commission ("SEC") or an effective registration statement, Shareholders holding 75% or more of the Newly Issued Shares (which, for purposes of such calculation, shall include the Pledged Shares) may request in writing that the Company register such Newly Issued Shares under the Securities Act (a "Registration Request"). The Company shall use all reasonable efforts to expedite and effect the registration of such Newly Issued Shares that are the subject of the Registration Request (the "Registrable Shares"). The Company may include in any such registration (x) similar securities held by other parties with registration rights and (y) similar securities that the Company desires to register (provided, however, that the Newly Issued Shares shall, to the maximum extent the Company is then permitted to do so, always have first priority with respect to any registration pursuant to this Section 4.12(b)). The Company shall have up to 180 days from the date of the Registration Request to file a registration statement with the SEC. Notwithstanding anything herein to the contrary any registration pursuant to this Section 4.12(b) (a "Demand Registration") will not be deemed to have been effected unless it has become effective and remained effective no less than 90 days (unless terminated with the consent of the holders of such Registrable Shares); provided further, than any such registration that does not become effective after the Company has filed a registration statement in accordance with the provisions of this Section 4.12(b) solely by reason of the refusal to proceed of the holders of such Registrable Shares that have made a Registration Request, including failure to comply with the provisions of this Agreement (other than any refusal to proceed based upon the advice of counsel to such holders that the registration statement, or the prospectus contained therein, contains an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing, or that such registration statement or such prospectus, or the distribution contemplated thereby, otherwise violates or would, if such distribution using such prospectus took place, violate any applicable state or federal securities law) shall be deemed to have been effected by the Company at the request of such holders. Notwithstanding anything herein to the contrary, the NATK shall not be obligated to perform in the aggregate more than one Demand Registration under the provisions of this Section 4.12(b). (c) Expenses. NATK will pay the Registration Expenses (as defined below), but the Underwriting Commissions (as defined below) will be shared by NATK and the holders of the Newly Issued Shares that are included in the Piggyback Registration or a Demand Registration (each sometimes referred to as a "Securities Registration" herein) in proportion to any securities included on their behalf. (d) Priority on Primary Registrations. If a Piggyback Registration is an underwritten primary registration on behalf of NATK, and the managing underwriters advise NATK that in their opinion the number of shares of NATK Common Stock requested to be included in such registration exceeds the number that can be sold in such offering, at a price reasonably related to fair value, NATK will allocate the shares of Common Stock to be included as follows: first, the securities NATK proposes to sell on its own behalf; and second, other shares of NATK Common Stock (including without limitation the Newly Issued Shares owned of record by the Shareholders) requested by any shareholders or other parties (with rights against NATK relating to such registration) to be included in such registration, pro rata on the basis of the number of shares of NATK Common Stock owned of record by the parties (other than NATK) desiring to have their shares so included (or, at the sole option and in the discretion of NATK, any other reasonable method it deems equitable, so long as such equitable method is determined by NATK in good faith, primarily taking into account any contractual or other legal obligations of NATK with respect thereto). The allocation priority specified above may not be changed to lower the priority given to the Newly Issued Shares held by the Shareholders to a priority below that of any other shareholder who acquired equity securities of the Company as a result of the purchase by the Company (or its affiliates) of the assets of another organization, or the acquisition by the Company (or its affiliates) of another organization, whether by merger, consolidation, stock purchase or otherwise. (e) Priority on Secondary Registrations. If a Piggyback Registration is initiated as an underwritten secondary registration on behalf of holders of NATK Common Stock, and the managing underwriters advise NATK in writing that in their opinion the number of shares of NATK Common Stock requested to be included in such registration exceeds the number that can be sold in such offering, at a price reasonably related to fair value, NATK will allocate the securities to be included as follows: first, the shares of NATK Common Stock requested to be included by the holders initiating such registration; and second, other shares of NATK Common Stock (including without limitation the Newly Issued Shares owned of record by the Shareholders) requested by any shareholders or other parties (with rights against NATK relating to such registration) to be included in such registration, pro rata on the basis of the number of shares of NATK Common Stock owned of record by the parties (other than NATK) desiring to have their shares so included (or, at the sole option and in the discretion of NATK, any other reasonable method it deems equitable, so long as such equitable method is determined by NATK in good faith, primarily taking into account any contractual or other legal obligations of NATK with respect thereto). The allocation priority specified above may not be changed to lower the priority given to the Newly Issued Shares held by the Shareholders to a priority below that of any other shareholder who acquired equity securities of the Company as a result of the purchase by the Company (or its affiliates) of the assets of another organization, or the acquisition by the Company (or its affiliates) of another organization, whether by merger, consolidation, stock purchase or otherwise. (f) Selection of Underwriters. In any Securities Registration, the selection of investment banks(s), underwriters and manager(s), and the other decisions regarding the underwriting arrangements and related matters for the offering, shall be made exclusively by NATK. (g) Registration Procedures. Whenever a holder of Newly Issued Shares exercises its rights under this Section 4.12 (each an "Exercising Shareholder"), will, as expeditiously as possible: (i) furnish to each Exercising Shareholder such number of copies of the applicable registration statement, each amendment and supplement thereto and the prospectus included in such registration statement (including each preliminary prospectus), and such other documents as such Exercising Shareholder may reasonably request in order to facilitate the disposition of the Newly Issued Shares owned of record by such Exercising Shareholder to be included in (ii) use its best efforts to register or qualify such Newly Issued Shares under such other securities or blue sky laws of such jurisdictions as the managing underwriter(s) may request; and (iii) cause such Newly Issued Shares to be listed or included on securities exchanges on which shares of NATK Common Stock are then listed or included. (i) NATK will indemnify, to the extent permitted by law, each Exercising Shareholder against all losses, claims, damages, liabilities and expenses arising out of or resulting from any untrue or alleged untrue statement of material fact contained in any registration statement, prospectus or preliminary prospectus or any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, except insofar as the same are caused by or contained in any information furnished in writing to NATK by such Exercising Shareholder expressly for use therein or by any such Exercising Shareholder's failure to deliver a copy of the registration statement or prospectus or any amendments or supplements thereto after NATK has furnished such Exercising Shareholder with a sufficient number of copies of the same. (ii) In connection with any registration statement in which an Exercising Shareholder is participating, each such Exercising Shareholder will furnish to NATK in writing such information as is reasonably requested by NATK for use in any such registration statement or prospectus and will indemnify, to the extent permitted by law, NATK, its directors and officers and each person who controls NATK (within the meaning of the Securities Act) against any losses, claims, damages, liabilities and expenses resulting from any untrue or alleged untrue statement of material fact or any omission or alleged omission of a material fact required to be stated in the registration statement or prospectus or any amendment thereof or supplement thereto or necessary to make the statements therein not misleading, but only to the extent that such untrue statement or omission is contained in, or omitted from, information so furnished in writing by such holder specifically for use in preparing the registration statement. Notwithstanding the foregoing, the liability of an Exercising Shareholder under this subsection (h)(ii) shall be limited to an amount equal to the net proceeds actually received by such Exercising Shareholder from the sale of such Exercising Shareholder's Newly Issued Shares covered by the registration statement. (iii) Any party entitled to indemnification under this subsection (h) will: (x) give prompt notice to the indemnifying party of any claim with respect to which such indemnified party seeks indemnification and (y) unless in such indemnified party's reasonable judgment a conflict of interest between such indemnified and indemnifying parties may exist with respect to such claim, permit such indemnifying party to assume the defense of such claim with counsel reasonably satisfactory to the indemnified party. If such defense is assumed, the indemnifying party will not be subject to any liability for any settlement made without its consent (but such consent will not be unreasonably withheld). An indemnifying party who is not entitled, or elects not, to assume the defense of a claim will not be obligated to pay the fees and expenses of more than one counsel for all parties indemnified by such indemnifying party with respect to such claim, unless in the reasonable judgment of any indemnified party a conflict of interest may exist between such indemnified party and any other of such indemnified parties with respect to such claim, in which case such indemnifying party shall pay the fees and expenses of a sufficient number of counsel so that such conflicts are resolved. (i) Compliance with Underwriting Arrangements. No Shareholder may participate in any Securities Registration unless such Shareholder: (i) agrees to sell his Newly Issued Shares on the basis provided in any underwriting arrangements approved by NATK and (ii) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents required under the terms of such underwriting arrangements. (j) Limitations on NATK's Obligations. In connection with its obligations to register any of the Newly Issued Shares as provided in this Section 4.12, NATK shall have no obligation (i) to assist or cooperate in the offering or disposition of such Newly Issued Shares, (ii) except as expressly provided in this Section 4.12, to indemnify any Shareholder, (iii) to obtain a commitment from an underwriter relative to the sale of such Newly Issued Shares, or (iv) to include such Newly Issued Shares within an underwritten offering of NATK conducted on a firm basis. (k) Definitions. As used in this Section 4.12, (x) "Registration Expenses" means all expenses incident to NATK's performance of or compliance with the provisions of this Section 5.12 and the registration of any other securities in connection therewith, including without limitation all registration and filing fees, fees and expenses of compliance with securities or blue sky laws, printing expenses, messenger and delivery expenses, expenses and fees for listing the securities to be registered on exchanges, and fees and disbursements of counsel for NATK and all independent certified public accountants, underwriters (other than Underwriting Commissions) and other persons retained by NATK in connection therewith, and (y) "Underwriting Commissions" means all underwriting discounts or commissions relating to the sale of securities of NATK, but excludes any expenses reimbursed to underwriters. (l) Limited Transferability or Assignability of Registration Rights. Notwithstanding anything in this Section 4.12 or elsewhere in this Agreement to the contrary, none of the rights granted to any holder of Newly Issued Shares under this Section 4.12 shall be assignable or transferable by such Shareholder, nor shall any such rights inure to the benefit of such Shareholder's assigns or beneficiaries or any other party, including without limitation any subsequent beneficial or record holder of any of the Newly Issued Shares or any interest therein, without the prior written consent thereto of NATK (which consent shall not be unreasonably withheld); provided, however, that such rights may be transferred or assigned, without the prior written consent thereto of NATK, to any current shareholder of Gaia Holdings or any member of Thor Ventures, or to the spouse or children of any such shareholder or member who is a natural person, to any trust the sole beneficiaries of which are any of such shareholder's or member's spouse or children, and upon the death of any such shareholder or member, to his or her estate; and provided further, that such rights may not be further transferred or assigned to any other party or parties. 4.13 DISCLOSURE DOCUMENTS. Each Seller shall supply to NATK the necessary information in writing, or cause the necessary information to be supplied in writing, relating to Seller for inclusion in any documents to be filed with the Securities and Exchange Commission or any regulatory agency in connection with the transactions contemplated by this Agreement. 4.14. ONE DIRECTOR NOMINEE. NATK shall use its best efforts to cause Mr. Aldrich (or another nominee selected by Sellers then holding a majority of the NATK Shares and reasonably acceptable to NATK) to be elected or appointed to the Board of Directors of NATK not later than the first regularly scheduled NATK Board of Directors meeting in 1996. In addition, from the date hereof and continuing until the Crosstie Purchase Option (as defined in the Crosstie Purchase Option Period) is either exercised or has expired (which occurs first), NATK shall use its best efforts to cause the name of Mr. Aldrich (or another nominee selected by Sellers then holding a majority of the NATK Shares and reasoanbly acceptable to NATK) to be included in the list of nominees for the Board of Directors of NATK in the each proxy statement delivered to the stockholders of NATK in connection with the each meeting of stockholders of NATK at which directors are to be elected. If, on or before the date such proxy is prepared in preliminary form, such nominee is then (for any reason) not an employee of NATK, Sub or any of its affiliates, then, at the election of Sellers, NATK shall use its best efforts to substitute for such nominee the name of another substitute nominee (as selected by Sellers then holding a majority of the NATK Shares) mutually acceptable to such Sellers and NATK in such list of director nominees. CONDITIONS TO CONSUMMATION OF THE CLOSING TRANSACTIONS 5.1 CONDITIONS TO SELLER'S OBLIGATIONS. The obligations of each Seller to consummate the purchase and sale of the Purchased Assets and the other contemplated to be consummated by it at the Closing (collectively, the "Closing Transactions") are subject to the satisfaction (or waiver by Seller) at or prior to the Closing (or at such other time prior thereto as may be expressly provided in this Agreement) of each of the following conditions: (a) Seller shall have had the opportunity to conduct a due diligence review of the books, records, operations, physical plant and facilities, contracts and other documents of NATK and nothing shall have come to its attention that would reasonably be expected to have a Material Adverse Effect on NATK on and after the Closing. (b) The representations and warranties of NATK and the Sub set out in this Agreement shall be true and correct in all material respects, and no fact or circumstance shall have come to the attention of Seller that is not disclosed in this Agreement or any document or other writing delivered by NATK to Seller prior to the date of this Agreement that could reasonably be expected to have a Material Adverse Effect on NATK or the consideration to be received by the Seller in connection with the transactions contemplated hereby to be consummated at the Closing. (c) Each of NATK and the Sub shall have complied in a timely manner and in all material respects with their respective covenants and agreements set out in this Agreement. (d) All director, shareholder, lender, lessor and other parties' consents and approvals, as well as all filings with, and all necessary consents or approvals of, all federal, state and local governmental authorities and agencies, as are required under this Agreement, applicable law or any applicable contract or agreement (other than as contemplated by this Agreement) to complete the purchase and sale of the Purchased Assets and the other transactions at the Closing shall have been secured, including without limitation that this Agreement shall have been approved by the affirmative vote of the owners of each Seller in accordance with applicable law. (e) No statute, rule, regulation, executive order, decree, injunction or restraining order shall have been enacted, entered, promulgated or enforced by any court of competent jurisdiction or governmental authority that prohibits or restricts the consummation of the purchase and sale of the Assets at the Closing or the related transactions. (f) The Closing shall have occurred not later than January 31, 1996, unless such date is extended by the mutual written agreement of the parties hereto. 5.2 CONDITIONS TO NATK'S AND THE SUB'S OBLIGATIONS. The obligations of NATK and the Sub to consummate the Closing Transactions at the Closing are subject to the satisfaction (or waiver by NATK) at or prior to the Closing (or at such other time prior thereto as may be expressly provided in this Agreement) of each of the following conditions: (a) NATK shall have been provided with an executed copy of each of those certain Termination of License Agreements, in the form of EXHIBIT M-1 and EXHIBIT M-2, attached hereto and made a part hereof, and that certain Termination of Sublicense, in the form of EXHIBIT N, attached hereto and made a part hereof, and the parties thereto shall have certified to NATK at the Closing that each such License Termination Agreement is in full force and effect, and has not been amended, altered or terminated as of the Closing. (b) NATK shall have had the opportunity to conduct a due diligence review of the books, records, operations, physical plant and facilities, contracts and other documents of each Seller and nothing shall have come to its attention that would reasonably be expected to have a Material Adverse Effect on any Seller or the Purchased Assets (taken as a whole) on and after the Closing. (c) None of the owners of any Seller shall have filed with a Seller a written objection to the sale of the Purchased Assets, as required by Article 5.12A(1)(a) of the TBCA or the applicable provisions of any other law in order for such owner to perfect the right to dissent from such proposed action. (d) NATK shall be satisfied that the acquisition of the Purchased Assets pursuant to this Agreement is a tax-free transaction to NATK under the Code (as defined in this Agreement). (e) The representations and warranties of Seller set out in this Agreement shall be true and correct in all material respects, and no fact or circumstance that is not disclosed in this Agreement or any document or other writing delivered by Seller to NATK prior to the date of this Agreement shall have come to the attention of NATK that could reasonably be expected to have a Material Adverse Effect on Seller or any of them or the Purchased Assets (take as a whole). (f) Seller shall have complied in a timely manner and in all material respects with their covenants and agreements set out in this Agreement. (g) All director, shareholder, lender, lessor and other parties' consents and approvals, as well as all filings with, and all necessary consents or approvals of, all federal, state and local governmental authorities and agencies, as are required under this Agreement, applicable law or any applicable contract or agreement (other than as contemplated by this Agreement) to complete the transactions contemplated to occur at the Closing shall have been secured, including without limitation that this Agreement shall have been approved by the affirmative vote of the owners of each Seller by the requisite vote, if any, in accordance with the TBCA or other applicable laws. (h) No statute, rule, regulation, executive order, decree, injunction or restraining order shall have been enacted, entered, promulgated or enforced by any court of competent jurisdiction or governmental authority that prohibits or restricts the consummation of the purchase and sale of the Purchased Assets at the Closing or the related transactions. (i) The Closing shall have occurred not later than January 31, 1996, unless such date is extended by the mutual written agreement of the parties hereto. (j) NATK shall be satisfied that the offer and issuance of the shares of NATK Shares to Seller in connection with the transactions contemplated to occur at the Closing are exempt from the registration provisions of the Securities Act and similar provisions under applicable state securities laws. (k) Each of the shareholders of Gaia Holdings and Thor Industries, and each of the members of Thor Ventures, shall have executed and delivered to NATK at or prior to the Closing a copy of an investment representation letter ("Investment Representation Letter") substantially in the form of EXHIBIT O, attached hereto and made a part hereof. 6.1 INDEMNIFICATION BY SELLER. Each Seller jointly and severally agrees to indemnify, defend and hold harmless, NATK, Sub and their affiliates, officers, directors, employees, contractors and agents (collectively, NATK, Sub and such other parties are being referred to as the "NATK Parties") against and from any and all taxes, penalties, interest, claims, suits, causes of action (recognized now or at any later time), liabilities, responsibilities, damages, losses, costs, assessments and expenses, including without limitation reasonable attorney's fees and other expenses of defending any actions or claims, amounts of judgments and amounts paid in settlement (collectively, all of the foregoing being referred to herein as "Costs") incurred by, asserted against or imposed upon any of the NATK Parties arising out of or attributable to: (a) any breach of any representation, warranty, covenant or agreement made by Seller herein or in any schedule, exhibit, certificate, document or agreement furnished by Seller in connection herewith (including without limitation any of the documents to be executed and delivered at the Closing), or made by a shareholder or member of any Seller in such party's Investment Representation (b) Any nonfulfillment of any agreement hereunder or entered into in connection herewith by Seller or by a shareholder or member of any Seller; or (c) Any claim, known or unknown, arising out of, or by virtue of, or based upon any Seller's operation of any Purchased Asset prior to the Closing. 6.1 INDEMNIFICATION BY NATK AND SUB. NATK and Sub jointly and severally agree to indemnify, defend and hold harmless, each Seller and their affiliates, officers, directors, employees, contractors and agents (collectively, each Seller and such other parties are being referred to as the "Seller Parties") against and from any and all Costs incurred by, asserted against or imposed upon any of the Seller Parties arising out of or attributable to: (a) any breach of any representation, warranty, covenant or agreement made by NATK or Sub herein or in any schedule, exhibit, certificate, document or agreement furnished by NATK or Sub in connection herewith or relating hereto (including without limitation any of the documents to be executed and delivered (b) Any nonfulfillment of any agreement hereunder or entered into in connection herewith by NATK or Sub; or (c) Any claim, known or unknown, arising out of, or by virtue of, or based upon any NATK's or Sub's operation of any Purchased Asset after the Closing. 6.3 CERTAIN INDEMNIFICATION-RELATED MATTERS. Any party entitled to indemnification under the provisions of this Article VI will: (a) give prompt notice to the indemnifying party of any claim with respect to which such indemnified party seeks indemnification and (b) unless in such indemnified party's reasonable judgment a conflict of interest between such indemnified and indemnifying parties may exist with respect to such claim, permit such indemnifying party to assume the defense of such claim with counsel reasonably satisfactory to the indemnified party. If such defense is assumed, the indemnifying party will not be subject to any liability for any settlement made without its consent (but such consent will not be unreasonably withheld). An indemnifying party who is not entitled, or elects not, to assume the defense of a claim will not be obligated to pay the fees and expenses of more than one counsel for all parties indemnified by such indemnifying party with respect to such claim, unless in the reasonable judgment of any indemnified party a conflict of interest may exist between such indemnified party and any other of such indemnified parties with respect to such claim, in which case such indemnifying party shall pay the fees and expenses of a sufficient number of counsel so that such conflicts are resolved. 7.1 TERMINATION. This Agreement may be terminated and the purchase and sale of the Purchased Assets and the other Closing Transactions may be abandoned at any time prior to the Closing: (a) by mutual written consent of the board of directors of NATK, the Sub (b) by either of NATK or Seller: (i) if the Closing shall not have occurred on or before January 31, 1996, unless such date is extended by the mutual written agreement of the parties hereto, and in such event, only until the date the Closing has been extended; provided, however, that the right to terminate this Agreement under this Section 7.1(b)(i) shall not be available to any party whose failure to fulfill any obligation under this Agreement has been the cause of, or resulted in, the failure of the Closing to occur on or before that date; or (ii) if any court of competent jurisdiction, or any governmental body, regulatory or administrative agency or commission having appropriate jurisdiction shall have issued an order, decree or ruling or taken any other action restraining, enjoining or otherwise prohibiting the transactions contemplated by this Agreement and such order, decree, ruling or other action shall not have been overturned; or (iii) if the board of directors or managers (as appropriate) of any Seller, in the exercise of its fiduciary duties and after consultation with counsel, shall have withdrawn its recommendation to such corporation's shareholders or such organization's members that they approve of this Agreement, or if the board of directors of NATK, in the exercise of its fiduciary duty and after consultation with counsel, shall have failed to approve of the consummation of the transactions contemplated hereby. 7.2 NOTICE AND EFFECT OF TERMINATION. In the event of the termination and abandonment of this Agreement pursuant to Section 7.1, written notice thereof shall forthwith be given to the other party or parties specifying the provision pursuant to which such termination is made, and this Agreement shall forthwith become void and have no effect without any liability on the part of any party or its directors, officers or shareholders, except for the provisions of this Section 7.2 and Sections 4.4 and 4.9, which shall survive any termination of this Agreement. Nothing contained in this Section 7.2 shall relieve any party from any liability for any breach of this Agreement. 7.3 EXTENSION; WAIVER. Any time prior to the Closing, the parties may (a) extend the time for the performance of any of the obligations or other acts of any other party under or relating to this Agreement; (b) waive any inaccuracies in the representations or warranties by any other party or (c) waive compliance with any of the agreements of any other party or with any conditions to its own obligations. Any agreement on the part of any other party to any such extension or waiver shall be valid only if set forth in an instrument in writing signed on behalf of such party. 7.4 AMENDMENT AND MODIFICATION. This Agreement may not be amended except by an instrument in writing signed by all of the parties hereto. 8.1 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. The respective representations and warranties of the parties hereto shall not be deemed waived or otherwise affected by any investigation made by any other party hereto. Each representation and warranty shall continue for a period of three (3) years after the Closing Date. The provisions of this Section shall have no effect upon any other obligation of the parties, whether to be performed before or after the Closing. 8.2 NOTICES. All notices, requests, demands, waivers and other communications required or permitted to be given under this Agreement shall be in writing and shall be deemed to have been duly given if delivered personally or mailed, certified or registered mail with postage prepaid, or sent by telex, telegram or telecopier, as follows (or at such other address or facsimile number for a party as shall be specified by like notice): (a) if to Seller, at: with a copy to: Gaia Holdings, Inc. Jeffrey Horowitz 4710 Bellaire Blvd., Suite 301 Crain, Caton & James Bellaire, Texas 77401 909 Fannin, Suite 3300 Attention: Henry W. Sullivan/ Houston, Texas 77010 William T. Aldrich Fax: (713) 658-1921 and with a copy to: (b) if to NATK or the Sub, at: with a copy to: North American Technologies Theodore J. Lee Group, Inc. 3104 Edloe, Suite 204 4710 Bellaire Blvd., Suite 301 Houston, Texas 77027 Bellaire, Texas 77401 Fax: (713) 623-0990 NATK and the Sub may rely on any notice it receives in accordance with the above provisions from Thor Ventures or Gaia Holdings as a notice from Seller. Each Seller may rely on any notice it receives in accordance with the above provisions from NATK as a notice from NATK and the Sub. 8.3 ENTIRE AGREEMENT; ASSIGNMENT. This Agreement, including all Exhibits and Schedules hereto, (a) constitutes the entire agreement among the parties with respect to its subject matter and supersedes all prior agreements and understandings, both written and oral, among the parties or any of them with respect to such subject matter and (b) shall not be assigned by operation of law or otherwise, provided that, subject to any approvals required by applicable law, NATK or the Sub may assign its respective rights and obligation to any majority-owning or owned, direct or indirect, parent, subsidiary or subsidiaries of NATK, but no such assignment shall relieve NATK or the Sub of its obligations under this Agreement. 8.4 BINDING EFFECT; BENEFIT. This Agreement shall inure to the benefit of and be binding upon the parties and their respective successors and assigns. Nothing in this Agreement is intended to confer on any person other than the parties to this Agreement or their respective successors and assigns any rights, remedies, obligations or liabilities under or by reason of this Agreement. 8.5 HEADINGS. The descriptive headings of the articles, sections, subsections, exhibits and schedules of this Agreement are inserted for convenience only, do not constitute a part of this Agreement and shall not affect in any way the meaning or interpretation of this Agreement. 8.6. COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original, and all of which together shall be deemed to be one and the same instrument. 8.7 GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the state of Texas, without regard to the laws that might otherwise govern under principles of conflicts of laws applicable thereto. 8.8 ARBITRATION. In the event any party believes any other party hereto has committed a breach of any provision of this Agreement or such parties cannot agree on an interpretation of one or more of the provisions of this Agreement, such parties agree to first meet in Houston, Texas, and discuss the same, and attempt in good faith to resolve such matter. Any such matter, controversy or claim arising out of or relating to this Agreement, or the breach of any provision hereof, that cannot otherwise be resolved between the relevant parties in such a meeting and discussion shall be settled by arbitration in Houston, Texas, in accordance with the Commercial Arbitration Rules of the American Arbitration Association and judgment upon any award rendered by the arbitrator(s) may be entered in any court of competent jurisdiction. Any award rendered may include an award of reasonable attorneys' fees, costs and expenses. 8.9 COURTS IN HARRIS COUNTY, TEXAS TO HAVE EXCLUSIVE JURISDICTION. THE PARTIES AGREE THAT THE FEDERAL AND STATE COURTS LOCATED IN HARRIS COUNTY, TEXAS SHALL HAVE EXCLUSIVE JURISDICTION OVER AN ACTION BROUGHT TO ENFORCE THE RIGHTS AND OBLIGATIONS CREATED IN OR ARISING FROM THIS AGREEMENT TO ARBITRATE, AND EACH PARTIES HERETO IRREVOCABLY SUBMITS TO THE JURISDICTION OF SAID COURTS. NOTWITHSTANDING THE ABOVE, APPLICATION MAY BE MADE BY A PARTY TO ANY COURT OF COMPETENT JURISDICTION WHEREVER SITUATED FOR ENFORCEMENT OF ANY JUDGMENT AND THE ENTRY OF WHATEVER ORDERS ARE NECESSARY FOR SUCH ENFORCEMENT. 8.10 SEVERABILITY. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction or other authority to be invalid, void, unenforceable or against its regulatory policy, the remainder of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 8.11. FURTHER ASSURANCES. From time to time hereafter and without further consideration, each of the parties hereto shall execute and deliver such additional or further instruments of conveyance, assignment, assumption and transfer, and take such actions, as any other party hereto may reasonably request in order to more effectively convey and transfer to such other party the assets, rights or other property to be sold or conveyed to such other party hereunder or as shall be reasonably necessary or appropriate in connection with the carrying out of such other party's obligations hereunder or the purposes of this Agreement. 8.12 CERTAIN DEFINITIONS. As used herein: (a) "affiliate" shall have the meanings ascribed to such term in Rule 12b- 2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended to date (the "Exchange Act"); (b) "business day" shall mean any day other than a Saturday, Sunday or a day on which federally chartered financial institutions are not open for business in the City of Houston, Texas; (c) "Encumbrance" shall mean any lien, claim, charge, pledge, security interest hypothecation or other claim or encumbrance; (d) "Material Adverse Effect" shall mean any adverse effect on the business, condition (financial or otherwise) or results of operation of the relevant party and its subsidiaries, if any, which is material to such party and its subsidiaries, if any, taken as a whole; (e) "Person" means any individual, corporation, partnership, association, trust or other entity or organization, including a governmental or political subdivision or any agency or institution thereof; and (f) "subsidiary" shall mean, when used with reference to an entity, any corporation, a majority of the outstanding voting securities of which is owned directly or indirectly, or a majority of the board of directors of which may be elected, by such entity. IN WITNESS WHEREOF, each of the parties have caused this Agreement to be duly executed by or on behalf of such party, all as of the date first written above. Exhibit A Gaia/Thor Royalty Agreement Exhibit B Gaia-TieTek License Agreement Exhibit C-1 Bill of Sale (GAIA Holdings) Exhibit C-2 Bill of Sale (Thor Industries, Inc.) Exhibit C-3 Bill of Sale (Thor Ventures, L.C.) Exhibit D Assignment of Patents Exhibit E Form of 90 Day Note Exhibit H Aldrich Employment Agreement Exhibit I Sullivan Employment Agreement Exhibit J Option Agreement (Retek Equipment Purchase Option) Exhibit K NATK/Sub Representations and Warranties Exhibit L Representations and Warranties of Seller Exhibit M-1 Termination of License (Saturn-GAIA) Exhibit M-2 Termination of License (Thor-GAIA) Exhibit N Termination of Sublicense Exhibit O Investment Representation Letter	8-K	EX-2.0	1996-01-12T00:00:00	1996-01-12T16:52:02
0000950131-96-000066	0000950131-96-000066_0000.txt	As filed with the Securities and Exchange Commission on January 12, 1996 REGISTRATION STATEMENT UNDER THE SECURITIES Post-Effective Amendment No. 17 [X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY (Check appropriate box or boxes) (Exact Name of Registrant as Specified in Charter) 733 Third Avenue - 3rd Floor (Address of Principal Executive Office)(Zip Code) Registrant's telephone number, including area code: (800) 858-8850 Senior Vice President and General Counsel SunAmerica Asset Management Corp. 733 Third Avenue - 3rd Floor (Name and Address of Agent for Service) Shereff, Friedman, Hoffman, & Goodman LLP Approximate Date of Proposed Public Offering: As soon as practicable after this Registration Statement becomes effective. It is proposed that this filing will become effective (check appropriate box) Registrant has elected to register an indefinite number of shares of beneficial interest, par value $.01 per share, under the Securities Act of 1933 pursuant to Rule 24f-2 under the Investment Company Act of 1940. The Rule 24f-2 Notice for Registrant's fiscal year ended September 30, 1995 was filed on November 14, 1995. Under the Securities Act of 1933 The information required to be included in Part C is set forth under the appropriate item, so numbered in Part C of this Registration Statement. * Included in the Annual Shareholders Report with respect to Registrant's fiscal period ended September 30, 1995. THE SUNAMERICA CENTER, 733 THIRD AVENUE, NEW YORK, NY 10017-3204 GENERAL MARKETING AND SHAREHOLDER INFORMATION SunAmerica Equity Funds is an open-end management investment company organized as a Massachusetts business trust (the "Trust") with six different investment funds (each, a "Fund" and collectively, the "Funds"). Each Fund is a separate series of the Trust with distinct investment objectives and/or strategies. Each Fund is advised and/or managed by SunAmerica Asset Management Corp. (the "Adviser"). AIG Global Investment Corp. ("AIG Global") serves as sub-adviser for the foreign equity component and Goldman Sachs Asset Management International ("GSAM") serves as sub-adviser for the global bond component of the SunAmerica Global Balanced Fund. (AIG Global and GSAM are collectively referred to hereinafter as the "Sub-Advisers"). An investor may invest in one or more of the following Funds: SunAmerica Balanced Assets Fund ("Balanced Assets Fund")--seeks to conserve principal by maintaining at all times a balanced portfolio of stocks and bonds. SunAmerica Global Balanced Fund ("Global Balanced Fund")--seeks capital appreciation while conserving principal by maintaining at all times a balanced portfolio of domestic and foreign stocks and bonds. SunAmerica Blue Chip Growth Fund ("Blue Chip Growth Fund")--seeks capital appreciation by investing primarily in equity securities of companies with large market capitalizations. SunAmerica Mid-Cap Growth Fund ("Mid-Cap Growth Fund")--seeks capital appreciation by investing primarily in equity securities of medium-sized companies. SunAmerica Small Company Growth Fund ("Small Company Growth Fund")--seeks capital appreciation by investing primarily in equity securities of small capitalization growth companies. SunAmerica Growth and Income Fund ("Growth and Income Fund")--seeks capital appreciation and current income by investing primarily in common stocks. Each Fund currently offers Class A shares and Class B shares. The offering price is the next-determined net asset value per share, plus for each class a sales charge which, at the investor's option, may be (i) imposed at the time of purchase (Class A shares) or (ii) deferred (Class B shares and purchases of Class A shares in excess of $1 million). Class B shares are offered without an initial sales charge, although a declining contingent deferred sales charge may be imposed on redemptions made within six years of purchase. Class B shares of each Fund will convert automatically to Class A shares on the first business day of the month following the seventh anniversary of the issuance of such Class B shares and at such time will be subject to the lower distribution fee applicable to Class A shares. Each class makes distribution and account maintenance and service fee payments under a distribution plan pursuant to Rule 12b-1 under the Investment Company Act of 1940, as amended (the "1940 Act"). See "Purchase of Shares." Shares of the Funds are not deposits or obligations of, or guaranteed or endorsed by, any bank through which such shares may be sold, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency. This Prospectus explains concisely what you should know before investing in any of the Funds. Please read it carefully before investing and retain it for future reference. You can find more detailed information about the Funds in the Statement of Additional Information dated January 12, 1996, which is incorporated by reference into this Prospectus, and further information about the performance of the Funds in the Trust's Annual Report to Shareholders. The Statement of Additional Information and Annual Report to Shareholders may be obtained without charge by contacting the Trust at the address or telephone number listed above. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURI- TIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COM- MISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. PROSPECTUS DATED JANUARY 12, 1996 A general comparison of the sales arrangements and other non-recurring expenses applicable to Class A shares and Class B shares follows: (1) The front-end sales charge on Class A shares decreases with the size of the purchase to 0% for purchases of $1,000,000 or more. See "Purchase of Shares." (2) Purchases of Class A shares in excess of $1,000,000 will be subject to a contingent deferred sales charge on redemptions made within one year of purchase. The contingent deferred sales charge on Class B shares applies only if a redemption occurs within six years from their purchase date. (3) A $15.00 fee may be imposed for wire redemptions. (4) The information provided is based on data for the fiscal year ended September 30, 1995, with the exception of Growth and Income Fund Class A and Class B, which represents estimated expenses for the current fiscal year. The Growth and Income Fund's expenses for the year ended September 30, 1995 were .46% for Class A and .30% for Class B, net of expenses waivers and reimbursements. (5) 0.25% of the 12b-1 fee comprises an Account Maintenance and Service Fee. A portion of the Account Maintenance and Service Fee is allocated to member firms of the National Association of Securities Dealers, Inc. for continuous personal service by such members to investors in the Funds, such as responding to shareholder inquiries, quoting net asset values, providing current marketing material and attending to other shareholder matters. Class B shareholders who own their shares for an extended period of time may pay more in Rule 12b-1 distribution fees than the economic equivalent of the maximum front-end sales charge permitted under the Rules of Fair Practice of the National Association of Securities Dealers, Inc. (6) For the fiscal year ended September 30, 1995, the total operating expenses (on a gross basis) for Global Balanced Fund Class A and Class B, Blue Chip Growth Fund Class A, Mid-Cap Growth Fund Class B, and Growth and Income Fund Class A and Class B were: 2.55%, 3.25%, 1.69%, 2.48%, 3.42% and 5.37%, respectively. You would pay the following expenses on a $1,000 investment over various time periods assuming (1) a 5% annual rate of return and (2) redemption at the end of each time period. The 5% return and the expenses used in this example should not be considered indicative of actual or expected performance or expenses both of which will vary: You would pay the following expenses on the same investment, assuming no redemption: The foregoing examples should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. * Class B shares convert to Class A shares on the first business day of the month following the seventh anniversary of the purchase of such Class B shares. Therefore, with respect to the 10-year expense information, years 8, 9 and 10 reflect the expenses attributable to ownership of Class A shares. The following financial highlights for each of the two years ended September 30, 1995 and for the period July 1, 1993 through September 30, 1993 and for the three years in the period ended June 30, 1993 for the Balanced Assets Fund and the periods through September 30, 1995 for the Blue Chip Growth Fund, has been audited by Price Waterhouse LLP, each Fund's independent accountants, whose report on the financial statements containing such information for the five years in the period ended September 30, 1995 is included in the Annual Report to Shareholders. These Financial Highlights should be read in conjunction with each Fund's financial statements and notes thereto, which are included in the Statement of Additional Information and are incorporated by reference herein. (1) Calculated based upon average shares outstanding. (2) Total return is not annualized and does not reflect sales load. (3) Annualized. (4) Net of expense reimbursement equivalent to .29% of average net assets in fiscal 1991. (5) Net of expense reimbursement equivalent to .12% of average net assets in fiscal 1992. (6) Net of expense reimbursement equivalent to .05% of average net assets in fiscal 1993. (7) Net of expense reimbursement equivalent to .04% of average net assets for the period ended September 30, 1993. (8) Shares of the SunAmerica Balanced Assets Fund series of SunAmerica Fund Group were redesignated as Class B shares of SunAmerica Balanced Assets Fund. In addition, the Fund changed its fiscal year end to September 30, effective September 24, 1993. (9) Blue Chip Growth Fund changed its fiscal year end to September 30, effective September 24, 1993. (10) Net of fee waiver equivalent to .05% of average net assets in fiscal 1987. (11) Commencement of sale of respective class of shares. (12) Net of expense reimbursement equivalent to 1.66% of average net assets for the period ended September 30, 1994. (13) Net of fee waiver/expense reimbursement equivalent to .11% of average net assets for the fiscal year ended September 30, 1995. The following financial highlights for the periods through September 30, 1995, has been audited by Price Waterhouse LLP, each Fund's independent accountants, whose report on the financial statements containing such information for the five years in the period ended September 30, 1995 is included in the Annual Report to Shareholders. These Financial Highlights should be read in conjunction with each Fund's financial statements and notes thereto, which are included in the Statement of Additional Information and are incorporated by reference herein. (1) Does not reflect sales load. (2) For the period January 28, 1987 (commencement of operations) to November 30, 1987. (3) Annualized. (4) Net of fee waiver equivalent to .82% and .51% of average net assets of the Mid-Cap Growth Fund and Small Company Growth Fund, respectively, in fiscal 1987. (5) Calculated based upon average shares outstanding. (6) Mid-Cap Growth Fund and Small Company Growth Fund both changed their fiscal year ends to September 30, effective September 24, 1993. (7) Restated to reflect a 0.984460367 for 1.00 stock split effective September 24, 1993. (8) Commencement of sale of respective class of shares. (9) Net of expense reimbursement equivalent to .48% of average net assets for the period ended September 30, 1994. (10) Net of fee waiver/expense reimbursement equivalent to .17% of average net assets for the year ended September 30, 1995. The following financial highlights for each of the periods ended September 30, 1995 for the Global Balanced Fund and the Growth and Income Fund, has been audited by Price Waterhouse LLP, each Fund's independent accountants, whose report on the financial statements containing such information is included in the Annual Report to Shareholders. These Financial Highlights should be read in conjunction with each Fund's financial statements and notes thereto, which are included in the Statement of Additional Information and are incorporated by reference herein. (1) Calculated based upon average shares outstanding. (2)Total return is not annualized and does not reflect sales load. (3)Commencement of sale of respective class of shares. (5)Net of the following fee waivers/expense reimbursements (based on average net assets): The investment objective of the Balanced Assets Fund is to conserve princi- pal by maintaining at all times a balanced portfolio of stocks and bonds. The investment objective of the Global Balanced Fund is to seek capital apprecia- tion while conserving principal by investing in a balanced portfolio of domes- tic and foreign stocks and bonds. The investment objective of the Blue Chip Growth Fund, the Mid-Cap Growth Fund and the Small Company Growth Fund is cap- ital appreciation. Each seeks to achieve this objective through investment primarily in equity securities (common stock and securities convertible into common stock), as described below. Under normal market conditions, at least 65% of the total assets of the Blue Chip Growth Fund, the Mid-Cap Growth Fund and the Small Company Growth Fund will be invested in such securities. The in- vestment objectives of the Growth and Income Fund are capital appreciation and current income. There can be no assurance that the investment objective of a Fund will be achieved. See "Investment Techniques and Risk Factors" for a full discussion of the types of securities in which the Funds may invest and the risks attendant thereto. Except as specifically indicated, the investment policies and strategies de- scribed herein are not fundamental policies of the Funds and may be changed by the Board of Trustees (the "Trustees") without the approval of shareholders. Each Fund's respective investment objective and fundamental investment re- strictions, however, may not be changed without approval of shareholders of the affected Fund. See "Investment Restrictions." In seeking to achieve the investment objective of the Balanced Assets Fund, the Adviser has the flexibility to select among different types of investments for capital growth and income and may alter the composition of the portfolio as economic and market trends change. This investment approach, designated by the Adviser as a "fully managed" investment policy, distinguishes the Balanced Assets Fund from many other investment companies, which often seek either cap- ital appreciation or current income. The Adviser considers both the opportunity for gain and the risk of loss in making investments. While the Adviser anticipates that, over the long term, the portfolio will consist primarily of equity investments, in the form of common and preferred stocks, it may also invest in long-term bonds and other debt securities such as convertible securities, short-term investments, U.S. government securities and warrants and other rights. The Balanced Assets Fund will normally invest at least 25% of its assets in fixed-income senior securi- ties; however, the fixed income component will exceed 25% when the Adviser be- lieves such an adjustment in portfolio mix to be necessary in order to con- serve principal, such as in anticipation of a decline in the equities market. Flexibility to choose among various kinds of investments is a principal fea- ture of the Adviser's fully managed investment approach. The Adviser shifts its emphasis among these different types of investments, as well as among var- ious industry sectors, as financial trends and economic conditions change. For example, one strategy is to increase the investments in equity securities when the Adviser anticipates a generally rising stock market. A corresponding strategy is to reduce investments in equity securities when the Adviser fore- sees a declining stock market or when it believes that the total return from debt or convertible securities and short-term investments can be expected to exceed returns from equity investments. In selecting equity investments, the Adviser typically seeks companies of medium to large capitalizations (generally $800 million or more) that, based on their future prospects or opportunities, it believes are undervalued in the marketplace; however, the Fund intends to limit its investments in companies with market capitalizations of less than $800 million to 20% of its total as- sets. Consistent with the Adviser's approach to equity selection, the Adviser will direct the sale of equity investments that it judges to be overpriced or when it believes other investments offer better values. Investments in compa- nies with market capitalizations of less than $800 million may be more vola- tile than investments in companies with larger market capitalizations. In selecting debt investments, the Adviser is primarily concerned with de- termining the most appropriate time to buy and sell debt securities. The Ad- viser seeks debt securities with longer maturities during periods of antici- pated lower interest rates and shorter-term debt securities when interest rates are expected to rise. The Adviser generally selects long-term debt secu- rities from high-quality bonds (rated "AA" or higher by Standard & Poor's Rat- es, a Division of The McGraw-Hill Companies Inc. ("S&P"), "Aa" or higher by Moody's Investors Service, Inc. ("Moody's"), or determined by the Adviser to be of equivalent quality if unrated) to achieve income and capital gains. The Adviser may also invest the Fund's assets in high-quality, short-term debt se- curities (such as commercial paper rated "A-1" by S&P or "P-1" by Moody's or determined by the Adviser to be of equivalent quality if unrated). However, the Adviser may invest up to 10% of the value of the Fund's total assets (mea- sured at the time of investment) in securities rated as low as "BBB" by S&P or "Baa" by Moody's (or determined by the Adviser to be of equivalent quality if unrated). See "Fixed Income Securities" in "Investment Techniques and Risk Factors" below for a discussion of the risks associated with investing in such securities. See also the Appendix to the Statement of Additional Information for a description of securities ratings. In seeking to achieve the investment objective of the Global Balanced Fund, the Adviser and the Sub-Advisers have the flexibility to select among a combi- nation of domestic and foreign equity and debt securities designed for capital growth and/or income, which will be varied from time to time both with respect to types of securities and markets in response to changing markets and eco- nomic trends. This investment approach, designated by the Adviser as a "fully managed" investment policy, distinguishes the Global Balanced Fund from many other investment companies, which often seek either capital appreciation or current income. In addition, the Fund may employ a variety of instruments and techniques to enhance performance and to hedge against market and currency risks as described further below. Investment in foreign securities involves risks not generally associated with investment in domestic securities. See "Investment Techniques and Risk Factors" below and the Statement of Additional Information for a full discussion of the risks associated with investment in foreign securities. The Adviser and Sub-Advisers consider both the opportunity for gain and the risk of loss in making investments. While it is anticipated that, over the long term, the portfolio will consist primarily of foreign and domestic equity securities, in the form of common and preferred stocks, the Fund may also in- vest in global bonds and other global debt securities such as convertible se- curities, short-term instruments, securities of U.S. and foreign governments and warrants and other rights. Under normal circumstances, the Fund will in- vest at least (i) 25% of its assets in global fixed-income senior securities; (ii) 10% of its assets in domestic equity securities; and (iii) 45% of its as- sets in foreign equity securities. Each component may exceed its designated minimum when it is believed that such an adjustment in portfolio mix is neces- sary in order to enhance performance or conserve principal. In addition, it is anticipated that, under normal circumstances, the Fund will invest its assets in at least 10 countries at any time, although it is only required, under such circumstances, to maintain investments in at least three countries (one of which may be the United States). Notwithstanding the foregoing, the number of countries in which the Fund actually invests may vary from time to time when, in the opinion of the Adviser and/or Sub-Advisers, economic or political con- ditions warrant investment in a greater or lesser number of countries. Fur- thermore, the Fund reserves the right to invest substantially all of its as- sets in U.S. markets or U.S. dollar-denominated obligations when market condi- tions warrant such an investment decision. The allocation among the components will be reviewed by the Adviser and Sub-Advisers on at least a monthly basis. In determining the allocation of assets among countries and/or capital mar- kets, the Adviser and Sub-Advisers will consider, among other factors, the relative valuation, condition and growth potential of the various economies, including interest rates, monetary and fiscal policy, current and anticipated changes in the rates of economic growth, rates of inflation, corporate prof- its, capital reinvestment resources, self-sufficiency, balance of payments, governmental deficits or surpluses and other pertinent financial, social and political factors which may affect such markets. In allocating between equity and debt securities within each market, consideration will also be given to the relative opportunity for capital appreciation of equity and debt securi- ties, dividend yields, and the level of interest rates paid on debt securities of various maturities. In selecting securities denominated in foreign currencies, each Sub-Adviser will consider, among other factors, the effect of movement in currency ex- change rates on the U.S. dollar value of such securities. An increase in the value of a currency can be expected to increase the value of the Fund's secu- rities denominated in such currency, while a decline in the value of the currency could produce the opposite effect. A Sub-Adviser may seek to hedge all or a portion of the Fund's foreign securities through the use of forward foreign currency contracts, currency options, futures contracts and options thereon. The Fund will also engage in such transactions to enhance returns. See "Investment Techniques and Risk Factors" below. It is expected that the Fund will employ certain active currency and inter- est-rate management techniques involving risks different from those associated with investing solely in dollar-denominated securities of U.S. issuers. Such include transactions in options (including yield curve options), futures, op- tions on futures, forward foreign currency exchange contracts, currency op- tions and futures, currency and interest rate swaps, mortgage swaps, caps, collars and floors. The aggregate amount of the Fund's net currency exposure will not exceed its total asset value. However, to the extent that the Fund is fully invested in securities while also maintaining currency positions, it may be exposed to greater combined risk. The Fund's net currency positions may ex- pose it to risks independent of its securities positions. See "Risks and Con- siderations Applicable to Investment in Securities of Foreign Issuers" and "Foreign Currency Transactions" in "Investment Techniques and Risk Factors" below. While there are no prescribed limits on the geographical allocation of the Fund's assets, the Adviser anticipates that investment of the Fund's assets will be subject to the following guidelines, which may be revised from time to time as market conditions warrant: In addition, no more than 20% of the Fund's total assets will be invested in countries or regions with relatively low gross national product per capita compared to the world's major economies, and in countries or regions with the potential for rapid economic growth ("emerging markets"). Emerging markets will include any country: (i) having an "emerging stock market" as defined by the International Finance Corporation; (ii) with low-to middle-income econo- mies according to the International Bank for Reconstruction and Development (the "World Bank"); (iii) listed in World Bank publications as developing; or (iv) determined by the Adviser or a Sub-Advisers to be an emerging market as defined above. The Fund may invest in securities of: (i) companies the princi- pal securities trading market for which is located in an emerging market coun- try; (ii) companies organized under the laws of, and with a principal office in, an emerging market country; (iii) companies whose principal activities are located in emerging market countries; or (iv) companies traded in any market that derive 50% or more of their total revenue from either goods or services produced in an emerging market or sold in an emerging market. None of the Fund's fixed income investments will be in emerging markets or countries. See "Investment Techniques and Risk Factors" below for a discussion of the risks associated with investments in emerging markets. Within the portion of the Fund's portfolio allocated to equity securities, the Adviser, with respect to the domestic equity component of the Fund, and AIG Global, with respect to the foreign equity component of the Fund, will each seek to identify the securities of companies and industry sectors which are expected to provide high total return relative to alternative equity in- vestments. The Fund generally will seek to invest in securities which are be- lieved to be undervalued. Undervalued issues include securities selling at a discount from the price-to-book value ratios and price/earnings ratios com- puted with respect to the relevant stock market averages. The Fund may also consider as undervalued, securities selling at a discount from their historic price-to-book value or price/earnings ratios, even though these ratios may be above the ratios for the stock market averages. Securities offering dividend yields higher than the yields for the relevant stock market averages or higher than such securities' historic yield may also be considered to be undervalued. The Fund may also invest in the securities of small and emerging growth compa- nies when such companies are expected to provide a higher total return than other equity investments. Such companies are characterized by rapid historical growth rates, above-average returns on equity or special investment value in terms of their products or services, research capabilities or other unique at- tributes. The Adviser and AIG Global will seek to identify small and emerging sess superior management, marketing ability, research and product development skills and sound balance sheets. See "Investment Techniques and Risk Factors" below for a discussion of the risks associated with investments in small com- panies. The debt securities in which the Fund may invest include securities issued or guaranteed by the U.S. government and its agencies or instrumentalities, by foreign governments (including foreign states, provinces and municipalities) and agencies or instrumentalities thereof and debt obligations issued by U.S. and foreign corporations. Such securities may include mortgage-backed securi- ties issued or guaranteed by governmental entities or by private issuers. In addition, the Fund may invest in debt securities issued or guaranteed by in- ternational organizations designed or supported by multiple governmental enti- ties (which are not obligations of the U.S. government or foreign governments) to promote economic reconstruction or development ("supranational entities") such as the World Bank. The Fund may also invest in certificates of deposit, bankers' acceptances, time deposits of certain size banks, commercial paper and asset-backed securities, and enter into dollar rolls. Under normal circum- stances, GSAM expects that at least 30% of the fixed income component, ad- justed to reflect such component's net exposure after giving effect to cur- rency transactions and positions, will be denominated in U.S. dollars. Fur- ther, because the securities markets in each of Canada, Germany, Japan and the United Kingdom are highly developed, liquid and subject to extensive regula- tions, GSAM may invest more than 25% of the fixed income component in the se- curities of corporate and government issuers located in any of one of such countries. Allocation of investments in such issuers could subject the Fund to the risks of adverse social, political or economic events which may occur in those countries. The obligations of foreign governmental entities have various kinds of gov- ernment support and include obligations issued or guaranteed by foreign gov- ernmental entities with taxing power. These obligations may or may not be sup- ported by the full faith and credit of a foreign government. The Fund will in- vest in foreign government securities of issuers considered stable by GSAM. GSAM does not believe that the credit risk inherent in the obligations of sta- ble foreign governments is significantly greater than that of U.S. government securities. The Fund may invest the portion of its assets allocated to debt obligations in the securities of governmental issuers and in corporate debt securities, including convertible debt securities, rated "BBB" or better by S&P or "Baa" or better by Moody's or which, in GSAM's judgement, possess similar credit characteristics ("investment grade bonds"). Notwithstanding the foregoing, it is expected that the Fund will generally invest a significant portion of such component in securities having the highest applicable credit quality rating or, if unrated, determined by GSAM at the time of investment to be of compara- ble quality, with the remainder of such component invested in securities rated of high quality by S&P or Moody's (i.e., "AA" or "Aa") or of comparable quali- ty. However, with respect to obligations of a government issuer, the Fund may invest in such obligations if rated "A" or better by S&P or Moody's, or if unrated, determined by GSAM to be of comparable credit quality; provided that the obligations are denominated in the issuer's own currency. See "Fixed In- come Securities" in "Investment Techniques and Risk Factors" below for a dis- cussion of the risks associated with investing in debt securities rated in the fourth highest rating category. See also the Statement of Additional Informa- tion for more information regarding ratings of debt securities. The ratings assigned by S&P and Moody's are considered as one of several factors in GSAM's independent credit analysis of issuers. The average maturity of the Fund's portfolio of debt securities will vary based on GSAM's assessment of pertinent economic market conditions. As with all debt securities, changes in market yields will affect the value of such securities. Prices generally increase when interest rates decline and decrease when interest rates rise. Prices of longer term securities generally fluctuate more in response to interest rate changes than do the prices of shorter-term securities. The Fund may use various techniques to shorten or lengthen the dollar-weighted average duration of its fixed income portfolio, including the acquisition of debt obligations at a premium or discount, transactions in op- tions, futures contracts and options on futures and interest rate swaps, mort- gage swaps, caps and floors. Under normal circumstances, the Fund will main- tain a dollar-weighted average duration of not more than 7.5 years. However, the Fund is not subject to any limitation with respect to the average maturity of its portfolio or the individual securities in which the Fund may invest. See "Hedging and Income Enhancement Strategies" and "Special Risks of Hedging and Income Enhancement Strategies" in "Investment Techniques and Risk Factors" below for more information concerning the use of these investment techniques. The Blue Chip Growth Fund will invest, under normal circumstances, at least 65% of its total assets in equity securities of companies with large market capitalizations, and which have conducted operations for at least five years. A "blue chip" or "large-cap" stock is one which the Adviser considers compara- ble to the stocks included in the Standard & Poor's 500 Index ("S&P 500") at the time of purchase, and which has a minimum market capitalization of $5 bil- lion, and that is traded on the New York Stock Exchange ("NYSE"), American Stock Exchange ("AMEX") or on other national exchanges or on foreign ex- changes. The Fund may also invest in equity securities that are (i) issued by small companies which are believed by the Adviser to have significant growth potential; (ii) issued by companies considered by the Adviser to be underval- ued or overlooked and that have above-average earnings growth or value; or (iii) unlisted, but these will generally be securities that have an estab- lished over-the-counter market, although the depth and liquidity of that mar- ket may vary from time to time and from security to security. In pursuing its investment objective, the Fund may, under normal circumstances, invest up to 35% of its total assets in debt securities that have the potential for capital appreciation due to anticipated market conditions. The Fund may invest in se- curities rated as low as "BBB" or "Baa." See "Fixed Income Securities" in "In- vestment Techniques and Risk Factors" below for a discussion of the risks as- sociated with investing in such securities. The Mid-Cap Growth Fund will invest, under normal circumstances, at least 65% of its total assets in the equity securities of medium-sized companies ("Mid-Cap Companies") with market capitalizations of $1 billion to $5 billion, which have conducted operations for at least five years. The Fund may also in- vest in equity securities that are issued by (i) small companies which are be- lieved by the Adviser to have significant growth potential, or (ii) companies considered by the Adviser to have above-average earnings growth or value. A significant portion of the Fund's equity investments are in securities listed on the NYSE or other national securities exchanges or on foreign exchanges. The Fund will also invest in unlisted securities, but these will generally be securities that have an established over-the-counter market, although the depth and liquidity of that market may vary from time to time and from secu- rity to security. In pursuing its investment objective, the Fund may, under normal circumstances, invest up to 35% of its total assets in debt securities that have the potential for capital appreciation due to anticipated market conditions. The Fund may invest in securities rated as low as "BBB" or "Baa." See "Fixed Income Securities" in "Investment Techniques and Risk Factors" be- low for a discussion of the risks associated with investing in such securi- ties. The Small Company Growth Fund pursues its investment objective by investing, under normal circumstances, at least 65% of its total assets in the equity se- curities of small, lesser known or new growth companies or industries, such as telecommunications, media and biotechnology. Such "Small Cap" companies will typically have market capitalizations of under $1 billion and have achieved, or are expected to achieve, growth or earnings over various major business cy- cles. The Fund may invest in securities issued by well known and established domestic or foreign companies, as well as in newer and less-seasoned compa- nies. Such securities may be listed on an exchange or traded over-the-counter. See "Investment in Small Companies" in "Investment Techniques and Risk Fac- tors" below for a discussion of the risks associated with investing in small companies. In pursuing its investment objectives, the Fund may, under normal circumstances, invest up to 35% of its total assets in debt securities that have the potential for capital appreciation due to anticipated market condi- tions. The Fund may invest in securities rated as low as "BBB" or "Baa." See "Fixed Income Securities" in "Investment Techniques and Risk Factors" below for a discussion of the risks associated with investing in such securities. The Growth and Income Fund will invest primarily in common stocks that offer ital appreciation, current income, or both. The Fund may also purchase corpo- rate bonds, notes, debentures, preferred stocks, convertible securities (both debt securities and preferred stocks) or U.S. government securities, if the Adviser determines that their purchase would help further the achievement of the Fund's investment objectives. In addition, the Fund may invest in equity securities that are (i) issued by small companies which are believed by the Adviser to have significant growth potential; (ii) issued by companies consid- ered by the Adviser to be undervalued or overlooked and that have above-aver- age earnings growth or value; or (iii) unlisted, but these will generally be securities that have an established over-the-counter market, although the depth and liquidity of that market may vary from time to time and from secu- rity to security. The types of securities held by the Fund may vary from time to time in light of the Fund's investment objectives, changes in interest rates, and economic and other factors. The Fund may also hold a portion of its assets in cash or money market instruments. At times, when market conditions warrant, the Fund may, as a temporary defensive measure, invest without limi- tation in debt securities or preferred stocks, or invest in any other securi- ties which the Adviser considers consistent with a defensive posture. See "In- vestment in Small Companies" in "Investment Techniques and Risk Factors" below for a discussion of the risks associated with investment in small companies. The Fund is authorized to invest a portion of its debt portfolio in fixed income securities rated below investment grade by a nationally recognized statistical rating organization or in unrated securities which, in the Adviser's judgment, possess similar credit characteristics ("high yield bonds"). The Adviser has adopted a policy that the Fund will not invest more than 15% of the Fund's total assets in obligations rated below "BBB" or "Baa." Investment in high yield bonds (which are commonly referred to as "junk" bonds) involves substantial risk. Investments in high yield bonds will be made only when, in the judgment of the Adviser, such securities provide attractive total return potential, relative to the risk of such securities, as compared to higher quality debt securities. Securities rated "BB" or lower by S&P or "Ba" or lower by Moody's are considered by those rating agencies to have varying degrees of speculative characteristics. Consequently, although high yield bonds can be expected to provide higher yields, such securities may be subject to greater market price fluctuations and risk of loss of principal than lower yielding, higher rated fixed income securities. The Fund generally will not invest in debt securities in the lowest rating categories ("CC" or lower for S&P or "Ca" or lower for Moody's) unless the Adviser believes that the financial condition of the issuer or the protection afforded the particular securities is stronger than would otherwise be indicated by such low ratings. In the event the rating of a debt security is down-graded below the lowest rating category deemed by the Adviser to be acceptable for the Fund's investments, the Adviser will determine on a case-by-case basis the appropriate action to best serve the interest of shareholders, including disposition of the security. See the Statement of Additional Information for additional information regarding high yield bonds. High yield bonds may be issued by less creditworthy companies or by larger, highly leveraged companies and are frequently issued in corporate restructurings such as mergers and leveraged buyouts. Such securities are par- ticularly vulnerable to adverse changes in the issuer's industry and in gen- eral economic conditions. High yield bonds frequently are junior obligations of their issuers, so that in the event of the issuer's bankruptcy, claims of the holders of high yield bonds will be satisfied only after satisfaction of the claims of senior security-holders. While the high yield bonds in which the Fund may invest normally do not include securities which, at the time of in- vestment, are in default or the issuers of which are in bankruptcy, there can be no assurance that such events will not occur after the Fund purchases a particular security, in which case the Fund may experience losses and incur costs. High yield bonds tend to be more volatile than higher rated fixed income se- curities so that adverse economic events may have a greater impact on the prices of high yield bonds than on higher rated fixed income securities. Like higher rated fixed income securities, high yield bonds are generally purchased and sold through dealers who make a market in such securities for their own accounts. However, there are fewer dealers in the high yield bond market which may be less liquid than the market for higher rated fixed income securities even under normal economic conditions. Also, there may be significant dispari- ties in the prices quoted for high yield bonds by various dealers. Adverse economic conditions or investor perceptions (whether or not based on economic damentals) may impair the liquidity of this market and may cause the prices the Fund receives for its high yield bonds to be reduced, or the Fund may ex- perience difficulty in liquidating a portion of its portfolio. Under such con- ditions, judgment may play a greater role in valuing certain of the Fund's portfolio securities than in the case of securities trading in a more liquid market. INVESTMENT TECHNIQUES AND RISK FACTORS ILLIQUID SECURITIES. Each Fund may invest up to 10% of its net assets, determined as of the date of purchase, in illiquid securities including repurchase agreements which have a maturity of longer than seven days, securities with legal or contractual restrictions on resale (restricted securities), and securities that are not readily marketable in securities markets either within or without the United States. Restricted securities eligible for resale pursuant to Rule 144A under the Securities Act of 1933, as amended, or certain private placements of commercial paper issued in reliance on an exemption from such Act pursuant to Section 4(2) thereof, that have a readily available market are not considered illiquid for purposes of a Fund's 10% limitation on purchases of illiquid securities. Because it is not possible to predict with assurance how the market for restricted securities will develop, the Adviser (or Sub-Advisers) will monitor the liquidity of such restricted securities under the supervision of the Trustees. To the extent that, for a period of time, qualified institutional buyers cease purchasing such restricted securities pursuant to Rule 144A, the Fund's investing in such securities may have the effect of increasing the level of illiquidity in the Fund's portfolio during such period. See "Illiquid Securities" in the Statement of Additional Information for a discussion of the risks associated with investments in such securities. REPURCHASE AGREEMENTS. Each Fund may enter into repurchase agreements in order to generate income while providing liquidity. When a Fund acquires a security from a bank or securities dealer, it may simultaneously enter into a repurchase agreement, wherein the seller agrees to repurchase the security at a mutually agreed-upon time (generally within seven days) and price. The repurchase price is in excess of the purchase price by an amount which reflects an agreed-upon market rate of return, which is not tied to the coupon rate or maturity of the underlying security. Repurchase agreements will be fully collateralized. If, however, the seller defaults on its obligation to repurchase the underlying security, the Fund may experience delay or difficulty in exercising its rights to realize upon the security and might incur a loss if the value of the security has declined. The Fund might also incur disposition costs in liquidating the security. There is no limit on the amount of a Fund's net assets that may be subject to repurchase agreements having a maturity of seven days or less for temporary defensive purposes. SHORT-TERM AND TEMPORARY DEFENSIVE INVESTMENTS. In addition to their primary investments, each Fund may also invest up to 10% of its total assets in money market instruments for liquidity purposes (to meet redemptions and expenses). For temporary defensive purposes, each Fund may invest up to 100% of its total assets in fixed-income securities, including corporate debt obligations and money market instruments rated in one of the two highest categories by a nationally recognized statistical rating organization (or determined by the Adviser or Sub-Advisers to be of equivalent quality). Money market instruments include securities issued or guaranteed by the U.S. government, its agencies or instrumentalities, repurchase agreements, commercial paper, bankers' acceptances and certificates of deposit. See the Appendix to the Statement of Additional Information for a description of securities ratings. U.S. GOVERNMENT SECURITIES. Each Fund may invest in U.S. Treasury securities, including bills, notes, bonds and other debt securities issued by the U.S. Treasury. These instruments are direct obligations of the U.S. government and, as such, are backed by the "full faith and credit" of the United States. They differ primarily in their interest rates, the lengths of their maturities and the dates of their issuances. Each Fund may also invest in securities issued by agencies of the U.S. government or instrumentalities of the U.S. government. These obligations, including those which are guaranteed by Federal agencies or instrumentalities, may or may not be backed by the full faith and credit of the United States. Obligations of the Government National Mortgage Association ("GNMA"), the Farmers Home Administration and the Export-Import Bank are backed by the full faith and credit of the United States. In the case of securities not backed by the full faith and credit of the United States, a Fund must look principally to the agency issuing or guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the United States if the agency or instrumentality does not meet its commitments. Mortgage-backed Government Securities. The Balanced Assets Fund and the Global Balanced Fund may, in addition to the securities noted above, invest in mortgage-backed securities, including those representing an undivided ownership interest in a pool of mortgages, e.g., GNMA, Federal National Mortgage Association and Federal Home Loan Mortgage Corporation Certificates. The U.S. government or the issuing agency guarantees the payment of interest and principal of these securities. However, the guarantees do not extend to the securities' yield or value, which are likely to vary inversely with fluctuations in interest rates. These certificates are in most cases "pass- through" instruments, through which the holder receives a share of interest and principal payments from the mortgages underlying the certificate, net of certain fees. Because the prepayment characteristics of the underlying mortgages vary, it is not possible to predict accurately the average life of a particular issue of pass-through certificates. Mortgage-backed securities are often subject to more rapid repayment than their stated maturity date would indicate as a result of the pass-through of prepayments of principal on the underlying mortgage obligations. During periods of declining interest rates, prepayment of mortgages underlying mortgage-backed securities can be expected to accelerate. In addition, the Fund may invest in collaterized mortgage obligations and stripped mortgage-backed securities, including interest-only and principal-only securities. While interest-only and principal-only securities are generally regarded as being illiquid, such securities may be deemed to be liquid if they can be disposed of promptly in the ordinary course of business at a value reasonably close to that used in the calculation of the Fund's net asset value per share. Only government interest-only and principal- only securities backed by fixed-rate mortgages and determined to be liquid under guidelines and standards established by the Trustees may be considered liquid not subject to a Fund's limitation on investment in illiquid securities. See "U.S. Government Securities" in the Statement of Additional Information for a further discussion of those types of securities. FIXED INCOME SECURITIES. In addition to U.S. government securities, each Fund may invest, subject to the percentage and credit quality limitations stated in the prospectus, in debt securities, including corporate obligations issued by domestic and foreign corporations and money market instruments, without regard to the maturities of such securities. Those debt securities which are rated "BBB" or "Baa", while considered to be "investment grade", may have speculative characteristics and changes in economic conditions or other circumstances are more likely to lead to a weakened capacity to make principal and interest payments than is the case with higher grade bonds. As a conse- quence of the foregoing, the opportunities for income and gain may be limited. While the Funds have no stated policy with respect to the disposition of secu- rities whose ratings fall below investment grade, each occurrence is examined by the Adviser or Sub-Advisers to determine the appropriate course of action. ASSET-BACKED SECURITIES. The Global Balanced Fund may invest in asset-backed securities. These securities, issued by trusts and special purpose corporations, are backed by a pool of assets, such as credit card or automobile loan receivables, representing the obligations of a number of different parties. Corporate asset-backed securities present certain risks. For instance, in the case of credit card receivables, these securities may not have the benefit of any security interest in the related collateral. See the Statement of Additional Information for further information on these securities. ZERO COUPON BONDS, DEFERRED INTEREST BONDS AND PIK BONDS. Fixed income securities in which the Global Balanced Fund and Growth and Income Fund may invest also include zero coupon bonds, deferred interest bonds and bonds on which the interest is payable in kind ("PIK bonds"). Zero coupon and deferred interest bonds are debt obligations which are issued or purchased at a significant discount from face value. The discount approximates the total amount of interest the bonds will accrue and compound over the period until maturity or the first interest payment date at a rate of interest reflecting the market rate of the security at the time of issuance. While zero coupon bonds do not require the periodic payment of interest, deferred interest bonds provide for a period of delay before the regular payment of interest begins. PIK bonds are debt obligations which provide that the issuer thereof may, at its option, pay interest on such bonds in cash or in the form of additional debt obligations. Such investments benefit the issuer by mitigating its need for cash to meet debt service, but also require a higher rate of return to attract investors who are willing to defer receipt of such cash. Such investments may experience greater volatility in market value due to changes in interest rates and other factors than debt obligations which make regular payments of interest. A Fund will accrue income on such investments for tax and accounting purposes, as required, which is distributable to shareholders and which, because no cash is received at the time of accrual, may require the liquidation of other portfolio securities under disadvantageous circumstances to satisfy the Fund's distribution obligations. WARRANTS. Each Fund may invest in warrants which give the holder of the warrant a right to purchase a given number of shares of a particular issue at a specified price until expiration. A Fund may not invest more than 5% of its total assets in such warrants, and, of such amount, no more than 2% of total assets in warrants not listed on the NYSE or AMEX. INVESTMENT IN SMALL COMPANIES. The Small Company Growth Fund will invest, and the other Funds may each invest, in small companies having market capitalizations of under $1 billion. It may be difficult to obtain reliable information and financial data on such companies and the securities of these small companies may not be readily marketable, making it difficult to dispose of shares when desirable. Securities of small or emerging growth companies may be subject to more abrupt or erratic market movements than larger, more established companies or the market average in general. A risk of investing in smaller, emerging companies is that they often have limited product lines, markets or financial resources, and their securities may be subject to more abrupt or erratic market movements than securities of larger, more established companies or the market averages in general. In addition, certain issuers in which these Funds may invest may face difficulties in obtaining the capital necessary to continue in operation and may go into bankruptcy, which could result in a complete loss of the Fund's investment. WHEN-ISSUED AND DELAYED-DELIVERY TRANSACTIONS. Each Fund may purchase or sell securities on a when-issued or delayed-delivery basis. When-issued or delayed-delivery transactions arise when securities are purchased or sold by a Fund with payment and delivery taking place a month or more in the future in order to secure what is considered to be an advantageous price and yield to the Fund at the time of entering into the transaction. While the Fund will only purchase securities on a when-issued or delayed-delivery basis with the intention of acquiring the securities, the Fund may sell the securities before the settlement date, if it is deemed advisable. At the time the Fund makes the commitment to purchase securities on a when-issued or delayed-delivery basis, the Fund will record the transaction and thereafter reflect the value, each day, of such security in determining the net asset value of the Fund. At the time of delivery of the securities, the value may be more or less than the purchase price. The Fund will maintain in a segregated account of the Fund liquid assets having a value equal to or greater than the Fund's purchase commitments. The Fund will likewise segregate liquid assets in respect of securities sold on a delayed-delivery basis. Subject to this requirement, each Fund may purchase securities on such basis without limitation. FOREIGN SECURITIES. Although foreign securities are generally not expected to constitute a significant portion of any Fund's investment portfolio (other than the Global Balanced Fund), each Fund is authorized to invest, without limitation, in foreign securities. A Fund may purchase securities issued by issuers in any country; provided, that a Fund (other than the Global Balanced Fund) may not invest more than 25% of its total assets in the securities is- sued by entities domiciled in any one foreign country. Foreign investments may be affected favorably or unfavorably by changes in currency rates and ex- change-control regulations and costs will be incurred in connection with con- versions between various currencies. The value of a security may fluctuate as a result of currency exchange rates in a manner unrelated to the underlying value of the security. There may be less publicly available information about a foreign company than about a U.S. company, and foreign companies may not be subject to uniform accounting, auditing and financial reporting standards and requirements comparable to those applicable to U.S. companies. Securities of some foreign companies may be less liquid or more volatile than securities of U.S. companies, and foreign brokerage commissions and custodian fees are gen- erally higher than in the U.S. In addition, there is generally less governmental regulation of stock ex- changes, brokers and listed companies abroad than in the U.S. Investments in foreign securities may also be subject to other risks, different from those affecting U.S. investments, including local political or economic develop- ments, expropriation or nationalization of assets and imposition of withhold- ing taxes on dividend or interest payments. Each Fund may also invest in securities of foreign issuers in the form of American Depositary Receipts (ADRs), European Depositary Receipts (EDRs), Global Depositary Receipts (GDRs) or other similar securities convertible into securities of foreign issuers. These securities may not necessarily be denominated in the same currency as the securities into which they may be converted. ADRs are certificates issued by a U.S. depository (usually a bank) and represent a specified quantity of shares of an underlying non-U.S. stock on deposit with a custodian bank as collateral. EDRs, GDRs and other types of depositary receipts are typically issued by foreign depositaries, although they may also be issued by U.S. depositaries, and evidence ownership interests in a security or pool of securities issued by either a foreign or a U.S. corporation. Each Fund also may invest in securities denominated in European Currency Units (ECUs). An ECU is a "basket" consisting of specified amounts of currencies of certain of the twelve member states of the European Community. The specific amount of currencies comprising the ECU may be adjusted by the Council of Ministers of the European Community from time to time to reflect changes in relative values of the underlying currencies. In addition, the Funds may invest in securities denominated in other currency "baskets." See "Foreign Securities" in the Statement of Additional Information for a further discussion of these types of securities. Emerging Markets. Investment may be made from time to time in issuers domi- ciled in, or governments of, developing countries or emerging markets as well as developed countries. Although there is no universally accepted definition, a developing country is generally considered to be a country which is in the initial stages of its industrialization cycle with a low per capita gross na- tional product. Historical experience indicates that the markets of developing countries or emerging markets have been more volatile than the markets of de- veloped countries; however, such markets can provide higher rates of return to investors. Investment in an emerging market country may involve certain risks, including a less diverse and mature economic structure, a less stable politi- cal system, an economy based on only a few industries or dependent on interna- tional aid or development assistance, the vulnerability to local or global trade conditions, extreme debt burdens, or volatile inflation rates. Risks and Considerations Applicable to Investment in Securities of Foreign Issuers. Elements of risk and opportunity when investments in foreign issuers are made include trade imbalances and related economic policies; currency fluctuations; foreign exchange control policies; expropriation or confiscatory taxation; limitation on the removal of funds or other assets; political or so- cial instability; the diverse structure and liquidity of securities markets in various countries and regions; policies of governments with respect to possi- ble nationalization of their industries; and other specific local political and economic considerations. Foreign companies and foreign investment prac- tices are generally not subject to uniform accounting, auditing and financial reporting standards and practices or regulatory requirements comparable to those of U.S. companies. There may by less information publicly available about foreign companies. Investment decisions made in the context of the Funds' objectives and policies involve the evaluation of opportunities and risks presented by probable future currency relationships, especially during periods of broad adjustments in such relationships. The performance of investments in securities denominated in a foreign cur- rency ("non-dollar securities") will depend on, among other things, the strength of the foreign currency against the dollar and the interest rate en- vironment in the country issuing the foreign currency. Absent other events which could otherwise affect the value of non-dollar securities (such as a change in the political climate or an issuer's credit quality), appreciation in the value of the foreign currency generally can be expected to increase the value of a Fund's non-dollar securities in terms of U.S. dollars. A rise in foreign interest rates or decline in the value of foreign currencies relative to the U.S. dollar generally can be expected to depress the value of the Fund's non-dollar securities. Currencies are evaluated on the basis of funda- mental economic criteria (e.g., relative inflation levels and trends, growth rate forecasts, balance of payments status and economic policies) as well as technical and political data. Foreign Currency Transactions. Currency exchange rate fluctuations are a ma- jor area of risk and opportunity for the Global Balanced Fund. The Fund has the ability to hold a portion of its assets in foreign currencies and to enter into forward foreign currency exchange contracts. It may also purchase and sell exchange-traded futures contracts relating to foreign currency and pur- chase and sell put and call options on currencies and futures contracts. A significant portion of the Fund's currency transactions will be over-the- counter transactions. The Global Balanced Fund may enter into forward foreign currency exchange contracts to reduce the risks of fluctuations in exchange rates; however, these contracts cannot eliminate all such risks and do not eliminate fluctua- tions in the prices of the Fund's portfolio securities. For example, purchas- ing (selling) a currency forward limits the Fund's exposure to risk of loss from a rise (decline) in the U.S. dollar value of the currency, but also lim- its its potential for gain from a decline (rise) in the currency's U.S. dollar value. The Global Balanced Fund may purchase and write put and call options on cur- rencies for the purpose of protecting against declines in the U.S. dollar value of foreign portfolio securities and against increases in the U.S. dollar cost of foreign securities to be acquired. As with other kinds of option transactions, however, the writing of an option on currency will constitute only a partial hedge, up to an amount of the premium received. The Fund could be required to purchase or sell currencies at disadvantageous exchange rates, thereby incurring losses. The purchase of an option on currency may constitute an effective hedge against exchange rate fluctuations; however, in the event of exchange rate movements adverse to the Fund's position, the Fund may for- feit the entire amount of the premium plus related transaction costs. The Global Balanced Fund may enter into forward foreign currency exchange contracts, currency options and currency swaps for non-hedging purposes when a Sub-Adviser anticipates that a foreign currency will appreciate or depreciate in value, but securities denominated in that currency do not present attrac- tive investment opportunities or are not included in the Fund. The Fund may use currency contracts and options to cross-hedge, which involves selling or purchasing instruments in one currency to hedge against changes in exchange rates for a different currency with a pattern of correlation. To limit any leverage in connection with currency contract transactions for non-hedging purposes, the Fund will segregate liquid assets such as cash, U.S. government securities or other appropriate high-grade obligations in an amount sufficient to meet its payment obligations in these transactions. Initial margin deposits made in connection with currency futures transactions or premiums paid for currency options traded over-the-counter or on a commodities exchange may each not exceed 5% of the Fund's total assets in the case of non-bona fide hedging transactions. The Global Balanced Fund may enter into currency swaps. Currency swaps in- volve the exchange by the Fund with another party of their respective rights to make or receive payments in specified currencies. Since currency swaps are individually negotiated, the Fund expects to achieve an acceptable degree of correlation between its portfolio investments and its currency swap positions. Currency swaps usually involve the delivery of the entire principal value of one designated currency in exchange for the other designated currency. There- fore, the entire principal value of a currency swap is subject to the risk that the other party to the swap will default on its contractual delivery ob- ligations. The Fund will maintain in a segregated account with the Fund's cus- todian cash and liquid high grade debt securities equal to the net amount, if any, of the excess of the Fund's obligations over its entitlements with re- spect to swap transactions. To the extent that the net amount of a swap is held in a segregated account consisting of cash and liquid, high grade debt securities, the Fund, the Adviser and Sub-Advisers believe that swaps do not constitute senior securities under the 1940 Act and, accordingly, will not treat them as being subject to the Fund's borrowing restriction. The use of currency swaps is a highly specialized activity which involves investment techniques and risks different from those associated with ordinary portfolio securities transactions. If a Sub-Adviser is incorrect in its forecasts of market values and currency exchange rates, the investment performance of the Fund would be less favorable that it would have been if this investment tech- nique were not used. LOANS OF PORTFOLIO SECURITIES. Each Fund may lend portfolio securities in amounts up to 33% of its respective total assets to brokers, dealers and other financial institutions, provided such loans are callable at any time by the Fund and are at all times secured by cash or equivalent collateral. By lending its portfolio securities, a Fund will receive income while retaining the securities' potential for capital appreciation. As with any extensions of credit, there are risks of delay in recovery and, in some cases, even loss of rights in the collateral should the borrower of the secu- rities fail financially. However, these loans of portfolio securities will only be made to firms deemed by the Adviser (or Sub-Advisers) to be credit- worthy. The proceeds of such loans will be invested in high-quality short-term debt securities, including repurchase agreements. LEVERAGE. In seeking to enhance investment performance, the Global Balanced Fund, Small Company Growth Fund and Growth and Income Fund may borrow money for investment purposes and may each pledge assets to secure such borrowings. This is the speculative factor known as leverage. This practice may help a Fund increase the net asset value of its shares in an amount greater than would otherwise be the case when the market values of the securities purchased through borrowing increase. In the event the return on an investment of bor- rowed monies does not fully recover the costs of such borrowing, the net asset value of the Fund's shares would be reduced by a greater amount than would otherwise be the case. The effect of leverage will therefore tend to magnify the gains or losses to a Fund as a result of investing the borrowed monies. During periods of substantial borrowings, the net asset value of a Fund's shares would be reduced due to the added expense of interest on borrowed mon- ies. Each Fund is authorized to borrow, and to pledge assets to secure such borrowings, up to the maximum extent permissible under the 1940 Act (i.e., presently 50% of net assets). The time and extent to which a Fund may employ leverage will be determined by the Adviser (or Sub-Advisers) in light of changing facts and circumstances, including general economic and market condi- tions, and will be subject to applicable lending regulations of the Board of Governors of the Federal Reserve Board. The Funds' policies regarding the use of leverage are fundamental policies which may not be changed without the ap- proval of shareholders of the respective Fund. Under the 1940 Act, the value of a Fund's assets less liabilities, other than borrowings, must be at least three times all of the Fund's borrowings, including the proposed borrowing. If for any reason the value of a Fund's as- sets falls below the 1940 Act requirement, the Fund must within three business days reduce its borrowings to satisfy such requirement. To do this, a Fund may have to sell a portion of its investments at a time when it may be disadvanta- geous to do so. HEDGING AND INCOME ENHANCEMENT STRATEGIES. Each Fund may write covered calls to enhance income. For hedging purposes as a temporary defensive maneuver, each Fund may use interest rate futures and stock and bond index futures (to- gether, "Futures"); forward contracts on foreign currencies; and call and put options on equity and debt securities, Futures, stock and bond indices and foreign currencies (all of the foregoing are referred to as "Hedging Instru- ments"). A call or put may be purchased only if, after such purchase, the value of all call and put options held by the Fund would not exceed 5% of the Fund's total assets. A Fund will not use Futures and options on Futures for speculation. All puts and calls on securities, interest rate futures or stock and bond index futures or options on such Futures purchased or sold by the Fund will be listed on a national securities or commodities exchange or on U.S. over-the-counter markets. The Global Balanced Fund may invest up to 5% of its total assets in yield curve options. See "Foreign Securities--Foreign Cur- rency Transactions." Special Risks of Hedging and Income Enhancement Strategies. Participation in the options or Futures markets and in currency exchange transactions involves investment risks and transaction costs to which a Fund would not be subject absent the use of these strategies. If the Adviser's (or Sub-Adviser's) pre- dictions of movements in the direction of the securities, foreign currency and interest rate markets are inaccurate, the adverse consequences to the Fund may leave the Fund in a worse position than if such strategies were not used. Risks inherent in the use of options, foreign currency and Futures contracts and options on Futures contracts include (1) dependence on the Adviser's (or Sub-Adviser's) ability to predict correctly movements in the direction of in- terest rates, securities prices and currency markets; (2) imperfect correla- tion between the price of options and Futures contracts and options thereon and movements in the prices of the securities or currencies being hedged; (3) the fact that skills needed to use these strategies are different from those needed to select portfolio securities; (4) the possible absence of a liquid ary market for any particular instrument at any time; (5) the possible need to defer closing out certain hedged positions to avoid adverse tax consequences; and (6) the possible inability of the Fund to purchase or sell a portfolio se- curity at a time that otherwise would be favorable for it to do so, or the possible need for the Fund to sell a portfolio security at a disadvantageous time, due to the need for the Fund to maintain "cover" or to segregate securi- ties in connection with hedging transactions. A transaction is "covered" when the Fund owns the security subject to the option on such security, or some other security acceptable for applicable escrow requirements. See the State- ment of Additional Information for further information concerning income en- hancement and hedging strategies and the regulation requirements relating thereto. SHORT SALES. Each Fund may make "short sales against the box." A short sale is effected by selling a security which the Fund does not own. A short sale is against the box to the extent that the Fund contemporaneously owns, or has the right to obtain without payment, securities identical to those sold short. A Fund may not enter into a short sale against the box, if, as a result, more than 25% of its total assets would be subject to such short sales. OTHER INVESTMENTS. Each Fund may enter into reverse repurchase agreements. In addition, the Global Balanced Fund may enter into dollar rolls, interest- rate swaps and mortgage swaps or purchase or sell interest-rate caps, floors or collars. The Global Balanced Fund may also invest in leveraged inverse floating rate debt instruments. See the Statement of Additional Information for further information concerning these investment techniques. SPECIAL SITUATIONS. Each Fund may invest, subject to its particular invest- ment limitations described above, up to 25% of its assets in "special situa- tions" that the Adviser (or Sub-Advisers) believes present opportunities for capital growth, or in the case of the Balanced Assets Fund, Global Balanced Fund, and Growth and Income Fund, for total return. A "special situation" may involve a merger, reorganization, or other unusual development that is ex- pected to occur which, in the opinion of the Adviser (or Sub-Advisers), may prompt an increase in the value of an issuer's securities regardless of gen- eral business conditions or the movement of the market as a whole. A risk is present that the price of the security may decline if the anticipated develop- ment fails to occur. FUTURE DEVELOPMENTS. Each Fund may invest in securities and other instru- ments which do not presently exist but may be developed in the future, pro- vided that each such investment is consistent with the Fund's investment ob- jectives, policies and restrictions and is otherwise legally permissible under federal and state laws. The Prospectus will be amended or supplemented as ap- propriate to discuss any such new investments. Each Fund (other than the Global Balanced Fund) has adopted certain funda- mental policies designed to maintain the diversity of its portfolio and reduce investment risk. With respect to 75% of each such a Fund's total assets, the Fund may not invest more than 5% of its assets in the securities of any one issuer (other than obligations of the U.S. government, its agencies and in- strumentalities) or purchase more than 10% of an issuer's voting securities or more than 10% of any class of an issuer's outstanding securities. In addition, none of the Funds may purchase securities (other than obligations issued or guaranteed by the U.S. government, its agencies and instrumentalities) if as a result of such purchase more than 25% of a Fund's total assets would be in- vested in any one industry. See the Statement of Additional Information for information concerning other fundamental policies. The Global Balanced Fund is classified as non- diversified within the mean- ing of the 1940 Act, which means that the Fund is not limited by such Act in the proportion of its assets which may be invested in the securities of any one issuer. However, the Fund's investments will be limited so as to qualify as a "regulated investment company" for purposes of the Internal Revenue Code of 1986, as amended (the "Code"). To qualify, among other requirements, the Fund will limit its investments so that, at the close of each quarter of the taxable year, (i) not more than 25% of the market value of the Fund's total assets will be invested in the securities of a single issuer, and (ii) with respect to 50% of the market value of its total assets, not more than 5% of the market value of its total assets will be invested in the securities of a single issuer (other than obligations of the U.S. government, its agencies and instrumentalities), and the Fund will not own more than 10% of the outstanding voting securities of a single issuer. To the extent that the Fund assumes large positions in the securities of a small number of is- suers, the Fund may be more susceptible to any single economic, political or regulatory occurrence and to the financial conditions of the issuer in which it invests. TRUSTEES. The Trustees of the Trust are responsible for the overall supervi- sion of the operation of the Trust and each Fund and perform various duties imposed on trustees of investment companies by the 1940 Act and by the Common- wealth of Massachusetts. THE ADVISER. The Adviser selects and/or manages the investments of each Fund, provides various administrative services and supervises the Funds' daily business affairs, subject to general review by the Trustees. The Adviser is an indirect wholly owned subsidiary of SunAmerica Inc. ("SunAmerica"), an invest- ment-grade financial services company which has total capital of approximately $1.8 billion. SunAmerica's principal executive offices are located at 1 SunAmerica Center, Century City, Los Angeles, CA 90067-6022. In addition to serving as adviser to the Funds, the Adviser and its affiliates serve as ad- viser, manager and/or administrator for Anchor Pathway Fund, SunAmerica Income Funds, SunAmerica Money Market Funds, Inc., Anchor Series Trust and SunAmerica Series Trust. The Adviser and its affiliates managed, advised and/or adminis- tered assets of approximately 7.6 billion as of December 31, 1996 for invest- ment companies, individuals, pension accounts, and corporate and trust ac- counts. Pursuant to the Investment Advisory and Management Agreement entered into between the Adviser and the Trust, on behalf of each Fund, each Fund (other than the Global Balanced Fund) pays the Adviser a fee, payable monthly, com- puted daily at the annual rate of .75% on the first $350 million of the Fund's average daily net assets, .70% on the next $350 million of net assets and .65% on net assets over $700 million for the services performed, on behalf of the Fund and the facilities furnished by the Adviser. The Global Balanced Fund pays the Adviser a fee, payable monthly, computed daily at the annual rate of 1.00% on the first $350 million of the Fund's average daily net assets, .90% on the next $350 million of net assets and .85% on net assets over $700 mil- lion. These advisory fee rates are higher than those paid by most other in- vestment companies. For the fiscal year ended September 30, 1995, each Fund paid the Adviser a fee equal to the following percentage of average daily net assets: Balanced Assets Fund -- .75%; Blue Chip Growth Fund -- .75%; Global Balanced Fund -- 1.00%; Growth and Income Fund -- .75%; Mid-Cap Growth Fund -- .75% and Small Company Growth Fund -- .75%. For the fiscal year ended September 30, 1995, the Adviser waived its fees with respect to the Global Balanced Fund and Growth and Income Fund amounting to $115,214 and $32,455, respectively. THE SUB-ADVISERS. The Adviser has entered into sub-advisory agreements with AIG Global and GSAM pursuant to which the Sub-Advisers provide the Global Bal- anced Fund with investment advisory services, including the continuous review and administration of the Fund's foreign equity (AIG Global) and global bond (GSAM) investment programs. The Sub-Advisers discharge their responsibilities subject to the direction and control of the Trustees and the oversight and re- view of the Adviser. AIG Global serves as sub-adviser for the foreign equity component of the Global Balanced Fund. AIG Global's principal offices are located at 70 Pine Street, New York, NY 10270. In providing sub-advisory services to the foreign equity component of the Fund with respect to European, Japanese and Southeast Asian securities and markets, AIG Global will utilize the services of certain of its affiliates. Each of AIG Global and its affiliated companies providing services on behalf of the foreign equity component of the Fund is an indirect wholly owned subsidiary of American International Group, Inc. ("AIG"). AIG is an international insurance organization whose member companies write insurance in approximately 130 countries and jurisdictions and are engaged in a range of financial services businesses. As of December 31, 1995, AIG Global Investment Corp., and its foreign affiliates advised on approximately $60 billion of as- sets, of which more than $10 billion represented assets of non-affiliated cli- ents. The Adviser pays AIG Global a monthly fee with respect to those net as- sets of the Global Balanced Fund actually managed by AIG Global and its affil- iates (as described above), computed on average daily net assets at the fol- annual rates: .50% on the first $50 million of such assets, .40% of the next $100 million of such assets, .30% on the next $150 million of such assets, and .25% of such assets in excess of $300 million. For the fiscal year ended Sep- tember 30, 1995, the Adviser paid to AIG Global a fee equal to .50% of the Global Balanced Fund's average daily net assets. The foregoing fees are paid from the management fee paid to the Adviser and do not increase Fund expenses. GSAM serves as sub-adviser for the global bond component of the Global Balanced Fund. GSAM, an affiliate of Goldman, Sachs & Co., a Delaware limited partnership, is located at 140 Sleet Street, London EC 4A-B, England. GSAM serves a wide range of clients including private and public pension funds, endowments, foundations, banks, thrifts, insurance companies, corporations, and private investors and family groups. GSAM was organized in 1990. As a company with limited liability under the laws of England, it is authorized to conduct investment advisory business in the United Kingdom as a member of IMRO. The asset management services are divided into the following areas: institutional fixed income investment management; global currency management; institutional equity investment management; fund management; money market mutual fund management and administration; and private asset management. In performing its investment advisory services, GSAM, while remaining ultimately responsible for management of the global bond component of the Global Balanced Fund, is able to draw on the research and market expertise of its affiliate offices, including Goldman Sachs (Asia) L.L.C., its Hong Kong affiliate, for portfolio decisions and management. As of December 31, 1995, GSAM, together with its affiliates, acted as investment adviser, administrator or distributor for approximately $55.3 billion in assets. The Adviser pays GSAM a monthly fee with respect to those net assets of the Global Balanced Fund actually managed by GSAM, computed on average daily net assets, at the following annual rates: .40% on the first $50 million of such assets, .30% on the next $100 million of such assets, .25% on the next $100 million of such assets, and .20% of such assets in excess of $250 million. For the fiscal year ended September 30, 1995, the Adviser paid to GSAM a fee equal to .40% of the Global Balanced Fund's average daily net assets. The foregoing fees are paid from the management fee paid to the Adviser and do not increase Fund expenses. PORTFOLIO MANAGERS. There are eight portfolio managers of the Funds. The following individuals are primarily responsible for the day-to-day management of the particular Funds indicated: Stanton J. Feeley has served as 1) portfolio manager of the Balanced Assets Fund and Blue Chip Growth Fund since February 1992, 2) portfolio manager of the domestic equity component of the Global Balanced Fund since the inception date of June 15, 1994 and 3) portfolio manager of the Growth and Income Fund since the inception date of July 1, 1994. Mr. Feeley is an Executive Vice President of the Adviser and serves as the firm's Chief Investment Officer. Mr. Feeley has 31 years experience in the investment industry, including expe- rience in institutional sales management. P. Christopher Leary has served as assistant portfolio manager of the Balanced Assets Fund since June 1991. Mr. Leary is a Senior Vice President of the Adviser and has been a portfolio manager with the firm since 1990. Previously, Mr. Leary was an investment manager with Equitable Capital Management. Francis D. Gannon has served as assistant portfolio manager of the Balanced Assets Fund since December 1995. Mr. Gannon is an Assistant Vice President of the Adviser and has been an equity analyst with the firm since 1993. Audrey L. Snell has served as portfolio manager of the Small Company Growth Fund since November 1991 and portfolio manager of the Mid-Cap Growth Fund since February 1993. Ms. Snell is a Vice President of the Adviser and has been a portfolio manager with the firm since 1991. Gerald P. Sullivan has served as assistant portfolio manager of the Growth and Income Fund since December 1995. Mr. Sullivan has been an equity analyst for the Adviser since February 1995. Prior to joining the Adviser, Mr. Sullivan spent two years as a portfolio manager for Texas Commerce Investment Management. Prior to his time at Texas Commerce, he spent four years as a director for the Southmore Foundation, Inc. and as an adjunct professor at Rice University in Houston, Texas. Stephen Fitzgerald has served as the portfolio manager for the global bond component of the Global Balanced Fund since the inception date of June 15, 1994. Mr. Fitzgerald is Vice President in GSAM's London office, and joined GSAM in 1992. Prior to 1992, he spent two years managing multi-currency fixed income and balanced portfolios at Invesco MIM Limited, where he was a senior member of the derivative products group. Andrew F. Wilson has served as co-portfolio manager for the global bond com- ponent of the Global Balanced Fund since joining GSAM in December 1995. Mr. Wilson is a Senior International Fixed Income Portfolio Manager in GSAM's Lon- don office. Prior to joining GSAM, Mr. Wilson spent two years as an Assistant Director of Rothschild Asset Management, where he was responsible for economic and bond market forecasts for the U.S. and Canadian economies. Prior to his time at Rothschild, he spent a year as a Trading Manager at the Reserve Bank of New Zealand, where he oversaw the bank's four portfolio managers. Prior to that, he spent two years as an Investment Manager in the Foreign Exchange Di- vision at the Bank of England, on secondment from the Reserve Bank of New Zea- land. Peter G. Wignall has served as co-portfolio manager for the foreign equity component of the Global Balanced Fund since the inception date of June 15, 1994. Mr. Wignall, Managing Director and Chief Executive of AIG Global Invest- ment Corp. (Europe) Ltd., is responsible for asset allocation, strategy and currency management. Previously, Mr. Wignall was a senior portfolio manager at Citibank Investment Management in Australia and London. THE DISTRIBUTOR. SunAmerica Capital Services, Inc. (the "Distributor"), an indirect wholly owned subsidiary of SunAmerica, acts as distributor of the shares of each Fund pursuant to the Distribution Agreement between the Distributor and the Trust on behalf of each Fund. The Distributor receives all initial and deferred sales charges in connection with the sale of Fund shares, all or a portion of which it may reallow to other broker-dealers. The Distributor and other broker-dealers pay commissions to salespersons, as well as the cost of printing and mailing prospectuses to potential investors and of any advertising expenses incurred by them in connection with their distribution of Fund shares. The Distributor, at its expense, may from time-to-time, provide additional compensation to broker-dealers (including in some instances, exclusively to Royal Alliance Associates, Inc., SunAmerica Securities, Inc. and/or Advantage Capital Management Corporation, affiliates of the Distributor) in connection with sales of shares of the Fund. Such compensation may include (i) full re- allowance of the front-end sales charge on Class A shares; (ii) additional compensation with respect to the sale of Class A or Class B shares; or (iii) financial assistance to broker-dealers in connection with conferences, sales or training programs for their employees, seminars for the public, advertising campaigns regarding one or more of the Funds, and/or other broker-dealer spon- sored special events. In some instances, this compensation will be made avail- able only to certain broker-dealers whose representatives have sold a signifi- cant amount of shares of the Fund. Compensation may also include payment for travel expenses, including lodging, incurred in connection with trips taken by invited registered representatives and members of their families to locations within or outside of the United States for meetings or seminars of a business nature. In addition, the following types of non-cash compensation may be of- fered through sales contests: (i) travel mileage on major air carriers; (ii) tickets for entertainment events (such as concerts or sporting events); or (iii) merchandise (such as clothing, trophies, clocks, pens or other elec- tronic equipment). Broker-dealers may not use sales of the Funds' shares to qualify for this compensation to the extent receipt of such compensation may be prohibited by the laws of any state or any self-regulatory agency, such as, for example, the National Association of Securities Dealers, Inc. Dealers who receive bonuses or other incentives may be deemed to be underwriters under the Securities Act of 1933. Certain laws and regulations limit the ability of banks and other depository institutions to underwrite and distribute securities. However, in the opinion of the Adviser based upon the advice of counsel, these laws and regulations do not prohibit such depository institutions from providing other services to in- vestment companies of the type contemplated by the Distribution Plans (as de- scribed below). The Trustees will consider appropriate modifications to the operations of the Funds, including discontinuance of payments under the Dis- tribution Plans to banks and other depository institutions, in the event such institutions can no longer provide the services called for under their agree- ments. Banks and other financial services firms may be subject to various state laws regarding services described, and may be required to register as dealers pursuant to state law. DISTRIBUTION PLANS. Rule 12b-1 under the 1940 Act permits an investment company directly or indirectly to pay expenses associated with the distribution of its shares ("distribution expenses") in accordance with a plan adopted by the investment company's board of directors and approved by its shareholders. Pursuant to such rule, the Trustees and the shareholders of each class of shares of each Fund have adopted Distribution Plans hereinafter referred to as the "Class A Plan" and the "Class B Plan." In adopting the Class A Plan and the Class B Plan, the Trustees determined that there was a reasonable likelihood that each such Plan would benefit the Trust and the shareholders of the respective class. The sales charge and distribution fees of a particular class will not be used to subsidize the sale of shares of any other class. Under the Class A Plan, the Distributor may receive payments from a Fund at an annual rate of up to 0.10% of average daily net assets of such Fund's Class A shares to compensate the Distributor and certain securities firms for pro- viding sales and promotional activities for distributing that class of shares. Under the Class B Plan, the Distributor may receive payments from a Fund at the annual rate of up to 0.75% of the average daily net assets of such Fund's Class B shares, to compensate the Distributor and certain securities firms for providing sales and promotional activities for distributing that class of shares. The distribution costs for which the Distributor may be reimbursed out of such distribution fees include fees paid to broker-dealers that have sold Fund shares, commissions, and other expenses such as those incurred for sales literature, prospectus printing and distribution and compensation to wholesal- ers. It is possible that in any given year the amount paid to the Distributor under the Class A Plan or Class B Plan may exceed the Distributor's distribu- tion costs as described above. The Distribution Plans provide that each class of shares of each Fund may also pay the Distributor an account maintenance and service fee of up to 0.25% of the aggregate average daily net assets of such class of shares for payments to broker-dealers for providing continuing ac- count maintenance. In this regard, some payments are used to compensate bro- ker-dealers with account maintenance and service fees in an amount up to 0.25% per year of the assets maintained in a Fund by their customers. For the fiscal year ended September 30, 1995, under the Class A Plan, each Fund paid the Distributor a fee equal to the following percentages of average daily net assets: Balanced Assets Fund -- .35%; Blue Chip Growth Fund -- .35%; Global Balanced Fund -- .35%; Mid-Cap Growth Fund -- .35% and Small Company Growth Fund -- .35%. For the same period, under the Class B Plan, each Fund paid the Distributor a fee equal to the following percentages of average daily net assets: Balanced Assets Fund --1.00%; Blue Chip Growth Fund -- 1.00%; Global Balanced Fund -- 1.00%; Mid-Cap Growth Fund --1.00% and Small Company Growth Fund -- 1.00%. For the fiscal year ended September 30, 1995, the Growth and Income Fund (Class A and Class B shares) paid the Distributor a fee equal to .12% and .16%, respectively, of the Fund's average daily net assets, pursu- ant to a voluntary fee waiver by the Distributor. ADMINISTRATOR. The Trust has entered into a Service Agreement under the terms of which SunAmerica Fund Services, Inc. ("SAFS"), an indirect wholly owned subsidiary of SunAmerica, assists the Transfer Agent in providing shareholder service and may receive reimbursement from the Trust of its costs in providing such services through a fee approved annually by the Trustees. GENERAL. Shares of each of the Funds are sold at the respective net asset value next calculated after receipt of a purchase order, plus a sales charge, which, at the election of the investor, may be imposed either (i) at the time of purchase (Class A shares), or (ii) on a deferred basis (Class B shares and certain Class A shares). The minimum initial investment in each Fund is $500 and the minimum subse- quent investment is $100. However, for Individual Retirement Accounts ("IRAs"), Keogh Plan accounts and accounts for other qualified plans, the min- imum initial investment is $250 and the minimum subsequent investment is $25. The decision as to which class is most beneficial to an investor depends on the amount and intended length of the investment. Investors making large in- vestments, qualifying for a reduced initial sales charge, might consider Class A shares because there is a lower distribution fee than Class B shares (prior to conversion). Investors making small investments might consider Class B shares because 100% of the purchase price is invested immediately. Sharehold- ers who purchase $1,000,000 or more of shares of the Funds should only pur- chase Class A shares. Dealers may receive different levels of compensation de- pending on which class of shares they sell. Upon making an investment in shares of a Fund, an open account will be established under which shares of the applicable Fund and additional shares acquired through reinvestment of dividends and distributions will be held for each shareholder's account by State Street Bank and Trust Company ("State Street") and its affiliate, National Financial Data Services ("NFDS") (collectively, the "Transfer Agent"). Shareholders will not be issued certificates for their shares unless they specifically so request in writing. Shareholders receive regular statements from the Transfer Agent that report each transaction affecting their accounts. Further information may be obtained by calling Shareholder/Dealer Services at (800) 858-8850. CLASS A SHARES. Class A shares are offered at net asset value plus an initial sales charge, which varies with the size of the purchase as follows: No sales charge is payable at the time of purchase on investments of $1 mil- lion or more. Nevertheless, the Distributor will pay a commission to any dealer who initiates or is responsible for such an investment, in the amount of 1.00% of the amount invested. Redemptions of such shares within the twelve months following their purchase will be subject to a contingent deferred sales charge at the rate of 1.00% of the lesser of the net asset value of the shares being redeemed (exclusive of reinvested dividends and distributions) or the total cost of such shares. This contingent deferred sales charge is paid to the Distributor. Redemptions of such shares held longer than twelve months would not be subject to a contingent deferred sales charge. However, one-half of the commission paid with respect to such a purchase is subject to forfei- ture by the dealer in the event the redemption occurs during the second year from the date of purchase. In determining whether a deferred sales charge is payable, it is assumed that shares purchased with reinvested dividends and distributions and then other shares held the longest are redeemed first. To the extent that sales are made for personal investment purposes, the sales charge is waived as to Class A shares purchased by current or retired officers, directors, and other full-time employees of SunAmerica and its affiliates, as well as members of the selling group and family members of the foregoing. In addition, the sales charge is waived with respect to shares purchased by "wrap accounts" for the benefit of clients of broker-dealers, financial institutions or financial planners adhering to certain standards established by the Distributor. Shares purchased under this waiver are subject to certain limitations described in the Statement of Additional Information. Complete details concerning how an investor may purchase shares at reduced sales charges may be obtained by contacting Shareholder/Dealer Services at (800) 858-8850. There are certain special purchase plans for Class A shares which can reduce the amount of the initial sales charge to investors in the Funds. For more in- formation about "Rights of Accumulation," the "Letter of Intent," "Combined Purchase Privilege," "Reduced Sales Charges for Group Purchases" and the "Net Asset Value Transfer Program," see the Statement of Additional Information. CLASS B SHARES. Class B shares are offered at net asset value. Certain redemptions of Class B shares within the first six years of the date of purchase are subject to a CDSC. The charge is assessed on an amount equal to the lesser of the then-current market value or the purchase price of the shares being redeemed. No charge is assessed on shares derived from reinvestment of dividends or capital gains distributions. In determining whether the CDSC is applicable to a redemption, the calculation is determined in the manner that results in the lowest possible rate being charged. Therefore, it is assumed that the redemption is first of any Class A shares, second of any shares in the shareholder's Fund account that are not subject to a CDSC (i.e., shares representing reinvested dividends and distributions), third of shares held for more than six years and fourth of shares held the longest during the six-year period. The CDSC will not be applied to dollar amounts representing an increase in the net asset value of the shares being redeemed since the time of purchase of such redeemed shares. The amount of the CDSC, if any, will vary depending on the number of years from the time of payment for the purchase of Fund shares until the time of redemption of such shares. Solely for purposes of determining the number of years from the time of any payment for the purchase of shares, all payments during a month are aggregated and deemed to have been made on the first day of the month. The following table sets forth the rates of the CDSC. The CDSC will be waived in connection with redemptions which are (a) re- quested within one year of the death or the initial determination of disabil- ity of a shareholder; (b) taxable distributions or loans to participants made by qualified retirement plans or retirement accounts (not including rollovers) for which the Adviser serves as fiduciary (e.g., prepares all necessary tax reporting documents); provided that, in the case of a taxable distribution, the plan participant or accountholder has attained the age of 59 1/2 at the time the redemption is made; (c) made pursuant to a Systematic Withdrawal Plan, up to a maximum amount of 12% per year from a shareholder account based on the value of the account at the time the Plan is established, provided, however, that all dividends and capital gains distributions are reinvested in Fund shares; and (d) made of shares in accounts consisting of assets which were originally individually managed by the Adviser and had paid an investment advisory fee to the Adviser. See the Statement of Additional Information for further information concerning conditions with respect to (a) above. For Fed- eral income tax purposes, the amount of the CDSC will reduce the amount real- ized on the redemption of shares, concomitantly reducing gain or increasing loss. For information on the imposition and waiver of the CDSC contact Shareholder/Dealer Services at (800) 858-8850. Shareholders of a Fund that acquired their Class B shares pursuant to a reorganization effected with another SunAmerica mutual fund will remain subject to the terms of the CDSC in effect for the previous fund at the time of such reorganization. For additional information, see "Additional Information Regarding Purchase of Shares" in the Statement of Additional Information. Conversion Feature. Class B shares (including a pro-rata portion of the Class B shares purchased through the reinvestment of dividends and distribu- tions) will convert automatically to Class A shares on the first business day of the month following the seventh anniversary of the issuance of such Class B shares. Subsequent to the conversion of a Class B share to a Class A share, such share will no longer be subject to the higher distribution fee of Class B shares. Such conversion will be on the basis of the relative net asset values of Class B shares and Class A shares, without the imposition of any sales load, fee or charge. ADDITIONAL PURCHASE INFORMATION. All purchases are confirmed to each share- holder. The Trust reserves the right to reject any purchase order and may at any time discontinue the sale of any class of shares of any Fund. Share cer- tificates are issued upon written request, but no certificate is issued for fractional shares. Shares of the Funds may be purchased through the Distributor or SAFS, by check or federal funds wire and through a dollar cost averaging program. Shares will be priced at the net asset value next determined after the order is placed with the Distributor or SAFS. See "Additional Information Regarding Purchase of Shares" in the Statement of Additional Information for more information regarding these services and the procedures involved and when orders are deemed to be placed. Investors may purchase Class A shares of a Fund at net asset value to the extent that the investment represents the proceeds from a redemption of shares of a non-SunAmerica mutual fund in which the investor either (a) paid a front- end sales load or (b) was subject to or paid a CDSC on the redemption proceeds. See " Net Asset Value Transfer Program" in the Statement of Additional Information for more details regarding this privilege. Shares of any Fund may be redeemed at any time at their net asset value next determined, less any applicable contingent deferred sales charge, after receipt by the Fund of a redemption request in proper form. Any capital gain or loss realized by a shareholder upon any redemption of shares must be recognized for federal income tax purposes. See "Dividends, Distributions and Taxes." REGULAR REDEMPTION. Shareholders may redeem their shares by sending a writ- ten request to SAFS, Mutual Fund Operations, The SunAmerica Center, 733 Third Avenue, New York, NY 10017-3204. All written requests for redemption must be endorsed by the shareholder(s) with signature(s) guaranteed by an "eligible guarantor institution" which includes: banks, brokers, dealers, credit unions, securities and exchange associations, clearing agencies and savings associa- tions. Guarantees must be signed by an authorized signatory of the eligible guarantor and the words "Signature Guaranteed" must appear with the signature. Signature guarantees by notaries will not be accepted. SAFS may request fur- ther documentation from corporations, executors, administrators, trustees or guardians. REPURCHASE THROUGH DISTRIBUTOR. The Distributor is authorized, as agent for the Funds, to offer to repurchase shares which are presented by telephone to the Distributor by investment dealers. Orders received by dealers must be at least $500. The repurchase price is the net asset value per share of the ap- plicable class of shares of a Fund next determined after the repurchase order is received, less any applicable contingent deferred sales charge. Repurchase orders received by the Distributor after 4:00 P.M., Eastern time, will be priced based on the next business day's close. Dealers may charge for their services in connection with the repurchase, but neither the Funds nor the Dis- tributor imposes any charge. The offer to repurchase may be suspended at any time, as described below. TELEPHONE REDEMPTION. The Trust accepts telephone requests for redemption of shares with a value of less than $100,000. The proceeds of a telephone redemption may be sent by wire to the shareholder's bank account as set forth in the New Account Application Form or in a subsequent written authorization. Shareholders utilizing the redemption through the electronic funds transfer method will incur a $15.00 transaction fee. The Trust will employ reasonable procedures to confirm that instructions communicated by telephone are genuine. Failure to do so may result in liability to the Trust for losses incurred due to unauthorized or fraudulent telephone instructions. Such procedures include, but are not limited to, requiring some form of personal identification prior to acting upon instructions received by telephone and/or tape recording of telephone instructions. A shareholder making a telephone redemption should call Shareholder/Dealer Services at (800) 858-8850, and state (i) the name of the shareholder(s) appearing on the Fund's records, (ii) his or her account number with the Fund, (iii) the amount to be redeemed and (iv) the name of the person(s) requesting the redemption. The Trust reserves the right to terminate or modify the telephone redemption service at any time. SYSTEMATIC WITHDRAWAL PLAN. Shareholders who have invested at least $5,000 in any of the Funds may provide for the periodic payment from the account pur- suant to the Systematic Withdrawal Plan. At the shareholder's election, such payment may be made directly to the shareholder or to a third party on a monthly, quarterly, semi-annual or annual basis. The minimum periodic payment is $50. Maintenance of a withdrawal plan concurrently with purchases of addi- tional shares may be disadvantageous to a shareholder because of the sales charge applicable to such purchases. Shareholders who have been issued share certificates will not be eligible to participate in the Systematic Withdrawal Plan and will have to comply with certain additional procedures in order to redeem shares. Further information may be obtained by calling Shareholder/Dealer Services at (800) 858-8850. GENERAL. Normally payment is made on the next business day for shares redeemed, but in any event, payment is made by check within seven days after receipt by the Transfer Agent of share certificates or of a redemption request, or both, in proper form. Under unusual circumstances, the Funds may payment for up to seven days or longer, as permitted by the federal securities laws. At various times, a Fund may be requested to redeem shares for which it has not yet received good payment. A Fund may delay or cause to be delayed the mailing of a redemption check until such time as good payment (e.g., cash or certified check drawn on a United States bank) has been collected for the pur- chase of such shares, which will not exceed 15 days. Because of the high cost of maintaining smaller shareholder accounts, the Funds may redeem, on at least 60 days' written notice and without shareholder consent, any account that, due to a shareholder redemption and not to market fluctuation of the account's value, has a net asset value of less than $500 ($250 for retirement plan accounts), as of the close of business on the day preceding such notice, unless such shareholder increases the account balance to at least $500 during such 60-day period. In the alternative, the applicable Fund may impose a $2.00 monthly charge on accounts below the minimum account size. If a shareholder redeems shares of any class of a Fund and then within one year from the date of redemption decides the shares should not have been re- deemed, the shareholder may use all or any part of the redemption proceeds to reinstate, free of sales charges (Class A shares) and with the crediting of any CDSC paid with respect to such reinstated shares at the time of redemption (Class B shares), all or any part of the redemption proceeds in shares of the Fund at the then-current net asset value. Reinstatement may affect the tax status of the prior redemption. GENERAL. Shareholders in any of the Funds may exchange their shares for the same class of shares of any other Fund or other funds in the SunAmerica Family of Mutual Funds that offer such class at the respective net asset value per share. Before making an exchange, a shareholder should obtain and review the prospectus of the fund whose shares are being acquired. All exchanges are sub- ject to applicable minimum initial investment requirements and can only be ef- fected if the shares to be acquired are qualified for sale in the state in which the shareholder resides. Exchanges of shares generally will constitute a taxable transaction except for IRAs, Keogh Plans and other qualified or tax- exempt accounts. The exchange privilege may be terminated or modified upon 60 days' written notice. Further information about the exchange privilege may be obtained by calling Shareholder/Dealer Services at (800) 858-8850. If a shareholder acquires Class A shares through an exchange from another fund in the SunAmerica Family of Mutual Funds where the original purchase of such fund's Class A shares was not subject to an initial sales charge because the purchase was in excess of $1 million, such shareholder will remain subject to the 1% CDSC, if any, applicable to such redemptions. In such event, the pe- riod for which the original shares were held prior to the exchange will be "tacked" with the holding period of the shares acquired in the exchange for purposes of determining whether the 1% CDSC is applicable upon a redemption of any of such shares. A shareholder who acquires Class B shares through an exchange from another fund in the SunAmerica Family of Mutual Funds will retain liability for any deferred sales charge which is outstanding on the date of the exchange. In such event, the period for which the original shares were held prior to the exchange will be "tacked" with the holding period of the shares acquired in the exchange for purposes of determining what, if any, CDSC is applicable upon a redemption of any of such shares. RESTRICTIONS ON EXCHANGES. Because excessive trading (including short-term "market timing" trading) can hurt a Fund's performance, each Fund may refuse any exchange sell order (1) if it appears to be a market timing transaction involving a significant portion of a Fund's assets or (2) from any shareholder account if previous use of the exchange privilege is considered excessive. Ac- counts under common ownership or control, including, but not limited to, those with the same taxpayer identification number and those administered so as to redeem or purchase shares based upon certain predetermined market indications, will be considered one account for this purpose. In addition, a Fund reserves the right to refuse any exchange purchase order if, in the judgment of the Adviser, the Fund would be unable to invest effec- tively in accordance with its investment objective and policies, or would oth- erwise potentially be adversely affected. A shareholder's purchase exchange may be restricted or refused if the Fund receives or anticipates simultaneous orders affecting significant portions of the Fund's assets. In particular, a pattern of exchanges that coincide with a "market timing" strategy may be dis- ruptive to the Fund and may therefore be refused. Finally, as indicated under "Purchase of Shares", the Fund and Distributor reserve the right to refuse any order for the purchase of shares. PORTFOLIO TRANSACTIONS, BROKERAGE AND TURNOVER The Adviser is responsible for decisions to buy and sell securities for the Funds, selection of broker-dealers and negotiations of commission rates. With respect to the Global Balanced Fund, AIG Global and GSAM are responsible for decisions to buy and sell foreign equity and global fixed income securities, respectively, selection of broker-dealers and negotiation of commission rates for their respective component of the portfolio. In the over-the-counter mar- ket, securities are generally traded on a "net" basis with dealers acting as principal for their own accounts without a stated commission (although the price of the security usually includes a profit to the dealer). In underwrit- ten offerings, securities are purchased at a fixed price which includes an un- derwriter's concession or discount. On occasion, certain money market securi- ties may be purchased directly from an issuer, in which case no commissions or discounts are paid. As a general matter, the Adviser (or Sub-Advisers) selects broker-dealers which, in its best judgment, provide prompt and reliable execution at favora- ble security prices and reasonable commission rates. The Adviser (or Sub-Ad- viser) may select broker-dealers which provide it with research services and may cause a Fund to pay such broker-dealers commissions which exceed those which other broker-dealers may have charged, if in the Adviser's (or Sub-Ad- viser's) view the commissions are reasonable in relation to the value of the brokerage and/or research services provided by the broker-dealer. Brokerage arrangements may take into account the distribution of Fund shares by broker- dealers, subject to best price and execution. The Adviser, AIG Global and GSAM may effect portfolio transactions through an affiliated broker-dealer, acting as agent and not as principal, in accordance with Rule 17e-1 under the 1940 Act and other applicable securities laws. Each Fund has no limitation regarding its policy with respect to portfolio turnover. The portfolio turnover rate is calculated by dividing the lesser of sales or purchases of portfolio securities, excluding short-term securities, by the average monthly value of the Fund's long-term portfolio securities. High portfolio turnover involves correspondingly greater brokerage commissions and other transaction costs which will be borne directly by the Fund. In addi- tion, high portfolio turnover may result in increased short-term capital gains, which, when distributed to shareholders, are treated as ordinary in- come. DETERMINATION OF NET ASSET VALUE Each Fund calculates the net asset value of each class of its shares separately by dividing the total value of each class's net assets by the shares of each class outstanding. Shares are valued each day as of the close of regular trading on the NYSE (currently, 4:00 P.M., Eastern time). Investments for which market quotations are readily available are valued at market. All other securities and assets are valued at fair value following procedures approved by the Trustees. Each Fund may advertise performance data that reflect its total investment return. A brief summary of the computations is provided below and a detailed discussion is in the Statement of Additional Information. Both total return and yield figures are based on historical earnings and are not intended to in- dicate future performance. Total return performance data may be advertised by each Fund. The average annual total return may be calculated for one-, five- and ten-year periods or for the lesser period since inception. These performance data represent the average annual percentage changes of a hypothetical $1,000 investment and as- sumes the reinvestment of all dividends and distributions and includes sales charges and recurring fees that are charged to shareholder accounts. A Fund's advertisements may also reflect total return performance data calculated by means of cumulative, aggregate, aver- age, year-to-date, or other total return figures. Further, the Fund may adver- tise total return performance for periods of time in addition to those noted above. Yield will be calculated based on a 30-day (or one-month) period ended on the date of the applicable Fund's most recent balance sheet and for other such periods, as deemed appropriate. The net investment income per share earned during the period will be divided by the maximum offering price per share on the last day of the period and annualized to obtain the yield. For purposes of calculating yields, net income is determined by a standard formula prescribed by the Securities and Exchange Commission to facilitate comparison with yields quoted by other mutual funds. Although expenses for Class B shares may be higher than those for Class A shares, the performance of Class B shares may be higher than the performance of Class A shares after giving effect to the impact of the sales charges and 12b-1 fees applicable to each class of shares. DIVIDENDS AND DISTRIBUTIONS. Dividends from net investment income are paid annually for the Global Balanced Fund; semi-annually for the Blue Chip Growth Fund, Mid-Cap Growth Fund and Small Company Growth Fund; and quarterly for the Balanced Assets Fund and Growth and Income Fund. Dividends and distributions generally are taxable in the year in which they are paid, except any dividends paid in January which were declared in the previous calendar quarter will be treated as paid in December of the previous year. Dividends and distributions are paid in additional shares based on the next determined net asset value, unless the shareholder elects in writing, not less than five business days prior to the payment date, to receive such amounts in cash. In addition to having the dividends and distributions of a Fund reinvested in shares of such Fund, a shareholder may, if he or she so elects on the New Account Application Form, have dividends and distributions invested in the same class of shares of any other SunAmerica Mutual Fund at the then-current net asset value of such Fund(s). The excess of net realized long-term capital gains over net capital losses ("capital gain distributions"), if any, will be distributed to the shareholders annually. Each Fund's policy is to offset any prior year capital loss carry forward against any realized capital gains, and accordingly, no distribution of capital gains will be made until gains have been realized in excess of any such loss carry forward. TAXES. Each Fund is qualified and intends to continue to qualify and elect to be taxed as a regulated investment company under the Code. While so qualified, the Trust and each of the Funds will not be subject to U.S. Federal income tax on the portion of its investment company taxable income and net capital gains distributed to its shareholders. For Federal income tax purposes, dividends of net investment income and distributions of any net realized short-term capital gain, whether paid in cash or reinvested in shares of the Fund, are taxable to shareholders as ordinary income. To the extent a Fund's income is derived from certain dividends received from domestic corporations, a portion of the dividends paid to corporate shareholders of such Fund will be eligible for the 70% dividends received deduction. Income and capital gains received by the Global Balanced Fund may give rise to withholding and other taxes imposed by foreign countries. Tax conventions between certain countries and the U.S. may reduce or eliminate such taxes. Shareholders may be able to claim U.S. foreign tax credits with respect to such taxes, subject to certain provisions and limitations contained in the Code. If more than 50% in value of the Fund's total assets at the close of its taxable year consists of securities of foreign corporations, the Fund will be eligible, and intends, to file an election with the Internal Revenue Service when beneficial to shareholder pursuant to which shareholders of the Fund will be required to include their proportionate share of such withholding taxes in their U.S. income tax returns as gross income, treat such proportionate share as taxes paid by them, and deduct such proportionate share in computing their taxable incomes or, alternatively, use them as foreign tax credits against their U.S. income taxes. No deductions for foreign taxes, however, may be claimed by non-corporate shareholders who do not itemize deductions. Of course, certain retirement accounts which are not subject to tax cannot claim foreign tax credits on in vestments in foreign securities held in the Fund. A shareholder that is a non- resident alien individual or a foreign corporation may be subject to U.S. withholding tax on the income resulting from the Fund's election described in this paragraph but may not be able to claim a credit or deduction against such U.S. tax for the foreign taxes treated as having been paid by such sharehold- er. The Fund will report annually to its shareholders the amount per share of such withholding taxes. Under Code Section 988, foreign currency gains or losses from certain for- ward contracts, from futures contracts that are not "regulated futures con- tracts" and from unlisted non-equity options will generally be treated as or- dinary income or loss. Such Code Section 988 gains or losses will generally increase or decrease the amount of a fund's investment company taxable income available to be distributed to shareholders as ordinary income, rather than increasing or decreasing the amount of the Fund's net capital gain. Addition- ally, if Code Section 988 losses exceed other investment company taxable in- come during a taxable year, a Fund would not be able to make any ordinary div- idend distributions, and any distributions made in the same taxable year may be recharacterized as a return of capital to shareholders, thereby reducing the basis of each shareholder's fund shares. In certain cases, a Fund may be entitled to elect to treat foreign currency gains on forward or futures con- tracts, or options thereon, as capital gains. The Global Balanced Fund and Growth and Income Fund may purchase debt securities (such as zero-coupon or pay-in-kind securities) that contain original issue discount. Original issue discount that accrues in a taxable year is treated as earned by a Fund and therefore is subject to the distribution requirements of the Code. Because the original issue discount earned by the Fund in a taxable year may not be represented by cash income, the Fund may have to dispose of other securities and use the proceeds to make distributions to shareholders. Statements as to the tax status of distributions to shareholders of the Funds will be mailed annually. Shareholders are urged to consult their own tax advisors regarding specific questions as to federal, state or local taxes. Foreign shareholders are also urged to consult their own tax advisors regarding the foreign tax consequences of ownership of interests in a Fund. See "Dividends, Distributions and Taxes" in the Statement of Additional Information. REPORTS TO SHAREHOLDERS. The Trust sends to its shareholders audited annual and unaudited semi-annual reports for the Fund. The financial statements ap- pearing in annual reports are audited by independent accountants. In addition, the Transfer Agent sends to each shareholder having an account directly with the Trust a statement confirming transactions in the account. ORGANIZATION. The Trust, a business trust organized under the laws of the Commonwealth of Massachusetts on June 18, 1986, is an open-end diversified management investment company, commonly referred to as a mutual fund. The Trust consists of six investment series or funds: the Balanced Assets Fund, the Global Balanced Fund, the Blue Chip Growth Fund, the Mid-Cap Growth Fund, the Small Company Growth Fund, and the Growth and Income Fund. The Trustees have the authority to issue an unlimited number of shares of beneficial inter- est of separate series, par value $.01 per share, of the Trust, and to divide each such series into one or more classes of shares. The Trust does not hold annual shareholder meetings. The Trustees are re- quired to call a meeting of shareholders for the purpose of voting upon the question of removal of any Trustee when so requested in writing by the share- holders of record holding at least 10% of the Trust's outstanding shares. Each share of each Fund has equal voting rights on each matter pertaining to that Fund or matters to be voted upon by the Trust, except as noted above. Each share of each Fund is entitled to participate equally with the other shares of that Fund in dividends and other distributions and the proceeds of any liqui- dation, except that, due to the differing expenses borne by the two classes, such dividends and proceeds are likely to be lower for Class B shares than for Class A shares. See the Statement of Additional Information for more informa- tion with respect to the distinctions among classes. Under Massachusetts law, shareholders of a trust, such as the Trust, in cer- tain circumstances may be held personally liable as partners for the obliga- tions of the trust. However the Declaration of Trust, pursuant to which the Trust was organized, contains an express disclaimer of shareholder liability for acts or obligations of the Trust. The Declaration of Trust also provides for indemnification out of the Trust's property for any shareholder held personally liable for any Trust obligation. Thus the risk of a shareholder being personally liable, as a partner for obliga- tions of the Trust, is limited to the unlikely circumstance in which the Trust itself would be unable to meet its obligations. INDEPENDENT ACCOUNTANTS AND LEGAL COUNSEL. Price Waterhouse LLP has been selected as independent accountants for the Funds. The firm of Shereff, Friedman, Hoffman & Goodman, LLP has been selected as legal counsel for the Funds. SHAREHOLDER INQUIRIES. All inquiries regarding the Trust should be directed to the Trust at the telephone number or address on the cover page of this Pro- spectus. For questions concerning share ownership, dividends, transfer of own- ership or share redemption, contact SAFS, Mutual Fund Operations, The SunAmerica Center, 733 Third Avenue, New York, NY 10017-3204, or call Shareholder/Dealer Services at (800) 858-8850. NO PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTA- TIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS OR THE STATEMENT OF ADDI- TIONAL INFORMATION AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESEN- TATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND, THE AD- VISER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT LAWFULLY BE MADE. GOLDMAN SACHS ASSET MANAGEMENT INTERNATIONAL STATE STREET BANK AND TRUST COMPANY SUNAMERICA BLUE CHIP GROWTH FUND SUNAMERICA SMALL COMPANY GROWTH FUND SUNAMERICA GROWTH AND INCOME FUND The SunAmerica Center General Marketing and 733 Third Avenue Shareholder Information New York, NY 10017-3204 (800) 858-8850 SunAmerica Equity Funds is a mutual fund consisting of six different investment funds: SunAmerica Balanced Assets Fund, SunAmerica Global Balanced Fund, SunAmerica Blue Chip Growth Fund, SunAmerica Mid-Cap Growth Fund, SunAmerica Small Company Growth Fund and SunAmerica Growth and Income Fund. Each Fund has distinct investment objectives and strategies. This Statement of Additional Information is not a Prospectus, but should be read in conjunction with the Funds' Prospectus dated January 12, 1996. To obtain a Prospectus, please call the Fund at (800) 858-8850. Capitalized terms used herein but not defined have the meanings assigned to them in the Prospectus. History of the Funds . . . . . . . . . . . . . . . . . . . . .B-2 Investment Objectives and Policies . . . . . . . . . . . . . .B-3 Portfolio Turnover . . . . . . . . . . . . . . . . . . . . B-33 Investment Restrictions. . . . . . . . . . . . . . . . . . . B-34 Trustees and Officers. . . . . . . . . . . . . . . . . . . . B-37 Adviser, Sub-Advisers, Personal Trading, Distributor and Administrator. . . . . . . . . . . . . . . . . . . . . . . B-40 Portfolio Transactions and Brokerage . . . . . . . . . . . . B-49 Additional Information Regarding Purchase of Shares. . . . . B-52 Additional Information Regarding Redemption of Shares. . . . B-60 Determination of Net Asset Value . . . . . . . . . . . . . . B-61 Performance Data . . . . . . . . . . . . . . . . . . . . . . B-62 Dividends, Distributions and Taxes . . . . . . . . . . . . . B-67 Retirement Plans . . . . . . . . . . . . . . . . . . . . . . B-72 Description of Shares. . . . . . . . . . . . . . . . . . . . B-73 Additional Information . . . . . . . . . . . . . . . . . . . B-75 Financial Statements . . . . . . . . . . . . . . . . . . . . B-75 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . B-76 No dealer, salesman or other person has been authorized to give any information or to make any representations, other than those contained in this Statement of Additional Information or in the Prospectus, and, if given or made, such other information or representations must not be relied upon as having been authorized by the Fund, the Adviser, Sub-Advisers or the Distributor. This Statement of Additional Information and the Prospectus do not constitute an offer to sell or a solicitation of an offer to buy any of the securities offered hereby in any jurisdiction in which such an offer to sell or solicitation of an offer to buy may not lawfully be made. This Statement of Additional Information relates to the six different investment funds (each, a "Fund," and collectively, the "Funds") of SunAmerica Equity Funds, a Massachusetts business trust (the "Trust"), which is registered as an open-end investment company under the Investment Company Act of 1940, as amended (the "1940 Act"). The six Funds are: SunAmerica Balanced Assets Fund ("Balanced Assets Fund"), SunAmerica Global Balanced Fund ("Global Balanced Fund"), SunAmerica Blue Chip Growth Fund ("Blue Chip Growth Fund"), SunAmerica Mid-Cap Growth Fund ("Mid-Cap Growth Fund"), SunAmerica Small Company Growth Fund ("Small Company Growth Fund") and SunAmerica Growth and Income Fund ("Growth and Income Fund"). The Trust was organized under the name "Integrated Equity Portfolios" in 1986 and subsequently renamed "SunAmerica Equity Portfolios" in 1990. On September 24, 1993, the Trust reorganized with certain funds in the SunAmerica Family of Mutual Funds (the "Reorganization") and was renamed "SunAmerica Equity Funds". In the Reorganization, all outstanding shares of the two then-existing series of the Trust, the Growth Portfolio ("Growth Portfolio") and the Aggressive Growth Portfolio ("Aggressive Growth Portfolio"), were redesignated Class A shares and renamed the SunAmerica Growth Fund ("Growth Fund") and the SunAmerica Emerging Growth Fund ("Emerging Growth Fund"), respectively. In addition, the SunAmerica Emerging Growth Fund series of SunAmerica Fund Group ("Old Emerging Growth") reorganized with, and its shareholders received Class B shares of, the Emerging Growth Fund. With regard to the Balanced Assets Fund series of the Trust, the Total Return Fund series of SunAmerica Multi-Asset Portfolios, Inc. ("Total Return") and the SunAmerica Balanced Assets Fund series of SunAmerica Fund Group ("Old Balanced Assets") reorganized with, and their shareholders received Class A and Class B shares of the Balanced Assets Fund, respectively. The SunAmerica Capital Appreciation Fund, Inc. ("Capital Appreciation") was reorganized with, and its shareholders received Class B shares of, the SunAmerica Value Fund ("Value Fund"). The Reorganization was approved by the shareholders of the Funds or their predecessors who were entitled to vote with respect thereto on September 23, 1993. On March 16, 1994, the Board of Trustees of the Trust (the "Trustees") approved changing the names of the Value Fund, Growth Fund and Emerging Growth Fund to the Blue Chip Growth Fund, Mid-Cap Growth Fund and Small Company Growth Fund, respectively, and such name changes became effective on June 7, 1994. On December 21, 1993, the Trustees approved the creation of the Global Balanced Fund and on March 16, 1994, the Trustees approved the creation of the Growth and Income Fund. The investment objectives and policies of each of the Funds are described in the Funds' Prospectus. Certain types of securities in which the Funds may invest and certain investment practices which the Funds may employ, which are described under "Other Investment Practices and Restrictions" in the Prospectus and in the Appendix to the Prospectus, are discussed more fully below. Illiquid Securities. Each Fund may invest up to 10% of its net assets, determined as of the date of purchase, in illiquid securities including repurchase agreements and time deposits which have a maturity of longer than seven days or in other securities that are illiquid by virtue of the absence of a readily available market or legal or contractual restrictions on resale. Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended (the "Securities Act"), securities which are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Repurchase agreements subject to demand are deemed to have a maturity equal to the notice period. Securities which have not been registered under the Securities Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Mutual funds do not typically hold a significant amount of these restricted or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. A mutual fund might also have to register such restricted securities in order to dispose of them, resulting in additional expense and delay. There will generally be a lapse of time between a mutual fund's decision to sell an unregistered security and the registration of such security promoting sale. Adverse market conditions could impede a public offering of such securities. When purchasing unregistered securities, each of the Funds will seek to obtain the right of registration at the expense of the issuer. In recent years, a large institutional market has developed for certain securities that are not registered under the Securities Act, including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer's ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. Restricted securities eligible for resale pursuant to Rule 144A under the Securities Act for which there is a readily available market will not be deemed to be illiquid. The Adviser (or Sub-Adviser) will monitor the liquidity of such restricted securities subject to the supervision of the Trustees. In reaching liquidity decisions the Adviser (or Sub-Adviser) will consider, inter alia, pursuant to guidelines and procedures established by the Trustees, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell the security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security; and (4) the nature of the security and the nature of the marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers and the mechanics of the transfer). Commercial paper issues in which the Funds may invest include securities issued by major corporations without registration under the Securities Act in reliance on the exemption from such registration afforded by Section 3(a)(3) thereof, and commercial paper issued in reliance on the so-called private placement exemption from registration which is afforded by Section 4(2) of the Securities Act ("Section 4(2) paper"). Section 4(2) paper is restricted as to disposition under the federal securities laws in that any resale must similarly be made in an exempt transaction. Section 4(2) paper is normally resold to other institutional investors through or with the assistance of investment dealers who make a market in Section 4(2) paper, thus providing liquidity. Section 4(2) paper that is issued by a company that files reports under the Securities Exchange Act of 1934 is generally eligible to be sold in reliance on the safe harbor of Rule 144A described above. A Fund's 10% limitation on investments in illiquid securities includes Section 4(2) paper other than Section 4(2) paper that the Adviser (or Sub-Adviser) has determined to be liquid pursuant to guidelines established by the Trustees. The Trustees delegated to the Adviser (or Sub-Adviser) the function of making day-to-day determinations of liquidity with respect to Section 4(2) paper, pursuant to guidelines approved by the Trustees that require the Adviser (or Sub-Adviser) to take into account the same factors described above for other restricted securities and require the Adviser (or Sub-Adviser) to perform the same monitoring and reporting functions. The staff of the Securities and Exchange Commission (the "SEC") has taken the position that purchased over-the-counter ("OTC") options and the assets used as "cover" for written OTC options are illiquid. The assets used as cover for OTC options written by a Fund will be considered illiquid unless the OTC options are sold to qualified dealers who agree that the Fund may repurchase any OTC option it writes at a maximum price to be calculated by a formula set forth in the option agreement. The cover for an OTC option written subject to this procedure will be considered illiquid only to the extent that the maximum repurchase price under the option formula exceeds the intrinsic value of the option. Repurchase Agreements. Each Fund may enter into repurchase agreements with banks, brokers or securities dealers. In such agreements, the seller agrees to repurchase a security from a Fund at a mutually agreed-upon time and price. The period of maturity is usually quite short, either overnight or a few days although it may extend over a number of months. The resale price is in excess of the purchase price, reflecting an agreed-upon rate of return effective for the period of time a Fund's money is invested in the security. Whenever a Fund enters into a repurchase agreement, it obtains collateral having a value at least equal to the amount of the purchase price. The instruments held as collateral are valued daily and if the value of the instruments declines, a Fund will require additional collateral. If the seller defaults and the value of the collateral securing the repurchase agreements declines, a Fund may incur a loss. In addition, if bankruptcy proceedings are commenced with respect to the seller of the security, realization of the collateral by the Fund may be delayed or limited. The Trustees have established guidelines to be used by the Adviser (or Sub-Adviser) in connection with transactions in repurchase agreements and will regularly monitor each Fund's use of repurchase agreements. A Fund will not invest in repurchase agreements maturing in more than seven days if the aggregate of such investments along with other illiquid securities exceeds 10% of the value of its net assets. However, there is no limit on the amount of a Fund's net assets that may be subject to repurchase agreements having a maturity of seven days or less for temporary defensive purposes. Reverse Repurchase Agreements. Each Fund may enter into reverse repurchase agreements. In a reverse repurchase agreement, the Fund sells a security subject to the rights and obligations to repurchase such security. The Fund then invests the proceeds from the transaction in another obligation in which the Fund is authorized to invest. In order to minimize any risk involved, the Fund maintains, in a segregated account with the custodian, cash, cash equivalents or liquid high grade debt securities equal in value to the repurchase price. Reverse repurchase agreements are considered to be borrowings and are subject to the percentage limitations on borrowings. See "Investment Restrictions." Risks of Investing in Lower Rated Bonds. Debt securities in which the Growth and Income Fund may invest may be in the lower rating categories of recognized rating agencies (that is, ratings of Ba or lower by Moody's Investors Service, Inc. ("Moody's") or BB or lower by Standard & Poor's Corporation ("S&P")) (and comparable unrated securities) (commonly known as "junk bonds"). For a these and other rating categories, see Appendix A. No minimum rating standard is required for a purchase by the Fund. It should be noted that lower-rated securities are subject to risk factors such as (a) vulnerability to economic downturns and changes in interest rates; (b) sensitivity to adverse economic changes and corporate developments; (c) redemption or call provisions which may be exercised at inopportune times; (d) difficulty in accurately valuing or disposing of such securities; (e) federal legislation which could affect the market for such securities; and (f) special adverse tax consequences associated with investments in certain high-yield, high-risk bonds. High yield bonds, like other bonds, may contain redemption or call provisions. If an issuer exercises these provisions in a declining interest rate market, the Fund would have to replace the security with a lower yielding security, resulting in lower return for investors. Conversely, a high yield bond's value will decrease in a rising interest rate market. There is a thinly traded market for high yield bonds, and recent market quotations may not be available for some of these bonds. Market quotations are generally available only from a limited number of dealers and may not represent firm bids from such dealers or prices for actual sales. As a result, a Fund may have difficulty valuing the high yield bonds in their portfolios accurately and disposing of these bonds at the time or price desired. Ratings assigned by Moody's and S&P to high yield bonds, like other bonds, attempt to evaluate the safety of principal and interest payments on those bonds. However, such ratings do not assess the risk of a decline in the market value of those bonds. In addition, ratings may fail to reflect recent events in a timely manner and are subject to change. If a rating with respect to a portfolio security is changed, the Adviser will determine whether the security will be retained based upon the factors the Adviser considers in acquiring or holding other securities in the portfolio. Investment in high yield bonds may make achievement of the Fund's objective more dependent on the Adviser's own credit analysis than is the case for higher-rated bonds. Market prices for high yield bonds tend to be more sensitive than those for higher-rated securities due to many of the factors described above, including the credit-worthiness of the issuer, redemption or call provisions, the liquidity of the secondary trading market and changes in credit ratings, as well as interest rate movements and general economic conditions. In addition, yields on such bonds will fluctuate over time. An economic downturn could severely disrupt the market for high yield bonds. In addition, legislation impacting high yield bonds may have a materially adverse effect on the market for such bonds. example, federally insured savings and loan associations have been required to divest their investments in high yield bonds. The risk of default in payment of principal and interest on high yield bonds is significantly greater than with higher-rated debt securities because high yield bonds are generally unsecured and are often subordinated to other obligations of the issuer, and because the issuers of high yield bonds usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates. Upon a default, bondholders may incur additional expenses in seeking recovery. As a result of all these factors, the net asset value of a Fund to the extent it invests in high yield bonds, is expected to be more volatile than the net asset value of funds which invest solely in higher-rated debt securities. This volatility may result in an increased number of redemptions from time to time. High levels of redemptions in turn may cause a fund to sell its portfolio securities at inopportune times and decrease the asset base upon which expenses can be spread. Asset-Backed Securities. The Global Balanced Fund may invest in asset- backed securities. These securities, issued by trusts and special purpose corporations, are backed by a pool of assets, such as credit card and automobile loan receivables, representing the obligations of a number of different parties. The Fund may also invest in privately issued asset-backed securities. Asset-backed securities present certain risks. For instance, in the case of credit card receivables, these securities may not have the benefit of any security interest in the related collateral. Credit card receivables are generally unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit laws, many of which give such debtors the right to set off certain amounts owed on the credit cards, thereby reducing the balance due. Most issuers of automobile receivables permit the services to retain possession of the underlying obligations. If the servicer were to sell these obligations to another party, there is a risk that the purchaser would acquire an interest superior to that of the holders of the related automobile receivables. In addition, because of the large number of vehicles involved in a typical issuance and technical requirements under state laws, the trustee for the holders of the automobile receivables may not have a proper security interest in all of the obligations backing such receivables. Therefore, there is the possibility that recoveries on repossessed collateral may not, in some cases, be available to support payments on these securities. Asset-backed securities are often backed by a pool of assets representing the obligations of a number of different parties. To lessen the effect of failures by obligors to make payments on underlying assets, the securities may support which fall into two categories: (i) liquidity protection and (ii) protection against losses resulting from ultimate default by a obligor on the underlying assets. Liquidity protection refers to the provision of advances, generally by the entity administering the pool of assets, to ensure that the receipt of payments on the underlying pool occurs in a timely fashion. Protection against losses resulting from ultimate default ensures payment through insurance policies or letters of credit obtained by the issuer or sponsor from third parties. The Fund will not pay any additional or separate fees for credit support. The degree of credit support provided for each issue is generally based on historical information respecting the level of credit risk associated with the underlying assets. Delinquency or loss in excess of that anticipated or failure of the credit support could adversely affect the return on an investment in such a security. Dollar Rolls. The Global Balanced Fund may enter into "dollar rolls" in which the Fund sells mortgage or other asset-backed securities ("Roll Securities") for delivery in the current month and simultaneously contracts to repurchase substantially similar (same type, coupon and maturity) securities on a specified future date. During the roll period, the Fund foregoes principal and interest paid on the Roll Securities. The Fund is compensated by the difference between the current sales price and the lower forward price for the future purchase (often referred to as the "drop") as well as by the interest earned on the cash proceeds of the initial sale. The Fund also could be compensated through the receipt of fee income equivalent to a lower forward price. A "covered roll" is a specific type of dollar roll for which there is an offsetting cash position or a cash equivalent security position which matures on or before the forward settlement date of the dollar roll transaction. The Fund will only enter into covered rolls. Because "roll" transactions involve both the sale and purchase of a security, they may cause the reported portfolio turnover rate to be higher than that reflecting typical portfolio management activities. Dollar rolls involve certain risks including the following: if the broker-dealer to whom the Fund sells the security becomes insolvent, the Fund's right to purchase or repurchase the security subject to the dollar roll may be restricted and the instrument which the Fund is required to repurchase may be worth less than an instrument which the Fund originally held. Successful use of dollar rolls will depend upon the Adviser's or Sub-Adviser's ability to predict correctly interest rates and in the case of mortgage dollar rolls, mortgage prepayments. For these reasons, there is no assurance that dollar rolls can be successfully employed. Interest-Rate Swaps, Mortgage Swaps, Caps, Collars and Floors. In order to protect the value of the Global Balanced Fund from interest rate fluctuations and to hedge against fluctuations in the fixed income market in which certain of the Fund's investments are traded, the Fund may enter into interest-rate swaps and mortgage swaps or purchase or sell interest-rate caps, floors or collars. The Fund will enter into these hedging transactions primarily to preserve a return or spread on a particular investment or portion of the portfolio and to protect against any increase in the price of securities the Fund anticipates purchasing at a later date. The Fund may also enter into interest-rate swaps for non-hedging purposes. Interest-rate swaps are individually negotiated, the Fund expects to achieve an acceptable degree of correlation between its portfolio investments and interest-rate positions. The Fund will only enter into interest- rate swaps on a net basis, which means that the two payment streams are netted out, with the Fund receiving or paying, as the case may be, only the net amount of the two payments. Interest- rate swaps do not involve the delivery of securities, other underlying assets or principal. Accordingly, the risk of loss with respect to interest-rate swaps is limited to the net amount of interest payments that the Fund is contractually obligated to make. If the other party to an interest-rate swap defaults, the Fund's risk of loss consists of the net amount of interest payments that the Fund is contractually entitled to receive. The use of interest-rate swaps is a highly specialized activity which involves investment techniques and risks different from those associated with ordinary portfolio securities transactions. All of these investments may be deemed to be illiquid for purposes of the Fund's 10% limitation on investment in such securities. Inasmuch as these investments are entered into for good faith hedging purposes, and inasmuch as segregated accounts will be established with respect to such transactions, the Adviser, Sub-Advisers and the Fund believe such obligations do not constitute senior securities and accordingly, will not treat them as being subject to its borrowing restrictions. The net amount of the excess if any, of the Fund's obligations over its entitlements with respect to each interest-rate swap will be accrued on a daily basis and an amount of cash, U.S. government securities or other liquid high grade debt obligations having an aggregate net asset value at least equal to the accrued excess will be maintained in a segregated account by a custodian that satisfies the requirements of the 1940 Act. The Fund will also establish and maintain such segregated accounts with respect to its total obligations under any interest-rate swaps that are not entered into on a net basis and with respect to any interest-rate caps, collars and floors that are written by the Fund. The Fund will enter into these transactions only with banks and recognized securities dealers believed by the Adviser and Sub-Advisers to present minimal credit risk in accordance with guidelines established by the Fund's Board of Trustees. If there is a default by the other party to such a transaction, the Fund will have to rely on its contractual remedies (which may be limited by bankruptcy, insolvency or similar laws) pursuant to the agreements related to the transaction. The swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and as agents utilizing standardized swap documentation. Caps, collars and floors are more recent innovations for which documentation is less standardized, and accordingly, they are less liquid than swaps. Mortgage swaps are similar to interest-rate swaps in that they represent commitments to pay and receive interest. The notional principal amount, upon which the value of the interest payments is based, is tied to reference pool or pools of mortgages. The purchase of an interest-rate cap entitles the purchaser, to the extent that a specified index exceeds a predetermined interest rate, to receive payments of interest on a notional principal amount from the party selling such interest-rate cap. The purchase of an interest-rate floor entitles the purchaser, to the extent that a specified index falls below a predetermined interest rate, to receive payments of interest on a notional principal amount from the party selling such interest-rate floor. The Global Balanced Fund will not enter into any mortgage swap, interest-rate swap, cap or floor transaction unless the unsecured commercial paper, senior debt, or the claims paying ability of the other party thereto is rated either AA or A-1 or better by S&P or Aa or P-1 or better by Moody's, or is determined to be of equivalent quality by the applicable Sub-Adviser. Inverse Floaters. The Global Balanced Fund may invest in leveraged inverse floating rate debt instruments ("inverse floaters"). The interest rate on an inverse floater resets in the opposite direction from the market rate of interest to which the inverse floater is indexed. An inverse floater may be considered to be leveraged to the extent that its interest rate varies by a magnitude that exceeds the magnitude of the change in the index rate of interest. The higher degree of leverage inherent in inverse floaters is associated with greater volatility in their market values. Accordingly, the duration of an inverse floater may exceed its stated final maturity. Certain inverse floaters may be deemed to be illiquid securities for purposes of the Fund's 10% limitation on investments in such securities. Short-Term and Temporary Defensive Instruments. In addition to their primary investments, each Fund may also invest up to 10% of its total assets in money market instruments for liquidity purposes (to meet redemptions and expenses). For temporary defensive purposes, each Fund may invest up to 100% of its total assets in fixed-income securities, including corporate debt obligations and money market instruments rated in one of the two highest categories by a nationally recognized statistical rating organization (or determined by the Adviser or Sub-Adviser to be of equivalent quality). A description of securities ratings is contained in the Appendix to this Statement of Additional Information. Subject to the limitations described above, the following is a description of the types of money market and fixed-income securities in which the Funds may invest: U.S. Government Securities: See section entitled "U.S. Government Securities" below. Commercial Paper: Commercial paper consists of short-term (usually from 1 to 270 days) unsecured promissory notes issued by entities in order to finance their current operations. Each Fund's commercial paper investments may include demand notes and floating rate or variable rate notes. Variable amount master demand notes and variable amount floating rate notes are obligations that permit the investment of fluctuating amounts by a Fund at varying rates of interest pursuant to direct arrangements between a Fund, as lender, and the borrower. Master demand notes permit daily fluctuations in the interest rates while the interest rate under variable amount floating rate notes fluctuates on a weekly basis. These notes permit daily changes in the amounts borrowed. A Fund has the right to increase the amount under these notes at any time up to the full amount provided by the note agreement, or to decrease the amount, and the borrower may repay up to the full amount of the note without penalty. Because these types of notes are direct lending arrangements between the lender and the borrower, it is not generally contemplated that such instruments will be traded and there is no secondary market for these notes. Master demand notes are redeemable (and, thus, immediately repayable by the borrower) at face value, plus accrued interest, at any time. Variable amount floating rate notes are subject to next-day redemption 14 days after the initial investment therein. With both types of notes, therefore, a Fund's right to redeem depends on the ability of the borrower to pay principal and interest on demand. In connection with both types of note arrangements, a Fund considers earning power, cash flow and other liquidity ratios of the issuer. These notes, as such, are not typically rated by credit rating agencies. Unless they are so rated, a Fund may invest in them only if at the time of an investment the issuer has an outstanding issue of unsecured debt rated in one of the two highest categories by a nationally recognized statistical rating organization. The Funds will generally purchase commercial paper only of companies of medium to large capitalizations (i.e., $1 billion or more). In addition, the Global Balanced Fund may purchase commercial paper rated in the two highest rating categories, or deemed by the Adviser (or Sub-Adviser) to be of comparable quality, without regard to the size of the issuer. Certificates of Deposit and Bankers' Acceptances: Certificates of deposit are receipts issued by a bank in exchange for the deposit of funds. The issuer agrees to pay the amount deposited plus interest to the bearer of the receipt on the date specified on the certificate. The certificate usually can be traded in the secondary market prior to maturity. Bankers' acceptances typically arise from short-term credit arrangements designed to enable businesses to obtain funds to finance commercial transactions. Generally, an acceptance is a time draft drawn on a bank by an exporter or an importer to obtain a stated amount of funds to pay for specific merchandise. The draft is then "accepted" by another bank that, in effect, unconditionally guarantees to pay the face value of the instrument on its maturity date. The acceptance may then be held by the accepting bank as an earning asset or it may be sold in the secondary market at the going rate of discount for a specific maturity. Although maturities for acceptances can be as long as 270 days, most maturities are six months or less. The Funds will generally open interest-bearing accounts only with, or purchase certificates of deposit, time deposits or bankers' acceptances only from, banks or savings and loan associations whose deposits are federally- insured and whose capital is at least $50 million. Corporate Obligations: Corporate debt obligations (including master demand notes). For a further description of variable amount master demand notes, see the section entitled "Commercial Paper" above. Repurchase Agreements: See the section entitled "Repurchase Agreements" above. U.S. Government Securities. Each Fund may invest in U.S. Treasury securities, including bills, notes, bonds and other debt securities issued by the U.S. Treasury. These instruments are direct obligations of the U.S. government and, as such, are backed by the "full faith and credit" of the United States. They differ primarily in their interest rates, the lengths of their maturities and the dates of their issuances. Each Fund may also invest in securities issued by agencies of the U.S. government or instrumentalities of the U.S. government. These obligations, including those which are guaranteed by federal agencies or instrumentalities, may or may not be backed by the "full faith and credit" of the United States. Obligations of the Government National Mortgage Association ("GNMA"), the Farmers Home Administration and the Export-Import Bank are backed by the full faith and credit of the United States. In the case of securities not backed by the full faith and credit of the United States, a Fund must look principally to the agency issuing or guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the United States if the agency or instrumentality does not meet its commitments. The Balanced Assets Fund and the Global Balanced Fund may, in addition to the U.S. government securities noted above, invest in mortgage-backed securities (including private mortgage-backed securities), such as GNMA, FNMA or FHLMC certificates (as defined below), which represent an undivided ownership interest in a pool of mortgages. The mortgages backing these securities include conventional thirty-year fixed-rate mortgages, fifteen-year fixed-rate mortgages, graduated payment mortgages and adjustable rate mortgages. These certificates are in most cases pass-through instruments, through which the holder receives a share of all interest and principal payments, including prepayments, on the mortgages underlying the certificate, net of certain fees. The yield on mortgage-backed securities is based on the average expected life of the underlying pool of mortgage loans. The actual life of any particular pool will be shortened by any unscheduled or early payments of principal and interest. Principal prepayments generally result from the sale of the underlying property or the refinancing or foreclosure of underlying mortgages. The occurrence of prepayments is affected by a wide range of economic, demographic and social factors and, accordingly, it is not possible to predict accurately the average life of a particular pool. Yield on such pools is usually computed by using the historical record of prepayments for that pool, or, in the case of newly-issued mortgages, the prepayment history of similar pools. The actual prepayment experience of a pool of mortgage loans may cause the yield realized by the Balanced Assets Fund or Global Balanced Fund to differ from the yield calculated on the basis of the expected average life of the pool. Prepayments tend to increase during periods of falling interest rates, while during periods of rising interest rates prepayments will most likely decline. When prevailing interest rates rise, the value of a pass-through security may decrease as do the value of other debt securities, but, when prevailing interest rates decline, the value of a pass-through security is not likely to rise on a comparable basis with other debt securities because of the prepayment feature of pass-through securities. The reinvestment of scheduled principal payments and unscheduled prepayments that the Balanced Assets Fund or Global Balanced Fund receives may occur at higher or lower rates than the original investment, thus affecting the yield of the Fund. Monthly interest payments received by the Balanced Assets Fund or Global Balanced Fund have a compounding effect which may increase the yield to shareholders more than debt obligations that pay interest semi-annually. Because of those factors, mortgage- backed securities may be less effective than U.S. Treasury bonds of similar maturity at maintaining yields during periods of declining interest rates. Accelerated prepayments adversely affect yields for pass-through securities purchased at a premium (i.e., at a price in excess of principal amount) and may involve additional risk of loss of principal because the premium may not have been fully amortized at the time the obligation is repaid. The opposite is true for pass-through securities purchased at a discount. The Balanced Assets Fund or Global Balanced Fund may purchase mortgage-backed securities at a premium or at a discount. The following is a description of GNMA, FNMA and FHLMC certificates, the most widely available mortgage-backed securities: GNMA Certificates. GNMA certificates ("GNMA Certificates") are mortgage- backed securities which evidence an undivided interest in a pool or pools of mortgages. GNMA Certificates that the Balanced Assets Fund or Global Balanced Fund may purchase are the modified pass-through type, which entitle the holder timely payment of all interest and principal payments due on the mortgage pool, net of fees paid to the issuer and GNMA, regardless of whether or not the mortgagor actually makes the payment. GNMA guarantees the timely payment of principal and interest on securities backed by a pool of mortgages insured by the Federal Housing Administration ("FHA") or the Farmers' Home Administration ("FMHA"), or guaranteed by the Veterans Administration ("VA"). The GNMA guarantee is authorized by the National Housing Act and is backed by the full faith and credit of the United States. The GNMA is also empowered to borrow without limitation from the U.S. Treasury if necessary to make any payments required under its guarantee. The average life of a GNMA Certificate is likely to be substantially shorter than the original maturity of the mortgages underlying the securities. Prepayments of principal by mortgagors and mortgage foreclosure will usually result in the return of the greater part of principal investment long before the maturity of the mortgages in the pool. Foreclosures impose no risk to principal investment because of the GNMA guarantee, except to the extent that a Fund has purchased the certificates at a premium in the secondary market. FHLMC Certificates. The Federal Home Loan Mortgage Corporation ("FHLMC") issues two types of mortgage pass-through securities: mortgage participation certificates ("Pcs") and guaranteed mortgage certificates ("GMCs") (collectively, "FHLMC Certificates"). Pcs resemble GNMA Certificates in that each PC represents a pro rata share of all interest and principal payments made and owed on the underlying pool. The FHLMC guarantees timely monthly payment of interest (and, under certain circumstances, principal) of Pcs and the ultimate payment of principal. GMCs also represent a pro rata interest in a pool of mortgages. However, these instruments pay interest semi-annually and return principal once a year in guaranteed minimum payments. The expected average life of these securities is approximately ten years. The FHLMC guarantee is not backed by the full faith and credit of the U.S. Government. FNMA Certificates. The Federal National Mortgage Association ("FNMA") issues guaranteed mortgage pass-through certificates ("FNMA Certificates"). FNMA Certificates represent a pro rata share of all interest and principal payments made and owed on the underlying pool. FNMA guarantees timely payment of interest and principal on FNMA Certificates. The FNMA guarantee is not backed by the full faith and credit of the U.S. Government. Another type of mortgage-backed security in which the Balanced Assets Fund or Global Balanced Fund may invest is a collateralized mortgage obligation ("CMO"). CMOs are fully collateralized bonds which are the general obligations of the issuer thereof (e.g., the U.S. government, a U.S. government instrumentality, or a private issuer). Such bonds generally are secured by an assignment to a trustee (under the indenture pursuant to which the bonds are issued) of collateral consisting of a pool of mortgages. Payments with respect to the underlying mortgages generally are made to the trustee under the indenture. Payments of principal and interest on the underlying mortgages are not passed through to the holders of the CMOs as such (i.e., the character of payments of principal and interest is not passed through, and therefore payments to holders of CMOs attributable to interest paid and principal repaid on the underlying mortgages do not necessarily constitute income and return of capital, respectively, to such holders), but such payments are dedicated to payment of interest on and repayment of principal of the CMOs. CMOs often are issued in two or more classes with varying maturities and stated rates of interest. Because interest and principal payments on the underlying mortgages are not passed through to holders of CMOs, CMOs of varying maturities may be secured by the same pool of mortgages, the payments on which are used to pay interest on each class and to retire successive maturities in sequence. Unlike other mortgage-backed securities, CMOs are designed to be retired as the underlying mortgages are repaid. In the event of prepayment on such mortgages, the class of CMO first to mature generally will be paid down. Therefore, although in most cases the issuer of CMOs will not supply additional collateral in the event of such prepayment, there will be sufficient collateral to secure CMOs that remain outstanding. Certain CMOs may be deemed to be investment companies under the 1940 Act. The Balanced Assets Fund or Global Balanced Fund intends to conduct operations in a manner consistent with this view, and therefore generally may not invest more than 10% of its total assets in such issuers without obtaining appropriate regulatory relief. In reliance on recent SEC staff interpretations, a Fund may invest in those CMOs and other mortgage-backed securities that are not by definition excluded from the provisions of the 1940 Act, but have obtained exemptive orders from the SEC from such provisions. The Balanced Assets Fund or Global Balanced Fund may also invest in stripped mortgage-backed securities. Stripped mortgage-backed securities are often structured with two classes that receive different proportions of the interest and principal distributions on a pool of mortgage assets. Stripped mortgage-backed securities have greater market volatility than other types of U.S. Government securities in which a Fund invests. A common type of stripped mortgage-backed security has one class receiving some of the interest and all or most of the principal (the "principal only" class) from the mortgage pool, while the other class will receive all or most of the interest (the "interest only" class). The yield to maturity on an interest only class is extremely sensitive not only to changes in prevailing interest rates, but also to the rate of principal payments, including principal prepayments, on the underlying pool of mortgage assets, and a rapid rate of principal payment may have a material adverse effect on the Fund's yield. While interest-only and principal-only securities are generally regarded as being illiquid, such securities may be deemed to be liquid if they can be disposed of promptly in the ordinary course of business at a value reasonably close to that used in the calculation of the Fund's net asset value per share. Only government interest only and principal only securities backed by fixed-rate mortgages and determined to be liquid under guidelines and standards established by the Trustees may be considered liquid securities not subject to a Fund's limitation on investments in illiquid securities. Investment in Small, Unseasoned Companies. As described in the Prospectus, the Small Company Growth Fund will invest, and the other Funds Growth Fund may each invest, in the securities of small companies having market capitalizations under $800 million. These securities may have a limited trading market, which may adversely affect their disposition and can result in their being priced lower than might otherwise be the case. If other investment companies and investors who invest in such issuers trade the same securities when a Fund attempts to dispose of its holdings, the Fund may receive lower prices than might otherwise be obtained. Warrants. Each Fund may invest in warrants which give the holder of the warrant a right to purchase a given number of shares of a particular issue at a specified price until expiration. Such investments generally can provide a greater potential for profit or loss than investments of equivalent amounts in the underlying common stock. The prices of warrants do not necessarily move with the prices of the underlying securities. If the holder does not sell the warrant, he risks the loss of his entire investment if the market price of the underlying stock does not, before the expiration date, exceed the exercise price of the warrant plus the cost thereof. Investment in warrants is a speculative activity. Warrants pay no dividends and confer no rights (other than the right to purchase the underlying stock) with respect to the assets of the issuer. When-Issued and Delayed Delivery Securities. Each Fund may purchase or sell such securities on a "when-issued" or "delayed delivery" basis. Although a Fund will enter into such transactions for the purpose of acquiring securities for its portfolio or for delivery pursuant to options contracts it has entered into, the Fund may dispose of a commitment prior to settlement. "When-issued" or "delayed delivery" refers to securities whose terms and indenture are available and for which a market exists, but which are not available for immediate delivery. When such transactions are negotiated, the price (which is generally expressed in yield terms) is fixed at the time the commitment is made, but delivery and payment for the securities take place at a later date. During the period between commitment by a Fund and settlement (generally within two months but not to exceed 120 days), no payment is made for the securities purchased by the purchaser, and no interest accrues to the purchaser from the transaction. Such securities are subject to market fluctuation, and the value at delivery may be less than the purchase price. A Fund will maintain a segregated account with its custodian, consisting of cash, U.S. government securities or other high grade debt obligations at least equal to the value of purchase commitments until payment is made. A Fund will likewise segregate liquid assets in respect of securities sold on a delayed delivery basis. A Fund will engage in when-issued transactions in order to secure what is considered to be an advantageous price and yield at the time of entering into the obligation. When a Fund engages in when-issued or delayed delivery transactions, it relies on the buyer or seller, as the case may be, to consummate the transaction. Failure to do so may result in a Fund losing the opportunity to obtain a price and yield considered to be advantageous. If a Fund chooses to (i) dispose of the right to acquire a when-issued security prior to its acquisition or (ii) dispose of its right to deliver or receive against a forward commitment, it may incur a gain or loss. (At the time a Fund makes a commitment to purchase or sell a security on a when-issued or forward commitment basis, it records the transaction and reflects the value of the security purchased, or if a sale, the proceeds to be received in determining its net To the extent a Fund engages in when-issued and delayed delivery transactions, it will do so for the purpose of acquiring or selling securities consistent with its investment objectives and policies and not for the purposes of investment leverage. A Fund enters into such transactions only with the intention of actually receiving or delivering the securities, although (as noted above) when-issued securities and forward commitments may be sold prior to the settlement date. In addition, changes in interest rates in a direction other than that expected by the Adviser (or Sub-Adviser) before settlement will affect the value of such securities and may cause a loss to a Fund. When-issued transactions and forward commitments may be used to offset anticipated changes in interest rates and prices. For instance, in periods of rising interest rates and falling prices, a Fund might sell securities in its portfolio on a forward commitment basis to attempt to limit its exposure to anticipated falling prices. In periods of falling interest rates and rising prices, a Fund might sell portfolio securities and purchase the same or similar securities on a when-issued or forward commitment basis, thereby obtaining the benefit of currently higher cash yields. Foreign Securities. Investments in foreign securities offer potential benefits not available from investments solely in securities of domestic issuers by offering the opportunity to invest in foreign issuers that appear to offer growth potential, or in foreign countries with economic policies or business cycles different from those of the U.S., or to reduce fluctuations in portfolio value by taking advantage of foreign stock markets that do not move in a manner parallel to U.S. markets. Each Fund may invest in securities of foreign issuers in the form of American Depository Receipts (ADRs), European Depository Receipts (EDRs), Global Depository Receipts (GDRs) or other similar securities convertible into securities of foreign issuers. ADRs are securities, typically issued by a U.S. financial institution, that evidence ownership interests in a security or a pool of securities issued by a foreign issuer and deposited with the depository. ADRs may be sponsored or unsponsored. A sponsored ADR is issued by a depository which has an exclusive relationship with the issuer of the underlying security. An unsponsored ADR may be issued by any number of U.S. depositories. Holders of unsponsored ADRs generally bear all the costs associated with establishing the unsponsored ADR. The depository of an unsponsored ADR is under no obligation to distribute shareholder communications received from the underlying issuer or to pass through to the holders of the unsponsored ADR voting rights with respect to the deposited securities or pool of securities. A Fund may invest in either type of ADR. Although the U.S. investor holds a substitute receipt of ownership rather than direct stock certificates, the use of the depository receipts in the United States can reduce costs and delays as well as potential currency exchange and other difficulties. The Fund may purchase securities in local markets and direct delivery of these ordinary shares to the local depository of an ADR agent bank in the foreign country. Simultaneously, the ADR agents create a certificate which settles at the Fund's custodian in five days. The Fund may also execute trades on the U.S. markets using existing ADRs. A foreign issuer of the security underlying an ADR is generally not subject to the same reporting requirements in the United States as a domestic issuer. Accordingly the information available to a U.S. investor will be limited to the information the foreign issuer is required to disclose in its own country and the market value of an ADR may not reflect undisclosed material information concerning the issuer of the underlying security. For purposes of a Fund's investment policies, the Fund's investments in these types of securities will be deemed to be investments in the underlying securities. Generally ADRs, in registered form, are dollar denominated securities designed for use in the U.S. securities markets, which represent and may be converted into the underlying foreign security. EDRs, in bearer form, are designed for use in the European securities markets. Investments in foreign securities, including securities of developing countries, present special additional investment risks and considerations not typically associated with investments in domestic securities, including reduction of income by foreign taxes; fluctuation in value of foreign portfolio investments due to changes in currency rates and control regulations (e.g., currency blockage); transaction charges for currency exchange; lack of public information about foreign issuers; lack of uniform accounting, auditing and financial reporting standards comparable to those applicable to domestic issuers; less volume on foreign exchanges than on U.S. exchanges; greater volatility and less liquidity on foreign markets than in the U.S.; less regulation of foreign issuers, stock exchanges and brokers than the U.S.; greater difficulties in commencing lawsuits; higher brokerage commission rates than the U.S.; increased possibilities in some countries of expropriation, confiscatory taxation, political, financial or social instability or adverse diplomatic developments; and differences (which may be favorable or unfavorable) between the U.S. economy and foreign economies. Loans of Portfolio Securities. Consistent with applicable regulatory requirements, each Fund may lend portfolio securities in amounts up to 33% of total assets to brokers, dealers and other financial institutions, provided, that such loans are callable at any time by the Fund and are at all times secured by cash or equivalent collateral that is equal to at least the market value, determined daily, of the loaned securities. In lending its portfolio securities, a Fund receives income while retaining the securities' potential for capital appreciation. The advantage of such loans is that a Fund continues to receive the interest and dividends on the loaned securities while at the same time earning interest on the collateral, which will be invested in short-term obligations. A loan may be terminated by the borrower on one business day's notice or by a Fund at any time. If the borrower fails to maintain the requisite amount of collateral, the loan automatically terminates, and the Fund could use the collateral to replace the securities while holding the borrower liable for any excess of replacement cost over collateral. As with any extensions of credit, there are risks of delay in recovery and in some cases even loss of rights in the collateral should the borrower of the securities fail financially. However, these loans of portfolio securities will only be made to firms deemed by the Adviser (or Sub-Adviser) to be creditworthy. On termination of the loan, the borrower is required to return the securities to a Fund; and any gain or loss in the market price of the loaned security during the loan would inure to the Fund. Each Fund will pay reasonable finders', administrative and custodial fees in connection with a loan of its securities or may share the interest earned on collateral with the borrower. Loans of portfolio securities will only be made to firms deemed by the Adviser (or Sub-Adviser) to be creditworthy. Since voting or consent rights which accompany loaned securities pass to the borrower, each Fund will follow the policy of calling the loan, in whole or in part as may be appropriate, to permit the exercise of such rights if the matters involved would have a material effect on the Fund's investment in the securities which are the subject of the loan. Income Enhancement Strategies. Each Fund may write (i.e., sell) call options ("calls") on securities that are traded on U.S. and foreign securities exchanges and over-the-counter markets to enhance income through the receipt of premiums from expired calls and any net profits from closing purchase transactions. After any such sale up to 100% of a Fund's total assets may be subject to calls. All such calls written by a Fund must be "covered" while the call is outstanding (i.e., the Fund must own the securities subject to the call or other securities acceptable for applicable escrow requirements). Calls on Futures (defined below) used to enhance income must be covered by deliverable securities or by liquid assets segregated to satisfy the Futures contract. If a call written by the Fund is exercised, the Fund forgoes any profit from any increase in the market price above the call price of the underlying investment on which the call was written. In addition, the Fund could experience capital losses which might cause previously distributed short-term capital gains to be re-characterized as a non- taxable return of capital to shareholders. The Balanced Assets Fund and Global Balanced Fund also may write put options ("puts") which give the holder of the option the right to sell the underlying security to the Fund at the stated exercise price. A Fund will receive a premium for writing a put option which increases the Fund's return. A Fund writes only covered put options which means that so long as the Fund is obligated as the writer of the option it will, through it custodian, have deposited and maintained cash, cash equivalents, U.S. government securities or other high grade liquid debt or equity securities denominated in U.S. dollars or non-U.S. currencies with a securities depository with a value equal to or greater than the exercise price of the underlying securities. Puts on Futures (defined below) will be considered "covered" if the a Fund owns an option to sell that Futures contract having a strike price equal to or greater than the strike price of the "covered" option, or if the Fund segregates and maintains with its custodian for the term of the option cash, U.S. government securities or liquid high-grade debt obligations at all times equal in value to the exercise price of the put (less any initial margin deposited by the Fund with its custodian with respect to such option). Hedging Strategies. For hedging purposes as a temporary defensive maneuver, each Fund may use interest rate futures contracts, foreign currency futures contracts, and stock and bond index futures contracts (together, "Futures"); forward contracts on foreign currencies ("Forward Contracts"); and call and put on equity and debt securities, Futures, stock and bond indices and foreign currencies (all the foregoing referred to as "Hedging Instruments"). Hedging Instruments may be used to attempt to: (i) protect against possible declines in the market value of a Fund's portfolio resulting from downward trends in the equity and debt securities markets (generally due to a rise in interest rates); (ii) protect a Fund's unrealized gains in the value of its equity and debt securities which have appreciated; (iii) facilitate selling securities for investment reasons; (iv) establish a position in the equity and debt securities markets as a temporary substitute for purchasing particular equity and debt securities; or (v) reduce the risk of adverse currency fluctuations. A Fund's strategy of hedging with Futures and options on Futures will be incidental to its activities in the underlying cash market. When hedging to attempt to protect against declines in the market value of a Fund's portfolio, to permit a Fund to retain unrealized gains in the value of portfolio securities which have appreciated, or to facilitate selling securities for investment reasons, a Fund could: (i) sell Futures; (ii) purchase puts on such Futures or securities; or (iii) write calls on securities held by it or on Futures. When hedging to attempt to protect against the possibility that portfolio securities are not fully included in a rise in value of the debt securities market, a Fund could: (i) purchase Futures, or (ii) purchase calls on such Futures or on securities. When hedging to protect against declines in the dollar value of a foreign currency-denominated security, a Fund could: (i) purchase puts on that foreign currency and on foreign currency Futures; (ii) write calls on that currency or on such Futures; or (iii) enter into Forward Contracts at a lower rate than the spot ("cash") rate. Additional information about the Hedging Instruments the Funds may use is provided below. The Global Balanced Fund may engage in the foregoing for non-hedging purposes as well. Options on Securities. As noted above, each Fund may write and purchase call and put options (including yield curve options) on equity and debt securities. When a Fund writes a call on a security it receives a premium and agrees to sell the underlying security to a purchaser of a corresponding call on the same security during the call period (usually not more than 9 months) at a fixed price (which may differ from the market price of the underlying security), regardless of market price changes during the call period. A Fund has retained the risk of loss should the price of the underlying security decline during the call period, which may be offset to some extent by the premium. To terminate its obligation on a call it has written, a Fund may purchase a corresponding call in a "closing purchase transaction." A profit or loss will be realized, depending upon whether the net of the amount of the option transaction costs and the premium received on the call written was more or less than the price of the call subsequently purchased. A profit may also be realized if the call expires unexercised, because a Fund retains the underlying security and the premium received. Any such profits are considered short-term capital gains for Federal income tax purposes, and when distributed by the Fund are taxable as ordinary income. If a Fund could not effect a closing purchase transaction due to lack of a market, it would hold the callable securities until the call expired or was exercised. When a Fund purchases a call (other than in a closing purchase transaction), it pays a premium and has the right to buy the underlying investment from a seller of a corresponding call on the same investment during the call period at a fixed exercise price. A Fund benefits only if the call is sold at a profit or if, during the call period, the market price of the underlying investment is above the sum of the call price plus the transaction costs and the premium paid and the call is exercised. If the call is not exercised or sold (whether or not at a profit), it will become worthless at its expiration date and a Fund will lose its premium payment and the right to purchase the underlying investment. A put option on securities gives the purchaser the right to sell, and the writer the obligation to buy, the underlying investment at the exercise price during the option period. Writing a put covered by segregated liquid assets equal to the exercise price of the put has the same economic effect to a Fund as writing a covered call. The premium a Fund receives from writing a put option represents a profit as long as the price of the underlying investment remains above the exercise price. However, a Fund has also assumed the obligation during the option period to buy the underlying investment from the buyer of the put at the exercise price, even though the value of the investment may fall below the exercise price. If the put expires unexercised, a Fund (as the writer of the put) realizes a gain in the amount of the premium. If the put is exercised, a Fund must fulfill its obligation to purchase the underlying investment at the exercise price, which will usually exceed the market value of the investment at that time. In that case, a Fund may incur a loss, equal to the sum of the sale price of the underlying investment and the premium received minus the sum of the exercise price and any transaction costs incurred. A Fund may effect a closing purchase transaction to realize a profit on an outstanding put option it has written or to prevent an underlying security from being put. Furthermore, effecting such a closing purchase transaction will permit a Fund to write another put option to the extent that the exercise price by the deposited assets, or to utilize the proceeds from the sale of such assets for other investments by the Fund. A Fund will realize a profit or loss from a closing purchase transaction if the cost of the transaction is less or more than the premium received from writing the option. As described above for writing covered calls, any and all such profits described herein from writing puts are considered short-term gains for Federal tax purposes, and when distributed by a Fund, are taxable as ordinary income. When a Fund purchases a put, it pays a premium and has the right to sell the underlying investment to a seller of a corresponding put on the same investment during the put period at a fixed exercise price. Buying a put on an investment a Fund owns enables the Fund to protect itself during the put period against a decline in the value of the underlying investment below the exercise price by selling such underlying investment at the exercise price to a seller of a corresponding put. If the market price of the underlying investment is equal to or above the exercise price and as a result the put is not exercised or resold, the put will become worthless at its expiration date, and the Fund will lose its premium payment and the right to sell the underlying investment pursuant to the put. The put may, however, be sold prior to expiration (whether or not at a profit.) Buying a put on an investment a Fund does not own permits the Fund either to resell the put or buy the underlying investment and sell it at the exercise price. The resale price of the put will vary inversely with the price of the underlying investment. If the market price of the underlying investment is above the exercise price and as a result the put is not exercised, the put will become worthless on its expiration date. In the event of a decline in the stock market, a Fund could exercise or sell the put at a profit to attempt to offset some or all of its loss on its portfolio securities. When writing put options on securities, to secure its obligation to pay for the underlying security, a Fund will deposit in escrow liquid assets with a value equal to or greater than the exercise price of the underlying securities. A Fund therefore forgoes the opportunity of investing the segregated assets or writing calls against those assets. As long as the obligation of a Fund as the put writer continues, it may be assigned an exercise notice by the broker-dealer through whom such option was sold, requiring a Fund to take delivery of the underlying security against payment of the exercise price. A Fund has no control over when it may be required to purchase the underlying security, since it may be assigned an exercise notice at any time prior to the termination of its obligation as the writer of the put. This obligation terminates upon expiration of the put, or such earlier time at which a Fund effects a closing purchase transaction by purchasing a put of the same series as that previously sold. Once a Fund has been assigned an exercise notice, it is thereafter not allowed to effect a closing purchase transaction. Options on Foreign Currencies. Each Fund may write and purchase puts and calls on foreign currencies. A call written on a foreign currency by a Fund is "covered" if the Fund owns the underlying foreign currency covered by the call or has an absolute and immediate right to acquire that foreign currency without additional cash consideration (or for additional cash consideration held in a segregated account by its custodian) upon conversion or exchange of other foreign currency held in its portfolio. A put option is "covered" if the Fund deposits with its custodian cash, U.S. government securities or other high-grade liquid debt securities with a value at least equal to the exercise price of the put option. A call written by a Fund on a foreign currency is for cross-hedging purposes if it is not covered, but is designed to provide a hedge against a decline in the U.S. dollar value of a security which the Fund owns or has the right to acquire and which is denominated in the currency underlying the option due to an adverse change in the exchange rate. In such circumstances, a Fund collateralizes the option by maintaining in a segregated account with the Fund's custodian, cash or U.S. government securities in an amount not less than the value of the underlying foreign currency in U.S. dollars marked-to-market daily. Options on Securities Indices. As noted above, each Fund may write and purchase call and put options on securities indices. Puts and calls on broadly- based securities indices are similar to puts and calls on securities except that all settlements are in cash and gain or loss depends on changes in the index in question (and thus on price movements in the securities market generally) rather than on price movements in individual securities or Futures. When a Fund buys a call on a securities index, it pays a premium. During the call period, upon exercise of a call by a Fund, a seller of a corresponding call on the same investment will pay the Fund an amount of cash to settle the call if the closing level of the securities index upon which the call is based is greater than the exercise price of the call. That cash payment is equal to the difference between the closing price of the index and the exercise price of the call times a specified multiple (the "multiplier") which determines the total dollar value for each point of difference. When a Fund buys a put on a securities index, it pays a premium and has the right during the put period to require a seller of a corresponding put, upon the Fund's exercise of its put, to deliver to the Fund an amount of cash to settle the put if the closing level of the securities index upon which the put is based is less than the exercise price of the put. That cash payment is determined by the multiplier, in the same manner as described above as to calls. Futures and Options on Futures Futures. Upon entering into a Futures transaction, a Fund will be required to deposit an initial margin payment with the futures commission merchant (the "futures broker"). The initial margin will be deposited with the Fund's custodian in an account registered in the futures broker's name; however the futures broker can gain access to that account only under specified conditions. As the Future is marked to market to reflect changes in its market value, subsequent margin payments, called variation margin, will be paid to or by the futures broker on a daily basis. Prior to expiration of the Future, if a Fund elects to close out its position by taking an opposite position, a final determination of variation margin is made, additional cash is required to be paid by or released to the Fund, and any loss or gain is realized for tax purposes. All Futures transactions are effected through a clearinghouse associated with the exchange on which the Futures are traded. Interest rate futures contracts are purchased or sold for hedging purposes to attempt to protect against the effects of interest rate changes on a Fund's current or intended investments in fixed-income securities. For example, if a Fund owned long-term bonds and interest rates were expected to increase, that Fund might sell interest rate futures contracts. Such a sale would have much the same effect as selling some of the long-term bonds in that Fund's portfolio. However, since the Futures market is more liquid than the cash market, the use of interest rate futures contracts as a hedging technique allows a Fund to hedge its interest rate risk without having to sell its portfolio securities. If interest rates did increase, the value of the debt securities in the portfolio would decline, but the value of that Fund's interest rate futures contracts would be expected to increase at approximately the same rate, thereby keeping the net asset value of that Fund from declining as much as it otherwise would have. On the other hand, if interest rates were expected to decline, interest rate futures contracts may be purchased to hedge in anticipation of subsequent purchases of long-term bonds at higher prices. Since the fluctuations in the value of the interest rate futures contracts should be similar to that of long- term bonds, a Fund could protect itself against the effects of the anticipated rise in the value of long-term bonds without actually buying them until the necessary cash became available or the market had stabilized. At that time, the interest rate futures contracts could be liquidated and that Fund's cash reserves could then be used to buy long-term bonds on the cash market. Purchases or sales of stock or bond index futures contracts are used for hedging purposes to attempt to protect a Fund's current or intended investments from broad fluctuations in stock or bond prices. For example, a Fund may sell stock or bond index futures contracts in anticipation of or during a market attempt to offset the decrease in market value of the Fund's securities portfolio that might otherwise result. If such decline occurs, the loss in value of portfolio securities may be offset, in whole or part, by gains on the Futures position. When a Fund is not fully invested in the securities market and anticipates a significant market advance, it may purchase stock or bond index futures contracts in order to gain rapid market exposure that may, in part or entirely, offset increases in the cost of securities that the Fund intends to purchase. As such purchases are made, the corresponding positions in stock or bond index futures contracts will be closed out. As noted above, each Fund may purchase and sell foreign currency futures contracts for hedging or income enhancement purposes to attempt to protect its current or intended investments from fluctuations in currency exchange rates. Such fluctuations could reduce the dollar value of portfolio securities denominated in foreign currencies, or increase the cost of foreign-denominated securities to be acquired, even if the value of such securities in the currencies in which they are denominated remains constant. Each Fund may sell futures contracts on a foreign currency, for example, when it holds securities denominated in such currency and it anticipates a decline in the value of such currency relative to the dollar. In the event such decline occurs, the resulting adverse effect on the value of foreign-denominated securities may be offset, in whole or in part, by gains on the Futures contracts. However, if the value of the foreign currency increases relative to the dollar, the Fund's loss on the foreign currency futures contract may or may not be offset by an increase in the value of the securities since a decline in the price of the security stated in terms of the foreign currency may be greater than the increase in value as a result of the change in exchange rates. Conversely, each Fund could protect against a rise in the dollar cost of foreign-denominated securities to be acquired by purchasing Futures contracts on the relevant currency, which could offset, in whole or in part, the increased cost of such securities resulting from a rise in the dollar value of the underlying currencies. When a Fund purchases futures contracts under such circumstances, however, and the price of securities to be acquired instead declines as a result of appreciation of the dollar, the Fund will sustain losses on its futures position which could reduce or eliminate the benefits of the reduced cost of portfolio securities to be acquired. Options on Futures. As noted above, the Funds may purchase and write options on interest rate futures contracts, stock and bond index futures contracts and foreign currency futures contracts. (Unless otherwise specified, options on interest rate futures contracts, options on stock and bond index futures contracts and options on foreign currency futures contracts are collectively referred to as "Options on Futures.") The writing of a call option on a Futures contract constitutes a partial hedge against declining prices of the securities in a Fund's portfolio. If the Futures price at expiration of the option is below the exercise price, the Fund will retain the full amount of the option premium, which provides a partial hedge against any decline that may have occurred in the Fund's portfolio holdings. The writing of a put option on a Futures contract constitutes a partial hedge against increasing prices of the securities or other instruments required to be delivered under the terms of the Futures contract. If the Futures price at expiration of the put option is higher than the exercise price, a Fund will retain the full amount of the option premium which provides a partial hedge against any increase in the price of securities which the Fund intends to purchase. If a put or call option a Fund has written is exercised, the Fund will incur a loss which will be reduced by the amount of the premium it receives. Depending on the degree of correlation between changes in the value of its portfolio securities and changes in the value of its Options on Futures positions, a Fund's losses from exercised Options on Futures may to some extent be reduced or increased by changes in the value of portfolio securities. The Fund may purchase Options on Futures for hedging purposes, instead of purchasing or selling the underlying Futures contract. For example, where a decrease in the value of portfolio securities is anticipated as a result of a projected market-wide decline or changes in interest or exchange rates, a Fund could, in lieu of selling a Futures contract, purchase put options thereon. In the event that such decrease occurs, it may be offset, in whole or part, by a profit on the option. If the market decline does not occur, the Fund will suffer a loss equal to the price of the put. Where it is projected that the value of securities to be acquired by a Fund will increase prior to acquisition, due to a market advance or changes in interest or exchange rates, a Fund could purchase call Options on Futures, rather than purchasing the underlying Futures contract. If the market advances, the increased cost of securities to be purchased may be offset by a profit on the call. However, if the market declines, the Fund will suffer a loss equal to the price of the call but the securities which the Fund intends to purchase may be less expensive. A Forward Contract involves bilateral obligations of one party to purchase, and another party to sell, a specific currency at a future date (which may be any fixed number of days from the date of the contract agreed upon by the parties), at a price set at the time the contract is entered into. These contracts are traded in the interbank market conducted directly between currency traders (usually large commercial banks) and their customers. No price is paid or received upon the purchase or sale of a Forward Contract. A Fund may use Forward Contracts to protect against uncertainty in the level of future exchange rates. The use of Forward Contracts does not eliminate fluctuations in the prices of the underlying securities a Fund owns or intends to acquire, but it does fix a rate of exchange in advance. In addition, although Forward Contracts limit the risk of loss due to a decline in the value of the hedged currencies, at the same time they limit any potential gain that might result should the value of the currencies increase. A Fund (other than the Global Balanced Fund) will not speculate with Forward Contracts or foreign currency exchange rates. A Fund may enter into Forward Contracts with respect to specific transactions. For example, when a Fund enters into a contract for the purchase or sale of a security denominated in a foreign currency, or when a Fund anticipates receipt of dividend payments in a foreign currency, the Fund may desire to "lock-in" the U.S. dollar price of the security or the U.S. dollar equivalent of such payment by entering into a Forward Contract, for a fixed amount of U.S. dollars per unit of foreign currency, for the purchase or sale of the amount of foreign currency involved in the underlying transaction. A Fund will thereby be able to protect itself against a possible loss resulting from an adverse change in the relationship between the currency exchange rates during the period between the date on which the security is purchased or sold, or on which the payment is declared, and the date on which such payments are made or received. A Fund may also use Forward Contracts to lock in the U.S. dollar value of portfolio positions ("position hedge"). In a position hedge, for example, when a Fund believes that foreign currency may suffer a substantial decline against the U.S. dollar, it may enter into a Forward Contract to sell an amount of that foreign currency approximating the value of some or all of the Fund's portfolio securities denominated in such foreign currency, or when a Fund believes that the U.S. dollar may suffer a substantial decline against a foreign currency, it may enter into a Forward Contract to buy that foreign currency for a fixed dollar amount. In this situation a Fund may, in the alternative, enter into a Forward Contract to sell a different foreign currency for a fixed U.S. dollar amount where the Fund believes that the U.S. dollar value of the currency to be sold pursuant to the forward contract will fall whenever there is a decline in the U.S. dollar value of the currency in which portfolio securities of the Fund are denominated ("cross-hedged"). The Fund's custodian will place cash not available for investment or U.S. government securities or other liquid high-quality debt securities in a separate account of the Fund having a value equal to the aggregate amount of the Fund's commitments under Forward Contracts entered into with respect to position hedges and cross-hedges. If the value of the securities placed in a separate account declines, additional cash or securities will be placed in the account on a daily basis so that the value of the account will equal the amount of the Fund's commitments with respect to such contracts. As an alternative to maintaining all or part of the separate account, a Fund may purchase a call option permitting the Fund to purchase the amount of foreign currency being hedged by a forward sale contract at a price no higher than the Forward Contract price or the Fund may purchase a put option permitting the Fund to sell the amount of foreign currency subject to a forward purchase contract at a price as high or higher than the Forward Contract price. Unanticipated changes in currency prices may result in poorer overall performance for a Fund than if it had not entered into such contracts. The precise matching of the Forward Contract amounts and the value of the securities involved will not generally be possible because the future value of such securities in foreign currencies will change as a consequence of market movements in the value of these securities between the date the Forward Contract is entered into and the date it is sold. Accordingly, it may be necessary for a Fund to purchase additional foreign currency on the spot (i.e., cash) market (and bear the expense of such purchase), if the market value of the security is less than the amount of foreign currency a Fund is obligated to deliver and if a decision is made to sell the security and make delivery of the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received upon the sale of the portfolio security if its market value exceeds the amount of foreign currency a Fund is obligated to deliver. The projection of short-term currency market movements is extremely difficult, and the successful execution of a short-term hedging strategy is highly uncertain. Forward Contracts involve the risk that anticipated currency movements will not be accurately predicted, causing a Fund to sustain losses on these contracts and transactions costs. At or before the maturity of a Forward Contract requiring a Fund to sell a currency, the Fund may either sell a portfolio security and use the sale proceeds to make delivery of the currency or retain the security and offset its contractual obligation to deliver the currency by purchasing a second contract pursuant to which the Fund will obtain, on the same maturity date, the same amount of the currency that it is obligated to deliver. Similarly, a Fund may close out a Forward Contract requiring it to purchase a specified currency by entering into a second contract entitling it to sell the same amount of the same currency on the maturity date of the first contract. A Fund would realize a gain or loss as a result of entering into such an offsetting Forward Contract under either circumstance to the extent the exchange rate or rates between the currencies involved moved between the execution dates of the first contract and offsetting contract. The cost to a Fund of engaging in Forward Contracts varies with factors such as the currencies involved, the length of the contract period and the market conditions then prevailing. Because Forward Contracts are usually entered into on a principal basis, no fees or commissions are involved. Because such contracts are not traded on an exchange, a Fund must evaluate the credit and performance risk of each particular counterparty under a Forward Contract. Although a Fund values its assets daily in terms of U.S. dollars, it does not intend to convert its holdings of foreign currencies into U.S. dollars on a daily basis. A Fund may convert foreign currency from time to time, and investors should be aware of the costs of currency conversion. Foreign exchange dealers do not charge a fee for conversion, but they do seek to realize a profit based on the difference between the prices at which they buy and sell various currencies. Thus, a dealer may offer to sell a foreign currency to a Fund at one rate, while offering a lesser rate of exchange should the Fund desire to resell that currency to the dealer. Additional Information About Hedging Instruments and Their Use The Fund's custodian, or a securities depository acting for the custodian, will act as the Fund's escrow agent, through the facilities of the Options Clearing Corporation ("OCC"), as to the securities on which the Fund has written options or as to other acceptable escrow securities, so that no margin will be required for such transaction. OCC will release the securities on the expiration of the option or upon a Fund's entering into a closing transaction. An option position may be closed out only on a market which provides secondary trading for options of the same series and there is no assurance that a liquid secondary market will exist for any particular option. A Fund's option activities may affect its turnover rate and brokerage commissions. The exercise by a Fund of puts on securities will cause the sale of related investments, increasing portfolio turnover. Although such exercise is within a Fund's control, holding a put might cause the Fund to sell the related investments for reasons which would not exist in the absence of the put. A Fund will pay a brokerage commission each time it buys a put or call, sells a call, or buys or sells an underlying investment in connection with the exercise of a put or call. Such commissions may be higher than those which would apply to direct purchases or sales of such underlying investments. Premiums paid for options are small in relation to the market value of the related investments, and consequently, put and call options offer large amounts of leverage. The leverage offered by trading in options could result in a Fund's net asset value being more sensitive to changes in the value of the underlying investments. In the future, each Fund may employ Hedging Instruments and strategies that are not presently contemplated but which may be developed, to the extent such investment methods are consistent with a Fund's investment objectives, legally permissible and adequately disclosed. Regulatory Aspects of Hedging Instruments Each Fund must operate within certain restrictions as to its long and short positions in Futures and options thereon under a rule (the "CFTC Rule") adopted by the Commodity Futures Trading Commission (the "CFTC") under the Commodity Exchange Act (the "CEA"), which excludes the Fund from registration with the CFTC as a "commodity pool operator" (as defined in the CEA) if it complies with the CFTC Rule. In particular, the Fund may (i) purchase and sell Futures and options thereon for bona fide hedging purposes, as defined under CFTC regulations, without regard to the percentage of the Fund's assets committed to margin and option premiums, and (ii) enter into non-hedging transactions, provided that the Fund may not enter into such non-hedging transactions if, immediately thereafter, the sum of the amount of initial margin deposits on the Fund's existing Futures positions and option premiums would exceed 5% of the fair value of its portfolio, after taking into account unrealized profits and unrealized losses on any such transactions. Each Fund intends to engage in Futures transactions and options thereon only for hedging purposes, but the Global Balanced Fund may also engage in such transactions for non-hedging purposes. Margin deposits may consist of cash or securities acceptable to the broker and the relevant contract market. Transactions in options by a Fund are subject to limitations established by each of the exchanges governing the maximum number of options which may be written or held by a single investor or group of investors acting in concert, regardless of whether the options were written or purchased on the same or different exchanges or are held in one or more accounts or through one or more exchanges or brokers. Thus, the number of options which a Fund may write or hold may be affected by options written or held by other entities, including other investment companies having the same or an affiliated investment adviser. Position limits also apply to Futures. An exchange may order the liquidation of positions found to be in violation of those limits and may impose certain other sanctions. Due to requirements under the 1940 Act, when a Fund purchases a Future, the Fund will maintain, in a segregated account or accounts with its custodian bank, cash or readily marketable, short-term (maturing in one year or less) debt instruments in an amount equal to the market value of the securities underlying such Future, less the margin deposit applicable to it. Tax Aspects of Hedging Instruments Each Fund intends to qualify as a "regulated investment company" under the Internal Revenue Code of 1986, as amended (the "Code"). One of the tests for such qualification is that less than 30% of its gross income must be derived from gains realized on the sale of stock or securities held for less than three months. This limitation may limit the ability of a Fund to engage in options transactions and, in general, to hedge investment risk. Possible Risk Factors in Hedging In addition to the risks discussed in the Prospectus and above, there is a risk in using short hedging by selling Futures to attempt to protect against decline in value of a Fund's portfolio securities (due to an increase in interest rates) that the prices of such Futures will correlate imperfectly with the behavior of the cash (i.e., market value) prices of the Fund's securities. The ordinary spreads between prices in the cash and Futures markets are subject to distortions due to differences in the natures of those markets. First, all participants in the Futures markets are subject to margin deposit and maintenance requirements. Rather than meeting additional margin deposit requirements, investors may close Futures contracts through offsetting transactions which could distort the normal relationship between the cash and Futures markets. Second, the liquidity of the Futures markets depend on participants entering into offsetting transactions rather than making or taking delivery. To the extent participants decide to make or take delivery, liquidity in the Futures markets could be reduced, thus producing distortion. Third, from the point-of-view of speculators, the deposit requirements in the Futures markets are less onerous than margin requirements in the securities markets. Therefore, increased participation by speculators in the Futures markets may cause temporary price distortions. If a Fund uses Hedging Instruments to establish a position in the debt securities markets as a temporary substitute for the purchase of individual debt securities (long hedging) by buying Futures and/or calls on such Futures or on debt securities, it is possible that the market may decline; if the Adviser then determines not to invest in such securities at that time because of concerns as to possible further market decline or for other reasons, the Fund will realize a loss on the Hedging Instruments that is not offset by a reduction in the price of the debt securities purchased. Leverage. In seeking to enhance investment performance, the Global Balanced Fund, Small Company Growth Fund, and Growth and Income Fund may increase their ownership of securities by borrowing from banks at fixed rates of interest and investing the borrowed funds, subject to the restrictions stated in the Prospectus. Any such borrowing will be made only from banks and pursuant to the requirements of the 1940 Act and will be made only to the extent that the value of each Fund's assets less its liabilities, other than borrowings, is equal to at least 300% of all borrowings including the proposed borrowing. If the value of a Fund's assets, so computed, should fail to meet the 300% asset coverage requirement, the Fund is required, within three business days, to reduce its bank debt to the extent necessary to meet such requirement and may have to sell a portion of its investments at a time when independent investment judgment would not dictate such sale. Interest on money borrowed is an expense the Fund would not otherwise incur, so that it may have little or no net investment income during periods of substantial borrowings. Since substantially all of a Fund's assets fluctuate in value, but borrowing obligations are fixed when the Fund has outstanding borrowings, the net asset value per share of a Fund correspondingly will tend to increase and decrease more when the Fund's assets increase or decrease in value than would otherwise be the case. A Fund's policy regarding use of leverage is a fundamental policy which may not be changed without approval of the shareholders of the Fund. The portfolio turnover rate is calculated for each Fund by dividing (a) the lesser of purchases or sales of portfolio securities for the fiscal year by (b) the monthly average of the value of portfolio securities owned during the fiscal year. For purposes of this calculation, securities which at the time of purchase had a remaining maturity of one year or less are excluded from the numerator and the denominator. Transactions in Futures or the exercise of calls written by a Fund may cause the Fund to sell portfolio securities, thus increasing its turnover rate. The exercise of puts also may cause a sale of securities and increase turnover; although such exercise is within a Fund's control, holding a protective put might cause the Fund to sell the underlying securities for reasons which would not exist in the absence of the put. A Fund will pay a brokerage commission each time it buys or sells a security in connection with the exercise of a put or call. Some commissions may be higher than those which would apply to direct purchases or sales of portfolio securities. The following table sets forth the portfolio turnover rates for the fiscal years ended September 30, 1995 and 1994. Balanced Assets Fund 130% 141% Blue Chip Growth Fund 251% 170% Global Balanced Fund 169% 18%* Growth and Income Fund 230% 8%** Mid-Cap Growth Fund 392% 555% Small Company Growth Fund 351% 411% * For the period 6/15/94 (commencement of operations) through 9/30/94 ** For the period 7/1/94 (commencement of operations) through 9/30/94 High portfolio turnover involves correspondingly greater brokerage commissions and other transaction costs which will be borne directly by a Fund. High portfolio turnover may also involve a possible increase in short-term capital gains or losses. Each Fund is subject to a number of investment restrictions that are fundamental policies and may not be changed without the approval of the holders of a majority of that Fund's outstanding voting securities. A "majority of the outstanding voting securities" of a Fund for this purpose means the lesser of (i) 67% of the shares of the Fund represented at a meeting at which more than 50% of the outstanding shares are present in person or represented by proxy or (ii) more than 50% of the outstanding shares. Unless otherwise indicated, all percentage limitations apply to each Fund on an individual basis, and apply only at the time the investment is made; any subsequent change in any applicable percentage resulting from fluctuations in value will not be deemed an investment contrary to these restrictions. Under these restrictions, no Fund may: (1) With respect to 75% of its total assets, invest more than 5% of its total assets (taken at market value at the time of each investment) in the securities of any one issuer or purchase more than 10% of the outstanding voting securities of any one company or more than 10% of any class of a company's outstanding securities, except that these restrictions shall not apply to securities issued or guaranteed by the U.S. government or its agencies or instrumentalities ("U.S. government securities"). The foregoing restriction shall not apply to the Global Balanced Fund. (2) Invest more than 5% of its total assets (taken at market value at the time of each investment) in securities of companies having a record, together with predecessors, of less than three years of continuous operations, except that this restriction shall not apply to U.S. government securities. (3) Purchase securities on margin, borrow money or pledge their assets, except that the Global Balanced Fund, Small Company Growth Fund and Growth and Income Fund may borrow money to purchase securities as set forth in the Prospectus and Statement of Additional Information and each Fund may borrow from a bank for temporary or emergency purposes in amounts not exceeding 5% (taken at the lower of cost or current value) of its total assets (not including the amount borrowed) and pledge its assets to secure such borrowings. Further, to the extent that an investment technique engaged in by the Global Balanced Fund or Growth and Income Fund required pledging of assets, the Funds may pledge assets in connection with such transactions. For purposes of this restriction and restriction (5) below, collateral arrangements with respect to the options, financial futures and options thereon described in the Prospectus and Statement of Additional Information are not deemed to constitute a pledge or loan of assets. (4) Invest more than 25% of each Fund's assets in the securities of issuers engaged in the same industry. (5) Engage in arbitrage transactions, buy or sell commodities or commodity contracts or real estate or interests in real estate, except that each Fund may (a) purchase or sell financial futures and options thereon for hedging purposes, as described in the Prospectus and Statement of Additional Information, under policies developed by the Trustees and (b) purchase and sell marketable securities which are secured by real estate and marketable securities of companies which invest or deal in real estate. (6) Act as underwriter, except to the extent that in connection with the disposition of portfolio securities, the Funds may be deemed to be underwriters under certain Federal securities laws. (7) Make loans, except through (i) repurchase agreements, (ii) loans of portfolio securities, or (iii) the purchase of portfolio securities consistent with a Fund's investment objectives and policies, as described in the Prospectus. (8) Make short sales of securities or maintain a short position, except that each Fund may effect short sales against the box. (9) Issue senior securities as defined in the 1940 Act, except that each Fund may enter into repurchase agreements, lend its portfolio securities and borrow money from banks, as described in restriction (3), and the Global Balanced Fund may enter into dollar rolls. The following additional restrictions are not fundamental policies and may be changed by the Trustees without a vote of shareholders. Each Fund may not: (10) Invest in securities of any issuer if, to the knowledge of the Trust, any officer, trustee or director of the Trust or the Adviser (or Sub-Adviser), owns more than 1/2% of the outstanding securities of such issuer and such officers, trustees and directors who own more than 1/2%, own in the aggregate, more than 5% of the outstanding securities of such issuer. (11) Make investments for the purpose of exercising control or management. (12) Invest more than 10% of its net assets in illiquid securities, including repurchase agreements which have a maturity of longer than seven days, securities with legal or contractual restrictions on resale and securities that are not readily marketable in securities markets either within or without the United States. Restricted securities eligible for resale pursuant to Rule 144A under the Securities Act that have a readily available market, and commercial paper exempted from registration under the Securities Act pursuant to Section 4(2) of that Act that may be offered and sold to "qualified institutional buyers" as defined in Rule 144A, which the Adviser (or Sub-Adviser) has determined to be liquid pursuant to guidelines established by the Trustees, will not be considered illiquid for purposes of this 10% limitation on illiquid securities. (13) Invest in securities of other registered investment companies, except by purchases in the open market involving only customary brokerage commissions and as a result of which the Fund will not hold more than 3% of the outstanding voting securities of any one investment company, will not have invested more than 5% of its total assets in any one investment company and will not have invested more than 10% of its total assets in such securities of one or more investment companies (each of the above percentages to be determined at the time of investment), or except as part of a merger, consolidation or other acquisition. (14) Invest in interests in oil, gas or other mineral exploration or development programs, or mineral leases, although it may invest in the common stocks of companies which invest in or sponsor such programs. The Trust, on behalf of each of the Funds, has undertaken with certain securities commissions not to invest (i) more than 5% of the total assets of each Fund in puts, calls, straddles, spreads or any combination thereof, (ii) in real estate limited partnerships, or (iii) more than 10% of total assets in real estate investment trusts. The Funds have also undertaken that investments in unseasoned issuers and illiquid or restricted securities, together with investments in Rule 144A securities and/or Section 4(2) commercial paper, will not exceed 15% of a Fund's total assets. The following table lists the Trustees and executive officers of the Trust, their ages, business addresses, and principal occupations during the past five years. The SunAmerica Mutual Funds consist of SunAmerica Equity Funds, SunAmerica Income Funds and SunAmerica Money Market Funds, Inc. An asterisk indicates those Trustees who are interested persons of the Trust within the meaning of the 1940 Act. Name, Age and Address with the Fund During Past 5 Years S. James Coppersmith, 62 Trustee Formerly, President and 7 Elmwood Road General Manager, WCVB-TV, a Marblehead, MA 01945 division of the Hearst Trust. Samuel M. Eisenstat, 55 Chairman of Attorney in private practice; 430 East 86 Street the Board Trustee of RPS Realty Trust New York, NY 10028 since December 1988; Sciences, Inc. since October 1993; Chairman of the Board of the SunAmerica Mutual Fund Family and Anchor Series Trust. Stephen J. Gutman, 52 Trustee Chairman of the Board, Chief 340 East 79 Street Operating and Executive New York, NY 10021 Officer of Beau Brummel Casuals Limited, Inc., a menswear specialty retailer since May 1989; Trustee/ Director of the SunAmerica Mutual Fund Family and Trustee of Anchor Series Trust. Peter A. Harbeck, 42 Trustee and President, SunAmerica Asset The SunAmerica Center President Management Corp. ("SAAMCo")and 733 Third Avenue SunAmerica Capital Services, New York, NY 10017-3204 Inc.("SACS") since August, 1995; Mutual Funds and Anchor Series Trust; Executive Vice President and Chief Operating Officer of SAAMCo, from May 1988 to August 1995; from November 1991 to August 1995; Company. Peter McMillan III, 38 Trustee Executive Vice President and 1 SunAmerica Center Chief Investment Officer of Century City SunAmerica Investments, Inc. Los Angeles, CA 90067 since August 1989. Sebastiano Sterpa, 66 Trustee Founder of Sterpa Realty Suite 200 Inc., a full service real 200 West Glenoaks Blvd estate firm, since 1962; Glendale, CA 91202 Chairman of the Sterpa Group, real SunAmerica Mutual Fund Family. Stanton J. Feeley, 58 Executive Vice Executive Vice President and The SunAmerica Center President Chief Investment Officer, Sun- 733 Third Avenue America Asset Management New York, NY 10017-3204 Corp., since February 1992; Delaware Management Company, Inc. from December 1987 to February 1992. Nancy Kelly, 45 Vice Vice President and Head The SunAmerica Center President Trader, SAAMCo, since April 733 Third Avenue 1994; Formerly, Vice New York, NY 10017-3204 President, Whitehorne & Co. Trader, Lynch Jones & Ryan (1992-1994). Audrey L. Snell, 43 Vice Vice President and Equity The SunAmerica Center President Portfolio Manager, SAAMCo, 733 Third Avenue since March 1991; Formerly, New York, NY 10017-3204 held investment management position with Campbell Associates, Inc. from 1986 to 1991. Peter C. Sutton, 31 Controller Vice President, SAAMCo, since The SunAmerica Center September 1994; Controller, 733 Third Avenue SunAmerica Funds (since New York, NY 10017-3204 March 1993); Assistant (1990-1993). Robert M. Zakem, 37 Secretary and Senior Vice President and The SunAmerica Center Chief Compli- General Counsel of SAAMCo, 733 Third Avenue ance Officer since April 1993; Executive New York, NY 10017-3204 Vice President and Director, SACS, since February 1993; and Vice President of SAFS, since Counsel, SAAMCo, from March 1992 to April 1993; Associate, Piper & Marbury from 1989 to 1992. Trustees and officers of the Trust are also trustees and officers of some or all of the other investment companies managed, administered or advised by the Adviser, and distributed by SunAmerica Capital Services, Inc. ("SACS" or the "Distributor") and other affiliates of SunAmerica Inc. The Trust pays each Trustee who is not an interested person of the Trust or the Adviser (each a "disinterested" Trustee) annual compensation in addition to reimbursement of out-of-pocket expenses in connection with attendance at meetings of the Trustees. Specifically, each disinterested Trustee receives a pro rata portion (based upon the Trust's net Assets) aggregate of $40,000 in annual compensation for acting as director or trustee to all the retail funds in the SunAmerica Mutual Funds. In addition, Mr. Eisenstat receives an aggregate of $2,000 in annual compensation for serving as Chairman of the Boards of the retail funds in the SunAmerica Mutual Funds. Officers of the Trust receive no direct remuneration in such capacity from the Trust or any of the Funds. In addition, each disinterested Trustee also serves on the Audit Committee of the Board of Trustees. Each member of the Audit Committee receives an aggregate of $5,000 in annual compensation for serving on the Audit Committees of all of the SunAmerica Family of Mutual Funds. With respect to the Trust, each member of the committee receives a pro rata portion of the $5,000 annual compensation, based on the relative net assets of the Trust. The Trust also has a Nominating Committee, comprised solely of disinterested Trustees, which recommends to the Trustees those persons to be nominated for election as Trustees by shareholders and selects and proposes nominees for election by Trustees between shareholders' meetings. Members of the Nominating Committee serve without compensation. The Trustees (and Directors) of the SunAmerica Mutual Funds have adopted the SunAmerica Disinterested Trustees' and Directors' Retirement Plan (the "Retirement Plan") effective January 1, 1993 for the unaffiliated Trustees. The Retirement Plan provides generally that if a disinterested Trustee who has at least 10 years of consecutive service as a disinterested Trustee of any of the SunAmerica Mutual Funds (an "Eligible Trustee") retires after reaching age 60 but before age 70 or dies while a Trustee, such person will be eligible to receive a retirement or death benefit from each SunAmerica mutual fund with respect to which he or she is an Eligible Trustee. As of each birthday, prior to the 70th birthday, each Eligible Trustee will be credited with an amount equal to (i) 50% of his or her regular fees (excluding committee fees) for services as a disinterested Trustee of each SunAmerica mutual fund for the calendar year in which such birthday occurs, plus (ii) 8.5% of any amounts credited under clause (i) during prior years. An Eligible Trustee may receive any benefits payable under the Retirement Plan, at his or her election, either in one lump sum or in up to fifteen annual installments. As of January 4, 1996, the Trustees and officers of the Trust owned in the aggregate, less than 1% of the Trust's total outstanding shares. The following table sets forth information summarizing the compensation of each disinterested Trustee for his services as Trustee for the fiscal year ended September 30, 1995. Neither the Trustees who are interested persons of the Trust receive any compensation. Compensation Accrued as and Fund from Part of Fund Complex Paid to S. James Coppersmith $10,109 $39,472 $65,000 Samuel M. Eisenstat $10,590 $ 9,678 $69,000 Stephen J. Gutman $10,109 $16,460 $65,000 Sebastiano Sterpa $10,256 $14,960 $43,333** * Information is as of September 30, 1995 for the four investment companies in the complex which pay fees to these directors/trustees. The complex consists of the SunAmerica Mutual Funds and Anchor Series Trust. *Mr. Sterpa is not a trustee of Anchor Series Trust. ADVISER, SUB-ADVISERS, DISTRIBUTOR AND ADMINISTRATOR The Adviser. The Adviser, organized as a Delaware corporation in 1982, is located at The SunAmerica Center, 733 Third Avenue, New York, NY 10017-3204, and acts as adviser to each of the Funds pursuant to the Investment Advisory and Management Agreement dated September 23, 1993 as amended May 20, 1994 (the "Advisory Agreement") with the Trust, on behalf of each Fund. The Adviser is an owned subsidiary of SunAmerica Inc. (formerly, Broad Inc.). SunAmerica Inc., is incorporated in the State of Maryland and maintains its principal executive offices at 1 SunAmerica Center, Century City, Los Angeles, CA 90067-6022, telephone (310) 772-6000. Under the Advisory Agreement, the Adviser manages the investment of the assets of each Fund and obtains and evaluates economic, statistical and financial information to formulate and implement investment policies for each Fund. Any investment program undertaken by the Adviser will at all times be subject to the policies and control of the Trustees. The Adviser also provides certain administrative services to each Fund. Except to the extent otherwise specified in the Advisory Agreement, each Fund pays, or causes to be paid, all other expenses of the Trust and each of the Funds, including, without limitation, charges and expenses of any registrar, custodian, transfer and dividend disbursing agent; brokerage commissions; taxes; engraving and printing of share certificates; registration costs of the Funds and their shares under Federal and state securities laws; the cost and expense of printing, including typesetting, and distributing Prospectuses and Statements of Additional Information respecting the Funds, and supplements thereto, to the shareholders of the Funds; all expenses of shareholders' and Trustees' meetings and of preparing, printing and mailing proxy statements and reports to shareholders; all expenses incident to any dividend, withdrawal or redemption options; fees and expenses of legal counsel and independent accountants; membership dues of industry associations; interest on borrowings of the Funds; postage; insurance premiums on property or personnel (including Officers and Trustees) of the Trust which inure to its benefit; extraordinary expenses (including, but not limited to, legal claims and liabilities and litigation costs and any indemnification relating thereto); and all other costs of the Trust's operation. As compensation for its services to the Funds, the Adviser receives a fee from each Fund (other than the Global Balanced Fund), payable monthly, computed daily at the annual rate of.75% on the first $350 million of such Fund's average daily assets, .70% on the next $350 million of net assets and .65% on net assets over $700 million. With respect to the Global Balanced Fund, the Adviser receives a fee, payable monthly, computed daily at the annual rate of 1.00% on the first $250 million of the Fund's average daily net assets, .90% on the next $350 million of net assets and .85% on net assets over $700 million. The Advisory Agreement with respect to each Fund, other than the Global Balanced Fund and Growth and Income Fund, was approved by the Trustees, including a majority of the Trustees who are not parties to the Advisory Agreement or "interested persons" of any such party, on March 31, 1993 and, with respect to the Class A shares of Mid-Cap Growth Fund and Small Company Growth Fund, by the shareholders of each Fund on September 23, 1993 and with respect to the Class A shares and Class B shares of Blue Chip Growth Fund, Class B shares of Mid-Cap Growth Fund, Class B shares of Small Company Growth Fund, and Class A and Class B shares of Balanced Assets Fund, by the Adviser, the sole initial shareholder, on September 23, 1993. The Advisory Agreement with respect to each Fund, other than the Global Balanced Fund and Growth and Income Fund, became effective on September 24, 1993. The Advisory Agreement in respect of the Global Balanced Fund and Growth and Income Fund, which became effective on June 15, 1994, was approved by the Trustees, including a majority of the disinterested Trustees, on May 20, 1994 and, with respect to the Global Balanced Fund, by its sole initial shareholder on June 14, 1994 and, with respect to the Growth and Income Fund, by its sole initial shareholder on June 30, 1994. The following table sets forth the total advisory fees received by the Adviser from each Fund pursuant to the Advisory Agreement for the fiscal years ended September 30, 1995, 1994, and 1993. Balanced Assets Fund $1,821,586 $1,642,572 $229,811 Amount Waived -- -- $11,979 Blue Chip Growth Fund $565,835 $615,020 $463,678 Global Balanced Fund $269,441 $54,220 n/a Amount Waived $115,214 $48,797 -- Growth and Income Fund $32,455 $6,177** n/a Amount Waived $32,455 $6,177 -- Mid-Cap Growth Fund $294,505 $284,308 $189,944 Small Company Growth Fund $819,449 $607,020 $214,110 * For the period 6/15/94 (commencement of operations) through 9/30/94 ** For the period 7/1/94 (commencement of operations) through 9/30/94 Certain states in which the shares of the Funds are qualified for sale impose limitations on the expenses of the Funds. The current annual expense limitations require that the Adviser reimburse each Fund in any amount necessary to prevent such Fund's aggregate ordinary operating expenses (excluding interest, taxes, distribution and brokerage fees and commissions, and extraordinary charges such as litigation costs) from exceeding, in any fiscal year, 2-1/2% of the first $30 million of the average daily net assets of each Fund, 2% of the next $70 million of such assets, plus 1-1/2% of such assets in excess of $100 million. In accordance with the terms of the Advisory Agreement, if the expenses of a Fund exceed the amount of the fees paid by the Fund to the Adviser, then the Adviser will reimburse the Fund the amount of such excess. For the fiscal year ended September 30, 1995, pursuant to the foregoing limitation, the Adviser waived its management fee in the amount of $32,455 for the Growth and Income Fund. The following table sets forth the fee waivers and expense reimbursements made to the Funds by the Adviser for the fiscal years ended September 30, 1995, 1994, and 1993. Fee Waivers and Expense Reimbursements Class A Class B Class A Class B Assets Fund -- -- -- -- $11,979 Growth Fund $13,179 -- $25,518 -- -- Balanced Fund -- -- $35,826 * $21,221 * n/a Income Fund $64,080 $37,971 $34,720 $9,874 n/a Growth Fund $10,554 -- $17,806 -- -- Growth Fund -- -- -- -- -- * For the period 6/15/94 (commencement of operations) through 9/30/94 ** For the period 7/1/94 (commencement of operations) through 9/30/94 Continuance of the Advisory Agreement with respect to each Fund, other than the Global Balanced Fund and Growth and Income Fund, is subject to annual approval by vote of a majority of the Trustees or by the holders of a majority of the respective Fund's outstanding voting securities. The Advisory Agreement will continue in effect with respect to the Global Balanced Fund and the Growth and Income Fund, until June 15, 1996, and thereafter from year-to-year, if approved at least annually by vote of a majority of the Trustees or by the holders of a majority of the respective Fund's outstanding voting securities. Any such continuation also requires approval by a majority of the Trustees who are not parties to the Advisory Agreement or "interested persons" of any such party as defined in the 1940 Act by vote cast in person at a meeting called for such purpose. The Advisory Agreement may be terminated with respect to a Fund at any time, without penalty, on 60 days' written notice by the Trustees, by the holders of a majority of the respective Fund's outstanding voting securities or by the Adviser. The Advisory Agreement automatically terminates with respect to each Fund in the event of its assignment (as defined in the 1940 Act and the rules thereunder). Under the terms of the Advisory Agreement, the Adviser is not liable to the Funds, or their shareholders, for any act or omission by it or for any losses sustained by the Funds or their shareholders, except in the case of willful misfeasance, bad faith, gross negligence or reckless disregard of duty. The Sub-Advisers. The Adviser has entered into a sub-advisory agreement (the "Sub-Advisory Agreement") with each of AIG Global and GSAM pursuant to which the Sub-Advisers provide the Global Balanced Fund with investment advisory services, including the continuous review and administration of such Fund's investment program. Each Sub-Adviser discharges its responsibilities subject to the direction and control of the Trustees and the oversight and review of the Adviser. AIG Global serves as sub-adviser for the foreign equity component of the Fund, and GSAM serves as sub-adviser for its global bond component. In providing sub-advisory services to the foreign equity component of the Fund with respect to European, Japanese, and Southeast Asian securities and markets, AIG Global will utilize the services of certain of its affiliates. Each Sub-Adviser is a professional investment counseling firm which provides investment services to investment companies, employee benefit plans, endowments, foundations and/or other institutions and individuals. AIG Global is located at 70 Pine Street, New York, NY 10270. GSAM is located at 85 Broad Street, New York, NY 10004. The Adviser pays each Sub-Adviser a monthly fee with respect to the actual component of the Fund for which the Sub-Adviser performs services, computed on average daily net assets, at the following annual rates: AIG Global .50% on the first $50 million .40% on the next $100 million .30% on the next $150 million GSAM .40% on the first $50 million .30% on the next $100 million .25% on the next $100 million The following table sets forth the fees paid to AIG Global and GSAM for the fiscal years ended September 30, 1995 and 1994. * For the period 6/15/94 (commencement of operations) through 9/30/94 The Sub-Advisory Agreements were approved by the Trustees, including a majority of the Trustees who are not parties to the Sub-Advisory Agreement or "interested persons" of any such party, on May 20, 1994, and by the sole initial shareholder on June 14, 1994. The Sub-Advisory Agreements became effective on June 15, 1994. The Sub-Advisory Agreements will expire on April 22, 1996. They may be renewed from year-to-year thereafter, so long as continuance is specifically approved at least annually in accordance with the requirements of the 1940 Act. The Sub-Advisory Agreements provide that they will terminate in the event of an assignment (as defined in the 1940 Act) or upon termination of the Advisory Agreement. The Sub-Advisory Agreements may be terminated by the Fund, the Adviser or the respective Sub-Adviser upon 60 days' prior written notice. Personal Trading. The Trust and the Adviser have adopted a written Code of Ethics (the "Code") which prescribes general rules of conduct and sets forth guidelines with respect to personal securities trading by "Access Persons" thereof. An Access Person as defined in the Code is an individual who is a trustee, director, officer, general partner or advisory person of the Trust or the Adviser. Among the guidelines on personal securities trading include: (i) securities being considered for purchase or sale, or purchased or sold, by any Investment Company advised by the Adviser, (ii) Initial Public Offerings, (iii) private placements, (iv) blackout periods, (v) short-term trading profits, (vi) gifts, and (vii) services as a director. These guidelines are substantially similar to those contained in the Report of the Advisory Group on Personal Investing issued by the Investment Company Institute's Advisory Panel. The Adviser reports to the Board of Trustees on a quarterly basis, as to whether there were any violations of the Code by Access Persons of the Trust or the Adviser during the quarter. The Sub-Advisers have adopted a written Code of Ethics, the provisions of which are materially similar to those in the Code, and have undertaken to comply with the provisions of the Code to the extent such provisions are more restrictive. Further, the Sub-Advisers report to the Adviser on a quarterly basis, as to whether there were any Code of Ethics violations by employees thereof who may be deemed Access Persons of the Trust. In turn, the Adviser reports to the Board of Trustees as to whether there were any violations of the Code by Access Persons of the Trust or the Adviser. The Distributor. The Trust, on behalf of each Fund, has entered into a distribution agreement (the "Distribution Agreement") with the Distributor, a registered broker-dealer and an indirect wholly owned subsidiary of SunAmerica Inc., to act as the principal underwriter of the shares of each Fund. The address of the Distributor is The SunAmerica Center, 733 Third Avenue, New York, NY 10017-3204. The Distribution Agreement provides that the Distributor has the exclusive right to distribute shares of the Funds through its registered representatives and authorized broker-dealers. The Distribution Agreement also provides that the Distributor will pay the promotional expenses, including the incremental cost of printing prospectuses, annual reports and other periodic reports respecting each Fund, for distribution to persons who are not shareholders of such Fund and the costs of preparing and distributing any other supplemental sales literature. However, certain promotional expenses may be borne by the Funds (see "Distribution Plans" below). The Distribution Agreement with respect to each Fund, other than the Global Balanced Fund and the Growth and Income Fund, was approved by the Trustees, including a majority of those Trustees who are not "interested persons" of the Trust, on March 31, 1993, and with respect to the Global Balanced Fund and the Growth and Income Fund on May 20, 1994. The Distribution Agreement became effective with respect to each Fund, other than the Global Balanced Fund and Growth and Income Fund, on September 24, 1993, and with respect to the Global Balanced Fund and the Growth and Income Fund on June 15, 1994. Continuance of the Distribution Agreement with respect to each Fund, other than the Global Balanced Fund and the Growth and Income Fund, is subject to annual approval by vote of the Trustees, including a majority of the Trustees who are not "interested persons" of the Trust. The Distribution Agreement will remain in effect until June 15, 1996 and thereafter from year-to-year with respect to the Global Balanced Fund and the Growth and Income Fund, if such continuance is approved at least annually by the Trustees, including a majority of the Trustees who are not "interested persons" of the Trust. The Trust and the Distributor each has the right to terminate the Distribution Agreement with respect to a Fund on 60 days' written notice, without penalty. The Distribution Agreement will terminate automatically in the event of its assignment as defined in the 1940 Act and the rules thereunder. The Distributor may, from time to time, pay additional commissions or promotional incentives to brokers, dealers or other financial services firms that sell shares of the Funds. In some instances, such additional commissions, fees or other incentives may be offered only to certain firms, including Royal Alliance Associates, Inc. and SunAmerica Securities, Inc. affiliates of the Distributor, that sell or are expected to sell during specified time periods certain minimum amounts of shares of the Funds, or of other funds underwritten by the Distributor. In addition, the terms and conditions of any given promotional incentive may differ from firm to firm. Such differences will, nevertheless, be fair and equitable, and based on such factors as size, geographic location, or other reasonable determinants, and will in no way affect the amount paid to any investor. Distribution Plans. As indicated in the Prospectus, the Trustees of the Trust and the shareholders of each class of shares of each Fund have adopted Distribution Plans (the "Class A Plan" and the "Class B Plan," and collectively, the "Distribution Plans"). Reference is made to "Management of the Trust - Distribution Plans" in the Prospectus for certain information with respect to the Distribution Plans. Under the Class A Plan, the Distributor may receive payments from a Fund at an annual rate of up to 0.10% of average daily net assets of such Fund's Class A shares to compensate the Distributor and certain securities firms for providing sales and promotional activities for distributing that class of shares. Under the Class B Plan, the Distributor may receive payments from a Fund at the annual rate of up to 0.75% of the average daily net assets of such Fund's Class B shares to compensate the Distributor and certain securities firms for providing sales and promotional activities for distributing that class of shares. The distribution costs for which the Distributor may be reimbursed out of such distribution fees include fees paid to broker-dealers that have sold Fund shares, commissions and other expenses such as sales literature, prospectus printing and distribution and compensation to wholesalers. It is possible that in any given year the amount paid to the Distributor under the Class A Plan or Class B Plan will exceed the Distributor's distribution costs as described above. The Distribution Plans provide that each class of shares of each Fund may also pay the Distributor an account maintenance and service fee of up to 0.25% of the aggregate average daily net assets of such class of shares for payments to broker-dealers for providing continuing account maintenance. In this regard, some payments are used to compensate broker-dealers with trail commissions or account maintenance and service fees in an amount up to 0.25% per year of the assets maintained in a Fund by their customers. The Distribution Plans with respect to each Fund, other than the Global Balanced Fund and the Growth and Income Fund, were approved on March 31, 1993 by the Trustees, including a majority of the Trustees who are not "interested persons" of the Trust and who have no direct or indirect financial interest in the operation of the Distribution Plans (the "Independent Trustees"), and with respect to the Class A shares of Mid-Cap Growth Fund and Small Company Growth Fund, by the shareholders of each Fund on September 23, 1993, and with respect to the Class A shares and Class B shares of Blue Chip Growth Fund, Class B shares of Mid-Cap Growth Fund, Class B shares of Small Company Growth Fund, and Class A and Class B shares of Balanced Assets Fund, by the Adviser, the sole initial shareholder, on September 23, 1993. These Distribution Plans became effective on September 24, 1993. The Distribution Plans in respect of the Global Balanced Fund and Growth and Income Fund were approved by the Trustees, including a majority of the Independent Trustees, on May 20, 1994 and with respect to the Global Balanced Fund by its sole initial shareholder on June 14, 1994 and with respect to the Growth and Income Fund, by its sole initial shareholder on June 30, 1994. The following table sets forth the distribution and service maintenance fees the Distributor received from the Funds for the fiscal years ended September 30, 1995, 1994, and 1993. Distribution and Service Maintenance Fees Class A Class B Class A Class B Class A Class B Assets Fund $237,888 $1,749,100 $158,785 $1,736,424 $1,268 $243,481 Growth Fund $42,755 $632,288 $5,390 $804,627 $0 $706,958 Balanced Fund $44,919 $141,100 $11,026* $22,717* n/a n/a Income Fund $11,338* $10,876* $2,714 $480 n/a n/a Growth Fund $115,641 $62,270 $119,773 $36,868 $88,640 $0 Growth Fund $187,524 $556,816 $132,081 $431,989 $98,420 $4,133 * For the period 6/15/94 (commencement of operations) through 9/30/94 For the period 7/1/94 (commencement of operations) through 9/30/94 * For the fiscal year ended 9/30/95 the Distributor waived fees in the amount of $16,747 for Growth and Income Fund. Continuance of the Distribution Plans with respect to each Fund is subject to annual approval by vote of the Trustees, including a majority of the Independent Trustees. A Distribution Plan may not be amended to increase materially the amount authorized to be spent thereunder with respect to a class of shares of a Fund, without approval of the shareholders of the affected class of shares of the Fund. In addition, all material amendments to the Distribution Plans must be approved by the Trustees in the manner described above. A Distribution Plan may be terminated at any time with respect to a Fund without payment of any penalty by vote of a majority of the Independent Trustees or by vote of a majority of the outstanding voting securities (as defined in the 1940 Act) of the affected class of shares of the Fund. So long as the Distribution Plans are in effect, the election and nomination of the Independent Trustees of the Trust shall be committed to the discretion of the Independent Trustees. In the Trustees' quarterly review of the Distribution Plans, they will consider the continued appropriateness of, and the level of, compensation provided in the Distribution Plans. In their consideration of the Distribution Plans with respect to a Fund, the Trustees must consider all factors they deem relevant, including information as to the benefits of the Fund and the shareholders of the relevant class of the Fund. The Administrator. The Trust has entered into a Service Agreement, under the terms of which SunAmerica Fund Services, Inc. ("SAFS"), an indirect wholly owned subsidiary of SunAmerica Inc., acts as a servicing agent assisting State Street Bank and Trust Company ("State Street") in connection with certain services offered to the shareholders of each of the Funds. Under the terms of the Service Agreement, SAFS may receive reimbursement of its costs in providing such shareholder services. SAFS is located at The SunAmerica Center, 733 Third Avenue, New York, NY 10017-3204. The Trustees, including a majority of the Trustees who are not parties to the Service Agreement or "interested persons", as that term is defined in the 1940 Act, approved the Service Agreement with respect to each Fund, other than the Global Balanced Fund and Growth and Income Fund, on March 31, 1993, and with respect to the Global Balanced Fund and Growth and Income Fund on May 20, 1994. The Service Agreement will remain in effect until June 15, 1996 and from year- to-year thereafter provided its continuance is approved annually by vote of the Trustees including a majority of the disinterested Trustees. Pursuant to the Service Agreement, as compensation for services rendered, SAFS will receive a fee from the Trust subject to review and approval by the Trustees. This fee represents the full cost of providing shareholder and transfer agency services to the Trust. From this fee, SAFS pays a fee to State Street, and its affiliate, National Financial Data Services ("NFDS" and with State Street, the "Transfer Agent") (other than out-of-pocket charges which would be paid by the Trust). For further information regarding the Transfer Agent see the section entitled "Additional Information" below. As discussed in the Prospectus, the Adviser is responsible for decisions to buy and sell securities for each Fund, selection of broker-dealers and negotiation of commission rates. With respect to the Global Balanced Fund, AIG Global and GSAM are responsible for decisions to buy and sell foreign equity and global fixed income securities, respectively, selection of broker-dealers and negotiation of commission rates for their respective component of the portfolio. Purchases and sales of securities on a securities exchange are effected through brokers-dealers who charge a negotiated commission for their services. Orders may be directed to any broker-dealer including, to the extent and in the manner permitted by applicable law, an affiliated brokerage subsidiary of the Adviser, AIG Global or GSAM. In the over-the-counter market, securities are generally traded on a "net" basis with dealers acting as principal for their own accounts without a stated commission (although the price of the security usually includes a profit to the dealer). In underwritten offerings, securities are purchased at a fixed price which includes an amount of compensation to the underwriter, generally referred to as the underwriter's concession or discount. On occasion, certain money market instruments may be purchased directly from an issuer, in which case no commissions or discounts are paid. The Adviser's (or Sub-Adviser's) primary consideration in effecting a security transaction is to obtain the best net price and the most favorable execution of the order. However, the Adviser (or Sub-Adviser) may select broker- dealers which provide it with research services and may cause a Fund to pay such broker-dealers commissions which exceed those that other broker-dealers may have charged, if in its view the commissions are reasonable in relation to the value of the brokerage and/or research services provided by the broker-dealer. Certain research services furnished by brokers may be useful to the Adviser (or Sub- Adviser) with clients other than the Trust. No specific value can be determined for research services furnished without cost to the Adviser (or Sub-Adviser) by a broker. The Adviser (and each Sub-Adviser) is of the opinion that because the material must be analyzed and reviewed by its staff, its receipt does not tend to reduce expenses, but may be beneficial in supplementing the Adviser's (or Sub-Adviser's) research and analysis. Therefore, it may tend to benefit the Funds by improving the quality of the Adviser's (or Sub-Adviser's) investment advice. The investment advisory fees paid by the Funds are not reduced because the Adviser (or Sub-Adviser) receives such services. When making purchases of underwritten issues with fixed underwriting fees, the Adviser (or Sub-Adviser) may designate the use of broker-dealers who have agreed to provide the Adviser (or Sub-Adviser) with certain statistical, research and other information. Subject to applicable law and regulations, consideration may also be given to the willingness of particular brokers to sell shares of a Fund as a factor in the selection of brokers for transactions effected on behalf of a Fund, subject to the requirement of best price and execution. Although the objectives of other accounts or investment companies which the Adviser (or Sub-Adviser) manages may differ from those of the Funds, it is possible that, at times, identical securities will be acceptable for purchase by one or more of the Funds and one or more other accounts or investment companies which the Adviser manages. However, the position of each account or company in the securities of the same issue may vary with the length of the time that each account or company may choose to hold its investment in those securities. The timing and amount of purchase by each account and company will also be determined by its cash position. If the purchase or sale of a security is consistent with the investment policies of one or more of the Funds and one or more of these other accounts or companies is considered at or about the same time, transactions in such securities will be allocated in a manner deemed equitable by the Adviser (or Sub-Adviser). The Adviser (or Sub-Adviser) may combine such transactions, in accordance with applicable laws and regulations, the transaction would enable it to negotiate a better price or reduced commission. However, simultaneous transactions could adversely affect the ability of a Fund to obtain or dispose of the full amount of a security, which it seeks to purchase or sell, or the price at which such security can be purchased or sold. The following tables set forth the brokerage commissions paid by the Funds and the amounts of the brokerage commissions which were paid to affiliated broker-dealers by the Funds for the fiscal years ended September 30, 1995, 1994, and 1993. Growth Fund $302,994 $6,054 2.0% Balanced Fund $58,702* $0* 0.0%* Income Fund $3,930 $0 %0.0** Growth Fund $534,360 $20,400 3.8% * For the period 6/15/94 (commencement of operations) through 9/30/94 ** For the period 7/1/94 (commencement of operations) through 9/30/94 Aggregate Amount paid to Percentage paid Assets Fund $94,633 $0 0.0% Growth Fund $264,610 $9,744 3.7% Growth Fund $177,179 $450 0.25% ADDITIONAL INFORMATION REGARDING PURCHASE OF SHARES Shares of each of the Funds are sold at the respective net asset value next determined after receipt of a purchase order, plus a sales charge, which, at the election of the investor, may be imposed either (i) at the time of purchase (Class A shares), or (ii) on a deferred basis (Class B shares and certain Class A shares). Reference is made to "Purchase of Shares" in the Prospectus for certain information as to the purchase of Fund shares. The following tables set forth the front-end sales concessions with respect to Class A shares of each Fund, the amount of the front-end sales concessions which was reallowed to affiliated broker-dealers, and the contingent deferred sales charges with respect to Class B shares of each Fund, received by the Distributor for the fiscal years ended September 30, 1995, 1994, and 1993. * For the period 6/15/94 (commencement of operations) through 9/30/94 ** For the period 7/1/94 (commencement of operations) through 9/30/94 CONTINGENT DEFERRED SALES CHARGES ("CDSCS") APPLICABLE TO CERTAIN CLASS B SHARES. Class B shares of the Small Company Growth Fund and the Balanced Assets Fund issued to shareholders in exchange for shares of Old Emerging Growth and Old Balanced Assets, respectively, in the Reorganization, are subject to the CDSC schedule that applied to redemptions of shares of these funds at the time of reorganization. Upon a redemption of these shares, the shareholder will receive credit for the periods both prior to and after the Reorganization during which the shares were held. The following table sets forth the rates of the CDSC applicable to these shares: Any Class B shares purchased after the date of the Reorganization (other than through the reinvestment of dividends and distributions, which are not subject to the CDSC) will be subject to the CDSC schedule reflected in the Prospectus. CONVERSION FEATURE APPLICABLE TO CERTAIN CLASS B SHARES. Shareholders of Class B shares of the Small Company Growth Fund and the Balanced Assets Fund issued in exchange for shares of Old Emerging Growth and Old Balanced Assets, respectively, in the Reorganization, will receive credit for the periods both prior to and after the Reorganization during which the shares were held, for purposes of computing the seven year holding period applicable to the conversion feature. WAIVER OF CONTINGENT DEFERRED SALES CHARGES. As discussed under "Purchase of Shares" in the Prospectus, CDSCs may be waived on redemptions of Class B shares under certain circumstances. The conditions set forth below are applicable with respect to the following situations with the proper documentation: Death. CDSCs may be waived on redemptions within one year following the death (i) of the sole shareholder on an individual account, (ii) of a joint tenant where the surviving joint tenant is the deceased's spouse, or (iii) of the beneficiary of a Uniform Gifts to Minors Act, Uniform Transfers to Minors Act or other custodial account. The CDSC waiver is also applicable in the case where the shareholder account is registered as community property. If, upon the occurrence of one of the foregoing, the account is transferred to an account registered in the name of the deceased's estate, the CDSC will be waived on any redemption from the estate account occurring within one year of the death. If the Class B shares are not redeemed within one year of the death, they will remain Class B shares and be subject to the applicable CDSC, when redeemed. Disability. CDSCs may be waived on redemptions occurring within one year after the sole shareholder on an individual account or a joint tenant on a spousal joint tenant account becomes disabled (as defined in Section 72(m)(7) of the Internal Revenue Code of 1986, as amended). To be eligible for such waiver, (i) the disability must arise after the purchase of shares and (ii) the disabled shareholder must have been under age 65 at the time of the initial determination of disability. If the account is transferred to a new registration and then a redemption is requested, the applicable CDSC will be charged. Purchases through the Distributor. An investor may purchase shares of a Fund through dealers which have entered into selected dealer agreements with the Distributor. An investor's dealer who has entered into a distribution arrangement with the Distributor is expected to forward purchase orders and payment promptly to the Fund. Orders received by the Distributor before the close of business will be executed at the offering price determined at the close of regular trading on the NYSE that day. Orders received by the Distributor after the close of business will be executed at the offering price determined after the close of the NYSE on the next trading day. The Distributor reserves the right to cancel any purchase order for which payment has not been received by the fifth business day following the investment. A Fund will not be responsible for delays caused by dealers. Purchase by Check. In the case of a new account, purchase orders by check must be submitted directly by mail to SunAmerica Fund Services, Inc., Mutual Fund Operations, The SunAmerica Center, 733 Third Avenue, New York, NY 10017-3204, together with payment for the purchase price of such shares and a completed New Account Application. Shares of each Fund may be purchased directly through the Transfer Agent. Upon receipt of the completed New Account Application and payment check, the Transfer Agent will purchase full and fractional shares of the applicable Fund at the net asset value next computed after the check is received, plus the applicable sales charge. Certified checks are not necessary, but checks are accepted subject to collection at full face value in United States funds and must be drawn on a bank located in the United States. There are restrictions on the redemption of shares purchased by check for which funds are being collected. (See "Redemption of Shares.") Purchase through SAFS. SAFS will effect a purchase order on behalf of a customer who has an investment account upon confirmation of a verified credit balance at least equal to the amount of the purchase order (subject to the minimum $500 investment requirement for wire orders). If such order is received at or prior to 4:00 P.M., Eastern time, on a day the NYSE is open for business, the purchase of shares of a Fund will be effected on that day. If the order is received after 4:00 P.M., Eastern time, the order will be effected on the next business day. Purchase by Federal Funds Wire. An investor may make purchases by having his or her bank wire Federal funds to the Trust's Transfer Agent. Federal funds purchase orders will be accepted only on a day on which the Trust and the Transfer Agent are open for business. In order to insure prompt receipt of a Federal funds wire, it is important that these steps be followed: 1. You must have an existing SunAmerica Fund Account before wiring funds. To establish an account, complete the New Account Application and send it via facsimile to SunAmerica Fund Services, Inc. at: (212) 551-5343. 2. Call SunAmerica Fund Services' Shareholder/Dealer Services, toll free at (800) 858-8850, extension 5125 to obtain your new account number. 3. Instruct the bank to wire the specified amount to the Transfer Agent: State Street Bank and Trust Company, Boston, MA, ABA# 0110-00028; DDA# 99029712, SunAmerica [name of Fund, Class __] (include shareholder name and account number). Waiver of Sales Charges with Respect to Certain Purchases of Class A Shares. To the extent that sales are made for personal investment purposes, the sales charge is waived as to Class A shares purchased by current or retired officers, directors, and other full-time employees of SunAmerica and its affiliates, as well as members of the selling group and family members of the foregoing. In addition, the sales charge is waived with respect to shares purchased by certain qualified retirement plans or employee benefit plans (other than IRAs), which are sponsored or administered by SunAmerica or an affiliate thereof. Further, the sales charge is waived with respect to shares purchased by "wrap accounts" for the benefit of clients of broker-dealers, financial institutions or financial planners adhering to the following standards established by the Distributor: (i) the broker-dealer, financial institution or financial planner charges its client(s) an advisory fee based on the assets under management on an annual basis, and (ii) such broker-dealer, financial institution or financial planner does not advertise that shares of the Funds may be purchased by clients net asset value. Shares purchased under this waiver may not be resold except to the Fund. Shares are offered at net asset value to the foregoing persons because of anticipated economies in sales effort and sales related expenses. Reductions in sales charges apply to purchases or shares by a "single person" including an individual; members of a family unit comprising husband, wife and minor children; or a trustee or other fiduciary purchasing for a single fiduciary account. Complete details concerning how an investor may purchase shares at reduced sales charges may be obtained by contacting the Distributor. Reduced Sales Charges (Class A Shares only). As discussed under "Purchase of Shares" in the Prospectus, investors in Class A shares of a Fund may be entitled to reduced sales charges pursuant to the following special purchase plans made available by the Trust. Combined Purchase Privilege. The following persons may qualify for the sales charge reductions or eliminations by combining purchases of Fund shares into a single transaction: (i) an individual, or a "company" as defined in Section 2(a)(8) of the 1940 Act (which includes corporations which are corporate affiliates of each other); (ii) an individual, his or her spouse and their minor children, purchasing for his, her or their own account; (iii) a trustee or other fiduciary purchasing for a single trust estate or single fiduciary account (including a pension, profit-sharing, or other employee benefit trust created pursuant to a plan qualified under Section 401 of the (iv) tax-exempt organizations qualifying under Section 501(c)(3) of the Internal Revenue Code (not including 403(b) plans); (v) employee benefit plans of a single employer or of affiliated employers, other than 403(b) plans; and (vi) group purchases as described below. A combined purchase currently may also include shares of other funds in the SunAmerica Mutual Funds (other than money market funds) purchased at the same time through a single investment dealer, if the dealer places the order for such shares directly with the Distributor. Rights of Accumulation. A purchaser of Fund shares may qualify for a reduced sales charge by combining a current purchase (or combined purchases as described above) with shares previously purchased and still owned; provided the cumulative value of such shares (valued at cost or current net asset value, whichever is higher), amounts to $50,000 or more. In determining the shares previously purchased, the calculation will include, in addition to other Class A shares of the particular Fund that were previously purchased, shares of the other classes of the same Fund, as well as shares of any class of any other Fund or of any of the other Funds advised by the Adviser, as long as such shares were sold with a sales charge or acquired in exchange for shares purchased with such a sales charge. The shareholder's dealer, if any, or the shareholder, must notify the Distributor at the time an order is placed of the applicability of the reduced charge under the Right of Accumulation. Such notification must be in writing by the dealer or shareholder when such an order is placed by mail. The reduced sales charge will not be granted if: (a) such information is not furnished at the time of the order; or (b) a review of the Distributor's or the Transfer Agent's records fails to confirm the investor's represented holdings. Letter of Intent. A reduction of sales charges is also available to an investor who, pursuant to a written Letter of Intent which is set forth in the New Account Application in the Prospectus, establishes a total investment goal in Class A shares of one or more Funds to be achieved through any number of investments over a thirteen-month period, of $50,000 or more. Each investment in such Funds made during the period will be subject to a reduced sales charge applicable to the goal amount. The initial purchase must be at least 5% of the stated investment goal and shares totaling 5% of the dollar amount of the Letter of Intent will be held in escrow by the Transfer Agent, in the name of the investor. Shares of any class of shares of any Fund, or of other funds advised by the Adviser which impose a sales charge at the time of purchase, which the investor intends to purchase or has previously purchased during a 30-day period prior to the date of execution of the Letter of Intent and still owns, may also be included in determining the applicable reduction; provided, the dealer or shareholder notifies the Distributor of such prior purchase(s). The Letter of Intent does not obligate the investor to purchase, nor the Trust to sell, the indicated amounts of the investment goal. In the event the investment goal is not achieved within the thirteen-month period, the investor is required to pay the difference between the sales charge otherwise applicable to the purchases made during this period and sales charges actually paid. Such payment may be made directly to the Distributor or, if not paid, the Distributor is authorized by the Letter of Intent to liquidate a sufficient number of escrowed shares to obtain such difference. If the goal is exceeded and purchases pass the next sales charge break-point, the sales charge on the entire amount of the purchase that results in passing that break-point, and on subsequent purchases, will be subject to a further reduced sales charge in the same manner as set forth above under "Rights of Accumulation," but there will be no retroactive reduction of sales charges on previous purchases. At any time while a Letter of Intent is in effect, a shareholder may, by written notice to the Distributor, increase the amount of the stated goal. In that event, shares of the applicable Funds purchased during the previous 90-day period and still owned by the shareholder will be included in determining the applicable sales charge. The 5% escrow and the minimum purchase requirement will be applicable to the new stated goal. Investors electing to purchase shares of one or more of the Funds pursuant to this purchase plan should carefully read such Letter of Intent. Reduced Sales Charge for Group Purchases. Members of qualified groups may purchase Class A shares of the Funds under the combined purchase privilege as described above. To receive a rate based on combined purchases, group members must purchase Class A shares of a Fund through a single investment dealer designated by the group. The designated dealer must transmit each member's initial purchase to the Distributor, together with payment and completed New Account Application. After the initial purchase, a member may send funds for the purchase of Class A shares directly to the Transfer Agent. Purchases of a Fund's shares are made at the public offering price based on the net asset value next determined after the Distributor or the Transfer Agent receives payment for the Class A shares. The minimum investment requirements described above apply to purchases by any group member. Qualified groups include the employees of a corporation or a sole proprietorship, members and employees of a partnership or association, or other organized groups of persons (the members of which may include other qualified groups) provided that: (i) the group has at least 25 members of which at least ten members participate in the initial purchase; (ii) the group has been in existence for at least six months; (iii) the group has some purpose in addition to the purchase of investment company shares at a reduced sales charge; (iv) the group's sole organizational nexus or connection is not that the members are credit card customers of a bank or broker-dealer, clients of an investment adviser or security holders of a company; (v) the group agrees to provide its designated investment dealer access to the group's membership by means of written communication or direct presentation to the membership at a meeting on not less frequently than an annual basis; (vi) the group or its investment dealer will provide annual certification, in form satisfactory to the Transfer Agent, that the group then has at least 25 members and that at least ten members participated in group purchases during the immediately preceding 12 calendar months; and (vii) the group or its investment dealer will provide periodic certification, in form satisfactory to the Transfer Agent, as to the eligibility of the purchasing members of the group. Members of a qualified group include: (i) any group which meets the requirements stated above and which is a constituent member of a qualified group; (ii) any individual purchasing for his or her own account who is carried on the records of the group or on the records of any constituent member of the group as being a good standing employee, partner, member or person of like group or constituent member; or (iii) any fiduciary purchasing shares for the account of a member of a qualified group or a member's beneficiary. For example, a qualified group could consist of a trade association which would have as its members individuals, sole proprietors, partnerships and corporations. The members of the group would then consist of the individuals, the sole proprietors and their employees, the members of the partnership and their employees, and the corporations and their employees, as well as the trustees of employee benefit trusts acquiring a Fund's shares for the benefit of any of the foregoing. Interested groups should contact their investment dealer or the Distributor. The Trust reserves the right to revise the terms of or to suspend or discontinue group sales with respect to shares of the Funds at any time. Net Asset Value Transfer Program. Investors may purchase Class A shares of a Fund at net asset value to the extent that the investment represents the proceeds from a redemption of a non-SunAmerica mutual fund in which the investor either (a) paid a front-end sales load or (b) was subject to, or paid a CDSC on the redemption proceeds. Nevertheless, the Distributor will pay a commission to any dealer who initiates or is responsible for such an investment, in the amount of .50% of the amount invested, subject, however, to forfeiture in the event of a redemption during the fiscal year from the date of purchase. In addition, it is essential that a NAV Transfer Program Form accompany the New Account Application to indicate that the investment is intended to participate in the Net Asset Value Transfer Program (formerly, Exchange Program for Investment Company Shares). This program may be revised or terminated without notice by the Distributor. For current information, contact Shareholder/Dealer Services at (800) 858-8850. ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES Reference is made to "Redemption of Shares" in the Prospectus for certain information as to the redemption of Fund shares. If the Trustees determine that it would be detrimental to the best interests of the remaining shareholders of a Fund to make payment wholly or partly in cash, the Trust, having filed with the SEC a notification of election pursuant to Rule 18f-1 on behalf of each of the Funds, may pay the redemption price in whole, or in part, by a distribution in kind of securities from a Fund in lieu of cash. In conformity with applicable rules of the SEC, the Funds are committed to pay in cash all requests for redemption, by any shareholder of record, limited in amount with respect to each shareholder during any 90-day period to the lesser of (i) $250,000, or (ii) 1% of the net asset value of the applicable Fund at the beginning of such period. If shares are redeemed in kind, the redeeming shareholder would incur brokerage costs in converting the assets into cash. The method of valuing portfolio securities is described below in the section entitled "Determination of Net Asset Value," and such valuation will be made as of the same time the redemption price is determined. DETERMINATION OF NET ASSET VALUE Each Fund calculates the net asset value of its shares separately by dividing the total value of each class's net assets by the shares of such class outstanding. Shares are valued each day the New York Stock Exchange ("NYSE") is open as of approximately 4:00 P.M., Eastern time. The net asset value of a Fund's shares will also be computed on each other day in which there is a sufficient degree of trading in such Fund's securities that the net asset value of its shares might be materially affected by changes in the values of the portfolio securities; provided, however, that on such day the Trust receives a request to purchase or redeem such Fund's shares. The days and times of such computation may, in the future, be changed by the Trustees in the event that the portfolio securities are traded in significant amounts in markets other than the NYSE, or on days or at times other than those during which the NYSE is open for trading. Securities that are actively traded over-the-counter, including listed securities for which the primary market is believed by the Adviser (or Sub- Adviser) to be over-the-counter, are valued on the basis of the bid prices provided by principal market makers. Securities listed on the NYSE or other national securities exchanges, other than those principally traded over-the- counter, are valued on the basis of the last sale price on the exchange on which they are primarily traded. However, if the last sale price on the NYSE is different than the last sale price on any other exchange, the NYSE price will be used. If there are no sales on that day, then the securities are valued at the bid price on the NYSE or other primary exchange for that day. Options traded on national securities exchanges are valued at the last sale price on such exchanges preceding the valuation, and Futures and options thereon, which are traded on commodities exchanges, are valued at their last sale price as of the close of such commodities exchanges. Securities that are traded on foreign exchanges are ordinarily valued at the last quoted sales price available before the time when the assets are valued. If a securities price is available from more than one foreign exchange, a Fund uses the exchange that is the primary market for the security. Values of portfolio securities primarily traded on foreign exchanges are already translated into U.S. dollars when received from a quotation service. The above procedures need not be used to determine the value of debt securities owned by a Fund if, in the opinion of the Trustees, some other method would more accurately reflect the fair market value of such debt securities in the quantities owned by such Fund. Securities for which quotations are not readily available and other assets are appraised at fair value, as determined pursuant to procedures adopted in good faith by the Trustees. Short-term debt securities are valued at their current market value or fair value, which for securities with remaining maturities of 60 days or less has been determined in good faith by the Trustees to be represented by amortized cost value, absent unusual circumstances. A pricing service may be utilized to value the Funds' assets under the procedures set forth above. Any use of a pricing service will be approved and monitored by the Trustees. The value of all assets and liabilities initially expressed in foreign currencies will be converted into U.S. dollars at the mean between the bid and offered prices of such currencies against U.S. dollars last quoted by any large New York bank which is a dealer in foreign currency. The values of securities held by the Funds, and other assets used in computing net asset value, are determined as of the time trading in such securities is completed each day, which in the case of foreign securities may be at a time prior to 4:00 P.M., Eastern time. On occasion, the values of foreign securities and exchange rates may be affected by events occurring between the time as of which determinations of such values or exchange rates are made and 4:00 P.M., Eastern time. When such events materially affect the values of securities held by the Funds or their liabilities, such securities and liabilities will be valued at fair value as determined in good faith by the Trustees. Each Fund may advertise performance data that reflects various measures of total return and the Balanced Assets Fund may advertise data that reflects yield. An explanation of the data presented and the methods of computation that will be used are as follows. A Fund's performance may be compared to the historical returns of various investments, performance indices of those investments or economic indicators, including, but not limited to, stocks, bonds, certificates of deposit, money market funds and U.S. Treasury Bills. Certain of these alternative investments may offer fixed rates of return and guaranteed principal and may be insured. Average annual total return is determined separately for Class A and Class B shares in accordance with a formula specified by the SEC. Average annual total return is computed by finding the average annual compounded rates of return for the 1-, 5-, and 10-year periods or for the lesser included periods of effectiveness. The formula used is as follows: P(1 + T)/n/ = ERV P = a hypothetical initial purchase payment of $1,000 T = average annual total return N = number of years ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1-, 5-, or 10- year periods at the end of the 1-, 5-, or 10-year periods (or fractional portion thereof). The above formula assumes that: 1. The maximum sales load (i.e., either the front-end sales load in the case of the Class A shares or the deferred sales load that would be applicable to a complete redemption of the investment at the end of the specified period in the case of the Class B shares) is deducted from the 2. All dividends and distributions are reinvested at net asset value; and 3. Complete redemption occurs at the end of the 1-, 5-, or 10-year periods or fractional portion thereof with all nonrecurring charges deducted accordingly. The Funds' average annual total return for the 1-, 5- and 10-year periods (or from date of inception, if sooner) ended September 30, 1995, are as follows: Class A Since One Five Ten Shares Inception Year Years Years ------- --------- ---- ----- ----- Balanced 7.07%/1/ 13.75% N/A N/A Blue Chip 6.43%/1/ 14.32% N/A N/A Mid-Cap 11.99%/2/ 22.06% 16.87% N/A Small Company 14.36%/2/ 41.37% 25.87% N/A Global 0.12%/3/ 0.59% N/A N/A Growth and 12.06%/4/ 12.66% N/A N/A (1) From date of September 24, 1993. (2) From date of inception of January 27, 1987. (3) From date of inception of June 15, 1994. (4) From date of inception of July 1, 1994. (1) From dates of inception of April 15, 1985 and March 13, 1985, respectively. (2) From date of September 24, 1993. (3) From date of inception of June 15, 1994. (4) From date of inception of July 1, 1994. Each Fund may advertise cumulative, rather than average return, for each class of its shares for periods of time other than the 1-, 5-, and 10-year periods or fractions thereof, as discussed above. Such return data will be computed in the same manner as that of average annual total return, except that the actual cumulative return will be computed. Each Fund may compare its total return or yield to similar measures as calculated by various publications, services, indices, or averages. Such comparisons are made to assist in evaluating an investment in a Fund. The following references may be used: a) Dow Jones Composite Average or its component averages -- an unmanaged index composed of 30 blue-chip industrial corporation stocks (Dow Jones Industrial Average), 15 utilities company stocks (Dow Jones Utilities Average), and 20 transportation company stocks (Dow Jones Transportation Average). Comparisons of performance assume reinvestment of dividends. b) Standard & Poor's 500 Stock Index or its component indices -- an unmanaged index composed of 400 industrial stocks, 40 financial stocks, 40 utilities stocks, and 20 transportation stocks. Comparisons of performance assume reinvestment of dividends. Standard & Poor's 100 Stock Index -- an unmanaged index based on the prices of 100 blue chip stocks, including 92 industrials, one utility, two transportation companies, and five financial institutions. The Standard & Poor's 100 Stock Index is a smaller, more flexible index for options trading. c) The New York Stock Exchange composite or component indices-- unmanaged indices of all industrial, utilities, transportation, and finance stocks listed on the New York Stock Exchange. d) Wilshire 5000 Equity Index or its component indices --represents the return on the market value of all common equity securities for which daily pricing is available. Comparisons of performance assume reinvestment of dividends. e) Lipper: Mutual Fund Performance Analysis, Fixed Income Analysis, and Mutual Fund Indices -- measures total return and average current yield for the mutual fund industry. Ranks individual mutual fund performance over specified time periods assuming reinvestment of all distributions, exclusive of sales charges. f) CDA Mutual Fund Report, published by CDA Investment Technologies, Inc., analyzes price, current yield, risk, total return, and average rate of return (average annual compounded growth rate) over specified time periods for the mutual fund industry. g) Mutual Fund Source Book, published by Morningstar, Inc. --analyzes price, risk and total return for the mutual fund industry. h) Financial publications: Wall Street Journal, Business Week, Changing Times, Financial World, Forbes, Fortune, Money, Pension and Investment Age, United Mutual Fund Selector, and Wiesenberger Investment Companies Service, and other publications containing financial analyses which rate mutual fund performance over specified time periods. i) Consumer Price Index (or Cost of Living Index), published by the U.S. Bureau of Labor Statistics -- a statistical measure of periodic change in the price of goods and services in major expenditure groups. j) Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -- historical measure of yield, price, and total return for common and small company stock, long-term government bonds, treasury bills, and inflation. k) Savings and Loan Historical Interest Rates as published in the U.S. Savings & Loan League Fact Book. l) Shearson-Lehman Municipal Bond Index and Government/Corporate Bond Index -- unmanaged indices that track a basket of intermediate and long-term bonds. Reflect total return and yield and assume dividend reinvestment. m) Salomon GNMA Index published by Salomon Brothers Inc. -- Market value of all outstanding 30-year GNMA Mortgage Pass-Through Securities that includes single family and graduated payment mortgages. Salomon Mortgage Pass-Through Index published by Salomon Brothers Inc. -- Market value of all outstanding agency mortgage pass-through securities that includes 15- and 30-year FNMA, FHLMC and GNMA Securities. n) Value Line Geometric Index -- broad based index made up of approximately 1700 stocks each of which have an equal weighting. o) Morgan Stanley Capital International EAFE Index -- an arithmetic, market value-weighted average of the performance of over 900 securities on the stock exchanges of countries in Europe, Australia and the Far East. p) Goldman Sachs 100 Convertible Bond Index -- currently includes 67 bonds and 33 preferred stocks. The original list of names was generated by screening for convertible issues of $100 million or more in market capitalization. The index is priced monthly. q) Salomon Brothers High Grade Corporate Bond Index -- consists of publicly issued, non-convertible corporate bonds rated "AA" or "AAA". It is a value- weighted, total return index, including approximately 800 issues. r) Salomon Brothers Broad Investment Grade Bond Index -- is a market- weighted index that contains approximately 4700 individually priced investment grade corporate bonds rated "BBB" or better, U.S. Treasury/agency issues and mortgage pass-through securities. s) Salomon Brother World Bond Index -- measures the total return performance of high-quality securities in major sectors of the international bond market. The index covers approximately 600 bonds from 10 currencies: European Currency Units UK Pound Sterling Japanese Yen German Deutsche Marks t) J.P. Morgan Global Government Bond Index -- a total return, market capitalization-weighted index, rebalanced monthly, consisting of the following countries: Australia, Belgium, Canada, Denmark, France, Germany, Italy, Japan, The Netherlands, Spain, Sweden, the United Kingdom, and the United States. u) Shearson Lehman LONG-TERM Treasury Bond Index -- is comprised of all bonds covered by the Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or greater. v) NASDAQ Industrial Index -- is comprised of more than 3,000 industrial issues. It is a value-weighted index calculated on pure change only and does not include income. w) The MSCI Combined Far East Free ex Japan Index -- a market capitalization weighted index comprised of stocks in Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore and Thailand. Korea is included in this index at 20% of its market capitalization. x) First Boston High Yield Index -- generally includes over 180 issues with an average maturity range of seven to ten years with a minimum capitalization of $100 million. All issues are individually trader-priced monthly. y) Morgan Stanley Capital International World Index -- An arithmetic, market value-weighted average of the performance of over 1,470 securities list on the stock exchanges of countries in Europe, Australia, the Far East, Canada and the United States. z) Russell 3000 and 2000 Index -- represents the top 3,000 and the next 2,000 stocks traded on the New York Stock Exchange, American Stock Exchange and National Association of Securities Dealers Automated Quotations, by market capitalizations. In assessing such comparisons of performance, an investor should keep in mind that the composition of the investments in the reported indices and averages is not identical to a Fund's portfolio, that the averages are generally unmanaged and that the items included in the calculations of such averages may not be identical to the formula used by a Fund to calculate its figures. Specifically, a Fund may compare its performance to that of certain indices which include securities with government guarantees. However, a Fund's shares do not contain any such guarantees. In addition, there can be no assurance that a Fund will continue its performance as compared to such other standards. Dividends and Distributions. Each Fund intends to distribute to the registered holders of its shares substantially all of its net investment income, which includes dividends, interest and net short-term capital gains, if any, in excess of any net long-term capital losses. Each Fund intends to distribute any net long-term capital gains in excess of any net short-term capital losses. The current policy of the Balanced Assets Fund and Growth and Income Fund is to pay investment income dividends quarterly. The current policy of each of the Blue Chip Growth Fund, the Mid-Cap Growth Fund and the Small Company Growth Fund is to pay investment income dividends semi-annually. The current policy of the Global Balanced Fund is to pay investment income dividends, if any, annually. Each Fund intends to pay net capital gains, if any, annually. In determining amounts of capital gains to be distributed, any capital loss carry-forwards from prior years will be offset against capital gains. Distributions will be paid in additional Fund shares based on the net asset value at the close of business on the Ex or reinvestment date, unless the shareholder notifies the Fund at least five business days prior to the payment date to receive such distributions in cash. Taxes. Each Fund is qualified and intends to remain qualified and elects to be treated as a regulated investment company under Subchapter M of the Code for each taxable year. In order to be qualified as a regulated investment company, each Fund generally must, among other things, (a) derive at least 90% of its gross income from dividends, interest, proceeds from loans of stock or securities and certain other related income; (b) derive less than 30% of its gross income from the sale or other disposition of stock or securities held less than 3 months; and (c) diversify its holdings so that, at the end of each fiscal quarter, (i) 50% of the market value of each Fund's assets is represented by cash, government securities, securities of other regulated investment companies and other securities limited, in respect of any one issuer, to an amount no greater than 5% of each Fund's assets and not greater than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the value of its assets is invested in the securities of any one issuer (other than government securities or the securities of other regulated investment companies). As a regulated investment company, each Fund will not be subject to U.S. Federal income tax on its income and capital gains which it distributes as dividends or capital gains distributions to shareholders provided that it distributes to shareholders at least 90% of its investment company taxable income for the taxable year. Each Fund intends to distribute sufficient income to meet this qualification requirement. Under the Code, amounts not distributed on a timely basis in accordance with a calendar year distribution requirement are subject to a nondeductible 4% excise tax. To avoid the tax, each Fund must distribute during each calendar year (1) at least 98% of its ordinary income (not taking into account any capital gains or losses) for the calendar year, (2) at least 98% of its capital gains in excess of its capital losses for the 12-month period ending on October 31 of the calendar year, and (3) all ordinary income and net capital gains for the previous years that were not distributed during such years. To avoid application of the excise tax, each Fund intends to make distributions in accordance with the calendar year distribution requirement. A distribution will be treated as paid on December 31 of the calendar year if declared by each Fund in October, November or December of such year, payable to shareholders of record on a date in such month and paid by each Fund during January of the following year. Any such distributions paid during January of the following year will be shareholders as of such December 31, rather than the date on which the distributions are received. Distributions of net investment income and short-term capital gains are taxable to the shareholder as ordinary dividend income regardless of whether the shareholder receives such distributions in additional shares or in cash. The portion of such dividends received from each Fund that will be eligible for the dividends received deduction for corporations will be determined on the basis of the amount of each Fund's gross income, exclusive of capital gains from sales of stock or securities, which is derived as dividends from domestic corporations, other than certain tax-exempt corporations and certain real estate investment trusts, and will be designated as such in a written notice to shareholders mailed not later than 60 days after the end of each fiscal year. Distributions of net long-term capital gains, if any, are taxable as long-term capital gains regardless of whether the shareholder receives such distributions in additional shares or in cash or how long the investor has held his or her shares, and are not eligible for the dividends received deduction for corporations. Upon a sale or exchange of its shares, a shareholder will realize a taxable gain or loss depending upon its basis in the shares. Such gain or loss will be treated as capital gain or loss if the shares are capital assets in the shareholder's hands and will be long-term capital gain or loss if the shares have been held for more than one year. Generally, any loss realized on a sale or exchange will be disallowed to the extent the shares disposed of are replaced within a period of 61 days beginning 30 days before and ending 30 days after the shares are disposed of. Any loss realized by a shareholder on the sale of shares of a Fund held by the shareholder for six months or less will be treated for tax purposes as a long-term capital loss to the extent of any distributions of net capital gains received by the shareholder with respect to such shares. Under certain circumstances (such as the exercise of an exchange privilege), the tax effect of sales load charges imposed on the purchase of shares in a regulated investment company is deferred if the shareholder does not hold the shares for at least 90 days. Income received by a Fund from sources within foreign countries may be subject to withholding and other taxes imposed by such countries. Income tax treaties between certain countries and the United States may reduce or eliminate such taxes. It is impossible to determine in advance the effective rate of foreign tax to which a Fund will be subject, since the amount of that Fund's assets to be invested in various countries is not known. It is not anticipated that any Fund (other than the Global Balanced Fund) will qualify to pass through to its shareholders the ability to claim as a foreign tax credit their respective shares of foreign taxes paid by such Fund. If more than 50% in value of Global Balanced Fund's total assets at the close of its taxable year consists of securities of foreign corporations, the Fund will be eligible, and intends, to file an election with the Internal Revenue Service pursuant to which shareholders of the Fund will be required to include their proportionate share of such withholding taxes in their U.S. income tax returns as gross income, treat such proportionate share as taxes paid by them, and deduct such proportionate share in computing their taxable incomes or, alternatively, use them as foreign tax credits against their U.S. income taxes. No deductions for foreign taxes, however, may be claimed by non-corporate shareholders who do not itemize deductions. Of course, certain retirement accounts which are not subject to tax cannot claim foreign tax credits on investments in foreign securities held in the Fund. A shareholder that is a nonresident alien individual or a foreign corporation may be subject to U.S. withholding tax on the income resulting from the Fund's election described in this paragraph but may not be able to claim a credit or deduction against such U.S. tax for the foreign taxes treated as having been paid by such shareholder. Under the Code, gains or losses attributable to fluctuations in exchange rates which occur between the time a Fund accrues interest or other receivables or accrues expenses or other liabilities denominated in a foreign currency and the time such Fund actually collects such receivables or pays such liabilities are treated as ordinary income or ordinary loss. Similarly, gains or losses on forward foreign currency exchange contracts, sale of currencies or dispositions of debt securities denominated in a foreign currency attributable to fluctuations in the value of the foreign currency between the date of acquisition of the security and the date of disposition generally also are treated as ordinary gain or loss. These gains, referred to under the Code as "Section 988" gains or losses, increase or decrease the amount of each Fund's investment company taxable income available to be distributed to its shareholders as ordinary income. The Code includes special rules applicable to the listed non-equity options, regulated futures contracts, and options on futures contracts which a Fund may write, purchase or sell. Such options and contracts are classified as Section 1256 contracts under the Code. The character of gain or loss resulting from the sale, disposition, closing out, expiration or other termination of Section 1256 contracts, except forward foreign currency exchange contracts, is generally treated as long-term capital gain or loss to the extent of 60% thereof and short-term capital gain or loss to the extent of 40% thereof ("60/40 gain or loss"). Such contracts, when held by a Fund at the end of a fiscal year, generally are required to be treated as sold at market value on the last day of such fiscal year for Federal income tax purposes ("marked-to-market"). Over-the- counter options are not classified as Section 1256 contracts and are not subject to the marked-to-market rule or to 60/40 gain or loss treatment. Any gains or losses recognized by a Fund from transactions in over-the-counter options generally constitute short-term capital gains or losses. When call options written, or put options purchased, by a Fund are exercised, the gain or loss realized on the sale of the underlying securities may be either short-term or long-term, depending on the holding period of the securities. In determining the amount of gain or loss, the sales proceeds are reduced by the premium paid for the puts or increased by the premium received for calls. A substantial portion of each Fund's transactions in options, futures contracts and options on futures contracts, particularly its hedging transactions, may constitute "straddles" which are defined in the Code as offsetting positions with respect to personal property. A straddle consisting of a listed option, futures contract, or option on a futures contract and of U.S. Government securities would constitute a "mixed straddle" under the Code. The Code generally provides with respect to straddles (i) "loss deferral" rules which may postpone recognition for tax purposes of losses from certain closing purchase transactions or other dispositions of a position in the straddle to the extent of unrealized gains in the offsetting position, (ii) "wash sale" rules which may postpone recognition for tax purposes of losses where a position is sold and a new offsetting position is acquired within a prescribed period, (iii) "short sale" rules which may terminate the holding period of securities owned by a Fund when offsetting positions are established and which may convert certain losses from short-term to long-term, and (iv) "conversion transaction" rules which recharacterize capital gains as ordinary income. The Code provides that certain elections may be made for mixed straddles that can alter the character of the capital gain or loss recognized upon disposition of positions which form part of a straddle. Certain other elections also are provided in the Code; no determination has been reached to make any of these elections. The Global Balanced Fund and Growth and Income Fund may purchase debt securities (such as zero-coupon or pay-in-kind securities) that contain original issue discount. Original issue discount that accrues in a taxable year is treated as earned by a Fund and therefore is subject to the distribution requirements of the Code. Because the original issue discount earned by the Fund in a taxable year may not be represented by cash income, the Fund may have to dispose of other securities and use the proceeds to make distributions to shareholders. A Fund may be required to backup withhold U.S. Federal income tax at the rate of 31% of all taxable distributions payable to shareholders who fail to provide their correct taxpayer identification number or fail to make required certifications, or who have been notified by the Internal Revenue Service that they are subject to backup withholding. Backup withholding is not an additional tax. Any amounts withheld may be credited against a shareholder's U.S. Federal income tax liability. The foregoing is a general and abbreviated summary of the applicable provisions of the Code and Treasury regulations currently in effect. Shareholders are urged to consult their tax advisors regarding specific questions as to Federal, state and local taxes. In addition, foreign investors should consult with their own tax advisors regarding the particular tax consequences to them of an investment in each Fund. Qualification as a regulated investment company under the Code for tax purposes does not entail government supervision of management and investment policies. Shares of each Fund are eligible to be purchased in conjunction with various types of qualified retirement plans. The summary below is only a brief description of the Federal income tax laws for each plan and does not purport to be complete. Further information or an application to invest in shares of a Fund by establishing any of the retirement plans described below may be obtained by calling Retirement Plans at (800) 858-8850. However, it is recommended that a shareholder considering any retirement plan consult a tax adviser before participating. PENSION AND PROFIT-SHARING PLANS. Sections 401(a) and 401(k) of the Code permit business employers and certain associations to establish pension and profit sharing plans for employees. Shares of a Fund may be purchased by those who would have been covered under the rules governing old H.R. 10 (Keogh) Plans, as well as by corporate plans. Each business retirement plan provides tax advantages for owners and participants. Contributions made by the employer are tax-deductible, and participants do not pay taxes on contributions or earnings until withdrawn. TAX-SHELTERED CUSTODIAL ACCOUNTS. Section 403(b)(7) of the Code permits public school employees and employees of certain types of charitable, educational and scientific organizations specified in Sections 501(c)(3) of the Code, to purchase shares of a Fund and, subject to certain limitations, exclude the amount of purchase payments from gross income for tax purposes. INDIVIDUAL RETIREMENT ACCOUNTS (IRA). Section 408 of the Code permits eligible individuals to contribute to an individual retirement program, including Simplified Employee Pension Plans, commonly referred to as SEP-IRA. These IRA's are subject to limitations with respect to the amount that may be contributed, the eligibility of individuals, and the time in which distributions would be allowed to commence. In addition, certain distributions from some other types of retirement plans may be placed on a tax-deferred basis in an IRA. SALARY REDUCTION SIMPLIFIED EMPLOYEE PENSION. This plan was introduced by a provision of the Tax Reform Act of 1986 as a unique way for small employers to provide the benefit of retirement planning for their employees. Contributions are deducted from the employee's paycheck before tax deductions and are deposited into an IRA by the employer. These contributions and are not included in the employee's income and therefore are not reported or deducted on his or her tax return. Ownership of the Trust is represented by transferable shares of beneficial interest. The Declaration of Trust of the Trust (the "Declaration of Trust") permits the Trustees to issue an unlimited number of full and fractional shares, $.01 par value, and to divide or combine the shares into a greater or lesser number of shares without thereby changing the proportionate beneficial interests of the Trust. Currently, six series of shares of the Trust have been authorized pursuant to the Declaration of Trust: the Balanced Assets Fund, the Global Balanced Fund, the Blue Chip Growth Fund, the Mid-Cap Growth Fund, the Small Company Growth Fund and the Growth and Income Fund. Each series has been divided into two classes of shares, designated as Class A and Class B shares. The Trustees may authorize the creation of additional series of shares so as to be able to offer to investors additional investment portfolios within the Trust that would operate independently from the Trust's present portfolios, or to distinguish among shareholders, as may be necessary, to comply with future regulations or other unforeseen circumstances. Each series of the Trust's shares represents the interests of the shareholders of that series in a particular portfolio of Trust assets. In addition, the Trustees may authorize the creation of additional classes of shares in the future, which may have fee structures different from those of existing classes and/or may be offered only to certain qualified investors. Shareholders are entitled to a full vote for each full share held. The Trustees have terms of unlimited duration (subject to certain removal procedures) and have the power to alter the number of Trustees, and appoint their own successors, provided that at all times at least a majority of the Trustees have been elected by shareholders. The voting rights of shareholders are not cumulative, so that holders of more than 50% of the shares voting can, if they choose, elect all Trustees being elected, while the holders of the remaining shares would be unable to elect any Trustees. Although the Trust need not hold annual meetings of shareholders, the Trustees may call special meetings of shareholders for action by shareholder vote as may be required by the 1940 Act or the Declaration of Trust. Also, a shareholders meeting must be called, if so requested in writing by the holders of record of 10% or more of the outstanding shares of the Trust. In addition, the Trustees may be removed by the action of the holders of record of two-thirds or more of the outstanding shares. All series of shares will vote with respect to certain matters, such as election of Trustees. When all series of shares are not affected by a matter to be voted upon, such as approval of investment advisory agreements or changes in a Fund's policies, only shareholders of the series affected by the matter may be entitled to vote. Both classes of shares of a given series are identical in all respects, except that (i) each class may bear differing amounts of certain class-specific expenses, (ii) Class A shares are subject to an initial sales charge, a distribution fee and an ongoing account maintenance and service fee, (iii) Class B shares are subject to a contingent deferred sales charge, a distribution fee and an ongoing account maintenance and service fee, (iv) Class B shares convert automatically to Class A shares on the first business day of the month seven years after the purchase of such Class B Shares, (v) each class has voting rights on matters that pertain to the Rule 12b-1 plan adopted with respect to such class, except that under certain circumstances, the holders of Class B shares may be entitled to vote on material changes to the Class A Rule 12b-1 plan, and (vi) each class of shares will be exchangeable only into the same class of shares of any other Fund or other funds in the SunAmerica Family of Mutual Funds that offers that class. All shares of the Trust issued and outstanding and all shares offered by the Prospectus when issued, are fully paid and non-assessable. Shares have no preemptive or other subscription rights and are freely transferable on the books of the Trust. In addition, shares have no conversion rights, except as described above. The Declaration of Trust provides that no Trustee, officer, employee or agent of the Trust is liable to the Trust or to a shareholder, nor is any Trustee, officer, employee or agent liable to any third persons in connection with the affairs of the Trust, except as such liability may arise from his or its own bad faith, willful misfeasance, gross negligence or reckless disregard of his duties. It also provides that all third persons shall look solely to the Trust's property for satisfaction of claims arising in connection with the affairs of the Trust. With the exceptions stated, the Declaration of Trust provides that a Trustee, officer, employee or agent is entitled to be indemnified against all liability in connection with the affairs of the Trust. The Trust shall continue, without limitation of time, subject to the provisions in the Declaration of Trust concerning termination by action of the shareholders. Computation of Offering Price per Share The following is the offering price calculation for Class A and Class B shares of the Funds, based on the value of each Fund's net assets as of September 30, 1995. * Rounded to nearest one-hundredth percent; assumes maximum sales charge is ** Class B shares are not subject to an initial sales charge but may be subject to a contingent deferred sales charge on redemption of shares within six years of purchase. Reports to Shareholders. The Trust sends audited annual and unaudited semi- annual reports to shareholders of each of the Funds. Price Waterhouse LLP serves as the Trust's independent accountants, and in that capacity, audits the annual financial statements of the Trust. In addition, the Transfer Agent sends a statement to each shareholder having an account directly with the Trust to confirm transactions in the account. Custodian and Transfer Agency. State Street Bank and Trust Company, 1776 Heritage Drive, North Quincy, MA 02171, serves as Custodian and Transfer Agent for the Funds and in those capacities maintains certain financial and accounting books and records pursuant to agreements with the Trust. Transfer agent functions are performed for State Street, by National Financial Data Services, P.O. Box 419572, Kansas City, MO 64141-6572, an affiliate of State Street. Independent Accountants and Legal Counsel. Price Waterhouse LLP, 1177 Avenue of the Americas, New York, NY 10036, has been selected to serve as the Trust's independent accountants and in that capacity examines the annual financial statements of the Trust. The firm of Shereff, Friedman, Hoffman & Goodman, LLP, 919 Third Avenue, New York, NY 10022, has been selected as legal counsel to the Trust. Set forth following this Statement of Additional Information are the financial statements of SunAmerica Equity Funds with respect to Registrant's fiscal year ended September 30, 1995. STATEMENT OF ASSETS AND LIABILITIES -- September 30, 1995 See Notes to Financial Statements STATEMENT OF OPERATIONS -- For the year ended September 30, 1995 See Notes to Financial Statements STATEMENT OF CHANGES IN NET ASSETS See Notes to Financial Statements STATEMENT OF CHANGES IN NET ASSETS (a) For the periods beginning June 15, 1994 and July 1, 1994 for the Global Balanced Fund and Growth and Income Fund, respectively. See Notes to Financial Statements (1) Calculated based upon average shares outstanding (2) Total return is not annualized and does not reflect sales load (3) Commencement of sale of respective class of shares (5) Pursuant to a reorganization of the SunAmerica Mutual Funds, the Equity Funds fiscal year ends were changed to September 30 (6) Net of the following expense reimbursements (based on average net assets): See Notes to Financial Statements (1) Total return is not annualized and does not reflect sales load (2) Calculated based upon average shares outstanding (4) Pursuant to a reorganization of the SunAmerica Mutual Funds, the Equity Funds fiscal year ends were changed to September 30 (5) Commencement of sale of respective class of shares (6) Net of expense reimbursement equivalent to .48% of average net assets for (7) Net of expense reimbursement equivalent to .17% of average net assets for (8) Restated to reflect a 0.984460367 for 1.00 stock split effective September See Notes to Financial Statements (1) Calculated based upon average shares outstanding (2) Total return is not annualized and does not reflect sales load (3) Commencement of sale of respective class of shares (5) Net of the following expense reimbursements (based on average net assets): See Notes to Financial Statements PORTFOLIO OF INVESTMENTS -- September 30, 1995 PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) (2)Security on Loan, see Note 2 See Notes to Financial Statements SUNAMERICA BLUE CHIP GROWTH FUND PORTFOLIO OF INVESTMENTS -- September 30, 1995 SUNAMERICA BLUE CHIP GROWTH FUND PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) (1) ADR ("American Depositary Receipts") See Notes to Financial Statements PORTFOLIO OF INVESTMENTS -- September 30, 1995 PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) (1) ADR ("American Depositary Receipt") (2) Fair valued security, see Note 2 See Notes to Financial Statements SUNAMERICA SMALL COMPANY GROWTH FUND PORTFOLIO OF INVESTMENTS -- September 30, 1995 SUNAMERICA SMALL COMPANY GROWTH FUND PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) SUNAMERICA SMALL COMPANY GROWTH FUND PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) (1) ADR ("American Depositary Receipt") (2) At September 30, 1995 the Fund held a restricted security amounting to 0.1% of net assets. The Fund will not bear any costs, including those involved in registration under the Securities Act of 1933, in connection with the disposition of the security. (3) Fair valued security, see Note 2. See Notes to Financial Statements PORTFOLIO OF INVESTMENTS -- September 30, 1995 PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) (5)Fair valued security, see Note 2. Allocation of net assets by currency as of September 30, 1995: See Note to Financial Statements SUNAMERICA GROWTH & INCOME FUND PORTFOLIO OF INVESTMENTS -- September 30, 1995 SUNAMERICA GROWTH & INCOME FUND PORTFOLIO OF INVESTMENTS -- September 30, 1995 -- (continued) (1) ADR ("American Depositary Receipt") See Notes to Financial Statements NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 SunAmerica Equity Funds is an open-end diversified management investment company organized as a Massachusetts business trust (the "Trust" or "Equity Funds") on June 16, 1986. It currently consists of six different investment funds (each, a "Fund" and collectively, the "Funds"). Each Fund is a separate series of the Trust with a distinct investment objective and/or strategy. Each Fund is advised and/or managed by SunAmerica Asset Management Corp. (the "Adviser" or "SAAMCo"). An investor may invest in one or more of the following Funds: SunAmerica Balanced Assets Fund ("Balanced Assets Fund"), SunAmerica Blue Chip Growth Fund ("Blue Chip Growth Fund"), SunAmerica Mid-Cap Growth Fund ("Mid-Cap Growth Fund"), SunAmerica Small Company Growth Fund ("Small Company Growth Fund"), SunAmerica Global Balanced Fund ("Global Balanced Fund") and SunAmerica Growth and Income Fund ("Growth and Income Fund"). The Funds are considered to be separate entities for financial and tax reporting purposes. Each Fund currently offers two classes of shares. Class A shares are offered at net asset value per share plus an initial sales charge. Class B shares are offered without an initial sales charge, although a declining contingent sales charge may be imposed on redemptions made within six years of purchase. Additionally, any purchases of Class A shares in excess of $1,000,000 will be subject to a contingent deferred sales charge on redemptions made within one year of purchase. Class B shares of each Fund will convert automatically to Class A shares on the first business day of the month after seven years from the issuance of such Class B shares and at such time will be subject to the lower distribution fee applicable to Class A shares. Each class of shares bears the same voting, dividend, liquidation and other rights and conditions and each makes distribution and account maintenance and service fee payments under the distribution plans pursuant to Rule 12b-1 under the Investment Company Act of 1940 (the "1940 Act"), except that Class B shares are subject to higher distribution fee rates. Note 2. Significant Accounting Policies The following is a summary of the significant accounting policies followed by the Funds in the preparation of their financial statements: SECURITY VALUATIONS: Securities that are actively traded in the over-the- counter market, including listed securities for which the primary market is believed by the Adviser to be over-the-counter, are valued at the quoted bid price provided by principal market makers. Securities listed on the New York Stock Exchange ("NYSE") or other national securities exchanges, are valued on the basis of the last sale price on the exchange on which they are primarily traded or, if there is no sale on such day, the last bid price quoted on such day. If there is no sale on that day, then securities are valued at the bid price on the NYSE or other primary exchange for that day. However, if the last sale price on the NYSE is different than the last sale price on any other exchange, the NYSE price is used. Options traded on national securities exchanges are valued as of the close of the exchange on which they are traded. Futures and options traded on commodities exchanges are valued at their last sale price as of the close of such exchange. The Funds may make use of a pricing service in the determination of NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 -- (continued) their net asset values. Securities for which market quotations are not readily available and other assets are valued at fair value as determined pursuant to procedures adopted in good faith by the Trustees. Short-term investments which mature in less than 60 days are valued at amortized cost, if their original maturity was 60 days or less, or by amortizing their value on the 61st day prior to maturity, if their original term to maturity exceeded 60 days. REPURCHASE AGREEMENTS. The Funds, along with other affiliated registered investment companies, transfer uninvested cash balances into a single joint account, the daily aggregate balance of which is invested in one or more repurchase agreements collateralized by U.S. Treasury or federal agency obligations. The Funds' custodian takes possession of the collateral pledged for investments in repurchase agreements. The underlying collateral is valued daily on a mark to market basis to ensure that the value, including accrued interest, is at least equal to the repurchase price. In the event of default of the obligation to repurchase, a Fund has the right to liquidate the collateral and apply the proceeds in satisfaction of the obligation. If the seller defaults and the value of the collateral declines or if bankruptcy proceedings are commenced with respect to the seller of the security, realization of the collateral by the Fund may be delayed or limited. OPTIONS: The premium paid by a Fund for the purchase of a call or a put option is included in the Fund's Statement of Assets and Liabilities as an investment and subsequently marked to market to reflect the current market value of the option. When a Fund writes a call or a put option, an amount equal to the premium received by the Fund is included in the Fund's Statement of Assets and Liabilities as a liability and is subsequently marked to market to reflect the current market value of the option written. If an option which the Fund has written either expires on its stipulated expiration date, or if the Fund enters into a closing purchase transaction, the Fund realizes a gain (or loss if the cost of a closing purchase transaction exceeds the premium received when the option was written) without regard to any unrealized gain or loss on the underlying security, and the liability related to such options is extinguished. If a call option which the Fund has written is exercised, the Fund realizes a capital gain or loss from the sale of the underlying security and the proceeds from such sale are increased by the premium originally received. If a put option which the Fund has written is exercised, the amount of the premium originally received reduces the cost basis of the security which the Fund purchased upon exercise of the option. SECURITIES TRANSACTIONS, INVESTMENT INCOME, DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS: Securities transactions are recorded on the trade date. Realized gains and losses on sales of investments are calculated on the identified cost basis. Interest income is recorded on the accrual basis; dividend income is recorded on the ex-dividend date. The Equity Funds, except for the Global Balanced Fund and the Growth and Income Fund, do not amortize premiums or accrue discounts except original issue discounts and on interest only securities for which amortization is required for federal income tax purposes. Net investment income, other than class specific expenses and realized and unrealized gains and losses, is allocated daily to each class of shares based upon the relative net asset value of outstanding shares (of the value of the dividend-eligible shares, as appropriate) of each class of shares at the beginning of the day (after adjusting for the current capital shares activity of the respective class). NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 -- (continued) Dividends from net investment income are paid semiannually, except for Balanced Assets Fund and Growth and Income Fund which pay quarterly. Capital gain distributions, if any, are paid annually. INVESTMENT SECURITIES LOANED: During the year ended September 30, 1995, Balanced Assets Fund participated in securities lending with qualified brokers. In lending portfolio securities to brokers the Funds receive cash as collateral against the loaned securities, which must be maintained at not less than 100% of the market value of the loaned securities during the period of the loan. To the extent income is earned on the cash collateral invested, it is recorded as interest income. As with other extensions of credit, should the borrower of the securities fail financially, the Funds may bear the risk of delay in recovery or may be subject to replacing the loaned securities by purchasing them with the cash collateral held, which may be less than 100% of the market value of such securities at the time of replacement. At September 30, 1995, Balanced Assets Fund had loaned a security having a value of $5,446,100 and held cash collateral of $5,443,750 for this loan. The value of the collateral was sufficient at the time the loan agreement was entered into. As a result of an increase in the market value of the loaned security, the Fund was furnished with additional collateral on the following business day. FOREIGN CURRENCY TRANSACTION: The books and records of the Fund are maintained in U.S. dollars. Foreign currency amounts are translated into U.S. dollars at published rates on the following basis: (i) market value of investment securities, other assets and liabilities--at the closing rate of exchange. (ii) purchases and sales of investment securities, income and expenses-- at the rate of exchange prevailing on the respective dates of such transactions. Assets and liabilities denominated in foreign currencies and commitments under forward foreign currency contracts are translated into U.S. dollars at the mean of the quoted bid and asked prices of such currencies against the U.S. dollar. Purchases and sales of portfolio securities are translated at the rate of exchange prevailing when such securities were acquired or sold. Income and expenses are translated at rates of exchange prevailing when earned or incurred. The Fund does not isolate that portion of the results of operations arising as a result of changes in the foreign exchange rates from the changes in the market prices of securities held at fiscal year-end. Similarly, the Fund does not isolate the effect of changes in foreign exchange rates from the changes in the market prices of portfolio securities sold during the year. Realized foreign exchange gains and losses on other assets and liabilities and change in unrealized foreign exchange gains and losses on other assets and liabilities include foreign exchange gains and losses from currency gains or losses between the trade and settlement dates of securities transactions, the difference between the amounts of interest, dividends and foreign withholding taxes recorded on the Fund's books and the U.S. dollar equivalent amounts actually received or paid and changes in the unrealized foreign exchange gains and losses relating to other assets and liabilities arising as a result of changes in the exchange rate. NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 -- (continued) FEDERAL INCOME TAXES: It is the Funds' policy to meet the requirements of the Internal Revenue Code of 1986, as amended, applicable to regulated investment companies and to distribute all of their taxable net income to their shareholders. Therefore, no federal income tax or excise tax provisions are required. Global Balanced Fund may be subject to taxes imposed by countries in which it invests. Such taxes are generally based on either income or gains earned or repatriated. The Fund accrues such taxes when the related income is earned. ORGANIZATIONAL EXPENSES: Costs incurred by SAAMCo in connection with the organization of Global Balanced Fund and Growth and Income Fund amounted to $4,347 and $1,383, respectively. These costs are being amortized on a straight line basis by the Funds over a period not to exceed 60 months from the date the Funds commenced operations. Costs incurred by SAAMCo in connection with the registration of Global Balanced (Class A, Class B) and Growth and Income Fund (Class A, Class B) amounted to $10,808 for each class of each Fund. These costs are being amortized on a straight line basis by the classes over a period not to exceed 12 months from the date each class commenced operations. EXPENSES: Expenses common to all Funds, not directly related to individual Funds, are allocated among the Equity Funds based upon their relative net asset values. STATEMENT OF POSITION 93-2: As required by Statement of Position 93-2, Determination, Disclosure, and Financial Statement Presentation of Income, Capital Gain, and Return of Capital Distributions by Investment Companies, permanent book-tax differences relating to shareholder distributions have been reclassified. Net investment income/loss, net realized gain/loss, and net assets are not affected. The following table discloses the current year reclassifications between accumulated undistributed net investment income/loss and accumulated undistributed net realized gain/loss on investments. Note 3. Joint Repurchase Agreement Account As of September 30, 1995, Balanced Assets Fund, Blue Chip Growth Fund, Mid- Cap Growth Fund, Small Company Growth Fund, Global Balanced Fund and Growth and Income Fund had a 15.2%, 4.6%, 3.0%, 19.3%, 0.1% and 0.9% undivided interest, respectively, which represented $15,638,000, $4,715,000, $3,059,000, $19,896,000, $121,000 and $941,000, respectively, in principal amount in a joint repurchase agreement with Chemical Securities, Inc. In addition, the Growth and Income Fund NOTES TO FINANCIAL STATEMENTS --September 30, 1995 -- (continued) had a 0.8% undivided interest which represented $940,000 in principal amount in a joint repurchase agreement with Yamaichi International, Inc. As of such date, the cash repurchase agreement in the joint account and the collateral therefore was as follows: Chemical Securities, Inc. Repurchase Agreement, 6.25% dated 9/29/95, in the principal amount of $102,947,000 repurchase price $103,000,618 due 10/02/95 collateralized by $50,000,000 U.S. Treasury Notes 6.875% due 10/31/96, $50,000,000 U.S. Treasury Notes 6.125% due 5/31/97 and $1,850,000 U.S. Treasury Notes 6.125% due 5/31/97, approximate aggregate value $105,092,351. Yamaichi International, Inc. Repurchase Agreement, 6.45% dated 9/29/95, in the principal amount of $120,864,000 repurchase price $120,928,964 due 10/02/95 collateralized by $49,250,000 U.S. Treasury Notes 8.75% due 11/15/08, $22,375,000 U.S. Treasury Bills 5.365% due 8/22/96, $19,375,000 U.S. Treasury Notes 6.25% due 8/15/23, $13,090,000 U.S. Treasury Notes 8.75% due 8/15/00 and $8,500,000 U.S. Treasury Notes 9.25% due 2/15/16, approximate aggregate value $128,362,436. Note 4. Investment Advisory and Management Agreement, Distribution Agreement The Trust, on behalf of each Fund, has an Investment Advisory and Management Agreement (the "Agreement") with SAAMCo (the "Adviser"), an indirect wholly-owned subsidiary of SunAmerica Inc. Under the Agreement, SAAMCo provides continuous supervision of a Fund's portfolio and administers its corporate affairs, subject to general review by the Trustees. In connection therewith, SAAMCo furnishes the Funds with office facilities, maintains certain of the Fund's books and records, and pays the salaries and expenses of all personnel, including officers of the Funds who are employees of SAAMCo and its affiliates. The investment advisory and management fee to SAAMCo with respect to each Fund (other than the Global Balanced Fund) is computed daily and payable monthly, at an annual rate of .75% of a Fund's average daily net assets up to $350 million, .70% of the next $350 million, and .65% thereafter. The Global Balanced Fund pays the Adviser a fee, payable monthly, computed daily at the annual rate of 1.00% on the first $350 million of the Fund's average daily net assets, .90% on the next $350 million of net assets and .85% on net assets over $700 million. For the year ended September 30, 1995, SAAMCo earned fees of $1,821,586, $565,835, $294,505, $819,449, $269,441 and $32,455 for Balanced Assets Fund, Blue Chip Growth Fund, Mid-Cap Growth Fund, Small Company Growth Fund, Global Balanced Fund and Growth and Income Fund, respectively (of which SAAMCo agreed to waive $115,214 and $32,455 for Global Balanced and Growth and Income Fund, respectively.) In addition to the aforementioned, SAAMCo, on behalf of SunAmerica Global Balanced Fund, has entered into Sub-Advisory Agreements with AIG Asset Management, Inc. ("AIGAM") and Goldman Sachs Asset Management International ("GSAM") under which AIGAM and GSAM act as sub-advisers for the Fund. SAAMCo pays to AIGAM a monthly fee with respect to those net assets of the Global Balanced Fund actually managed by AIGAM computed based on average daily net assets at the following annual rates: .50% on the first $50 million of such assets, .40% of the next $100 million of such assets, .30% on the next $150 million of such assets, and .25% of such assets in excess of $300 million. Also, from the investment advisory fee the Adviser pays GSAM a monthly fee with respect to those net assets of NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 -- (continued) the Global Balanced Fund actually managed by GSAM computed based on average daily net assets, at the following annual rates: .40% on the first $50 million of such assets, .30% on the next $100 million of such assets, .25% on the next $100 million of such assets, and .20% of such assets in excess of $250 million. For the year ended September 30, 1995, SAAMCo paid AIGAM and GSAM fees of $75,883 and $29,912, respectively. SAAMCo has agreed that, in any fiscal year, it will refund or rebate its management fees to each of the Funds to the extent that the Fund's expenses (including the fees of SAAMCo and amortization of organizational expenses, but excluding interest, taxes, brokerage commissions, distribution fees and other extraordinary expenses) exceed the most restrictive expense limitation imposed by states where the Fund's shares are sold. The most restrictive expense limitation is presently believed to be 2 1/2% of the first $30 million of the Fund's average daily net assets, 2% of the next $70 million of average net assets and 1 1/2% of such net assets in excess of $100 million. For the year ended September 30, 1995, SAAMCo refunded its management fee in the amount of $32,455 for Growth and Income Fund. For the year ended September 30, 1995, SAAMCo has agreed to voluntarily waive fees and reimburse expenses of $13,179 and $10,554, for Blue Chip Growth Fund (Class A) and Mid-Cap Growth Fund (Class B), respectively, related to registration and transfer agent fees. For the year ended September 30, 1995, SAAMCo has agreed to voluntarily reimburse expenses of $64,080 and $37,971 for Growth and Income Fund (Class A, Class B), respectively, related to both class specific and fund level expenses. The Trust, on behalf of each Fund, has a Distribution Agreement with SunAmerica Capital Services, Inc. ("SACS"). Each Fund has adopted a Distribution Plan (the "Plan") in accordance with the provisions of Rule 12b-1 under the 1940 Act. Rule 12b-1 under the Act permits an investment company directly or indirectly to pay expenses associated with the distribution of its shares ("distribution expenses") in accordance with a plan adopted by the investment company's board of directors and approved by its shareholders. Pursuant to such rule, the Trustees and the shareholders of each class of shares of each Fund have adopted Distribution Plans hereinafter referred to as the "Class A Plan" and the "Class B Plan." In adopting the Class A Plan and the Class B Plan, the Trustees determined that there was a reasonable likelihood that each such Plan would benefit the Trust and the shareholders of the respective class. The sales charge and distribution fees of a particular class will not be used to subsidize the sale of shares of any other class. Under the Class A Plan, the Distributor receives payments from a Fund at an annual rate of up to 0.10% of average daily net assets of such Fund's Class A shares to compensate the Distributor and certain securities firms for providing sales and promotional activities for distributing that class of shares. Under the Class B Plan, the Distributor receives payments from a Fund at the annual rate of up to 0.75% of the average daily net assets of such Fund's Class B shares to compensate the Distributor and certain securities firms for providing sales and promotional activities for distributing that class of shares. The distribution costs for which the Distributor may be reimbursed out of such distribution fees include fees paid to broker-dealers that have sold Fund shares, commissions, and other expenses such as those incurred for sales literature, prospectus printing NOTES TO FINANCIAL STATEMENTS --September 30, 1995 -- (continued) compensation to wholesalers. It is possible that in any given year the amount paid to the Distributor under the Class A Plan or Class B Plan may exceed the Distributor's distribution costs as described above. The Distribution Plans provide that each class of shares of each Fund may also pay the Distributor an account maintenance and service fee up to an annual rate of 0.25% of the aggregate average daily net assets of such class of shares for payments to broker-dealers for providing continuing account maintenance. In this regard, some payments are used to compensate broker- dealers with account maintenance and service fees in an amount up to 0.25% per year of the assets maintained in a Fund by their customers. For the year ended September 30, 1995, SACS earned fees of $1,986,988, $675,044, $177,911, $744,340, $186,019 and $22,214 for Balanced Assets Fund, Blue Chip Growth Fund, Mid-Cap Growth Fund, Small Company Growth Fund, Global Balanced Fund and Growth and Income Fund, respectively (of which $16,747 was waived on Growth and Income Fund.) For the year ended September 30, 1995, SACS has advised the Funds that it has received sales concessions on each Fund's Class A shares, portions of which are reallowed to affiliated broker-dealers and non-affiliated broker- dealers as follows: SACS also receives the proceeds of contingent deferred sales charges paid by investors in connection with certain redemptions of each Fund's Class B shares. For the year ended September 30, 1995, SACS informed the Balanced Assets Fund, Blue Chip Growth Fund, Mid-Cap Growth Fund, Small Company Growth Fund, Global Balanced Fund and Growth and Income Fund that it received approximately $367,583, $88,628, $40,076, $105,710, $47,198, and $1,965, respectively, in contingent deferred sales charges. The Trust has entered into a Service Agreement with SunAmerica Fund Services, Inc. ("SAFS"), an indirect wholly-owned subsidiary of SunAmerica Inc. Under the Service Agreement, SAFS performs certain shareholder account functions by assisting the Funds' transfer agent in connection with the services that it offers to the shareholders of the Funds. The Service Agreement permits the Funds to reimburse SAFS for costs incurred in providing such services which is approved annually by the Trustees. For the year ended September 30, 1995, Balanced Assets Fund (Class A, Class B), Blue Chip Growth Fund (Class A, Class B), Mid-Cap Growth Fund (Class A, Class B), and Small Company Growth Fund (Class A, Class B), Global Balanced Fund (Class A, Class B) and Growth and Income Fund (Class A, Class B) incurred expenses of $137,209, $352,821, $25,108, $116,049, $61,957, $10,794, $105,105, $107,097, $23,995, $25,833, $5,388 and $2,143, respectively, to reimburse SAFS pursuant to the terms of the Service Agreement. Of these amounts, $21,110, $28,440, $7,580, $6,769, $6,872, $2,060, $16,380, $12,014, $1,903, $2,512, $619 and $391, respectively, were payable to SAFS at September 30, 1995. NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 -- (continued) Note 5. Purchases and Sales of Investment Securities The aggregate cost of purchases and proceeds form sales and maturities of investments (excluding U.S. Government securities and short-term investments) during the year ended September 30, 1995 were as follows: Note 6. Portfolio Securities (Tax Basis) The cost of securities and the aggregate gross unrealized appreciation and depreciation of securities at September 30, 1995 were as follows: Capital losses incurred after October 31 within the taxable year are deemed to arise on the first business day of the Funds' next taxable year. Accordingly, the Global Balanced Fund incurred and will defer net capital losses of $1,443,904 to the taxable year ended September 30, 1996. To the extent these losses are used to offset future gains, it is probable that the gains so offset will not be distributed. At September 30, 1995, Global Balanced Fund had net capital loss carryforwards of $17,364 which are available to the extent provided in regulations to offset future capital gains and which will expire in 2003. To the extent that these carryforwards are used to offset future capital gains, it is probable that the gains so offset will not be distributed. NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 -- (continued) Note 7. Open Forward Currency Contracts At September 30, 1995, the Global Balanced Fund engaged in the trading of forward foreign currency exchange contracts ("forward contracts") in order to hedge against changes in future foreign exchange rates and enhance return. Forward contracts involve elements of market risk in excess of the amount reflected in the Statement of Assets and Liabilities. The Fund bears the risk of an unfavorable change in the foreign exchange rate underlying the forward contract. Global Balanced Fund held the following forward currency contracts at September 30, 1995: NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 -- (continued) Represents open forward currency contracts and offsetting open forward foreign currency contracts that do not have additional market risk but have continued counterparty settlement risk. AUD--Australian DEM--Deutsche Mark GBP--Great Britain NZD--New Zealand BEF--Belgium ESP--Spanish Peseta ITL--Italian Lira USD--United States CAD--Canadian FRF--French Franc JPY--Japanese Yen XEU--European NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 -- (continued) Note 8. Capital Share Transactions Transactions in capital shares of each class of each series were as follows: (a) Commencement of sale of respective class of shares NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 -- (continued) (a) Commencement of sale of respective class of shares NOTES TO FINANCIAL STATEMENTS -- September 30, 1995 -- (continued) Note 9. Commitments and Contingencies The SunAmerica family of mutual funds may borrow up to $75,000,000 under an uncommitted line of credit with State Street Bank and Trust Company with interest payable at the Federal Funds rate plus 100 basis points. Borrowings under the line of credit will commence when the respective Fund's cash shortfall exceeds $100,000. Note 10. Trustees Retirement Plan The Trustees (and Directors) of the SunAmerica Family of Mutual Funds have adopted the SunAmerica Disinterested Trustees' and Directors' Retirement Plan (the "Retirement Plan") effective January 1, 1993 for the unaffiliated Trustees. The Retirement Plan provides generally that if an unaffiliated Trustee who has at least 10 years of consecutive service as a Disinterested Trustee of any of the SunAmerica mutual funds (an "Eligible Trustee") retires after reaching age 60 but before age 70 or dies while a Trustee, such person will be eligible to receive a retirement or death benefit from each SunAmerica mutual fund with respect to which he or she is an Eligible Trustee. As of each birthday, prior to the 70th birthday, each Eligible Trustee will be credited with an amount equal to (i) 50% of his or her regular fees (excluding committee fees) for services as a Disinterested Trustee of each SunAmerica mutual fund for the calendar year in which such birthday occurs, plus (ii) 8.5% of any amounts credited under clause (i) during prior years. An Eligible Trustee may receive any benefits payable under the Retirement Plan, at his or her election, either in one lump sum or in up to fifteen annual installments. As of September 30, 1995, the Funds had accrued $5,120, $1,867, $886, $2,243, $436 and $58 which is included in accrued expenses on the Statement of Assets and Liabilities, and for the year ended September 30, 1995 expensed $3,883, $1,381, $670, $1,716, $436 and $56 for the Balanced Assets Fund, Blue Chip Growth Fund, Mid-Cap Growth Fund, Small Company Growth Fund, Global Balanced Fund and Growth and Income Fund, respectively, for the Retirement Plan which is included in Trustees' fees and expenses on the Statement of Operations. To the Trustees and Shareholders of SunAmerica Equity Funds In our opinion, the accompanying statements of assets and liabilities, including the portfolios of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of SunAmerica Balanced Assets Fund, SunAmerica Blue Chip Growth Fund, SunAmerica Mid-Cap Growth Fund, SunAmerica Small Company Growth Fund, SunAmerica Global Balanced Fund and SunAmerica Growth and Income Fund (constituting SunAmerica Equity Funds, hereafter referred to as the "Fund") at September 30, 1995, and the results of each of their operations, the changes in each of their net assets and the financial highlights for each of the periods presented, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at September 30, 1995 by correspondence with the custodian and brokers and the application of alternative auditing procedures where confirmations from brokers were not received, provide a reasonable basis for the opinion expressed above. 1177 Avenue of the Americas New York, New York November 10, 1995 Certain tax information regarding the SunAmerica Equity Funds is required to be provided to shareholders based upon each Fund's income and distributions for the taxable year ended September 30, 1995. The information and distributions reported herein may differ from the information and distributions taxable to the shareholders for the calendar year ending December 31, 1995. The information necessary to complete your income tax returns will be included with your Form 1099-DIV which will be sent to you under separate cover in January 1996. During the year ended September 30, 1995 the Funds paid the following dividends per share: For the year ended September 30, 1995, 24.5%, 19.5%, 4.1%, 34.9% and 17.2% of the dividends paid from ordinary income by Balanced Assets Fund, Blue Chip Growth Fund, Mid-Cap Growth Fund, Global Balanced Fund and Growth and Income Fund, respectively, qualified for the 70% dividends received deductions for corporations. CORPORATE BOND AND COMMERCIAL PAPER RATINGS Description of Moody's Investors Service, Inc.'s ("Moody's") Corporate Ratings Aaa Bonds which are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long- term risks appear somewhat larger than in Aaa securities. A Bonds which are rated A possess many favorable investment attributes and are to considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. Baa Bonds which are rated Baa are considered as medium grade obligations; i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Ba Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate, and therefore not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. B Bonds which are rated B generally lack characteristics of desirable investments. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Caa Bonds which are rated Caa are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest. Ca Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings. C Bonds which are rated C are the lowest rated class of bonds, and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. Note: Moody's may apply numerical modifiers 1, 2 and 3 in each generic rating classification from Aa through B in its corporate bond rating system. The modifier 1 indicates that the security ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the issue ranks in the lower end of the generic rating category. Description of Moody's Commercial Paper Ratings The term "commercial paper" as used by Moody's means promissory obligations not having an original maturity in excess of nine months. Moody's makes no representations as to whether such commercial paper is by any other definition "commercial paper" or is exempt from registration under the Securities Act. Moody's commercial paper ratings are opinions of the ability of issuers to repay punctually promissory obligations not having an original maturity in excess of nine months. Moody's makes no representation that such obligations are exempt from registration under the Securities Act, nor does it represent that any specific note is a valid obligation of a rated issuer or issued in conformity with any applicable law. Moody's employs the following three designations, all judged to be investment grade, to indicate the relative repayment capacity of rated issuers: Issuers rated Prime-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. Prime-1 repayment capacity will normally be evidenced by the following characteristics: -- Leading market positions in well established industries -- High rates of return on funds employed -- Conservative capitalization structures with moderate reliance on debt -- Broad margins in earnings coverage of fixed financial charges and high -- Well established access to a range of financial markets and assured sources of alternate liquidity. Issuers rated Prime-2 (or related supporting institutions) have a strong capacity for repayment of short-term promissory obligations. This will normally be evidenced by many of the characteristics cited above but to a lesser degree. Earnings trends and coverage ratios, while sound, will be more subject to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternate liquidity is maintained. Issuers rated Prime-3 (or related supporting institutions) have an acceptable capacity for repayment of short-term promissory obligations. The effect of industry characteristics and market composition may be more pronounced. Variability in earnings and profitability may result in changes in level of debt protection measurements and the requirement for relatively high financial leverage. Adequate alternate liquidity is maintained. Issuers rated Not Prime do not fall within any of the Prime rating categories. If an issuer represents to Moody's that its commercial paper obligations are supported by the credit of another entity or entities, then the name or names of such supporting entity or entities are listed within parentheses beneath the name of the issuer, or there is a footnote referring the reader to another page for the name or names of the supporting entity or entities. In assigning ratings to such issuers, Moody's evaluates the financial strength of the indicated affiliated corporations, commercial banks, insurance companies, foreign governments or other entities, but only as one factor in the total rating assessment. Moody's makes no representation and gives no opinion on the legal validity or enforceability of any support arrangement. You are cautioned to review with your counsel any questions regarding particular support arrangements. Among the factors considered by Moody's in assigning ratings are the following: (1) evaluation of the management of the issuer; (2) economic evaluation of the issuer's industry or industries and an appraisal of speculative type risks which may be inherent in certain areas; (3) evaluation of the issuer's products in relation to competition and customer acceptance; (4) liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over a period of ten years; (7) financial strength of a parent company and the relationships which exist with the issuer; and (8) recognition by management of obligations which may be present or may arise as a result of public interest questions and preparations to meet such obligations. Description of Standard & Poor's Corporate Debt Ratings A Standards & Poor's corporate or municipal rating is a current assessment of the creditworthiness of an obligor with respect to a specific obligation. This assessment may take into consideration obligers such as guarantors, insurers, or lessees. The debt rating is not a recommendation to purchase, sell or hold a security, inasmuch as it does not comment as to market price or suitability for a particular investor. The ratings are based on current information furnished by the issuer or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any rating and may, on occasion, rely on unaudited financial information. The ratings may be changed, suspended or withdrawn as a result of changes in, or unavailability of, such information, or for other reasons. The ratings are based, in varying degrees, on the following considerations: (1) likelihood of default capacity and willingness of the obligor as to the timely payment of interest and repayment of principal in accordance with the terms of the obligation: (2) nature of and provisions of the obligation; and (3) protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization or other arrangement under the laws of bankruptcy and other laws affecting creditors' rights. AAA Debt rated AAA has the highest rating assigned by Standard & Poor's. Capacity to pay interest and repay principal is extremely strong. AA Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the highest-rated issues only in small degree. A Debt rated A has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher- rated categories. BBB Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than for debt in higher-rated categories. Debt rated BB, B, CCC, CC and C are regarded as having predominantly speculative characteristics with respect to capacity to pay interest and repay principal. BB indicates the least degree of speculation and C the highest degree of speculation. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposure to adverse conditions. BB Debt rated BB has less near-term vulnerability to default than other speculative grade debt. However, it faces major ongoing uncertainties or exposure to adverse business, financial or economic conditions which could lead to inadequate capacity to meet timely interest and principal payment. The BB rating category is also used for debt subordinated to senior debt that is assigned an actual or implied BBB-rating. B Debt rated B has a greater vulnerability to default but presently has the capacity to meet interest payments and principal repayments. Adverse business, financial or economic conditions would likely impair capacity or willingness to pay interest and repay principal. The B rating category is also used for debt subordinated to senior debt that is assigned an actual or implied BB or BB-rating. CCC Debt rated CCC has a current identifiable vulnerability to default, and is dependent upon favorable business, financial and economic conditions to meet timely payments of interest and repayments of principal. In the event of adverse business, financial or economic conditions, it is not likely to have the capacity to pay interest and repay principal. The CCC rating category is also used for debt subordinated to senior debt that is assigned an actual or implied B or B- rating. CC The rating CC is typically applied to debt subordinated to senior debt which is assigned an actual or implied CCC rating. C The rating C is typically applied to debt subordinated to senior debt which is assigned an actual or implied CCC-debt rating. The C rating may be used to cover a situation where a bankruptcy petition has been filed but debt service payments are continued. CI The rating CI is reserved for income bonds on which no interest is being paid. D Debt rated D is in default. The D rating is assigned on the day an interest or principal payment is missed. The D rating also will be used upon the filing of a bankruptcy petition if debt service payments are jeopardized. Plus (+) or minus (-): The ratings of AA to CCC may be modified by the addition of a plus or minus sign to show relative standing within these ratings categories. Provisional ratings: The letter "p" indicates that the rating is provisional. A provisional rating assumes the successful completion of the project being financed by the debt being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful and timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the likelihood or risk of default upon failure of such completion. The investor should exercise judgment with respect to such likelihood and risk. L The letter "L" indicates that the rating pertains to the principal amount of those bonds to the extent that the underlying deposit collateral is insured by the Federal Savings & Loan Insurance Corp. or the Federal Deposit Insurance Corp. and interest is adequately collateralized. Continuance of the rating is contingent upon Standard & Poor's receipt of an executed copy of the escrow agreement or closing documentation confirming investments and cash flows. NR Indicates that no rating has been requested, that there is insufficient information on which to base a rating or that Standard & Poor's does not rate a particular type of obligation as a matter of policy. Debt Obligations of Issuers outside the United States and its territories are rated on the same basis as domestic corporate and municipal issues. The ratings measure the credit worthiness of the obligor but do not take into account currency exchange and related uncertainties. Bond Investment Quality Standards: Under present commercial bank regulations issued by the Comptroller of the Currency, bonds rated in the top four categories ("AAA", "AA", "A", "BBB", commonly known as "investment grade" ratings) are generally regarded as eligible for bank investment. In addition, the laws of various states governing legal investments impose certain rating or other standards for obligations eligible for investment by savings banks, trust companies, insurance companies and fiduciaries generally. Description of Standard & Poor's Commercial Paper Ratings. A Standard & Poor's commercial paper rating is a current assessment of the likelihood of timely payment of debt having an original maturity of not more than 365 days. Ratings are graded into four categories, ranging from "A" for the highest quality obligations to "D" for the lowest. A Issues assigned this highest rating are regarded as having the greatest capacity for timely payment. Issues in this category are delineated with the numbers 1, 2 and 3 to indicate the relative degree of safety. A-1 This designation indicates that the degree of safety regarding timely payment is either overwhelming or very strong. Those issues determined to possess overwhelming safety characteristics are denoted with a plus (+) sign designation. A-2 Capacity for timely payment on issues with this designation is strong. However, the relative degree of safety is not as high as for issues designated "A-1". A-3 Issues carrying this designation have a satisfactory capacity for timely payment. They are, however, somewhat more vulnerable to the adverse effect of changes in circumstances than obligations carrying the higher designations. B Issues rated "B" are regarded as having only adequate capacity for timely payment. However, such capacity may be damaged by changing conditions or short-term adversities. C This rating is assigned to short-term debt obligations with a doubtful capacity for payment. D This rating indicates that the issue is either in default or is expected to be in default upon maturity. The commercial paper rating is not a recommendation to purchase or sell a security. The ratings are based on current information furnished to Standard & Poor's by the issuer or obtained from other sources it considers reliable. The ratings may be changed, suspended, or withdrawn as a result of changes in or unavailability of such information. Item 24. Financial Statements and Exhibits. Set forth in Part B of Registrant's Statement of Additional Information are the audited financial statements of the SunAmerica Equity Funds with respect to Registrant's fiscal year ended September 30, 1995. Selected per share data and ratios are set forth in Part A of the Prospectus under the caption "Financial Highlights." No financial statements are included in Part C. All other financial statements, schedules and historical financial information are omitted because the conditions requiring their filing do not exist. (1) Declaration of Trust, as amended. (4) Specimen Certificates with respect to Global Balanced Fund and Growth and Income Fund series. Incorporated herein by reference to Post-Effective Amendment No. 15 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on January 27, 1995. Specimen Certificates with respect to Balanced Assets Fund, Value Fund, Growth Fund and Emerging Growth Fund series. Incorporated herein by reference to Post-Effective Amendment No. 12 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on January 27, 1994. (5)(a) Investment Advisory and Management Agreement between Registrant and SunAmerica Asset Management Corp. with respect to the Balanced Assets Fund, Blue Chip Growth Fund, Mid-Cap Growth, and Small Company Growth Fund. Incorporated herein by reference to Post-Effective Amendment No. 12 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on January 27, 1994. Form of Investment Advisory and Management Agreement between Registrant and SunAmerica Asset Management Corp. with respect to the Global Balanced Fund and Growth and Income Fund series. Incorporated herein by reference to Post-Effective Amendment No. 13 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on April 7, 1994. (5)(b) Form of Sub-Advisory Agreement between SunAmerica Asset Management Corp. and Goldman Sachs Asset Management ("GSAMI") with respect to the Global Balanced Fund series, and a form of Sub-Advisory Agreement between SunAmerica Asset Management Corp. and AIG Asset Management, Inc. ("AIGAM") with respect to the Global Balanced Fund series. Incorporated herein by reference to Post-Effective Amendment No. 13 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on April 7, 1994. (5)(c) Form of Sub-Sub-Advisory Agreement between AIGAM and AIGAM International Limited with respect to the foreign equity component of the Global Balanced Fund series. Incorporated herein by referenced to Post-Effective Amendment No. 14 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on June 7, 1994. (6)(a) Distribution Agreement between Registrant and SunAmerica Capital Services, Inc. with respect to the Balanced Assets, Blue Chip Growth Fund, Mid-Cap Growth, and Small Company Growth Fund. Incorporated herein by reference to Post- Effective Amendment No. 12 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on January 27, 1994. Form of Distribution Agreement between Registrant and SunAmerica Capital Services, Inc. with respect to the Global Balanced Fund and Growth and Income Fund series. Incorporated herein by reference to Post-Effective Amendment No. 13 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on April 7, 1994. (6)(b) Dealer Agreement. Incorporated herein by reference to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on August 14, 1986. (7) Directors'/Trustees' Retirement Plan. Incorporated herein by reference to Post-Effective Amendment No. 13 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on April 7, 1994. (8) Custodian Agreement between Registrant and State Street Bank and Trust Company. Incorporated herein by reference to Post-Effective Amendment No. 15 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on January 27, 1995. (9)(a) Transfer Agency and Service Agreement between Registrant and State Street Bank and Trust Company. Incorporated herein by reference to Post-Effective Amendment No. 15 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on January 27, 1995. (9)(b) Service Agreement between Registrant and SunAmerica Fund Services, Inc. with respect to the Balanced Assets Fund, Blue Chip Growth Fund, Mid-Cap Growth, and Small Company Growth Fund series. Incorporated herein by reference to Post-Effective Amendment No. 12 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on January 27, 1994. Form of Service Agreement between Registrant and SunAmerica Fund Services, Inc. with respect to the Global Balanced Fund and Growth and Income Fund series. Incorporated herein by reference to Post-Effective Amendment No. 13 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on April 7, 1994. (10) Opinion and Consent of Counsel. Incorporated herein by reference to Post-Effective Amendment No. 13 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on April 7, 1994. (11) Consent of Independent Accountants. (15) Distribution Plans pursuant to Rule 12b-1 (Class A Shares and Class B Shares) with respect to the Balanced Assets Fund, Blue Chip Growth Fund, Mid-Cap Growth, and Small Company Growth Fund series. Incorporated herein by reference to Post-Effective Amendment No. 12 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on January 27, 1994. Forms of Distribution Plans pursuant to Rule 12b-1 (Class A Shares and Class B Shares) with respect to the Global Balanced Fund and Growth and Income Fund series. Incorporated herein by reference to Post-Effective Amendment No. 13 to Registrant's Registration Statement on Form N-1A (File No. 33-8021) filed on April 7, 1994. (16) Schedule of Computation of Performance Quotations. Item 25. Persons Controlled By or Under Common Control With Registrant. There are no persons controlled by or under common control with Registrant. Item 26. Number of Holders of Securities. Class A Shares Class B Shares Number of Record Number of Record Holders as of Holders as of Title of Class December 31, 1995 December 31, 1995 Balanced Assets Fund 14,310 10,384 Blue Chip Growth Fund 6,896 4,461 Mid-Cap Growth Fund 3,618 901 Small Company Growth Fund` 10,635 5,439 Global Balanced Fund 874 1,206 Growth and Income Fund 156 273 Insofar as indemnification for liability arising under the Securities Act of 1933, as amended (the "Act") may be permitted to trustees, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a trustee, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted against the Registrant by such trustee, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by the controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. Item 28. Business and Other Connections of the Investment Adviser. Information concerning the business and other connections of SunAmerica Asset Management Corp. is incorporated herein by reference to SunAmerica Asset Management Corp.'s Form ADV (File No. 801-19813) and information concerning the business and other connections of GSAMI is incorporated herein by reference to GSAMI's Form ADV (File No. 801-16048), and information concerning the business and other connections of AIGAM is incorporated herein by reference to AIGAM's Form ADV (File No. 801-42213), which are currently on file with the Securities and Exchange Commission. Reference is also made to the caption "Management of the Trust" in the Prospectus constituting Part A of the Registration Statement and "Adviser, Sub-Advisers, Distributor and Administrator" and "Trustees and Officers" constituting Part B of the Registration Statement. (a) The principal underwriter of the Registrant also acts as principal underwriter for: SunAmerica Money Market Funds, Inc. (b) The following persons are the officers and directors of SunAmerica Capital Services, Inc., the principal underwriter of Registrant's Shares: Name and Principal Position Position with the Business Address With Underwriter Registrant Peter A. Harbeck President President and Robert M. Zakem Executive Vice Secretary and The SunAmerica Center President and Chief Compliance 733 Third Avenue Director Officer Name and Principal Position Position with the Business Address With Underwriter Registrant Susan L. Harris Secretary None SunAmerica Inc. Steven E. Rothstein Treasurer None Item 30. Location of Accounts and Records. SunAmerica Asset Management Corp., The SunAmerica Center, 733 Third Avenue, New York, NY 10017-3204, or an affiliate thereof, maintains physical possession of each such accounts, books or other documents of Registrant, except for those maintained by Registrant's custodian, State Street Bank and Trust Company, 1776 Heritage Drive, North Quincy, MA 02171, and its affiliate, National Financial Data Services, P.O. Box 419572, Kansas City, MO 64141-6572. (c) To furnish, upon request and without charge, to each person to whom a Prospectus is delivered a copy of the Registrant's latest annual report to shareholders. Pursuant to the requirements of the Securities Act of 1933, as amended, (the "1933 Act") and the Investment Company Act of 1940, as amended, Registrant certifies that it meets all of the requirements for effectiveness of the Post- Effective Amendment No. 17 to the Registration Statement (the "Post-Effective Amendment") pursuant to Rule 485(b) under the 1933 Act and that Registrant has duly caused the Post-Effective Amendment to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of New York, and State of New York, on the 11th of January, 1996. Pursuant to the requirements of the 1933 Act, the Post-Effective Amendment No. 17 to Registrant's Registration Statement on Form N-1A has been signed below by the following persons in the capacities and on the dates indicated: /s/Peter A. Harbeck President and Trustee January 11, 1996 * Controller January 11, 1996 Peter C. Sutton and Financial Officer) * Trustee January 11, 1996 * Trustee January 11, 1996 * Trustee January 11, 1996 * Trustee January 11, 1996 * Trustee January 11, 1996 Exhibit No. Name Page No. 1 Declaration of Trust, as amended -------- 2 By-Laws, as amended -------- 11 Consent of Independent Accountants -------- 14 Model Retirement Plan -------- 17 Powers of Attorney --------	485BPOS	485BPOS	1996-01-12T00:00:00	1996-01-12T16:13:13
0000950131-96-000066	0000950131-96-000066_0018.txt	KNOW ALL MEN BY THESE PRESENTS, that the undersigned officers of SunAmerica Equity Funds do hereby severally constitute and appoint Peter A. Harbeck, Peter Sutton and Robert M. Zakem or any of them, the true and lawful agents and attorneys-in-fact of the undersigned with respect to all matters arising in connection with the Registration Statement on Form N-1A and any and all amendments (including post-effective amendments) thereto, with full power and authority to execute said Registration Statement for and on behalf of the undersigned, in our names and in the capacity indicated below, and to file the same, together with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission. The undersigned hereby gives to said agents and attorneys-in-fact full power and authority to act in the premises, including, but not limited to, the power to appoint a substitute or substitutes to act hereunder with the same power and authority as said agents and attorneys-in fact would have if personally acting. The undersigned hereby ratify and confirm all that said agents and attorneys-in-fact, or any substitute or substitutes, may do by virtue hereof. WITNESS the due execution hereof on the date and in the capacity set forth below. /s/ Peter A. Harbeck Trustee and President November 30, 1994 /s/ Peter C. Sutton Controller (Principal November 30, 1994 ------------------- Financial and Accounting Officer) /s/ S. James Coppersmith Trustee November 30, 1994 /s/ Samuel M. Eisenstat Trustee November 30, 1994 /s/ Stephen J. Gutman Trustee November 30, 1994 /s/ Sebastiano Sterpa Trustee November 30, 1994 /s/ Peter McMillan III Trustee December 4, 1995	485BPOS	EX-99.17	1996-01-12T00:00:00	1996-01-12T16:13:13
0000950134-96-000099	0000950134-96-000099_0000.txt	<DESCRIPTION>SUPPLEMENT DATED JANUARY 2, 1996 SUPPLEMENT DATED JANUARY 2, 1996 TO PROSPECTUS DATED MAY 1, 1995, Effective January 1, 1996, BZW Barclays Global Fund Advisors ("BGFA") replaced Wells Fargo Nikko Investment Advisors ("WFNIA") as sub-investment adviser to the Asset Allocation Fund (the "Fund") of Overland Express Funds, Inc. BGFA was created by the reorganization of WFNIA with and into an affiliate of Wells Fargo Institutional Trust Company, N.A. ("WFITC"). Pursuant to a Sub-Advisory Contract with the Fund and subject to the overall supervision of Wells Fargo Bank, the Fund's investment adviser, BGFA is responsible for the day-to-day portfolio management of the Fund. BGFA will continue to employ substantially the same personnel and will continue to use the computer-based investment model developed and previously used by WFNIA to determine the recommended mix of assets in the Fund's portfolio. BGFA is entitled to receive from Wells Fargo an annual fee of $60,000 and monthly fees at the annual rate of 0.20% of the Fund's average daily net assets as compensation for its sub-advisory services. BGFA is an indirect subsidiary of Barclays Bank PLC and is located at 45 Fremont Street, San Francisco, CA 94105. As of January 1, 1996, BGFA and its affiliates provide investment advisory services for over $220 billion of assets under management. As of January 1, 1996, Wells Fargo Bank provides investment advisory services for approximately $33 billion of assets. Effective January 1, 1996, WFITC, due to a change in control of its outstanding voting securities, became a wholly owned subsidiary of BZW Barclays Global Investors Holdings Inc. (formerly, The Nikko Building U.S.A., Inc.) and WFITC was renamed BZW Barclays Global Investors, N.A. ("BGI"). BGI currently acts as the Fund's custodian. BGFA is a subsidiary of BGI. BGI will not be entitled to receive compensation for its services to the Fund so long as BGFA is entitled to receive fees for providing investment advisory services to the Fund. The principal business address of BGI is 45 Fremont Street, San Francisco, California 94105. The Prospectus and Statement of Additional Information describing the Fund are hereby amended accordingly. Stephens Inc. -- Sponsor, Administrator and Distributor Wells Fargo Bank, N.A. -- Investment Adviser, Transfer and Dividend Disbursing Wells Fargo Nikko Investment Advisors -- Sub-Investment Adviser Wells Fargo Institutional Trust Company, N.A. -- Custodian Overland Express Funds, Inc. (the "Company") is a professionally managed, open-end, series investment company. This Prospectus contains information about one of the funds in the Overland Express Family of Funds -- the ASSET ALLOCATION FUND (the "Fund"). The Asset Allocation Fund seeks to earn over the long term a high level of total investment return (that is, income and capital appreciation combined), consistent with the assumption of reasonable risk, by pursuing an "asset allocation" strategy whereby its investments are allocated, based on changes in market conditions, among three asset classes -- common stocks in the Standard & Poor's Index of 500 Stocks (the "S&P Index"), U.S. Treasury bonds and money market instruments. This Prospectus describes two classes of shares of the Fund -- Class A Shares and Class D Shares. This Prospectus sets forth concisely the information a prospective investor should know before investing in the Fund. A Statement of Additional Information dated May 1, 1995, containing additional and more detailed information about the Fund (the "SAI"), has been filed with the Securities and Exchange Commission (the "SEC") and is hereby incorporated by reference into this Prospectus. The SAI is available without charge and can be obtained by writing the Company at P.O. Box 63084, San Francisco, CA 94163, or by calling the Company at the telephone number printed above. INVESTORS SHOULD READ THIS PROSPECTUS CAREFULLY AND RETAIN IT FOR FUTURE REFERENCE. FUND SHARES ARE NOT DEPOSITS OR OTHER OBLIGATIONS OF, OR ISSUED, ENDORSED OR GUARANTEED BY, WELLS FARGO BANK, N.A. ("WELLS FARGO BANK") OR ANY OF ITS AFFILIATES. SUCH SHARES ARE NOT INSURED BY THE U.S. GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER GOVERNMENTAL AGENCY. AN INVESTMENT IN THE FUND INVOLVES CERTAIN INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL. WELLS FARGO BANK IS THE INVESTMENT ADVISER AND PROVIDES CERTAIN OTHER SERVICES TO THE FUND, FOR WHICH IT IS COMPENSATED. STEPHENS INC. ("STEPHENS"), WHICH IS NOT AFFILIATED WITH WELLS FARGO BANK, IS THE SPONSOR AND DISTRIBUTOR FOR THE FUND. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION, ANY STATE SECURITIES COMMISSION OR ANY OTHER REGULATORY AUTHORITY, NOR HAVE ANY OF THE FOREGOING AUTHORITIES PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. PROSPECTUS DATED MAY 1, 1995 The Company, as an open-end investment company, provides a convenient way for you to invest in portfolios of securities selected and supervised by professional management. The following provides information about the Fund and its investment objective. Q. WHAT IS THE FUND'S INVESTMENT OBJECTIVE? A. The ASSET ALLOCATION FUND seeks to earn over the long term a high level of total investment return (that is, income and capital appreciation combined), consistent with the assumption of reasonable risk, by pursuing an "asset allocation" strategy whereby its investments are allocated, based on changes in market conditions, among three asset classes -- common stocks in the S&P Index, U.S. Treasury bonds and money market instruments. As with all mutual funds, there can be no assurance that the Fund will achieve its investment objective. Q. WHAT ARE PERMISSIBLE INVESTMENTS? A. The Fund may invest in three asset classes: common stocks in the S&P Index, U.S. Treasury bonds with maturities generally between 20 and 30 years and high-quality money market instruments. The Fund seeks to maximize its long-term investment results by shifting its investments periodically among the various asset classes to attempt to achieve a return that is superior to an investment in any single asset class. Q. WHO IS THE INVESTMENT ADVISER? A. Wells Fargo Bank serves as the investment adviser of the Fund. Wells Fargo Bank is entitled to receive a monthly advisory fee at the annual rate of 0.70% of the average daily net assets of the Fund up to $500 million, and 0.60% of such assets in excess of $500 million. Wells Fargo Nikko Investment Advisors ("WFNIA") serves as the sub-investment adviser to the Fund and receives compensation for its services out of the fee paid to Wells Fargo Bank. See "Advisory, Administration and Distribution Arrangements." Q. WHO IS THE SPONSOR, ADMINISTRATOR AND DISTRIBUTOR? A. Stephens serves as the sponsor, administrator and distributor for the Company. Stephens is entitled to receive a monthly administration fee at the annual rate of 0.10% of the average daily net assets of the Fund; decreasing to 0.05% of the average daily net assets of the Fund in excess of $200 million. See "Advisory, Administration and Distribution Arrangements." Q. HOW MAY I PURCHASE SHARES? A. Shares of the Fund may be purchased on any day the New York Stock Exchange (the "Exchange") is open for trading. There is a maximum sales load of 4.50% (4.71% of the net amount invested) for purchasing Class A Shares of the Fund. Class D Shares are subject to a maximum contingent deferred sales charge of 1.00% of the lesser of net asset value at purchase or net asset value at redemption. In most cases, the minimum initial purchase amount for the Fund is $1,000. The minimum initial purchase amount is $100 for purchases through the Systematic Purchase Plan and $250 for purchases through qualified retirement plans. The minimum subsequent purchase amount is $100 or more. You may purchase shares of the Fund through Stephens, Wells Fargo Bank, as transfer agent (the "Transfer Agent"), or any authorized broker/dealer or financial institution. Purchases of shares of the Fund may be made by wire directly to the Transfer Agent. The Fund may pay the Distributor a monthly fee at an annual rate of up to 0.25% of the Fund's average daily net assets attributable to Class A Shares and a monthly fee at an annual rate of up to 0.75% of the Fund's average daily net assets attributable to Class D Shares to compensate the distributor for distribution-related services provided by it or to reimburse it for other distribution-related expenses. See "Purchase of Shares" and "Distribution Plans." The Fund also may pay servicing agents a fee at an annual rate of up to 0.25% of the Fund's average daily net assets attributable to Class D Shares to compensate them for certain services. See "Servicing Plan." Q. HOW WILL I RECEIVE DIVIDENDS? A. Dividends on shares of the Fund are declared quarterly and paid quarterly. Dividends are automatically reinvested in additional shares of the same class of the Fund unless you elect to receive dividends by check. Any capital gains will be distributed annually and may be reinvested in Fund shares of the same class or paid by check at your election. All reinvestments of dividends and/or capital gain distributions in shares of the Fund are effected at the then current net asset value free of any sales load. In addition, you may elect to reinvest Fund dividends and/or capital gain distributions in shares of the same class of another fund in the Overland Express Family of Funds with which you have an established account that has met the applicable minimum initial investment requirement. The net investment income available for distribution to holders of the Fund's Class D Shares is reduced by the amount of servicing fees payable to servicing agents under the Servicing Plan (as defined below). See "Dividends and Distributions." Q. HOW MAY I REDEEM SHARES? A. On any day the Exchange is open, shares may be redeemed upon request to Stephens or the Transfer Agent directly or through any authorized broker/dealer or financial institution. Shares may be redeemed by a request in good form in writing or through telephone direction. Proceeds are payable by check. Accounts of less than the applicable minimum initial purchase amount may be redeemed at the option of the Company. Except for any contingent deferred sales charge which may be applicable upon redemption of Class D Shares, the Company does not charge for redeeming your shares. However, the Company reserves the right to impose charges for wiring your redemption proceeds. See "Redemption of Shares." Q. WHAT ARE SOME OF THE POTENTIAL RISKS ASSOCIATED WITH AN INVESTMENT IN THE FUND? A. An investment in the Fund is not insured against loss of principal. When the value of the securities that the Fund owns declines, so does the value of your Fund shares. Therefore, you should be prepared to accept some risk with the money you invest in the Fund. Because the Fund may shift its investment allocations significantly from time to time, its performance may differ from funds which invest in one asset class or from funds with a stable mix of assets. Further, shifts among asset classes may result in relatively high portfolio turnover rates, which may, in turn, result in increased brokerage and transaction costs, and/or subject shareholders to increased short-term capital gains or losses. The portfolio debt securities of the Fund are subject to interest rate risk. Interest rate risk is the risk that increases in market interest rates may adversely affect the value of the debt securities in which the Fund invests and hence the value of your investment in the Fund. The values of such securities generally change inversely to changes in market interest rates. which a high percentage of the Fund's portfolio is invested in long-term bonds, the Fund's exposure to interest rate risk will be greater because the longer maturity of such securities means they are generally more sensitive to changes in market interest rates than shorter term securities. The stock investments of the Fund are subject to equity market risk. Equity market risk is the possibility that common stock prices will fluctuate or decline over short or even extended periods. The U.S. stock market tends to be cyclical, with periods when stock prices generally rise and periods when prices generally decline. Additionally, the Fund may lend its portfolio securities, which entails certain risks, although any such loans will be fully collateralized. As with all mutual funds, there can be no assurance that the Fund will achieve its investment objective. You should be prepared to accept the risk that the Fund may under-perform (over the short- and/or long-term) one or more of the three classes of securities in which it invests. (AS A PERCENTAGE OF AVERAGE NET ASSETS) (1) After any waivers or reimbursements * See "Contingent Deferred Sales Charge." ** As further described in the Prospectus under the caption "Advisory, Administration and Distribution Arrangements," Stephens and Wells Fargo Bank each has agreed to waive all or a portion of its respective fees in circumstances where Fund expenses that are subject to limitations imposed under state securities laws and regulations exceed such limitations. In addition, Stephens and Wells Fargo Bank each may elect, in its sole discretion, to otherwise waive its respective fees or reimburse expenses. Any such waivers or reimbursements with respect to the Fund will reduce the total expenses of the Fund. The percentages shown above with respect to Class A Shares under "Total Other Expenses" and "Total Fund Operating Expenses" reflect voluntary fee waivers and expense reimbursements for the most recent fiscal year. Absent such waivers and reimbursements, these percentages would have been 0.43% and 1.38%, respectively, for Class A Shares, and would have been 0.75% and 2.20%, respectively for Class D Shares. Long-term shareholders of the Fund could pay more in distribution related charges than the economic equivalent of the maximum front-end sales charges applicable to mutual funds sold by members of the National Association of Securities Dealers, Inc. ("NASD"). Of course, there can be no assurances that the foregoing voluntary fee waivers and expense reimbursements will continue. The purpose of the foregoing tables is to assist you in understanding the various costs and expenses that an investor in the Fund will bear directly or indirectly. There are no other sales loads, redemption fees or exchange fees charged by the Fund. However, the Company reserves the right to impose charges for wiring redemption proceeds. The Examples should not be considered a representation of past or future expenses; actual expenses may be greater or lesser than those shown. See Prospectus sections captioned "Advisory, Administration and Distribution Arrangements," "Distribution Plans" and "Purchase of Shares" for more complete descriptions of the various costs and expenses applicable to the Fund. The S&P Index is an unmanaged index of stocks comprised of 500 industrial, financial, utility and transportation companies. "Standard & Poor's(R)", "S&P(R)", "S&P 500(R)", "Standard & Poor's 500", and "500" are trademarks of McGraw-Hill, Inc. and have been licensed. The Fund is not sponsored, endorsed, sold or promoted by Standard & Poor's and Standard & Poor's makes no representation regarding the advisability of investing in the Fund. The following information has been derived from the Financial Highlights in the Fund's 1994 annual financial statements. The financial statements are incorporated by reference into the SAI and have been audited by KPMG Peat Marwick LLP, independent auditors, whose report dated February 17, 1995 also is incorporated by reference in the SAI. This information should be read in conjunction with the Fund's 1994 annual financial statements and the notes thereto. The SAI has been incorporated by reference into this Prospectus. FOR A CLASS A SHARE OUTSTANDING AS SHOWN * The Fund commenced operations on April 7, 1988. + Total returns do not include any sales charges. FOR A CLASS D SHARE OUTSTANDING AS SHOWN * This Class commenced operations on July 1, 1993. + Total returns do not include the 1% contingent deferred sales charge. INVESTMENT OBJECTIVE. The Asset Allocation Fund seeks to earn over the long term a high level of total investment return (that is, income and capital appreciation combined), consistent with the assumption of reasonable risk, by pursuing an "asset allocation" strategy whereby its investments are allocated, based on changes in market conditions, among three asset classes -- common stocks in the S&P Index, U.S. Treasury bonds and money market instruments. As with all mutual funds, there can be no assurance that the Fund, which is a diversified portfolio, will achieve its investment objective. The asset allocation strategy is based upon the premise that, from time to time, certain asset classes are more attractive long-term investments than others and, accordingly, that timely shifts among common stocks, U.S. Treasury bonds with maturities of 20 to 30 years and money market instruments, as determined by their relative over-valuation or under-valuation, can produce superior investment returns. Subject to the direction of the Company's Board of Directors and the overall supervision and control of Wells Fargo Bank and the Company, WFNIA, as sub-investment adviser to the Fund, uses a proprietary investment model to make recommendations regarding the investment and periodic readjustment of the Fund's assets in accordance with the investment objective, policies and restrictions set forth herein and in the Fund's SAI. The investment model has been developed over the past 17 years, and investments totalling approximately $14 billion were being managed by WFNIA and its divisions and affiliates using this investment model as of December 31, 1994. The investment model analyzes extensive financial data from numerous sources, and, based on such data, recommends percentage allocations among common stocks, U.S. Treasury bonds and money-market instruments. The principal financial data used by WFNIA in connection with the investment model currently are: (i) consensus estimates of the earnings, dividends and payout ratios on a broad cross-section of common stocks as reported by independent financial reporting services that survey over 1,000 Wall Street analysts; (ii) the estimated current yield to maturity on new long-term corporate bonds rated "AA" by Standard & Poor's Corporation ("S&P") or on long-term U.S. Treasury bonds; (iii) the present yield on money market instruments; (iv) the historical standard statistical deviation in investment return for each class of assets; and (v) the historical standard statistical correlation of investment return among the various asset classes. Stocks. Common stocks purchased by the Fund generally will not be individually selected. Rather, the goal will be to achieve a representative holding of publicly traded common stocks by investing, to the extent permissible under applicable law, in the stocks of the S&P Index on a capitalization weighted basis (the same basis used by the S&P Index). If, and to the extent that the common stock of Wells Fargo & Company, an affiliate of Wells Fargo Bank, is contained in the S&P Index, the Fund is permitted to invest in such securities with the stock portion of its portfolio. The S&P Index is an unmanaged index of common stocks widely used as a measure of stock market price movements. If a particular industry grows to represent more than 25% of the S&P Index, the Fund may, consistent with its concentration policy (as set forth in the SAI), continue to invest in all industry components of this index. When the total of the Fund's assets allocated to stocks is less than the amount needed for a full investment in round (100-share) lots, the Fund will either utilize odd (less than 100-share) lots, which may increase transaction costs, or will not purchase some stocks, with relatively low capitalizations, that make up the S&P Index, or both. These factors will likely result in the performance of the Fund's common stocks deviating from the performance of the stocks composing the full S&P Index. Bonds. The Fund purchases U.S. Treasury bonds with maturities generally ranging from 20 to 30 years. This form of debt instrument has been selected because of the high quality of, and the relatively low cost of buying and selling, U.S. Treasury bonds. The value of the bonds in which the Fund invests varies inversely with changes in market interest rates. In general, the variations in market value associated with bonds with remaining average maturities of 20 to 30 years can be expected to be greater than variations in the value of shorter term U.S. Treasury bonds, notes and bills. Money Market Instruments. The money market instrument portion of the Fund's portfolio will generally be invested in the following money market instruments that have remaining maturities not exceeding one year: (i) obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities (including government-sponsored enterprises); (ii) negotiable certificates of deposit, bankers' acceptances, fixed time deposits and other obligations of domestic banks (including foreign branches) that have more than $1 billion in total assets at the time of investment and are members of the Federal Reserve System or are examined by the Comptroller of the Currency or whose deposits are insured by the Federal Deposit Insurance Corporation; (iii) commercial paper rated at the date of purchase "P-1" by Moody's Investors Service, Inc. ("Moody's") or "A-1" or "A-1 +" by S&P; (iv) certain repurchase agreements; and (v) high-quality municipal obligations, the income from which may or may not be exempt from federal income taxes. The Fund also may invest in short-term U.S. dollar-denominated obligations of foreign banks (including U.S. branches) that at the time of investment: (i) have more than $10 billion, or the equivalent in other currencies, in total assets; (ii) are among the 75 largest foreign banks in the world as determined on the basis of assets; and (iii) have branches or agencies in the United States. The value of the money market instruments in which the Fund may invest varies inversely with changes in market interest rates. How the Allocation Computer Model is Used by WFNIA. WFNIA compares the Fund's portfolio investments to the investment model's recommended asset allocation on a daily basis. The investment model recommends allocations among each asset class in 10% increments only. Any recommended reallocation will be implemented in accordance with trading policies that have been designed to take advantage of market opportunities and to reduce transaction costs. Under current trading policies employed by WFNIA, recommended reallocations may be implemented promptly upon receipt of recommendations or may not be acted upon for as long as two to three months thereafter depending on factors such as the percentage change from previous recommendations and the consistency of recommended reallocations over a period of time. In addition, the Fund generally will invest the net proceeds from the sale of shares of the Fund and will liquidate existing Fund investments to meet net redemption requirements in a manner that best allows the Fund's existing asset allocation to follow that recommended by the investment model. Notwithstanding any recommendation of the investment model to the contrary, the Fund will generally maintain at least that portion of its assets in money market instruments reasonably considered necessary to meet redemption requirements. There is no requirement that the Fund maintain positions in any particular asset class or classes. WFNIA, as sub-investment adviser, intends generally to allocate investments among the asset classes of the Fund in accordance with its trading policies used in connection with implementing the investment model's recommendations. WFNIA will, however, independently evaluate each recommended allocation and may under certain circumstances vary the allocation from that recommended by the model. For example, WFNIA may determine not to follow the model if to do so would result in the Fund's ceasing to be qualified as a regulated investment company under the Internal Revenue Code of 1986, as amended (the "Code"), if WFNIA believes that the Fund would incur unreasonable transaction costs in reallocating among asset classes in a highly erratic market environment, or if necessary to satisfy liquidity requirements. Certain of the debt instruments that the Fund may purchase bear interest at rates that are not fixed, but vary with changes in specified market rates or indices or at specified intervals. Certain of these instruments may carry a demand feature that would permit the holder to tender them back to the issuer at par value prior to maturity. The floating- and variable-rate instruments that the Fund may purchase include certificates of participation in floating- and variable-rate obligations purchased from banks. Wells Fargo Bank, as investment adviser, monitors on an ongoing basis the ability of an issuer of a demand instrument to pay principal and interest on demand. Events occurring between the date the Fund elects to demand payment and the date payment is due may affect the ability of the issuer of the instrument to make payment when due, and unless such demand instrument permits same-day settlement, may affect the Fund's right to obtain payment at par. Demand instruments whose demand features cannot be exercised within seven days may be treated as liquid, provided that an active secondary market exists. The Fund may lend securities from its portfolio to brokers, dealers and financial institutions (but not individuals) if cash, U.S. Government securities or other high grade debt instruments equal to at least 100% of the current market value of the securities loaned (including accrued interest thereon) plus the interest payable to the Fund with respect to the loan is maintained with the Fund. In determining whether to lend a security to a particular broker, dealer or financial institution, the Fund's investment adviser will consider all relevant facts and circumstances, including the creditworthiness of the broker, dealer or financial institution. Any loans of portfolio securities will be fully collateralized based on values that are marked to market daily. The Fund will not enter into any portfolio security lending arrangement having a duration of longer than one year. Any securities that the Fund may receive as collateral will not become part of the Fund's portfolio at the time of the loan and, in the event of a default by the borrower, the Fund will, if permitted by law, dispose of such collateral except for such part thereof that is a security in which the Fund is permitted to invest. During the time securities are on loan, the borrower will pay the Fund any accrued income on those securities, and the Fund may invest the cash collateral in U.S. Government securities or other high grade debt obligations and earn additional income or receive an agreed-upon fee from a borrower that has delivered cash-equivalent collateral. The Fund will not lend securities having a value that exceeds one-third of the current value of its total assets. Loans of securities by the Fund will be subject to termination at the Fund's or the borrower's option. The Fund may pay reasonable administrative and custodial fees in connection with a securities loan and may pay a negotiated portion of the interest or fee earned with respect to the collateral to the borrower or the placing broker. Borrowers and placing brokers may not be affiliated, directly or indirectly, with the Company, its investment adviser, or its distributor. The Fund may enter into repurchase agreements wherein the seller of a security to the Fund agrees to repurchase that security from the Fund at a mutually agreed-upon time and price. The period of maturity is usually quite short, often overnight or a few days, although it may extend over a number of months. The Fund may enter into repurchase agreements only with respect to U.S. Government obligations and other securities that are permissible investments for the Fund. All repurchase agreements will be fully collateralized based on values that are marked to market daily. The maturities of the underlying securities in a repurchase agreement transaction may be greater than one year. If the seller defaults and the value of the underlying securities has declined, the Fund may incur a loss. In addition, if bankruptcy proceedings are commenced with respect to the seller of the security, the Fund's disposition of the security may be delayed or limited. The Fund may not enter into a repurchase agreement with a maturity of more than seven days, if, as a result, more than 10% of the market value of the Fund's total net assets would be invested in repurchase agreements with maturities of more than seven days, restricted securities and illiquid securities. The Fund will only enter into repurchase agreements with registered broker/dealers and commercial banks that meet guidelines established by the Board of Directors and are not affiliated with the investment adviser. The Fund may participate in pooled repurchase agreement transactions with other funds advised by Wells Fargo Bank. The Fund may invest in securities of foreign governmental and private issuers that are denominated in and pay interest in U.S. dollars. Investments in foreign securities involve certain considerations that are not typically associated with investing in domestic securities. There may be less publicly available information about a foreign issuer than about a domestic issuer. Foreign issuers also are not generally subject to the same accounting, auditing and financial reporting standards or governmental supervision as domestic issuers. In addition, with respect to certain foreign countries, interest may be withheld at the source under foreign income tax laws, and there is a possibility of expropriation or confiscatory taxation, political or social instability or diplomatic developments that could adversely affect investments in, the liquidity of, and the ability to enforce contractual obligations with respect to, securities of issuers located in those countries. The Fund's investment objective, as set forth in the first paragraph of the section describing the Fund's objective and policies, is fundamental; that is, the investment objective may not be changed without approval by the vote of the holders of a majority of the Fund's outstanding voting securities, as described under "Capital Stock" in the SAI. If the Board of Directors determines, however, that the Fund's investment objective can best be achieved by a substantive change in a non-fundamental investment policy or strategy, the Company may make such change without shareholder approval and will disclose any such material changes in the then current prospectus. In addition, as matters of fundamental policy, the Fund may: (i) borrow from banks up to 10% of the current value of its net assets for temporary purposes only in order to meet redemptions, and these borrowings may be secured by the pledge of up to 10% of the current value of its net assets (but investments may not be purchased while any such borrowing exists); (ii) make loans of portfolio securities; (iii) invest up to 10% of the current value of its net assets in repurchase agreements having maturities of more than seven days, restricted securities and illiquid securities; and (iv) invest up to 10% of the current value of its net assets in fixed time deposits that are subject to withdrawal penalties and that have maturities of more than seven days. The Board of Directors, in addition to supervising the actions of the investment adviser, administrator and distributor, as set forth below, decides upon matters of general policy. Pursuant to an Amended Advisory Contract, the Fund is advised by Wells Fargo Bank, 420 Montgomery Street, San Francisco, California 94163, a wholly owned subsidiary of Wells Fargo & Company. Wells Fargo Bank, one of the ten largest banks in the United States, was founded in 1852 and is the oldest bank in the western United States. As of December 31, 1994, various divisions and affiliates of Wells Fargo Bank (including WFNIA) provided investment advisory services for approximately $200 billion of assets of individuals, trusts, estates and institutions. As of December 31, 1994, WFNIA managed or advised over $158 billion in assets. Wells Fargo Bank is the investment adviser to the other separately managed series of the Company (other than those structured as "feeder funds"), and to seven other registered open-end management investment companies, each of which consists of several separately managed investment portfolios. The Amended Advisory Contract provides that Wells Fargo Bank shall furnish to the Fund investment guidance and policy direction in connection with the daily portfolio management of the Fund. Pursuant to the Amended Advisory Contract, Wells Fargo Bank furnishes to the Board of Directors periodic reports on the investment strategy and performance of the Fund. Wells Fargo Bank, pursuant to a Sub-Advisory Contract between the Fund, Wells Fargo Bank and WFNIA, has engaged WFNIA to provide sub-investment advisory services to the Fund. WFNIA is located at 45 Fremont Street, San Francisco, California 94105. WFNIA is a general partnership owned 50% by a wholly owned subsidiary of Wells Fargo Bank and 50% by a subsidiary of The Nikko Securities Co., Ltd. In mid-April 1995, it was announced that Wells Fargo Bank and The Nikko Securities Co., Ltd. had begun considering a variety of potential transactions which could result in a change of ownership or control of WFNIA. It is not possible at the date of this Prospectus to predict whether any such transaction will occur or if it does, what structure it would take. Purchase and sale orders of the securities held by the Fund may be combined with those of other accounts that Wells Fargo Bank manages, and for which it has brokerage placement authority, in the interest of seeking the most favorable overall net results. When Wells Fargo Bank determines that a particular security should be bought or sold for the Fund and other accounts managed by Wells Fargo Bank, Wells Fargo Bank undertakes to allocate those transactions among the participants equitably. From time to time, the Fund, to the extent consistent with its investment objective, policies and restrictions, may invest in securities of companies with which Wells Fargo Bank has a lending relationship. For its services under the Amended Advisory Contract, Wells Fargo Bank is entitled to monthly advisory fees at the annual rate of 0.70% of the average daily net assets of the Fund up to $500 million and 0.60% of average daily net assets in excess of $500 million. From time to time Wells Fargo Bank may waive such fees in whole or in part. Any such waiver would reduce expenses of the Fund and, accordingly, have a favorable impact on the yield or return of the Fund. Out of its fees received from the Fund pursuant to the Amended Advisory Contract, Wells Fargo Bank pays WFNIA for its sub-advisory services an annual fee equal to $60,000 plus a monthly fee at the annual rate of 0.20% of the average daily net assets of the Fund. For the year ended December 31, 1994, Wells Fargo Bank was paid 0.70% of the average daily net assets of the Fund for its services as investment adviser. Stephens, 111 Center Street, Little Rock, Arkansas 72201, has entered into an agreement with the Fund under which Stephens acts as administrator for the Fund. For these administrative services, Stephens is entitled to receive from the Fund a monthly fee at the annual rate of 0.10% of its average daily net assets; decreasing to 0.05% of the average daily net assets of the Fund in excess of $200 million. From time to time Stephens may waive fees from the Fund in whole or in part. Any such waiver will reduce expenses of the Fund and, accordingly, have a favorable impact on the yield or return of the Fund. The Administration Agreement between Stephens and the Fund states that Stephens shall provide as administrative services, among other things, general supervision: (i) of the operation of the Fund, including coordination of the services performed by the Fund's investment adviser, transfer agent, custodian, independent auditors and legal counsel, (ii) in connection with regulatory compliance, including the compilation of information for documents such as reports to, and filings with, the SEC and state securities commissions and preparation of proxy statements and shareholder reports for the Fund; and (iii) general supervision relative to the compilation of data required for the preparation of periodic reports distributed to the Company's officers and Board of Directors. Stephens also furnishes office space and certain facilities required for conducting the business of the Fund and pays the compensation of the Company's directors, officers and employees who are affiliated with Stephens. Stephens, as the principal underwriter of the Fund within the meaning of the Investment Company Act of 1940 (the "1940 Act"), has also entered into a Distribution Agreement with the Company pursuant to which Stephens has the responsibility for distributing Class A Shares and Class D Shares of the Fund. Stephens bears the cost of printing and mailing prospectuses to potential investors and any advertising expenses incurred by it in connection with the distribution of Class A Shares and Class D Shares, subject to the terms of the distribution plans described below. Under the Distribution Agreement, Stephens is entitled to receive from the Fund a monthly fee at an annual rate of up to 0.25% of the average daily net assets of the Class A Shares of the Fund and a monthly fee at an annual rate of up to 0.75% of the average daily net assets of the Class D Shares of the Fund. The actual fee payable to Stephens is determined, within such limits, from time to time by mutual agreement between the Company and Stephens, and may not exceed the maximum amount payable under the Rules of Fair Practice of the NASD. Stephens may enter into selling agreements with one or more selling agents under which such agents may receive from Stephens compensation for sales support services. Such compensation may include, but is not limited to, commissions or other payments based on the average daily net assets of Fund shares attributable to such agents. The principal sales support service provided to the Fund are services provided by selling agents in exchange for commissions and other payments to selling agents. Stephens may retain any portion of the total distribution fee payable under the Distribution Agreement to compensate it for distribution-related services provided by Stephens or to reimburse it for other distribution-related expenses. Since the Distribution Agreement provides for fees that are used by Stephens to pay for distribution services, a plan of distribution for each class of shares (individually a "Plan", collectively the "Plans") and the Distribution Agreement are approved and reviewed in accordance with Rule 12b-1 under the Act, which regulates the manner in which an investment company may, directly or indirectly, bear the expense of distributing its shares. Stephens is a full service broker/dealer and investment advisory firm. Stephens and its predecessor have been providing securities and investment services for more than 60 years. Additionally, they have been providing discretionary portfolio management services since 1983. Stephens currently manages investment portfolios for pension and profit sharing plans, individual investors, foundations, insurance companies and university endowments. The Fund may enter into servicing agreements with one or more servicing agents on behalf of Class D Shares of the Fund. Under such agreements, servicing agents provide shareholder liaison services, which may include responding to customer inquiries and providing information on shareholder investments, and provide such other related services as the Fund or a Class D Shareholder may reasonably request. For these services, a servicing agent receives a fee which will not exceed, on an annualized basis for the Fund's then current fiscal year, 0.25% of the average daily net assets of the Class D Shares of the Fund represented by Class D Shares owned by investors with whom the servicing agent maintains a servicing relationship, or an amount which equals the maximum amount payable to the servicing agent under applicable laws, regulations or rules, whichever is less. DETERMINATION OF NET ASSET VALUE Net asset value per share for the Fund is determined by Wells Fargo Bank on each day that the Exchange is open for trading. The net asset value of a share of a class of a Fund is the value of total net assets attributable to each class divided by the number of outstanding shares of that class. The value of net assets per class is determined daily by adjusting the net assets per class at the beginning of the day by the value of each class's shareholder activity, net investment income and net realized and unrealized gains or losses for that day. Net investment income is calculated each day for each class by attributing to each class a pro rata share of daily income and common expenses, and by assigning class-specific expenses to each class as appropriate. The net asset value of each class is expected to fluctuate daily. The value of assets of the Fund (other than debt obligations maturing in 60 days or less) is determined as of the close of regular trading on the Exchange (referred to hereafter as the "close of the Exchange"), which is currently 4:00 p.m. New York time. Except for debt obligations with remaining maturities of 60 days or less, which are valued at amortized cost, assets are valued at current market prices, or if such prices are not readily available, at fair value as determined in good faith by the Board of Directors. Prices used for such valuations may be provided by independent pricing services. From time to time, the Company may advertise various total return information with respect to a class of shares of the Fund. Total return of a class of shares is based on the historical earnings and performance of such class of shares and should not be considered representative of future performance. The total return of a class of shares of the Fund is calculated by subtracting (i) the public offering price of the class of shares (which includes the maximum sales charge for the class of shares) of one share of the class of shares at the beginning of the period, from (ii) the net asset value of all shares of the class of shares an investor would own at the end of the period for the share held at the beginning of the period (assuming reinvestment of all dividends and capital gain distributions), and dividing by (iii) the public offering price per share of the class of shares at the beginning of the period. The resulting percentage indicates the positive or negative rate of return that an investor would have earned from reinvested dividends and capital gain distributions and changes in share price during the period for the class of shares. The Fund may also, at times, calculate total return of a class of shares based on net asset value per share of a class of shares (rather than the public offering price), in which case the figures would not reflect the effect of any sales charges that would have been paid by an investor in the class of shares, provided that total return data derived pursuant to the calculation described above are also presented. Because of differences in the fees and/or expenses borne by Class D Shares of the Fund, the total return on such shares can be expected, at any given time, to differ from the total return on Class A Shares. Performance information will be computed separately for Class A Shares and Class D Shares. Additional Information about the performance of the Fund is contained in the Annual Report for the Fund. The Annual Report may be obtained free of charge by calling the Company at 800-552-9612. Shares of the Fund may be purchased on any day the Exchange is open for trading through Stephens, the Transfer Agent, or any authorized broker/dealers or financial institutions with which Stephens has entered into agreements. Such broker/dealers or financial institutions are responsible for the prompt transmission of purchase, exchange or redemption orders, and may independently establish and charge additional fees to their clients for such services, other than services related to purchase orders, which would reduce the clients' overall yield or return. The Exchange is closed on New Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day (each, a "Holiday"). When any Holiday falls on a Saturday, the Exchange usually is closed the preceding Friday, and when any Holiday falls on a Sunday, the Exchange is closed the following Monday. In most cases, the minimum initial purchase amount for the Fund is $1,000. The minimum initial purchase amount is $100 for purchases through the Systematic Purchase Plan and $250 for purchases through a retirement plan qualified under the Code. The minimum subsequent purchase amount is $100. The minimum initial or subsequent purchase amount requirements may be waived or lowered for investments effected on a group basis by certain entities and their employees, such as pursuant to a payroll deduction or other accumulation plan. The Company reserves the right to reject any purchase order. All funds, net of sales loads, will be invested in full and fractional shares. Checks will be accepted for the purchase of the Fund's shares subject to collection at full face value in U.S. dollars. Inquiries may be directed to the Company at the address or telephone number on the front cover of the Prospectus. Shares of the Fund are offered continuously at the applicable offering price (including any sales load) next determined after a purchase order is received. Payment for shares purchased through a broker/dealer will not be due from the broker/dealer until the settlement date, currently five business days after the order is placed. Effective June 7, 1995, settlement date normally will be three business days after the order is placed. It is the broker/dealer's responsibility to forward payment for shares being purchased to the Fund promptly. Payment for orders placed directly through the Transfer Agent must accompany the order. When payment for shares of the Fund through the Transfer Agent is by a check that is drawn on any domestic bank, federal funds normally become available to the Fund on the business day after the day the check is deposited. Checks drawn on a non-member bank or a foreign bank may take substantially longer to be converted into federal funds and, accordingly, may delay the execution of an order. When shares of the Fund are purchased through a broker/dealer or financial institution, Stephens reallows that portion of the sales load designated below as the Dealer Allowance. Stephens has established a non-cash compensation program, pursuant to which broker/dealers or financial institutions that sell shares of the Fund may earn additional compensation in the form of trips to sales seminars or vacation destinations, tickets to sporting events, theater or other entertainment, opportunities to participate in golf or other outings and gift certificates for meals or merchandise. If all sales charges are paid or reallowed to a broker/dealer or financial institution, it may be deemed an "underwriter" under the Securities Act of 1933. When shares are purchased directly through the Transfer Agent and no broker/dealer or financial institution is involved with the purchase, the entire sales load is paid to Stephens. Sales loads relating to the purchase of Class A Shares in the Fund are as follows: Class D Shares are not subject to a front-end sales load. However, Class D Shares which are redeemed within one year from the receipt of a purchase order will be subject to a contingent deferred sales charge equal to 1.00% of the dollar amount equal to the lesser of the net asset value at the time of purchase of the shares being redeemed or the net asset value of such shares at the time of redemption. A selling agent or servicing agent and any other person entitled to receive compensation for selling or servicing shares may receive different compensation for selling or servicing Class A Shares as compared with Class D Shares. REDUCED SALES CHARGE -- CLASS A SHARES The above Volume Discounts are also available to you based on the combined dollar amount being invested in Class A Shares of the Fund or of Class A Shares of other portfolios of the Company which assess a sales load (the "Load Funds"). Because Class D Shares are not subject to a front-end sales charge, the amount of Class D Shares you hold is not considered in determining any volume discount. The Right of Accumulation allows you to combine the amount being invested in Class A Shares in the Fund with the total net asset value of Class A Shares in any of the Load Funds to determine reduced sales loads in accordance with the above sales load schedule. For example, if you own Class A Shares of the Load Funds with an aggregate net asset value of $90,000 and invest an additional $20,000 in Class A Shares of the Fund, the sales load on the entire additional amount would be 4.00% of the offering price. To obtain such discount, you must provide sufficient information at the time of purchase to permit verification that the purchase qualifies for the reduced sales load, and confirmation of the order is subject to such verification. The Right of Accumulation may be modified or discontinued at any time with respect to all Class A Shares purchased thereafter. A Letter of Intent allows you to purchase Class A Shares of the Fund over a 13-month period at reduced sales loads based on the total amount intended to be purchased plus the total net asset value of Class A Shares in any of the Load Funds already owned. Each investment made during the period receives the reduced sales load applicable to the total amount of the intended investment. If such amount is not invested within the period, you must pay the difference between the sales loads applicable to the purchases made and the charges previously paid. You may Reinvest proceeds from a redemption of Class A Shares of the Fund in Class A Shares of the Fund or in Class A Shares of another of the Company's investment portfolios that offers Class A Shares at net asset value, without a sales load, within 120 days after such redemption. However, if the other investment portfolio charges a sales load that is higher than the sales load that you have paid in connection with the Class A Shares you have redeemed, you pay the difference. In addition, the Class A Shares of the investment portfolio to be acquired must be registered for sale in the shareholder's state of residence. The amount that may be so reinvested may not exceed the amount of the redemption proceeds, and a written order for the purchase of the Class A Shares must be received by the Fund or the Transfer Agent within 120 days after the effective date of the redemption. If you realized a gain on your redemption, the reinvestment will not alter the amount of any federal capital gains tax payable on the gain. If you realized a loss on your redemption, the reinvestment may cause some or all of the loss to be disallowed as a tax deduction, depending on the number of Class A Shares purchased by reinvestment and the period of time that has elapsed after the redemption, although for tax purposes, the amount disallowed is added to the cost of the Class A Shares acquired upon the reinvestment. Reductions in front-end sales loads apply to purchases by a single "person," including an individual, members of a family unit, consisting of a husband, wife, and children under the age of 21 purchasing securities for their own account, or a trustee or other fiduciary purchasing for a single fiduciary account or single trust estate. Reductions in front-end sales loads also apply to purchases by individual members of a "qualified group." The reductions are based on the aggregate dollar amount of Class A Shares purchased by all members of the qualified group. For purposes of this paragraph, a qualified group consists of a "company," as defined in the 1940 Act, which has been in existence for more than six months and which has a primary purpose other than acquiring shares of the Fund at a reduced sales load, and the "related parties" of such company. For purposes of this paragraph, a "related party" of a company is: (i) any individual or other company who directly or indirectly owns, controls or has the power to vote five percent or more of the outstanding voting securities of such company; (ii) any other company of which such company directly or indirectly owns, controls or has the power to vote five percent of more of its outstanding voting securities; (iii) any other company under common control with such company; (iv) any executive officer, director or partner of such company or of a related party; and (v) any partnership of which such company is a partner. Class A Shares of the Fund may be purchased at a purchase price equal to the net asset value of such shares, without a sales load, by directors, officers and employees (and their spouses and children under the age of 21) of the Company, Stephens, its affiliates and other broker-dealers that have entered into agreements with Stephens to sell such shares. Class A Shares of the Fund also may be purchased at a purchase price equal to the net asset value of such shares, without a sales load, by present and retired directors, officers and employees (and their spouses and children under the age of 21) of Wells Fargo Bank and its affiliates if Wells Fargo Bank and/or the respective affiliates agree. Such shares also may be purchased at such price by employee benefit and thrift plans for such persons and by any investment advisory, trust or other fiduciary account (other than an individual retirement account) that is managed or advised by Wells Fargo Bank or Stephens or their affiliates. Class A Shares also may be purchased at net asset value by pension, profit sharing or other employee benefit plans established under Section 401 of the Code. Class A Shares of the Fund may be purchased at a purchase price equal to the net asset value of such shares, without a sales load, by the following types of investors that place trades through an omnibus account maintained at the Fund by a discount broker/dealer: trust companies; investment advisers and financial planners on behalf of their clients; retirement and deferred compensation plans and the trusts used to fund these plans. By investing in the Fund, you appoint the Transfer Agent, as agent, to establish an open account to which all shares purchased will be credited, together with any dividends and capital gain distributions that are paid in additional shares. See "Dividends and Distributions." Although most shareholders elect not to receive stock certificates, certificates for full shares of the Fund can be obtained on request. It is more complicated to redeem shares held in certificated form, and the expedited redemption described below is not available with respect to certificated shares. CONTINGENT DEFERRED SALES CHARGE -- CLASS D SHARES Class D Shares which are redeemed within one year of the receipt of a purchase order affecting such shares will be subject to a contingent deferred sales charge equal to 1.00% of an amount equal to the lesser of the net asset value at the time of purchase for the Class D Shares being redeemed or the net asset value of such shares at the time of redemption. Accordingly, a contingent deferred sales charge will not be imposed on amounts representing increases in net asset value above the net asset value at the time of purchase. In addition a charge will not be assessed on Class D Shares purchased through reinvestment of dividends or capital gains distributions. In determining whether a contingent deferred sales charge is applicable to a redemption, Class D Shares are considered redeemed on a first-in, first-out basis so that Class D Shares held for a longer period of time are considered redeemed prior to more recently acquired shares. The contingent deferred sales charge is waived on redemptions of Class D Shares (i) following the death or disability (as defined in the Code) of a shareholder, (ii) to the extent that the redemption represents a minimum required distribution from an individual retirement account or other retirement plan to a shareholder who has reached age 70 1/2, (iii) effected pursuant to the Company's right to liquidate a shareholder's account if the aggregate net asset value of the shareholder's account is less than the minimum account size, or (iv) in connection with the combination of the Company with any other registered investment company by a merger, acquisition of assets, or by any other reorganization transaction. Investors who are entitled to purchase Class A Shares of the Fund at net asset value without a sales load should not purchase Class D Shares. Other investors including those who are entitled to purchase Class A Shares of the Fund at a reduced sales load, should compare the fees assessed on Class A Shares against those assessed on Class D Shares (including potential deferred sales charges and higher Rule 12b-1 fees) in light of the amount to be invested and the anticipated time that the shares will be owned. Shares of the Fund may be purchased by any of the methods described below. INITIAL PURCHASES OF SHARES OF THE FUND BY WIRE 1. Telephone toll free (800) 572-7797. Give the name of the Fund in which the investment is to be made, the class of shares to be purchased, and the name(s) in which the shares are to be registered, address, social security or tax identification number (where applicable) of the person or entity in whose name(s) the shares are to be registered, dividend payment election, amount to be wired, name of the wiring bank and name and telephone number of the person to be contacted in connection with the order. An account number will be assigned. 2. Instruct the wiring bank to transmit the specified amount in federal funds ($1,000 or more) to: Wire Purchase Account Number: 4068-000462 Attention: Overland Express Asset Allocation Fund (designate Class A or Account Name(s): (name(s) in which to be registered) Account Number: (as assigned by telephone) 3. A completed Account Application should be mailed, or sent by telefacsimile with the original subsequently mailed, to the following address immediately after the funds are wired and must be received and accepted by the Transfer Agent before an account can be opened: 4. Share purchases are effected at the public offering price, or, in the case of Class D Shares, at the net asset value, next determined after the Account Application is received and accepted. INITIAL PURCHASES OF SHARES OF THE FUND BY MAIL 1. Complete an Account Application. Indicate the services to be used. 2. Mail the Account Application and a check for $1,000 or more, payable to "Overland Express Asset Allocation Fund (designate Class A or D)" at its mailing address set forth above. Additional purchases of $100 or more may be made by instructing the Fund's Transfer Agent to debit an approved account designated in the Account Application, by wire by instructing the wiring bank to transmit the specified amount as directed above for initial purchases, or by mail with a check payable to "Overland Express Asset Allocation Fund (designate Class A or D)" to the above address. Write the Fund account number on the check and include the detachable stub from a Statement of Account or a letter providing the account number. The Company's Systematic Purchase Plan provides you with a convenient way to establish or add to your existing accounts on a monthly basis. If you elect to participate in this plan, you must specify an amount ($100 or more) to be withdrawn automatically by the Transfer Agent on a monthly basis from a designated bank account (provided your bank is a participant in the automated clearing house system). The Transfer Agent withdraws and uses this amount to purchase shares of the designated Fund on or about the fifth business day of each month. There are no additional fees charged for participating in this plan. You may change the investment amount, suspend purchases or terminate the election at any time by providing written notice to the Transfer Agent at least five business days prior to any scheduled transaction. An election will be terminated automatically if the designated bank account balance is insufficient to make a scheduled withdrawal, or if either the designated bank account or your account is closed. PURCHASES THROUGH AUTHORIZED BROKER/DEALERS AND FINANCIAL INSTITUTIONS Purchase orders for shares in the Fund placed through authorized broker/dealers and financial institutions by the close of the Exchange on any day that the Fund's shares are offered for sale, including orders for which payment is to be made from free cash credit balances in securities accounts held by a dealer, will be effective on the same day the order is placed if received by the Transfer Agent before the close of business. Purchase orders that are received by a dealer or financial institution after the close of the Exchange or by the Transfer Agent after the close of business generally will be effective on the next day that shares are offered. The broker/dealer or financial institution is responsible for the prompt transmission of purchase orders to the Transfer Agent. Payment for Fund shares is not due until settlement date. Broker/dealers and financial institutions may benefit from temporary use of payments to the Fund during this time. A broker/dealer or financial institution that is involved in a purchase transaction may charge separate account, service or transaction fees. Financial institutions may be required to register as dealers pursuant to applicable state securities laws, which may differ from federal law and any interpretations expressed herein. You may exchange Class A Shares of the Fund for shares of the same class of the Company's other investment portfolios or for shares of the California Tax-Free Money Market Fund, the Money Market Fund or the U.S. Treasury Money Market Fund in an identically registered account at respective net asset values, provided that, if the other investment portfolio charges a sales load on the purchase of the class of shares being exchanged that is higher than the sales load that you have paid in connection with the shares you are exchanging, you pay the difference. Class D Shares of the Fund may be exchanged for Class D Shares of one of the Company's other investment portfolios that offer Class D Shares or for Class A Shares of the Money Market Fund in an identically registered account at respective net asset values. You are not charged a contingent deferred sales charge on exchanges of Class D Shares for shares of another of the Company's investment portfolios or for Class A Shares of the Money Market Fund. If you exchange Class D Shares for shares of the same class of another investment portfolio, or for Class A Shares of the Money Market Fund, the remaining period of time (if any) that the contingent deferred sales charge is in effect will be computed from the time of the initial purchase of the previously held shares. Accordingly, if you exchange Class D Shares for Class A Shares of the Money Market Fund, and redeem the shares of the Money Market Fund within one year of the receipt of the purchase order for the exchanged Class D Shares, you will have to pay a deferred sales charge equal to the contingent deferred sales charge applicable to the previously exchanged Class D Shares. If you exchange Class D Shares of an investment portfolio for Class A Shares of the Money Market Fund you may subsequently re-exchange the acquired shares only for Class D Shares. If you re-exchange the Class A Shares of the Money Market Fund for Class D Shares, the remaining period of time (if any) that the contingent deferred sales charge is in effect will be computed from the time of your initial purchase of Class D Shares. In addition, shares of the investment portfolio to be acquired must be registered for sale in your state of residence. Investors should obtain, read and retain the Prospectus for the investment portfolio which they desire to exchange into before submitting an exchange order. You may exchange shares by writing the Transfer Agent as indicated below under Redemption by Mail, or by calling the Transfer Agent or your authorized broker/dealer or financial institution or servicing agent, unless you have elected not to authorize telephone exchanges in your Account Application (in which case you may subsequently authorize such telephone exchanges by completing a Telephone Exchange Authorization Form and submitting it to the Transfer Agent in advance of the first such exchange). Shares held in certificated form may not be exchanged by telephone. The Transfer Agent's number for exchanges is (800) 572-7797. Procedures applicable to redemption of the Fund's shares are also applicable to exchanging shares, except that, with respect to an exchange transaction between accounts registered in identical names, no signature guarantee is required unless the amount being exchanged exceeds $25,000. The Company reserves the right to limit the number of times shares may be exchanged between Funds, or to reject in whole or in part any exchange request into a fund when management believes that such action would be in the best interest of the Fund's other shareholders, such as when management believes that such action would be appropriate to protect such fund against disruptions in portfolio management resulting from frequent transactions by those seeking to time market fluctuations. Any such rejection will be made by management on a prospective basis only, upon notice to the shareholder given not later than 10 days following such shareholder's most recent exchange. The Company reserves the right to modify or discontinue exchange privileges at any time. Under SEC rules, 60 days prior notice of any amendments or termination of exchange privileges will be given to shareholders, except under certain extraordinary circumstances. A capital gain or loss for tax purposes may be realized upon an exchange, depending upon the cost or other basis of shares redeemed. Telephone redemption or exchange privileges are made available to you automatically upon opening an account, unless you decline such privileges. These privileges authorize the Transfer Agent to act on telephone instructions from any person representing himself or herself to be the investor and reasonably believed by the Transfer Agent to be genuine. The Company will require the Transfer Agent to employ reasonable procedures, such as requiring a form of personal identification, to confirm that instructions are genuine. If the Transfer Agent does not follow such procedures, the Company and the Transfer be liable for any losses attributable to unauthorized or fraudulent instructions. Neither the Company nor the Transfer Agent will be liable for following telephone instructions reasonably believed to be genuine. Shares may be redeemed at their next determined net asset value after receipt of a request in proper form by the Transfer Agent directly or through any authorized broker/dealer or financial institution. Except for any contingent deferred sales charge which may be applicable upon redemption of Class D Shares, as described under "Purchase of Shares," the Company does not charge for redemption transactions. However, a broker/dealer or financial institution that is involved in a redemption transaction may charge separate account, service or transaction fees. On a day the Fund is open for business, redemption orders received by an authorized broker/dealer or financial institution before the close of the Exchange received by the Transfer Agent before the close of business on the same day will be executed at the net asset value per share determined at the close of the Exchange on that day. Redemption orders received by authorized broker/dealers or financial institutions after the close of the Exchange, or not received by the Transfer Agent prior to the close of business, will be executed at the net asset value determined at the close of the Exchange on the next business day. Redemption proceeds, net of any contingent deferred sales charge applicable with respect to Class D Shares, ordinarily will be remitted within seven days after the order is received in proper form, except proceeds may be remitted over a longer period to the extent permitted by the SEC under extraordinary circumstances. If an expedited redemption is requested, redemption proceeds will be distributed only if the check used for investment is deemed to be cleared for payment by your bank, currently considered by the Company to be a period of 15 days after investment. The proceeds, of course, may be more or less than cost. Payment of redemption proceeds may be made in securities, subject to regulation by some state securities commissions. 1. Write a letter of instruction. Indicate the dollar amount of or number of shares to be redeemed. Refer to your Fund account number and provide either a social security or a tax identification number (as applicable). 2. Sign the letter in exactly the same way the account is registered. If there is more than one owner of the shares, all must sign. 3. If shares to be redeemed have a value of $5,000 or more, or redemption proceeds are to be paid to someone other than you at your address of record, the signature(s) must be guaranteed by an "eligible guarantor institution," which includes a commercial bank that is a member of the Federal Deposit Insurance Corporation, a trust company, a member firm of a domestic stock exchange, a savings association, or a credit union that is authorized by its charter to provide a signature guarantee. Signature guarantees by notaries public are not acceptable. Further documentation will be requested from corporations, administrators, executors, personal representatives, trustees or custodians. 4. If shares to be redeemed are held in certificated form, enclose the certificates with the letter. Do not sign the certificates and for protection use registered mail. 5. Mail the letter to the Transfer Agent at the mailing address set forth under "Purchase of Shares." Unless other instructions are given in proper form, a check for the proceeds of redemption, net of any contingent deferred sales charge applicable with respect to Class D Shares, will be sent to your address of record. The Company's Systematic Withdrawal Plan provides a way for you to have shares redeemed from your account and the proceeds, net of any contingent deferred sales charge applicable with respect to Class D Shares, distributed to you on a monthly basis. You may elect to participate in this plan if you have a shareholder account valued at $10,000 or more as of the date of the election to participate, and are not also a participant in the Company's Systematic Purchase Plan at any time while participating in this plan. To participate in the plan you must specify an amount ($100 or more) to be distributed by check to your address of record or deposited in a designated bank account. The Transfer Agent redeems sufficient shares and mails or deposits the proceeds of the redemption, net of any contingent deferred sales charge applicable with respect to Class D Shares, as instructed on or about the fifth business day prior to the end of each month. There are no additional fees charged for participating in this plan. You may change the withdrawal amount, suspend withdrawals or terminate the election at any time by providing written notice to the Transfer Agent at least five business days prior to a scheduled transaction. An election will be terminated automatically if your account balance is insufficient to make a scheduled withdrawal or if your account is closed. If shares are not held in certificated form, you may request an expedited redemption of shares by letter or telephone (unless you have elected not to authorize telephone redemptions on the Account Application or other form that is on file with the Transfer Agent) on any day the Fund is open for business. See "Exchange Privileges" for additional information regarding telephone redemption privileges. You may request expedited redemption by telephone by calling the Transfer Agent at (800) 572-7797. You may request expedited redemption by mail by mailing your expedited redemption request to the Transfer Agent at the mailing address set forth under "Purchase of Shares -- Initial Purchases of Fund Shares by Wire." Upon request, proceeds of expedited redemptions of $5,000 or more, net of any contingent deferred sales charge applicable with respect to Class D Shares, will be wired or credited to the bank indicated in your Account Application or wired to an authorized broker/dealer or financial institution designated in your Account Application. The Company reserves the right to impose charges for wiring redemption proceeds. When proceeds of an expedited redemption are to be paid to someone other than yourself, to an address other than that of record, or to a bank, broker/dealer or other financial institution that has not been predesignated, the expedited redemption request must be made by letter and the signature(s) on the letter must be guaranteed, regardless of the amount of the redemption. If an expedited redemption request is received by the Transfer Agent by the close of business on any day the Fund is open for business, the redemption proceeds will be transmitted to your bank or predesignated tion on the next business day (assuming the investment check has cleared as described above), absent extraordinary circumstances. A check for proceeds of less than $5,000 will be mailed to your address of record, except that, in the case of investments in the Company that have been effected through broker/dealers, banks and other institutions that have entered into special arrangements with the Company, the full amount of the redemption proceeds may be transmitted by wire or credited to a designated account. REDEMPTIONS THROUGH AUTHORIZED BROKER/DEALERS AND FINANCIAL INSTITUTIONS Redemption requests placed through authorized broker/dealers and financial institutions by the close of the Exchange on any day the Fund's shares are offered for sale will be effective on the same day the request is placed if received by the Transfer Agent before the close of business. Redemption requests that are received after the close of business generally will be effective on the next day that shares are offered. The broker/dealer or financial institution is responsible for the prompt transmission of redemption requests to the Transfer Agent. Unless you have made other arrangements, and have informed the Transfer Agent of such arrangements, proceeds of redemptions made through authorized broker/dealers and financial institutions will be credited to your account with such broker/dealer or institution. You may request a check from the broker/dealer or financial institution or may elect to retain the redemption proceeds in your account. The broker/dealer or financial institution may benefit from the use of the redemption proceeds prior to the clearance of a check issued to you for such proceeds or prior to disbursement or reinvestment of such proceeds on your behalf. The proceeds of redemption may be more or less than the amount invested and, therefore, a redemption may result in a gain or loss for federal and state income tax purposes. Due to the high cost of maintaining small accounts, the Company reserves the right to redeem accounts that fall below $1,000. Prior to such a redemption, you will be notified in writing and permitted 30 days to make additional investments to raise the account balance to the specified minimum. The Company's Board of Directors has adopted a Plan on behalf of each class of shares of the Fund. Under the Plans and pursuant to the Distribution Agreement, the Fund may pay the distributor a monthly fee at an annual rate of up to 0.25% of the average daily net assets of the Class A Shares of the Fund and a monthly fee at an annual rate of up to 0.75% of the average daily net assets of the Class D Shares of the Fund as compensation for distribution-related services. The actual fee payable to the distributor shall, within such limits, be determined from time to time by mutual agreement between the Company and the distributor. Under the Plans, the distributor may enter into selling agreements with one or more selling agents under which such agents may receive compensation for distribution-related services from the distributor, including, but not limited to, commissions or other payments to such agents based on the average daily net assets of Class A Shares and Class D Shares attributable to them. The distributor may retain any portion of the total distribution fee payable under the Plans to compensate it for distribution- related services provided by it or to reimburse it for other distribution-related expenses. The Fund may participate in joint distribution activities with any other portfolio of the Company, in which event expenses reimbursed out of the assets of the Fund may be attributable, in part, to the distribution-related activities of another portfolio. Generally, the expenses attributable to joint distribution activities will be allocated among the Fund and any other portfolio of the Company in proportion to their relative net asset sizes, although the Board of Directors may allocate such expenses in any other manner that it deems fair and equitable. The Company's Board of Directors has adopted a servicing plan ("Servicing Plan") on behalf of the Class D Shares of the Fund. Pursuant to the Servicing Plan the Fund may enter into servicing agreements with one or more servicing agents who agree to provide administrative support services to their customers who are the record or beneficial owners of Class D Shares. Such servicing agents will be compensated at an annual rate of up to 0.25% of the average daily net asset value of the Class D Shares held of record or beneficially by such customers. The Fund intends to declare as a dividend substantially all of its net investment income quarterly to all shareholders of record at 4:00 p.m. (New York time) on the day of declaration. Net capital gains of the Fund, if any, will be distributed annually (or more frequently to the extent permitted to avoid imposition of the 4.00% excise tax described in the SAI). Dividends and/or capital gain distributions paid by the Fund will be invested in additional shares of the same class of the Fund at net asset value (without any sales load) and credited to your account on the reinvestment date or, at your election, paid by check. Dividend checks and Statements of Account will be mailed within approximately three business days after the payment date. In addition, you may elect to reinvest Fund dividends and/or capital gain distributions in shares of another fund in the Overland Express Family of Funds with which you have an established account that has met the applicable minimum initial investment requirement. The Fund's net investment income available for distribution to the holders of Class D Shares will be reduced by the amount of shareholder servicing fees payable to shareholder servicing agents under the Servicing Plan and by the incremental distribution fees payable under the Distribution Plan. There may be certain other differences in fees (e.g. transfer agent fees) between Class A Shares and Class D Shares that would affect their relative dividends. By complying with applicable provisions of the Code, the Fund will not be subject to federal income taxes with respect to net investment income and net realized capital gains distributed to their shareholders. Dividends from the investment income (which includes net short-term capital gains, if any) declared and paid by the Fund will be taxable as ordinary income to the Fund's shareholders. Whether you take dividend payments in cash or have them automatically reinvested in additional shares, they will be taxable. Generally, dividends are taxable to shareholders at the time they are paid. However, dividends declared payable in October, November and December and made payable to shareholders of record in such a month are treated as paid and are thereby taxable as of December 31, provided that such dividends are actually paid no later than January 31 of the following year. You may be eligible to defer the taxation of dividend and capital gain distributions on shares of the Fund which are held under a qualified tax-sheltered retirement plan. The Fund intends to pay out all its net investment income and net realized capital gains (if any) for each year. Corporate shareholders may be eligible for the dividends-received deduction on the dividends (excluding the net capital gain dividends) paid by the Fund to the extent such Fund's income is derived from certain dividends received from domestic corporations. In order to qualify for the dividends- received deduction, a corporate shareholder must hold the Fund shares paying the dividends upon which a dividend-received deduction is based for at least 46 days. The Fund will inform you of the amount and nature of such dividends and capital gains distributions. You should keep all statements you receive to assist in your personal record keeping. The Company is required to withhold, subject to certain exemptions, at a rate of 31% on dividends paid and redemption proceeds (including proceeds from exchanges) paid or credited to individual shareholders of the Fund if a correct Taxpayer Identification Number, certified when required, is not on file with the Company or the Transfer Agent. In connection with this withholding requirement, you will be asked to certify on your Account Application that the social security or taxpayer identification number you provide is correct and that you are not subject to 31% backup withholding for previous underreporting to the IRS. Foreign shareholders may be subject to different tax treatment, including a withholding tax. See "Federal Income Taxes - Foreign Shareholders" in the SAI. Further federal tax considerations are discussed in the SAI. You should consult your individual tax advisor with respect to your particular tax situation as well as the state and local tax status of investments in shares of the Fund. CUSTODIAN AND TRANSFER AND DIVIDEND DISBURSING AGENT Wells Fargo Bank has been retained to act as the Fund's transfer and dividend disbursing agent. Its principal place of business is 420 Montgomery Street, San Francisco, California 94163 and its transfer and dividend disbursing agency activities are managed at 525 Market Street, San Francisco, California 94105. Wells Fargo Institutional Trust Company, N.A. ("WFITC") serves as the Fund's custodian. WFITC, located at 45 Fremont Street, San Francisco, California 94105, is a special purpose trust company that is owned 99.9% by WFNIA and 0.1% by Wells Fargo & Company. The Company, an open-end investment company, was incorporated in Maryland on April 27, 1987. The authorized capital stock of the Company consists of 20,000,000,000 shares having a par value of $.001 per share. The Company currently offers twelve series of shares, each representing an interest in one of the funds in the Overland Express Family of Funds -- the Asset Allocation Fund, the California Tax-Free Bond Fund, the California Tax-Free Money Market Fund, the Money Market Fund, the Municipal Income Fund, the Overland Sweep Fund, the Short-Term Government-Corporate Income Fund, the Short-Term Municipal Income Fund, the Strategic Growth Fund, the U.S. Government Income Fund, the U.S. Treasury Money Market Fund and the Variable-Rate Government Fund. The Board of Directors may, in the future, authorize the issuance of other series of capital stock representing shares of additional investment portfolios or funds. All shares of the Company have equal voting rights and will be voted in the aggregate, and not by series or class, except where voting by series or class is required by law or where the matter involved affects only one series or class. The Company may dispense with the annual meeting of shareholders in any fiscal year in which it is not required by the 1940 Act to elect Directors; however, shareholders are entitled to call a meeting of shareholders for purposes of voting on removal of a Director or Directors. A more detailed statement of the voting rights of shareholders is contained in the SAI. All shares of the Company, when issued, will be fully paid and nonassessable. Wells Fargo Nikko Investment Advisors FOR MORE INFORMATION ABOUT THE FUND, OR WRITE:	497	497	1996-01-12T00:00:00	1996-01-12T15:24:16
0000718482-96-000002	0000718482-96-000002_0000.txt	QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended November 30, 1995 Commission file number 1-8527 State of Incorporation I.R.S. Employer Identification No. Registrant's telephone number, including area code: (314) 289-3000 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 of 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 At January 1, 1996, there were 63,377,364 shares of A.G. Edwards, Inc. common stock, par value $1, issued and outstanding. Consolidated statements of cash flows Notes to consolidated financial statements A.G. EDWARDS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED NOVEMBER 30, 1995 The consolidated financial statements include the accounts of A.G. Edwards, Inc. and its wholly owned subsidiaries (collectively referred to as the "Company"), including its principal subsidiary, A.G. Edwards & Sons, Inc. ("Edwards"), and have been prepared in conformity with generally accepted accounting principles. These financial statements should be read in conjunction with the Company's annual report for the year ended February 28, 1995. All adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the interim periods have been reflected. All such adjustments consist of normal recurring accruals unless otherwise disclosed in these interim financial statements. The results of operations for the nine months ended November 30, 1995, are not necessarily indicative of the results for the year ending February 29, 1996. Options to purchase 1,250,000 shares of common stock granted under the Employee Stock Purchase Plan are exercisable October 1, 1996 at 85% of market price based on dates specified in the plan. Employees purchased 1,247,073 shares at $18.09 per share in October 1995. Edwards is subject to the uniform net capital rule administered by the Securities and Exchange Commission ("SEC"). This rule requires Edwards to maintain a minimum net capital, as defined, and to notify, and sometimes obtain approval of, the SEC and other regulatory organizations for substantial withdrawals of capital and loans to affiliates. At November 30, 1995, Edwards' net capital of $677,165,000 was $650,146,000 in excess of the minimum required. A.G. EDWARDS, INC. AND SUBSIDIARIES NINE MONTHS ENDED NOVEMBER 30, 1995 COMPARED WITH NINE MONTHS ENDED NOVEMBER 30, 1994 The nine months ended November 30, 1995, saw an upturn of retail investor activity compared with the level experienced during our last fiscal year. The NYSE and Nasdaq overall trading volumes increased 23% and 41%, respectively, over the prior year, which is reflected in a 21% increase in total company customer trades. The number and size of customer trades and the product mix generally affect the level of revenues. The number of branches and brokers increased to 534 and 5,668, which represent increases of 6% and 5%, respectively, compared with the same period last year. Total revenue increased $l63 million (18%) over last year, from $886 million to $1,049 million. Expenses were $852 million, an increase of $115 million (16%), resulting in a rise in net profit margins from 10.4% last year to 11.6% this year. Total commission revenues increased $137 million (28%) primarily due to increases in listed, OTC and mutual fund revenues. The combined listed and OTC revenue increased $108 million reflecting the recent rise in volume in the equity markets, contrasted with the uncertainty in the equity markets last year caused by rising interest rates. Revenue from mutual fund sales and distribution fees increased $19 million (12%) primarily due to the strong performances of growth funds following the rise in the equity markets. Revenue from principal transactions declined $15 million (9%) with lower revenue from all debt products partially offset by higher corporate equity revenue. Customer demand for debt securities declined primarily due to the strong equity market and relatively flat interest rates this year, compared with a sluggish equity market and a rising interest rate environment last year. As a result, revenue from bond sales has fallen $32 million. As a partial offset, bond inventory gains rose $3 million due to lower gains last year from rising interest rates. Corporate equity revenue rose $13 million (47%) reflecting a 41% increase in overall Nasdaq volume caused by the rising equity market. Investment banking revenues were flat primarily due to decreases in corporate equity and management fee revenues offset by increases in corporate debt revenue. Revenues from corporate equity issues and management fees declined a combined $4 million due to the participation in several large deals last fiscal year. Although activity in the initial public offering market has increased recently, it was slow early this year due to the poor performance of the equity markets last year. Revenue from corporate debt issues rose $4 million due to increased activity in the new issue market for corporate debt securities and a rise in sales of certificates of deposit. Interest revenue increased $24 million (33%) primarily due to higher interest rates earned on customer receivables, debt inventory and short-term investments. Higher levels of debt inventory and short-term investments also contributed to this increase. Other revenue increased $18 million (23%) resulting from an increase in customer investments under professional management. Revenue from service fees also increased due to a rise in custodial and administrative transaction fees. Compensation and benefits expenses increased $100 million (18%) due to increases in most categories. Commission expense increased due to the rise in commissionable revenue. General and administrative salaries and related benefits increased due primarily to general increases and expansion. Incentive related compensation rose as a result of higher earnings. No material changes have taken place since February 28, 1995 regarding the Company's liquidity, capital resources and overall financial condition. THREE MONTHS ENDED NOVEMBER 30, 1995 COMPARED WITH THREE MONTHS ENDED NOVEMBER 30, 1994 Net earnings for the quarter ended November 30, 1995 were $43 million on revenues of $362 million compared with net earnings of $30 million on revenues of $289 million for the same period one year ago. The explanation of revenue and expense fluctuations presented for the nine month period are generally applicable to the three months of operations with the exception of investment banking revenue. Investment banking revenue increased $4 million (18%) due to the rise in activity in the initial public offering market for equities during the third quarter this year, which follows the continued strength of the equity markets. There have been no material changes in the legal proceedings previously reported in the Company's Annual Report on Form 10-K for the year ended February 28, 1995. Item 6: Exhibits and Reports on 8-K Exhibit 27 Financial Data Schedule. (This financial data schedule is only required to be submitted with the Company's Quarterly Report in Form 10-Q as filed electronically to the SEC's EDGAR There were no reports on Form 8-K filed during the quarter ended November 30, 1995. Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: January 12, 1996 /s/ Benjamin F. Edwards III Date: January 12, 1996 /s/ David W. Mesker	10-Q	10-Q	1996-01-12T00:00:00	1996-01-12T16:32:17
0000033798-96-000002	0000033798-96-000002_0001.txt	SIXTH AMENDMENT, dated as of November 29, 1995 (this "Amendment"), to the Loan and Security Agreement, dated as of December 15, 1993 (as heretofore amended, supplemented or otherwise modified, the "Loan Agreement"), between BankAmerica Business Credit, Inc. (the "Lender") and Grossman's Inc. (the "Borrower"). W I T N E S S E T H : WHEREAS, the Lender and the Borrower are parties to the Loan WHEREAS, the Borrower has requested that the Lender amend the Loan Agreement to permit additional time for the Borrower to demonstrate to the Lender that the Borrower has the ability to repay upon scheduled maturity the Borrower's 14% debentures maturing January 1, 1996; and WHEREAS, the Lender is willing to make such amendment but only on the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the premises and for other good and valuable consideration, the receipt of which is hereby acknowledged, the parties hereto hereby agree as follows: 1. Defined Terms. Unless otherwise defined herein, capitalized terms used herein have the respective meanings ascribed thereto in the Loan Agreement. 2. Amendment of Section 11.1 (Events of Default). Section 11.1 of the Loan Agreement is hereby amended by deleting paragraph (q) thereof in its entirety and substituting therefor the following: "(q) (i) the Borrower shall have failed to demonstrate to the Lender's satisfaction on or prior to December 15, 1995 that the Borrower shall have the ability (other than through the Borrower's operations after December 15, 1995) to repay upon scheduled maturity the Borrower's 14% debentures maturing January 1, 1996, or (ii) the Borrower shall have failed to provide the Lender on or prior to December 15, 1995 with projections of monthly financial and business performance (including balance sheets, statements of operations, Availability projections and cash flows) for the period from December 1, 1995 through April 30, 1996 in form satisfactory to the Lender which confirm to the Lender's satisfaction that the Borrower will (A) maintain projected Availability satisfactory to the Lender and (B) pay all Debt as it matures." 3. Representations and Warranties. To induce the Lender to enter into this Amendment, the Borrower hereby represents and warrants to the Lender as follows, with the same effect as if such representations and warranties were set forth in the Loan Agreement: (a) The Borrower has the corporate power and authority to enter into this Amendment and has taken or will take all corporate action required to authorize or ratify its execution and delivery of this Amendment and its performance of the Loan Agreement, as amended hereby (as so amended, the "Amended Agreement"). This Amendment has been duly executed and delivered by the Borrower and the Amended Agreement constitutes the valid and binding obligation of the Borrower, enforceable against the Borrower in accordance with its terms. The execution, delivery, and performance of this Amendment and the Amended Agreement by the Borrower will not violate its certificate of incorporation or by-laws or any agreement or legal requirement binding on the Borrower. (b) On the date hereof and after giving effect to the terms of this Amendment, (i) the Loan Agreement and the other Loan Documents are in full force and effect and constitute the Borrower's binding obligations, enforceable against the Borrower in accordance with their respective terms; (ii) no Event or Event of Default has occurred and is continuing; and (iii) the Borrower does not have any defense to or setoff, counterclaim or claim against payment of the Obligations and enforcement of the Loan Documents based upon a fact or circumstance existing or occurring on or prior to the date hereof. 4. Effectiveness. This Amendment shall be effective as of the date first written above upon receipt by the Lender of a counterpart hereof duly executed by the Borrower. 5. Limited Effect. This Amendment shall be limited solely to the matters expressly set forth herein and shall not (a) constitute an amendment of any other term or condition of the Loan Agreement or of any instrument or agreement referred to therein or (b) prejudice any right or rights which the Lender may now have or may have in the future under or in connection with the Loan Agreement or any instrument or agreement referred to therein. Except as expressly amended hereby, all of the covenants and provisions of the Loan Agreement are and shall continue to be in full force and effect. 6. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF NEW YORK. 7. Counterparts. This Amendment may be executed by the parties hereto in any number of separate counterparts, each of which shall be an original, and all of which taken together shall be deemed to constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed and delivered by their respective proper and duly authorized officers as of the day and year first above written.	8-K	EX-10	1996-01-12T00:00:00	1996-01-12T13:44:55
0000950123-96-000100	0000950123-96-000100_0000.txt	<DESCRIPTION>FORM 10-QSB FOR QUARTER ENDED SEPTEMBER 30, 1995 /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended September 30, 1995 / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to (Exact Name of Registrant as Specified in its Charter) State or other jurisdiction of (I.R.S. Employer incorporation or organization Identification No.) 2255 Glades Road, Suite 324A, Boca Raton, FL 33431 (Address of Principal Executive Office) (Zip Code) (Registrant's telephone number including area code) 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 The number of shares of registrant's Common Stock, $.0001 par value, outstanding as of September 30, 1995 was 13,003,179 shares. See notes to financial statements See notes to financial statements See notes to financial statements NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited financial statements have been prepared in accordance with the instructions on Form 10-QSB and, therefore, do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. In the opinion of management, such financial statements reflect all adjustments necessary for a fair statement of the results of operations and financial position for the interim periods presented. Operating results for the nine months ended September 30, 1995 are not necessarily indicative of the results that may be expected for the year ended December 31, 1995. For a more complete understanding of the Company's financial position and results of operations, reference is made to the financial statements of Whitestone Industries, Inc. and related notes thereto previously filed with the Company's Form 10-KSB for the year ended December 31, 1994. NOTE 2 - DISCONTINUED OPERATIONS In October 1995 (effective July 1, 1995), the Company sold its oil and gas business (including all related assets and liabilities) to Magnum Petroleum, Inc. ("Magnum") in exchange for $300,000 in cash, 85,159 shares of Magnum common stock and 50,000 options to purchase Magnum common stock at prices from $4.00 to $4.25. Substantially all of this consideration was subsequently transferred to the Company's then president and majority stockholder in settlement of amounts owed to him by the Company and for his assumption of all remaining liabilities of the Company outstanding as of that date. Accordingly, the results of the oil and gas properties are shown separately as "discontinued operations". The Company's 1994 financial information has been reclassified to conform with the 1995 presentation. NOTE 3 - SUBSEQUENT EVENTS a. In October 1995 the Company distributed all of its assets, including Magnum Securities to its then President and majority stockholder to retire certain debts owed to him, and for his assumption of all remaning liabilities of the Company outstanding as of that date. In October 1995, the Company spun off Whitestone Games, a wholly owned subsidiary to its stockholders. The net effect of all the above transactions has been reported as a distribution of capital. b. On December 7, 1995, the Company, Whitestone Group, Ltd., a British Virgin Islands limited partnership organized under the laws of British Virgin Islands ("WGL"), Golden Bear Entertainment Corporation, a California corporation ("GBEC"), and Donald Yu, ("Yu") entered into a Stock Purchase and Exchange Agreement (the "Agreement"), which was effective on December 7, 1995. Pursuant to the Agreement, WGL contributed back to the Company its right and interest in 6,700,000 shares of its 8,700,000 shares of the Company's common stock, in exchange for the Company's interest in certain securities. Prior to December 7, 1995, WGL owned approximately 64.2% of the outstanding capital stock interest of the Company. Upon consummation of the transaction, WGL owned approximately 5.9% of the outstanding capital stock interest of the Company. Pursuant to the Agreement, the Company acquired all of the capital stock of GBEC in exchange for the distribution to Mr. Yu, the sole stockholder of GBEC, of (I) 3,200,000 shares of restricted common stock of the Company and (II) 500,000 shares of newly issued shares of Series A Convertible Preferred Stock (the "Series A Preferred Stock") that are convertible into 78,400,000 (subject to certain anti-dilution provisions) shares of common stock of the Company. The common stock and the Series A Preferred Stock issued to Mr. Yu represents approximately 79.89% of the outstanding capital stock interest of the Company. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PLAN OF In October 1995 the Company distributed all of its assets, including Magnum Securities to its then president and majority stockholder to retire certain debts owed to him and for his assumption of all remaning liabilities of the Company outstanding as of that date. In October 1995, the Company spun off Whitestone Games, a wholly owned subsidiary to its stockholders. The net effect of all the above transactions has been reported as a distribution of capital. In October 1995 (effective July 1, 1995), the Company sold its oil and gas business (including all related assets and liabilities) to Magnum Petroleum, Inc. ("Magnum") in exchange for $300,000 in cash, 85,159 shares of Magnum common stock and 50,000 options to purchase Magnum common stock at prices from $4.00 to $4.25. Substantially all of this consideration was subsequently transferred to the Company's then president and majority stockholder in settlement of amounts owed to him by the Company and for his assumption of all remaining liabilities of the Company outstanding as of that date. Accordingly, the results of the oil and gas properties are shown separately as "discontinued operations". The Company's 1994 financial information has been reclassified to conform with the 1995 presentation. PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS - NONE Item 2. CHANGES IN SECURITIES - NONE Item 3. DEFAULTS UPON SENIOR SECURITIES - NONE Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS - NONE Item 5. OTHER INFORMATION - NONE Item 6. EXHIBITS AND REPORTS ON FORM 8-K On December 7, 1995 the Company filed a report of Form 8-K. Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. EXHIBIT 27.1 FINANCIAL DATA SCHEDULE FOR NINE-MONTHS EXHIBIT 27.2 FINANCIAL DATA SCHEDULE FOR THREE-MONTHS	10QSB	10QSB	1996-01-12T00:00:00	1996-01-12T15:31:56
0000855654-96-000002	0000855654-96-000002_0000.txt	Report by Issuer of Securities Quoted on NASDAQ Inter-Dealer Quotation System Filed Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and Rules 13a-17 and 15d-17 Thereunder (Exact name of Issuer as Specified in Charter) 128 Sidney Street, Cambridge, Massachusetts 02139 (Address of Principal Executive Offices) (Issuer's Telephone Number, Including Area Code) I. CHANGE IN NUMBER OF SHARES OUTSTANDING Indicate any change (increase or decrease) of five percent or more in the number of shares outstanding: 1. Title of security ImmunoGen, Inc. Common Stock 2. Number of shares outstanding before the change 12,586,606 3. Number of shares outstanding after the change 13,656,884 4. Effective date of change November 6, 1995 5. Method of change: Specify method (such as merger, acquisition, exchange, distribution, stock split, reverse split, acquisition of stock for treasury, etc.) Conversion of Subordinated Convertible Debentures Give a brief description of transaction Conversion of Subordinated Convertible Debentures issued in previous Regulation S transaction. II. CHANGE IN NAME OF ISSUER 1. Name prior to change 3. Effective date of charter amendment changing name 4. Date of shareholder approval of change, if required /S/ Frank J. Pocher, Vice Pres- Date January 12, 1996 ident and Chief Financial Officer Report by Issuer of Securities Quoted on NASDAQ Inter-Dealer Quotation System Filed Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and Rules 13a-17 and 15d-17 Thereunder (Exact name of Issuer as Specified in Charter) 128 Sidney Street, Cambridge, Massachusetts 02139 (Address of Principal Executive Offices) (Issuer's Telephone Number, Including Area Code) I. CHANGE IN NUMBER OF SHARES OUTSTANDING Indicate any change (increase or decrease) of five percent or more in the number of shares outstanding: 1. Title of security ImmunoGen, Inc. Common Stock 2. Number of shares outstanding before the change 13,656,884 3. Number of shares outstanding after the change 14,347,799 4. Effective date of change November 29, 1995 5. Method of change: Specify method (such as merger, acquisition, exchange, distribution, stock split, reverse split, acquisition of stock for treasury, etc.) Conversion of Subordinated Convertible Debentures Give a brief description of transaction Conversion of Subordinated Convertible Debentures issued in previous Regulation S transaction. II. CHANGE IN NAME OF ISSUER 1. Name prior to change 3. Effective date of charter amendment changing name 4. Date of shareholder approval of change, if required /S/ Frank J. Pocher, Vice Pres- Date January 12, 1996 ident and Chief Financial Officer Report by Issuer of Securities Quoted on NASDAQ Inter-Dealer Quotation System Filed Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and Rules 13a-17 and 15d-17 Thereunder (Exact name of Issuer as Specified in Charter) 128 Sidney Street, Cambridge, Massachusetts 02139 (Address of Principal Executive Offices) (Issuer's Telephone Number, Including Area Code) I. CHANGE IN NUMBER OF SHARES OUTSTANDING Indicate any change (increase or decrease) of five percent or more in the number of shares outstanding: 1. Title of security ImmunoGen, Inc. Common Stock 2. Number of shares outstanding before the change 14,347,799 3. Number of shares outstanding after the change 15,074,226 4. Effective date of change December 13, 1995 5. Method of change: Specify method (such as merger, acquisition, exchange, distribution, stock split, reverse split, acquisition of stock for treasury, etc.) Conversion of Subordinated Convertible Debentures Give a brief description of transaction Conversion of Subordinated Convertible Debentures issued in previous Regulation S transaction. II. CHANGE IN NAME OF ISSUER 1. Name prior to change 3. Effective date of charter amendment changing name 4. Date of shareholder approval of change, if required /S/ Frank J. Pocher, Vice Pres- Date January 12, 1996 ident and Chief Financial Officer	10-C	10-C	1996-01-12T00:00:00	1996-01-12T14:30:34
0000906344-96-000001	0000906344-96-000001_0000.txt	<DESCRIPTION>AMENDMENT NO. 3 TO SCHEDULE 13D Under the Securities Exchange Act of 1934 Common Stock, $.001 par value) (Title of Class of Securities) Howard, Rice, Nemerovski, Canady, Falk & Rabkin, Three Embarcadero Center, Suite 700 (Name, Address and Telephone Number of Person Authorized to Receive Notices and Communications) (Date of Event which Requires If the filing person has previously filed a statement on Schedule 13G to report the acquisition which is the subject of this Schedule 13D, and is filing this schedule because of Rule 13d-1(b)(3) or (4), check the following box []. Check the following box if a fee is being paid with this statement []. (A fee is not required only if the filing person: (1) has a previous statement on file reporting beneficial ownership of more than five percent of the class of securities described in Item 1; and (2) has filed no amendment subsequent thereto reporting beneficial ownership of five percent or less of such class.) (See Rule 13d-7.) Note: Six copies of this statement, including all exhibits, should be filed with the Commission. See Rule 13d-1(a) for other parties to whom copies are to be sent. The remainder of this cover page shall be filled out for a reporting person's initial filing on this form with respect to the subject class of securities, and for any subsequent amendment containing information which would alter the disclosures provided in a prior cover page. The information required in the remainder of this cover page shall not be deemed to be "filed" for the purpose of Section 18 of the Securities Exchange Act of 1934 ("Act") or otherwise subject to the liabilities of that section of the Act but shall be subject to all other provisions of the Act (however, see the Notes). Exhibit Index Located on Page 18 CUSIP No. 895-818-201 SCHEDULE 13D Page 2 of 19 1 Name of Reporting Person BK CAPITAL PARTNERS II, L.P. IRS Identification No. of Above Person 94-3048313 2 Check the Appropriate Box if a Member of a Group (a) [x] 4 Source of Funds WC 5 Check Box if Disclosure of Legal Proceedings is Required Pursuant to Items 2(d) or 2(e) [] 6 Citizenship or Place of Organization California 7 Sole Voting Power -0- SHARES 8 Shared Voting Power 1,998,158 OWNED BY EACH 9 Sole Dispositive Power -0- 10 Shared Dispositive Power 1,998,158* 11 Aggregate Amount Beneficially Owned by Each Reporting 12 Check Box if the Aggregate Amount in Row 11 Excludes Certain 13 Percent of Class Represented by Amount in Row 11 11.5%* 14 Type of Reporting Person PN * See response to Item 5. CUSIP No. 895-818-201 SCHEDULE 13D Page 3 of 19 1 Name of Reporting Person BK CAPITAL PARTNERS III, L.P. IRS Identification No. of Above Person 94-3091845 2 Check the Appropriate Box if a Member of a Group (a) [x] 4 Source of Funds WC 5 Check Box if Disclosure of Legal Proceedings is Required Pursuant to Items 2(d) or 2(e) [] 6 Citizenship or Place of Organization California 7 Sole Voting Power -0- SHARES 8 Shared Voting Power 1,998,158* OWNED BY EACH 9 Sole Dispositive Power -0- 10 Shared Dispositive Power 1,998,158* 11 Aggregate Amount Beneficially Owned by Each Reporting 12 Check Box if the Aggregate Amount in Row 11 Excludes Certain 13 Percent of Class Represented by Amount in Row 11 11.5%* 14 Type of Reporting Person PN * See response to Item 5. CUSIP No. 895-818-201 SCHEDULE 13D Page 4 of 19 1 Name of Reporting Person BK CAPITAL PARTNERS IV, L.P. IRS Identification No. of Above Person 94-3139027 2 Check the Appropriate Box if a Member of a Group (a) [x] 4 Source of Funds WC 5 Check Box if Disclosure of Legal Proceedings is Required Pursuant to Items 2(d) or 2(e) [] 6 Citizenship or Place of Organization California 7 Sole Voting Power -0- SHARES 8 Shared Voting Power 1,998,158* OWNED BY EACH 9 Sole Dispositive Power -0- 10 Shared Dispositive Power 1,998,158* 11 Aggregate Amount Beneficially Owned by Each Reporting 12 Check Box if the Aggregate Amount in Row 11 Excludes Certain 13 Percent of Class Represented by Amount in Row 11 11.5%* 14 Type of Reporting Person PN * See response to Item 5. CUSIP No. 895-818-201 SCHEDULE 13D Page 5 of 19 1 Name of Reporting Person THE COMMON FUND IRS Identification No. of Above Person 23-7037968 2 Check the Appropriate Box if a Member of a Group (a) [] 4 Source of Funds WC 5 Check Box if Disclosure of Legal Proceedings is Required Pursuant to Items 2(d) or 2(e) [] 6 Citizenship or Place of Organization New York 7 Sole Voting Power -0- SHARES 8 Shared Voting Power 1,998,158* OWNED BY EACH 9 Sole Dispositive Power -0- 10 Shared Dispositive Power 1,998,158* 11 Aggregate Amount Beneficially Owned by Each Reporting 12 Check Box if the Aggregate Amount in Row 11 Excludes Certain 13 Percent of Class Represented by Amount in Row 11 11.5%* 14 Type of Reporting Person CO * See response to Item 5. CUSIP No. 895-818-201 SCHEDULE 13D Page 6 of 19 1 Name of Reporting Person RICHARD C. BLUM & ASSOCIATES, L.P. IRS Identification No. of Above Person 94-3205364 2 Check the Appropriate Box if a Member of a Group (a) [x] 4 Source of Funds Not applicable 5 Check Box if Disclosure of Legal Proceedings is Required Pursuant to Items 2(d) or 2(e) [] 6 Citizenship or Place of Organization California 7 Sole Voting Power -0- SHARES 8 Shared Voting Power 1,998,158* OWNED BY EACH 9 Sole Dispositive Power -0- 10 Shared Dispositive Power 1,998,158* 11 Aggregate Amount Beneficially Owned by Each Reporting 12 Check Box if the Aggregate Amount in Row 11 Excludes Certain 13 Percent of Class Represented by Amount in Row 11 11.5%* 14 Type of Reporting Person PN, IA * See response to Item 5. CUSIP No. 895-818-201 SCHEDULE 13D Page 7 of 19 1 Name of Reporting Person RICHARD C. BLUM & ASSOCIATES, INC. IRS Identification No. of Above Person 94-2967812 2 Check the Appropriate Box if a Member of a Group (a) [x] 4 Source of Funds Not applicable 5 Check Box if Disclosure of Legal Proceedings is Required Pursuant to Items 2(d) or 2(e) [] 6 Citizenship or Place of Organization California 7 Sole Voting Power -0- SHARES 8 Shared Voting Power 1,998,158* OWNED BY EACH 9 Sole Dispositive Power -0- 10 Shared Dispositive Power 1,998,158* 11 Aggregate Amount Beneficially Owned by Each Reporting 12 Check Box if the Aggregate Amount in Row 11 Excludes Certain 13 Percent of Class Represented by Amount in Row 11 11.5%* 14 Type of Reporting Person CO * See response to Item 5. CUSIP No. 895-818-201 SCHEDULE 13D Page 8 of 19 1 Name of Reporting Person RICHARD C. BLUM S.S. No. of Above Person 556 42 3196 2 Check the Appropriate Box if a Member of a Group (a) [x] 4 Source of Funds Not applicable 5 Check Box if Disclosure of Legal Proceedings is Required Pursuant to Items 2(d) or 2(e) [] 6 Citizenship or Place of Organization USA 7 Sole Voting Power 8,001 SHARES 8 Shared Voting Power 2,006,159* OWNED BY EACH 9 Sole Dispositive Power 8,001 10 Shared Dispositive Power 2,006,159* 11 Aggregate Amount Beneficially Owned by Each Reporting 12 Check Box if the Aggregate Amount in Row 11 Excludes Certain 13 Percent of Class Represented by Amount in Row 11 11.5%* 14 Type of Reporting Person IN * See response to Item 5. CUSIP No. 895-818-201 SCHEDULE 13D Page 9 of 19 Item 1. Security and Issuer This Amendment No. 3 (the "Amendment") to Schedule 13D relates to shares of common stock, $0.001 par value (the "Common Stock"), of Triad Systems Corporation, a Delaware corporation (the "Issuer"). The principal executive office and mailing address of the Issuer is 3055 Triad Drive, Livermore, CA 94550-9559. This Amendment amends and restates Amendment No. 2 to Schedule 13D. This Amendment is being filed because of certain dispositions of Common Stock described in Item 5(c) below. Item 2. Identity and Background This Amendment is filed on behalf of BK Capital Partners II, L.P., a California limited partnership ("BK II"), BK Capital Partners III, L.P., a California limited partnership ("BK III"), BK Capital Partners IV, L.P., a California limited partnership ("BK IV"), The Common Fund, a New York non-profit corporation, Richard C. Blum & Associates, L.P., a California limited partnership ("RCBA L.P."), Richard C. Blum & Associates, Inc., a California corporation ("RCBA Inc."), and Richard C. Blum, the Chairman and a substantial shareholder of RCBA Inc. BK II, BK III and BK IV are each California limited partnerships whose principal business is investing in securities, and whose principal office is located at 909 Montgomery Street, Suite 400, San Francisco, California 94133. RCBA L.P. is the sole general partner of BK II, BK III and BK IV. RCBA, L.P. is a California limited partnership whose principal business is acting as general partner for investment partnerships and providing investment advisory and financial consulting services. RCBA L.P. is a registered investment adviser with the Securities and Exchange Commission and with the State of California. The sole general partner of RCBA L.P. is RCBA Inc. The principal business office address of RCBA L.P. and RCBA Inc. is 909 Montgomery Street, Suite 400, San Francisco, California 94133. The names of the executive officers and directors of RCBA Inc., their addresses, citizenship and principal occupations are as follows: CUSIP No. 895-818-201 SCHEDULE 13D Page 10 of 19 Name and Office Business Address Citizen- Occupation Richard C. Blum 909 Montgomery St. USA Chairman and Chairman and Suite 400 Director, Director San Francisco, CA RCBA, L.P. Thomas L. Kempner 40 Wall Street USA Chairman, Director New York, NY 10005 Loeb Nils Colin Lind 909 Montgomery St. Norway Managing Managing Director Suite 400 Director, and Director San Francisco, CA RCBA, L.P. George A. Pavlov 909 Montgomery St. USA Managing Managing Suite 400 Director and Director, Chief San Francisco, CA Chief RCBA, L.P. Alexander L. Dean 909 Montgomery St. USA Managing Managing Director Suite 400 Director of of Investments San Francisco, CA Investments, and Director RCBA, L.P. Peter E. 909 Montgomery St. USA Managing Rosenberg Suite 400 Director of Managing Director San Francisco, CA Investments, of Investments RCBA, L.P. Michael Kane 909 Montgomery St. USA Managing Managing Director Suite 400 Director of of Investments San Francisco, CA Investments, RCBA, L.P. Jeffrey W. Ubben 909 Montgomery St. USA Managing Managing Director Suite 400 Director of of Investments San Francisco, CA Investments, RCBA, L.P. Marc Scholvinck 909 Montgomery St. USA Vice Vice President Suite 400 President and Controller San Francisco, CA and RCBA, L.P. CUSIP No. 895-818-201 SCHEDULE 13D Page 11 of 19 Donald S. Scherer 3 Embarcadero Ctr. USA Howard, Secretary Suite 700 Rice, et al. San Francisco, CA (law firm) The Common Fund is a New York not-for-profit corporation principally engaged in the business of managing investments for educational institutions. The principal administrative office of The Common Fund is located at 450 Post Road East, Westport, Connecticut 06881-0909. The name, business address and present principal occupation of each of the trustees and executive officers of The Common Fund are as follows (all are United States citizens): Paul J. Aslanian Norman G. Herbert Treasurer Treasurer and Investment Officer Macalester College University of Michigan 1600 Grand Avenue 5032 Fleming Administration Building St. Paul, MN 55105 Ann Arbor, MI 48109-1340 John B. Carroll William Hromadka President Treasurer and Assoc. Sr. GTE Investment Management Corp. Vice President Tresser Boulevard University of Southern California Seventh Floor University Park, Treasurer's Office Stamford, CT 06901 BKS 402 - Bookstore Building Managing Director, Global Research Lyn Hutton Morgan Stanley & Co., Inc. Vice President Finance and Treasurer 1251 Avenue of the Americas Dartmouth College New York, NY 10020 6008 Parkhurst Hall, Room 102 The Regents of the Partner University of California Hallenbeck, Lascell, Norris & Zorn Kaiser Center One Exchange Street 300 Lakeside Drive, 17th Floor Rochester, NY 14614-1403 Caspa L. Harris, Jr. Chairman National Association of College and 1925 Calvin Court University Business Officers River Woods, IL 60015 1 Dupont Circle, Suite 500 CUSIP No. 895-818-201 SCHEDULE 13D Page 12 of 19 Louis W. Moelchert Robert S. Salomon, Jr. Vice President for Business President and Finance STI Management LLC University of Richmond 36 Flying Cloud Road Campus Drive, Room 202 Stamford, CT 06902 Richmond, VA 23173 William T. Spitz Andre F. Perold Vanderbilt University Sylvan C. Coleman Professor of 102 Alumni Hall Financial Management Nashville, TN 37240-0159 Morgan Hall, 367, Soldiers Field The executive officers of The Common Fund who are not Trustees are as follows (the business address for each person is The Common Fund, 450 Post Road East, Westport, CT 06881-0909): John S. Griswold, Jr. Curt R. Tobey Senior Vice President Senior Vice President Robert E. Shultz Gary P. Watson Senior Vice President Chief Operating Officer and To the best knowledge of the Reporting Persons, none of the entities or persons identified in this Item 2 has, during the past five years, been convicted of any criminal proceeding (excluding traffic violations or similar misdemeanors), nor been a party to a civil proceeding of a judicial or administrative body of competent jurisdiction and as a result of such proceeding was or is subject to a judgment, decree or final order enjoining future violations of, or prohibiting or mandating activities subject to, federal or state securities laws or finding any violation with respect to such laws. Item 3. Source and Amount of Funds or Other Consideration The source of funds for the previous purchases of Securities was the working capital of BK II, BK III, BK IV and The Common Fund. CUSIP No. 895-818-201 SCHEDULE 13D Page 13 of 19 Item 4. Purpose of Transaction. As previously reported in the initial Schedule 13D and Amendment No. 1 thereto, BK II, BK III, BK IV, The Common Fund (collectively, the "Purchasers"), RCBA Inc. and the Issuer entered into a Unit Purchase Agreement dated as of July 2, 1992, as amended by the First Amendment to Unit Purchase Agreement dated August 3, 1992. Pursuant to such agreements, the Company sold the Purchasers, for an aggregate purchase price of $20,000,000, an aggregate of 1,000,000 units (collectively, the "Units"). Each Unit consisted of one share of the Issuer's Senior Cumulative Convertible Preferred Stock, par value $0.001 per share (the "Preferred Stock"), and a warrant to purchase 3.5 shares of the Issuer's Common Stock (individually, a "Warrant"). The Unit Purchase Agreement and the First Amendment thereto were filed as Exhibits 2 and 5, respectively, to the previous Schedule 13D and Amendment No. 1, respectively, and are incorporated herein by reference. As previously reported in Amendment No. 2, the Purchasers, RCBA L.P., and the Issuer entered into the Exchange Agreement and Second Amendment to Unit Purchase Agreement dated as of March 31, 1995 (the "Exchange Agreement"). Pursuant to the Exchange Agreement, the Purchasers surrendered all of their Units in exchange for (i) an aggregate cash payment of $10,000,000, (ii) accrued dividends in the aggregate amount of $200,000, and (iii) an aggregate of 2,222,222 shares of the Issuer's Common Stock. Such consideration was apportioned among the Purchasers in proportion to their prior ownership of the Units. The Unit Purchase Agreement and the First Amendment thereto continue in full force and effect, except as modified by the Exchange Agreement (collectively, the "Purchase Agreement"). The Purchasers originally entered into the Purchase Agreement solely for investment purposes. Depending upon market conditions and other factors, the Reporting Persons may acquire additional securities of the Issuer, including shares of Common Stock, in the open market, in privately negotiated transactions or otherwise. Alternatively, depending upon market conditions and other factors, the Reporting Persons may, from time to time, dispose of some or all of the securities of the Issuer that they beneficially own, although there are certain restrictions on transfer as set forth in Item 6 below. Pursuant to Section 3.6 of the Purchase Agreement, the Issuer will nominate and recommend a representative of the Purchasers (the "Purchaser Representative") reasonably acceptable to the Issuer to serve as a director of the Issuer. Richard C. Blum continues to serve as the Purchaser Representative on the Issuer's Board of Directors. The Purchase Agreement provides that the Purchasers will notify the Issuer of the identity of any proposed successor Purchaser Representative in order to permit CUSIP No. 895-818-201 SCHEDULE 13D Page 14 of 19 the Issuer to determine that such successor is reasonably acceptable to the Issuer. The Exchange Agreement has deleted in its entirety Section 3.14 of the Purchase Agreement which had imposed certain restrictions upon the Issuer's ability to declare or pay dividends upon shares of its capital stock ranking junior to the Preferred Stock. Other than as set forth in this statement, the Reporting Persons have no present plans or proposals that relate to or would result in any of the consequences listed in paragraphs (a)-(j) of Item 4 of Schedule 13D, although they may in the future take actions which would have such consequences. Item 5. Interest in Securities of the Issuer (a), (b) According to information furnished to the Reporting Persons by the Issuer, there were 17,402,215 shares of Common Stock issued and outstanding as of December 20, 1995. Based on such information, the following Reporting Persons report the following direct holdings and corresponding percentage interests in the Common Stock: The Common Fund 1,111,111 6.4% Because voting and investment decisions concerning the above shares are made by RCBA L.P., the Reporting Persons may be members in a group, in which case each Reporting Person would be deemed to have beneficial ownership of an aggregate of 1,998,158 shares of the Common Stock, which is 11.5% of the outstanding Common Stock. As Chairman, director and a substantial shareholder of RCBA Inc., Richard C. Blum might be deemed to be the beneficial owner of the securities beneficially owned by RCBA Inc. In addition, Mr. Blum has sole beneficial ownership of 8,001 shares of the Common Stock (consisting of options currently exercisable or exercisable within 60 days). If Mr. Blum were deemed to be the beneficial owner of the securities beneficially owned by RCBA Inc., he would own beneficially an aggregate of 2,006,159 shares, which is 11.5% of the Stock. Although Mr. Blum is joining in this Amendment as CUSIP No. 895-818-201 SCHEDULE 13D Page 15 of 19 a Reporting Person, the filing of this Amendment shall not be construed as an admission that he, or any of the other shareholders, directors or executive officers of RCBA Inc. is, for any purpose, the beneficial owner of any of the securities that are beneficially owned by RCBA Inc. (c) During the last 60 days, the following dispositions have been made: On January 2, 1996, BK IV distributed 224,064 shares of Common Stock to two of its limited partners in connection with such limited partners' withdrawal from BK IV. (d) and (e) Not applicable. Item 6. Contracts, Arrangements, Understandings or Relationships with Respect to Securities of the Issuer The Purchase Agreement provides that, with certain exceptions, RCBA L.P. and the Purchasers will not acquire, on their own behalf or on behalf of their controlled affiliates, any voting securities of the Issuer or securities convertible into or exercisable for the Issuer's voting securities. These limitations will be suspended if a third party commences or publicly announces a tender offer for a certain percentage of the Issuer's voting securities or takes certain other actions. In addition, Section 3.7(d) of the Purchase Agreement provides that if RCBA L.P. and the Purchasers beneficially own in excess of a specified percentage of the Issuer's voting securities, they will cause all of the voting securities owned by them in excess of such percentage to be voted in accordance with the recommendations of the Issuer's Board of Directors, except with respect to certain enumerated matters. Pursuant to Section 3.7(e) of the Purchase Agreement, the Purchasers executed an irrevocable proxy to secure their obligations under Section 3.7(d). The acquisition and voting limitations and the grant of the irrevocable proxy described in this paragraph will terminate on August 3, 1997 or at such time as RCBA L.P. and the Purchasers no longer beneficially own a specified percentage of the Issuer's securities, whichever is earlier. Furthermore, the acquisition and voting limitations summarized in this paragraph will terminate as to any Purchaser who ceases to be managed or advised by RCBA L.P. or to be an affiliate of RCBA L.P. The Purchase Agreement also contains certain restrictions on the transfer of the Common Stock. Section 3.11(a) of the Purchase Agreement requires that before a Purchaser and certain transferees (including RCBA, L.P., its affiliates and those which it manages or advises) may transfer any Common Stock, the shares must first be offered to the Issuer; however, the Exchange Agreement provides that such restrictions will not apply to sales to the public made in reliance on Rule 144. Section 3.11(b) of the Purchase Agreement provides that shares of Common Stock which are held by Purchasers or certain of their transferees may not be CUSIP No. 895-818-201 SCHEDULE 13D Page 16 of 19 knowingly transferred to a competitor of the Issuer without the consent of the Issuer's Board of Directors. Section 2.3 of the Exchange Agreement provides additional transfer restrictions on the Purchasers' Common Stock. So long as the Purchasers have certain rights pursuant to the Purchase Agreement, they will be subject to the Company's insider trading policies. In addition, until March 31, 1996, sales of Common Stock must be made in compliance with the volume limitations of Rule 144(e), regardless of whether Rule 144 is otherwise applicable. Except for the contracts, arrangements, understandings and relationships described above and attached as exhibits hereto, none of the Reporting Persons or, to the best knowledge of the Reporting Persons, the other persons named in Item 2, is a party to any contract, arrangement, understanding or relationship with respect to any securities of Issuer, including but not limited to the transfer or voting of any of the securities of the Issuer, finder's fees, joint ventures, loan or option arrangements, puts or calls, guarantees of profits, division of profits or loss, or the giving or withholding of proxies. Item 7. Material to be Filed as Exhibits Exhibit 10 Joint Filing Undertaking. CUSIP No. 895-818-201 SCHEDULE 13D Page 17 of 19 After reasonable inquiry and to the best of their knowledge and belief, the undersigned certify that the information set forth in this statement is true, complete and correct. BK CAPITAL PARTNERS II, L.P. RICHARD C. BLUM & ASSOCIATES, BK CAPITAL PARTNERS III, L.P. L.P. BK CAPITAL PARTNERS IV, L.P. By Richard C. Blum & Associates, By Richard C. Blum & Associates, Inc., its General Partner By Richard C. Blum & By /s/ Donald S. Scherer General Partner Donald S. Scherer, By /s/ Donald S. Scherer By Richard C. Blum & Associates, RICHARD C. BLUM & ASSOCIATES, L.P., its Investment Adviser INC. By Richard C. Blum & Associates, Inc., its By /s/ Donald S. Scherer By /s/ Donald S. Scherer Donald S. Scherer, /s/ George A. Pavlov CUSIP No. 895-818-201 SCHEDULE 13D Page 18 of 19 Exhibit 10 Joint Filing Undertaking 19 CUSIP No. 895-818-201 SCHEDULE 13D Page 19 of 19 The undersigned, being duly authorized thereunto, hereby execute this agreement as an exhibit to Amendment No. 3 to Schedule 13D to evidence the agreement of the below-names parties, in accordance with rules promulgated pursuant to the Securities Exchange Act of 1934, to file this Amendment jointly on behalf of each of such parties. BK CAPITAL PARTNERS II, L.P. RICHARD C. BLUM & ASSOCIATES, BK CAPITAL PARTNERS III, L.P. L.P. BK CAPITAL PARTNERS IV, L.P. By Richard C. Blum & Associates, By Richard C. Blum & Associates, Inc., its General Partner By Richard C. Blum & By /s/ Donald S. Scherer General Partner Donald S. Scherer, By /s/ Donald S. Scherer THE COMMON FUND RICHARD C. BLUM & ASSOCIATES, INC. By Richard C. Blum & Associates, By /s/ Donald S. Scherer By Richard C. Blum & _____________________ Associates, Inc., its Donald S. Scherer, By /s/ Donald S. Scherer /s/ George A. Pavlov Donald S. Scherer, RICHARD C. BLUM	SC 13D/A	SC 13D/A	1996-01-12T00:00:00	1996-01-12T17:30:07
0000950152-96-000084	0000950152-96-000084_0001.txt	FOR IMMEDIATE RELEASE For Further Information, Contact: Submitted: January 10, 1996 Jacqueline Thurston (614) 480-3878 COLUMBUS, Ohio -- Huntington Bancshares Incorporated (NASDAQ: HBAN; http://www.huntington.com) today reported net income of $65.5 million, or $.49 per share, for the fourth quarter of 1995 compared with $52.5 million, or $.39 per share, for the same period one year ago, an increase of 25.6%. For the year ended December 31, 1995, net income was $244.5 million versus $242.6 million for all of 1994. Earnings per share were $1.78 in both periods. Huntington's return on average assets for the fourth quarter and twelve months of 1995 was 1.31% and 1.28%, and return on average equity for the most recent quarter and full year was 17.50% and 16.27%, respectively. "Our company enjoyed another successful year in 1995. We are particularly pleased with the performance in the second half, as strong loan growth and lower non-interest expenses contributed to higher earnings compared with the first six months," stated Frank Wobst, chairman and chief executive officer of Huntington Bancshares Incorporated. Huntington experienced good loan growth in 1995, with average total loans expanding 13.5% from 1994. This increase was broad-based with average commercial loans up 13.6%, consumer loans up 13.3% and lease financing up 31.4%. Net interest income during the most recent quarter was $181.9 million, million in the same period last year primarily due to the higher level of earning assets. Net interest income for the past twelve months was $724.6 million compared with $756.1 million for all of 1994. The net interest margin in the fourth quarter was just below 4% and was 4.15% for the full year. Non-interest income, excluding securities transactions, in the last quarter and for the entire year of 1995 amounted to $68.1 million and $239.3 million, compared with $50.9 million and $219.7 million for the corresponding periods one year ago. The quarter-to-quarter increase was driven by improvements in all major categories. Growth in non-interest income was also broad-based on an annual basis, as mortgage banking income showed the only year-to-year decline which was attributable to the unusual market conditions experienced by that industry during the first half of 1994. The restructuring of the mortgage company has been completed and it posted a profit of $3.6 million during 1995 compared with a loss of $11.2 million in 1994. Non-interest expense declined for the fifth consecutive quarter to $138.8 million in the most recent three months representing a 5.3% drop from the same period in 1994. When compared with the prior year, a similar decline of 5.2% occurred for all of 1995. The decreases are primarily attributable to initiatives begun in 1994 to reduce operating costs through the restructuring of certain business activities. Measured against other major bank holding companies, Huntington's asset quality continues to remain very strong. Non-performing assets as a percent of total loans and other real estate were .58%, down significantly from .78% one year ago. Non-performing loans amounted to $55.0 million, or .41% of total loans, at December 31, 1995, compared with $44.5 million, or .36% of total loans last year. Other real estate declined 58% over the past twelve months, from $51.9 million to $22.0 million. Net charge-offs, as a percent of average total loans, were .53% in the fourth quarter but were only .32% for all of 1995. Huntington's allowance for loan losses totaled $194.5 million at December 31, 1995, or 1.47% of total loans and covered 353.8% of non-performing loans; when combined with the allowance for other real estate, it was 238.7% of total non-performing assets. Huntington's average equity to average assets ratio stood at 7.47% for the recent quarter and 7.89% for the full year. The company's Tier I and total risk based capital ratios were 8.39% and 12.03%, respectively, and its Tier I leverage ratio was 6.87% at December 31, 1995. Huntington's capital ratios continue to exceed the regulatory requirements to be considered a "well-capitalized" bank holding company. During 1995, Huntington expanded its franchise in Florida through the completion of three mergers, including Security National Corporation, Reliance Bank and First Seminole Bank. The acquisition of Peoples Bank of Lakeland, Florida is expected to be completed in late January 1996 bringing the company's total assets in Central and West Coast Florida to approximately $1.2 billion. Huntington Bancshares is a regional bank holding company headquartered in Columbus, Ohio with assets in excess of $20 billion. The company's banking subsidiaries operate 322 offices in Ohio, Florida, Indiana, Kentucky, Michigan and West Virginia. Huntington's mortgage, trust, investment banking, and automobile finance subsidiaries manage 74 offices in the six states mentioned as well as Georgia, Illinois, Maryland, New Jersey, North Carolina, Pennsylvania, Texas and Virginia. (in thousands of dollars, except per share amounts)	8-K	EX-99	1996-01-12T00:00:00	1996-01-12T14:43:25
0000931763-96-000004	0000931763-96-000004_0001.txt	dated December 27, 1995 between and among La-Man Corporation, Heritage Packaging Services, Inc., Nevada SEMCO, Inc., J.M. Stewart Corporation, J.M. Stewart Industries, Inc., Vision Trust Marketing, Inc., TracTel Communications, Inc., Don Bell Industries, Inc., Don Bell Industries of Nevada, Inc., and The Bank of Winter Park Effective December 27, 1995, La-Man Corporation, a Nevada corporation authorized to do business in Florida as La-Man Corporation of Nevada, whose executive office is located at 2180 West State Road 434, Suite 6136, Longwood, Florida 32779 (herein called the "the Borrower") hereby applies to THE BANK OF WINTER PARK (herein called the "Bank") for loans and other financial accommodations and, in consideration of the Bank extending the same, agrees with the Bank as follows: 1.1 Subject to the terms and conditions of this Loan Agreement, the Bank will lend and the Borrower will borrow up to a principal sum of One Million Five Hundred Ninety Thousand and 00/100 Dollars ($1,590,000.00), which borrowing shall be evidenced by a renewal note in the amount of $350,000.00, future advance note in the amount of $150,000.00, and consolidated master note in the amount of $500,000.00 (hereinafter "Loan A"), a mortgage note in the amount of $840,000.00 (hereinafter "Loan B"), and note in the amount of $250,000.00 (hereinafter "Loan C"). 1.2 Loan A is a revolving line of credit and the principal amount under the Loan may increase or decrease from time to time as the Borrower draws and repays Loan funds thereunder. Provided the Borrower is not in default, outstanding amounts under the Loan may be repaid or re-borrowed from time to time subject to the terms, conditions and limitations set forth in this Agreement, but the principal balance of the Loan outstanding from time to time shall not exceed the original, principal amount of the Note. Loan A requires monthly payments of interest only for a period of two years from the date of funding. Loan B is a term loan requiring monthly payments of principal and interest in the amount of $8,106.18 for a period of five years from the date of funding, based upon a twenty (20) year amortization schedule, with a balloon payment of the remaining principal balance and accrued interest, if any, being due and payable on December 27, 2000. Loan C is a term loan requiring monthly payments of principal in the amount of $4,166.67, plus accrued interest for a period of five years from the date of funding. 1.3 The Borrower represents, warrants and agrees that the proceeds of Loans A, B and C made hereunder will be used solely for the following purposes: (a) contemporaneously with the initial draw hereunder, the proceeds of such initial draw shall be used to the extent necessary to pay all indebtedness of the Don Bell Industries, Inc., a Florida corporation, d/b/a Don Bell & Company to First Union, Florida, Bank of America, California, Ed Neff, Lloyd B. Patrick, Jr. and Charles L. Waller III and Midland Bank, Missouri; and (b) all other proceeds shall be used for working capital by the Borrower and its subsidiaries Heritage Packaging Services, Inc., Nevada SEMCO, Inc., J.M. Stewart Corporation, J.M. Stewart Industries, Inc., Vision Trust Marketing, Inc., TracTel Communications, Inc., Don Bell Industries, Inc., and Don Bell Industries of Nevada, Inc. (herein referred to individually as "Subsidiary" and collectively as the "Subsidiaries"). Disbursement of Loan proceeds for purposes not within foregoing shall be at the Bank's sole discretion, and the Bank shall under no circumstances be obligated to disburse Loan proceeds except as expressly set forth in this Agreement. 1.4 The maturity date of Loan A is December 27, 1997. On the Loan A maturity date, all sums outstanding under Loan A shall be immediately due and payable, and the Bank's obligation to fund shall cease and terminate. The maturity date of Loan B is December 27, 2000. On the loan B maturity date, all sums outstanding under Loan B shall be immediately due and payable. The maturity date of Loan C is December 27, 2000. On the Loan C maturity date, all sums outstanding under Loan C shall be immediately due and payable. 1.5 The Borrower shall pay to the Bank a commitment fee of $4,700.00 as to Loan A, to be paid on acceptance , receipt of which is acknowledged by the Bank. The Borrower shall also pay to the Bank a document preparation fee of $250.00 as to Loan A. Such document preparation fee shall be due and payable in full at the time of the Borrower's first draw under the Loan. 1.6 The Borrower shall pay to the Bank a commitment fee of $8,400.00 as to Loan B, to be paid upon acceptance, receipt of which is acknowledged by the Bank. The Borrower shall also pay a document preparation fee of $250.00 as to Loan B. Such document preparation fee shall be due and payable in full at the time of funding under the Loan. 1.7 The Borrower shall pay to the Bank a commitment fee of $2,000.00 as to Loan C, to be paid upon acceptance receipt of which is acknowledged by the Bank. The Borrower shall also pay a document preparation fee of $250.00 as to Loan C. Such document preparation fee shall be due and payable in full at the time of funding under the Loan. SECTION 2. THE BORROWER'S REPRESENTATIONS, WARRANTIES AND COVENANTS. The Borrower represents, warrants and covenants as follows: 2.1 The Borrower is a corporation, duly organized, existing and in good standing under the laws of the State of Nevada, and is duly qualified and in good standing in Florida and in every other state in which it is doing business. 2.2 The execution, delivery and performance of this Agreement are within the Borrower's corporate powers, have been duly authorized, are not in contravention of law or the terms of its charter, by-laws or other incorporation papers, or of any indenture, agreement or undertaking to which it is a party or by which it is bound. 2.3 At the time any Account becomes subject to a security interest in favor of the Bank: the Account shall be a valid Account representing an undisputed indebtedness incurred by the account debtor for Inventory held subject to delivery instructions or theretofore shipped or delivered pursuant to a contract of sale, or for services theretofore performed by the Borrower or a Subsidiary; as to each such Account, there shall be no set-offs or counterclaims, no agreement under which any deduction or discount may be claimed shall have been made with the account debtor unless written notice thereof has theretofore been or concurrently is given to the Bank, and no agreement under which any goods may be returned shall have been made with the account debtor, where such set-offs or counterclaims, agreement for deductions or discounts or agreement for returns have an aggregate value of more than $25,000.00 per Account; and the Borrower or a Subsidiary, as applicable, shall be the lawful owner of the Account and shall have good right to subject the same to a security interest in the Bank. 2.4 The Borrower and its Subsidiaries are, and as to Inventory to be acquired after the date hereof, shall be, the owner of all Inventory and shall neither create or suffer to exist any lien or encumbrance thereon or security interest therein nor sell, assign, transfer or create or suffer to exist any lien or encumbrance on or security interest in any Account to or in favor of any person other than the Bank. 2.5 At the time the Borrower or any Subsidiary pledges, sells, assigns or transfers to the Bank any instrument, document of title, security, chattel paper or other property (including Inventory and Accounts) or any proceeds or products thereof, or any interest therein, the Borrower or its Subsidiary shall be the lawful owner thereof and shall have good right to pledge, sell, assign or transfer the same; none of such property shall have been pledged, sold, assigned, or transferred to any person other than the Bank or in any way encumbered; and the Borrower and its Subsidiaries shall defend the same against the claims and demands of all persons. 2.6 The Borrower shall give the Bank written notice of each location at which Inventory is or will be kept and of each office of the Borrower or any Subsidiary at which the records pertaining to Accounts Receivable are kept. 2.7 The Borrower shall maintain a "Tangible Net Worth" of no less than $750,000, to be measured at the end of each fiscal quarter, commencing December 31, 1995, and of no less than $1,500,000 to be measured at the end of each fiscal quarter, commencing June 30, 1996. "Tangible Net Worth" means total assets minus total liabilities minus any intangible assets as defined by Generally Accepted Accounting Principles (e.g., good will). 2.8 The Borrower shall maintain an interest coverage ratio, defined as earnings before interest and taxes divided by interest, of no less than 3 to 1, to be measured at each fiscal year end commencing June 30, 1996. 2.9 The Borrower shall maintain a cash flow coverage, defined as net income plus depreciation divided by current maturities of long term debt and capitalized leases, of no less than 2.5 to 1.0 at each fiscal year end commencing June 30, 1996. 2.10 Subject to any limitations stated therein or in connection therewith, all balance sheets, earnings statements and other financial data which have been or may hereafter be furnished to the Bank to induce it to enter into this Agreement or otherwise in connection herewith, do or shall fairly represent the financial condition of the Borrower and its Subsidiaries as of the dates and the results of their operations for the periods for which the same are furnished, and all other information, reports and other papers and data furnished to the Bank are, or shall be at the time the same are so furnished, accurate and correct in all material respects and complete insofar as completeness may be necessary to give the Bank true and accurate knowledge of the subject matter. 2.11 The Borrower shall pay any excise, sales or other tax or charge which may become due and payable with respect to any sale or other transaction giving rise to an Account or other right to the payment of money, or with respect to the collection thereof and shall reimburse the Bank for any payment by it of any such tax or charge. 2.12 The Borrower will not, unless the Bank shall consent in writing, make any loans or capitalized leases to any person, nor guarantee, endorse, become surety for, or otherwise in any way become or be responsible for, obligations of any other person, whether by agreement to purchase the indebtedness of any other person, or agreement for the furnishing of funds, directly or indirectly, through purchase of goods, supplies, or services (or by way of stock purchase, capital contribution, advance, or loan) or for the purpose of payment of indebtedness of any other person, or otherwise (except that the Borrower may endorse negotiable instruments for collection in the ordinary course of business), in excess of an aggregate of ONE HUNDRED THOUSAND AND NO\100 DOLLARS ($100,000.00) per year. Notwithstanding the foregoing, the Borrower shall have the right to acquire the stock or assets of another corporation or other entity in exchange for stock of the Borrower, providing the Borrower and its Subsidiaries continue to satisfy the applicable representations, warranties and covenants of this Agreement and provided that neither the Borrower nor any Subsidiary assume any debt of the acquired corporation or other entity. 2.13 This Loan is only for business or commercial purposes of the Borrower and the proceeds of the Loan are not being used for personal, household, family or agricultural purposes. 2.14 There are not now, nor to the Borrower's knowledge after reasonable investigation have there ever been, tanks or other facilities on, under, or at any real estate owned or occupied by the Borrower or any Subsidiary that contained materials which, if known to be present in soils or ground water, would require cleanup, removal or some other remedial action under Environmental Laws. To the Borrower's knowledge after reasonable investigation, there are no other conditions existing currently or likely to exist during the term of this Agreement that would subject the Borrower or any Subsidiary to any claim for damages, penalties, injunctive relief or cleanup costs under Environmental Laws or that require or are likely to require cleanup, removal, remedial action or other response pursuant to Environmental Laws by the Borrower or any Subsidiary. The Borrower affirms and incorporates by reference the representations and warranties contained in that certain Environmental Affidavit of even date herewith. 2.15 All covenants, representations and warranties set forth herein shall be true, correct and complete at the time this Agreement is executed and shall be deemed continuing. SECTION 3. BANK ACCOUNTS. Unless the Bank shall otherwise consent in writing, the Borrower and each Subsidiary agree that the Bank will be their primary concentration and disbursement bank while these facilities are in effect, and the Borrower and each Subsidiary agree to maintain their respective primary operating accounts with the Bank. The Borrower and its Subsidiaries agree to maintain balances in each of such accounts in amounts sufficient to compensate the Bank for servicing these accounts. If the Bank determines that the balances maintained in such accounts are not sufficient to compensate the Bank for servicing the accounts, the Bank may charge the Borrower and its Subsidiaries such amounts as the Bank determines necessary to compensate itself for such service, which charge shall be computed in accordance with the customary method employed by the Bank, and shall be immediately due and payable by the Borrower. SECTION 4. PROMISES TO PAY. The Borrower promises to pay to the Bank: 4.1 The current amount due according to the terms of the Renewal Note, Future Advance Note and Consolidated Master Note as to Loan A, and the current amount due according to the terms of the Note as to Loan B; 4.2 Any and all charges customarily made by the Bank; 4.3 All taxes, charges and expenses of every kind or description including attorney's fees and expenses of litigation, reasonably incurred or expended by the Bank in connection with the preparation of this Agreement or any amendment hereof, the making of any loans hereunder, the collection or sale or attempted collection or sale of Accounts or Obligations, the supervision, protection and collection of any realization upon any Collateral, and the protection or enforcement of the Bank's rights hereunder. SECTION 5. INSURANCE; REPORTS; INSPECTION OF RECORDS; FURTHER ASSURANCES. 5.1 The Borrower and each Subsidiary shall have and maintain at all times with respect to Inventory and Equipment, insurance against risks of fire, so- called extended coverage, sprinkler leakage and other risks customarily insured against by companies engaged in similar businesses, in amounts, containing such terms, in such form, for such periods and written by such companies as may be satisfactory to the Bank, such insurance to be payable to the Bank and to the Borrower, and each applicable Subsidiary, as their interests may appear. All policies of insurance shall provide for ten (10) days' written minimum cancellation notice to the Bank. In the event of failure to provide and maintain insurance as herein provided, the Bank may, at its option, provide such insurance and charge the amount thereof to the Loan Account. The Borrower shall furnish to the Bank certificates or other evidence satisfactory to the Bank of compliance with the foregoing insurance provisions. Evidence of insurance satisfactory to the Bank must be in place prior to the initial draw by the Borrower as to Loan A and the funding of Loan B. 5.2 The Borrower shall maintain and shall cause each Subsidiary to maintain a standard and modern system for accounting in accordance with generally accepted principles of accounting consistently applied throughout all accounting periods; and shall furnish to the Bank such information respecting the business, assets and financial condition of the Borrower and its Subsidiaries as the Bank may reasonably request and, without request, furnish to the Bank: (a) Within thirty (30) days after the end of each month, unaudited monthly statements of profit and loss for the Borrower and each of its Subsidiaries, such statements being in form and substance satisfactory to the (b) Within 45 days after the end of each of the first three quarters of each fiscal year of the Borrower (i) consolidated balance sheets of the Borrower and all of its Subsidiaries as of the close of such quarter and of the comparable quarter in the preceding fiscal year; and (ii) consolidated statements of income and surplus of the Borrower and all of its Subsidiaries for such quarter and for that part of the fiscal year ending with such quarter and for the corresponding periods of the preceding fiscal year; all in reasonable detail and certified as true and correct (subject to audit and normal year-end adjustments) by the chief financial officer of the Borrower; and (c) As soon as available, and in any event within 90 days after the close of each fiscal year of the Borrower, a copy of the audit report for such year and accompanying consolidated financial statements of the Borrower and its Subsidiaries, as prepared by independent public accountants of recognized standing selected by the Borrower and satisfactory to the Bank, which audit report shall be accompanied by an opinion of such accountants, in form satisfactory to the Bank, to the effect that the same fairly present the financial condition of the Borrower and its Subsidiaries and the results of its and their operations as of the relevant dates thereof; together with copies of any management letters issued by such accountants in connection with such audit; (d) As soon as available, copies of all reports or materials submitted or distributed to shareholders of the Borrower or filed with the SEC or other governmental agency having regulatory authority over the Borrower or any Subsidiary or with any national securities exchange; and (e) Promptly, and in any event within 10 days, after the Borrower has knowledge thereof a statement of the chief financial officer of the Borrower describing: (i) any event which, either of itself or with the lapse of time or the giving of notice or both, would constitute a default hereunder together with a statement of the actions which the Borrower proposes to take with respect thereto; (ii) any pending or threatened litigation or administrative proceeding involving an amount in excess of $5000.00; and (iii) any fact or circumstance which is materially adverse to the property, financial condition or business operations of the Borrower or any Subsidiary. 5.3 The Borrower shall at all reasonable times and from time to time allow the Bank by or through any of its officers, agents, attorneys, or accountants, to examine, inspect or make extracts from the Borrower's books and records, and those of any Subsidiary or other related company, and to arrange for verification of Accounts under reasonable procedures, directly with account debtors or by other methods; and shall do, make, execute and deliver all such additional and further acts, things, deeds, assurances and instruments as the Bank may require, including adjusting for clerical errors in any Loan documentation if deemed necessary or desirable in the reasonable discretion of the Bank, to vest in and assure to the Bank its rights hereunder or in any Collateral and to carry into effect the provisions and intent of this Agreement. SECTION 6. SECURITY INTEREST OF THE BANK IN COLLATERAL. 6.1 As security for the payment and performance of all obligations, the Bank shall have and the Borrower and each Subsidiary hereby grants to the Bank a continuing security interest in the following property of the Borrower and each Subsidiary, whether such property is now owned or existing or is owned, acquired, or arises hereafter, and whether or not such property is specifically assigned to the Bank: all Inventory of the Borrower and its Subsidiaries; all Accounts Receivable of the Borrower and its Subsidiaries; all interest of the Borrower and its Subsidiaries in goods as to which an Account Receivable shall have arisen; all Equipment of Don Bell Industries, Inc. described as all furniture, fixtures, equipment, motor vehicles, rolling stock and other tangible personal property of the Debtor of every description, except inventory, and includes without limitation all property included in the definition of "equipment" as used in Section 679.109 of the Florida Statutes, Uniform Commercial Code, and all files, records (including without limitation computer programs, tapes and related electronic data processing software) and writings of the Borrower and its Subsidiaries or in which any of them has an interest in any way relating to the foregoing property. The security interest of the Bank in the equipment of Don Bell Industries, Inc. d/b/a Don Bell and Company shall be subordinate to the security interest in that certain equipment described in the UCC-1 filings in favor of Heller Financial, Inc., file number 940000087141, and Vendor Funding Co., Inc., file number 910000121548, copies of which are attached hereto as Composite Exhibit "C" and incorporated herein by reference. The Bank is also given a lien and security interest in all property of the Borrower and its Subsidiaries now in or at any time hereafter coming into the control, custody, or possession of the Bank, whether for the express purpose of being used by the Bank as Collateral, or for any other purpose, and upon any balance or balances to the credit of any accounts maintained with the Bank by the Borrower and its Subsidiaries. 6.2 The Borrower and its Subsidiaries agree to execute and deliver Security Agreements and U.C.C. Financing Statements required by the Bank to perfect said security interests. 6.3 As additional security for Loans A and C, the Borrower shall grant to the Bank a first mortgage on the property described on Exhibit "A" attached hereto and made a part hereof. 6.4 As additional security for Loan C, Don Bell Industries, Inc., a Florida corporation, d/b/a Don Bell & Company, a subsidiary of the Borrower, shall grant to the Bank a second mortgage on the property described on Exhibit "B" attached hereto and made a part hereof. As security for Loan B, Don Bell Industries, Inc., a Florida corporation, d\b\a Don Bell & Company, a subsidiary of the Borrower, shall grant to the Bank a first mortgage on the property described on Exhibit "C" attached hereto and made a part hereof. 6.5 Borrower shall not remove or demolish any building or other property forming a part of the Mortgaged Property without the written consent of the Bank. Borrower shall not permit, commit, or suffer any waste, impairment or deterioration of the Mortgaged Property or any part thereof, and shall keep the same and improvements thereon in good condition and repair. Borrower shall notify the Bank in writing within five (5) days of any damage or impairment of the Mortgaged Property. The Bank may, at the Bank's discretion, have the Mortgaged Property inspected at any time and Borrower shall pay all costs incurred by the Bank in executing such inspection. SECTION 7. EVENTS OF DEFAULT. ACCELERATION. 7.1 Any and all of the Obligations of the Borrower to the Bank, shall, at the option of the Bank and notwithstanding the provisions of any instrument evidencing any Obligation, be immediately due and payable without notice or demand upon the occurrence of any of the following events of default: (a) a default in the payment or performance, when due or payable (after any applicable grace period), of any Obligation by the Borrower or by any endorser, guarantor or surety for any Obligation; (b) failure of the Borrower to pay, prior to the date for imposition of penalty, any tax not being contested in good faith, where the amount of tax, penalties and interest exceeds $10,000.00; (c) The making by the Borrower or any Subsidiary of any misrepresentation to the Bank for the purpose of obtaining credit or an extension of credit, or the Borrower or any Subsidiary shall fail to perform or observe any other term, covenant, or agreement contained in this Agreement on its part to be performed or observed and any such failure remains unremedied for a period of THIRTY (30) days after written notice thereof shall have been given to the Borrower by the Bank; (d) failure of the Borrower, within thirty (30) days after request by the Bank, to furnish financial information or to permit inspection of the books and records of the Borrower or any Subsidiary; (e) the Borrower or any endorser, guarantor or surety of any Obligation, shall: (i) file a voluntary petition in bankruptcy or a petition or answer seeking or acquiescing in any reorganization or for an arrangement, composition, readjustment, liquidation, dissolution, or similar relief for itself pursuant to the United States Bankruptcy Code or any similar law or regulation, federal or state, relating to any relief for debtors, now or hereafter in effect; or (ii) makes an assignment for the benefit of creditors or admits in writing its inability to pay or fails to pay its debts as they become due; or (iii) suspends payment of its obligations or takes any action in furtherance of the foregoing; or (iv) consents to or acquiesces in the appointment of a receiver, trustee, custodian, conservator, liquidator or other similar official of the Borrower, or any Subsidiary, for all or any part of the Collateral or other assets of such party, or either; or (v) has filed against it an involuntary petition, arrangement, composition, readjustment, liquidation, dissolution, or an answer proposing an adjudication of it as a bankrupt or insolvent, or is subject to reorganization pursuant to the United States Bankruptcy Code, or an action seeking to appoint a trustee, receiver, custodian, conservator, or liquidator, under any similar law, federal or state, now or hereafter in effect, and such action is approved by any court of competent jurisdiction and the order approving the same shall not be vacated or stayed within sixty (60) days from entry; or (vi) consents to the filing of any such petition or answer, or shall fail to deny the material allegations of the same in a timely manner; (f) final judgments for the payment of money in excess of Twenty Five Thousand Dollars ($25,000.00), excluding claims covered by insurance, shall be rendered against the Borrower or any Subsidiaries and the same shall remain undischarged for a period of thirty (30) consecutive days during which execution shall not be effectively stayed, provided that a judgment shall be deemed "final" only when the time for appeal shall have expired without an appeal having been claimed, or all appeals and further review claimed have been (g) the occurrence of any material adverse change in the financial condition or affairs of the Borrower or any endorser, guarantor or surety of any Obligation which causes the Bank to deem itself insecure; (h) termination of any guaranty by any guarantor of the Borrower's (i) the Borrower or any endorser, guarantor or surety of any Obligation shall grant a security interest in any Collateral to any third party; (j) the Borrower or any endorser, guarantor, or surety of any Obligation fails, in any material respect, to maintain, preserve and keep all its property, leased buildings, equipment, furniture and fixtures necessary for the operation of its business in good repair and condition, ordinary wear and tear excepted, and if it fails, from time to time, to make all needful, proper and necessary repairs and replacements thereof; (k) the Borrower or any endorser, guarantor, or surety of any Obligation fails to pay, when due, or within fifteen (15) days of receipt by Borrower of notice from the appropriate governmental body that such a mount is due, salaries and wages of employees and any and all Federal and other taxes lawfully assessed or imposed upon it, provided, however, that nothing herein contained shall be construed as prohibiting the payor from contesting, in good faith, the validity of any such (l) in the event there is any change in the Borrower's present executive management, i.e., the president and chief executive officer, without the prior written approval of the Bank. 7.2 Upon any event of default (as defined above) by the Borrower, the Bank shall have all the remedies for default provided in this Agreement, the Notes, the Security Agreements and all other documents executed in connection with the Loan, as well as all applicable law. Nothing herein contained shall be construed as making it obligatory upon the Bank to follow any particular course of action or to pursue any particular remedy in advance of any other or others accruing to the Bank by virtue of the Borrower's default. SECTION 8. DISPOSITION OF COLLATERAL. Upon the occurrence of any event of default and at any time thereafter (such default not having been cured), the Bank shall have the right to take immediate possession of the Collateral, and for that purpose the Bank may, so far as the Borrower and its Subsidiaries can give authority therefor, enter upon any premises on which Collateral may be situated and remove the same therefrom. The Borrower waives demand and notice with respect to and assents to any repossession of Collateral. Except for Collateral which is perishable or threatens to decline speedily in value or which is of a type customarily sold on a recognized market, the Bank shall give to the Borrower at least FIVE (5) days' prior written notice of the time and place of any public sale of Collateral or of the time after which any private sale or any other intended disposition is to be made. The Bank shall also have in any jurisdiction where enforcement hereof is sought, in addition to all other rights and remedies, the rights and remedies of a secured party under the Uniform Commercial Code of Florida. The residue of any proceeds of collection or sale, after satisfying all Obligations in such order of preference as the Bank may determine and making proper allowance for interest on Obligations not then due, shall be credited to any deposit account maintained by the Borrower with the Bank. The Borrower shall remain liable for any deficiency. SECTION 9. SET-OFF. Regardless of the adequacy of Collateral, upon any event of default, any deposits or other sums at any time credited by or due from the Bank to the Borrower or any Subsidiary may at any time be applied to or set off against Obligations on which the Borrower is primarily liable. Upon the occurrence of any default hereunder, the Bank shall have the right, immediately, without notice, and without further action by it, to set off against the Borrower's Obligations hereunder, all money owed by the Bank to the Borrower, and the Bank shall have been deemed to have exercised such right of set-off and to have made a charge against any such money immediately upon the occurrence of such default even though such charge is made or entered on the books of the Bank subsequent hereto. SECTION 10. WAIVERS. The Borrower waives demand, notice, protest, notice of acceptance of this Agreement, notice of loans made, credit extended, Collateral delivered or repossessed or other action taken in reliance thereon, and all other demands and notices of any description. With respect to both Obligations and Collateral, the Borrower assents to any extension or postponement of the time of payment or other indulgence, to any substitution, exchange or release of Collateral, to the addition or release of any party or person primarily or secondarily liable, to the acceptance of partial payments thereon and the settlement, compromising or adjusting of any thereof, all in such manner and at such time or times as the Bank may deem advisable. The Bank may exercise its rights with respect to Collateral without resorting to or regard to other collateral or sources of reimbursement for Obligations. The Bank shall not be deemed to have waived any of its rights upon or under Obligations or Collateral unless such waiver be in writing and signed by the Bank. No delay or omission on the part of the Bank in exercising any right shall operate as a waiver of such right or any other right. A waiver on any one occasion shall not be construed as a bar to or waiver of any right on any future occasion. All rights and remedies of the Bank, whether evidenced hereby or by any other instrument or papers, shall be cumulative and may be exercised separately or concurrently, and may be exercised by the Bank from time to time, at such times and in such order, as the Bank, in its sole discretion, shall determine. SECTION 11. NOTICES. Any notice required hereunder or by reason of the application of any law shall be deemed to have been given by either party hereto, when the same shall have been personally delivered or deposited in the United States Mail, postage prepaid, at least Five (5) calendar days prior to the action proposed thereby, addressed: (a) If to Borrower, at 2180 West State Road 434, Suite 6136 Attn: J. William Brandner, President (b) With copy to: Marshall S. Harris, Esquire Smith, MacKinnon, Harris, et al 255 S. Orange Avenue, Suite 800 (c) If to Bank, at 2006 Aloma Avenue Attn: Robert Baldwin, Asst. Vice President (d) With copy to: Frank L. Pohl, Esquire Pohl & Short, P.A. 280 W. Canton Avenue, Suite 410 12.1 The captions herein are inserted only as a matter of convenience and for reference and in no way define, limit, or describe the scope of this Agreement or the intent of any provision hereof. 12.2 As an inducement to the granting of the Loan secured hereby, written Guaranty Agreements from each Subsidiary will be required to guaranty the payment of this Loan, interest and any costs of collection, including a reasonable attorneys' fee, which written Guaranty Agreements shall be on a form prescribed by the Bank. Guarantors jointly and severally guarantee payment of the Bank's credit to the Borrower. 12.3 The Borrower agrees to pay any and all documentary stamps and taxes applicable to this Loan and any similar tax or taxes which are directly assessed on this Loan. 12.4 No delay or failure on the part of the Bank in exercising any right, power or privilege under the terms of this Agreement shall affect such right, power or privilege; nor shall a single or partial exercise thereof preclude any further exercise thereof, or the exercise of any other right, power or privilege. 12.5 In the event that the Borrower or any Subsidiary, or any of them, jointly or severally, shall default in their obligations hereunder and in the opinion of the Bank it becomes necessary or proper to employ an attorney to enforce its collection of the indebtedness owed by the Borrower to the Bank or to enforce compliance by the Borrower with any of the provisions herein contained, the Borrower agrees to pay a reasonable attorneys' fee and any and all other costs that may reasonably be incurred in connection therewith, and this provision shall not be deemed a limitation of any other obligation of the Borrower to pay costs of collection and reasonable attorneys' fees pursuant to the terms and provisions of any other document or agreement, such as the promissory note or any security agreements or guaranty agreements executed by the Borrower or the Subsidiaries hereunder. 12.6 This Agreement shall remain in full force and effect for so long as there shall remain unpaid principal, interest, or costs of collection, including reasonable attorneys' fees, under and pursuant to the terms and provisions of that certain renewal note, future advance note, and consolidated master note as to Loan A, and the note as to Loan B, evidencing the loan request by the Borrower from the Bank and agreed to be made by the Bank to the Borrower. 12.7 This Agreement shall not be modified or amended except by a written instrument signed by all of the parties hereto. 12.8 This Agreement and all the documents executed in connection therewith and all matters relating thereto shall be governed by and construed and interpreted in accordance with the laws of the State of Florida. The Borrower and all of its Subsidiaries hereby submit to the jurisdiction of the state and federal courts located in Florida and agree that the Bank may, at its option, enforce its rights under such loan documents in such courts. 12.9 If at any time or times by assignment or otherwise, the Bank transfers any Obligation and Collateral therefor, such transfer shall carry with it the Bank's powers and rights under this Agreement with respect to the Obligation and Collateral transferred and the transferee shall become vested with said powers and rights whether or not they are specifically referred to in the transfer. This Agreement shall be effective as a sealed instrument when it is received at the office of the Bank as set forth in Section 13(b) of this Agreement. The provisions of this Agreement are severable, and if any of these provisions shall be held by any court of competent jurisdiction to be unenforceable, such holding shall not affect or impair any other provision hereof. 12.10 Provided there has occurred an event of default under this Agreement, the Borrower hereby constitutes any officer of the Bank as its attorney-in-fact, with power to receive and open all mail addressed to the Borrower; to endorse the Borrower's name on any notes, acceptances, checks, drafts, money orders or other evidences of payment or collateral that may come into the Bank's possession; to sign the Borrower's name on any invoice or bill of lading relating to any assigned Account, on drafts against customers, to send requests for verification of Accounts to any customer; and to do all other acts and things necessary to carry out this Agreement. All acts of said Attorney or designee are hereby ratified and approved by the Borrower, and said Attorney or designee shall not be liable for any acts of commission or omission nor for any error of judgment or mistake of fact or law. This power, being coupled with an interest, is irrevocable while any assigned Account shall remain unpaid, or any money remains due to the Bank from the Borrower. 12.11 The terms "the Bank" and "the Borrower," as used in this Agreement, shall include their respective successors and assigns. 12.12 The parties mutually agree that neither party, nor any partner, assignee, heir, or legal representative of any party (all of whom are hereinafter referred to as "parties") shall seek a jury trial in any lawsuit, proceedings, counter-claim, or any litigation procedure based upon or arising out of this Agreement or any instrument evidencing, securing or relating to the indebtedness and other obligations evidenced hereby, any related agreement or instrument, any other collateral for the indebtedness evidenced hereby or the dealings or the relationship between or among the parties, or any of them. None of the parties will seek to consolidate any such action, in which a jury trial has been waived, with any other action in which a jury trial has not been waived. The provisions of this paragraph have been fully negotiated by the parties with the Bank, and these provisions shall be subject to no exceptions. The Bank has in no way agreed with or represented to any of the parties that the provisions of this paragraph will not be fully enforced in all instances. The waiver contained herein is irrevocable and constitutes a knowing and voluntary waiver. SECTION 13. DEFINITIONS. As used in this Agreement: 13.1 "Obligations" means any and all obligations of the Borrower to the Bank of every kind and description, direct or indirect, absolute or contingent, primary or secondary, due or to become due, now existing of hereafter arising, regardless of how they arise or by what agreement or instrument they may be evidenced or whether evidenced by any agreement or instrument, and includes obligations to perform acts and refrain from taking action as well as obligations to pay money. 13.2 "Inventory " means goods, merchandise and other personal property, now owned or hereafter acquired by the Borrower or any Subsidiary, which are held for sale or lease or are furnished or to be furnished under a contract of service or are raw materials, work in process or materials used or consumed or to be used or consumed in the business of the Borrower or any Subsidiary. 13.3 "Accounts" has the meaning ascribed to said term in Section 679.106 of the Florida Statutes, Uniform Commercial Code. 13.4 "General Intangibles" has the meaning ascribed to said term in Section 679.106 of the Florida Statutes, Uniform Commercial Code. 13.5 "Equipment" has the meaning ascribed to said term in Section 679.109 of the Florida Statutes, Uniform Commercial Code. 13.6 "Accounts Receivable" means all present and future Accounts, General Intangibles, chattel paper, instruments, notes, acceptances, documents or other rights to payment and all form of obligations owing at any time to the Borrower or any Subsidiary, arising out of the sale or lease of Inventory or rendering of services or otherwise made in the ordinary course of business; all rights of the Borrower or any Subsidiary earned or yet to be earned under contracts to sell Inventory or render services and all warehouse receipts or documents of any kind in respect of any of the foregoing, and all the proceeds thereof of every kind and nature and in whatsoever form. 13.7 "Collateral" means any and all personal property of the Borrower or its Subsidiaries in which the Bank now has, by this Agreement acquires or hereafter acquires, a security interest, as more fully described in Section 6 herein. 13.8 "Environmental Laws" means all federal, state, and local laws including statutes, regulations, ordinances, codes, rules, and other governmental restrictions and requirements relating to the discharge of air pollutants, water pollutants, or process waste water or otherwise relating to the environment or hazardous substances including, but not limited to, the Federal Solid Waste Disposal Act, the Federal Clean Air Act, the Federal Clean Water Act, the Federal Resource Conservation and Recovery Act of 1976, the Responsibility Cleanup and Liability Act of 1980, regulations of the Environmental Protection Agency, regulations of the Nuclear Regulatory Agency, and regulations of any state department of natural resources or state environmental protection agency now or at any time hereafter in effect. IN WITNESS WHEREOF, the Borrower and the Bank have executed this Agreement as of the date first above written. corporation doing business in Florida as BY: /s/ J. William Brandner J. William Brandner, as its President THE BANK OF WINTER PARK The Guarantors of the Loan secured hereby agree to abide by the terms and conditions of this Agreement.	8-K	EX-1	1996-01-12T00:00:00	1996-01-12T15:21:44
0000950130-96-000094	0000950130-96-000094_0003.txt	<DESCRIPTION>APPRAISAL OF THE TRUMP TAJ MAHAL CASINO RESORT TRUMP TAJ MAHAL CASINO RESORT [Letterhead of Appraisal Group International Appears Here] New York, New York 10022 Re: Trump Taj Mahal Casino Resort Pursuant to your authorization, an inspection and appraisal has been made of the above-captioned premises in order to estimate the Going Concern Value, as of March 18, 1994. Going Concern Value is defined within the report, which contains the collective data and analyses upon which our value estimate is concluded. Trump Taj Mahal Casino Resort, which will be known from this point on as the "Subject Property", is located at Virginia Avenue and the Boardwalk in Atlantic City, New Jersey. The property consists of a total of 29.24+ Acres, situated among various parcel, improved with a multi-story, multi-building, 120,000 square foot casino gaming area and 1,250 room resort hotel. Also included is the ancillary parking garage, steel pier, and storage warehouses in Pleasantville and egg harbor township. The employee parking lot, located on North Carolina Avenue and Huron Avenue is leased from the City of Atlantic City. Consideration has been given to all three recognized methods of valuation. They are the "Cost Approach," the "Sales Comparison Approach" and the "Capitalization of Income Approach." Due to the nature of this property, our value conclusion is based solely on the utilization of the Capitalization of Income Approach. This letter is not the appraisal, but merely serves to transmit the attached appraisal report and to convey the final conclusion of value. The attached report includes Definitions of Going Concern value, and of the property rights appraised as if free and clear of mortgages. The appraisal is subject to the assumptions and limiting conditions set forth in the appraisal report. Trump Taj Mahal Associates -2- March 18, 1994 This report has been prepared in compliance with the Office of Thrift Supervision of the Department of Treasury's Regulation 12 C.F.R. Part 564, the Uniform Standards of Professional Appraisal Practice, and the Office of the Comptroller of Currency (OCC) written appraisal guidelines. Based upon the findings, it is our opinion that the Going Concern Value, subject to the assumptions and limiting conditions as set forth herein, as of the value date, March 18, 1994, is: ONE BILLION ONE HUNDRED MILLION DOLLARS This letter and the accompanying report are integral parts of our findings and conclusions. [SEAL APPEARS HERE.] /s/ Irwin J. Steinberg N.J. State Certified Real Estate AVI M. VARDI, Senior Appraiser N.J. State Certified Real Estate EXECUTIVE SUMMARY AND CONCLUSIONS.................... 1 FUNCTION OF THE REPORT............................... 4 PROPERTY HISTORY & OWNERSHIP......................... 4 SCOPE OF THE ASSIGNMENT.............................. 4 DEFINITION OF MARKET VALUE........................... 7 QUALIFICATIONS OF THE APPRAISERS..................... 9 ASSUMPTIONS AND LIMITING CONDITIONS.................. 17 IDENTIFICATION OF SUBJECT PROPERTY................... 21 DESCRIPTION OF THE IMPROVEMENTS...................... 49 REAL ESTATE TAX AND ASSESSMENT DATA.................. 67 HIGHEST AND BEST USE................................. 69 CAPITALIZATION OF INCOME APPROACH.................... 79 APPENDIX I - Subject Property Photographs APPENDIX II - Floor Plans APPENDIX III - Trump Taj Mahal Associates Statement of Income APPENDIX IV - Property Real Estate Tax Assessments APPENDIX V - Economic Indicators [Insert graphical material here. This photograph depicts the outside of the Taj Mahal Casino Resort.] Location: Trump Taj Mahal Casino Resort is located at Virginia Avenue and the Boardwalk in Atlantic City, New Jersey. The casino/hotel complex occupies the majority of the land extending from Pacific Avenue to the Boardwalk, and from Pennsylvania Avenue to Maryland Avenue. The employee parking area is located on North Carolina and Huron Avenue and the warehouses are located in Pleasantville and Egg Harbor Township. Block/Lot: Hotel and Casino - 13/116, 118.01, 126, 128.03, 129.01, 129.02, 129.06, and 142 14/17, 18, 28, 41, 65, and 67 and various lots in Blocks 119 and 120. Employee Parking - RP017/3.Y (Leased) Land Area: The subject parcel consists of a main tract of 29.24(PLUS OR MINUS) acres; a separate, but adjacent, lot containing 1,360(PLUS OR MINUS) square feet, or 0.03 acres; and a riparian grant of 9.76 acres. The total area of all three is 39.0 acres. However, 1.96(PLUS OR MINUS) acres of Block 13, Lots 128.06 and 142 and 2.05(PLUS OR MINUS) acres of Block 13, Lots 128.03, 129.06, and 129.02 are land locked service roads and streets for the benefit of the subject and others. Improvements: 1250 rooms within a 51 story hotel/casino complex that contains a total of approximately 4,319,905 sq. ft. of gross building area. The casino gaming area is approximately 120,000 sq. ft. Also included is a multi- level parking garage, containing a total of 1,649,754 square foot of gross building area, with a capacity for approximately 4,538 vehicles. Zoning: RS-C: Resort Commercial District Best Use: As Vacant - The highest and best use of the subject site, as vacant, is the development of casino/hotel facility. As Improved - The highest and best use of the site, as improved, is that of an casino/hotel facility similar to the current improvements. Appraisal: To estimate The Going Concern Value Valuation Date: March 18, 1994 Inspection Date: March 18, 1994 DISCOUNTED CASH FLOW TECHNIQUE - Estimated Stabilized Occupancy Level: 92.00% 1st Year Average Room Rate: $97.00 Year 1 Casino Revenue: $3,749/sq. ft. Casino Area: 120,000 sq. ft. CAPITALIZATION OF INCOME APPROACH: (ROUNDED) $1,100,000,000 This is to certify that: The subject property was inspected by Irwin J. Steinberg, MAI, and Avi M. Vardi, Senior Appraiser of APPRAISAL GROUP International. To the best of our knowledge and belief the statements of fact contained in this report are true and correct. We have no financial or other interest, direct or indirect, present or prospective, in the subject premises, nor do we have a personal interest or bias with respect to the parties involved. Our employment, and the compensation thereof, is in no way contingent upon the amount of the valuation, nor is it contingent on an action or event resulting from the analyses, opinions or conclusions in, or the use of this report. This appraisal assignment was not based on a requested minimum valuation, a specific valuation, or the approval of a loan. The analyses and conclusions contained within this appraisal report were prepared solely by us, unless specifically noted in sections where significant professional assistance was rendered. The reported analyses, opinions and conclusions are limited only by the reported assumptions and limiting conditions, and are our personal, unbiased professional analyses, opinions and conclusions. Our analyses, opinions, and conclusions were developed, and this report was prepared, in conformity with the requirements of the Code of Professional Ethics and the Standards of Professional Practice of the Appraisal Institute and the Uniform Standards of Professional Appraisal Practice of The Appraisal Foundation. The use of this report is subject to the requirements of the Appraisal Institute relating to peer review by its duly authorized representatives. /s/ Avi M. Vardi /s/ Irwin J. Steinberg AVI M. VARDI, Senior Appraiser IRWIN J. STEINBERG, MAI/1/ N.J. State Certified Real Estate N.J. State Certified Real Estate General Appraisers #RG00641 General Appraisers #RG00347 /1/ Irwin J. Steinberg, MAI is currently certified under the voluntary continuing education program of the Appraisal Institute. The purpose of this appraisal is to estimate the Going Concern Value of certain property rights, as delineated below, of the herein described premises, subject to the assumptions and limiting conditions stated, as of March 18, 1994. The property rights being appraised consist of the Partnership's Fee Simple and Leasehold Estates, as if free and clear of all liens and encumbrances, except those which are stated within this report, but subject to the limitations of eminent domain, escheat, police power and taxation. It is our understanding that this appraisal report is to be used for financial and administrative purposes. This report has been prepared in compliance with the Office of Thrift Supervision of the Department of Treasury's Regulations 12 CFR Part 564, the Uniform Standards of Professional Appraisal Practice and the Office of the Comptroller (OCC) written appraisal guidelines. The site was assembled between 1962 and 1986 under various corporations set up by Resorts International, Inc. ("RII"). A large portion of the site was purchased from the Housing Authority and Urban Redevelopment Agency of the City of Atlantic City (the "Housing Authority"). The total purchase price of this acquisition was $1,892,821.20. Of the total acquisition, 368,550 square feet is now part of the subject site. While under construction, the subject property along with other assets were purchased for $230,000,000 plus a liquidated sum of $25,000,000 and adjustments and construction costs after March 31, 1988 as per that certain Asset Purchase Agreement dated May 27, 1988, from RII and certain of its subsidiaries by Trump Taj Mahal Associates Limited Partnership, a New Jersey limited partnership owned by Donald J. Trump. The property opened on April 2, 1990. Property ownership is as follows: 13 126 Trump Taj Mahal Assoc. 14 67 Trump Taj Mahal Assoc. 13 128.03, 128.04, 128.06 ,128.07, Trump Taj Mahal Realty 128.08, 129.01, 129.02 ,129.06, Corp. 14 65, 17, 18, 28, 41 Trump Taj Mahal Realty Corp. 119 6, 22, 39, 58, 68, 85 Trump Taj Mahal Realty Corp. 120 23, 33, 44, 58, 65, 66 Trump Taj Mahal Realty Corp. In addition, there is a 9.76 acre, riparian grant that extends 150' wide and 2,835' deep into the Atlantic Ocean (Block 14, Lot 28) that is partially (3.45 (PLUS OR MINUS) acres) improved with a pier; an easement 60' x 150' permitting a skyway above the Boardwalk; a non-exclusive easement over Pennsylvania Avenue used to connect the Taj Mahal and Resorts that is 40' x 80' (Block 14, Lot 67.02) and two other, unused non-exclusive, easements over Pennsylvania Avenue that are 30' x 80'. There is also a non-exclusive easement for a tunnel at the end of Pennsylvania Avenue. INTRODUCTION SCOPE OF THE ASSIGNMENT Trump Taj Mahal Associates was formed on June 23, 1988, as a New Jersey limited partnership. The Partnership was converted to a general partnership in December, 1990. As a result of the Plan of Reorganization, the current partners and their respective ownership interests are Trump Taj Mahal, Inc. ("TTMI"), 49.995%, The Trump Taj Mahal Corporation ("Trump Corp."), .01%, and TM/GP Corporation ("TMGP"), the managing general partner, and a wholly owned subsidiary of Taj Mahal Holding Corp. ("Holding"), 49.995%. The Partnership was formed for the purpose of acquiring, constructing and operating the Trump Taj Mahal Casino Resort (the "Taj Mahal"), an Atlantic City Hotel, Casino and Convention Center Complex. On April 2, 1990, the Partnership opened the Taj Mahal to the public. Prior to such date, the Partnership was in the development stage and incurred losses amounting to approximately $24,164,000 (unaudited). Prepare a complete appraisal report, in a narrative format, of the subject property. The report shall include: 1. Identification and description of the specific estate(s) to be appraised and the effective date. 2. A description of the property to be appraised. 3. Its neighborhood and environment, both physical and economic, along with a conclusion as to anticipated future value trends. 4. An analysis of Highest and Best Use. 5. A discussion of the appraisal techniques considered and used in the development of the valuation. 6. A complete presentation of each applicable appraisal approach. 7. A summary and reconciliation of the approaches into a final value estimate as of the value date in question. INTRODUCTION DEFINITION OF MARKET VALUE The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: 1. Buyer and seller are typically motivated; 2. Both parties are well-informed or well-advised, and each acting in what they consider their own best interest; 3. A reasonable time is allowed for exposure in the open market; 4. Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and 5. The price represents the normal consideration for the property sold unaffected by special or relative financing or sales concessions granted by anyone associated with the sale. /2/ As currently adopted and required by the Resolution Trust Corporation and agencies acting under Title XI of the Federal Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), and the Office of the Comptroller of Currency (OCC). Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat. The value created by a proven property operation; considered a separate entity to be valued with a specific business establishment; also called going value. An ownership interest, held by a landlord with the rights of use and occupancy conveyed by lease to others. The rights of the lessor (the leased fee owner) and the leased fee are specified by contract terms contained within the lease. The interest held by the lessee (the tenant or renter) through a lease conveying the rights of use and occupancy for a stated term under certain conditions. The rental income that a property would most probably command in the open market; indicated by the current rents paid and asked for comparable space as of the date of the appraisal. The value a specific property has for a specific use. /3/ THE DICTIONARY OF REAL ESTATE APPRAISAL, THIRD EDITION, APPRAISAL INSTITUTE, PAGES 140, 160, 204, 221, 383. INTRODUCTION QUALIFICATIONS OF IRWIN J. STEINBERG American Institute of Real Estate Appraisers Courses: No. 1 Principles - New York University No. 2 Urban Problems - Syracuse University Real Estate Appraising Courses No. 1 and No. 2 Active in the appraisal, sale and research of real property throughout the United States, Canada and the Caribbean Islands since 1953. Included were all industrial and commercial properties. Condominium Conversion and Use Analysis American Society of Appraisers - A.S.A.* American Right-of-Way Association, Senior Member -SR/WA* (Past President Chapter No. 15) Florida State Certified Real Estate General Appraiser - Certificate No. New Jersey State Certified Real Estate General Appraiser - Certificate New York State Certified Real Estate General Appraiser - Certificate No. Licensed New Jersey, New York and Florida Real Estate Broker INTRODUCTION QUALIFICATIONS OF IRWIN J. STEINBERG Bureau of National Affairs, Inc. Institute for Professional & Executive Development, Inc. National Real Estate Development Center New Jersey Association of Realtors PARTIAL LIST OF CLIENTS SERVED - Corps of U.S. Army Engineers Department of Housing and Urban Development F.D.I.C. Housing & Homes Finance Agency Berkeley Federal Savings & Loan Association Carteret Savings and Loan Association Commercial Trust Company of N.J. Crestmont Federal Savings & Loan Association Dai-Ichi Kangyo Bank, Ltd. Dime Savings of N.Y. INTRODUCTION QUALIFICATIONS OF IRWIN J. STEINBERG East New York Savings Bank Eastdil Realty, Inc. Equitable Life Insurance Company of Iowa First Fidelity Bank, N.A., N.J. First National State Bank of New Jersey Goldome Realty Credit Corp. Lehman Bros. Lincoln First Real Estate Credit Corp. Lincoln Savings Bank (New York) Morgan Stanley and Company, Inc. New Jersey Sports & Exposition Authority New York & Suburban Federal Savings & Loan Association New York Urban Servicing Company, Inc. Paine Webber, Inc. Peoples Bank, N.A. Reliance Federal Savings & Loan Association The Controller of the State of New York U.S. Life Real Estate Services Corp. Unity Savings & Loan Association (Northridge, Illinois) Upper Avenue National Bank (Chicago, Illinois) INTRODUCTION QUALIFICATION OF IRWIN J. STEINBERG Yasuda Trust and Banking Company, Ltd. Associated Commercial Corporation (A Division of Gulf & Western) Eberhard Faber, Inc. Lefrak Organization, Inc. Power Holdings U.S., Inc. Spector Terminals, Inc. Titan Group, Inc. United Advertising Company (Eller Advertising) Verdun Industrial Center (Verdun, Canada) Wickes Companies, Inc. INTRODUCTION QUALIFICATIONS OF IRWIN J. STEINBERG The Appraisal Institute conducts a voluntary program of continuing education for its designated members. MAls and RMs, who meet the minimum standards of this program, are awarded periodic educational certification. I am currently certified under the voluntary continuing education program. INTRODUCTION QUALIFICATIONS OF AVI M. VARDI American Institute of Real Estate Appraisers Courses: Real Estate Appraisal Principles (#IA1/8-1) Capitalization Theory and Techniques - Part A (#lBA) Capitalization Theory and Techniques - Part B (#lBB) Case Studies in Real Estate Valuation (#2-1) Report Writing and Valuation Analysis (#2-2) Standards of Professional Practice (SPP) N.Y. State Certified Real Estate General Appraiser - Certificate No. 0733 N.J. State Certified Real Estate General Appraiser - Certificate No. RG MAI Candidate - New York Metropolitan District Chapter of the Appraisal National Association of Real Estate Appraisers - CREA (#48831) Member - New York Metropolitan Young Mortgage Bankers Association Senior Appraiser - APPRAISAL GROUP International, West Orange, New Jersey TYPES OF PROPERTIES APPRAISED: ENGAGED IN: Casinos Highest and Best Use Analysis Condominium Conversions Discounted Value Approach (R41B/C) Hotels & Resorts Market Research INTRODUCTION QUALIFICATIONS OF AVI M. VARDI REAL ESTATE VALUATIONS AND EVALUATIONS DONE IN THE FOLLOWING STATES: District of Columbia New Hampshire Texas PARTIAL LIST OF CLIENTS SERVED: Bank Leumi Trust Company of New York Citibank, N.A. City Federal Savings and Loan Association Federal Deposit Insurance Corporation (FDIC) The Yasuda Trust & Banking Company UMB Bank & Trust Company INTRODUCTION QUALIFICATIONS OF AVI M. VARDI Brick Church Quick Chek Pizza Hut British Land of America Residential Financial Corporation Chatwal Hotels Lefrak Organization Sovran Mortgage Corp. The Sudler Companies Newport Management Trump Organization U.S. Power INTRODUCTION ASSUMPTIONS & LIMITING CONDITIONS This appraisal report has been made with the following general assumptions: 1. Unless otherwise stated, the value appearing in this appraisal represents our opinion of market value or the value defined as of the date specified. Market value of real estate is affected by national and local economic conditions and consequently will vary with future changes in such conditions. 2. No responsibility is assumed for the legal description or for matters including legal or title considerations. Title to the property is assumed to be good and marketable unless otherwise stated. 3. The property is appraised free and clear of any or all liens or encumbrances unless otherwise stated. 4. Responsible ownership and competent property management are assumed. 5. The information furnished by others is believed to be reliable. However, no warranty is given for its accuracy. 6. All engineering is assumed to be correct. The plot plans and illustrative material in this report are included only to assist the reader in visualizing the property. 7. It is assumed that there are no hidden or unapparent conditions of the property, subsoil, or structures that render it more or less valuable. No responsibility is assumed for such conditions or for arranging for engineering studies that may be required to discover them. 8. It is assumed that there is full compliance with all applicable federal, state, and local environmental regulations and laws unless noncompliance is stated, defined, and considered in the appraisal report. 9. It is assumed that all applicable zoning and use regulations and restrictions have been complied with, unless a nonconformity has been stated, defined, and considered in the appraisal report. 10. It is assumed that all required licenses, certificates of occupancy, consents, or other legislative or administrative authority from any local, state, or national government or private entity or organization have been or can be obtained or renewed for any use on which the value estimate contained in this report is based. 11. It is assumed that the utilization of the land and improvements is within the boundaries or property lines of the property described and that there is no encroachment or trespass unless noted in the report. 12. The distribution, if any, of the total valuation in this report between land and improvements applies only under the stated program of utilization. The INTRODUCTION ASSUMPTIONS & LIMITING CONDITIONS allocations for land and buildings must not be used in conjunction with any other appraisal and are invalid if so used. 13. Possession of this report, or a copy thereof, does not carry with it the right of publication. 14. The contract for appraisal, consultation, or analytical service is fulfilled and total fee is payable upon completion of the report. The appraisers will not be asked or required to give testimony in court or hearing because of having made the appraisal in full or in part, nor engage in post-appraisal consultation with the client or third parties, except under separate and special arrangement and at additional fee. 15. No environmental or impact study, special market study or analysis, highest and best use analysis or feasibility study has been requested or made unless otherwise specified in an agreement for services or in the report. The appraisers reserve the unlimited right to alter, amend, revise or rescind any of the statements, findings, opinions, values, estimates or conclusions upon any subsequent such study or analysis or previous study or analysis subsequently becoming known to him. 16. Neither all nor any part of the contents of this report (especially any conclusions as to value, the identity of the appraiser, or the firm with which the appraiser is connected) shall be disseminated to the public through advertising, public relations, news, sales, or other media without the prior written consent and approval of the appraisers. 17. The appraisers may not divulge material contents of the report, analytical findings or conclusions or give a copy of the report to anyone other than the client or his designee as specified in writing, except as may be required by the Appraisal Institute as it may request in confidence for ethics enforcement or by a court of law or body with the power of subpoena. 18. This appraisal is to be used only in its entirety and no part is to be used without the whole report. All conclusions and opinions concerning the analyses which are set forth in the report were prepared by the appraisers whose signatures appear on the appraisal report, unless indicated as review appraiser. No change of any items in the report shall be made by anyone other than the appraisers and the appraisers shall have no responsibility if any such unauthorized change is made. 19. The signatories of this appraisal report are members (or candidates) of the Appraisal Institute. The By-laws and Regulations of the Appraisal Institute require each member and candidate to control the use and distribution of each appraisal report signed by such member or candidate. 20. No responsibility is assumed for matters legal in character or nature, nor matters of survey, nor any architectural, structural, mechanical or engineering nature. No opinion is rendered as to the title, which is presumed to be good and merchantable. The property is appraised as if free and clear, unless otherwise stated in particular parts of the report. INTRODUCTION ASSUMPTIONS & LIMITING CONDITIONS 21. Comparable data relied upon in this report has been confirmed with one or more parties familiar with the transaction or from affidavit. All are considered appropriate for inclusion to the best of our factual judgement and knowledge. 22. The market value estimated and the cost used are as of the date of the estimate of value. All dollar amounts are based on the purchasing power and price of the dollar as of the date of the value estimate. 23. The identity of the appraisers or firm with which they are connected, or any reference to the Appraisal Institute or to the MAI designation, or to the American Society of Appraisers or to the A.S.A. designation, shall not be divulged without the written consent and approval of the authors. 24. This appraisal expresses our opinion and employment to make this appraisal and was in no way contingent upon reporting a predetermined value or conclusion. The fee for this appraisal or study is for the service rendered and not for time spent on the physical report. 25. The value estimated in this appraisal report is gross without consideration given to any encumbrance, restriction, or question of title unless specifically defined. The estimate of value in the appraisal report is not based in whole or in part upon race, color or national origin of the present owners or occupants of properties in the vicinity of the property appraised. 26. There is no reason to believe that this site has ever been used to process or store any hazardous substance or toxic waste, and the owners have indicated that there are no hazardous substances or wastes on the site. Nevertheless, the appraisers are not engineers or environmental experts, and the appraisal assumption that there are no hazardous substances or toxic wastes on the site should not be construed as an expert conclusion. 27. Unless otherwise stated in this report, the existence of hazardous substances, including without limitation asbestos, polychlorinated biphenyls, petroleum leakage, or agricultural chemicals, which may or may not be present on the property, or other environmental conditions, were not called to the attention of nor did the appraisers become aware of such during the appraisers' inspection. The appraisers have no knowledge of the existence of such materials on or in the property unless otherwise stated. The appraisers, however, are not qualified to test such substances or conditions. If the presence of such substances, such as asbestos, urea formaldehyde foam insulation, or other hazardous substances or environmental conditions may affect the value of the property, the value estimated is predicated on the assumption that there is no such condition on or in the property or in such proximity thereto that it would cause a loss in value. No responsibility is assumed for any such conditions, nor for any expertise or engineering knowledge required to discover them. 28. Unless otherwise stated in this report, we did not make a survey and analysis of the property to determine whether or not it is in conformity with the various detailed requirements of the INTRODUCTION ASSUMPTIONS & LIMITING CONDITIONS Americans with Disabilities Act (ADA). It is possible that a compliance survey of the property, together with a detailed analysis of the requirements of the ADA, could reveal that the property is not in compliance with one or more of the requirements. If so, this fact could have a negative effect upon the value of the property. Since we have no direct evidence relating to this issue, we did not consider possible noncompliance with the requirements of the ADA in estimating the value of the property. 29. ACCEPTANCE AND/OR USE OF THIS APPRAISAL REPORT CONSTITUTES ACCEPTANCE OF THE PRECEDING CONDITIONS. BACKGROUND DATA & ANALYSIS IDENTIFICATION OF SUBJECT PROPERTY Trump Taj Mahal Casino Resort is located at Virginia Avenue and the Boardwalk in Atlantic City, New Jersey. The casino/hotel complex is bounded by the Boardwalk and the Atlantic Ocean to the south, Pacific Avenue to the north, Pennsylvania Avenue to the west, and Maryland Avenue to the east. The property occupies nearly the entire block. On the tax rolls of Atlantic City, the subject property is identified as Block 13, Lots 116, 118.01, 126, 128.03, 128.04, 128.06, 128.07, 128.08, 129.01, 129.02, 129.06, and 142, Block 14, Lots 17, 18, 28, 41, 65, and 67 and various lots in Blocks 119 and 120. The property consists of 29.24 (PLUS OR MINUS) acres of upland improved with 1,250 room within a 51-story hotel/casino complex that containing a total of approximately 4,319,905 square feet of gross building area. Also included is the ancillary parking garage, steel pier, storage warehouses on Delilah Road in Pleasantville and Egg Harbor Township (Block 190, Lot 15 and Block 36-A, Lot 5), and employee parking lot, leased from the City of Atlantic City and is located on North Carolina Avenue and Huron Avenue, known as, Block RP017, Lot 3.4. Maps, a plot plan and photographs on the following pages will visually acquaint the reader with the property appraised, its location, environs, size and shape of the land, plus improvements and other details. [Graphic material omitted. The graphic is a street map depicting The Boardwalk area of Atlantic City. The map shows the locations of the following casinos (from North to South): Showboat, Taj Mahal, Merv Griffin's Resorts, Sands, Claridge, Bally's Park Place, Caesar's Boardwark Regency, Trump Plaza, Trump Regency (Hotel), Trop World and Bally's Grand. The map highlights the location BACKGROUND DATA & ANALYSIS AREA DATA Atlantic County is located on New Jersey's southeastern coast and encompasses a total of 611.4 square miles, with a land surface of 567.0 square miles and water and tidal flow areas of 44.4 square miles. The entire county represents 7.5% of the total area of the state and contains 2.9% of New Jersey's population. Atlantic County's major city, Atlantic City, an older urban resort city which has gone through a long period of decline, began its revitalization when its first hotel-casino opened in May 1978. Trump Taj Mahal Casino Resort, the city's latest and 12th hotel-casino opened in April 1990. During 1991 over 30 million tourists flocked to Atlantic City and an average of 44,200 persons were employed in the county's gaming industry. The gaming industry also is indirectly responsible for most of the noncasino employment growth (nearly 30,000 jobs) the county has experienced since 1978. Three principal roads, the Atlantic City Expressway, the White Horse Pike (Rt. 30) and the Black Horse Pike (Rt. 322), link the shore with the Philadelphia- Camden area. The Garden State Parkway is the major access route from northern New Jersey, New York and the New England states. Persons residing as far south as Norfolk and Richmond, Virginia can travel to Atlantic County by way of the Chesapeake Bay Bridge Tunnel and the Cape-May-Lewes Ferry. Population centers in the Baltimore-Washington, D.C. area have routes such as I-95 which tie in with the Delaware Memorial Bridge connecting New Castle County in Delaware to Salem County in New Jersey. Atlantic City is only some 60 miles from the bridge. BACKGROUND DATA & ANALYSIS AREA DATA In 1989 passenger rail service was restored between Atlantic City and Philadelphia. This includes daily commuter and express schedules. Up until recently, air traffic from the major carriers has been minimal in Atlantic County. However, the Atlantic City International Airport, located in Pomona, adjacent to the Federal Aviation Administration Technical Center (FAATC) in Egg Harbor Township, has the capabilities for handling large aircraft and has been expanding as the number of hotel-casinos has grown. Prior to casino gambling (pre-1978), the county's employment growth rate tracked that of the state. Since the advent of casino gambling, however, the county's rate has remained well above that of the state. The county's service-producing sector accounted for nearly all of the increase in jobs during the 1981-1990 period. The hotel-casinos, which fall within the services subcategory, accounted for most of the 10-year gain, with appreciable job growth also occurring in the business and health services segments. The wholesale and retail trade industry, which experienced job growth every year from 1981 through 1988, leveled in 1989. Trade employment expanded by 29.9% from 1981 through 1990, a little more than the state's 28.0% growth rate in trade jobs over the same period. Employment in the county's transportation communications/public utilities industry advanced at a slightly faster pace than that of the state during the 1981-1990 period (23.9% vs 22. 1%, respectively). BACKGROUND DATA & ANALYSIS AREA DATA In contrast to the other service-producing industries, employment growth in Atlantic County's finance/insurance/real estate industry lagged well behind that of the state during the 1980s. The gain during the 1981-1990 period was a 7.0% advance for the county, well below the state's 46.4%. Atlantic County's goods-producing sectors (manufacturing and construction) recorded an overall decline of 0.6% from 1981 to 1990, compared with a decline of 13.8% for the state during the same period. Of course, the county has a much smaller proportion of manufacturing jobs to total private- sector employment (5.5% in 1990) than the state (19.9% in 1990). In construction, the county and the state have the same share (5.5% in 1990) of employment to total private- sector employment. Construction employment peaked in Atlantic County during the 1987-1989 period and started to drop in 1990 because of the completion of the Taj Mahal Casino Resort and, like the state and nation, because of the onset of the national recession. Atlantic County's factory payrolls declined by 18.5% from 1981 through 1990, with most of the losses occurring since 1989. The county's recent decline primarily can be traced to losses in the apparel, stone/clay/glass, rubber/plastics and transportation equipment industries. Foreign competition tended to be the primary cause behind the long-term declines in the county's apparel and stone/clay/glass industries, as in the state and the nation. BACKGROUND DATA & ANALYSIS AREA DATA The total civilian population in Atlantic County, according to the 1990 census, was 226,700. This represented an increase of 32,600 or 16.8% from 1980 which was more than three times the state's rate of population growth (5.0%) during the same period. Overall, the county ranked fifth in percentage population growth among New Jersey's 21 counties during the 1980s. The county's most significant numeric gains since 1980 were reported in three principal municipalities: Egg Harbor (5,136), Galloway (11,154) and Hamilton (6,513) townships. Countering some of the growth was a population decline of 2,213 or 5.5% in Atlantic City during the 1980-1990 period. In comparison, Atlantic City's population declined by 7,660 or 16% from 1970 to 1980. Factors which contributed to Atlantic City's population decline over the past two decades included: the demolition of some of the city's aging and deteriorated housing stock; the erosion of the city's resort economy through most of the 1970's, and the national trend of population flight from urban environments. A moderate inland shift in population from 1980 to 1990 did not alter the concentration along the shore areas, considering the proximity to the ocean of Egg Harbor and Galloway townships where the major growth has occurred. According to the 1990 census, the total number of dwelling units in Atlantic County was 106,877, up by 17,535 or 19.6% from 1980. The county's housing stock expanded almost twice as fast as the state's (10.9%) during the 1980s. Of the total, about 95,000 units were year-round with the remainder being seasonal units. Single-family, detached homes accounted for the majority of the BACKGROUND DATA & ANALYSIS AREA DATA year-round housing stock (56,002). There also were 36,642 multi-family units and 9,069 single-family attached units. The five municipalities which had the largest number of dwelling units authorized since 1981 were Atlantic City, Brigantine and the townships of Egg Harbor, Galloway and Hamilton. Except for Atlantic City, these communities also experienced most of the population growth since 1980. The availability of seasonal housing and its conversion to year-round use in Atlantic City, Ventnor, Margate, and Brigantine have helped meet the demand for primary housing. Earlier in this decade the fastest selling housing development on the county's mainland were often townhouses or condominiums that were purchased as investments for rental purposes. This trend has slowed in recent years and most units are now purchased as primary residences. The demand for single-family detached homes also has been increasing, fueled in part by the desire of homebuyers to move up to this type of housing. Hamilton, Galloway and Egg Harbor townships have a good deal of land available for development and their proximity to Atlantic City is an asset. Most of the new housing development outside of Atlantic City may well be concentrated in these three mainland areas for many years to come. During the 1981-1989 period (latest data available at the county level), the growth of total personal income was greater in Atlantic County than in the state or nation. This was almost entirely the result of the development of the hotel- casino industry in Atlantic City. The initial investment in these hotel-casinos (construction costs for a single hotel-casino can reach several hundred million BACKGROUND DATA & ANALYSIS AREA DATA dollars), their payrolls and their ongoing purchases of other goods and services have all helped spur income growth for persons in the county. Per capita personal income grew by 77.4% in the county during the period, reaching a level of $23,723 in 1989, which ranked Atlantic 10th among New Jersey's 21 counties. In comparison, per capita personal income in the state and nation increased by 83.1% and 60.7%, respectively. Another income indicator is the annual average wage derived using reports submitted by employers (private sector only) covered under state unemployment insurance program. Contrary to per capita income, which is by place of residence, the annual average wage is by work location. Atlantic County's annual average wage of $22,948 ranked the county 16th in the state in 1990. This was lower than the statewide annual average wage of $28,192. Two factors are largely responsible for the county's annual average wage being lower than the state's. The county has a greater percentage of its employment in the service industry (60% for the county vs 31% for the state) where wages tend to be lower on average. Also, the county's diminishing but still relatively prevalent number of seasonal and other part-time jobs help dilute the annual average wage. Although the volume and percent of unemployed persons in Atlantic County was lower in 1985 (the earliest year for which comparable data are available) than in 1991, a recession year, both fell to the lowest levels in 1988, a boom year, when the unemployment rate averaged 4.9%. The slowing of economic growth in both the state and nation, which culminated with the onset of the current recession in July 1990, was responsible for the cyclical upturn in joblessness through 1991. BACKGROUND DATA & ANALYSIS AREA DATA With this slowing pace of economic development in Atlantic County and the surrounding area, the average rate of unemployment rose from 5.8% in 1990 to 8.3% in 1991 and continued at high levels into early 1992. The rise was even more pronounced than the statewide increase from 1990 (5.0%) to 1991 (6.6%). This increase in both Atlantic County and the state is the result of the recession that partially resulted from a slowdown in unsustainable high levels of economic activity during the late 1980s in the region, especially in the hotel-casino industry. Although both the nation's and the state's economic boom, together with the local hotel-casino industry growth, had pushed the annual average rate of unemployment below 6.0% in Atlantic County during the 1987-1990 period, the number of unemployed has tended to remain relatively high compared with the state due to several factors. Atlantic County still experiences seasonal variation in employment which keep the number of unemployed higher on average than areas with little seasonal variation. During the peak summer months of July and August, the county's labor force and total employment are 20% -25% above the winter lows. Tourism and agriculture are the two sectors of the county's economy most affected by seasonal factors. The area is served by two airports, Bader Field in Atlantic City and the International Airport in Pomona. Both airports have a master plan in effect. The end result could be regularly scheduled airline flights by all the major carriers by the mid 1990s. The implementation of regularly scheduled airline flights will have a significant positive impact on the area. BACKGROUND DATA & ANALYSIS AREA DATA The first phase of the Airport Master Plan has been released and calls for $46 million in new facilities and upgrading at Pomona and $5.5 million for Bader Field. The renovations will allow for scheduled air service to Atlantic City from major airlines. Atlantic County is served by a vast network of highways and secondary roadways. The Garden State Parkway is the major north/south roadway through the region, while the Atlantic City Expressway is the major east/west thoroughfare. Other major roadways through the region are Routes 9, 30, 40, and 322. The New Jersey Highway Authority has recently announced plans to widen sections of the Garden State Parkway and to increase the number of toll booths in order to improve traffic flow on the southern end of the highway. The existing four- lane highway is planned to be widened to six lanes and additional improvements will be planned for the highway's intersection with the Atlantic City Expressway. The Atlantic City Expressway has been widened from four to six lanes between Winslow and the Pleasantville Toll Plaza. This $28.3 million project was completed in December 1987. In addition, the Authority is committed to extending the third lane into Atlantic City in conjunction with the development of the Convention/Rail Service Center. Atlantic County has proposed the construction of a beltway from the Garden State Parkway near Smithville southwest to U.S. Route 30, past Pomona Airport and the BACKGROUND DATA & ANALYSIS AREA DATA before rejoining the Parkway. The limited-access highway is expected to relieve congestion in the mainland areas near Atlantic City. Approximately $55 million will be spent under a joint public-private venture for significant improvements on U.S. Route 30 and Route 87 within Atlantic County. Construction of these improvements began in the fall of 1985, and is ongoing at the present time. As previously noted, plans to develop the Convention/Rail Terminal at the Atlantic City Expressway are now progressing. Plans call for the convention complex to be located on a 30.5 acre site across from the rail terminal and parking facility and connected by an open atrium. In total, the proposed complex will include 486,600 square feet of contiguous exhibit space, making it comparable to most of the largest convention centers in the United States. The new Convention Center will also include parking facilities for up to 40 buses, a multi-level parking structure for approximately 1,600 cars, restaurant and retail facilities, and direct linkage via an overpass to the Atlantic City Expressway. Groundbreaking for the convention center was on February 24, 1993. It is expected to be completed by February 1996. While the local economy would no doubt benefit from a sustained national rebound in consumer confidence and spending during 1994, Atlantic County is at a unique period in its economic history because little growth is expected in the hotel- casino industry for at least the next several years. The BACKGROUND DATA & ANALYSIS AREA DATA casino gaming industry's sometimes painful transition from a rapid early growth phase to a consolidating or maturing phase should continue in 1994 and for the next several years. Over the past 13 years, both the pattern and pace of economic development in Atlantic County has been tied either directly or indirectly to casino gambling. Troubled times for the gaming industry, an industry which now accounts for about one of every three jobs, usually causes similar ripples throughout most sectors of the local economy. Overall, the gaming industry's level of employment should stabilize at current levels or show only marginal gains during 1994. Elsewhere in the local economy, little, if any, employment growth is expected and will depend almost entirely on a rebound in consumer spending, especially for the trade, services and construction industries. Atlantic County's rate of unemployment may begin to gradually fall in 1994, if the economic recovery takes hold at both the national and state levels. Developments that are necessary to the future well-being of the county's tourism, convention and gambling industries include: clean beaches, a new Atlantic City Convention Center and a revitalized Atlantic City Airport (4/93). BACKGROUND DATA & ANALYSIS AREA DATA Retail Sales and Buying Power Index (BPI) 1990 retail sales ($000) $2,135,828 % Change 1990 - 1995 6.3% Information was obtained from The Survey of Buying Power Demographics USA 1991 [Graphic material omitted. The graphic is a map depicting the major roads in Southeastern New Jersey. The map highlights the location of Atlantic City.] BACKGROUND DATA & ANALYSIS ATLANTIC CITY DATA Atlantic City is part of Absecon Island which is located in the southeastern portion of Atlantic County. The total area of Atlantic City is 11.84 square miles. Atlantic City is located approximately 125 miles south of New York City, 60 miles east of Philadelphia, and 175 miles north of Washington D.C. The City was incorporated in 1852, and soon afterward became world renowned as a resort town. In 1870, the first boardwalk was constructed, and in 1929, Atlantic City built the world's largest convention center and became almost fully dependent on tourism. The tourism industry prospered for many years and then gradually started to decline, and by the 1960s the area had become depressed. In 1977, when the Casino Gambling Act legalized gaming in Atlantic City, the stagnant tourist industry began to flourish. The legalization of gaming in Atlantic City has brought unprecedented growth and development to Atlantic City and to Atlantic County. As of 1991, gaming has added approximately 44,200 casino related employees, a drop from 2,500 from 1990. The dramatic impact that the gaming industry has had on revenues can be illustrated by analyzing the revenue it has generated for the State of New Jersey and for Atlantic City. Since 1979, gaming has generated $211,500,000 in reinvestment obligations for Atlantic City. BACKGROUND DATA & ANALYSIS ATLANTIC CITY DATA The CRDA (Casino Reinvestment Development Authority) was established to counteract the deteriorated portions of Atlantic City. This department is funded by the casino industry by contributing 1.25% of gross casino revenues minus bad debt. The executive director of the CRDA expects what he called a balanced residential community to emerge in the Inlet which has been the most rundown area of the city. He expects this transformation to occur in 5 to 7 years. Over the next 25 years it is expected that the casino industry will have contributed over 2 billion dollars to Atlantic City. It is expected that the reinvestment obligations that are funded by the casino industry, will improve the city's rundown areas dramatically. Since the first casino opened in 1978 through the end of 1992 the casino revenue tax has generated over $2,600,000,000 in revenues for the State of New Jersey. The operating casinos contributed approximately $106,000,000 in property taxes for Atlantic City and Atlantic County in 1992. This amount represented nearly 30.00% of the total taxes paid in Atlantic City in 1992. Since 1978, the Casino Industry has contributed approximately $4,850,000,000 in total taxes including New Jersey Casino Revenue Tax, Atlantic City and Atlantic County Property Tax, Federal Income Tax, Social Security, State Corporate Tax, Federal and State Unemployment Tax and Regulatory Fees and Reinvestment Obligations. A positive development for Atlantic City's hotel-casino industry occurred in June 1991 when significant changes to the Casino Control Act were signed into law. In the long run, the much BACKGROUND DATA & ANALYSIS ATLANTIC CITY DATA anticipated changes are expected to expand Atlantic City's casino market and spur growth in the region. The most notable changes allow round-the-clock gambling on weekends, holidays and other special events; permit slot coverage of the casino floor to increase to 45% over the next three years; and allows three new games of chance. Gaming industry officials indicate that surge in gaming revenues during the third quarter of 1991 was at least partially due to these new regulatory changes. Even though the number of visitors to Atlantic City, as calculated by the New Jersey Expressway Authority (NJEA), declined for the fifth year in a row during 1993, an estimated 30.0 million visitors traveled to Atlantic City in 1993. Cars and buses still formed the bulk of the travelers, despite the casinos' efforts to broaden their market beyond those who can arrive within a day's drive. City and tourism officials attributed the 3.2% drop in the number of visitors from 1990 to the recession, and in the first half of 1991, to the Gulf War. However, the decrease in visitors did not affect the gross gaming revenues of the casinos, which was $3.23 billion in 1992, an 8.06% increase over 1991. 1993 gross gaming revenue of the casinos was $3.287 billion, a 1.69% increase over 1992. According to the Atlantic City visitors and convention bureau, the 1993 decline is the result of fewer charter bus passengers, as part of the casino marketing program. BACKGROUND DATA & ANALYSIS ATLANTIC CITY DATA While the implementation of the Amtrak and PATCO lines will have a substantial impact on the area, major plans for airport expansion are also underway. $46 million improvements project are underway. Serving all of Southern New Jersey and located just 10 miles outside of Atlantic City, Atlantic City International Airport has regularly scheduled flights by major carriers such as: Continental, US Air, Northwest and Spirit, with service from over 75 major cities. The master plan which is in effect, could eventually lead to regularly scheduled airline flights by most major carriers. As noted in the area data section of this report, the Amtrak Express trains are operational, and provide non-stop service between Philadelphia and Atlantic City. Construction of the $15 million rail terminal is the final step in an overall $101 million rail project which is rebuilding the 67 miles of tracks connecting Atlantic City and Philadelphia. The 22,000 square-foot rail terminal will include five tracks and three platforms capable of handling 12-car trains and facilitating an estimated 1,900 passengers per hour during peak operating hours and some 2.2 million travelers a year. Amtrak will operate five daily round-trip express trains between the resort and Philadelphia's 30th Street Station, and six on weekends, plus one daily non-stop to and from New York and Philadelphia which will allow connections to virtually the complete Amtrak nationwide rail system. BACKGROUND DATA & ANALYSIS ATLANTIC CITY DATA Parking for 250 cars will be offered at the rail terminal, and its 14,000 square-foot concourse will include seating for 200 people, ticket facilities and restaurant and newsstand concessions. Atlantic City's new convention and exposition center, when it opens in 1996, should significantly increase the resort's capabilities in attracting new convention and trade show business. The convention center will contain a total of 510,000 square feet of convention space, including 486,600 square feet of continuous exhibit halls, a 32,000 square foot multipurpose room, 104,200 square feet of meeting rooms and 20,000 square feet of ancillary facilities. The entire Convention Center is expected to be ready by February 1996 and will have a substantial positive impact on Atlantic City. Recent studies by the Atlantic City Convention and Visitors Bureau favorably reflect on both convention industry interest in the new facility and its capability of accommodating major shows currently not considering the resort. The shows which will be utilizing this new facility represent 1.1 million delegates generating a national average of $787.54 apiece over four days, or more than $866 million, including $177 million in hotel room revenue and $11 million on convention center rental fees, with the balance expended on items such as food, shopping and entertainment. Atlantic City's convention and trade show industry is enjoying dramatic growth. While gaming has brought Atlantic City back on the path of economic growth and development, there are still major social and economic problems to be overcome. BACKGROUND DATA & ANALYSIS ATLANTIC CITY DATA positive impact of the gaming industry on employment in Atlantic City, the casino reinvestment obligations that are beginning to transform the blighted portions of the city, the in-progress improvements to the transportation network, and the emergence of a more broad based local economy, it is our opinion that Atlantic City is on the path to long term economic growth and development. BACKGROUND DATA & ANALYSIS NEIGHBORHOOD DATA A property is an integral part of its surroundings and must not be treated as an entity separate and apart from its environment. The value of a property is not found exclusively in its physical characteristics. Physical, economic, political and sociological forces found in the area interact to give value to a property. In order to determine the degree of influence extended by these forces upon a property, their past and probable future trends must be analyzed in depth. Therefore, in order to determine the value of a property, a careful and thorough analysis must be made of the area in which is found the property under study. This area is commonly referred to as a neighborhood. A neighborhood can be a portion of a city, a community, or an entire town. It is usually considered to be an area which exhibits a certain degree of homogeneity as to use, tenancy and other characteristics. Homogeneity is a state of uniform structure or composition throughout. Therefore, in real estate terminology, a homogeneous neighborhood is one in which the property uses are similar. The subject property is located at the Boardwalk between North Carolina Avenue and Pennsylvania Avenue in Atlantic City. The neighborhood can be delineated by the Boardwalk and the Atlantic Ocean to the south, Pacific Avenue to the north, New York Avenue to the west, and New Jersey Avenue to the east. The subject property fronts on the Boardwalk which was the main tourist attraction in Atlantic City until the introduction of gaming in 1978. The Boardwalk runs the entire length of Atlantic City along the beach from the Absecon Inlet to the western city limit at Ventnor. The BACKGROUND DATA & ANALYSIS NEIGHBORHOOD DATA Boardwalk is now the center casino area in Atlantic City, and is improved with casinos, hotels, restaurants, piers, and various other tourist orientated support facilities. The Atlantic City convention center is also located on the Boardwalk west of the subject property near Trump Plaza. The main east and west roadways running near the beach block of Atlantic City are Atlantic and Pacific Avenues, which run parallel with the Boardwalk. Both roadways are within 2 blocks of the Boardwalk. The advent of gaming in the area has led to rapidly escalating land prices for area zoned for casino use. The casino zoning district is located along the beach block running from Maryland Avenue, west to Albany Avenue. The northern boundary is Pacific Avenue, while the southern boundary is the Boardwalk. Two other small areas zoned for casino use are located by the Absecon Inlet and the Marina Area. A casino site, which requires a minimum of 2 acres area, can now command land prices in the $200-$300 per square foot range. Typical land uses within the area are restaurants, older hotels, condominiums, apartments, and other assorted residential and commercial uses. While there is new and planned development, many of these improvements are in deteriorating condition. Although much of the area is in need of revitalization, the casinos have spurred additional commercial and residential development and will eventually lead to long term economic growth in the neighborhood. Trump Taj Mahal Casino Resort is next to the Showboat and Resorts. The opening of the Taj Mahal benefitted the neighborhood by giving it the two newest casinos BACKGROUND DATA & ANALYSIS NEIGHBORHOOD DATA Resort and Showboat). Additionally, there are four piers located within four blocks of the subject property. They include the Garden Pier, the Steel Pier, the Steeplechase Pier, and the Central Pier. To the west of the subject property is currently the main Boardwalk casino area. This area is bounded by Brighton Avenue to the west, and Indiana Avenue to the east. This area spans approximately 15 blocks and includes casinos such as The Sands, The Claridge, Bally's Park Place, Caesars Boardwalk Regency, Trump Plaza, and the Tropicana. Since the opening of the subject property, this area of the Boardwalk become more of a center point of the casino district than it was, due to the large concentration of hotel rooms, convention space, and casino space. The opening of the Taj Mahal have had a significant impact on the casino industry in Atlantic City. In addition to the 120,000 square foot casino, Trump Taj Mahal Casino Resort added approximately 1,250 hotel rooms and 230,000 square feet of convention space to this section of the Boardwalk. The concentration of hotel rooms and convention space added by the Taj Mahal spurred additional development and renovations which have a positive impact on property values and property utilization in the neighborhood. Based upon current, as well as proposed developments in the neighborhood, it is our opinion that area has passed the point of decline and is headed for a period of revitalization. Four great forces influencing value include social, economic, environmental, and governmental forces. We were unable to detect any detrimental factors from any of these forces. Therefore, it is our opinion that the neighborhood will continue to exert a positive influence on property values and continue to remain economically viable into the foreseeable future. [Graphic material omitted. The graphic is a map depicting Ventnor City and Atlantic City. The graphic depicts the locations of (from West to East): Atlantic City Convention Center, Bally's Grand Hotel and Casino, Trop World Casino and Entertainment Resort, Trump Regency Hotel, Trump Plaza Hotel and Casino, Caesar's Atlantic City Hotel and Casino, Bally's Park Place Hotel and Casino, Claridge Hotel and Casino, Sands Hotel and Casino, Merv Griffin's Resorts Hotel and Casino, Taj Mahal Hotel and Casino, Showboat Hotel and Casino, Trump Castle Hotel and Casino and Harrah's Marina Hotel and Casino. The graphic highlights the location of the appraised property.] BACKGROUND DATA & ANALYSIS SITE DESCRIPTION LOCATION: Trump Taj Mahal Casino Resort is located at Virginia Avenue and the Boardwalk in Atlantic City, New Jersey. The casino/hotel complex occupies the majority of the land extending from Pacific Avenue to the Boardwalk and from Pennsylvania Avenue to Maryland Avenue. The employee parking area leased from the City of Atlantic City is located on North Carolina Avenue and Huron Avenue and the warehouses are located in Pleasantville and Egg Harbor Township. BLOCK/LOT: Hotel and Casino - 13/116, 118.01, 126, 128.03, 129.01, 129.02, 129.06, and 142 14/17, 18, 28, 41, 65, and 67 and various lots in Blocks 119 and 120. Employee Parking - RP017/3.Y (Leased) AREA: The subject parcel consists of a main tract of 29.24 (PLUS OR MINUS) acres; a separate, but adjacent lot containing 1,360 sq. ft. or 0.03 acres; and a riparian grant of 9.76 acres. The total area of all three parcels is 39.0 acres. However, 1.96 (PLUS OR MINUS) acres of Block 13, Lots 128.06 and 142 and 2.05 (PLUS OR MINUS) acres of Block 13, Lots 128.03, 129.06, and 129.02 are land locked service roads and streets for the benefit of the subject and others. SHAPE: The main parcel is irregular in shape FRONTAGE: The main parcel has a total frontage of 625' on Pacific Avenue (interrupted by Virginia Avenue - 80' wide) and former Presbyterian Avenue (20' wide) both of which proceed into the subject parcel to depths of 558' and 262', respectively. There is also 1,460' of frontage on Pennsylvania Avenue from Pacific Avenue to the Boardwalk and 952.27' along the Boardwalk. A portion of Virginia Avenue, that has not been vacated, serves a BACKGROUND DATA & ANALYSIS SITE DESCRIPTION separate property, the "Best of Life" Apartments (a senior citizen complex - not part of the subject property), which is almost surrounded by the subject. Maryland Avenue vacated in 1983, is now a service road for the benefit of the subject and others. A tunnel, that runs from the end of Pennsylvania Avenue, underneath the subject, to former Maryland Avenue is used for one-way traffic from Pennsylvania Avenue back out to Pacific Avenue. TERRAIN: Predominantly level and at road grade. We have not commissioned nor conducted any soil or subsoil studies. However, based on the existence of the subject, as well as neighboring structures, the soil load bearing qualities appear adequate. UTILITIES: All municipal services, public and private utilities are available to the site including police protection and fire fighting services, electric, storm and sanitary sewers, water, gas telephone, and cable television. ACCESS: The site is accessible from public right-of-ways. Vehicular ingress and egress is available from Pennsylvania Avenue (80 feet wide), Virginia Avenue (80 feet wide) and Maryland Avenue. In addition to the above mentioned streets, pedestrian ingress and egress is available from the Boardwalk. EASEMENTS: Typical utility and public easements run through the site. None of these easements, however, have an adverse impact on value. FLOOD HAZARDS: The site is located in the F.E.M.A. Firm Zone A-8, as designated by the National Flood Insurance Program-Firm Insurance Rate Map for the City of Atlantic City, Atlantic County, New Jersey, Community #345278. REMARKS: An additional small lot is located just past the northeast corner of the main parcel and is almost rectangular in shape with 17' of frontage on Pacific Avenue; sidelines of 80'(PLUS OR MINUS) and a rear line of 17'. It is used as part of a roadway providing public access to the Beach and an exit area for Showboat. LOT 42 IN BLOCK 14 IS A LEASEHOLD. The riparian grant for the Steel Pier is 150' wide and extends 2,835' from the subject, across the Boardwalk, into the Atlantic Ocean to the Pierhead Line BACKGROUND DATA & ANALYSIS SITE DESCRIPTION February 20, 1933. However, only 150' x 1,002' (PLUS OR MINUS) can be, and is being used, and the public has certain rights to use the pier and the beach and water below. In addition, there are the following: an easement 60' x 150' permitting a skyway above the Boardwalk; an easement over Pennsylvania Avenue used to connect the Trump Taj Mahal Casino Resort that is 40' x 80' (Block 14, Lot 67.02); two other, unused easements over Pennsylvania Avenue that are each 30' x 80'; and an easement for the tunnel at the end of Pennsylvania Avenue. The subject property's site, including utilities and improvements, is considered typical for the neighborhood area. There were no adverse encroachments, or detrimental off site conditions noted. Routine inspections and questions concerning the subject property did not reveal any hazardous toxic conditions. However, the appraisers are NOT experts in the identification of toxic or hazardous conditions. Therefore, if a definitive evaluation is required, the client or reader is advised to seek the services of an expert. BACKGROUND DATA & ANALYSIS SITE DESCRIPTION [Graphic material omitted. The graphic is a site plan that depicts the area bounded by Pacific Avenue to the North, The Boardwalk to the South, Maryland Avenue to the East and Pennsylvania Avenue to the West. The graphic includes Block 13, Block 14 and the vacated portion of Virginia Avenue.] BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS Trump Taj Mahal Casino Resort is improved with a multi-story, multi-building casino/hotel complex that opened April 2, 1990. It consists of a low rise section that houses the casino, restaurants, shops, offices, ballrooms, conference rooms, back of house uses, hotel lobby, lounges, a health spa, an arena, and a theater. The low rise tower is the building base and contains all common facilities. The Casino area is located in the central southeast portion of the building with access from the Boardwalk, the hotel lobby, restaurants and the Steel Pier Area. This area is 120,000 square feet of actual gaming area with an additional 34,162 square feet for casino support. The restaurant section of the complex is primarily located in the southwest corner, however, restaurants and lounges are scattered throughout the complex in strategic locations, where pedestrian traffic is the highest. The restaurant section in the southwest corner contains an Italian restaurant with seating for 300 (Marco Polo), an Oriental restaurant which seats 185 (Dynasty), a Continental restaurant which also seats 185 (Scheherazade), a Steak House with seating for 200 (Safari Steakhouse), and the Food Bazaar, which have seating for 500 (Sultans Feast). In addition, Trump Taj Mahal Casino Resort offers Sinbad's (a seafood restaurant) new Delhi Deli, the Bombay Cafe, Gobi Dessert, Rock 'n Rolls (1950's Themal Super Diner) and Koo Koo Roo (a chicken restaurant). BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS There is a hotel tower that contains guest rooms and suites; 2 parking garages; and a pier, located across the Boardwalk, which is improved with a 2 story building (partially completed) attached to the main complex by an enclosed bridge. LOW RISE TOWER CASINO & RESTAURANT The low rise area is 3 to 7 stories and contains most of the casino and hotel facilities except for a majority of the guest rooms, and some offices. Basic construction consists of a fire-proofed steel frame; poured concrete floors; and an insulated, poured concrete roof deck with a rubber membrane surface except that the roof over the ballroom is insulted metal panel. Exterior walls consist of prefabricated panels constructed of heavy gauge metal studs; exterior gypsum board, rigid insulation; and Dryvit plaster. They are decorated with signs, lights, and fiberglass ornamentation. The ground floor contains the casino; hotel lobby; porte cochere; various restaurants and related service areas; shops; back of house uses; and mechanical and storage rooms. The new Oasis Lounge in the hotel lobby is currently under construction. The casino of 120,000 sq. ft. is highly irregular in shape (See diagram). Finishes include carpeted floors; mirrors and various other wall coverings; chandeliers and fixtures with incandescent lights. The ceiling is mirrored, observation windows or decorative acoustic block, and numerous, covered surveillance cameras. According to the Trump Organization, at the end of January 1994 there were 3,158 slot machines and 212 table games divided as follows: 99 blackjack, 20 craps, 4 big six, 21 roulette, 4 baccarat, 4 BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS other slot machines. There are a total of 3,158 slot machines, including 155 nickel machines, 1,982 quarter machines, 315 fifty-cents machines, 619 dollar machines, 79 five dollar machines, 5, $25 machines and 3, $100 machines. It should be noted that due to the shape of the casino, the required width of the aisles and the location of the exits, the use of stools, and the source and amount of traffic affect the number and placement of machines and tables. In addition, there are change booths, cashier counters, security and Casino Control Commission offices, and the 1,200 seat, The Casbah Lounge. The remaining public areas including hotel lobby, corridors, restaurants, and shops all have high grades of finish including marble and carpeted floors, various types of wall coverings including marble and fabric; and decorative acoustic ceilings with crystal chandeliers and high hat lighting. Adjacent to the casino is the Mark G. Etess Arena, a 63,000 sq. ft. facility (plus a 16,950 sq. ft. prefunction lobby) that is used for conventions, trade shows, concerts, and sporting events. It has a banquet capacity of 5,000 people and a seating capacity of approximately 6,000, depending on layout (4,000 seats are available by 12 movable, motorized folding bleachers). In addition, there is a stage; 8 dressing rooms, 6 VIP/press booths; 15,625 sq. ft. staging area; and 14,000 sq. ft. of storage. Back of house facilities include hard and soft count room; coin and chip storage; miscellaneous offices; a dealers' lounge; and storage areas. Finishes are generally sealed concrete and composition tile floors; painted sheetrock walls and acoustic panel ceilings with recessed fluorescent lighting. The restaurants are serviced by 4 kitchens which have quarry tile floors; stainless steel counters; and acoustic panel ceilings with recessed fluorescent lighting. BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS The first level mezzanine contains various offices; storage areas; a surveillance room that is approximately 26' x 32', which has a raised computer floor and halon fire extinguishing system and metal catwalks that cover the casino floor and are used for surveillance through mirrored glass. The second floor is divided into 3 ballrooms; meeting rooms, restaurants; shops; offices; and service area. The ballrooms can be divided by pocket doors into a maximum of 9. In addition, there are 10 separate meeting rooms, divisible into 16 units and 4 restaurants and 1 lounge with finishes of good quality that vary with their theme. These areas are serviced by 4 separate kitchens, a service bar, and a banquet kitchen. Also on this level is 22,771 sq. ft. of retail space, divided into 8 separate upscale shops and a salon; 10,725 sq. ft. of offices including the executive offices with a high grade of finish; and various storage and mechanical rooms. The second floor mezzanine is divided into 3 meeting rooms containing a total of 1,740 sq. ft.; a 916 sq. ft. prefunction room; a restaurant and kitchen; a shop; and various offices. "Level 14" (the numbers between 2M and 14 are not used) has the hospitality suites, Lanai Suites, health spa, day care center, video arcade, offices, and mechanical and storage rooms. The hospitality suites (7) are designed for entertainment and have an oversized parlor, bar, outdoor area, and bathroom. They are roughly 2,100 sq. ft. and sleeping arrangements are available by connecting, adjoining bedrooms. The Lanai suites (50 on two floors) contain 1,000 to 1,500 sq. ft. and have 1 or 2 bedrooms, a living room with dining area, BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS and a bar. All of the suites have high grades of finish. The health spa contains 10,184 sq. ft. (plus an 11,484 sq. ft. enclosed pool). The fitness portion is divided into 3 sections for weights, cardiovascular equipment, and aerobics. Finishes include carpeted floors, mirrored and painted walls, and acoustic panel ceilings. Men's and women's locker rooms have lockers, a whirlpool, sauna, steam room, and massage room. There are shower stalls, sinks, and toilets. The hotel portion of the structure tower 38 stories on top of the base and four hundred and twenty-nine feet above sea level. This portion of the building is designed for 1,201 rooms of the 1,250 total. Total square footage for the hotel section is 1,002,173. The rooms contain high quality furniture, fixtures and amenities. The room count is as follows: King 247 (28 are not in the tower) Lanai Suites 21 (not in tower) BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS Basic construction of the tower consists of a fire proofed steel frame; precast, prestressed concrete plank floors with a poured concrete top coat; and a heavy steel truss roof with an insulated concrete deck and rubber membrane surface. Exterior walls are prefabricated aluminum panels and insulated, vision and spandrell glass. Floors 14-38 are "standard" floors while levels 39-51 are considered "upgraded", with a higher quality of corridor and room finish. The standard corridors are finished with carpeted floors (the elevator lobby's floor is marble); vinyl covered walls; and painted ceilings with incandescent lights. The rooms have carpeted (marble in the bathrooms) floors; vinyl, covered walls; and stuccoed ceilings. The upgraded floors use better grades of marble and carpet; mirrors and polished metal; and more lights. There are 10 different types of units including 4 of guest rooms and 6 of suites. Guest Rooms - The 4 room types, averaging 465 sq. ft. each, have similar layouts and have either a king size bed or 2 doubles. There are standard and upgraded styles. Viceroy Suites - "L" shaped mini-suites containing 660 (PLUS OR MINUS) square feet with sleeping and living/dining are and a 3 fixture bathroom. Sultan Suites - 2 1/2 room suites containing 1,200 (PLUS OR MINUS) square feet. Each has a parlor and dining area; a master bedroom with a whirlpool bath; a bathroom; and a powder room. Raja Suites - One or two bedrooms suites containing 1,400 (PLUS OR MINUS) square feet. The units are divided into a living room with dining area; a master bedroom with a whirlpool bath; a master bathroom with a tub, stall shower, sink and toilet; a foyer with a bar; and a powder room. If a second bedroom is required, an adjacent guest room is used. BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS Lanai Suites - One and two bedroom suites which range from 1,000 to 1,500 sq. ft. These contain a living room with dining area; a bar area; master bedroom with a whirlpool bath; a master bathroom; and a second bathroom. Hospitality Suites - These units are designed for entertaining but can be used for sleeping by attaching an adjacent guestroom. They are approximately 2,100 sq. ft. and can accommodate 50 people. The rooms contain a bar area, sitting areas, greenhouse enclosure, and a lavatory. Each unit is individually finished with an animal theme. Penthouse Suites - These are large suites named and styled after famous historical figures. They have high grades of finish. All, except one, have two bedrooms, one or two bathrooms, a whirlpool, sauna, dining room, bar, and lavatory. TYPICAL GUEST ROOM - KING Each room is finely appointed with decorative wall coverings, matching bed spread and curtains, rugs, mirrors and paintings. The furniture includes (1) king size bed, (4) lamps, (1) six drawer low dresser, (1) desk and chair, (1) love seat, (1) reading chair, (3) night stands and end tables, telephone and television. TYPICAL GUEST ROOM - DOUBLE Each room contains (2) double beds, (1) high rise dresser, (2) lamps (2) reading chairs, a small table and all the other amenities mentioned under King. BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS Each suite is decorated slightly differently, however, most contain several couches, chairs, lamps and tables. They also contain widescreen television, wet bars, pantries and in most cases spas. The master bedrooms have the king sized beds on a riser, a built in canopy over the bed and access to the outside balcony via sliding glass doors. The floors are carpeted and the walls are papered. The trim in the rooms is chrome or brass. On the 49th and 50th floors is the two level Maharajah Club (access by invitation only). It contains 6,500 sq. ft. and serves as a private club. There is a bar on each level and food is available. The entire hotel/casino facility is protected by fire alarms and sprinklers. Heating and cooling is supplied to the complex by a central steam and chilled water system. There are eight, 700 horsepower oil/gas fire, Cleaver Brooks boilers and eight chillers. The water is then distributed to individual HVAC units in each of the guest rooms and 120 air handlers located in other areas of the complex. The guest rooms are all connected to a computer system that allows the reservation desk to individually adjust room temperatures, as needed, prior to patron arrivals. In the low rise there are 6 passenger elevators; 4 service elevators, 4 freight elevators; 3 dumbwaiters; one 500 lb. platform lift; and 21 escalators. The hotel tower has a bank of 12 elevators (serve all levels); an additional passenger elevator; and 5 service cars. BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS The following pages refer to the complex's vital statistics and electrical, heating and safety features. BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS The TERRACE BUILDING is a 30 (PLUS OR MINUS) year old, 11 story structure that has a total floor area of 64,147 sq. ft. It was formerly a hotel, 10 floors of which are used as offices; one has rooms for employees. Basic construction consists of a steel frame with brick veneered exterior walls; concrete floors; and a flat roof deck. It is sprinklered and HVAC is supplied by the main, complex plant. The ground floor has an entrance lobby, offices, and two, 2,000 lb. Otis passenger elevators. The upper floors, in general, have a center corridor with rooms off of each side. Finishes are, generally, carpeted floors; vinyl covered and painted walls; and acoustic panel ceilings with recessed fluorescent lighting on the floors which are used. Overall, this structure is in fair condition and is in need of extensive renovations and reconstruction. BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS The THEATER BUILDING (Xanadu) is a 3 story structure containing a total gross area of 113,429 sq. ft. Construction began in March, 1989 and stopped in November, 1989. The project was then mothballed until February, 1992 when it was then renewed. Basic construction consists of a fireproof frame with dryvit exterior walls; concrete floors; and a flat roof deck. Development plans show the ground level divided into a 3,328 sq. ft. restaurant with a 1,152 sq. ft. kitchen; a 3,367 sq. ft. lounge; offices; stage support areas; dressing rooms; storage; and men's and ladies lavatories. A first floor mezzanine house support areas. The second level contains the 13,488 sq. ft. theater. There is a stage area with seating in front; scaffolding for lighting; and a mezzanine area for control rooms. Also, there is a bar area to serve the showroom. The structures have 1 passenger elevator, 1 service elevator, 1 freight elevator, and 4 escalators. The SELF PARKING GARAGE is a twelve-story parking structure containing 1,233,204 sq. ft. with a capacity of 2,930 cars. Basic construction consists of a concrete frame with precast, prestressed concrete panel floors and partial walls. The ground floor is for an entrance and exit, facility vehicle parking, a 6 bay loading dock, storage, staging areas, and a 1,090 sq. ft. office. The upper levels are used for parking and 32 cooling towers. There are 6 passenger elevators. The VALET PARKING AREA is an eight-story parking garage containing 416,550 sq. ft. with a capacity of 1,608 cars. Basic construction consists of a concrete BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS floors and concrete partial walls. The ground floor is used for a 5 bay loading dock and service areas. There are 3 passenger elevators. The STEEL PIER is located across the Boardwalk from the hotel/casino complex. It is 150' (PLUS OR MINUS) wide and extends 1,002.60' across the beach and into the Atlantic Ocean or a total surface area of 150,390 (PLUS OR MINUS) sq. ft. Basic construction consists of concrete columns and a flat, tier concrete deck. Ramps connect the different levels. Chain link fencing runs around the perimeter of the entire pier and across each section. A majority of the area is open and has been used for special events. The ocean end has lighting, fencing, and painting for a helipad. In addition, there is a small, movable, modular structure which was used as office space. A blocked off, stub tunnel under the Boardwalk extends out from the vehicular tunnel that goes from Pennsylvania to Maryland Avenues. It was to connect to a ramp to be built east of the present pier for access to the pier. The land over which it was to go has reverted to the City. There is a 2 story building at the end closest to the Boardwalk. Basic construction consists of a fireproofed steel frame; Dryvit exterior walls; concrete floors; and a flat roof deck. An enclosed bridge provides access from the hotel/casino complex, across the Boardwalk, to the second level of the building. The ground floor is entered from the Boardwalk - there are no stairs or elevators between the two stories. The ground floor level contains 2, unfinished, 40' high, areas used for storage and bike rental of 1,830 (PLUS OR MINUS) square feet and 2,700 (PLUS OR MINUS) square feet with a passageway between for access to the remainder of the Pier. The upper level is also; unfinished and was intended for BACKGROUND DATA & ANALYSIS DESCRIPTION OF IMPROVEMENTS use as a restaurant. However, it has not been needed nor is it intended to be finished as such in the immediate future. The building known as the "SOCIAL SECURITY BUILDING" located at N/E/C of Pacific Avenue and Pennsylvania Avenue (Block 14, Lot 17), has been demolished. It was finished for offices and utilized by the Taj Mahal for personnel offices until its demolition in the spring of 1993. Generally, zoning looks to the future as a result of planning. Its purpose is to promote and maintain a degree of homogeneity in the use of real estate within the confines of a given geographic, political subdivision. The Appraisal Institute in their book, "The Dictionary of Real Estate Appraisal" - third edition (page 399) have defined zoning as: "The public regulation of the character and extent of real estate use through police power; accomplished by establishing districts or areas with uniform restrictions relating to improvements; structural height, area, and bulk; density of population; and other aspects on the use and development of private property." The casino hotel is located within the RSC-Resort Commercial District of Atlantic City. Portion of the site, (Approx. 17 (PLUS OR MINUS) acres) are in the Urban Renewal Tract. The purpose of this district is to provide for the City's main industry, consisting predominantly of casino and other transient and tourist oriented uses. BACKGROUND DATA & ANALYSIS ZONING DATA Some of the bulk regulations of this district are as follows: Minimum Lot Area 2 Acres Minimum Lot Width 150 Feet Minimum Lot Depth 150 Feet Minimum Front Yard 0 Feet (Along Boardwalk) Minimum Front Yard 10 feet (along Public streets) Minimum Side Yard 0 Feet Minimum Rear Yard 0 Feet Maximum Building Height 385 feet above sea level Parking Requirements: 1 space/hotel room for first 500 rooms; 1 space/2 rooms beyond 500 rooms plus 12 spaces/1,000 sq. ft. of non-hotel space for first 40,000 sq. ft., and 6 spaces/1,000 sq. ft. for next 60,000 sq. ft., and 3 spaces/1,000 sq. ft., over 100,000 sq. ft. Our analysis of the existing regulations indicate that the subject property represents a conforming use. [Graphic material omitted. This graphic is an Atlantic City Zoning Map promulgated by the Department of Planning and Development. The graphic highlights the location of the appraised property in the Urban Renewal Tract.] BACKGROUND DATA & ANALYSIS REAL ESTATE TAX & ASSESSMENT DATA REAL ESTATE TAX AND ASSESSMENT DATA The real estate tax assessment, synonymous with assessed value, is the official valuation level of property for ad valorem tax purposes. "The Appraisal of Real Estate" 10th edition 1992, Page 24, states: "Assessed value applies in ad valorem taxation and refers to the value of a property according to the tax rolls. Assessed value may not conform to market value but it is usually calculated in relation to a market value base." Since the assessment is a dollar amount assigned to taxable property by the assessor for the purpose of taxation, it may not reflect the independent value conclusions found within this report. Breakdown of the 1994 real estate assessments, assembled by the Trump Organization and verified by Appraisal Group International, are presented in the Addenda of this report. 1994 total assessment reflect $657,621,700, which includes the employee parking area, leased from the city of Atlantic City. The 1994 tax rate totals $2.497 per $100.00 of assessed valuation. The subject's current real estate tax liability is as follows: BACKGROUND DATA & ANALYSIS REAL ESTATE TAX & ASSESSMENT DATA 1993-1994 Total Tax Assessment: $657,621,700 1993-1994 Tax Rate: $2.497 per $100 Tax Liability - Hotel & Casino: $ 16,187,462 - Employee Parking Lot: $ 233,352 Total Tax Liability: $ 16,420,814 1994 Ratio = 89.23% of market value [Graphic material omitted. This graphic depicts a floor plan of the Taj Mahal BACKGROUND DATA & ANALYSIS HIGHEST & BEST USE ANALYSIS Highest and Best Use is a valuation concept that can be applied to either the land or improvements. It normally is used to mean that use of a parcel of land (without regard to any improvements upon it) that will bring the greatest net return to the land over a given period of time. The concept of highest and best use can also be applied to a property which has some improvements upon it that have a remaining economic life. In this context, highest and best use can refer to that use of the existing improvements which is most profitable to the owner. It is possible to have two different highest and best uses for the same property; one for the land ignoring the improvements; and another that recognizes the presence of the improvements. In cases where the site is improved, the results of the highest and best use analysis (of the land only) may indicate a different use than the existing use. The existing use will continue, however, until such time as the land value less cost of conversion or demolition in its highest and best use exceeds the total value of the property in its existing use. Therefore, as long as the improved property has a higher market value than the land alone as if vacant, the existing use will serve as the highest and best use. This analysis will address the highest and best use as improved. The highest and best use must meet the following criteria: 1. It must be legal in conformity with existing zoning and other building and land use restrictions. 2. The use must not be speculative or conjectural, but probable and reasonable. 3. Sufficient market demand must exist. BACKGROUND DATA & ANALYSIS HIGHEST & BEST USE ANALYSIS 4. The use must return the greatest profit for the longest period, considering all alternatives. Inherent in reaching any conclusion as to the highest and best use of a property is the consideration of the many principles related to valuation. The Principle of Anticipation is predicated on the foundation that value is created by the anticipation of future benefits. It is not based on historical costs, but on what current market participants believe the future benefits of the purchase will be. In essence, value is the present worth of future benefits. The Principle of Conformity addresses itself to the issue that property achieves its optimum value when the use to which it is put, and the design and layout of any structure situated on the land, blends in well with its environs. The use need not be the same as all surrounding properties, but it need be homogenous with those uses. All of these factors must be considered in arriving at a conclusion as to the highest and best use of a property. Central to the determination of Highest and Best Use, as it pertains to wealth maximization of individual property owners, is the consideration of four critical factors: Usually this study is unbiased; however, in the subject's case a hotel and casino facility has been constructed on the site. Primary consideration will be given to that use. There are four critical factors that will be analyzed in regard to this particular use for the subject property. They are listed on the following pages: BACKGROUND DATA & ANALYSIS HIGHEST & BEST USE ANALYSIS Refers to the physical adaptability of a site for a proposed use. The subject site was clear land at the time construction commenced. The site is already improved and, as a result, its existence proves it is physically adaptable. This inspection focused particularly on the physical elements or characteristics of the site, which include size, shape, terrain, frontage and depth, topography, soil conditions, and capacity and availability of public utilities. An analysis of all physical elements, both individually and collectively, produces the conclusion that the subject site is well suited for development. The physically possible test determines what is possible on the site. The choices are to renovate, convert, demolish, or leave the improvements as they are. The subject is functional for its existing and intended use. No changes to the physically possible criterion are warranted. The subject passes the test of physically possible. Refers to the legality or conformance of a given or proposed use to existing zoning and other land use controls. When investigating the legality of a proposed use, factors to consider include private restrictions, zoning, building codes, historic district controls, and environmental regulations. BACKGROUND DATA & ANALYSIS HIGHEST & BEST USE ANALYSIS The subject is located within the RS-C Resort Commercial district of Atlantic City. The property was constructed in conformance with the regulations of the RS-C zoning district. The subject is a legally permissible use (The legally permissible test would require a more in-depth analysis if the subject were a preexisting nonconforming use). The subject passes the test of legally permissible. Analysis of the physically possible and legally permissible uses of the subject site has indicated that the development of the site with a hotel and casino facility was both possible and permissible. Additionally, and in conformity with the discussions of the definitions of Highest and Best Use, the improvements blend harmoniously with neighboring and existing uses and complement community development goals. However, in analyzing the financial feasibility of a possible use, the marketplace must be tested in order to determine if a positive rate of return sufficient to attract investment capital to the project is generated by its potential operation. In order to investigate the above-mentioned factors, an "Immediate Market Area Overview" was conducted. This immediate market area was defined as containing hotel and casino facilities in the Atlantic City Market. The result of the analysis may be found in the Capitalization of Income Approach section of this report. BACKGROUND DATA & ANALYSIS HIGHEST & BEST USE ANALYSIS An analysis of average room rents and casino win, coupled with increasing demand for such facilities, indicates that positive net income from operations is sufficient to attract investment capital. In conclusion, the subject property passes the test of financially feasible. This refers to the use which will result in the greatest "net return" to the land as the result of the proposed use, as compared to a higher use. With reference to maximally productive, it is doubtful that the subject could be put to a higher use. Once a casino license is granted to a developer, the revenues attributable to the land and improvements far exceed the income that can be generated by any alternate use. Therefore, the highest and best use of the subject property is for continued use as a hotel and casino. The subject property is well located in a desirable location in the on the Boardwalk in Atlantic City. As mentioned in the Neighborhood Data and General Area Data Section of this report, the area is in a mixed use neighborhood containing commercial, and retail properties. The preceding analysis indicates that the subject sites pass all four tests of the critical factors utilized to determine Highest and Best Use. Thus, it is our opinion that the current utilization BACKGROUND DATA & ANALYSIS HIGHEST & BEST USE ANALYSIS of the subject property as a hotel and casino facility represents the Highest and Best Use of each. Typically, the appraiser first comes to a conclusion as to the highest and best use of the site as if it were vacant and available for development. This helps in the proper valuation of the land in the Cost Approach to value. In the subject's case, this approach is not relevant. Without an extensive analysis, we have concluded that the highest and best use of the site, if vacant, would be for development of a hotel and casino facility. In reference to the employees parking facility on North Carolina Avenue and Huron Avenue, this parcel of land is considered an integral part of the Trump Taj Mahal Casino Resort, because it is a vital component to the daily operation of this facility. Therefore, the employees parking facility is considered an essential part of the subject property. Furthermore, and in reference to the warehouse facilities which are located in the Pleasantville and Township of Egg Harbor, the warehouse facilities are considered an integral part of the Trump Taj Mahal Casino Resort, because it is a vital component to the daily operation of this facility. Therefore, for the purpose of this report, the warehouse facilities are considered part of the casino and hotel facility. The highest and best use of the warehouse buildings is for industrial/warehouse use. However, inasmuch as a casino needs back storage space in a less expensive area, the highest and best use of the warehouse facility is in conjunction with the operation of the casino. VALUATION & CONCLUSIONS VALUATION METHOD The valuation of real estate is, essentially, the valuation of the rights inherent to the ownership of the property. The valuation approaches are based on sound economic principles, as they relate directly to real estate. The three traditional approaches to the valuation of real estate are as follows: COST APPROACH: In this approach, the improvements are replaced as if new, and any applicable depreciation is deducted to arrive at a net improvement value. To this is added the value of the land and any site improvements or allied appurtenances, in order to arrive at a value estimate. SALES COMPARISON APPROACH: A technique of finding sales of similar properties, extracting units of comparison, and carefully analyzing and comparing them by virtue of their minor differences and major similarities, to arrive at an indication of value for the appraised property. CAPITALIZATION OF INCOME APPROACH: Converts the net operating income attributable to the real estate after all expenses, into a valuation estimate. This approach capitalizes the income by an appropriate method and rate as derived from a market study of similar properties and/or competitive investments. The valuation of the subject property will employ the Capitalization of Income Approach to value. This section will be preceded by an explanation of the steps involved in arriving at the independent value estimate. VALUATION & CONCLUSIONS VALUATION METHOD The subject property, as a hotel and casino facility is considered income producing and investment grade real estate. As an investment vehicle, real estate is most often purchased for its ability to generate economic benefits, such as protection of capital, appreciation, tax benefits and an annual return on investment or dividend. Of the three valuation methods, the Capitalization of Income Approach most accurately reflects the aggregate value of these benefits. It traditionally produces the most reliable indication of value for income producing real estate and, thus, will be given primary consideration for the final value estimate. The Cost Approach, in this valuation has not been implemented. In order to reflect a value indication by the Cost Approach, the improvements are replaced as if new, and any accrued depreciation is deducted to arrive at a net improvement value. Depreciation falls into three broad categories: Physical Deterioration, Functional Obsolescence and External Obsolescence. Physical Deterioration may be sub-categorized into Curable and Incurable. Curable physical deterioration is that loss in value which occurs as the short lived components of the structure gradually wear out, but are not yet ready to be replaced or redone. Incurable deterioration refers to the actual physical wear and tear to the major components of the building. Functional Obsolescence refers to the adequacy of the building in relation to the site, and to the utility of the layout and equipment inherent to the building. It is often the measure of an overimprovement or underimprovement. Any functional obsolescence has the ability to be VALUATION & CONCLUSIONS VALUATION METHOD cured, but the cost, in relation to its contribution to value, is the measure of whether it is curable. The third category of depreciation is Economic Obsolescence. Sometimes referred to as Environmental Obsolescence, this form of depreciation is a result of external interference to the property, and is incurable. Due to the characteristics of the subject property, estimates of accrued physical deterioration and functional obsolescence becomes inordinately subjective and extremely difficult to measure with any degree of accuracy. As accrued depreciation is fundamental to a value estimate by the Cost Approach, this approach has been precluded from the subject's valuation. The Cost Approach may provide a reliable estimate of value for newly constructed properties; however, as buildings and other forms of improvements increase in age and begin to deteriorate, the resultant loss in value becomes increasingly difficult to quantify accurately. We find that knowledgeable buyers of similar properties generally base their purchase decisions on economic factors such as forecasted cash flow and return on investment. Because the Cost Approach does not reflect any of these income- related considerations, but does require a number of highly subjective and insubstantial depreciation estimates, this approach is usually given minimal weight in the valuation process. Additionally, in a similar casino facility, we know of no instance where the replacement cost of a building was the basis for a purchase decision. VALUATION & CONCLUSIONS VALUATION METHOD The Sales Comparison Approach has not been utilized. This valuation method provides an accurate value estimate for simple forms of real estate, such as single family dwellings or vacant land, where comparable properties tend to be homogenous and a purchaser's individual goals are similar. However, for income producing real estate such as the subject, there are numerous subjective adjustments to be made which are difficult to quantify accurately. Furthermore, more often than not, income producing real estate (comparable improved sales) is sold subject to numerous conditions of sale including, but not limited to, cash flow guarantees, advantageous management agreements and advantageous seller financing. Any one or all of these conditions, which may affect the negotiated sale price, are almost always impossible to uncover and verify when researching a comparable improved sale, thereby diminishing the reliability of a value indication by the Sales Comparison Approach. Furthermore, the Sales Comparison Approach could not be used for lack of market transactions. Since the market for this type of real estate gives most consideration to a property's economic benefits, the Capitalization of Income Approach will be utilized as a value indicator. Capitalization, in real estate terminology, is the process by which an income projection is converted into an indication of value. The element that transforms the income projection is a rate that reflects the return necessary to attract investment capital. The process of Income Capitalization generally reflects the principle of anticipation. Defined as the present worth of VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH anticipated future benefits, anticipation follows a pattern similar to investor thinking and motivation. We studied the market, in addition to the past operating history of casino hotels similar to the subject, so as to determine the best method or process of Income Capitalization. Factors considered in our decision making included the following: - The age, quality and condition of the improvements. - Occupancy levels in the market. - Projected future growth of the market. - Typical investor requirements for a property of this type. We have concluded that annuity capitalization, utilizing the discounted cash flow technique, is the most appropriate method of capitalization. This valuation process utilizes the following five steps: 1. Projection of Investment Holding Period. 2. Projection of Annual Casino Revenue for each year of the holding period. 3. Selection of a Yield Rate. 4. Projection of Reversionary Value. 5. Calculation of Net Present Value based on Steps 1 through 4. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH In this valuation of the subject property, we will utilize a ten (10) year holding period for the investment. Although the subject has a much longer useful life, an investment analysis becomes more manageable and meaningful if limited to a time period considerably less than the real estate's economic life. A ten (10) year holding period for this investment is long enough to model the subject's performance with some degree of accuracy, but short enough to reasonably estimate expected income and expenses of the real estate. It should be mentioned that the eleventh (11th) year cash flow was projected in order to calculate the reversionary interest, which is explained in detail in Step 4. In determining future casino revenue for the subject property we have analyzed historical operating data on the gaming industry in Atlantic City since 1982. 1982 was the first year comprehensive operating data was available on the individual casinos. While we did consider and review statistics of the gaming industries in Las Vegas, Reno, and Laughlin, the information was not considered in this report, due to the vast differences in these gaming markets. The table below lists total inventory of casino space as of December 31 of each year. As can be seen on the following chart, the inventory of casino space increased by 20.54% from 1983 to 1984, 13.4% from 1984 to 1985, 10.00% from 1986 to 1987, and 6.4% from 1987 to 1988. From 1988 to 1989, casino space decreased 6.67% due to the closing of the Atlantis VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Hotel and Casino. In April 1990, the Taj Mahal opened it's 120,000 square foot casino, increasing industry casino space by 18.49%. From 1990 to 1992, casino space increased less than 1.00%. The casinos periodically change the casino floor area slightly to accommodate different games and slots. This accounts for the less than 1% increase in casino floor area from 1990 to 1991. 1993 casino floor area remained at 1991 level. Historical increases in casino space are explored on the following table; VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH CASINO WIN 1982 - 1993 The following data lists total casino win, percentage of increase/decrease in casino win, casino area, and win per square foot per year. The following win analysis is based upon win per square foot of casino floor area per year (Win/SF). In some instances total win and Win/SF/Year will indicate different top performers. For example, in 1982 Resorts International had the largest win, while the Golden Nugget (now, Bally's Grand) had the largest Win/SF/Year. The Golden Nugget is referred to as Bally's Grand throughout the exhibits. In 1982 the Golden Nugget was the top performer at $4,526/SF, followed by Harrah's at $3,985/SF. Caesars came in third at $3,958/SF. The worst performers in 1982 were the Atlantis at $2,623/SF, the Tropicana at $2,948/SF, and the Claridge at $2,986/SF. Total industry casino win in 1982 was $1,493,164,092, representing nearly a 36% increase over 1981. In 1983 all of the casinos showed revenue increases over 1982. The top performer in 1983 was the Golden Nugget with revenues of $6,455/SF, followed by Sands at $4,814/SF. The worst performers in 1983 were, again, the Atlantis at $2,819/SF and the Claridge at $3,203/SF. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH In 1984, Trump Plaza opened and most of the casinos continued to show revenue increases per square foot, while other casinos earnings/SF declined due in part to the additional supply. In aggregate terms, however, all casinos except the Golden Nugget showed increases in casino revenue in 1984. The top performer in 1984 was the Golden Nugget at $6,151/SF, followed by Harrah's at $4,708/SF. The worst in 1984 were the Atlantis at $2,880, and Sands at $3,225/SF. In 1985 Trump's Castle opened and 6 casinos showed decreases in revenue on an aggregate basis, while 4 casinos experienced moderate increases. Top performers in 1985 were the Golden Nugget at $5,893/SF, Caesars at $4,167/SF, and Tropicana at $4,151 /SF. The worst performers in 1985 were the Atlantis at $2,731/SF, and Trump Plaza at $3,390/SF. In 1986, no additional casino space came on line. Most casinos showed small increases in revenue, while others showed decreases in revenue. The top performers in 1986 were the Golden Nugget at $5,791/SF, Tropicana at $4,390/SF, and Caesars at $4,379/SF. The worst performers in 1986 were the Atlantis at $2,038/SF, and the Claridge at $2,799/SF. The Atlantis experienced a 25.64% decrease in casino revenue between 1985 and 1986. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH In 1987 the top performer was Bally's Grand, formerly the Golden Nugget, at $5,557/SF and the worst performer was the Atlantis at $1,453/SF. In 1987 the Showboat came on line and added 59,388 additional square feet of casino floor area to Atlantic City. In 1988, TropWorld expanded its casino by 27,562 square feet. Since the TropWorld expansion became effective in the fourth quarter of 1988, the win/SF figures are low, as the facility did not benefit from a full year of expanded casino floor area. The top performers in 1988 were Caesars at $5,160/SF, and Trump Plaza at $5,014/SF. The worst performer in 1988 was the Atlantis at $1,663/SF. The top performer in 1989 was Trump Plaza at $5,095/SF, followed by Caesars at $5,051/SF. The worst performer in 1989 was the Claridge at $2,988/SF. The Atlantis casino discontinued operations on May 22, 1989. Total casino floor area decreased by 50,601 square feet in 1989. The Trump Taj Mahal opened on April 4, 1990 adding 120,000 square feet of casino floor area. While the Taj helped increase total industry win by approximately 5%, it was at the expense of other casinos. With the exception of the Sands and the Claridge, all casinos experienced a drop in casino revenues in 1990. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH In nine months operation, the Taj won $304,890,000 topping the industry in gross win. With regard to win/square foot, however, the top performer was Caesars at $4,840 followed by Trump Plaza at $4,645. The year of 1991 was the first full year the Taj Mahal was open. While showing the lowest win/square foot in the industry ($3,198/sf), the Taj had the highest gross casino revenues ($383,764,374) the industry has ever seen. While minimal casino space came on line, Atlantic City casino revenues showed an increase of 8.17%. This is due in part to new legislation allowing 24-hour-a- day, seven days a week gambling. Total casino revenue was $3,232,600,000. The biggest percentage increase from 1991, reported by Trump's Castle (25.48%), while the lowest, 1.67% reported by Harrah's. Although 1993 had a 2.28% less visitor trips to Atlantic City, gross gaming revenue of the casinos increased by 1.69% over 1992. The biggest percentage increase from 1992, reported by Bally's Grand (9.02%) while the lowest, 5.38% reported by Caesars. Once again, the Taj Mahal had the highest gross casino revenue ($442,064,270) the Atlantic City market has ever seen. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH In order to estimate future casino revenue we have considered existing casino win, expected trends in the local economy and projected increases in casino supply. The chart on the following pages lists historical market share for all casinos since 1982. This exhibit indicates fair share, actual share, and market share for each casino. Fair share is based upon the ratio of the subject property's casino floor area to the total casino floor area in Atlantic City. For example, in 1986 there was 594,085 square feet of total casino space. Resorts' casino space in 1986 was 59,857 square feet. Thus, the fair share for Resorts in 1986 was 10.08%. This fair share percentage is estimated by dividing Resorts' casino floor area by the total casino floor area in Atlantic City. The actual share for Resorts is calculated by dividing Resorts' casino win by total casino win in Atlantic City. Resorts actual share is greater than its fair share, which indicates a market share greater than 100.00%. The market share is calculated by dividing the actual share by the fair share. The resulting amount is expressed as a percentage. Any given property's fair share percentage will change as new casinos come on line. Assuming that each competitive property (including the subject property) were to receive only its fair share percentage of casino revenue, each property's total income would be its fair share percentage multiplied by total industry revenue. This method assumes that each casino has the VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH same characteristics and has no inherent advantages or disadvantages in relation to the competition. The chart on the following pages lists fair share, market share, and market share % for the various casinos from 1982 - 1993. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH The Atlantic City casino industry has reached the stability/maturity stage in its life cycle. Casino revenues growth has slowed from double-digit rates to mid single-digit rates, and now to low single digit rates. The industry is being squeezed by various factors including stagnant industry growth due in part to local/regional factors relating to infrastructure, and national factors, specifically, the current recession. Although the Nevada casinos do not affect the market, constant industry growth from Indian reservations such as Foxwoods in Connecticut and Riverboat casinos in Illinois, Iowa, Colorado, and most recently in Louisiana, will have some effect on the Atlantic City and Nevada casino market in the future. The Atlantic City Casino industry has matured at a time when the United States, and more particularly, the northeast is recovering from the recession. In 1985, for the first time since the inception of gaming, visitor trips to Atlantic City declined from previous levels. Visitor trips to Atlantic City are listed below. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Year Visitor Trips % Change As is evident in the foregoing table, visitor trips fell 3% from 1988 to 1989, 1% from 1989 to 1990 and 3.27% from 1990 to 1991, and a slight decline is reflected in 1992. 1993 reflected a further decline of 2.28%. Part of the reason for the decline in visits is due to the reduction in unprofitable casino hotel sponsored bus charters. Another factor is the local economic economy and increasing competition from Foxwoods in Connecticut. Factors limiting future growth in visitors to Atlantic City is the lack of accessibility to the airport and lack of sufficient hotel rooms. A study referred to by the Atlantic County Department of Regional Planning stated that Atlantic City ranks 60 out of 65 North American cities in terms of convenient airline service and 53 out of 65 cities as easy to get to. Accessibility has a severe impact on the convention industry as over 60% of convention delegates arrive by air transportation. The lack of accessibility will have a negative impact on the convention center, currently under construction. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Atlantic City also suffers from a lack of hotel rooms. The supply of rooms is not expected to be met until air transportation is improved and the convention center is built. While these conclusions set a negative outlook, a review of progress made toward these goals changes the picture. In an article in the Newark Star Ledger, Casino Control Commission Chairman Stephen P. Perskie outlined a six point agenda that could restart the resort's redevelopment. The agenda calls for: Continued movement toward expanding Atlantic City International Airport. The commencement of construction of a new Atlantic City High School. Implementation of a comprehensive demolition program. Continuation of the redevelopment programs of the Casino Reinvestment Development Authority (CRDA). Legislative action on financing the proposed convention center. Perskie further stated that the area should build on the airport agreement between Atlantic City's mayor and former Governor James Florio. Legislation has been enacted and signed and the planning and design of the airport are currently underway. The casino industry has currently reached a temporary stage of maturity. We call it temporary because we expect additional growth in this industry once the convention center is built and once the airport is fully expanded. The result of the expanded airport will be direct daily flights to Atlantic City. This will significantly increase the market area of the industry spurring additional growth and development. With this in mind, historical and future industry growth is detailed as follows: VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH The table on the following page illustrates historical growth rates for the casino industry from 1978 through 1992; As evident above, industry growth rates have been declining from 1985 to 1991 as the result of a maturing market. The approximate 1.36% growth from 1990 to 1991 was partially due to the national recession. However, in 1992, the 12 Atlantic City casinos reported an increase of 8.06%. 1993 reflects a 1.82% growth among the 12 Atlantic City casinos. Given the current state of the national economy, we anticipate a moderate growth rate in 1994 of 4.00%. By 1995 and forward, we expect the previously mentioned airport expansion and the convention center to increase the market area of the industry. With this in mind, we expect 4% growth throughout the remainder of the projection period. Our future industry casino revenue growth follows: VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH The next consideration in estimating market share for the subject property is the likelihood of other casinos coming on line in the future. This factor will have a negative impact on casino revenues for the subject property as additional casino floor area dilutes market share for the entire industry. Based upon the current economic conditions, the current problems in the banking system and financial markets, we do not anticipate any additional casino properties to be built over the next 11 years. Our market share estimation for the property follows. Casino revenue will be estimated based upon fair share of industry-wide casino win. However, to further refine the analysis and to provide a more realistic approach to estimating revenue for the subject property, we assessed the subject's competitive position in the market. Such a comparison considers the subject property's inherent advantages and disadvantages in relation to the competition. These factors influence the market penetration (market share) that VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH a property could achieve above or below 100% of its fair share. The subject's historical market share is listed below. As evident from the table, the Trump Taj Mahal Hotel and Casino market penetration (market share ratio) has been on the increase. In 1991 (first full year of casino operation), the property's market penetration increased to 82.57%. While 1992 market penetration only increased by 1.28% to 83.63%, 1993 reflects a 3.87% increase to 86.87%.. It is our opinion that the subject has reached a stabilized market penetration. Throughout the entire holding period, market penetration has been estimated at 85%, in line with 1993 performance. This is a realistic market penetration estimate for the property. Projected casino revenues are listed below. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH The subject property achieved an average room rate of $98.31 in 1992 and $96.57 in 1993. The subject's occupancy rate was 91.3% in 1992 and 92.3% in 1993. Additional statistics regarding average daily room rates and occupancy levels have been included for all the casino/hotels in Atlantic City. This information was obtained from the Atlantic City Casino Association. Listed on the following page are Average Daily Rates (ADR) and occupancy levels for the competitive properties for 1992. ATLANTIC CITY CASINO HOTEL STATISTICS - 1992 Trump Castle $ 76.45 85.7% Taj Mahal $ 98.31 91.3% The average room rate has been estimated at $97.00 in 1994, on par with 1993, and is projected to increase by 4.00% per year. The occupancy level has been stabilized at 92.00% throughout the projection period. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Food and Beverage income has been estimated as a function of casino revenue. Food and Beverage sales have been projected at 10.00% of casino revenue throughout the holding period. The revenue history is listed below: Revenues (000) 1990 1991 1992 1993 Casino Revenue $304,890 $383,764 $417,972 $442,064 Revenue $ 59,329 S40,294 $ 19,489 S40,767 Ratio to Casino Revenue 19.46% 10.50% 4.66%` 9.22% Other income has been projected as a function of casino revenue. This revenue source has been estimated at 4.00% of casino revenue throughout the projection period. The revenue history is detailed below. Revenues (000) 1990* 1991 1992 1993 Casino Revenue $304,890 $383,764 $417,972 $442,064 Other Revenue $ 11,405 $ 12,090 $ 16,458 17,304 Ratio to Casino Revenue 3.74% 3.15% 3.94% 3.91% The promotional allowance reflects the aggregate retail value of complimentary services provided to casino guests in order to draw visitors to the casino. This is a standard industry practice provided by all casinos. Some of the complimentary services include hotel rooms, food and beverage, theater and other entertainment, and miscellaneous services. The past expense history for this item is as follows: VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Revenues (000) 1990* 1991 1992 1993 Casino Revenue $304,890 $383,764 $417,972 $442,064 Promotional Allowance $ 51,443 $ 53,935 $ 61,250 $ 56,444 Ratio to Casino Revenue 16.87% 14.05% 14.65% 12.77% As evident above, the promotional allowances as a percentage of casino revenue have been decreasing. This is typical for most of the properties in Atlantic City. Based upon the most recent trends, this item has been estimated at 10.00% of casino revenue throughout the projection period. This category is an allowance for doubtful accounts for casino play on a credit basis. Based upon the most recent data, bad debt expenses have been estimated at 1.00% of casino revenue throughout the projection period. Departmental expenses are costs directly attributable to the line item revenues. Included within this general category are casino expenses, room department expenses, food and beverage expenses, and other expenses. Our category for other expenses will be costs directly attributable to the other income category. The casino expense represents the largest single expense category, and is substantially attributable to employee salaries and benefits, casino marketing, license and inspections, and other expenses. The other expenses include such items as playing materials, slot machine servicing, supplies and other expenses. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Casino taxes and other fees are also included in this expense category. The tax imposed by the State of New Jersey is the casino revenue tax which is currently 8.00% of casino revenues less bad debt. Another tax is the Casino Redevelopment Authority payments. All casinos are required by the New Jersey Casino Control Commission to make investments in the City of Atlantic City. The money is invested in projects according to the Casino Reinvestment Development Authority. The required payments are 1.25% of casino revenues less bad debt. Casino expenses have remained relatively constant as a function of revenue. Trump Taj Mahal Casino Resort's casino expense has been estimated at $202,425,000 and assumed to remain constant at 45.00% of gross revenue. This expense is based upon the fixed department costs, while the revenue tax and CRDA obligations are a function of revenue as outlined above. The rooms department expense has been stabilized at 35.0% of department revenue throughout the projection period. This ratio is consistent with the prior operating history of the property. Food and beverage expenses have been stabilized at a fixed ratio of 90% of departmental income throughout the projection period. This ratio is consistent with prior operating history of the property. This department expense has been stabilized at 75.00% of department revenue. This ratio is consistent with the prior operating history of the property. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Undistributed operating expenses are costs that are not directly attributable to a specific department. Included within this general category are general and administrative expenses, marketing expenses, and property operations and maintenance, which includes energy costs. Each expense item will be further described as follows: This category includes such items as employee salaries and benefits, office supplies, security and surveillance and service contracts, as well as other related expenses. This expense has been estimated at $32,945,000 in 1994 and is assumed to increase by 5% per annum. This expense item includes environmental and engineering and utilities expenses. This expense has been estimated at $34,034,000 and is assumed to increase by 5% per annum. This expense item includes direct mail, sales, and advertising. 1993 actual expense was $3,489,859. 1994 expense has been estimated based on 1993 actual, however increased by 5.00%. Management expenses is estimated at $1,572,000 per annum, as per the current Trump Services Agreement. Fixed charges are costs of operations irrespective of revenue or occupancy levels. Included within this category are real estate tax liability, insurance costs, and ground lease payments. VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH The indicated tax liability for Trump Taj Mahal Casino Resort is $16,420,814, which includes employee parking lot the city of Atlantic City. The above liability is based on total assessment of $657,621,700. The combined tax liability for the facility is as follows: Employee Parking Lot Site 233,352. We have increased real estate taxes at 5.00% per annum, which is in line with previous increases in Atlantic City (see Real Estate Tax section of this report). This expense category is estimated at $6,300,000 in Year 1, which is based on the 1993 actual, however increased by 5.00%. Again, we have increased insurance at 5.00% per annum. This expense category reflects the rent payments for all the leased land, such as the employee parking lot, etc. This category provides for the gradual replacement of limited life components necessary for the operation of the property. Included in this category are gaming equipment, furniture, fixtures and other equipment, and building components. The replacement reserve category is based upon the sinking fund premise. The expected life, and future replacement cost of each VALUATION & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH item is estimated, and a reserve fund is set up to cover these future expenditures. Consideration is then given to "yield" or "safe" rates currently available in the marketplace in order to establish the required sinking fund amount. While it is beyond the scope of this analysis to estimate replacement reserves based upon the expected life of each limited life component, a stabilized ratio of 1.50% of total revenue is sufficient to cover these future expenditures. This estimate is consistent with prior capital expenditures at the property over the past few years for new gaming equipment, and FF&E etc. The inclusion of replacement reserves is standard appraisal practice. Projection of Income and Expense The following projections of income and expenses reflect the subject property's anticipated performance over the next eleven years. The statements are expressed in current dollars for each calendar year. This analysis has been developed from computer software developed by APPRAISAL GROUP International. Our income and expense projections appear on the following pages. VALUATIONS & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Prepared by: TRUMP TAJ MAHAL CASINO RESORTS APPRAISAL GROUP International CASH FLOW PROJECTION VALUATIONS & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Prepared by: TRUMP TAJ MAHAL CASINO RESORTS APPRAISAL GROUP International CASH FLOW PROJECTION VALUATIONS & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Prepared by: TRUMP TAJ MAHAL CASINO RESORTS APPRAISAL GROUP International CASH FLOW PROJECTION VALUATIONS & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Prepared by: TRUMP TAJ MAHAL CASINO RESORTS APPRAISAL GROUP International CASH FLOW PROJECTION VALUATIONS & CONCLUSIONS CAPITALIZATION OF INCOME APPROACH Prepared by: TRUMP TAJ MAHAL CASINO RESORTS APPRAISAL GROUP International CASH FLOW PROJECTION The selection of a yield rate to discount the projected cash flow and eventual property reversion is based upon our analysis of yield rates anticipated by real estate investors in the marketplace. It is important to note that these rates do not exhibit any particular property's past history, but rather reflect an investor's current yield expectations on future cash flows. A yield rate utilized in annuity capitalization (discounted cash flow) differs from an income rate used in straight capitalization, in that a yield rate specifically addresses the time value of money and income stream patterns. If two identical properties have identical current income levels, except that one property's income will escalate faster than the other, an income rate such as an overall rate would not reflect different values, whereas a yield rate (discounted cash flow) would. The above is not meant to preclude the use of income rates. These rates are appropriate valuation tools when income levels are static and at regular intervals. Furthermore, income rates, such as overall rates, are useful when estimating a property's reversionary value, especially where long term income projections beyond a specified holding period are uncertain and highly subjective. In order to select an appropriate yield rate, we analyzed the motivating factors that potential purchasers of properties similar to the subject would most consider. Among the factors taken into consideration were the following: - Current income levels and future projections - Anticipated growth of the area - Future Value of the property. The yield, or rate of return, that a real estate investor is willing to accept on a current purchase is not only affected by returns on other real estate compares the expected yield on a real estate investment to yields he expects to earn on competitive investments with similar risk, duration, capital protection, and tax benefits. Some of the non-real estate investments, typically compared to properties such as the subject and their respective yields as of November 1993 (most recent indices published by the Appraisal Institute - see Addenda), are as follows: 10 year bonds - 5.72% yield rate 2. Corporate Bonds (A) - 7.29% yield rate 3 Municipal Bonds (A) - 5.39% yield rate At this time, it is somewhat difficult to substantiate an appropriate discount rate for casino facilities, such as the subject property, because few meaningful transactions have occurred that clearly illustrate current purchase criteria. However, a key issue that must be addressed is the fact that hotel and casino facilities, have fallen from favor as an investment option for most institutional level buyers. Sluggish economies have affected this attitude, and a turnaround is not expected for several years. An unwillingness to consider hotel and casino facilities as an investment, unless a property is stabilized, suggests that prices have gone down as a result of higher return requirements. But, as mentioned above, the few dated transactions that have occurred, both in Atlantic City and Nevada, do not provide a high degree of tangible support for this theory. The lack of sales illustrates the unwillingness of sellers to take less for their properties based on today's buyer yield requirements. We have found that the differential in returns between buyers and sellers now approximates 200 to 300 basis points. Obviously, the disparity goes far in explaining the paucity of closed transactions. Nonetheless, one pattern has been illustrated in purchaser due diligence that provides insight. Today's buyer is making purchase decisions with less emphasis on future returns (sale at reversion) and placing more emphasis on the current income to the property. In some cases, investors are reducing above-market contractual rents to market rates when making their investment decisions. This illustrates the conservative approach investors are taking and the risk now perceived with real estate as an investment vehicle. In essence, purchasers will not pay for speculative upside in today's uncertain market and as a result, sellers are facing lower than desired offering prices when transactions are in negotiation. In order to objectively and rationally select discount rates, we have considered two methods. First, we have analyzed yield rates of new bond issues and key money rates. Second, we have reviewed required rates of return with real estate investors. Recent key bond yields and money rates as of March 14, 1994 are set forth in the following table. Commercial Paper (90 days) 3.83% Treasury Bills (One Year) 3.95% Treasury Notes (Two Year) 4.97% Treasury Notes (Five Year) 5.93% Treasury Notes (Ten Year) 6.51% Treasury Notes (30 Year) 6.93% Source: The Wall Street Journal, March 14, 1994 The above rates indicate that a low-risk, long-term investment, such as a 30- Year U.S. Treasury Bond, yields a 6.93 percent return. A yield of 6.98 to 7.59 percent is obtainable through corporate bonds which typically have a lower risk than income-producing real estate, but higher than government issued paper. It should be noted that these rates have been very flat since the beginning of 1992, and the prospect of higher returns is not encouraging. In analyzing real estate as an investment vehicle relative to the financial markets, four factors differentiate real estate from the investment opportunities described in the above chart. These are tax treatment, credibility, liquidity and risk, and are described respectively in the following paragraphs. Potential arguments against utilizing bond yields and money market rates when analyzing real estate often include the vast differences in tax treatment. In the past, real property ownership enjoyed many tax benefits that were not available for bond and money instruments (i.e. interest rate deductions, etc.). However, changes (1986) in the tax laws have influenced required real estate yields upward due to fewer incentives. In addition to the tax laws surrounding real estate investments, two major concerns exist for the real estate industry according to a survey conducted by NCREIF (National Council of Real Estate Investment Fiduciaries): 1) the credibility of real estate as an investment class; and 2) the illiquidity of real estate in the market place. This index is similar to stock market indexes, such as the Dow Jones Industrial Average (DJIA), in that it has followed the performance of several specific real estate investments over a period of time. The credibility of real estate can only be determined through long-term performance. The NCREIF index has been in existence for fourteen years, which is short in comparison to the DJIA and other investment indexes. However, even in accounting for a severe downturn in the industry in the past several years, the index reveals long-term yield rates of 9.7 percent for all properties and 12.4 percent for eastern properties. Only time can add to the credibility of real estate as an investment, but the current trends indicate a respectable return. Real estate also suffers from illiquidity, particularly when compared to various financial instruments that may be converted into cash quickly. It is often a long and arduous task to transfer real estate, particularly when the property is very large and has numerous leases requiring much due diligence and legal counsel. This is often a deterring factor when purchasing real estate as an investment, thus requiring higher yields when compared to stocks and bonds. The last significant difference between real estate and the financial markets is the measure of risk. While no marketplace is perfect or any measure of risk absolute, the financial markets are more sensitive to fluctuations relative to the whole market. The trading of financial instruments is similar to the process of gathering comparable sales in the Sales Comparison Approach of the appraisal process. The magnitude of trading within the financial market, analysis of the same instrument by many informed participants and the adjustments made by the market participants provide a sound indication of yields at varying degrees of risk. This sensitivity tends to indicate that the financial markets illustrate a better measurement of risk than does the real estate market, due to the lower volume of transactions in real estate. Therefore, it is very important to analyze the differing levels of risk present in the financial markets at varying yield rates in order to perceive and select an appropriate discount rate applicable to the subject. For the above stated reason, investors of real estate typically require returns several hundred basis points above what can be achieved in the financial markets. In our experience of casino and hotel facilities transactions, return requirements have ranged from 600 to 800 basis points above medium quality Corporate bonds. Therefore, an appropriate discount rate for the subject would be in the range of approximately 13.00 to 16.00 percent. Additionally, we have reviewed two separate investor surveys and conducted our own telephone interviews. Respondents to the discount rate survey included national, institutional- grade, investment and pension fund advisors and local players in the market. The answers of the respondents in the retail, office and lodging categories ranged considerably. The Peter F. Korpacz Investor survey for the first quarter of 1994 indicated a discount rate (IRR) range of 9.00 to 20.00 percent, with an average discount rate of 13.93 percent for the National Luxury Hotel Market. The National Full-Service Hotel Market reflects a discount rate in the range of 10.00% to 20.00% with an average of 15.33%. It should be noted that the upper end of this range represents troubled or distressed properties and has not been considered. The CB National Investor Survey (2nd Quarter - 1993) indicated a discount rate (IRR) range of 12.00 to 20.00 percent for hotels with an average of 14.9%. The RCDH report indicates an initial rate (Ro) of 12.00% to 15.00%. Before the real estate market began to discernibly respond to the soft market conditions in most major U.S. Cities, competitive yields had been trending downward. In general, this followed the pattern of rates for all properties and alternative investments. Further, the downward pattern reflected a competitive environment in which supply, that is well-located, higher-profile stabilized facilities, did not match buyer demand. During this period, rates as low as 10.00 to 10.50 percent were not uncommon for top quality holdings in major metro areas. However, in the last eighteen to twenty-four months, we have seen a reversal of this trend, with rates now in the 11.0 to 15.0 percent range, and only trophy properties justifying rates below 10.0 to 11.0 percent. The discount rate is a function of several factors: a property's image, location, and physical characteristics; appreciation potential, competitive appeal, and cash flow stability; and the nature or degree of risk, real or perceived, inherent to the investment. The subject property is a mature hotel and casino facility, located along the Boardwalk in Atlantic City. A higher yield rate is necessary for a casino hotel because the investor is usually purchasing an ongoing business along with the real estate. The business or the "going concern" portion of the property is substantially dependent on the competency of the management team. Based on this analysis, considering the higher risk associated with the going concern portion of the investment for similar casino hotel properties and our cash flow projections, we believe the discount rate should fall toward the upper end of the 13.00 to 16.00 percent range. Therefore, we have estimated a discount rate of 15.00 percent. National investors are generally seeking a 7% "Real" rate of return over the growth or increase rate, as measured by the Consumer Price Indexes. Assuming a 4.00% CPI increase (400 basis points), and adding 400 basis points to reflect the added risk attributable to the going concern portion of the investment, a discount rate of 15.00% is further supported. Reversionary Value sometimes referred to as Residual Value, may be defined as the remainder which reverts to the fee owner at the end of a lease period, projection period or actual sale of real estate. The reversionary value is estimated by capitalizing the projected eleventh (11th) year cash flow by a terminal rate of 10.00%. A terminal capitalization rate, sometimes called outgoing rate, is the direct relationship between a future projection of Net Operating Income produced by the real estate and its price, or value, in the marketplace at a future certain point of time. Terminal capitalization rates are based upon investors' perceptions of future income value relationship giving consideration to future income levels, supply/demand relationship as it pertains to competition and remaining economic life of the subject. A recent survey indicates that investors active in the market employ terminal rates from 8.00% to 11.00%. Giving the nature of the subject property, we have selected a terminal capitalization rate of 10.00%, which reflects the added risk associated with a casino/hotel. Taken from the previously mentioned investor surveys, terminal capitalization rates for hotel facilities range from 8.0 to 11.0 percent, with the variance attributable to many of the same factors mentioned in our discussion of the discount rate. However, other issues influence the terminal capitalization rate and also warrant mention. First, the physical condition and competitive position of a property ten (10) years into the future must be studied. Second, the nature of the building's occupancy and casino wins in the initial years must be analyzed. Finally, the risk inherent to the reversion year's revenue and expense projections must be measured. Furthermore, in considering the terminal rate for the subject property, it is important to analyze all factors which may affect the subject property, such as gaming regulations and legislation. On this basis, we have elected to use a terminal capitalization rate of 10.00%. Value = $170,448,894 = $1,704,488,941 We have deducted 3.0% of the gross reversionary value in order to arrive at a net sale proceeds. Our discounted cash flow reflects the net reversionary value. The Net Present Value conclusion is based on the employment of the Discounted Cash Flow method. The process of discounting the cash flows, including the reversion, reflects the present worth of this investment given the information listed below: - A required rate of return - Receiving cash flows as projected - Reversion value as projected At a 15.00% rate of return, our discounted cash flow calculations appear on the following page. 11TH YEAR NOI: $ 170,448,894 VALUATION & CONCLUSIONS CORRELATION & VALUATION CONCLUSION Based upon our research and analysis, we arrived at the following independent value estimate: CAPITALIZATION OF INCOME APPROACH $1,100,000,000 In a typical appraisal assignment, this section of the report would assess the strengths and weaknesses of the various approaches to value utilized. However, since we are valuing the Going Concern Value of the subject property, only the Capitalization of Income Approach is applicable. Giving consideration to the forces that create and affect value, it is our opinion that the Going Concern Value of the subject property, AS OF MARCH 18, 1994, IS: ONE BILLION ONE HUNDRED MILLION DOLLARS LANAI SUITE #144 - CORNER UNIT ALEXANDER THE GREAT SUITE - GUEST BEDROOM ALEXANDER THE GREAT SUITE - DINING ROOM ALEXANDER THE GREAT SUITE - GENERAL VIEW ALEXANDER THE GREAT SUITE - BATHROOM ALEXANDER THE GREAT SUITE - LIVING ROOM ALEXANDER THE GREAT SUITE - JACUZZI ALEXANDER THE GREAT SUITE - BATHROOM AND EXERCISE ROOM VIEW OF THE SUBJECT FROM THE BOARDWALK CLOSE-UP VIEW OF THE TOWER MAIN ENTRANCE AND PORTE CHOCHERE HOTEL LOBBY AND FRONT DESK 2ND LEVEL PROMENADE TOWARDS THE BOARDWALKD RETAIL SHOPS ON 2ND LEVEL RETAIL SHOPS ON 2ND LEVEL THE SPA AT THE TAJ FIRST LEVEL PLAN OF TAJ MAHAL CASINO RESORT FIRST LEVEL MEZZANINE OF TAJ MAHAL CASINO RESORT SECOND LEVEL PLAN OF TAJ MAHAL CASINO RESORT SECOND LEVEL MEZZANINE OF TAJ MAHAL CASINO RESORT 5TH LEVEL OF TAJ MAHAL CASINO RESORT 6TH LEVEL OF TAJ MAHAL CASINO RESORT 7TH FLOOR OF TAJ MAHAL CASINO RESORT [DIAGRAM OF TRUMP TAJ MAHAL CASINO] TRUMP TAJ MAHAL CASINO* RESORT Trump Taj Mahal Associates Property Operating Statement TRUMP TAJ MAHAL CASINO* RESORT Games Drop/Games Win Summary 10 Slot Handle/Slot Win Summary 12 Food Covers by Outlet 14 Average Check by Outlet 15 General & Administrative Summary 22 TAJ MAHAL CASINO AND RESORT FOR THE MONTH ENDED DECEMBER 1993 TAJ MAHAL CASINO AND RESORT YEAR TO DATE DECEMBER 1993 TAJ MAHAL CASINO AND RESORT FOR THE MONTH ENDED DECEMBER 1993 TAJ MAHAL CASINO AND RESORT TAJ MAHAL CASINO AND RESORT OPERATING REVIEW - POKER & SIMULCASTING FOR THE MONTH ENDED DECEMBER 1993 PROPERTY OPERATING STATEMENT OPERATING REVIEW FOR THE PERIOD ENDED DECEMBER TRUMP TAJ MAHAL CASINO RESORT FOR THE PERIOD ENDEDED DECEMBER 1993 TABLE SUMMARY OPERATING REVIEW FOR THE PERIOD ENDED DECEMBER 1993 GAMING SUMMARY FOR TAJ MAHAL FOR THE PERIOD ENDED DECEMBER 1993 SLOT SUMMARY FOR TAJ MAHAL NOTE THAT THE YTD NUMBERS FOR 1990 REFLECT TOTALS AS OF APRIL 2, 1990. FOR THE PERIOD ENDING DECEMBER 1993 FOR THE PERIOD ENDING DECEMBER 1993 REPORT NUMBER 15225 TRUMP TAJ MAHAL ASSOCIATES RUN DATE 01/13/94 AVERAGE CHECK BY OUTLET FOR THE PERIOD ENDED DECEMBER 1993 FOR THE PERIOD ENDED DECEMBER 1993 REPORT NUMBER 15400 TRUMP TAJ MAHAL ASSOCIATES RUN DATE 01/13/94 LODGING SUMMARY FOR THE PERIOD ENDED DECEMBER 1993 13-Jan-94 TRUMP TAJ MAHAL CASINO* RESORT FOR THE YEAR ENDED DECEMBER 1993 FOR THE PERIOD ENDED DECEMBER 1993 FOR THE PERIOD ENDED DECEMBER 1993 FOR THE PERIOD ENDED DECEMBER 1993 Property Real Estate Tax Assessment (1) Demo of Soc. Sec. Bldg. Source: Appraisal Institute Research Department. Figures are derived from a survey of lenders in various geographic regions conducted during the first business week of December 1993. Data quoted are averages and do not reflect conditions in all markets. Readers are encouraged to contact local lenders for rates and terms applicable in local markets. For further information, contact the Research Department, (312) 335-4466. NATIONAL MARKET INDICATORS: Fourth Quarter 1993 B.p. Free & clear equity cap rate Residual cap rate Basis points Initial cash-on-cash rate of Overall capitalization return on the equity investment, rate used in calculation unencumbered by financing. of residual price at (all cash overall capitalization conclusion of forecast rate). period. Free and clear equity IRR Internal rate of return on equity, based on unencumbered by financing (all cash). Source: Korpacz Real Estate Investor Survey. Personal survey of a cross-section of major institutional equity real estate market participants conducted in October 1993 by Peter F. Korpacz & Associates, Inc. For complete information on Quarterly Survey results, contact Peter F. Korpacz & Associates, Inc.; Route 111, Suite 303; Smithtown, NY 11787-3713. (516) 979-9465. * Source: The Wall Street Journal + Source: Moody's Bond Survey ++ Revised figures used when available As 1993 brought about improvement for the hospitality industry, 1994 is forecast to show financial gains and increasing hotel values. Hotel investors struggled through another year of economic recovery, and those that survived the credit crunch and industry downturn during the past few years will see improved portfolio yields and growth opportunities. Participants in our hotel market forecast survey cited interest rates, job growth, employment/unemployment, and inflation as the most significant issues affecting the hotel investment market. Other factors the participants noted, in order of significance, include: productivity; federal, state, and local taxes; defense cutbacks; federal, state, and local deficits; corporate and personal debt, and foreign competition. Nearly 60.0% of the respondents view the next 12 months as a buyer's market. They expect the buyers to include Asian and European strategic investors, entrepreneurial (owner-operator) investors, REITs, pension funds, and equity funds. Sellers will be banks, insurance companies, and other institutional holders who are seeking to divest to reduce balance-sheet exposure. Wall Street is viewed as having a significant role in providing sources of capital to the hotel investment market. Debt securitization instruments (for example, public offerings and REMICS), REITs, pension funds, and foreign investors will be the most active capital sources funding growth. Banks are virtually out of the picture, and domestic insurance companies are now dealing with regulatory issues, putting most in a nonlending status. The most significant factors that will affect hotels positively, as ranked by the participants, are absorption of existing rooms, lack of new construction, national economic conditions, credit availability, and operating expense growth. Factors rated as having the greatest negative impact on the industry are increases in the minimum wage rate, continued room rate discounting, and inflation. One of the other factors that should not be overlooked is the need to reinvest capital into aging properties to maintain or obtain the appropriate franchise affiliation. According to Coopers & Lybrand's December 1993 Hospitality Directions, occupancy rates are forecast to improve to 66.1% in 1994, a 2.2% gain compared with 1993. Average daily rates, which have shown marginal improvement (1.52% average growth) over the past two years, are forecast to increase by 2.7% in 1994. The combined effect or RevPAR (revenue per available room) will yield a 6.8% year-end increase over one year ago. This gain will positively affect bottom-line performance, critical to the industry's building a measurable track record with many "side-line" investors are anxious to see. Most participants see the strongest investment opportunities in the full- service and economy/limited-service segments, whereas the luxury and resort segments will continue to lag. A composite of the rankings by product type is shown in Exhibit III. Scale (1 to 5. 1= best) Washington, D.C., Atlanta, Charlotte, and Chicago were selected as cities offering the best overall conditions for hotel investment in 1994. With the pendulum slowly shifting from what has been a strong buyers' market to a more balanced playing field, increasing competition among buyers for quality product is exerting downward pressure on cap rates and yield expectations. There are exceptions to this, most notably older noninstitutional- grade hotels and hotels located along the West Coast, south of San Francisco, where recessionary conditions still prevail. Survey participants were asked to evaluate seven investment criteria and the percent change anticipated for 1994. The criteria evaluated were free and clear equity IRRs, leverage equity IRRs, free and clear equity cap rates, residual cap rates, average daily rates, occupancy, and operating expenses. In addition, participants were asked to forecast 1994 price and value trends. Results are summarized below. The majority of the participants surveyed indicated that both free and clear and leveraged IRRs are generally expected to decline from prior-year requirements. The rate of change ranges from 0.0% to 5.0%. Free and clear equity cap rates are also expected to show a decline ranging from 0.0% to 10.0%. One participant took exception to this, noting that yields may trend upward by as much as 1.0% to 2.0%. Residual cap rates are also expected to decline as competition increases for quality earnings-producing assets. Average daily rates are projected to show a change rate ranging from 1.5% to 6.0%, with the consensus around 3.0%. By comparison, the WEFA Group (Wharton Econometrics) is projecting inflation at 2.9% for 1994. All participants expect occupancy to improve, particularly in light of limited new construction. Operating expenses are also forecast to increase within a 2.0% to 4.0% range. Finally, according to the participants surveyed, prices and values are forecast to increase from 0.0% to 10.0%. The forecast change in free and clear IRRs is within a range of 200 basis points up or down. However, the majority of participants indicated a decline from prior-year requirements. Clearly, there is now more seller resistance to discount pricing for quality product which would lower going-in yields, but by how much is yet to be determined. This also holds true for leveraged yields; however, there could be an ever greater swing in leveraged IRRs depending on the magnitude of changes in interest rates. This will be closely monitored as we track trends. Overall, equity and residual cap rates are forecast to show minimal change, approximately 100 basis points up or down. Average daily rates are forecast to show a change ranging from 2.0% to 6.0%, with occupancy increasing from 1.5 to 3.0 percentage points. Increases in operating expenses are forecast in the range of 1.0% to 4.0%, with the mean of approximately 3.0%. As in the full-service hotel market segment, prices and values are forecast to increase from 0.0% to 10.0%. Luxury hotels, which have experienced a significant decline in values and investor appeal, should begin to see some activity, particularly from off-shore investors and entrepreneurial funds. Institutional holders of these hotels have marked down asset values to levels that now make economic sense in some cases. The majority of participants with assets in this market segment forecast declining yields. The forecast change ranges from 0 to minus 450 basis points. Free and clear equity cap rates are expected to show a greater decline than residual cap rates, indicative of the increasingly competitive investment climate. Average daily rates are forecast to show a change rate ranging from 1.5% to 8.0%, with occupancy also increasing at a pace of 1.0 to 4.0 percentage points. Luxury properties will continue, though, to be hampered by increasing consumer price sensitivity and the significant capital required to acquire and maintain them. Operating expenses are forecast to increase at a rate of 3.0% to 4.0%. The participants anticipate that prices and values will increase in some cases by as much as 15.0%; however, this will still be well below original project cost. The participants were asked to share their 1993 hotel portfolio mix and what they foresee in 1996. The results are shown in Exhibit IV. Although the percentages are forecast to change slightly by 1996, hotel investors will continue to prefer full-service and economy/limited service hotels over luxury hotels and resorts. This chart depicts the Hotel Portfolio Mix, highlighting the luxury hotel percentages. In 1993, there were 26.9% luxury hotels compared to 25.6% in 1996. One question appraisers commonly ask is What are typical industry ratios for base and incentive management fees? If this item is not correctly reflected, there can be a material over- or understatement of value. Hotel management has experienced dramatic change over the past six years, with institutional owners and lenders requiring management to perform more like joint owners and take on a greater portion of the financial risk. Institutional owners recognize that a hotel is a management-intensive, going-concern asset, unlike other forms of real estate. Management contracts are now being negotiated with bottom-line performance emphasis and no or low penalty termination provisions. For full-service and luxury properties, conditions are even more demanding, and management often must provide performance guarantees and equity contributions. Is there a typical management fee structure? In an attempt to address this question, we asked the survey participants to provide data on both base and incentive fees by hotel market segment. All participants reported that base management fees are computed as a percentage of gross revenue. The ranges and averages in base management fees for each hotel market segment are as follows: Base fees have declined from historical levels of typically 5.0% of revenue as increasing emphasis is placed on what are referred to as "incentive fees." The long-term, high-cost, base management fees of the 1980s simply do not appear in agreements today. Incentive fees are performance driven and are often, but not always, computed as a percentage of pretax NOI or percentage of increased cash flow. For leveraged investments, pretax NOI often includes debt service. Several of the most common structures for incentive fees are highlighted below: . x% of NOI after FF&E reserve and minimum return to owner; percent can range from 10.0% to 20.0%. . x% over a minimum return to owner. . x% over pre-takeover annual performance. . x% of gross operating profit (GOP). The 1994 Hotel Market Forecast and Hotel Valuation Issues were prepared by Coopers & Lybrand. The future is becoming increasingly brighter for the full-service hotel market segment, as evidenced by the recent "good media" and the overall improvement in market conditions. Our survey participants anticipate that a continued strengthening of the financial performance of hotels will stimulate more interest for investment-grade assets. This interest is being fueled in part by corporate acquisitions with "off-shore dollars" and capital from the domestic public markets and pension and entrepreneurial funds. Although only the top 10.0% of investors seem to have what they believe is sufficient access to capital, the survey participants indicate that institutional lenders, such as credit companies and life insurance companies, will likely reenter the hotel investment market in late 1994. As a result, hotel prices and values will continue to rebound; however, regional disparities will exist. Hotel values are still depressed in California and little change is expected this year. Limited new construction and an increase in room demand from both the commercial and leisure markets are contributing to the increase in occupancy rates. With the improvement of occupancy, average daily rates will also grow. The survey results show a 51-basis-point increase in the average daily rate change rate to 3.29% (see Table 12). This compares favorably with 1994 inflation expectations of 2.9%, as projected by the WEFA Group. These increases will provide greater return to investors. As reported last quarter, many new buyers continue to enter the market, closing the gap between bid and asking prices. As this interest continues and the volume of RTC and institutional REO assets decreases, sellers will hold performing assets until a buyer meets their price. One respondent mentioned that "more capital is pursuing hotel product, with some money being rolled over from successful RTC investments." The average free and clear equity IRR increased 28 basis points to 15.33% this quarter. However, when excluding new survey participants, the equity free and clear IRR decreased 5 basis points. The average free and clear equity cap rate increased 5 basis points to 11.48% this quarter. However, once again when excluding new survey participants, the equity free and clear cap rate decreased 20 basis points. The average residual cap rate decreased 41 basis points to 11.48% from last quarter's 11.89%. While the overall averages would suggest an upward trend in return requirements, many respondents have lowered their required yields for nondistressed product. Hotel investors often seek some form of debt capital to finance investments. This quarter leveraged IRRs were surveyed to determine the premium and/or discount compared with free and clear equity IRRs. For the current quarter, the respondents reported an average leveraged IRR, assuming 50.0% to 60.0% debt, of 23.25%, a 792-basis-point premium over the average free and clear equity IRR. With current low interest rates, investors who can access debt capital can take advantage of the positive spread to boost leveraged equity returns. This is also enabling them to increase the bid on a property when competing with all-equity investors. Common investment criteria cited were positive current cash flow and the potential for stronger cash flow. Investors continue to emphasize cash-on-cash returns and direct capitalization when analyzing deals, with continuing emphasis on exit strategies. Most participants indicate a preference for the Midwest and South and are less interested in hotels in the Northeast. Overall, the hotel investment market is becoming more active with new buyers seeking quality product. Most participants indicate that the first quarter of 1994 will be a good time to buy. However, as competition increases, prices and values will respond by increasing. The National Full-Service Hotel Market report was prepared by Coopers & Lybrand. /a./ initial rates of change Our survey participants remain less interested in luxury hotels and resorts than in full-service and economy/limited-service properties. The large capital requirements, perceived higher risk, and historically longer period required to realize investment objectives deter many active investor groups from pursuing this type of product. Many of the participants report that an increase in investment capital pursuing quality product is exerting downward pressure on cap rates. Occupancy for this market segment has improved during the past 12 months, and further gains are anticipated this year. Average daily rates are also expected to improve this year, but gains will be limited by corporate and consumer price sensitivity. For the current quarter, survey participants anticipate an average initial year change rate of 3.0%, which compares favorably with the WEFA Group's 1994 inflation projection of 2.9%. Geographic areas for investments vary; some of the preferred locations include the Mid-Atlantic and Sunbelt, San Francisco, New York, Chicago, and Atlanta. Investment interest for luxury product is up, even though there have been significantly fewer transactions than reported in the other segments. Investors continue to look for quality assets at discounted prices as much as 50.0% below original project cost. One participant said, "The next wave of troubled properties to surface will be the worst of the 1980s deals," described as high-priced, long-term management contract deals. Another participant specifically noted that "the greatest dollar impact will be felt in the luxury segment as foreign lenders finally work through problems and sell off bad deals." The average free and clear equity IRR decreased 157 basis points to 13.93% this quarter (see Table 14). The decline is due to increased capital competing for a limited supply of quality assets, according to survey participants. Additionally, there is anticipation of improving market conditions in selected market areas, thereby reducing perceived investor risk. The average free and clear equity cap rate for the current quarter declined 150 basis points to 10.25%. The average residual cap rate decreased 70 basis points to 10.00%. It will be interesting to see whether this is a continuing trend or a new year adjustment in anticipation of increased competition. Investors were asked to provide equity return requirements on leveraged investments, where debt represents 50.0% to 60.0% of the financing. Survey respondents indicated a leveraged equity IRR of 19.83%, a 590-basis-point premium over the average free and clear equity IRR. Overall, investment interest in the luxury hotel market is on the rise although it lags their interest in the other hotel market segments by a considerable margin. This segment continues to be the most difficult to measure in terms of value trends due to a limited number of actual transactions. Investors still continue to search in strong growth markets for properties that have cash flow upside through repositioning and better management. One stimulus that can alter this is how active a role Wall Street takes in marketing these products through equity and/or debt securitization. THE NATIONAL LUXURY HOTEL MARKET REPORT WAS PREPARED BY COOPERS & LYBRAND. Representative sample; due to space constraints, not all responses are included. Source: Personal survey conducted by Coopers & Lybrand during January 1994. Source: Personal survey conducted by Cooper & Lybrand during January 1994. Market Source (IISN 1055-5579) is published quarterly by the Appraisal Institute, 875 N. Michigan Ave., Chicago, IL 60611-1980, (312) 335-4100. Fax: (312) 335-4400. Chair, Research and Information Committee Subscriptions: Subscription rates are $100 per year for Appraisal Institute members and affiliates, $150 per year for all others. Make checks payable to: Appraisal Institute, 875 N. Michigan Ave., Chicago, IL 60611-1980. Single copies, if available, are $25 each. (C) 1994 by the Appraisal Institute. All rights reserved. The opinions and statements set forth herein do not necessarily reflect the viewpoints of the Appraisal Institute or its individual members, and neither the Institute nor its editors and staff assume responsibility for such expressions of opinion or statement. The Appraisal Institute advocates equal opportunity and nondiscrimination in the appraisal profession and conducts its activities without regard to race, color, sex, religion, national origin, or handicap status. Source: Federal Reserve Statistical Release KEY RATES TRENDS 1990 to 1993 Sources: Federal Reserve Statistical Release and Appraisal CB Commercial Office Vacancy Index of the United States. CB Commercial Real Estate Group, Inc., Los Angeles. Quarterly. F.W. Dodge Real Estate Analysis and Planning Service. F.W. Dodge Group, McGraw-Hill, Inc. Lexington, Mass. Quarterly. Economic Indicators. Council of Economic Advisors to the Joint Economic Committee, U.S. Congress, Washington, D.C. Monthly. Employment and Earnings. U.S. Department of Labor, Bureau of Labor Statistics, Washington, D.C. Monthly. Federal Housing Finance Board News. Federal Housing Finance Board, Washington, D.C. Monthly. Federal Reserve Statistical Release. Board of Governors of the Federal Reserve System, Washington, D.C. Weekly. Forecast of Housing Activity. National Association of Home Builders of the United States, Washington, D.C. Monthly. Housing Starts, Current Construction Reports, series C20. U.S. Department of Commerce, Bureau of the Census, Washington, D.C. Monthly. Housing Units Authorized by Building Permits, Current Construction Reports, series C40. U.S. Department of Commerce, Bureau of the Census, Washington, D.C. Monthly. Housing Vacancies and Homeownership, Current Housing Reports, series H111. U.S. Department of Commerce, Bureau of the Census, Washington, D.C. Monthly. Monthly Retail Trade: Sales and Inventories, Current Business Reports, series BR. U.S. Department of Commerce, Bureau of the Census, Washington, D.C. Monthly. National Real Estate Index. Liquidity Fund, Emeryville, Calif. Quarterly. New One-Family Houses Sold, Current Construction Reports, series C25. U.S. Department of Commerce, Bureau of the Census, Washington, D.C. Monthly. New Residential Construction in Selected Metropolitan Areas, Current Construction Reports, series C21. U.S. Department of Commerce, Bureau of the Census, Washington, D.C. Quarterly. Real Estate Outlook. National Association of Realtors, Washington, D.C. Monthly. U.S. Housing Markets. Lomas Mortgage USA, Detroit. Quarterly. Source: Appraisal Institute Research Department NOTE: No regional averages appear for third quarter 1993 mortgage rates due to an insufficient sample size. Source: F.W. Dodge Group, McGraw-Hill, Inc. Second Quarter 1993 National Investor Survey ACB Commercial Appraisal Emerging Trends in Real Estate: 1994 Real Estate Research Corporation and Equitable Real Estate Investment Management, Inc. In the next two issues of the RERC Real Estate Report we will publish excerpts from this year's Emerging Trends. In this issue, we will reprint Chapter 1, It's Started, which outlines the major findings of this year's report. Every year since our 1985 report, in the midst of an unprecedented development boom, Emerging Trends in Real Estate has warned about and then chronicled the fall of the real estate markets. Victims of a "kill the messenger syndrome," our past cautions were not always welcomed by the industry, no matter their unfortunate accuracy. With this in mind, we cannot be accused of undue optimism in this year's forecast when our evaluation points finally to trends suggesting that markets have bottomed and are beginning what promises to be an extended convalescence. As always, Emerging Trends is based on face-to-face, in-depth interviews and surveys with more than 100 leading real estate investors and experts-executives from pension funds, banks, insurance companies, and advisors as well as investment bankers, developers and well known entrepreneurs. Their consensus views form the backbone of this report, which is supplemented by analysis and research of Real Estate Research Corporation and Equitable Real Estate Investment Management, Inc. For example, the August job figures showed a loss of 39,000 jobs, compared to a gain of 211,000 in July. Many analysts believe that the August numbers will be revised to show an employment gain. Overall, through August, the economy has added 1.2 million jobs in 1993, and this is expected to hit more than 2.0 million by year-end. The focus of Emerging Trends has changed over the past decade, reflecting the dramatic upheaval in the real estate business. Interviewees use to be dominated by developers and syndicators, the report's primary audience was developers, and its prognostications revolved around where the best development opportunities existed in the country. Now our interviewees are loathe to even reference the "D" word, let alone say it, and the continued absence of any significant commercial construction activity is the primary reason for why markets are starting to turn. When Will Values Begin to Increase? With development a moot point, we redirected Emerging Trends in recent years, writing the report for real estate investors--providing a broad overview for guiding decision-making, pointing out opportunities as well as the quicksand. Since the 1990 issue, we have also significantly expanded our survey to probe our interviewees for their investment perspectives on land uses, cities, capital sources, values, and pricing. These surveys provide a more quantitative context to the subjective interviewing process. Now in its fifteenth year, Emerging Trends has watched and predicted the movements of almost a complete real estate cycle and the ultimate downsizing of our industry. The report has evolved, changed, and expanded with the ups and downs of what has been the industry's most volatile era. Mostly thanks to the interviewees, our forecasts have been repeatedly on target. With some small measure of optimism at hand, we're actually looking forward to being right again. It's Started: Recovery Moves Forward Slowly For 1994, investors can size up the real estate markets in either of two ways--both accurate: . A sluggish economy, coupled with corporate makeovers and less-than-optional demographic shifts, hobbles the markets and set roadblocks to quick recovery. Office markets may not see real improvement until the end of the century. Development prospects are moribund, and new construction slumps to a 30-year low. Capital sources, aside from much-hyped and expensive Wall Street vehicles, are still in retreat, just-in-time, QVC, laptops, E-Mail, portable phones--the progeny of burgeoning technology--are threats to the real estate landscape as we've known it. . Tight capital is good news. Realism has taken hold, fostering disciplined underwriting and a focus on fundamentals--location, credit tenants, quality. The development bust is just what the industry needed to get back on its feet. Low interest rates continue to be a boon, helping values recover and making real estate yields more attractive. In fact, pension funds actually assess real estate as competitive with stocks and bonds for future investment potential and are ready to reenter the asset class--in a measured fashion. If anything, investors are missing the chance to lock in large yield spreads on very conservatively underwritten mortgages. Significantly, values are stabilizing; 1994 should even see slight upticks for warehouses and malls, as well as gains for apartments on top of good coupon returns. The success of high-quality equity REIT offerings has been a shot in the arm, restoring some confidence in the industry as they bail out prominent owners in need of refinancing. No matter how you call it, the recovery process has begun. Prospects for investment real estate should improve, slowly but steadily, through the end of the decade. Despite the depth of the real estate depression and its continuing, jarring aftershocks, this is the first time since 1984 that Emerging Trends has seen a generally positive directing taking hold--albeit for a smaller, transformed industry. There's no easy money to be made, and the shakeout isn't over by any means. Investors must be highly selective in identifying and analyzing prospective acquisitions or financing candidates. But it's time to start looking at real estate again--with a sober, calculated view. How protracted will the recovery period be? What obstacles still stand in the way? Where are the investment opportunities and the nasty traps? Who will own and finance real estate as we go forward, and what are the prospects for each major market and property category? Based on face-to-face interviews and in-depth surveys with the nation's leading real estate executives, Emerging Trends seeks to answer these and other questions in our annual industry outlook. Last year, Emerging Trends interviewees saw real estate as an impaired investment category, beset by negative returns and still-plunging short-term prospects. They wanted signs that markets were bottoming out and stabilizing before they would commit to the asset class again. Today those signals are coming through. While fixed-income securities and equities have at record highs, real estate is at a postwar low. However, most investors, while viewing real estate much more favorably, are somewhat chary of being first back into the markets. They want further evidence of firming before they move with conviction. They also wonder which specific properties to invest in, given the remaining market uncertainties. But they are ready to move. In 1994, look for marked improvement in investor appetites. In order of preference, multifamily, industrial warehouse, and regional mall properties will be the focus of investors coming back into the market. Apartments, the top choice, are in tight supply and values are actually increasing. Warehouse and retail mall values are stabilizing. Office properties, especially downtown, receive low ratings; but suburban office is strengthening, and with prices well below replacement costs there may be some excellent value plays. Despite improved balance sheets, there's still not much interest in hotels. No one expects a sudden, dramatic turnaround. In fact, for all the talk of improved real estate karma, the Emerging Trends panel is more worried now about an anemic economic delaying recovery than it was a year ago, especially for office markets. Nevertheless, as one interviewee sums it up: "It's going to take longer, but it's started. That's the important thing. We're stabilizing and we're finally looking up." There's little doubt that the real estate recovery will be slow and spotty. We define recovery as the stage in which values begin to increase as a result of improvement in effective rental rates and movement toward market equilibrium. For office properties, real rents won't increase until mid-1996, according to the consensus. Some regional malls may see small value hikes in '94, but others will shut down, unable to compete for the shrinking number of retail tenants. Washington, D.C., and Atlanta rank as the nation's strongest markets for real estate investment. Denver jumps to third, spurred by dramatic strengthening in its residential category. Overall, market assessments are more bullish than they were last year, but the nation's capital ranks as the only city where real estate values can be expected to increase--just barely--in 1994. Los Angeles again brings up the rear, with New York and Philadelphia also lagging. Sunbelt markets in general have stronger near-term prospects, as population growth promises to be the engine for better performance. Almost unanimously, the interviewees peg job growth as the key to pulling real estate out of its pit and triggering substantial improvement. But no one anticipates a wave of positive employment trends this is the biggest reason for tempered outlooks on the industry rebound. Company layoffs and much-ballyhooed reengineerings, the pressures of competing globally, and technological advancements that discourage the need for more space are stymieing white-collar job growth and will restrain office demand over the next decade. Government spending on major initiatives to produce jobs and encourage overall economic expansion is blocked by the federal deficit. Since the end of the 1991-1992 recession, job creation has been in lower-paying work with less security and lower benefits. This is not the type of employment growth that fills office buildings. Meanwhile, dampened consumer confidence, resulting in part from the tepid jobs picture, has been staunching any change for robust sales gains at malls. Available by fax or on If you would like to receive RERC's Quarterly Investment Survey summary tables via fax as soon as they are compiled, contact Real Estate Research Corporation at (312) 346-5885. As an additional convenience to subscribers, RERC will send the entire Investment Survey (text and tables) on computer diskette to those who request this service. The cost to receive the information on computer diskette is $7.50 per report. The diskette will contain the Quarterly Investment Survey narrative in both WordPerfect 5.1 and ASCII formats, and the Quarterly Survey Investment Criteria in both Lotus 1-2-3 and ASCII formats. The industry outlook for the overall economy is also underwhelming. On a scale of one to ten (one being very weak and ten very strong), interviewees rate the economy for 1994 at a plodding 4.8, not much better than 1993's 3.8 rating. Again, no one expects the type of economic rebound that will fuel a dramatic recovery in any of the real estate markets. On the other hand, interviewees acknowledge that low interest rates have been a godsend in allowing the recovery to take root. Their outlook is for rates to rise, but only slightly in 1994. Increased capital flows are another necessary ingredient for the market's comeback, and which raises perhaps the most interesting question for this year's Emerging Trends: Who will own and finance real estate after the great debacle? The traditional sources--banks and life insurance companies--have been forced to the sidelines by regulators and ratings agencies. They will return--banks sooner, insurers certainly not in 1994. Pension funds, while again considering new investments, can't be expected to fill the void, although may in the real estate industry would like to think they can. Foreign investors are back home nursing their wounds and will not be players in the foreseeable future. Wall Street activity REITs, commercial loan securitizations, and venture capital plays--are leading the way in returning some liquidity to the markets. But hoopla aside, REITs will remain a niche investment category. Yield greed, not necessarily real estate fundamentals, have been the REITs' great attraction in 1993. However, they have drawn a lot of positive attention to real estate, providing a badly needed boost for the beleaguered asset class. Probably more significant are the mortgage conduits being created to access Wall Street money and filling the temporary-financing gap left by banks and insurers. These sources will supply much-needed capitalization for smaller and midsized owners of multifamily and commercial real estate while REITs provide short-term relief for some of the bigger players. In keeping with the lukewarm turnaround under way, more capital will return to real estate in 1994 but it will still be in relatively short supply. The more traditional transaction volume from private sales should advance modestly in 1994, despite recent market inertia. Activity will pick up as banks shed more of their costly-to-manage REO holdings and insurers expedite portfolio reduction to meet stringent risk-based capital guidelines. Again, apartments, warehouses, and retail will be where the action is, as deal spreads narrow in the wake of improved performance trends. Pension funds will be investing in those categories. Entrepreneurs, less risk-averse, may dabble in picking off quality office buildings. As for development, forget about it! The industry has. And that's probably the most telling evidence of how realistic and purposeful the marketplace has become about what's needed to sustain recovery. Development has almost fallen out of the real estate vocabulary; trying to find a regional mall or office building under construction is like searching for a needle in a haystack. Any new project is basically pie-in-the-sky. To even think about discussing your pipe dreams is risking ridicule. The only possibilities for new construction are apartment developments in markets exhibiting both constrained supply and surging population growth and the occasional office or industrial warehouse build-to-suit. Changes in the tax code have their pluses and minuses, and could be viewed as a wash for the industry. Relief from onerous passive-loss rules is one positive, although owners will not be able to carry forward and deduct old passive losses incurred before January 1, 1994. The "five or 50" rule limiting pension fund investment in REITs was relaxed, but there are still some ownership limitations. A minus in the new laws is the provision that stretches depreciation schedules from 31.5 to 39 years on new properties placed in service. An increasingly important issue commanding the attention of all real estate owners today is property security and tenant safety. It's not a new concern but crime is just so much more pervasive and seemingly more violent. Malls can't afford headlines that suggest they're dangerous places. Corporate tenants make security an important negotiating point. Alarm systems and gatehouses are becoming expected amenities in apartment complexes. Of course, for hotels guest safety is absolutely crucial. It's a bleak commentary, but owners and investors who neglect providing secure environments are courting potentially devastating consequences for their properties. Real estate enters a period of extended convalescence in 1994. The cycle is making its turn upward after a harrowing, debilitating descent. No one wants to relive the joyride from excess to oblivion that made the '80s notorious. In the real estate world of the '90s, less will be viewed as more. Less capital, less development, less popularity, and reduced expectations will ultimately yield a stronger, more stable industry. This attitude adjustment has largely been imposed on the industry by the severity of its collapse and the realities of the economy. But now that heads are screwed on straighter, the real estate markets are finally moving slowly, but forward. Emerging Trends in Real Estate: 1994 is available for $25 from Real Estate Research Corporation, 2 N. LaSalle Street, Suite 400, Chicago, Illinois 60602. [graphic material omitted. This is a graph depicting a Comparison of Rates between the four quarters and year of 1984 and the four quarters and year of 1993. Real Estate Yields were highest, at approximately 14% in 1984 and 13% in 1993. Next are Moody's As Utilities, at approximate 14% in 1984 and 8% in 1993. Lowest are 10 year treasuries, at approximately 12% in 1984 and 6% in 1993] Kenneth P. Riggs, Jr. MAI Economic signals remain somewhat mixed as the Clinton Administration wrestles to get the domestic economy firmly on track and at the same time address larger policy issues. The economy has been growing at a faster pace than we thought. Every year at this time, the U.S. Department of Commerce revises its estimates of GDP. This year's update covered data back to 1990. The new figures show that for the past six quarters, the economy has grown at an annual rate of 3%, up from 2.5% based on the old data. Growth during 1992 was revised to 3.9%, up from 3.1%. The year finished strongly, with fourth-quarter 1992 growth revised upwards to 5.7%. The economy has slowed somewhat during the first half of 1993. Revised numbers place first-quarter growth at an anemic annual rate of 0.8%. Second-quarter growth GDP was not much better at 1.8%. The good news is that during this slowdown, job growth accelerated and domestic demand remained strong. This suggests that the economy has enough momentum for a second-half rebound. The employment picture is more encouraging, though the job market continues to move in fits and starts. For example, the August job figures showed a loss of 39,000 jobs, compared to a gain of 211,000 in July. Many analysts believe that the August numbers will be revised to show an employment gain. Overall, through August, the economy has added 1.2 million jobs in 1993, and this is expected to hit more than 2.0 million by year-end. . Not all the job news is good. The manufacturing sector continues to struggle. In August, manufacturing shed a further 42,000 jobs, bringing the year-to-date total to more than 200,000 jobs lost. Large corporations continue to announce cutbacks, including Kodak and Procter and Gamble during the third-quarter. Manufacturing employment is now at its lowest level since 1965 and its share of total employment has slipped from 26% in 1973 to 16% today. These losses are being offset by gains in the service sector which has seen payrolls rise by 1.3 million since January. . Indications are that consumers are beginning to climb to their feet once again. After slipping rapidly during the first-half of 1993, consumer confidence shows signs of strengthening. In September, the Conference Board's index of consumer confidence moved upwards to 62.6 from 59.3 in August. It marked the index's third consecutive monthly increase. Of interest, is the continued split between consumers' upbeat assessment of present conditions (at a 2-1/2 year high), but somewhat downbeat view of the long-term outlook. .Increased consumer confidence is reflected in retail sales. Retail sales continue to remain strong, rising 0.2% in August, and 0.3% in July. After adjusting for prices, retail sales have risen a healthy 5.3% over the past year. .The housing market is also showing more life. Housing starts in August increased nearly 8%, to an annual rate of 1.32 million, the highest level in 3- 1/2 years. Cheap mortgages and better weather fueled the gains and starts rose in all regions, except the Northeast where they fell. Low mortgage rates are now translating into increased sales. The Mortgage Bankers Association reports that by early September, mortgage applications had risen 35% from June. New home sales are critical to lifting the economy, as they translate into increased consumer spending for home-related goods. .Inflation remains under control. Through August, consumer prices were up just 2.8% from the previous year. They are expected to end the year well below 3%, the lowest pace in 21 years. On the producer side, inflationary pressure is virtually non-existent this year. During the past year, producer prices have risen at an annual rate of just 0.6%. [Insert graphic material here. This is The RERC Real Estate Barometer: Third Quarter 1993. The chart uses a scale of 1 to 10, with 1 being "very bad" and 10 being "very good." The question "Is now a good time to buy?" rates a 7.5. The question "Is it a good time to sell?" rates a 4.0. Finally, the question "What is the current availability of capital?" rates a 5.3.] .Continued low inflation should keep interest rates low. Long-term rates, critical to stimulating the economy, continue to be pushed lower. The 30-year Treasury fell below 6% in September. Signs are that these low rates are finally working their way across the economy. The best sign is that bank lending is up after two years of little or no growth, with personal and real estate loans accounting for the lion's share of the rise. Lower rates lift demand for the economy's interest-sensitive sectors, such as homebuilding, durable-goods, and autos. They also free up cash flow for businesses to invest elsewhere. Although economic signals remain somewhat mixed, the general trend is encouraging. It is against this economic back drop that our panel reported third-quarter figures. It's official, the bottom has been reached. This quarter we asked our panel to rate (on a 0 to 10 scale, with 0=falling, 5=bottom, and 10=rising) where we currently are in the real estate cycle. The overall average was 5.1. This rating supports our panel's growing mood of optimism over the past three quarters. Consensus is that the bid-ask spread continues to be squeezed (especially for apartment and warehouse properties), transaction activity has picked up, and capital has returned to the market. A number of respondents noted that the best opportunities may already have been past, though attractive buy opportunities remain. Panelists also commented that many markets have shown signs of stabilizing; concessions are being squeezed out, effective rents have stabilized, and, with no new construction, net absorption is zero or slightly positive. Our respondents remain realists, however, and note that although markets may have bottomed, the lack of new job growth and continued corporate downsizing and restructuring will mean that recovery will be a slow and protracted process. Transaction activity is being spurred by the increasing number of REITs that are coming to market, particularly in the apartment and retail sectors. The ability of REITs to access relatively inexpensive capital has resulted in their ability to bid aggressively for properties. This in turn has pushed capitalization rates downward. This movement is reflected in RERC's Real Estate Barometer. For the Third Quarter Survey, the bid-ask spread narrowed to 3.5, down from 4.2 the previous quarter and the lowest level since RERC started measuring the spread in 1991. Although the buy position continues to be heavily favored, scoring a 7.5 on the scale (10=high), it slipped slightly from last quarter. Conversely, the sell position scored a 4.0, still relatively weak, but up strongly from 3.4 the previous quarter. As reported by our respondents, transaction activity picked up in the prior, or second quarter. Fifteen panelists reported transaction activity for the first six months of 1993, totaling 35 deals, valued at $720 million. The average indicated deal size was $20.5 million. Of the 15 respondents providing data, three had yet to close a deal in 1993. Our panel continues to be bullish on the availability of capital. This quarter they rated capital availability an encouraging 5.3 on a 1 to 10 scale (10=plentiful). This is up from 5.0 last quarter, and an anaemic 3.8 for first- quarter 1993. Again, a prime factor influencing this response has been the continued appetite of Wall Street. However, Wall Street is not the only source of capital. Pension funds and entrepreneurial individuals continue to show increased interest. Even banks, which many had written off for the remainder of the decade, have shown signs that they will once again consider real estate loans. This is not too surprising given returns on alternative investments. Real estate yield expectations moved down or remained unchanged for all property types except neighborhood/community shopping centers. As Table 1 shows, reported yield requirements range from 10.0% to 15.0%, with property averages ranging from 11.3% to 12.8%. The mean required yield for all property types edged down for the second straight quarter, from 12.1% to 12.0%. Changes in yield expectations from the previous quarter were relatively small. The largest decrease was for 30 basis points for R&D properties. Office properties, both CBD and suburban, lead all property types with the highest average yield requirement (12.8%), followed by R&D (12.6%), and neighborhood/community shopping centers (12.2%). Regional malls continue to have the lowest return expectations (11.3%), followed by apartments (11.5%), and warehouse and retail power centers (both at 11.8%). As always, we underline that these rates represent unleveraged yield expectations, not realized returns. Going-in capitalization rates decreased for all property types, with the exception of CBD and suburban office properties. Average going-in rates ranged from 7.7% for regional malls to 10.6% for suburban office properties. The average going-in rate decreased by 20 basis points for warehouse buildings and retail power centers, while it increased 10 basis points for CBD and suburban office properties. Average terminal capitalization rates ranged from 8.4% for regional malls to 10.2% for suburban office properties. Changes in terminal capitalization rates were more mixed than changes in going-in rates. The gap between average going- in rates and average terminal rates ranges from +70 basis for regional malls and retail pow centers to -40 basis points for suburban office properties. As indicated in Table 1, investors are using higher going-in rates than terminal rates for office properties, and in some cases R&D properties. This reflects the continued state of disequilibrium in these markets and the expectation that market conditions will be better at the end of the holding period than they are today. Currently, investors are placing more emphasis on current cash flow than future appreciation when valuing property. This trend will be discussed in more detail later in the report. Table 3 illustrates historic spreads between the average targeted yield for real estate and actual yields for alternative investments. The gap between real estate yields and capital markets continues to increase. The current range in spreads is from 460 basis points on Aa Utilities to a whopping 630 basis points on 10-year Treasuries. The 630 basis points spread over Treasuries is the largest spread since the early 1980s. The continued widening of the gap highlights the relative attractiveness of real estate vis-a-vis other asset classes and the increasing attention real estate is generating from yield hungry institutional investors. Our respondents were asked to rate the nine property types in terms of their current investment conditions. Table 4 shows the average scores for each property type. This quarter, apartments moved solidly back to the top of the pile after slipping to second place last quarter. Apartments scored an impressive 7.0 on a 1 to 10 scale (10=very good). Apartments continue to top most investor's acquisition lists. But, as we have been saying for the past two quarters, this popularity has its price. Good quality apartment properties are becoming more difficult to find and competition has pushed capitalization rates down and prices up. Demand for apartments is coming from two main sources: pension funds, typically underweighted in this asset class; and REITs, flush with cash for acquisitions. Apartment REITs have flourished over the past year. NAREIT reported that apartment REITs raised over $780 million in the first half of 1993, double 1992's $326 million. By mid-1993, the 10 existing apartment REITs controlled approximately 71,500 units. The success of these REITs has resulted in a flurry of new issues. During third-quarter, no less than eight additional apartment REITs are expected to come to market, controlling an additional 71,000 units. Warehouse properties saw ratings move upwards this quarter, to 6.4 from 6.0. Despite mixed signals from the economy, industrial properties continue to be favored and placed near the top of most investor's acquisition lists. The reasons for this are relatively simple: compared to most other property types, warehouses have performed relatively well over the past three years. Although vacancies have increased and rents and values have slipped slightly, overall, the supply and demand fundamentals of this asset class have remained intact. However investors must be knowledgeable when making new acquisitions, paying attention to big-picture trends in manufacturing and distribution technology. The remaining property types, with the exception of R&D, saw their ratings drop this quarter. CBD office and hotels continue to languish at the bottom of the list. Although they receive low ratings, contrarian investors with courage and strong hearts are taking a serious look at these assets, figuring that the best buys may be just around the corner for these property types. Geographic preferences of our panel are gathered on a semiannual basis. Table 5 shows how investors rate the relative strengths of competing markets as of the third quarter 1993. Overall, the increased optimism of our panel is reflected in their ratings of the 16 major markets, with most cities seeing an increase in their ratings from first quarter 1993. Washington, D.C. and Atlanta continue to top our panelist's list with ratings of 6.9 and 6.6, respectively. Washington, D.C. has held the top spot for the past year. Our respondents feel this will be the first market to recover, buffered by stable government payrolls and a well compensated private sector. While the retail and residential markets are improving, office market remains troubled. Atlanta's affordable middle class lifestyle is a magnet for population migration to this metro area, and it ranks as the nation's leader in job growth. Typical of many sun-belt cities with room to grow and few barriers to entry, it is the suburbs that are expanding while the downtown suffers. Again, it is the residential and retail markets that are prospering, while the office markets are uniformly soft (with over 25% vacancy rate in the CBD). Recent major corporate relations have taken the build-to-suit route. Miami/South Florida recorded the largest increase this quarter, jumping from a rating of 5.1 in first-quarter 1993 to 5.9 this quarter. Miami's strength is its apartment sector which has very low vacancies and may be primed for new construction in 1994. Ironically, Hurricane Andrew has been a boon to Miami's residential and retail markets and stirrings of new activity from Latin America raise optimism on the office side. Recent acts of random violence, which have made national and international headlines, may dampen this area's attractiveness. Denver and Phoenix continue to show a steady increase in ratings. Both markets have seen residential values rise as Southern Californian's bailout of Los Angeles and surrounding areas. In Denver, the apartment market is tight and retailers are expanding. The new airport will open during the next year, which is seen as a positive for industrials. In Phoenix, the industrial sector is poised to benefit from the passage of the North American Free Trade Act (NAFTA). Further, Phoenix rates as one of the nation's hottest retail markets, buoyed by younger babyboomer demographics. One city that has seen its rating decline during the past year is Seattle. Boeing's announcement of widespread job cuts has led to uncertainty surrounding this market. The jetmaker's cutbacks have hurt office and residential over the short term. Seattle's growing high-tech sector, led by Microsoft, remains a plus. Further, the industrial sector remains strong, due largely to its role as a Pacific gateway. The larger cities, particularly New York and Los Angeles, continue to languish at the bottom of the ratings, with near-term prospects not encouraging. Although our respondents report more optimism, this has yet to be reflected in their underwriting assumptions which remain firmly conservative. For most asset classes, rent increases are expected to be minimal--0% to 3%--over the next one to three years, increasing 3% to 5% thereafter. A 3% to 4% annual average appears favored by most respondents. Again, the exception to this and good quality retail, where demand remains relatively strong and growth rates of 3% to 5% can be justified throughout the holding period. Expense growth rates typically mirror inflation expectations, ranging between 3% to 5%, with many respondents betting on continued low inflation, in the 3% to 4% range. The typical holding period remains 10 years. This quarter we asked our respondents to what renewal probabilities they typically use in their own internal analyses. Their responses are shown in Table 6. They range from a low of 51% of tenants renewing for CBD and suburban office, to a high of 62% for regional malls. Overall, the renewal probabilities provided by the panel are conservative and go hand-in-hand with the other underwriting assumptions used. As our respondents head into the year-end push, cautious optimism prevails. Signs are that the bottom has been reached, capital is returning and that sunnier skies are ahead. Transaction activity will be watched closely over the remainder of the year for confirmation of these trends. Table 1. Real Estate Investment Criteria by Property Type. Third Quarter 1993 Note: Income and expense growth rates are addressed in the accompanying text. * The survey was conducted in July and August 1993 and reflects expected returns for third-quarter 1993 investments. ** Ranges and other data reflect the central tendencies of respondents; high and low responses have generally been eliminated. Source: Real Estate Research Corporation. Table 2. Real Estate vis-a-vis Capital Market Returns* * This survey was conducted in July and August 1993 and reflects desired returns for third-quarter 1993 investments. Capital markets rates are for the first week of each quarter. Source: Real Estate Research Corporation. Table 3. Intermarket Yield Spreads: Real Estate vis-a-vis Capital Markets Real estate over other investments. Source: Real Estate Research Corporation. Table 4. Current Investment Conditions by Property Type * Rated on a scale of 1 (very bad) to 10 (very good) Source: Real Estate Research Corporation. Table 5. Current Investment Conditions by Major Markets* * Rated on a scale of 1 (very bad) to 10 (very good) Source: Real Estate Research Corporation. Source: Real Estate Research Corporation. Real Estate Report is published four times a year by Real Estate Research Corporation, 2 North LaSalle Street, Suite 400, Chicago, IL 60602. Copyright 1993 by Real Estate Research Corporation. All rights reserved. No part of this newsletter may be reproduced in any form, by microfilm, xerography, or otherwise, or incorporated into any information retrieval system, without the written permission of the copyright owner. Third-class postage paid at Chicago, IL. Subscriptions are $195 per year, or $357 for two years. Single copies and back issues, if available, are $55 each. POSTMASTER: Send address changes to RERC Real Estate Report, 2 North LaSalle St., Suite 400, Chicago, IL 60602, telephone (312) 346-5885. Publisher: Kenneth P. Riggs, Jr. Kenneth P. Riggs, Jr. This publication is designed to provide accurate information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal or accounting service. The publisher advises that no statement in this issue is to be construed as a recommendation to make any real estate investments or to buy or sell any security or as investment advice. The examples contained in the publication are intended for use as background on the real estate industry as a whole, not as support for any particular real estate investment or security. Although RERC Real Estate Report uses only sources that it deems reliable and accurate, Real Estate Research Corporation does not warrant the accuracy of the information contained herein. QUARTERLY SURVEY OF INVESTMENT CRITERIA: THIRD QUARTER 1993 QUARTERLY SURVEY OF INVESTMENT CRITERIA: THIRD QUARTER 1993 QUARTERLY SURVEY OF INVESTMENT CRITERIA: THIRD QUARTER 1993 QUARTERLY SURVEY OF INVESTMENT CRITERIA:THIRD QUARTER 1993 QUARTERLY SURVEY OF INVESTMENT CRITERIA: THIRD QUARTER 1993 Internal rate of return (IRR) is the rate of interest that discounts the pre- income tax cash flows received by the equity investor(s) back to a present value that is exactly equal to the amount of the original equity investment. It is in effect a time-weighted average return on equity and as used here, is synonomous with the term "yield." First-year NOI divided by present value (or purchase price), unless otherwise noted. Usually a capitalization rate used to estimate resale or reversion value at the end of the holding period. Annual compounded rate of increase in revenue and expenses over current-year levels. Further expenses are typically forecast on a line-by-line basis. QUARTERLY SURVEY OF INVESTMENT CRITERIA: THIRD QUARTER 1993	SC 13E3	EX-99.17.(B)(5)	1996-01-12T00:00:00	1996-01-11T17:58:48
0000950109-96-000200	0000950109-96-000200_0006.txt	DECLARATION OF TRUST made August 10, 1995 by the Trustees (together with all other persons from time to time duly elected, qualified and serving as Trustees in accordance with the provisions of Article II hereof, the "Trustees"). WHEREAS, the Trustees desire to establish a trust for the investment and reinvestment of funds contributed thereto; and WHEREAS, the Trustees desire that the beneficial interest in the trust assets be divided into transferable shares of beneficial interest, as NOW, THEREFORE, the Trustees declare that all money and property contributed to the trust established hereunder shall be held and managed in trust for the benefit of the holders, from time to time, of the shares of beneficial interest issued hereunder and subject to the provisions hereof. Section 1.1. Name. The name of the trust created hereby is "Weiss Treasury Fund." Section 1.2. Definitions. Wherever they are used herein, the following terms have the following respective meanings: (a) "By-laws" means the By-laws referred to in Section 2.8 hereof, as from time to time amended. (b) "Class" means the two or more Classes as may be established and designated from time to time by the Trustees pursuant to Section 5.13 hereof. (c) The term "Commission" has the meaning given it in the 1940 Act (as defined below). The term "Interested Person" has the meaning given it in the 1940 Act, as modified by any applicable order or orders of the Commission. Except as otherwise defined by the Trustees in conjunction with the establishment of any series of Shares (as defined below), the term "vote of a majority of the Shares outstanding and entitled to vote" shall have the same meaning as the term "vote of a majority of the outstanding voting securities" given it in the 1940 Act. (d) "Custodian" means any Person other than the Trust who has custody of any Trust Property as required by Section 17(f) of the 1940 Act, but does not include a system for the central handling of securities described in said Section 17(f). (e) "Declaration" means this Declaration of Trust as further amended from time to time. Reference in this Declaration to "Declaration," "hereof," "herein," and "hereunder" shall be deemed to refer to this Declaration rather than exclusively to the article or section in which such words appear. (f) "Distributor" means the party, other than the Trust, to the contract described in Section 3.1 hereof. (g) "His" shall include the feminine and neuter, as well as the masculine, genders. (h) "Investment Adviser" means the party, other than the Trust, to the contract described in Section 3.2 hereof. (i) "Municipal Bonds" means obligations issued by or on behalf of states, territories of the United States and the District of Columbia and their political subdivisions, agencies and instrumentalities, the interest from which is exempt from regular Federal income tax. (j) The "1940 Act" means the Investment Company Act of 1940, as amended from time to time, and rules thereunder. (k) "Person" means and includes individuals, corporations, partnerships, trusts, associations, joint ventures and other entities, whether or not legal entities, and governments and agencies and political subdivisions thereof. (l) "Series" individually or collectively means the two or more Series as may be established and designated from time to time by the Trustees pursuant to Section 5.11 hereof. Unless the context otherwise requires, the term "Series" shall include Classes into which Shares (as defined below) of the Trust, or of a Series, may be divided from time to time. (m) "Shareholder" means a record owner of Outstanding Shares (as defined below). (n) "Shares" means the equal proportionate units of interest into which the beneficial interest in the Trust shall be divided from time to time, including the Shares of any and all Series and Classes which may be established by the Trustees, and includes fractions of Shares as well as whole Shares. "Outstanding Shares" means those Shares shown from time to time on the books of the Trust or its Transfer Agent as then issued and outstanding, but shall not include Shares which have been redeemed or repurchased by the Trust and which are at the time held in the treasury of the Trust. (o) "Transfer Agent" means any one or more Persons other than the Trust who maintains the Shareholder records of the Trust, such as the list of Shareholders, the number of Shares credited to each account, and the like. (p) The "Trust" means Weiss Treasury Fund. (q) The "Trust Property" means any and all property, real or personal, tangible or intangible, which is owned or held by or for the account of the Trust or the Trustees. (r) The "Trustees" means the person or persons who has or have signed this Declaration, so long as he or they shall continue in office in accordance with the terms hereof, and all other persons who may from time to time or be duly qualified and serving as Trustees in accordance with the provisions of Article II hereof, and reference herein to a Trustee or the Trustees shall refer to such person or persons in this capacity or their capacities as Trustees hereunder. Section 2.1. General Powers. The Trustees shall have exclusive and absolute control over the Trust Property and over the business of the Trust to the same extent as if the Trustees were the sole owners of the Trust Property and business in their own right, but with such powers of delegation as may be permitted by this Declaration. The Trustees shall have power to conduct the business of the Trust and carry on its operations in any and all of its branches and maintain offices both within and outside of the Commonwealth of Massachusetts, in any and all states of the United States of America, in the District of Columbia, and in any and all commonwealths, territories, dependencies, colonies, possessions, agencies or instrumentalities of the United States of America and of foreign governments, and to do all such other things and execute all such instruments as they deem necessary, proper or desirable in order to promote the interests of the Trust although such things are not herein specifically mentioned. Any determination as to what is in the interests of the Trust made by the Trustees in good faith shall be conclusive. In construing the provisions of this Declaration, the presumption shall be in favor of a grant of power to the Trustees. The enumeration of any specific power herein shall not be construed as limiting the aforesaid power. Such powers of the Trustees may be exercised without order of or resort to any court. Section 2.2. Investments. The Trustees shall have the power: (a) To operate as and carry on the business of an investment company, and exercise all the powers necessary and appropriate to the conduct of such operations. (b) To invest in, hold for investment, or reinvest in, securities, including common and preferred stocks; warrants; bonds, debentures, bills, time notes and all other evidences of indebtedness; negotiable or non- negotiable instruments; government securities, including securities of any state, municipality or other political subdivision thereof, or any governmental or quasi-governmental agency or instrumentality; and money market instruments, including bank certificates of deposit, finance paper, commercial paper, bankers acceptances and all kinds of repurchase agreements of any corporation, company, trust, association, firm or other business organization however established, and of any country, state, municipality or other political subdivision, or any governmental or quasi-governmental agency or instrumentality. (c) To acquire (by purchase, subscription or otherwise), to hold, to trade in and deal in, to acquire any rights or options to purchase or sell, to sell or otherwise dispose of, to lend, and to pledge any such securities and to enter into repurchase agreements and forward foreign currency exchange contracts, to purchase and sell futures contracts on securities, securities indices and foreign currencies, to purchase or sell options on such contracts, foreign currency contracts and foreign currencies and to engage in all types of hedging and risk management transactions. (d) To exercise all rights, powers and privileges of ownership or interest in all securities, repurchase agreements, future contracts and options and other assets included in the Trust Property, including the right to vote thereon and otherwise act with respect thereto and to do all acts for the preservation, protection, improvement and enhancement in value of all such assets. (e) To acquire (by purchase, lease or otherwise) and to hold, use, maintain, develop and dispose of (by sale or otherwise) any property, real or personal, including cash, and any interest therein. (f) To borrow money and in this connection issue notes or other evidence of indebtedness; to secure borrowings by mortgaging, pledging or otherwise subjecting as security the Trust Property; to endorse, guarantee, or undertake the performance of any obligation or engagement of any other Person and to lend Trust Property. (g) To aid by further investment any corporation, company, trust, association or firm, any obligation of or interest in which is included in the Trust Property or in the affairs of which the Trustees have any direct or indirect interest; to do all acts and things designed to protect, to preserve, improve or enhance the value of such obligation or interest, and to guarantee or become surety on any or all of the contracts, stocks, bonds, notes, debentures and other obligations of any such corporation, company, trust, association or firm. (h) To enter into a plan of distribution and any related agreements whereby the Trust may finance directly or indirectly any activity which is primarily intended to result in the sale of Shares. (i) In general to carry on any other business in connection with or incidental to any of the foregoing powers, to do everything necessary, suitable or proper for the accomplishment of any purpose or the attainment of any object or the furtherance of any power hereinbefore set forth, either alone or in association with others, and to do every other act or thing incidental or appurtenant to or growing out of or connected with the aforesaid business or purposes, objects or powers. The foregoing clauses shall be construed both as objects and powers, and the foregoing enumeration of specific powers shall not be held to limit or restrict in any manner the general powers of the Trustees. The Trustees shall not be limited to investing in obligations maturing before the possible termination of the Trust, nor shall the Trustees be limited by any law limiting the investments which may be made by fiduciaries. Section 2.3. Legal Title. Legal title to all the Trust Property, including the property of any Series of the Trust, shall be vested in the Trustees as joint tenants except that the Trustees shall have power to cause legal title to any Trust Property to be held by or in the name of one or more of the Trustees, or in the name of the Trust, or in the name of any other Person as nominee, on such terms as the Trustees may determine, provided that the interest of the Trust therein is deemed appropriately protected. The right, title and interest of the Trustees in the Trust Property and the property of each Series of the Trust shall vest automatically in each Person who may hereafter become a Trustee. Upon the termination of the term of office, resignation, removal or death of a Trustee he shall automatically cease to have any right, title or interest in any of the Trust Property or the property of any Series of the Trust, and the right, title and interest of such Trustee in the Trust Property shall vest automatically in the remaining Trustees. Such vesting and cessation of title shall be effective whether or not conveyancing documents have been executed and delivered. Section 2.4. Issuance and Repurchase of Shares. The Trustees shall have the power to issue, sell, repurchase, redeem, retire, cancel, acquire, hold, resell, reissue, dispose of, transfer, and otherwise deal in Shares and, subject to the provisions set forth in Articles VI and VII and Section 5.11 hereof, to apply to any such repurchase, redemption, retirement, cancellation or acquisition of Shares any funds or property of the particular series of the Trust with respect to which such Shares are issued, whether capital or surplus or otherwise, to the full extent now or hereafter permitted by the laws of the Commonwealth of Massachusetts governing business corporations. Section 2.5. Delegation; Committees. The Trustees shall have the power to delegate from time to time to such of their number or to officers, employees or agents of the Trust the doing of such things and the execution of such instruments either in the name of the Trust or the names of the Trustees or otherwise as the Trustees may deem expedient, provided that such delegation is not prohibited by the 1940 Act. Section 2.6. Collection and Payment. The Trustees shall have power to collect all property due to the Trust; to pay all claims, including taxes, against the Trust Property; to prosecute, defend, compromise or abandon any claims relating to the Trust Property; to foreclose any security interest securing any obligations, by virtue of which any property is owed to the Trust; and to enter into releases, agreements and other instruments. Section 2.7. Expenses. The Trustees shall have the power to incur and pay any expenses which in the opinion of the Trustees are necessary or incidental to carrying out any of the purposes of this Declaration, and to pay reasonable compensation from the funds of the Trust to themselves as Trustees. The Trustees shall fix the compensation of all officers, employees and Trustees. Section 2.8. Manner of Acting; By-laws. Except as otherwise provided herein or in the By-laws, any action to be taken by the Trustees may be taken by a majority of the Trustees present at a meeting of Trustees (a quorum being present), including any meeting held by means of a conference telephone circuit or similar communications equipment by means of which all persons participating in the meeting can hear each other, or by written consents signed by a majority of Trustees then in office. The Trustees may adopt By-laws not inconsistent with this Declaration to provide for the conduct of the business of the Trust and may amend or repeal such By-laws to the extent such power is not reserved to the Shareholders. Notwithstanding the foregoing provisions of this Section 2.8 and in addition to such provisions or any other provision of this Declaration or of the By-laws, the Trustees may by resolution appoint a committee consisting of less than the whole number of Trustees then in office, which committee may be empowered to act for and bind the Trustees and the Trust, as if the acts of such committee were the acts of all the Trustees then in office, with respect to the institution, prosecution, dismissal, settlement, review or investigation of any action, suit or proceeding that is pending or threatened to be brought before any court, administrative agency or other adjudicatory body. Section 2.9. Miscellaneous Powers. Subject to Section 5.11, hereof, the Trustees shall have the power to: (a) employ or contract with such Persons as the Trustees may deem desirable for the transaction of the business of the Trust; (b) enter into joint ventures, partnerships and any other combinations or associations; (c) remove Trustees or fill vacancies in or add to their number, elect and remove such officers and appoint and terminate such agents or employees as they consider appropriate, and appoint from their own number, and terminate, any one or more committees which may exercise some or all of the powers and authority of the Trustees as the Trustees may determine; (d) purchase, and pay for out of Trust Property, insurance policies insuring the Shareholders, Trustees, officers, employees, agents, Investment Advisers, Distributors, Transfer Agents, selected dealers or independent contractors of the Trust against all claims arising by reason of holding any such position or by reason of any action taken or omitted by any such Person in such capacity, whether or not constituting negligence, or whether or not the Trust would have the power to indemnify such Person against such liability; (e) establish pension, profit-sharing, share purchase, and other retirement, incentive and benefit plans for any Trustees, officers, employees and agents of the Trust; (f) to the extent permitted by law, indemnify any person with whom the Trust has dealings, including the Investment Adviser, Distributor, Transfer Agent and selected dealers, to such extent as the Trustees shall determine; (g) guarantee indebtedness or contractual obligations of others; (h) determine and change the fiscal year of the Trust and the method by which its accounts shall be kept; and (i) adopt a seal for the Trust, but the absence of such seal shall not impair the validity of any instrument executed on behalf of the Trust. Section 2.10. Principal Transactions. Except in transactions not permitted by the 1940 Act or rules and regulations adopted by the Commission, the Trustees may, on behalf of the Trust, buy any securities from or sell any securities to, or lend any assets of the Trust to, any Trustee or officer of the Trust or any firm of which any such Trustee or officer is a member acting as principal, or have any such dealings with the Investment Adviser, Distributor or Transfer Agent or with any Interested Person of such Person; and the Trust may, upon customary terms, employ any such Person, or firm or company in which such Person is an Interested Person, as broker, legal counsel, registrar, Transfer Agent, dividend disbursing agent or custodian. Section 2.11. Number of Trustees. The number of Trustees shall initially be one (1), and thereafter shall be such number as shall be fixed from time to time by a written instrument signed by a majority of the Trustees, provided, however, that the number of Trustees shall in no event be more than fifteen (15). Section 2.12. Election and Term. Except for the Trustees named herein or appointed to fill vacancies pursuant to Section 2.14 hereof, the Trustees shall be elected by the Shareholders owning of record a plurality of the Shares voting at a meeting of Shareholders. Such a meeting shall be held on a date fixed by the Trustees. Except in the event of resignation or removals pursuant to Section 2.13 hereof, each Trustee shall hold office until such time as less than a majority of the Trustees holding office have been elected by Shareholders. In such event the Trustees then in office will call a Shareholders' meeting for the election of Trustees. Except for the foregoing circumstances, the Trustees shall continue to hold office and may appoint successor Trustees. Section 2.13. Resignation and Removal. Any Trustee may resign his trust (without the need for any prior or subsequent accounting) by an instrument in writing signed by him and delivered to the other Trustees and such resignation shall be effective upon such delivery, or at a later date according to the terms of the instrument. Any of the Trustees may be removed (provided the aggregate number of Trustees after such removal shall not be less than one) with cause, by the action of two-thirds of the remaining Trustees. Any Trustee may be removed at any meeting of Shareholders by vote of two thirds of the Outstanding Shares. The Trustee shall promptly call a meeting of the shareholders for the purpose of voting upon the question of removal of any such Trustee or Trustees when requested in writing so to do by the holders of not less than ten percent (10%) of the Outstanding Shares, and in that connection, the Trustees will assist shareholder communications to the extent provided for in Section 16(c) under the 1940 Act. Upon the resignation or removal of a Trustee, or his otherwise ceasing to be a Trustee, he shall execute and deliver such documents as the remaining Trustees shall require for the purpose of conveying to the Trust or the remaining Trustees any Trust Property or property of any series of the Trust held in the name of the resigning or removed Trustee. Upon the incapacity or death of any Trustee, his legal representative shall execute and deliver on his behalf such documents as the remaining Trustees shall require as provided in the preceding sentence. Section 2.14. Vacancies. The term of office of a Trustee shall terminate and a vacancy shall occur in the event of the death, resignation, removal, bankruptcy, adjudicated incompetence or other incapacity to perform the duties of the office of a Trustee. No such vacancy shall operate to annul the Declaration or to revoke any existing agency created pursuant to the terms of the Declaration. In the case of an existing vacancy, including a vacancy existing by reason of an increase in the number of Trustees, subject to the provisions of Section 16(a) of the 1940 Act, the remaining Trustees shall fill such vacancy by the appointment of such other person as they in their discretion shall see fit, made by a written instrument signed by a majority of the Trustees then in office. Any such appointment shall not become effective, however, until the person named in the written instrument of appointment shall have accepted in writing such appointment and agreed in writing to be bound by the terms of the Declaration. An appointment of a Trustee may be made in anticipation of a vacancy to occur at a later date by reason of retirement, resignation or increase in the number of Trustees, provided that such appointment shall not become effective prior to such retirement, resignation or increase in the number of Trustees. Whenever a vacancy in the number of Trustees shall occur, until such vacancy is filled as provided in this Section 2.14, the Trustees in office, regardless of their number, shall have all the powers granted to the Trustees and shall discharge all the duties imposed upon the Trustees by the Declaration. A written instrument certifying the existence of such vacancy signed by a majority of the Trustees in office shall be conclusive evidence of the existence of such vacancy. Section 2.15. Delegation of Power to Other Trustees. Any Trustee may, by power of attorney, delegate his power for a period not exceeding six (6) months at any one time to any other Trustee or Trustees; provided that in no case shall less than two (2) Trustees personally exercise the powers granted to the Trustees under this Declaration except as herein otherwise expressly provided. Section 3.1. Distribution Contract. The Trustees may in their discretion from time to time enter into an exclusive or non-exclusive underwriting contract or contracts providing for the sale of the Shares at a price based on the net asset value of a Share, whereby the Trustees may either agree to sell the Shares to the other party to the contract or appoint such other party their sales agent for the Shares, and in either case on such terms and conditions, if any, as may be prescribed in the By-laws; and such further terms and conditions as the Trustees may in their discretion determine not inconsistent with the provisions of this Article III or of the By-laws; and such contract or contracts may also provide for the repurchase of the Shares by such other party as agent of the Trustees. Section 3.2. Advisory or Management Contract. The Trustees may in their discretion from time to time enter into an investment advisory or management contract or separate advisory contracts with respect to one or more Series whereby the other party to such contract shall undertake to furnish to the Trust such management, investment advisory, statistical and research facilities and services and such other facilities and services, if any, and all upon such terms and conditions as the Trustees may in their discretion determine, including the grant of authority to such other party to determine what securities shall be purchased or sold by the Trust and what portion of its assets shall be uninvested, which authority shall include the power to make changes in the investments of the Trust or any Series. The Trustees may also employ, or authorize the Investment Adviser to employ, one or more sub-advisers from time to time to perform such of the acts and services of the Investment Adviser and upon such terms and conditions as may be agreed upon between the Investment Adviser and such sub-advisers and approved by the Trustees. Any reference in this Declaration to the Investment Adviser shall be deemed to include such sub-advisers unless the context otherwise requires. Section 3.3. Affiliations of Trustees or Officers, Etc. The fact that: (i) any of the Shareholders, Trustees or officers of the Trust is a shareholder, director, officer, partner, trustee, employee, manager, adviser or distributor of or for any partnership, corporation, trust, association or other organization or of or for any parent or affiliate of any such organization, with which a contract of the character described in Sections 3.1 or 3.2 above or for services as Custodian, Transfer Agent or disbursing agent or for related services may have been or may hereafter be made, or that any such organization, or any parent or affiliate thereof, is a Shareholder of or has an interest in the Trust, or that (ii) any partnership, corporation, trust, association or other organization with which a contract of the character described in Sections 3.1 or 3.2 above or for services as Custodian, Transfer Agent or disbursing agent or for related services may have been or may hereafter be made also has any one or more of such contracts with one or more other partnerships, corporations, trusts, associations or other organizations, or has other business shall not affect the validity of any such contract or disqualify any Shareholder, Trustee or officer of the Trust from voting upon or executing the same or create any liability or accountability to the Trust or its Shareholders. Section 3.4. Compliance with 1940 Act. Any contract entered into pursuant to Sections 3.1 or 3.2 shall be consistent with and subject to the requirements of Section 15 of the 1940 Act (including any amendment thereof or other applicable act of Congress hereafter enacted), as modified by any applicable order or orders of the Commission, with respect to its continuance in effect, its termination and the method of authorization and approval of such contract or renewal thereof. LIMITATIONS OF LIABILITY OF SHAREHOLDERS, Section 4.1. No Personal Liability of Shareholders, Trustees, Etc. No Shareholder shall be subject to any personal liability whatsoever to any Person in connection with Trust Property or the acts, obligations or affairs of the Trust. No Trustee, officer, employee or agent of the Trust shall be subject to any personal liability whatsoever to any Person, other than to the Trust or its Shareholders, in connection with Trust Property or the affairs of the Trust, save only that arising from bad faith, willful misfeasance, gross negligence or reckless disregard of his duties with respect to such Person; and all such Persons shall look solely to the Trust Property for satisfaction of claims of any nature arising in connection with the affairs of the Trust. If any Shareholder, Trustee, officer, employee, or agent, as such, of the Trust, is made a party to any suit or proceeding to enforce any such liability of the Trust, he shall not, on account thereof, be held to any personal liability. The Trust shall indemnify and hold each Shareholder harmless from and against all claims and liabilities to which such Shareholder may become subject by reason of his being or having been a Shareholder, and shall reimburse such Shareholder for all legal and other expenses reasonably incurred by him in connection with any such claim or liability. The indemnification and reimbursement required by the preceding sentence shall be made only out of the assets of the one or more Series of which the Shareholder who is entitled to indemnification or reimbursement was a Shareholder at the time the act or event that gave rise to the claim against or liability of said Shareholder occurred. The rights accruing to a Shareholder under this Section 4.1 shall not impair any other right to which such Shareholder may be lawfully entitled, nor shall anything herein contained restrict the right of the Trust to indemnify or reimburse a Shareholder in any appropriate situation even though not specifically provided herein. Section 4.2. Non-Liability of Trustees, Etc. No Trustee, officer, Shareholders, thereof for any action or failure to act (including without limitation the failure to compel in any way any former or acting Trustee to redress any breach of trust) except for his own bad faith, willful misfeasance, gross negligence or reckless disregard of the duties involved in the conduct of his office. (a) Subject to the exceptions and limitations contained in paragraph (b) below: (i) every person who is, or has been, a Trustee or officer of the Trust shall be indemnified by the Trust to the fullest extent permitted by law against all liability and against all expenses reasonably incurred or paid by him in connection with any claim, action, suit or proceeding in which he becomes involved as a party or otherwise by virtue of his being or having been a Trustee or officer and against amounts paid or incurred by him in the settlement (ii) the words "claim," "action," "suit," or "proceeding" shall apply to all claims, actions, suits or proceedings (civil, criminal, administrative or other, including appeals), actual or threatened; and the words "liability" and "expenses" shall include, without limitation, attorneys' fees, costs, judgments, amounts paid in settlement, fines, penalties and other liabilities. (b) No indemnification shall be provided hereunder to a Trustee or officer: (i) against any liability to the Trust, a Series thereof, or the Shareholders by reason of a final adjudication by a court or other body before which a proceeding was brought that he engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the (ii) with respect to any matter as to which he shall have been finally adjudicated not to have acted in good faith in the reasonable belief that his action was in the best interests of the Trust; or (iii) in the event of a settlement or other disposition not involving a final adjudication as provided in paragraph (b)(i) or (b)(ii) resulting in a payment by a Trustee or officer, unless there has been a determination that such Trustee or officer did not engage in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his office: (A) by the court or other body approving the settlement or other disposition; or (B) based upon a review of readily available facts (as opposed to a full trial-type inquiry) by (x) vote of a majority of the Disinterested Trustees (as defined below) acting on the matter (provided that a majority of the Disinterested Trustees then in office act on the matter), or (y) written opinion of independent legal counsel. (c) The rights of indemnification herein provided may be insured against by policies maintained by the Trust, shall be severable, shall not affect any other rights to which any Trustee or officer may now or hereafter be entitled, shall continue as to a person who has ceased to be such Trustee or officer and shall inure to the benefit of the heirs, executors, administrators and assigns of such a person. Nothing contained herein shall affect any rights to indemnification to which personnel of the Trust other than Trustees and officers may be entitled by contract or otherwise under law. (d) Expenses of preparation and presentation of a defense to any claim, action, suit or proceeding of the character described in paragraph (a) of this Section 4.3 may be advanced by the Trust prior to a final disposition thereof upon receipt of an undertaking by or on behalf of the recipient to repay such amount if it is ultimately determined that he is not entitled to indemnification under this Section 4.3, provided that either: (i) such undertaking is secured by a surety bond or some other appropriate security provided by the recipient, or the Trust shall be insured against losses arising out of any such advances; or (ii) a majority of the Disinterested Trustees acting on the matter (provided that a majority of the Disinterested Trustees act on the matter) or an independent legal counsel in a written opinion shall determine, based upon a review of readily available facts (as opposed to a full trial-type inquiry), that there is reason to believe that the recipient ultimately will be found entitled to indemnification. As used in this Section 4.3, a "Disinterested Trustee" is one who is not (i) an Interested Person of the Trust, as defined under 2(a)(19) of the 1940 Act (including anyone who has been exempted from being an Interested Person by any rule, regulation or order of the Commission), or (ii) involved in the claim, action, suit or proceeding. Section 4.4. No Bond Required of Trustees. No Trustee shall be obligated to give any bond or other security for the performance of any of his duties hereunder. Section 4.5. No Duty of Investigation; Notice in Trust Instruments, Etc. No purchaser, lender, transfer agent or other Person dealing with the Trustees or any officer, employee or agent of the Trust shall be bound to make any inquiry concerning the validity of any transaction purporting to be made by the Trustees or by said officer, employee or agent or be liable for the application of money or property paid, loaned, or delivered to or on the order of the Trustees or of said officer, employee or agent. Every obligation, contract, instrument, certificate, Share, other security of the Trust or undertaking, and every other act or thing whatsoever executed in connection with the Trust shall be conclusively presumed to have been executed or done by the executors thereof only in their capacity as Trustees under this Declaration or in their capacity as officers, employees or agents of the Trust. Every written obligation, contract, instrument, certificate, Share, other security of the Trust or undertaking made or issued by the Trustees may recite that the same is executed or made by them not individually, but as Trustees under the Declaration, and that the obligations of the Trust under any such instrument are not binding upon any of the Trustees or Shareholders individually, but bind only the trust estate, and may contain any further recital which they or he may deem appropriate, but the omission of such recital shall not operate to bind the Trustees individually. The Trustees shall at all times maintain insurance for the protection of the Trust Property, its Shareholders, Trustees, officers, employees and agents in such amount as the Trustees shall deem adequate to cover possible tort liability, and such other insurance as the Trustees in their sole judgment shall deem advisable. Section 4.6. Reliance on Experts, Etc.. Each Trustee and officer or employee of the Trust shall, in the performance of his duties, be fully and completely justified and protected with regard to any act or any failure to act resulting from reliance in good faith upon the books of account or other records of the Trust, upon an opinion of counsel, or upon reports made to the Trust by any of its officers or employees or by the Investment Adviser, the Distributor, Transfer Agent, selected dealers, accountants, appraisers or other experts or consultants selected with reasonable care by the Trustees, officers or employees of the Trust, regardless of whether such counsel or expert may also be a Trustee. Section 5.1. Beneficial Interest. The interest of the beneficiaries hereunder shall be divided into transferable Shares of beneficial interest, all of one class, except as provided in Section 5.11 and Section 5.13 hereof, par value $.01 per share. The number of Shares of beneficial interest authorized hereunder is unlimited. All Shares issued hereunder including, without limitation, Shares issued in connection with a dividend in Shares or a split of Shares, shall be fully paid and non-assessable. Section 5.2. Rights of Shareholders. The ownership of the Trust Property and the property of each Series of the Trust of every description and the right to conduct any business hereinbefore described are vested exclusively in the Trustees, and the Shareholders shall have no interest therein other than the beneficial interest conferred by their Shares, and they shall have no right to call for any partition or division of any property, profits, rights or interests of the Trust nor can they be called upon to share or assume any losses of the Trust or suffer an assessment of any kind by virtue of their ownership of Shares. The Shares shall be personal property giving only the rights specifically set forth in this Declaration. The Shares shall not entitle the holder to preference, preemptive, appraisal, conversion or exchange rights, except as the Trustees may determine with respect to any Series of Shares. Section 5.3. Trust Only. It is the intention of the Trustees to create only the relationship of Trustee and beneficiary between the Trustees and each Shareholder from time to time. It is not the intention of the Trustees to create a general partnership, limited partnership, joint stock association, corporation, bailment or any form of legal relationship other than a trust. Nothing in this Declaration of Trust shall be construed to make the Shareholders, either by themselves or with the Trustees, partners or members of a joint stock association. Section 5.4. Issuance of Shares. The Trustees in their discretion may, from time to time without vote of the Shareholders, issue Shares, in addition to the then issued and outstanding Shares and shares held in the treasury of the Trust, to such party or parties and for such amount and type of consideration, including cash or property, at such time or times and on such terms as the Trustees may deem best, and may in such manner acquire other assets (including the acquisition of assets subject to, and in connection with the assumption of liabilities) and businesses. In connection with any issuance may issue fractional Shares and Shares held in the treasury of the Trust. The Trustees may from time to time divide or combine the Shares into a greater or lesser number without thereby changing the proportionate beneficial interests in the Trust. Contributions to the Trust may be accepted for, and Shares shall be redeemed as, whole Shares and/or 1/1,000ths of a Share or integral multiples thereof. Section 5.5. Register of Shares. A register shall be kept at the principal office of the Trust or an office of the Transfer Agent which shall contain the names and addresses of the Shareholders and the number of Shares held by them respectively and a record of all transfers thereof. Such register shall be conclusive as to who are the holders of the Shares and who shall be entitled to receive dividends or distributions or otherwise to exercise or enjoy the rights of Shareholders. No Shareholder shall be entitled to receive payment of any dividend or distribution, nor to have notice given to him as herein or in the By-laws provided, until he has given his address to the Transfer Agent or such other officer or agent of the Trustees as shall keep the said register for entry thereon. It is not contemplated that certificates will be issued for the Shares; however, the Trustees, in their discretion, may authorize the issuance of share certificates and promulgate appropriate rules and regulations as to their use. Section 5.6. Transfer of Shares. Except as otherwise provided by the Trustees, shares shall be transferable on the records of the Trust only by the record holder thereof or by his agent thereunto duly authorized in writing, upon delivery to the Trustees or the Transfer Agent of a duly executed instrument of transfer, together with such evidence of the genuineness of each such execution and authorization and of other matters as may reasonably be required. Upon such delivery the transfer shall be recorded on the register of the Trust. Until such record is made, the Shareholder of record shall be deemed to be the holder of such Shares for all purposes hereunder and neither the Trustees nor any transfer agent or registrar nor any officer, employee or agent of the Trust shall be affected by any notice of the proposed transfer. Any person becoming entitled to any Shares in consequence of the death, bankruptcy, or incompetence of any Shareholder, or otherwise by operation of law, shall be recorded on the register of Shares as the holder of such Shares upon production of the proper evidence thereof to the Trustees or the Transfer Agent, but until such record is made, the Shareholder of record shall be deemed to be the holder of such Shares for all purposes hereunder and neither the Trustees nor any Transfer Agent or registrar nor any officer or agent of the Trust shall be affected by any notice of such death, bankruptcy or incompetence, or other operation of law. Section 5.7. Notices, Reports. Any and all notices to which any Shareholder may be entitled and any and all communications shall be deemed duly served or given if mailed, postage prepaid, addressed to any Shareholder of record at his last known address as recorded on the register of the Trust. A notice of a meeting, an annual report and any other communication to Shareholders need not be sent to a Shareholder (i) if an annual report and a proxy statement for two consecutive shareholder meetings have been mailed to such Shareholder's address and have been returned as undeliverable, (ii) if all, and at least two, checks (if sent by first class mail) in payment of dividends on Shares during a twelve-month period have been mailed to such Shareholder's address and have been returned as undeliverable, or (iii) in any other case in which a proxy statement concerning a meeting of security holders is not required to be given pursuant to the Commission's proxy rules as from time to time in effect under the Securities Exchange Act of 1934. However, delivery of such proxy statements, annual reports and other communications shall resume if and when such Shareholder delivers or causes to be delivered to the Trust written notice setting forth such Shareholder's then current address. Section 5.8. Treasury Shares. Shares held in the treasury shall, until reissued pursuant to Section 5.4, not confer any the Trustees, nor shall such Shares be entitled to any dividends or other distributions declared with respect to the Shares. Section 5.9. Voting Powers. The Shareholders shall have power to vote only (i) for the election of Trustees as provided in Section 2.12; (ii) for the removal of Trustees as provided in Section 2.13; (iii) with respect to any investment advisory or management contract entered into pursuant to Section 3.2; (iv) with respect to termination of the Trust as provided in Section 8.2; (v) with respect to any amendment of this Declaration to the extent and as provided in Section 8.3; (vi) with respect to any merger, consolidation or sale of assets as provided in Section 8.4; (vii) with respect to incorporation of the Trust or any Series to the extent and as provided in Section 8.5; (viii) to the same extent as the stockholders of Massachusetts business corporation as to whether or not a court action, proceeding or claim should or should not be brought or maintained derivatively or as a class action on behalf of the Trust or the Shareholders; (ix) with respect to any plan adopted pursuant to Rule 12b-1 (or any successor rule) under the 1940 Act; and (x) with respect to such additional matters relating to the Trust as may be required by this Declaration, the By-laws or any registration of the Trust as an investment company under the 1940 Act with the Commission (or any successor agency) or as the Trustees may consider necessary or desirable. Each whole Share shall be entitled to one vote as to any matter on which it is entitled to vote and each fractional Share shall be entitled to a proportionate fractional vote, except that the Trustees may, in conjunction with the establishment of any Series of Shares, establish or reserve the right to establish conditions under which the several Series shall have separate voting rights or, if a Series would not, in the sole judgment of the Trustees, be materially affected by a proposal, no voting rights. There shall be no cumulative voting in the election of Trustees. Until Shares are issued, the Trustees may exercise all rights of Shareholders and may take any action required by law, this Declaration or the By-laws to be taken by Shareholders. The By-laws may include further provisions for Shareholders' votes and meetings and related matters. Section 5.10. Meetings of Shareholders. Meetings of Shareholders may be called at any time by the President, and shall be called by the President and Secretary at the request in writing or by resolution, of a majority of Trustees, or at the written request of the holder or holders of ten percent (10%) or more of the total number of Shares then issued and outstanding of the Trust entitled to vote at such meeting. Any such request shall state the purpose of the proposed meeting. Section 5.11. Series Designation. The Trustees, in their discretion, may authorize the division of Shares into two or more Series, and the different Series shall be established and designated, and the variations in the relative rights and preferences as between the different Series shall be fixed and determined by the Trustees; provided, that all Shares shall be identical except that there may be variations so fixed and determined between different Series as to investment objective, purchase price, allocation of expenses, right of redemption, special and relative rights as to dividends and on liquidation, conversion rights, and conditions under which the several Series shall have separate voting rights. All references to Shares in this Declaration shall be deemed to be Shares of any or all Series as the context may require. If the Trustees shall divide the Shares of the Trust into two or more Series, the following provisions shall apply: (a) All provisions herein relating to the Trust shall apply equally to each Series of the Trust except as the context requires otherwise. (b) The number of authorized Shares and the number of Shares of each Series that may be issued shall be unlimited. The Trustees may classify or reclassify any unissued Shares or any Shares of any Series previously issued and reacquired into one or more Series that may be established and designated from time to time. The Trustees may hold as treasury Shares (of the same or some other Series), reissue for such consideration and on such terms as they may determine, or cancel any Shares of any Series reacquired by the Trust at their discretion from time to time. (c) All consideration received by the Trust for the issue or sale of Shares of a particular Series, together with all assets in which such consideration is invested or reinvested, all income, earnings, profits, and proceeds thereof, including any proceeds derived from the sale, exchange or liquidation of such assets, and any funds or payments derived from any reinvestment of such proceeds in whatever form the same may be, shall irrevocably belong to that Series for all purposes, subject only to the rights of creditors of such Series and except as may otherwise be required by applicable laws, and shall be so recorded upon the books of account of the Trust. In the event that there are any assets, income, earnings, profits, and proceeds thereof, funds or payments that are not readily identifiable as any particular Series, the Trustees shall allocate them among any one or more of the Series established and designated from time to time in such manner and on such basis as they, in their sole discretion, deem fair and equitable. Each such allocation by the Trustees shall be conclusive and binding upon the Shareholders of all Series for all purposes. (d) The assets belonging to each particular Series shall be charged with the liabilities of the Trust in respect of that Series and all expenses, costs, charges and reserves attributable to that Series, and any general liabilities, expenses, costs, charges or reserves of the Trust that are not readily identifiable as belonging to any particular Series, shall be allocated and charged by the Trustees to and among any one or more of the Series established and designated from time to time in such manner and on such basis as the Trustees in their sole discretion deem fair and equitable. Each allocation of liabilities, expenses, costs, charges and reserves by the Trustees shall be conclusive and binding upon the Shareholders of all Series for all purposes. The Trustees shall have full discretion, to the extent not inconsistent with the 1940 Act, to determine which items are capital, and each such determination and allocation shall be conclusive and binding upon the Shareholders. The assets for a particular Series of the Trust shall, under no circumstances, be charged with liabilities attributable to any other Series of the Trust. All persons extending credit to, or contracting with or having any claim against a particular Series of the Trust shall look only to the assets of that particular Series for payment of such credit, contract or claim. No Shareholder or former Shareholder of any Series shall have any claim on or right to any assets allocated or belonging to any other Series. (e) Each Share of a Series of the Trust shall represent a beneficial interest in the net assets of such Series. Each holder of Shares of a Series shall be entitled to receive his pro rata share of distributions of income and capital gains made with respect to such Series. Upon redemption of his Shares or indemnification for liabilities incurred by reason of his being or having been a Shareholder of a Series, such Shareholder shall be paid solely out of the funds and property of such Series of the Trust. Upon liquidation or termination of a Series of the Trust, Shareholders of such Series shall be entitled to receive a pro rata share of the net assets of such Series. A Shareholder of a particular Series of the Trust shall not be entitled to participate in a derivative or class action on behalf of any other Series or the Shareholders of any other Series of the Trust. The establishment and designation of any series of Shares shall be effective upon the execution by a majority of the then Trustees of an instrument setting forth such establishment and designation and the relative rights and preferences of such Series, or as otherwise provided in such instrument. The Trustees may by an instrument executed by a majority of their number abolish any Series and the establishment and designation thereof. Except as otherwise provided in this Article V, the Trustees shall have the power to determine the designations, preferences, privileges, limitations and rights of each class and Series of Shares. Each instrument referred to in this paragraph shall have the status of an amendment to this Declaration. Section 5.12. Assent to Declaration of Trust. Every Shareholder, by virtue of having become a Shareholder, shall be held to have expressly assented and agreed to the terms hereof and to have become a party hereto. Section 5.13. Class Designation. The Trustees, in their discretion, may authorize the division of the Shares of the Trust, or, if any Series be established, the Shares of any Series, into two or more Classes, and the different Classes shall be established and designated, and the variations in the relative rights and preferences as between the different Classes shall be fixed and determined, by the Trustees; provided, that all Shares of the Trust or of any Series shall be identical to all other Shares of the Trust or the same Series, as the case may be, except that there may be variations between different classes as to allocation of expenses, right of redemption, special and relative rights as to dividends and on liquidation, conversion rights, and conditions under which the several Classes shall have separate voting rights. All references to Shares in this Declaration shall be deemed to be Shares of any or all Classes as the context may require. If the Trustees shall divide the Shares of the Trust of any Series into two or more Classes, the following provisions shall be applicable: (a) All provisions herein relating to the Trust, or any Series of the Trust, shall apply equally to each Class of Shares of the Trust or of any Series of the Trust, except as the context requires otherwise. (b) The number of Shares of each Class that may be issued shall be unlimited. The Trustees may classify or reclassify any unissued Shares of the Trust or any Series or any Shares previously issued and reacquired of any Class of the Trust or of any Series into one or more Classes that may be established and designated from time to time. The Trustees may hold as treasury Shares (of the same or some other Class), reissue for such consideration on such terms as they may determine, or cancel any Shares of any Class reacquired by the Trust at their discretion from time to time. (c) Liabilities, expenses, costs, charges and reserves related to the distribution of, and other identified expenses that should properly be allocated to, the Shares of a particular Class may be charged to and borne solely by such Class and the bearing of expenses solely by a Class of Shares may be appropriately reflected (in a manner determined by the Trustees) and cause differences in the net asset value attributable to, and the dividend, redemption and liquidation rights of, the Shares of different Classes. Each allocation of liabilities, expenses, costs, charges and reserves by the Trustees shall be conclusive and binding upon the Shareholders of all Classes for all purposes. (d) The establishment and designation of any Class of Shares shall be effective upon the execution of a majority of the then Trustees of an instrument setting forth such establishment and designation and the relative rights and preferences of such Class, or as otherwise provided in such instrument. The Trustees may, by an instrument executed by a majority of their number, abolish any Class and the establishment and designation thereof. Each instrument referred to in this paragraph shall have the status of an amendment to this Declaration. REDEMPTION AND REPURCHASE OF SHARES Section 6.1. Redemption of Shares. All Shares of the Trust shall be redeemable, at the redemption price determined in the manner set out in this Declaration. Redeemed or repurchased Shares may be resold by the Trust. The Trust shall redeem the Shares upon the appropriately verified written application of the record holder thereof (or upon such other form of request as the Trustees may determine) at such office or agency as may be designated from time to time for that purpose in the Trust's then effective registration statement under the Securities Act of 1933. The Trustees may from time to time specify additional conditions, not inconsistent with the 1940 Act, regarding the redemption of Shares in the Trust's then effective registration statement under the Securities Act of 1933. Section 6.2. Price. Shares shall be redeemed at their net asset value determined as set forth in Section 7.1 hereof as of such time as the Trustees shall have theretofore prescribed by resolution. In the absence of such resolution, the redemption price of Shares deposited shall be the net asset value of such Shares next determined as set forth in Section 7.1 hereof after receipt of such application. Section 6.3. Payment. Payment for redeemed Shares shall be made in cash or in property out of the assets of the relevant Series for the Trust to the Shareholder of record at such time and in the manner, not inconsistent with the 1940 Act or other applicable laws, as may be specified from time to time in Trust's then effective registration statement under the Securities Act of 1933, subject to the provisions of Section 6.4 hereof. Section 6.4. Effect of Suspension of Determination of Net Asset Value. If, pursuant to Section 6.9 hereof, the Trustees shall declare a suspension of the determination of net asset value, the rights of Shareholders (including those who shall have applied for redemption pursuant to Section 6.1 hereof but who shall not yet have received payment) to have Shares redeemed and paid for by the Trust shall be suspended until the termination of such suspension is declared. Any record Shareholder who shall have his redemption right so suspended may, during the period of such suspension, by appropriate written notice of revocation at the office or agency where application was made, revoke any application for redemption not honored and withdraw any certificates on deposit. The redemption price of Shares for which redemption applications have not been revoked shall be the net asset value of such Shares next determined as set forth in Section 7.1 after the termination of such suspension, and payment shall be made within seven (7) days after the date upon which the application was made plus the period after such application during which the determination of net asset value was suspended. Section 6.5. Repurchase by Agreement. The Trust may repurchase Shares directly, or through the Distributor or another agent designated for the purpose, by agreement with the owner thereof at a price not exceeding the net asset value per share determined as of the time when the purchase or contract of purchase is made or the net asset value as of any time which may be later determined pursuant to Section 7.1 hereof, provided payment is not made for the Shares prior to the time as of which such net asset value is determined. Section 6.6. Redemption of Shareholder's Interest. The Trust shall have the right at any time without prior notice to redeem Shares of any Shareholder for their then current net asset value per Share if at such time the Shareholder owns Shares having an aggregate net asset value of less than an amount set from time to time by the Trustees subject to such terms and conditions as the Trustees may approve, and subject to the Trust's giving general notice to all Shareholders of its intention to avail itself of such right, either by publication in the Trust's registration statement, if any, or by such other means as the Trustees may determine. Section 6.7. Redemption of Shares in Order to Qualify as Regulated Investment Company; Disclosure of Holding. If the Trustees shall, at any time and in good faith, be of the opinion that direct or indirect ownership of Shares or other securities of the Trust has or may become concentrated in any Person to an extent that would disqualify any Series of the Trust as a regulated investment company under the Internal Revenue Code, then the Trustees shall have the power by lot or other means deemed equitable by them (i) to call for redemption by any such Person a number, or principal amount, of Shares or other securities of the Trust sufficient to maintain or bring the direct or indirect ownership of Shares or other securities of the Trust into conformity with the requirements of such qualification, and (ii) to refuse to transfer or issue Shares or other securities of the Trust to any Person whose acquisition of the Shares or other securities of the Trust in question would result in such disqualification. The redemption shall be effected at the redemption price and in the manner provided in Section 6.1. Shareholders of the Trust shall upon demand disclose to the Trustees in writing such information with respect to direct and indirect ownership of Shares or other securities of the Trust as the Trustees deem necessary to comply with the provisions of the Internal Revenue Code, or to comply with the requirements of any other taxing authority. Section 6.8. Reductions in Number of Outstanding Shares Pursuant to Net Asset Value Formula. The Trust may also reduce the number of Outstanding Shares pursuant to the provisions of Section 7.3. Section 6.9. Suspension of Right of Redemption. The Trust may declare a suspension of the right of redemption or postpone the date of payment or redemption for the whole or any part of any period (i) during which the New York Stock Exchange is closed other than customary weekend and holiday closings, (ii) during which trading on the New York Stock Exchange is restricted, (iii) during which an emergency exists as a result of which disposal by the Trust of securities owned by it is not reasonably practicable or it is not reasonably practicable for the Trust fairly to determine the value of its net assets, or (iv) during any other period when the Commission may for the protection of Shareholders of the Trust by order permit suspension of the right of redemption or postponement of the date of payment or redemption; provided that applicable rules and regulations of the Commission shall govern as to whether the conditions prescribed in (ii), (iii), or (iv) exist. Such suspension shall take effect at such time as the Trust shall specify but not later than the close of business on the business day next following the declaration of suspension, and thereafter there shall be no right of redemption or payment on redemption until the Trust shall declare the suspension terminated (except that the suspension shall terminate in any event on the first day on which said stock exchange shall have reopened or the period specified in (ii) or (iii) shall have expired, as to which, in the absence of an official ruling by the Commission, the determination of the Trust shall be conclusive). In the case of a suspension of the right of redemption, a Shareholder may either withdraw his request for redemption or receive payment based on the net asset value existing after the termination of the suspension. DETERMINATION OF NET ASSET VALUE, Section 7.1. Net Asset Value. The value of the assets of the Trust or any Series of the Trust shall be determined by appraisal of the securities of the Trust or allocated to such Series, such appraisal to be on the basis of the amortized cost of such securities in the case of money market securities, market value in the case of other be deemed to reflect the fair value thereof, determined in good faith by or under the direction of the Trustees. From the total value of said assets, there shall be deducted all indebtedness, interest, taxes, payable or accrued, including estimated taxes on unrealized book profits, expenses and management charges accrued to the appraisal date, net income determined and declared as a distribution, and all other items in the nature of liabilities attributable to the Trust or such Series or Class thereof which shall be deemed appropriate. The net asset value of a Share shall be determined by dividing the net asset value of the Class, or if no Class has been established, of the Series, or, if no Series has been established, of the Trust, by the number of Shares of that Class, or Series, or of the Trust, as applicable, outstanding. The net asset value of Shares of the Trust or any Class or Series thereof shall be determined pursuant to the procedure and methods prescribed or approved by the Trustees in their discretion and as set forth in the most recent registration statement of the Trust as filed with the Securities and Exchange Commission pursuant to the requirements of the Securities Act of 1933 and rules thereunder, as amended, and the 1940 Act. The net asset value of the Shares shall be determined at least once on each business day, as of the close of trading on the New York Stock Exchange or as of such other time or times as the Trustees shall determine. The power and duty to make the daily calculations may be delegated by the Trustees to the Investment Adviser, the Custodian, the Transfer Agent or such other Person as the Trustees may determine by resolution or by approving a contract which delegates such duty to another Person. The Trustees may suspend the daily determination of net asset value to the extent permitted by the 1940 Act. Section 7.2. Distributions to Shareholders. The Trustees shall from time to time distribute ratably among the Shareholders of the Trust or a Series thereof such proportion of the net profits, surplus (including paid-in surplus), capital, or assets of the Trust or such Series held by the Trustees as they may deem proper. Such distributions may be made in cash or property (including without limitation any type of obligations of the Trust or such Series or any assets thereof), and the Trustees may distribute ratably among the Shareholders additional Shares of the Trust or such Series issuable hereunder in such manner, at such times, and on such terms as the Trustees may deem proper. Such distributions may be among the Shareholders of record at the time of declaring a distribution or among the Shareholders of record at such other date or time or dates or times as the Trustees shall determine. The Trustees may in their determine that, solely for the proposes of such distributions, Outstanding Shares shall exclude Shares for which orders have been placed subsequent to a specified time on the date the distribution is declared or on the next preceding day if the distribution is declared as of a day on which Boston banks are not open for business, all as described in the Trust's registration statement under the Securities Act of 1933. The Trustees may always retain from the net profits such amounts they may deem necessary to pay the debts or expenses of the Trust or the Series or to meet obligations of the Trust or the Series, or as they may retain for future requirements or extensions of the business. The Trustees may adopt and offer to Shareholders such dividend reinvestment plans, cash dividend payout plans or related plans as the Trustees shall deem appropriate. Inasmuch as the computation of net income and gains for Federal income purposes may vary from the computation thereof on the books, the above provisions shall be interpreted to give the Trustees the power in their discretion to distribute for any fiscal year as ordinary dividends and as capital gains distributions, respectively, additional amounts sufficient to enable the Trust or the Series to avoid or reduce liability for taxes. Section 7.3. Determination of Net Income; Constant Net Asset Value; Reduction of Outstanding Shares. Subject to Section 5.11 hereof, the net income of the Trust or any Series thereof shall be determined in such manner as the Trustees shall provide by resolution. Expenses of the Trust or a Series, including the advisory or management fee, shall be accrued each day. Such net income may be determined by or under the direction of the Trustees as of the close of trading on the New York Stock Exchange on each day on which such Exchange is open or as of such other time or times as the Trustees shall determine, and, except as provided herein, all the net income of the Trust or any Series, as so determined, may be declared as a dividend on the Outstanding Shares of the Trust or such Series. If, for any reason, the net income of the Trust or any Series, determined at any time is a negative amount, the Trustees shall have the power with respect to the Trust or such Series (i) to offset each Shareholder's pro rata share of such negative amount from the accrued dividend account of such Shareholder, or (ii) to reduce the number of Outstanding Shares of the Trust or such Series by reducing the number of Shares in the account of such Shareholder by that number of full and fractional Shares which represents the amount of such excess negative net income, or (iii) to cause to be recorded on the books of the Trust or such Series an asset account in the amount of such negative net income, which account may be reduced by the amount, provided that the same shall thereupon become the property of the Trust or such Series with respect to the Trust or such Series and shall not be paid to any Shareholder, of dividends declared thereafter upon the outstanding Shares of the Trust or such Series on the day such negative net income is experienced, until such asset account is reduced to zero; or (iv) to combine the methods described in clauses (i) and (ii) and (iii) of this sentence, in order to cause the net asset value per Share of the Trust or such Series to remain at a constant amount per Outstanding Share immediately after each such determination and declaration. The Trustees shall also have the power to fail to declare a dividend out of net income for the purpose of causing the net asset value per Share to be increased to a constant amount. The Trustees shall not be required to adopt, but may at any time adopt, discontinue or amend the practice of maintaining the net asset value per Share of the Trust or a Series at a constant amount. Section 7.4. Allocation Between Principal and Income. The Trustees shall have full discretion to determine whether any cash or be treated as income or as principal and whether any item of expense shall be charged to the income or the principal account, and their good faith shall be conclusive upon the Shareholders. dividends received, the Trustees shall have full discretion to determine, in the light of the particular circumstances, how much if any of the value thereof shall be treated as income, the balance, if any, to be treated as principal. Section 7.5. Power to Modify Foregoing Procedures. Notwithstanding any of the foregoing provisions of this Article VII, the Trustees may prescribe, in their absolute discretion, such other bases and times for determining the per Share net asset value or net income, or the declaration and payment of dividends and distributions as they may deem necessary or desirable. Section 8.1. Duration. The Trust shall continue without limitation of time but subject to the provisions of this Article VIII. Section 8.2. Termination of Trust. (a) The Trust or any Series of the Trust may be terminated by an instrument in writing signed by a majority of the Trustees or by the affirmative vote of the holders a majority of the Shares outstanding and entitled to vote, at any meeting of Shareholders. Upon the termination of the Trust or any Series, (i) the Trust or any series shall carry on no business except for the purpose of winding up its affairs; (ii) the Trustees shall proceed to wind up the affairs of the Trust or Series and all of the powers of the Trustees under this Declaration shall continue until the affairs of the Trust or Series shall have been wound up, including the power to fulfill or discharge the contracts of the Trust or Series, collect its assets, sell, convey, assign, exchange, transfer or otherwise dispose of all or any part of the remaining Trust Property or property of the Series to one or more persons at public or private sale for consideration which may consist in whole or in part of cash, securities or other property of any kind, discharge or pay its liabilities, and do all other acts appropriate to (iii) after paying or adequately providing for the payment of all liabilities, and upon receipt of such releases, indemnities and refunding agreements as they deem necessary for their protection, the Trustees may distribute the remaining Trust Property or property of the Series, in cash or in kind or partly each, among the Shareholders of the Trust or Series according to their respective rights. (b) After termination of the Trust or any Series and distribution to the Shareholders as herein provided, a majority of the Trustees shall execute and lodge among the records of the Trust or Series an instrument in writing setting forth the fact of such termination, and the Trustees shall thereupon be discharged from all further liabilities and duties hereunder, and the rights and interests of all Shareholders of the Trust or Series shall thereupon cease. Section 8.3. Amendment Procedure. (a) This Declaration may be amended by a vote of the holders of a majority of the Shares outstanding and entitled to vote. Amendments shall be effective upon the taking of action as provided in this section or at such later time as shall be specified in the applicable vote or instrument. The Trustees may also amend this Declaration without the vote or consent of Shareholders if they deem it necessary to conform this Declaration to the requirements of applicable federal or state laws or regulations or the requirements of the regulated investment company provisions of the Internal Revenue Code (including those provisions of such Code relating to the retention of the exemption from federal income tax with respect to dividends paid by the Trust out of interest income received on Municipal Bonds), but the Trustees shall not be liable for failing so to do. The Trustees may also amend this Declaration without the vote or consent of Shareholders if they deem it necessary or desirable to change the name of the Trust or a Series of the Trust or to make any other changes in the Declaration which do not have a material adverse effect on the rights of Shareholders hereunder. (b) No amendment may be made under this Section 8.3 which would change any rights with respect to any Shares of the Trust or Series thereof by reducing the amount payable thereon upon liquidation of the Trust or Series or by diminishing or eliminating any voting rights pertaining thereto, except with the vote or consent of the holders of two-thirds of the Shares of the Trust or Series outstanding and entitled to vote. Nothing contained in this Declaration shall permit the amendment of this Declaration to impair the exemption from personal liability of the Shareholders, Trustees, officers, employees and agents of the Trust or to permit assessments upon Shareholders. (c) A certificate signed by a majority of the Trustees setting forth an amendment and reciting that it was duly adopted by the Shareholders or by the Trustees as aforesaid or a copy of the Declaration, as amended, and executed by a majority of the Trustees shall be conclusive evidence of such amendment when lodged among the records of the Trust. Notwithstanding any other provision hereof, until such time as a registration statement under the Securities Act of 1933, as amended, covering the first public offering of securities of the Trust shall have become effective, this Declaration may be terminated or amended in any respect by the affirmative vote of a majority of the Trustees or by an instrument signed by a majority of the Trustees. Section 8.4. Merger, Consolidation and Sale of Assets. The Trust or any Series thereof may merge or consolidate with any other corporation, association, trust or other organization or may sell, lease or exchange all or substantially all of the Trust Property or the property of any Series, including its good will, upon such terms and conditions and for such consideration when and as authorized at any meeting of Shareholders of the Trust or Series called for the purpose by the affirmative vote of the holders of a majority of the Shares of the Trust or Series. Section 8.5. Incorporation. With the approval of the holders of a majority of the Shares of the Trust or any Series outstanding and entitled to vote, the Trustees may cause to be organized or assist in organizing a corporation or corporations under the laws of any jurisdiction or any other trust, partnership, association or other organization to take over all of the Trust Property or the property of any Series or to carry on any business in which the Trust or the Series shall directly or indirectly have any interest, and to sell, convey and transfer the Trust Property or the property of any Series to any such corporation, trust, association or organization in exchange for the Shares or securities thereof or otherwise, and to lend money to, subscribe for the Shares or securities of, and enter into any contracts with any such corporation, trust, partnership, association or organization, or any corporation, partnership, trust, association or organization in which the Trust or the Series holds or is about to acquire shares or any other interest. The Trustees may also cause a merger or consolidation between the Trust or any Series or any successor thereto and any such corporation, trust, partnership, association or other organization if and to the extent permitted by law, as provided under the law then in effect. Nothing contained herein shall be construed as requiring approval of Shareholders for the Trustees to organize or assist in organizing one or more corporations, trusts, partnerships, associations or other organizations and selling, conveying or transferring a portion of the Trust Property to such organization or entities. The Trustees shall, at least semi-annually, submit to the Shareholders a written financial report of the transactions of the Trust, which may be included in the Trust's prospectus which shall include, at least annually, financial statements that are certified by independent public accountants. Section 10.1. Filing. This Declaration and any amendment hereto shall be filed in the Office of the Secretary of the Commonwealth of Massachusetts and in such other places as may be required under the laws of Massachusetts and may also be filed or recorded in such other places as the Trustees deem appropriate. Unless the amendment is embodied in an instrument signed by a majority of the Trustees, each amendment filed shall be accompanied by a certificate signed and acknowledged by a Trustee stating that such action was duly taken in a manner provided herein. A restated Declaration, integrating into a single instrument all of the provisions of the Declaration which are then in effect and operative, may be executed from time to time by a majority of the Trustees and shall, upon filing with the Secretary of the Commonwealth of Massachusetts, be conclusive evidence of all amendments contained therein and may hereafter be referred to in lieu of the original Declaration and the various amendments thereto. The restated Declaration may include any amendment which the Trustees are empowered to adopt, whether or not such amendment has been adopted prior to the execution of the restated Declaration. Section 10.2. Governing Law. This Declaration and delivered in the Commonwealth of Massachusetts and with reference to the internal laws thereof, and the rights of all parties and the validity and construction of every provision hereof shall be subject to and construed according to the internal laws of said State without regard to the choice of law rules thereof. Section 10.3. Counterparts. This Declaration may be simultaneously executed in several counterparts, each of which shall be deemed to be an original, and such counterparts, together, shall constitute one and the same instrument, which shall be sufficiently evidenced by any such original counterpart. Section 10.4. Reliance by Third Parties. Any certificate executed by an individual who, according to the records of the Trust appears to be a Trustee hereunder, certifying to: (a) the number or identity of Trustees or Shareholders, (b) the due authorization of the execution of any instrument or writing, (c) the form of any vote passed at a meeting of Trustees or Shareholders, (d) the fact that the number of Trustees or Shareholders present at any meeting or executing any written instrument satisfies the requirements of this Declaration, (e) the form of any By-laws adopted by or the identity of any officers elected by the Trustees, or (f) the existence of any fact or facts which in any manner relate to the affairs of the Trust, shall be conclusive evidence as to the matters so certified in favor of any Person dealing with the Trustees and their successors. Section 10.5. Provisions in Conflict with Law or Regulations. (a) The provisions of this Declaration are severable, and if the Trustees shall determine, with the advice of counsel, that any of such provisions are in conflict with the 1940 Act, the regulated investment company provisions of the Internal Revenue Code or with other applicable laws and regulations, the conflicting provision or provisions shall be deemed never to have constituted a part of this Declaration; provided, however, that such determination shall not affect any of the remaining provisions of this Declaration or render invalid or improper any action taken or omitted prior to such determination. (b) If any provision of this Declaration shall be held invalid or unenforceable in any jurisdiction, such invalidity or unenforceability shall attach only to such provision in such jurisdiction and shall not in any manner affect such provisions in any other jurisdiction or any other provision of this Declaration in any jurisdiction. IN WITNESS WHEREOF, the undersigned has executed this instrument this ______ day of August, 1995. Caroline Pearson, as Trustee and not Ten Post Office Square - South County of Suffolk August ____, 1995 Then personally appeared the above-named Caroline Pearson, who acknowledged the foregoing instrument to be her free act and deed.	N-1/A	EX-99	1996-01-12T00:00:00	1996-01-11T17:32:37
0000912938-96-000059	0000912938-96-000059_0000.txt	UNDER THE SECURITIES EXCHANGE ACT OF 1934 (Title of Class of Securities) Check the following box if a fee is being paid with this \|X\| statement. (A fee is not required only if the filing person: (1) has a previous statement on file reporting beneficial ownership of more than five percent of the class of securities described in Item 1; and (2) has filed no amendment subsequent thereto reporting beneficial ownership of five percent or less of such class.) The remainder of this cover page shall be filled out for a reporting person's initial filing on this form with respect to the subject class of securities, and for any subsequent amendment containing information which would alter the disclosures provided in a prior cover page. The information required in the remainder of this cover page shall not be deemed to be "filed" for the purpose of Section 18 of the Securities Exchange Act of 1934 ("Act") or otherwise subject to the liabilities of that section of the Act but shall be subject to all other provisions of the Act (however, see the Notes). CUSIP NO. 29440810 13G PAGE 2 OF 5 PAGES 1 NAME OF REPORTING PERSON S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON Massachusetts Financial Services Company ("MFS") 2 CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP (a) / / (b) / / 4 CITIZENSHIP OR PLACE OF ORGANIZATION NUMBER OF 5 SOLE VOTING POWER SHARES 593,810 shares of common stock OWNED BY 6 SHARED VOTING POWER REPORTING 7 SOLE DISPOSITIVE POWER PERSON 602,210 shares of common stock 9 AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 602,210 shares of common stock of which 560,400 shares are also beneficially owned by MFS Series Trust II - MFS Emerging Growth Fund (see page 3) and 41,810 shares are also owned by certain other non-reporting entities. 10 CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (9) EXCLUDES CERTAIN SHARES* 11 PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW 9 12 TYPE OF REPORTING PERSON* SEE INSTRUCTION BEFORE FILLING OUT! CUSIP NO. 29440810 13G PAGE 3 OF 5 PAGES 1 NAME OF REPORTING PERSON S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON MFS Series Trust II - MFS Emerging Growth Fund ("MEG") 2 CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP (a) / / (b) / / 4 CITIZENSHIP OR PLACE OF ORGANIZATION NUMBER OF 5 SOLE VOTING POWER OWNED BY 6 SHARED VOTING POWER REPORTING 7 SOLE DISPOSITIVE POWER 9 AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 560,400 shares of common stock (as noted on page 2, item 9, MFS is also a beneficial owner of these 560,400 shares). 10 CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (9) EXCLUDES CERTAIN SHARES* 11 PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW 9 12 TYPE OF REPORTING PERSON* SEE INSTRUCTION BEFORE FILLING OUT! SCHEDULE 13G PAGE 4 OF 5 PAGES ITEM 1: (a) NAME OF ISSUER: (b) ADDRESS OF ISSUER'S PRINCIPAL EXECUTIVE OFFICES: 1250 Wood Branch Park Drive ITEM 2: (a) NAME OF PERSON FILING: Massachusetts Financial Services Company ("MFS") (b) ADDRESS OF PRINCIPAL BUSINESS OFFICE OR, IF NONE, RESIDENCE: For MFS, see Item 4 on page 2; for MEG, see Item 4 on Page 3 (d) TITLE OF CLASS OF SECURITIES: ITEM 3: For MFS, see Item 12 on page 2; for MEG, see Item 12 on page 3 ITEM 4: (a) AMOUNT BENEFICIALLY OWNED: For MFS, see Item 9 on page 2; for MEG, see Item 9 on page 3 For MFS, see Item 11 on page 2; for MEG, see Item 11 on page 3 (c) NUMBER OF SHARES AS TO WHICH SUCH PERSON HAS: For MFS, see Items 5 and 7 on page 2 * This Schedule 13G is filed pursuant to Rule 13d-1(f) on behalf of MFS Series Trust II - MFS Emerging Growth Fund ("MEG") (see page 3 and Exhibit 1 attached hereto). SCHEDULE 13G PAGE 5 OF 5 PAGES ITEM 5: OWNERSHIP OF FIVE PERCENT OR LESS OF A CLASS: ITEM 6: OWNERSHIP OF MORE THAN FIVE PERCENT ON BEHALF OF ANOTHER PERSON: ITEM 7: IDENTIFICATION AND CLASSIFICATION OF THE SUBSIDIARY WHICH ACQUIRED THE SECURITY BEING REPORTED ON BY THE PARENT HOLDING COMPANY: ITEM 8: IDENTIFICATION AND CLASSIFICATION OF MEMBERS OF THE GROUP: ITEM 9: NOTICE OF DISSOLUTION OF GROUP: By signing below I certify that to the best of my knowledge and belief, the securities referred to above were acquired in the ordinary course of business and were not acquired for the purpose of and do not have the effect of changing or influencing the control of the issuer of such securities and were not acquired in connection with or as a participant in any transaction having such purposes or effect. After reasonable inquiry and to the best of my knowledge and belief, I certify that the information set forth in this statement is true, complete and correct. MFS EMERGING GROWTH FUND, a series of 500 BOYLSTON STREET o BOSTON o MASSACHUSETTS 02116 This letter is to memorialize our agreement that you shall file all statements on Schedule 13G required to be filed on behalf of MFS Emerging Growth Fund, a series of MFS Series Trust II, pursuant to Rule 13d-1 under the Securities Exchange Act of 1934. If the foregoing is acceptable to you, please sign and return to us the enclosed copy of this letter.	SC 13G	SC 13G	1996-01-12T00:00:00	1996-01-12T14:31:54
0000950146-96-000035	0000950146-96-000035_0000.txt	<DESCRIPTION>1996 NOTICE OF ANNUAL MEETING & PROXY STATEMENT at 9:30 A.M. local time James L. Knight International Center 32 Avenue of the Americas It is a pleasure to invite you to your Company's 1996 Annual Meeting in Miami, Florida, on Wednesday, April 17, beginning at 9:30 A.M. local time, at the James L. Knight International Center. This will be AT&T's 111th Annual Meeting of Shareholders and it marks a time of important transitions for the Company and its investors. I hope that those who find the time and place convenient will attend the meeting. An admission ticket, which will be required, is attached to the proxy card. The Center is fully accessible to disabled persons, and we will provide hearing amplification and sign interpretation for our hearing- impaired shareholders. Whether you own a few or many shares of stock and whether or not you plan to attend in person, it is important that your shares be voted on matters that come before the meeting. I urge you to specify your choices by marking the enclosed proxy card and returning it promptly. If you sign and return your proxy card without specifying your choices, it will be understood that you wish to have your shares voted in accordance with the directors' recommendations. Thank you for your interest. [SIGNATURE OF ROBERT E. ALLEN] The 111th Annual Meeting of Shareholders of AT&T Corp. (the "Company") will be held at the James L. Knight International Center, Miami Convention Center, 400 Southeast 2nd Avenue, Miami, Florida, on Wednesday, April 17, 1996, at 9:30 A.M. local time, for the following purposes: (bullet) To elect directors for the ensuing year (page ); (bullet) To ratify the appointment of auditors to examine the Company's accounts for the year 1996 (page ); (bullet) To approve the AT&T 1996 Employee Stock Purchase Plan (page ); (bullet) To act upon such other matters, including shareholder proposals (beginning on page ), as may properly come before the meeting. Holders of common shares of record at the close of business on February 27, 1996, will be entitled to vote with respect to this solicitation. Vice President - Law and Secretary 32 Avenue of the Americas This proxy statement and the accompanying proxy/voting instruction card (proxy card) are being mailed beginning February 27, 1996, to holders of common shares in connection with the solicitation of proxies by the board of directors for the 1996 Annual Meeting of Shareholders in Miami, Florida. Proxies are solicited to give all shareholders of record at the close of business on February 27, 1996, an opportunity to vote on matters that come before the meeting. This procedure is necessary because shareholders live in all states and abroad and most will not be able to attend. Shares can be voted only if the shareholder is present in person or is represented by proxy. When your proxy card is returned properly signed, the shares represented will be voted in accordance with your directions. You can specify your choices by marking the appropriate boxes on the enclosed proxy card. If your proxy card is signed and returned without specifying choices, the shares will be voted as recommended by the directors. Abstentions marked on the proxy card are voted neither "for" nor "against," but are counted in the determination of a quorum. If you wish to give your proxy to someone other than the Proxy Committee, all three names appearing on the enclosed proxy card must be crossed out and the name of another person or persons (not more than three) inserted. The signed card must be presented at the meeting by the person or persons representing you. You may revoke your proxy at any time before it is voted at the meeting by executing a later-dated proxy, by voting by ballot at the meeting, or by filing an instrument of revocation with the inspectors of election in care of the Vice President-Law and Secretary of the Company at the above address. Your vote is important. Accordingly, you are urged to sign and return the accompanying proxy card whether or not you plan to attend the meeting. If you do attend, you may vote by ballot at the meeting, thereby cancelling any proxy previously given. As a matter of policy, proxies, ballots, and voting tabulations that identify individual shareholders are kept private by the Company. Such documents are available for examination only by the inspectors of election and certain personnel associated with processing proxy cards and tabulating the vote. The vote of any shareholder is not disclosed except as may be necessary to meet legal requirements. Voting Shares Held in Dividend Reinvestment If a shareholder is a participant in the AT&T Shareowner Dividend Reinvestment and Stock Purchase Plan ("DRISPP"), the proxy card will represent the number of full shares in the DRISPP account on the record date, as well as shares registered in the participant's name. If a shareholder is a participant in the AT&T Employee Stock Ownership Plan, AT&T Long Term Savings Plan for Management Employees, AT&T Long Term Savings and Security Plan, AT&T Retirement Savings and Profit Sharing Plan, AT&T Long Term Savings and Security Employee Stock Ownership Trust, AT&T of Puerto Rico, Inc. Long Term Savings Plan for Management Employees, AT&T of Puerto Rico, Inc. Long Term Savings and Security Plan, AT&T Capital Corporation Retirement and Savings Plan, AT&T Capital Corporation Excess Benefit Plan, AGCS Savings Plan, or AGCS Hourly Savings Plan, the proxy card will also serve as a voting instruction for the trustees of those plans where all accounts are registered in the same name. If cards representing the shares in the above-named plans are not returned, those shares will not be voted with the exception of the AT&T Long Term Savings and Security Plan and the AT&T Long Term Savings and Security Employee Stock Ownership Trust where if cards are not returned, those shares will be voted by the trustees of those plans. Shares allocated to the accounts of participants in plans of AT&T Global Information Solutions Company, a wholly owned subsidiary of AT&T, such as the Corporation Payroll Employee Stock Ownership Plan, the Savings Plan, and the Employees' Profit Sharing Plan (referred to collectively as the "Future Income Plans") may be voted through separate participant direction cards that will be mailed to participants in these plans. If a participant also owns shares outside these plans, the participant must return both the proxy card and the participant direction card. The trustees of these plans will vote the number of shares allocated to a participant's account or accounts under such plans in accordance with the directions on the participant direction card if the card is duly signed and received by April , 1996. For participants in the Future Income Plans, allocated shares for which the trustee receives no instructions and all unallocated shares will be voted by the trustee. If you are a registered owner and plan to attend the meeting in person, please detach and retain the admission ticket which is attached to your proxy card and mark the appropriate box on the proxy card. Beneficial owners who plan to attend the meeting in person may obtain admission tickets in advance by sending written requests, along with proof of ownership, such as a bank or brokerage firm account statement, to: Manager - Shareowner Relations, AT&T Corp., 32 Avenue of the Americas, Room 2420E, New York, NY 10013-2412. Shareholders who do not present admission tickets at the meeting will be admitted upon verification of ownership at the admissions counter. Highlights of the meeting will be included in the next quarterly report. Information on obtaining a full transcript of the meeting will also be found in that quarterly report. Securities and Exchange Commission ("SEC") rules require that an annual report precede or be included with proxy materials. Shareholders with multiple accounts may be receiving more than one annual report, which is costly to AT&T and may be inconvenient to these shareholders. Such shareholders may authorize AT&T to discontinue mailing extra reports by marking the appropriate box on the proxy card for selected accounts. At least one account must continue to receive an annual report. Eliminating these duplicate mailings will not affect receipt of future proxy statements and proxy cards. To resume the mailing of an annual report to an account, please call the AT&T shareholder services number, 1-800-348-8288. On January 1, 1996, there were common shares outstanding. Each common share is entitled to one vote on each matter properly brought before the meeting. The board of directors has the responsibility for establishing broad corporate policies and for overseeing the overall performance of the Company. However, in accordance with corporate legal principles, it is not involved in day-to-day operating details. Members of the board are kept informed of the Company's business through discussions with the Chairman and other officers, by reviewing analyses and reports sent to them each month, and by participating in board and committee meetings. The board held 12 meetings in 1995; the committees held 23 meetings. The average attendance at the aggregate of the total number of meetings of the board and the total number of committee meetings was 97%. The board has established a number of committees, including the Audit Committee, the Compensation Committee, and the Committee on Directors, each of which is briefly described below. Other committees of the board are: the Corporate Public Policy Committee, the Employee Benefits Committee, the Executive Committee, the Finance Committee, and the Proxy Committee (which votes the shares represented by proxies at the annual meeting of shareholders). The Audit Committee meets with management to consider the adequacy of the internal controls and the objectivity of financial reporting; the committee also meets with the independent auditors and with appropriate Company financial personnel and internal auditors about these matters. The committee recommends to the board the appointment of the independent auditors, subject to ratification by the shareholders at the annual meeting. Both the internal auditors and the independent auditors periodically meet alone with the committee and always have unrestricted access to the committee. The committee, which consists of six non-employee directors, met five times in 1995. The Compensation Committee administers management incentive compensation plans, including stock option plans. The committee makes recommendations to the board with respect to compensation of directors and of the officers as listed on page . The committee, which consists of five non-employee directors, met six times in 1995. The Committee on Directors advises and makes recommendations to the board on all matters concerning directorship and corporate governance practices and the selection of candidates as nominees for election as directors. The committee, which consists of seven non-employee directors, met three times in 1995. The committee recommended this year's candidates at the January 1996 board meeting. In recommending board candidates, this committee seeks individuals of proven judgment and competence who are outstanding in their respective fields; it considers such factors as anticipated participation in board activities, education, geographic location, and special talents or personal attributes. Shareholders who wish to suggest qualified candidates should write to: Vice President-Law and Secretary, AT&T Corp., 32 Avenue of the Americas, Room 2420E, New York, NY 10013-2412, stating in detail the qualifications of such persons for consideration by the committee. Directors who are not employees receive an annual retainer of $30,000 and a fee of $1,500 for each board, committee, and shareholder meeting attended. The chairpersons of the Audit Committee, Compensation Committee, and Finance Committee each receive an additional annual retainer of $7,500. Other non- employee directors who chair committees receive additional annual retainers of $5,000. Pursuant to the Company's Deferred Compensation Plan for Non-Employee Directors, 15% of the annual retainer for each non-employee director is deferred and credited to a portion of a deferred compensation account, the value of which is measured from time to time by the value of shares (the "AT&T shares portion"). Directors may elect to defer the receipt of all or part of the remainder of their compensation into the AT&T shares portion or the cash portion of the deferred compensation account (the "cash portion"). The AT&T shares portion is credited on each dividend payment date for AT&T common shares with a number of deferred shares of common stock equivalent in market value to the amount of the quarterly dividend on the shares then credited in the accounts. The cash portion of the deferred compensation account earns interest, compounded quarterly, at an annual rate equal to the average interest rate for ten-year United States Treasury notes for the previous quarter, plus 5%. Non- employee directors with at least five years' service are eligible for an annual retirement benefit equal to their annual retainer at retirement. The benefit begins at age 70 and is payable for life. The Company also provides non-employee directors with travel accident insurance when on Company business. A non-employee director may purchase life insurance sponsored by the Company. The Company will share the premium expense with the director; however, all the Company contributions will be returned to the Company at the earlier of (a) the director's death or (b) the later of age 70 or 10 years from the policy's inception. This benefit will continue after the non- employee director's retirement from the board. Directors who are also employees of the Company or a subsidiary of the Company receive no compensation for serving as directors. ELECTION OF DIRECTORS (Item A on Proxy Card) The Proxy Committee intends to vote for the election of the nominees listed on the following pages unless otherwise instructed on the proxy card. These nominees have been selected by the board on the recommendation of the Committee on Directors. If you do not wish your shares to be voted for particular nominees, please identify the exceptions in the designated space provided on the proxy card. Directors will be elected by a plurality of the votes cast. Any shares not voted (whether by abstention, broker non-vote, or otherwise) have no impact on the vote. If at the time of the meeting one or more of the nominees have become unavailable to serve, shares represented by proxies will be voted for the remaining nominees and for any substitute nominee or nominees designated by the Committee on Directors or, if none, the size of the board will be reduced. The Committee on Directors knows of no reason why any of the nominees will be unavailable or unable to serve. Directors elected at the meeting will hold office until the next annual meeting or until their successors have been elected and qualified. For each nominee there follows a brief listing of principal occupation for at least the past five years, other major affiliations, and age as of January 1, 1996. NOMINEES FOR ELECTION AS DIRECTORS Robert E. Allen, Chairman and Chief Executive Officer of AT&T since 1988. Director of Bristol-Myers Squibb Co.; Chrysler Corporation; and PepsiCo, Inc. Director of AT&T since 1984; Chairman of the Executive and Proxy Committees. Age 60. [PHOTO OF ROBERT E. ALLEN] STOCK OWNERSHIP OF MANAGEMENT AND DIRECTORS The following table sets forth information concerning the beneficial ownership of the Company's common stock as of January 1, 1996, for (a) each director and nominee for director; (b) each of the named officers (the "named officers" as defined in the Compensation Report, herein) not listed as a director; and (c) directors and executive officers as a group. Except as otherwise noted, the nominee or family members had sole voting and investment power with respect to such securities. 1. No individual director and nominee for director or named officer beneficially owns 1% or more of the Company's outstanding common shares or the common shares of AT&T Capital Corporation, a majority- owned subsidiary of the Company, nor do the directors and executive officers as a group. 2. Share units held in deferred compensation accounts. RATIFICATION OF APPOINTMENT OF AUDITORS (Item B on Proxy Card) Subject to shareholder ratification, the board of directors, upon recommendation of the Audit Committee, has reappointed the firm of Coopers & Lybrand L.L.P. ("Coopers & Lybrand") as the independent auditors to examine the Company's financial statements for the year 1996. Coopers & Lybrand has audited the Company's books for many years. Your directors recommend that shareholders vote FOR such ratification. Ratification of the appointment of auditors requires a majority of the votes cast thereon. Any shares not voted (whether by abstention, broker non-vote, or otherwise) have no impact on the vote. If the shareholders do not ratify this appointment, other independent auditors will be considered by the board upon recommendation of the Audit Committee. Representatives of Coopers & Lybrand are expected to attend the annual meeting and will have the opportunity to make a statement if they desire and to respond to appropriate questions. For the year 1995, Coopers & Lybrand also examined the financial statements of the Company's subsidiaries and provided other audit services to the Company and subsidiaries in connection with SEC filings, review of financial statements, and audits of pension plans. DIRECTORS' PROPOSAL TO APPROVE THE AT&T 1996 (Item C on Proxy Card) In December 1995, the board adopted, subject to shareholder approval, the AT&T 1996 Employee Stock Purchase Plan (the "Plan"). If approved by shareholders, the Plan provides eligible employees (defined below) with an opportunity to purchase AT&T common stock (the "Common Stock") through payroll deductions. The Plan is intended to assist eligible employees in acquiring a stock ownership interest in the Company pursuant to a plan that is intended to qualify as an "employee stock purchase plan" under section 423 of the Internal Revenue Code of 1986, as amended (the "Code") to help employees provide for their future security and to encourage them to remain in the employment of the Company and participating subsidiaries. Shares Reserved for the Plan The aggregate number of shares of Common Stock which may be purchased under the Plan shall not exceed 50 million, subject to adjustment in the event of stock dividends, stock splits, combination of shares, recapitalizations, or other changes in the outstanding Common Stock. Any such adjustment will be made by the board. Shares issued under the Plan may consist, in whole or in part, of authorized and unissued shares or treasury shares. Full-time employees of the Company (or a subsidiary designated by the Company) are eligible if they meet certain conditions. To be eligible the employee must have completed six months of employment and the employee's customary employment must be greater than 20 hours per week. Approximately 200,000 employees would have been eligible to participate as of December 31, 1995. Material Features of the Plan The Company may make offerings on January 1 and/or July 1 of each Plan year or on such other date as the Administrator shall designate. Each offering shall be for a limited period ending on such exercise dates as the Administrator determines. Each eligible employee on an exercise date shall be entitled to purchase shares of Common Stock at the purchase price equal to 85% of the average of the reported highest and lowest sale prices of shares of Common Stock on the New York Stock Exchange on the applicable exercise date. Payment for shares of Common Stock purchased under the Plan will be made by authorized payroll deductions from an eligible employee's Eligible Compensation or, when authorized by the Administrator, an eligible employee may pay an equivalent amount for shares of Common Stock. "Eligible Compensation" means an eligible employee's total regular compensation payable Company or a subsidiary of the Company (a "Subsidiary") during an option period. Eligible employees who elect to participate in the Plan will designate a stated whole percentage equaling at least 1%, but no more than 10% of eligible compensation, to be deposited into a periodic deposit account. On the date of exercise, the entire periodic deposit account of each participant in the Plan is used to purchase whole and/or fractional shares of Common Stock. The Company shall maintain a stock purchase account for each participant to reflect the shares of Common Stock purchased under the Plan by each participant. No participant in the Plan is permitted to purchase Common Stock under the Plan at a rate that exceeds $25,000 in fair market value of Common Stock for each calendar year. All funds received by the Company from the sale of Common Stock under the Plan may be used for any corporate purpose. It is not possible to determine how many eligible employees will participate in the Plan in the future. Therefore, it is not possible to determine the dollar value or number of shares of Common Stock that will be distributed under the Plan. The Plan is intended to qualify as an employee stock purchase plan within the meaning of Section 423 of the Code. Under the Code, an employee who elects to participate in an offering under the Plan will not realize income at the time the offering commences or when the shares purchased under the Plan are transferred to him or her. If an employee disposes of such shares after two years from the date the offering of such shares commences and after one year from the date of the transfer of such shares to him or her, the employee will be required to include in income, as compensation for the year in which such disposition occurs, an amount equal to the lesser of (i) the excess of the fair market value of such shares at the time of disposition over the purchase price, or (ii) 15% of the fair market value of such shares at the time the offering commenced. The employee's basis in the shares disposed of will be increased by an amount equal to the amount so includable in his or her income as compensation, and any gain or loss computed with reference to such adjusted basis which is recognized at the time of the disposition will be a capital gain or loss, either short-term or long-term, depending on the holding period for such shares. In such event, the Company (or the subsidiary by which the employee is employed) will not be entitled to any deduction from income. If any employee disposes of the shares purchased under the Plan within such two-year or one-year period, the employee will be required to include in income, as compensation for the year in which such disposition occurs, an amount equal to the excess of the fair market value of such shares on the date of purchase over the purchase price. The employee's basis in such shares disposed of will be increased by an amount equal to the amount includable in his or her income as compensation, and any gain or loss computed with reference to such adjusted basis which is recognized at the time of disposition will be a capital gain or loss, either short-term or long- term, depending on the holding period for such shares. In the event of a disposition within such two-year or one-year period, the Company (or the subsidiary by which the employee is employed) will be entitled to a deduction from income equal to the amount the employee is required to include in income as a result of such disposition. An employee who is a nonresident of the United States will generally not be subject to the U.S. federal income tax described above with respect to the shares of Common Stock purchased under the Plan. The board of directors of the Company, or its delegate, shall appoint a committee (the "Administrator"), which shall be composed of one or more members, to administer the Plan on behalf of the Company. The Administrator may delegate any or all of the administrative functions under the Plan to such individuals, committees, or entities as the Administrator considers appropriate. The Administrator may adopt rules and procedures not inconsistent with the provisions of the Plan for its administration. The Administrator's interpretation and construction of the Plan is final and conclusive. The board may at any time, or from time to time, alter or amend the Plan in any respect, except that, without approval of the shareholders of AT&T, no amendment may increase the number of shares reserved for purchase, or reduce the purchase price per share under the Plan, other than as described above. The board shall have the right to terminate the Plan or any offering at any time for any reason. Unless terminated earlier, the Plan shall continue in effect through June 30, 2001, except that if at the end of any purchase period the aggregate funds available for purchase of Common Stock would purchase a greater number of shares than is available for purchase, the number of shares that would otherwise be purchased by each participant at the end of the purchase period will be proportionately reduced in order to eliminate the excess. The Plan would then automatically terminate after such purchase period. Upon expiration or termination of the Plan, any amount not applied toward the purchase of Common Stock will be refunded. Adoption of this proposal requires an affirmative vote by the holders of a majority of the outstanding Common Stock. Any shares not voted (whether by abstention, broker non-vote or otherwise) have the effect of a negative vote. The directors recommend that shareholders vote FOR the approval of the AT&T 1996 Employee Stock Purchase Plan. Proposals intended for inclusion in next year's proxy statement should be sent to: Vice President-Law and Secretary, AT&T Corp., 32 Avenue of the Americas, New York, NY 10013-2412, and must be received by ,1996. OTHER MATTERS TO COME BEFORE THE MEETING In addition to the matters described above, there will be an address by the Chairman of the Board and a general discussion period during which shareholders will have an opportunity to ask questions about the business. If any matter not described herein should come before the meeting, the Proxy Committee will vote the shares represented by it in accordance with its best judgment. At the time this proxy statement went to press, the Company knew of no other matters which might be presented for shareholder action at the meeting. BOARD COMPENSATION COMMITTEE REPORT ON The Compensation Committee is composed of five independent non-employee directors. The committee is responsible for setting and administering executive officer salaries and the annual bonus and long-term incentive plans that govern the compensation paid to all senior managers of the Company, except that the board consisting of "outside directors" within the meaning of Section 162(m) of the Code (other than directors who are employees) is responsible for setting and administering salaries and the annual bonus for the officers listed on page (the "named officers") based upon recommendations of the committee. On September 20, 1995, the AT&T CEO announced a strategic restructuring of AT&T designed to make AT&T more valuable to its shareowners, better able to focus on its markets and more responsive to its customers. This restructuring will separate AT&T into three stand-alone companies each focused on a major segment of the global information industry: communications services (including wireless); communications systems and technology (from infrastructure to end-user); and transaction-intensive computing. To protect the AT&T talent base and ensure a smooth transition to this new environment the Compensation Committee recommended and approved certain special equity incentive/retention grants to key managers. The committee also recommended some changes in the 1995 and 1996 compensation plans that will govern management actions throughout the transition. We will describe these awards and changes in the appropriate sections of this report. The following report represents the actions of the committee and the board regarding compensation paid to the named officers during 1995. The Company's compensation programs are designed to link executives' compensation to the performance of the Company. For example, the Chairman's annual bonus and long-term awards are performance-driven incentives and account for % of his total compensation structure. The other named officers have approximately % of their total compensation at risk in performance-driven incentive plans. AT&T targets executive competitive compensation levels at the mean of a select group of large, market-focused, progressive companies with whom it competes for senior executive talent. The Company's competitors for executive talent are not necessarily the same companies that would be included in a peer group established to compare shareholder returns because the Company requires skills and perspectives from a broader range of backgrounds. Thus, the comparable companies for purposes of executive compensation are not the same as the peer group index used in the Five-Year Performance Comparison graph included in this proxy statement. The target executive compensation levels determined with reference to the comparable market survey sample described above require that the compensation to each of the Company's top five officers exceeds the annual limit for deductibility under Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"). The Company, however, has taken steps to mitigate the negative impact of this tax provision on the shareholders. For example, elements of compensation under our annual bonus and long-term incentive plans qualify for exemption from the limit on tax deductibility as shareholder-approved performance-driven plans. In addition, we have a salary and incentive deferral plan which permits compensation deferred under the plan to be exempt from the limit on tax deductibility. The committee has developed executive compensation governing principles that provide guidance in the design and operation of the senior management compensation plans. These principles address key areas of AT&T senior executive compensation policy such as the identification of the markets to be surveyed, and the degree of flexibility of the compensation programs to facilitate strategic executive hires in global markets. The committee also has utilized these governing principles for review of officer performance. Among other things, these principles ensure that executive officer compensation is linked to corporate performance levels. The Company's executive compensation program consists of two key elements: (1) an annual component, i.e., base salary and annual bonus, and (2) a long-term component, i.e., performance shares, stock options, and restricted stock. The policies with respect to each of these elements, as well as the basis for determining the compensation of the Chairman of the Board and CEO, Mr. Allen, are described below. (1) Annual Component: Base Salary and Annual Bonus Base Salary: Base salaries for executive officers are determined with reference to a position rate for each officer. These position rates are determined annually by evaluating the responsibilities of the position and comparing it with other executive officer positions in the marketplace. Annual salary adjustments are determined by the Company's performance and the individual's contribution to that performance. For those executive officers responsible for particular business units, the financial and non- financial results (e.g., recognition within respective industries) of their business units are also considered. The committee presents the salary recommendations to the board for the named officers. While there are no individual performance matrices or pre-established weightings given to each factor, these salary recommendations are based on performance criteria such as: (bullet) financial performance with a balance between long- and short-term (bullet) initiatives to globalize the Company, (bullet) development of the leadership team, (bullet) response to a rapidly changing competitive environment, and (bullet) relative position to salary structure. Annual Bonus: The annual bonus for the Chairman and for the rest of the named officers is (i) % of the Company's "Net Cash Provided by Operating Activities", for the annual performance period as adjusted, divided by the total number of named officers with respect to such period, or (ii) a lesser amount based on factors including the Company's performance relative to pre-set financial, employee, customer, and individual performance targets. The pre-set financial target is based on Economic Value Added ("EVA"), which measures the return on investment that enhances shareholder value. Employee attitude measures are determined by an index called People Value Added ("PVA"). There are two components of the measurement: leadership of people and diversity. Components of this measurement are derived from an annual employee survey that measures employee perceptions of executive behavior such as: sharing roles and responsibilities, leadership, empowerment, and respect for individuals. The customer measure is Customer Value Added ("CVA") and it measures the relative value that customers perceive when our products are compared with those of our competitors. Targets for these measures were reviewed and approved by the committee. For the first three quarters of 1995 the executive officers had approximately 90% of their annual bonus tied to a level of achievement of annual EVA, CVA and PVA targets. In connection with the restructuring transition effort described above, for the fourth quarter of 1995, the senior executive incentive plan for annual bonuses was adjusted to provide 50% of the incentive on the EVA level of achievement and 50% based on successful accomplishment of the restructuring transition work. The Compensation Committee approved senior executive performance criteria for the restructuring transition work to assure accountability for meeting shareowner, financial, customer, and employee objectives through the transition. (2) Long-Term Component: Performance Shares, Stock Options, and Restricted To align shareholder and executive officer interests, the long- term component of the Company's executive compensation program uses grants whose value is related to the value of Company common shares. Grants of performance shares, stock options, and restricted stock are made under the AT&T 1987 Long Term Incentive Program which was approved by the shareholders. Historically, performance shares and stock options have been granted annually based on position rate, while restricted stock awards are granted on a selective basis. The size of annual performance share and stock option award levels are related to survey results of award levels of comparable companies in the marketplace. The size of previous grants and the number of shares held by an executive are not considered in determining annual award levels. Our target is to deliver approximately half of this long-term incentive value via performance shares and half via stock options. The awards provide rewards to executives upon creation of incremental shareholder value and the attainment of long-term goals. Performance Shares: Performance shares, which are awards of units equivalent in value to AT&T common shares, are awarded annually in numbers based on an executive's position rate. Payout of 0% to 150% of such performance shares is made in the form of cash and/or AT&T common shares at the end of a three-year performance period based on the Company's return-to-equity ("RTE") performance compared with a target. However, if an executive's annual compensation is subject to the limit on tax deductibility, under Section 162(m) of the Code, in the last year of a performance period, then the executive shall receive an Other Stock Unit Award payout, in lieu of the performance share payout, and the value of the payout to each such executive for the performance period shall be (i) 0.13% of the Company's "Net Cash Provided by Operating Activities," as adjusted, for each year in the performance period, divided by the total number of executives receiving such payouts, or (ii) a lesser amount, based on factors, including targets for the Company's RTE established for performance shares for such performance period. recognizes that the Company's impending restructure will render obsolete the performance criteria established for the long-term cycles 1994-1996 and 1995-1997. To address this transition period, and the difficulty of setting long-term financial targets while the restructure is in process, the committee has recommended and approved that the criteria for performance periods 1994-1996 and 1995-1997 are deemed to have been met at the target level. The opportunity to earn a payout above 100% is eliminated, and all other terms and conditions of the award continue to apply. Stock Options and Restricted Stock: Stock options are granted annually to executive officers also in numbers based on their position rate. Like performance shares, the magnitude of such awards is determined annually by the committee. Stock options are granted with an exercise price equal to or greater than the fair market value of AT&T common shares on the day of grant. Stock options are exercisable between one and ten years from the date granted. Such stock options provide incentive for the creation of shareholder value over the long term since the full benefit of the compensation package cannot be realized unless an appreciation in the price of Company common shares occurs over a specified number of years. Restricted stock awards are granted occasionally to executive officers under the AT&T 1987 Long Term Incentive Program. Restricted stock is subject to forfeiture and may not be disposed of by the recipient until certain restrictions established by the committee lapse. Recipients of restricted stock are not required to provide consideration other than the rendering of services or the payment of any minimum amount required by law. Following the September 20, 1995, restructuring announcement the Compensation Committee awarded special equity incentive/ retention grants of stock options and restricted stock units to key employees. These special grants are a program targeted to retain selected people during a three to four year transition period of organizational realignment . The size of the grants ranges from 1.5 to 4.5 times total compensation and the options are governed by price performance terms. The grants vest after four years provided that applicable price performance criteria have been satisfied. special grants will replace the normal annual stock option grants these employees would have received for 1996. Details of these grants for named officers are on page . During 1995, the Company's most highly compensated officer was Robert E. Allen, Chairman of the Board and CEO. Mr. Allen's 1995 performance was reviewed by the committee and discussed with the non-employee directors and Mr. Allen. The committee also made recommendations to the board concerning the annual component (base salary and annual bonus) and approved the long- term component (performance shares, stock options, and restricted stock) of his compensation. These actions were predicated on the considerations discussed below. A substantial portion of Mr. Allen's annual bonus is based on measurements of success with our three key stakeholders: shareholders, customers, and employees. The shareholder element was measured by success relative to an EVA target for the year of $ billion. Final results for 1995 indicate . An AT&T performance share payout was made in 1995 based on an aggressive average RTE target for the performance period from 1992-1994. The actual average return achieved was % of the RTE target and these results yielded a payout of % of the performance shares awarded to Mr. Allen at the beginning of 1992. During 1995, Mr. Allen also led AT&T in bold strategic actions, including: (bullet) Initiation of a massive restructuring of the Company into three stand-alone, global, strategically focused companies; (bullet) Strengthening of the Company's presence in the wireless arena by transitioning McCaw Cellular into AT&T Wireless Services, developing combined packages of wireless and other services, and acquiring licenses for new wireless services known as personal communication services, thereby extending AT&T's reach to 80 percent of the U.S. (bullet) Launching a new business, AT&T Solutions, to offer consulting, systems integration and outsourcing services to large global (bullet) Reaching agreement on a new three-year labor contract, a process considered a model for building on common goals and shared commitment. The graph below provides an indicator of cumulative total shareholder returns for the Company as compared with the S&P 500 Stock Index and a Peer Group(1) AT&T CORP S&P 500 PEER GROUP Assumes $100 invested on December 31, 1990 in AT&T Common Stock, the S&P 500 Index and Peer Group Common Stock Total Shareholder Returns Assume Reinvestment of Dividends 1. The peer group comprises the largest companies worldwide which compete against the Company in its two industry segments of information movement and management, and financial services and leasing. None of the companies competing with AT&T in information movement and management offers a fully comparable range of products and services, although each is widely recognized as a competitor of AT&T. The returns of each company have been weighted according to their respective stock market capitalization for purposes of arriving at a peer group average. The members of the peer group are as follows: American Express Company; Ameritech Corporation; Apple Computer, Inc.; Bell Atlantic Corporation; BellSouth Corporation; Cable & Wireless p.l.c.; Digital Equipment Corp.; GTE Corporation; Hewlett-Packard Co.; Intel Corp.; International Business Machines Corporation; ITT Corporation; L. M. Ericsson Telefonaktiebolaget; MCI Communications Corp.; Motorola, Inc.; NEC Corp.; Northern Telecom Limited; NYNEX Corporation; Pacific Telesis Group; SBC Communications Inc.; Sprint Corporation; Texas Instruments Incorporated; U S WEST, Inc.; and Xerox Corporation. 1. Includes Chairman of the Board and Chief Executive Officer and the four other most highly compensated executive officers as measured by salary and bonus. 2. Compensation deferred at the election of named officers is included in the category (e.g., bonus, LTIP payouts) and year it would have otherwise been reported had it not been deferred. 3. Includes (a) payments of above-market interest on deferred compensation, (b) dividend equivalents paid with respect to long-term performance shares prior to end of three-year performance period, and other earnings on long- term incentive compensation paid during the year, (c) tax payment reimbursements, and (d) the value of personal benefits and perquisites. 4. On December 31, 1995 Mr. Allen held an outstanding grant of restricted stock, and Messrs. , , , and held outstanding grants of restricted stock units. Mr. Allen held shares with a value of $ . On September 25, 1995, an award of restricted stock units was granted to Messrs. , , , and as part of the Company's special equity incentive/retention program in the amounts of units, units, units, and units, respectively, with a value at December 31, 1995 of $0,000,000, $000,000, $000,000, and $0,000,000, respectively. These grants vest four years after the date of grant and carry stringent penalties for competition and other adverse activities against the Company. The value at grant of these units is reflected in the table above. 5. Includes distribution in 1995 to Messrs. Allen, , , , and of performance shares whose three-year performance period ended December 31, 1994. The value of ,000 AT&T Restricted Shares which vested in 1995 is also reflected in the payout for that year for Mr. Allen. 6. In 1995, includes (a) Company contributions to savings plans (Mr. Allen $0,000; Mr. $ ; Mr. $ ; Mr. $ ; and Mr. $ ), (b) dollar value of the benefit of premiums paid for split-dollar life insurance policies (unrelated to term life insurance coverage) projected on an actuarial basis (Mr. Allen $0,000, Mr. $ ; Mr. $ ; Mr. $ ; and Mr. $ ), and (c) payments equal to lost Company savings match caused by IRS limitations (Mr. Allen $ ; Mr. $ ; Mr. $ ; Mr. $ , and Mr. $ ). ("SAR") EXERCISES IN 1995 AND YEAR-END VALUES LONG-TERM INCENTIVE PLANS--AWARDS IN 1995 1. Includes Chairman of the Board and Chief Executive Officer and the four other most highly compensated executive officers as measured by salary and bonus. 2. In January 1995, the Performance Shares listed in the table were awarded. Normally, the payout of awards is tied to achieving specified levels of return-to-equity ("RTE"). The target amount will be earned if 100% of the targeted RTE rate is achieved. At its December 1995 meeting, the Compensation Committee recommended and approved that the performance criteria for the 1995-1997 performance cycle be deemed to have been met at the target level. This action was taken in acknowledgment that the Company's restructuring had rendered the original performance criteria inapplicable and of the difficulty of establishing revised criteria while the restructuring was in progress. Awards will be distributed as common stock of the Company, or as cash in an amount equal to the value of those shares, or partly in common stock and partly in cash. However, if an executive's annual compensation is subject to the limit on tax deductibility, under Section 162(m) of the Code, in the last year of a performance period, then the executive shall receive an Other Stock Unit Award payout, in lieu of the performance share payout, and the value of the payout to each such executive for the performance period shall be (i) 0.13% of the Company's "Net Cash Provided by Operating Activities," as adjusted, for each year in the performance period, divided by the total number of executives receiving such payouts, or (ii) a lesser amount, based on factors, including targets for the Company's RTE established for performance shares for such performance period. 1. Includes Chairman of the Board and Chief Executive Officer and the four other most highly compensated executive officers as measured by salary and bonus. 2. Includes the regular annual grant of options as well as a special equity incentive/ retention grant following the announcement of the Company's intended restructuring. Options granted 1/3/95 become exercisable to the extent of one-third of the grant on 1/3/96, 1/3/97, and 1/3/98 respectively. Options granted 9/25/95 become exercisable four years after the date of grant. 3. In accordance with Securities and Exchange Commission rules, the Black-Scholes option pricing model was chosen to estimate the grant date present value of the options set forth in this table. The Company's use of this model should not be construed as an endorsement of its accuracy at valuing options. All stock option valuation models, including the Black-Scholes model, require a prediction about the future movement of the stock price. The following assumptions were made for purposes of calculating the Grant Date Present Value: for the January grant, an option term of 7 years, volatility at .1769, dividend yield at 2.77%, interest rate at 7.83%, and a 3% per year discount for each year in the vesting period for risk of forfeiture over the 3-year vesting schedule, and for the September grant, an option term of 7 years, volatility at .1572, dividend yield at 2.66%, interest rate at 6.40%, and a 3% per year discount for each year in the vesting period for risk of forfeiture over the 4-year vesting schedule. The real value of the options in this table depends upon the actual performance of the Company's stock during the applicable period. The Company maintains the AT&T Management Pension Plan, a non-contributory pension plan which covers all management employees, including Messrs. Allen, , , , and . The normal retirement age under this plan is 65; however, retirement before age 65 can be elected under certain conditions. Under the AT&T Management Pension Plan, annual pensions are computed on an adjusted career average pay basis. The adjusted career average pay formula is the sum of (a) 1.6% of the average annual pay for the six years ending December 31, 1992, times the number of years of service prior to January 1, 1993, plus (b) 1.6% of pay subsequent to December 31, 1992. Only the basic salary is taken into account in the formula used to compute pension amounts. Federal laws place limitations on pensions that may be paid from the pension trust related to the AT&T Management Pension Plan. Pension amounts based on the AT&T Management Pension Plan formula which exceed the applicable limitations will be paid as an operating expense. The Company also maintains the AT&T Non-Qualified Pension Plan. Under the plan, annual pensions for Messrs. Allen, , , , and , and other senior managers are computed based primarily on actual annual bonus awards under the Company's Short Term Incentive Plan. Pension benefits under this plan will generally commence at the same time as benefits under the AT&T Management Pension Plan. The annual pension amounts payable under this plan are equal to the greater of the amounts computed under the Basic or Alternate Formula described below. The sum of (a) 1.5% of the average of the actual annual bonus awards for the three-year period ending December 31, 1989, times the number of years of service prior to January 1, 1990, plus (b) 1.6% of the actual annual bonus awards subsequent to December 31, 1989. The excess of (a) 1.7% of the adjusted career average pay, over (b) 0.8% of the covered compensation base, times years of service to retirement, minus the benefit calculated under the AT&T Management Pension Plan formula (without regard to limitations imposed by the Internal Revenue Code). For purposes of this formula, adjusted career average pay is determined by dividing the sum of the employee's total adjusted career income by the employee's actual term of employment at retirement. Total adjusted career income is the sum of (A) and (B), where (A) is the sum of (i) the employee's years of service prior to January 1, 1993, multiplied by the employee's average annual compensation (within the meaning of the AT&T Management Pension Plan) for the three-year period ending December 31, 1992, without regard to the limitations imposed by the Internal Revenue Code, plus (ii) the employee's years of service prior to January 1, 1990, multiplied by the average of the employee's actual annual bonus awards for the three-year period ending December 31, 1989, and (B) is the sum of the employee's actual compensation (within the meaning of the AT&T Management Pension Plan) after December 31, 1992, without regard to the limitations imposed by the Internal Revenue Code, and actual annual bonus awards subsequent to December 31, 1989. The covered compensation base used in this formula is the average of the maximum wage amount on which an employee was liable for social security tax for each year beginning with 1961 and ending with 1995. In 1995, the covered compensation base was $25,800. In 1993, an Alternative Minimum Formula ("AMF"), applicable to active senior managers with five years of service who are participants in the AT&T Non-Qualified Pension Plan as of December 31, 1993, was established. The annual pension amount payable under the AMF is equal to the greater of the amounts computed under formulas A and B plus an additional percent increase factor as described below: The sum of (a) 1.5% of the average of the total compensation for the three-year period ending December 31, 1992, times the number of years of service prior to January 1, 1993, plus (b) 1.6% of the total compensation from January 1, 1993, to December 31, 1993. For purposes of this Formula A, total compensation shall be basic salary plus actual annual bonus awards. The pension amounts resulting from this Formula A will be reduced to reflect retirements prior to age 55. The excess of (a) 1.7% of the adjusted career average pay, over (b) 0.8% of the covered compensation base, times years of service to December 31, 1993. For purposes of this Formula B, adjusted career average pay is determined by dividing the sum of the employee's total adjusted career income used for purposes of Formula A, by the employee's actual term of employment to December 31, 1993. The covered compensation base used in this Formula B is the average of the maximum wage amounts on which an employee was liable for social security tax for each year beginning with 1959 and ending with 1993. In 1993, the covered compensation base was $22,800. The pension amounts resulting from this Formula B will be reduced to reflect retirements prior to age 60. An additional percent increase factor based on age and service is applied to the pension amount resulting from the higher of Formula A or B. The total AMF pension results in a fixed benefit and such amount is reduced by the amount payable under the AT&T Management Pension Plan. It is anticipated that after 1997, a senior manager's normal pension increases resulting from additional age and service as well as possible future pension plan amendments could cause the regular accrued pension benefit to exceed the fixed AMF benefit. Pensions resulting from the AMF will be payable under the AT&T Non-Qualified Pension Plan. As part of their employment agreements, the Company entered into a supplemental pension arrangement with Messrs. and . Pursuant to his arrangement, if Mr. employment is terminated on or after age 55 for any reason other than Company-initiated termination for "cause," as defined, he will be entitled to immediate pension benefits based on the higher of (1) a pension determined by his actual net credited service and calculated under the then-existing Company qualified and non-qualified pension formulas, but without reference to age and service eligibility requirements, or (2) a fixed minimum monthly pension schedule which ranges from $ at age 55 to $ at age 65. Pursuant to Mr. arrangement, if employment is terminated for any reason other than Company-initiated termination for "cause," as defined, after completion of eight years of Company service, he will be entitled to immediate pension benefits based on his actual net credited service and calculated under the then- existing Company qualified and non-qualified pension formulas, but without reference to age and service eligibility requirements. Pension benefits payable under these arrangements will be paid out of the Company's operating income, and will be offset by all amounts actually received by Messrs. and under any other Company qualified or non-qualified retirement plan or arrangement. In addition, Messrs. and will be entitled to certain other post-retirement benefits that are generally made available to retired executive officers and service pension-eligible senior managers from time to time. In the event Mr. employment is terminated by the Company for any reason other than for "cause," as defined, prior to age 55, he will be eligible for a severance benefit equal to 200% of his then base salary under the provisions of his employment agreement. The year 1996 is the final year of a three-year severance agreement with Mr. . In the event Mr. employment is terminated by the Company for any reason other than for "cause," as defined, anytime prior to August 9, 1996, he will be eligible for a severance benefit which ranges from 200% to 100% of base salary. Senior managers (including Messrs. and ) and certain other management employees who are hired at age 35 or over are covered by a supplemental AT&T Mid-Career Pension Plan. For specified managers retiring with at least five years in level, the plan provides additional pension credits equal to the 35 and their maximum possible years of service attainable at age 65, but not to exceed actual net credited service, at approximately one-half the rate in the AT&T Management Pension Plan. Pension amounts under either the AT&T Management Pension Plan formula, the AT&T Non-Qualified Pension Plan, or the AT&T Mid-Career Pension Plan are not subject to reductions for social security benefits or other offset amounts. If Messrs. Allen and continue in the positions given above and retire at the normal retirement age of 65, the estimated annual pension amounts payable under the AT&T Management Pension Plan formula and the AT&T Non-Qualified Pension Plan would be $ , and $ , respectively. Mr. Pelson announced his retirement effective the second quarter of 1996 and his pension at such retirement would approximate $000.000. For Messrs. and , the estimated annual pension amounts payable under the AT&T Management Pension Plan formula, the AT&T Non-Qualified Pension Plan, and the AT&T Mid-Career Pension Plan would be $ and $ , respectively. Amounts shown are straight- life annuity amounts not reduced by a joint and survivorship provision which is available to these officers named. The Company has reserved the right to purchase annuity contracts to satisfy its unfunded obligations to any of these officers under the AT&T Non-Qualified Pension Plan. In the event the Company purchases an annuity contract for any officer, the pension payments for such officer will vary from that set forth above. Then there would be a tax gross-up payment to the officer and annuity benefits paid by the annuity provider will be reduced to offset the tax gross-up payment. The after-tax pension benefit will be the same as the after-tax benefit the participant would otherwise have received under the AT&T Non-Qualified Pension Plan. A Directors' and Officers' Liability Policy was renewed effective July 1, 1995, with Lloyds of London and other carriers. The policy insures AT&T for certain obligations incurred in the indemnification of its directors and officers under New York law or under contract and insures directors and officers when such indemnification is not provided by AT&T. The one-year policy's cost is $1,416,000. The cost of soliciting proxies in the accompanying form will be borne by the Company. In addition to solicitations by mail, a number of regular employees of the Company and of its subsidiaries may solicit proxies in person or by telephone. The Company also has retained Morrow & Co. to aid in the solicitation of proxies, at an estimated cost of $18,000 plus reimbursement of reasonable out-of- pocket expenses. The above notice and proxy statement are sent by order of the board of directors. 32 Avenue of the Americas, New York, NY 10013 This proxy is solicited on behalf of the Board of Directors for the Annual Meeting on April 17, 1996. The undersigned hereby appoints R.E. Allen, B.K. Johnson and each of them, proxies, with powers the undersigned would possess if personally present, and with full power of substitution, to vote all common shares of the undersigned in AT&T Corp. at the annual meeting of shareholders to be held at James L. Knight International Center in Miami, Florida, at 9:30 a.m. on April 17, 1996, and at any adjournment thereof, upon all subjects that may properly come before the meeting, including the matters described in the proxy statement furnished herewith, subject to any directions indicated on the other side of this card. If no directions are given, the proxies will vote for the election of all listed nominees, in accord with the Directors' recommendations on the other subjects listed on the other side of this card and, at their discretion, on any other matter that may properly come before the meeting. (If you have indicated any changes or voting limitations on this side of the card, please mark the "comment" box on the other side.) This card also provides voting instructions for shares held in the dividend reinvestment plan and, if registrations are identical, shares held in the various employee stock purchase and savings plans as described in the proxy statement. Your vote for the election of Directors may be indicated on the other side. Nominees are-- . Please sign on the other side and return promptly to P.O. Box 8872, Edison, NJ 08818-9241. If you do not sign and return a proxy, or attend the meeting and vote by ballet, your shares cannot be voted. (If you have written in the above space, please mark the "comment" box on the other side of this card.) Please mark your vote with an X. Directors recommend a vote "FOR" (page 0) ( ) ( ) FOR ALL EXCEPT the following nominees (page 00) ( ) ( ) ( ) C. AT&T 1996 Employee ( ) ( ) ( ) Directors recommend a vote "AGAINST" Please sign this proxy as name(s) appears above and return it promptly whether or not you plan to attend the meeting. If signing for a corporation or partnership or as agent, attorney or fiduciary, indicate the capacity in which you are signing. If you do attend the meeting and decide to vote by ballot, such vote will supersede this proxy.	PRE 14A	PRE 14A	1996-01-12T00:00:00	1996-01-12T17:12:23
0000899243-96-000019	0000899243-96-000019_0009.txt	CROSSTIE PURCHASE OPTION AND LOAN AGREEMENT THIS PURCHASE OPTION AND LOAN AGREEMENT ("Agreement"), dated as of December 29, 1995, is by and between TIETEK, INC., a Texas corporation ("Borrower"), NORTH AMERICAN TECHNOLOGIES GROUP, INC., a Delaware corporation ("NATK"), and each of WILLIAM T. ALDRICH, J. DENNY BARTELL and HENRY W. SULLIVAN (Messrs. Aldrich, Bartell and Sullivan collectively referred to herein as the "TIETEK Owners"). Borrower desires to borrow from NATK, and NATK desires to lend to Borrower, certain funds to be used by Borrower exclusively for expenses incurred or to be incurred in connection with the commercial development of railroad crosstie technology as set out on a budget referred to below. In exchange for NATK's agreement to lend the amounts described below, the TIETEK Owners agree to grant to NATK the Crosstie Purchase Option, as defined below, upon the terms and conditions of this Agreement. NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows: (a) The Crosstie Loan and Crosstie Note. Upon the terms and subject to the conditions of this Agreement, NATK hereby agrees to lend to Borrower from time to time up to $1,500,000.00 pursuant to this Agreement. Such loan (the "Crosstie Loan") shall be evidenced by the execution and delivery by Borrower and the TIETEK Owners of that certain Promissory Note, Security Agreement and Pledge, in the form of EXHIBIT A, attached hereto and made a part hereof (the "Crosstie Note"). The parties acknowledge that certain amounts have already been advanced by NATK to Borrower as reflected on the Crosstie Note in the form of Exhibit A, and that the amounts advanced thereunder are to be treated for all purposes as loaned and borrowed pursuant to the terms of this Agreement, including without limitation the Crosstie Note. Notwithstanding anything in this Agreement or in the Crosstie Note to the contrary, no TIETEK Owner shall be individually responsible or liable for the payment or performance of Borrower's obligations under the Crosstie Note to pay any amount of principal, interest or other payment to NATK, except to the extent of the security interest, lien and pledge of the TIETEK Owner's Collateral (as defined in the TIETEK Note) granted or to be granted by such TIETEK Owner pursuant to the TIETEK Note, and NATK agrees that its sole recourse against any TIETEK Owner in connection with such payment or performance of Borrower's obligations shall be limited to the extent of such security interest, lien and pledge of such TIETEK Owner's Collateral granted or to be granted by such TIETEK Owner pursuant to the TIETEK Note. (b) The Crosstie Budget. Attached hereto as EXHIBIT B and made a part hereof is an initial budget prepared by Borrower setting out all currently intended needs and initial uses of funds for the operation of the Crosstie Business (as defined in Section 3.2(b) hereof) during the Crosstie Advance Period (as defined below in Section 1.2(a) hereof). (i) Not less than quarterly, and at such times as either Borrower or NATK shall reasonably request, Borrower shall present to NATK additional, revised budgets addressing specific business objectives of TIETEK and other business developments and new information affecting TIETEK and its business, and Borrower and NATK shall jointly review and revise such budget as appropriate, all as Borrower and NATK shall reasonably agree. Without limiting the generality of the foregoing, the parties agree that anticipated and actual revenues of Borrower shall not reduce NATK's obligations to fund the Crosstie Loan; provided, however, that the parties anticipate that any such revenues will be a factor in the budgeting process and, in particular, the cash flow analysis used to develop and revise a budget. Each party agrees to carry out its obligations under this clause (i) promptly and in good faith. (ii) In the event that, after using good faith efforts to resolve any disagreements the parties may have with respect to any budget, NATK does not approve of such budget (and regardless of whether such failure to approve of the budget is based upon NATK's good faith disagreement or disapproval of any material proposed expenditure, NATK's good faith belief that the Crosstie Business will not reasonably be expected to develop into an economically viable enterprise unless more than $1.5 million is invested in the Crosstie Business, or any other legitimate business reason), NATK shall not have any obligation to fund additional Crosstie Advances. The budget referred to in this clause (b), as revised and supplemented from time to time in accordance with the provisions of this clause (b), is referred to in this Agreement as the "Crosstie Budget." 1.2 PROCEDURE FOR FUNDING CROSSTIE ADVANCES. (a) Documents, Etc. Borrower may request, from time to time during the period beginning on the date of this Agreement and continuing until the second anniversary of the date hereof (the "Crosstie Advance Period"), that NATK fund an advance (a "Crosstie Advance") under the Crosstie Loan, and NATK agrees to fund such advance upon the receipt by NATK of: (i) Schedule 1 to the Crosstie Note, duly executed by Borrower, which shall evidence all prior Crosstie Advances made under the Crosstie Loan and the (ii) such documentation as NATK may reasonably request which shall evidence the particular uses of the funds to be included in the requested (iii) such documentation as NATK may reasonably request which shall evidence the application of funds provided pursuant to all prior Crosstie Advances in accordance with the Crosstie Budget (as defined below). (b) Crosstie Advance Funding. Each Crosstie Advance shall be made within five (5) business days of the date that NATK receives the documents referred to in clause (a) above and the other conditions set out in clause (c) of this Section have been fulfilled. (c) Conditions to Funding Obligations. It shall be a condition to the obligation of NATK to fund each Crosstie Advance that: (i) at the time of such Crosstie Advance, a Crosstie Budget shall be in place that was prepared and approved in accordance with the provisions of Section 1.1(b) of this Agreement; (ii) at all times prior to the funding of such Crosstie Advance, Borrower shall have complied in all material respects with all of its covenants and agreements set out in this Agreement (except as Borrower and NATK shall otherwise agree in writing); and (iii) at the time of such funding, NATK shall have sufficient resources to permit it to fund such Crosstie Advance and to fund its other financial obligations, in each such case, and such funding shall not result in NATK violating any financial covenants or agreements by which NATK or any of its assets are then bound, all as determined in the reasonable, good faith judgment of NATK. (d) How Crosstie Advance is to be Funded. Upon the fulfillment of the conditions described in clause (c) above, NATK shall apply the amounts to be funded pursuant to a Crosstie Advance, such application to be made, at the option of NATK, either (i) by advancing such amounts to Borrower for payment to the various third parties entitled thereto the various expenses and other amounts due such parties (as evidenced by the documents submitted by Borrower to NATK in requesting such Crosstie Advance) or (ii) by directly paying in a prompt manner to such third parties such expenses and other amounts due such parties (as evidenced by the documents submitted by Borrower to NATK in requesting such Crosstie Advance, and as directed by Borrower) for the account of Borrower. Copies of the disbursement payments (or reasonable evidence thereof) shall be made available to both parties at all times. For purposes of the Crosstie Note, interest shall be deemed to begin to accrue from the date NATK issues and mails (or delivers to Borrower) a check or otherwise makes such payment with respect to an amount paid from a Crosstie Advance. 2.1 GRANT OF CROSSTIE PURCHASE OPTION. Each TIETEK Owner hereby grants to NATK a right and option (the "Crosstie Purchase Option") to purchase all of the shares of capital stock of Borrower currently existing or at any time hereafter outstanding (the "TIETEK Shares") that are owned by such TIETEK Owner, upon the terms and conditions of this Article Two. 2.2 CROSSTIE PURCHASE OPTION PERIOD. NATK may exercise the Crosstie Purchase Option herein granted by delivering written notice to the TIETEK Owners (and the Escrow Agent, if any, as defined below) at any time after the date hereof and until the second anniversary date of the date hereof, subject to extension as provided in Section 2.4 hereof. The period during which such written notice may be given (including any extensions thereof) is referred to herein as the "Crosstie Purchase Option Period." Notwithstanding anything herein to the contrary, the Crosstie Purchase Option may not be exercised at any time that the 90 Day Note (as defined in the Asset Purchase Agreement that is referred to in the Crosstie Note) is outstanding, or is not otherwise paid in full. In the event such written notice is not delivered during the Crosstie Purchase Option Period, the Crosstie Purchase Option shall automatically expire and be of no further force or effect. The date NATK delivers such notice is referred to herein as the "Option Date." Such written notice shall specify a time, which shall be not more than 45 days after the Option Date, and place in Houston, Texas for the consummation and closing of the exercise of the Crosstie Purchase Option (the "Option Closing"). In the event that NATK does not exercise the Crosstie Purchase Option, then upon the request of the Borrower, NATK agrees promptly to deliver to the Borrower a copy of all accounting, payroll and other records (and all supporting documentation) then in its possession relating to the performance by NATK of the accounting, payroll and other functions described in Section 3.2(d)(iii) of this Agreement. 2.3 OPTION CLOSING. At the Option Closing: (a) The TIETEK Owners shall (either directly or pursuant to the terms of the Escrow Agreement, if any, as defined below) sell, transfer, convey, assign and deliver to NATK all outstanding shares of capital stock of the Borrower (including all of the TIETEK Shares), free and clear of all liens, claims, charges, pledges or interests of any other kind or nature; (b) NATK shall execute and deliver to the TIETEK Owners (or their designees) that certain TIETEK Royalty Agreement substantially in the form of EXHIBIT C, attached hereto and made a part hereof, together with such amendments and modifications thereto as the TIETEK Owners and NATK shall mutually agree; (c) NATK shall also release its security interest in, lien on and pledge of any of the Collateral (including without limitation the pledged shares of NATK capital stock, if any) to the extent that such security interest, lien and pledge was granted in order to secure payment of Borrower's obligations under the Crosstie Note. 2.4 EXTENSION OF CROSSTIE PURCHASE OPTION PERIOD. (a) NATK may extend the Crosstie Purchase Option Period for one additional year (i.e., until the third anniversary of the date hereof) if, prior to the second anniversary of the date hereof, NATK has funded the full amount of the Crosstie Loan (i.e., $1,500,000). (b) If NATK has not funded any amount requested (up to the full amount) of the Crosstie Loan, then NATK may, at its option, extend the Crosstie Purchase Option Period for one additional year if, and only if: (i) Either (x) Borrower did not request funding of an amount (up to the full amount) of the Crosstie Loan or (y) Borrower or one or more of the TIETEK Owners have failed to fulfill any of such party's obligations under this Agreement or the Crosstie Note, and such failure would reasonably be expected to have a material adverse effect on the business or financial condition of the Borrower or on NATK's ability to receive the benefits of having exercised the Crosstie Option; provided, however, that in order for NATK to extend the Crosstie Option for such additional year pursuant to the provisions of this clause (y), NATK shall have given written prompt notice of any such failure and shall use its good faith efforts to resolve any dispute or matter that arises in connection with such failure; and/or (ii) At the second anniversary date hereof, there is no unresolved material disagreement between NATK and Borrower regarding the legitimate need for further funding (up to the full amount) of the Crosstie Loan to assure the timely commercialization of the Crosstie Business; provided, however, that if Borrower believes, at any time prior to or at such second anniversary, that there is such a disagreement, it shall give NATK prompt written notice thereof, and both parties agree to use good faith efforts, and to act reasonably, in connection with the determination of the matters described in this clause (ii) and the resolution of any such disagreement. (c) NATK's election to extend the Crosstie Purchase Option Period as provided in this Section 2.4 shall be evidenced by its written notice to Borrower of such election, such notice to be delivered either (i) if the Crosstie Loan has been fully funded, then at any time after the Crosstie Loan has been fully funded, but not later than the second anniversary of the date hereof, or (ii) if the Crosstie Loan has not been fully funded but NATK is nonetheless entitled to exercise such election pursuant to the terms of this Section 2.4, then at any time during the period beginning on the sixtieth (60th) day before the second anniversary of the date hereof and ending on the second anniversary. (d) The provisions of this Section 2.4 shall relate exclusively to the provisions of this Agreement governing the extension of the Crosstie Purchase Option Period and no other purpose. 2.5 ADDITIONAL OBLIGATIONS RELATING TO PERFECTION OF PLEDGE OF SHARES. Each of the TIETEK Owners agrees to cause the certificate or certificates representing his shares of capital stock of Borrower, together with a stock power executed in blank, to be delivered to an escrow agent ("Escrow Agent"), pursuant to an escrow agreement ("Escrow Agreement") reasonably satisfactory in form and substance to NATK and the TIETEK Owners. Such Escrow Agent shall hold such documents and instruments as security for the Crosstie Note pursuant to the terms and provisions of this Agreement and the Crosstie Note, except as otherwise expressly amended by such Escrow Agreement or the Asset Purchase Agreement (as that term is defined in the Crosstie Note). Prior to the occurrence of an event of default under the Crosstie Note, NATK shall have no rights to vote any of such shares or to take any other action or receive any other benefits with respect to such shares, except as provided in the Crosstie Note. 3.1 BORROWER'S AND TIETEK OWNER'S REPRESENTATIONS AND WARRANTIES. The Borrower and each TIETEK Owner, severally but not jointly, represent and warrant to NATK those representations and warranties set out in the Crosstie Note and as follows: (a) Organization. Borrower is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Texas. Borrower has all corporate power and authority to own and operate the Crosstie Business and all other assets it may own or acquire during the term of this Agreement. Borrower has delivered a true, correct and complete copy of its Articles of Incorporation and Bylaws, together with all amendments thereto, as in effect on the date hereof. Notwithstanding anything herein to the contrary, the representations made by a TIETEK Owner in this subsection (a) are limited to the current actual knowledge of the TIETEK Owner making such representation. (b) Capitalization; Ownership of Shares. The capital stock of Borrower consists solely of 200,000 shares of common stock, par value $.01 per share, of which only three shares have been issued, one to each of the three TIETEK Owners, which three shares constitute all of the TIETEK Shares. The TIETEK Shares have been duly authorized, validly issued, are fully paid and non- assessable. There are no other securities convertible into or exchangeable for shares of Borrower's capital stock or any options, warrants or other rights to acquire any shares of its capital stock. Notwithstanding anything herein to the contrary, the representations made by Mr. Bartell in this subsection (b) are limited to his current actual knowledge. (c) Authorization. (i) The Borrower has full right, power and authority to execute, deliver and perform this Agreement and the Crosstie Note. All corporate, shareholder and other approvals required on the part of the Borrower, any TIETEK Owner or any other party in order for the Borrower or any TIETEK Owner to enter into and perform such party's obligations under this Agreement have been obtained on or before the date hereof. This Agreement and the Crosstie Note have been duly authorized by all necessary corporate action on behalf of the Borrower, and have been duly executed and delivered by Borrower. Each of this Agreement and the Crosstie Note constitutes the valid and binding obligation of the Borrower, enforceable against it in accordance with the respective terms thereof. There are no agreements restricting the ability of either the Borrower or any TIETEK Owner from entering into or performing such party's obligations under this Agreement. (ii) Each TIETEK Owner has duly executed and delivered this Agreement and any other document to be delivered by him in connection herewith, and this Agreement, and any such other document, constitute the valid and binding obligation of each TIETEK Owner enforceable against him in accordance with their respective terms. Notwithstanding anything herein to the contrary, the representations made by a TIETEK Owner in this subsection (c), as they relate to any other TIETEK Owner or to the Borrower, are limited to the current actual knowledge of the TIETEK Owner making such representation. (d) Assets/Liabilities; No Operations. On the date hereof, the Borrower has no liabilities or obligations of any kind or nature other than the obligation to repay to NATK those Crosstie Advances made on or before the date hereof, and such other obligations as TIETEK has incurred in the normal course of pursuing the development and commercialization of the Crosstie Business, none of which violates any of the provisions of Section 3.2 (except to the extent of NATK's knowledge of the same on or before the date hereof). The Borrower has not conducted any business or other operations prior to the date hereof other than those operations relating to the Crosstie Business that NATK has been made aware of on or before the date hereof. Notwithstanding anything herein to the contrary, the representations made by a TIETEK Owner in this subsection (d) are limited to the current actual knowledge of the TIETEK Owner making such representation. 3.2 BORROWER'S COVENANTS. The Borrower covenants and agrees with NATK as follows (except as NATK and Borrower shall otherwise agree in writing): (a) Expense and Payment Information. Until the earlier to occur of the payment in full of all obligations under the Crosstie Note or the exercise of the Crosstie Option, Borrower shall provide NATK in a timely manner all information reasonably required by NATK in order to pay any costs, expenses or other payments from the proceeds of a Crosstie Advance, and shall provide NATK with reasonable access during normal business hours to the books and records of the Borrower relating to the Crosstie Business. (b) Use of Proceeds of Crosstie Advances. The proceeds of all Crosstie Advances shall be use exclusively for expenses incurred or to be incurred in connection with the commercial development, production, manufacture, marketing and sale of railroad crosstie technology and business, including without limitation the production of the railroad crossties themselves (collectively, the "Crosstie Business"), as set out in the Crosstie Budget, as revised and supplemented from time to time in accordance with the provisions of Section 1.1(b) hereof. Upon the request of NATK, Borrower shall provide to NATK reasonable written documentation to evidence Borrower's compliance with the terms and provisions of this clause (b). (c) Ownership of Assets. Until the earlier to occur of the payment in full of all obligations under the Crosstie Note or the exercise of the Crosstie Option, all assets purchased with the proceeds of Crosstie Advances, and any and all other assets currently owned or acquired by Borrower during the term of this Agreement relating the Crosstie Business, shall be acquired in the name of Borrower, and Borrower shall remain the sole record and beneficial owner of all interests in and to such assets, free and clear of all liens, claims, pledges, security interest and charges, other than any of the same granted in favor of NATK or any of its affiliates. (d) Conduct of Business. During the Crosstie Purchase Option Period, Borrower (i) shall, subject to available funds, use its best efforts to develop, preserve and protect the Crosstie Business, including without limitation the Maker's Collateral (as defined in the Crosstie Note), and shall conduct its operations in accordance with sound business practices, (ii) shall not, without the prior consent of NATK (which consent shall not be unreasonably withheld), enter into any contract or commitment regarding the performance of any service or the delivery of any goods to or by Borrower that has a term of more than six (6) months or that requirements the payment of more than $10,000 in the aggregate and (iii) shall permit NATK, at the option of NATK, to carry out all accounting, payroll and other functions relating to the payment and recording of all costs and expenses incurred by Borrower; provided, however, that NATK shall provide Borrower with access at all reasonable times to all of NATK's related records maintained in connection with NATK's performance of such accounting, payroll and other functions. In the event NATK elects to carry out such accounting, payroll and/or other functions, it may allocate to Borrower a reasonable amount per month to cover the costs of such functions, such amount not to exceed $2,000 per month. The terms of this Section 3.2(d) shall cease to apply upon the expiration of the Crosstie Purchase Option Period. (e) Grant and Protection of Security Interest in Collateral. Until the earlier to occur of the payment in full of all obligations under the Crosstie Note or the exercise of the Crosstie Option, Borrower shall grant, maintain, preserve and protect the security interest, lien and pledge granted therein, and all rights and benefits with respect thereto, in favor of NATK with respect to Maker's Collateral (as defined in the Crosstie Note). (f) Capitalization; Certain Corporate Actions. During the Crosstie Purchase Option Period, Borrower shall not (i) issue any shares of capital stock, any securities convertible into or exchangeable for shares of its capital stock or any options, warrants or other rights to acquire any shares of its capital stock (except to reflect a transfer of shares of capital stock as expressly permitted by Section 3.3(a) below); (ii) amend its articles of incorporation or bylaws; (iii) merge with or consolidate into any other corporation or other entity; (iv) acquire any shares of capital stock or other evidences of ownership of any other entity; (v) execute any note, guaranty or any other evidence of an obligation for borrowed money, or otherwise become obligated for any other obligation for borrowed money or the payment of any sum or the performance of any other obligation, including without limitation any obligation incurred in connection with the purchase of equipment, inventory or other assets, if such note, guaranty or other obligation involves payments in excess of $10,000 or, in the aggregate with all other notes, guaranties and other obligations, in excess of $30,000 (provided, however, that NATK agrees that it will not unreasonably withhold its consent to any trade credit proposed to be entered into by Borrower in the ordinary course of Borrower's business in order to secure supplies, materials or equipment, if the terms of such trade credit are reasonably determined by both NATK and Borrower to be in the best interests of Borrower's business); (vi) make any dividend or other distribution, whether in cash, securities or otherwise, on or with respect to any shares of capital stock of Borrower or (vii) enter into any other transaction outside the ordinary course of business or unrelated to the Crosstie Business. The terms of this Section 3.2(f) shall cease to apply upon the expiration of the Crosstie Purchase Option Period. (g) Payment and Performance of the Crosstie Note. During the term of the Crosstie Note, Borrower shall pay all amounts of principal, interest and other payments, if any, that may come due thereunder in a timely manner, and shall perform all of its other obligations thereunder in accordance with the terms of the Crosstie Note. (h) Quarterly Meetings. During the term of this Agreement, Borrower agrees to meet not less than once during each quarter with representatives of NATK selected by NATK to discuss the results of operations and financial condition of the Crosstie Business. (i) Legend on Certificates. The Borrower agrees to cause the legend referred to in Section 3.3(d) hereof to be placed and maintained on all certificates representing the TIETEK Shares in accordance with the provisions of Section 3.3(d) hereof. (j) Federal Tax Election. For all periods before and during the Crosstie Purchase Option Period, the Borrower agrees (x) to make an election or elections under Section 174(b) of the Internal Revenue Code of 1986, as amended to date, or any successor provision, as NATK shall instruct (so long as such instruction is provided in a timely manner and such election is not illegal or unavailable for Borrower), with respect to qualifying research and experimental costs and expenditures and (y) for Federal income tax purposes, to treat such research and experimental costs and expenditures in accordance with such election. 3.3 TIETEK OWNER'S COVENANTS. Each TIETEK Owner covenants and agrees severally but not jointly with NATK as follows (except as NATK and such TIETEK Owner shall otherwise agree in writing): (a) No Transfer of the TIETEK Shares; Certain Other Actions. Such TIETEK Owner shall not transfer any of the TIETEK Shares or any interest therein, except in accordance with the terms and provisions of this Agreement; provided, however, that NATK agrees that (i) any TIETEK Owner may transfer all or a portion of his TIETEK Shares to another TIETEK Owner or, upon NATK's receipt of reasonable documentation evidencing a transferee's agreement to be bound (as a TIETEK Owner) by the terms and provisions of this Agreement and the Crosstie Note, to any other party who is (on the date of this Agreement) GAIA Holdings, Inc., a Delaware corporation, Thor Ventures, L.C., a Texas limited liability company, a shareholder of GAIA Holdings, Inc., a member of Thor Ventures, L.C., a Texas limited liability company, or any trust of which one or more of such parties or their affiliates are the sole beneficiaries, or any affiliates of the foregoing, and (ii) upon NATK's receipt of reasonable documentation evidencing a transferee's agreement to be bound (as a TIETEK Owner) by the terms and provisions of this Agreement and the Crosstie Note, and so long as NATK's rights will not be impaired in any material respect (as determined in the reasonable, good faith judgment of NATK), a TIETEK Owner may transfer all or a portion of his TIETEK Shares to any other natural person. Such TIETEK Owner shall not take any action that would reasonably be expected either to result in a breach of any covenant or agreement of the Borrower or any TIETEK Owner set out in this Agreement or that would reasonably be expected to cause NATK not to receive the benefits and rights offered to it pursuant to this Agreement. (b) Grant and Protection of Security Interest in Collateral. Until the earlier to occur of the payment in full of all obligations under the Crosstie Note or the exercise of the Crosstie Option, such TIETEK Owner shall grant, maintain, preserve and protect the security interest, lien and pledge granted therein, and all rights and benefits with respect thereto, in favor of NATK with respect to the Collateral (as defined in the Crosstie Note) that is owned or under the control of such TIETEK Owner at any time. (c) Capitalization; Certain Corporate Actions. Without limiting the generality of the provisions of subsections (a) and (b) above, during the such TIETEK Owner shall not vote any of his TIETEK Shares in favor of, or take any other action that would result in (i) the Borrower's issuance of any shares of capital stock, any securities convertible into or exchangeable for shares of its capital stock or any options, warrants or other rights to acquire any shares of its capital stock (other than solely to evidence a transfer of shares as expressly permitted by the terms of this Agreement); (ii) any amendment to the Borrower's articles of incorporation or bylaws; (iii) the Borrower's merger with or consolidate into any other corporation or other entity; (iv) the Borrower's acquisition of any shares of capital stock or other evidences of ownership of any other entity; (v) the Borrower's execution of any note, guaranty or any other evidence of an obligation for borrowed money, or the Borrower's otherwise becoming obligated for any other obligation for borrowed money or the payment of any sum or the performance of any other obligation, including without limitation any obligation incurred in connection with the purchase of equipment, inventory or other assets, if such note, guaranty or other obligation involves payments in excess of $10,000 or, in the aggregate with all other notes, guaranties and other obligations, in excess of $30,000 (provided, however, that NATK agrees that it will not unreasonably withhold its consent to any trade credit proposed to be entered into by Borrower in the ordinary course of Borrower's business in order to secure supplies, materials or equipment, if the terms of such trade credit are reasonably determined by both NATK and Borrower to be in the best interests of Borrower's business); or (vi) the Borrower's entering into any other transaction outside the ordinary course of business or unrelated to the Crosstie Business. (d) Legend on Certificates. Such TIETEK Owner hereby consents to the placement of a legend or legends, in form and substance reasoanbly satisfactory to NATK and the Borrower, on each certificate representing his TIETEK Shares, which legend(s) shall reference the existence of the various obligations of such TIETEK Owner under this Agreement, such legend to be maintained on such certificate or certificates during the term of the Crosstie Note. 4.1 NOTICES. All notices, requests, demands, waivers and other communications required or permitted to be given under this Agreement shall be in writing and shall be deemed to have been duly given if delivered personally or mailed, certified or registered mail with postage prepaid, or sent by telex, telegram or telecopier, as follows (or at such other address or facsimile number for a party as shall be specified by like notice): (a) if to Borrower or any TIETEK Owner, at: with a copy to: 4710 Bellaire Blvd., Suite 301 Crain, Caton & James Bellaire, Texas 77401 909 Fannin, Suite 3300 Attention: William T. Aldrich Houston, Texas 77010 and Henry W. Sullivan Fax: (713) 658-1921 and with a copy to: (b) if to NATK, at: North American Technologies Group, Inc. 4710 Bellaire Blvd., Suite 301 NATK may rely on any notice it receives in accordance with the above provisions that is signed by any President or Vice President of Borrower as a notice delivered to it by Borrower and the TIETEK Owners. 4.2 TERM OF AGREEMENT. Except as otherwise provided herein or in any Exhibit hereto, this Agreement, and the rights and obligations set out herein, shall continue in full force and effect until all obligations under the Crosstie Note have been paid and performed in full, or otherwise forgiven or discharged by NATK. 4.3 ENTIRE AGREEMENT; ASSIGNMENT; AND AMENDMENT. (a) This Agreement, including all Exhibits and Schedules hereto (which for all purposes, shall be deemed to be a part of this Agreement), constitutes the entire agreement among the parties with respect to its subject matter and supersedes all prior agreements and understandings, both written and oral, among the parties or any of them with respect to such subject matter. (b) This Agreement, including all rights (including without limitation the Crosstie Option) and obligations hereunder, shall not be assigned by operation of law or otherwise; provided, however, that subject to any approvals required by applicable law, NATK may assign its rights and obligations to any majority- owning or owned, direct or indirect, parent, subsidiary or subsidiaries of NATK, but no such assignment shall relieve NATK of its obligations under this Agreement. (c) This Agreement may not be amended except by an instrument in writing signed by each of the parties hereto. 4.4 BINDING EFFECT; BENEFIT. This Agreement shall inure to the benefit of and be binding upon the parties and their respective successors and assigns. Nothing in this Agreement is intended to confer on any person other than the parties to this Agreement or their respective successors and assigns any rights, remedies, obligations or liabilities under or by reason of this Agreement. 4.5 HEADINGS. The descriptive headings of the articles, sections, subsections, Exhibits and Schedules of this Agreement are inserted for convenience only, do not constitute a part of this Agreement and shall not affect in any way the meaning or interpretation of this Agreement. 4.6 COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original, and all of which together shall be deemed to be one and the same instrument. 4.7 GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the state of Texas, without regard to the laws that might otherwise govern under principles of conflicts of laws applicable thereto. 4.8 ARBITRATION. In the event any party believes any other party hereto has committed a breach of any provision of this Agreement or such parties cannot agree on an interpretation of one or more of the provisions of this Agreement, such parties agree to first meet in Houston, Texas, and discuss the same, and attempt in good faith to resolve such matter. Any such matter, controversy or claim arising out of or relating to this Agreement, or the breach of any provision hereof, that cannot otherwise be resolved between the relevant parties in such a meeting and discussion shall be settled by arbitration in Houston, Texas, in accordance with the Commercial Arbitration Rules of the American Arbitration Association and judgment upon any award rendered by the arbitrator(s) may be entered in any court of competent jurisdiction. Any award rendered may include an award of reasonable attorneys' fees, costs and expenses. 4.9 SEVERABILITY. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction or other authority to be invalid, void, unenforceable or against its regulatory policy, the remainder of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 4.10 CERTAIN DEFINITIONS. As used herein: (a) "affiliate" shall have the meanings ascribed to such term in Rule 12b- 2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended to date (the "Exchange Act"); (b) "business day" shall mean any day other than a Saturday, Sunday or a day on which federally chartered financial institutions are not open for business in the City of Houston, Texas; and (c) "subsidiary" shall mean, when used with reference to an entity, any corporation, a majority of the outstanding voting securities of which is owned directly or indirectly, or a majority of the board of directors of which may be elected, by such entity. IN WITNESS WHEREOF, each of the parties have caused this Agreement to be duly executed by or on behalf of such party, all as of the date first written above. By: /s/ Tim B. Tarrillion By: /s/ William T. Aldrich EXHIBIT A Promissory Note, Security Agreement and Pledge EXHIBIT B Initial Crosstie Budget EXHIBIT C TIETEK Royalty Agreement	8-K	EX-10.8	1996-01-12T00:00:00	1996-01-12T16:52:02
0000912938-96-000060	0000912938-96-000060_0000.txt	UNDER THE SECURITIES EXCHANGE ACT OF 1934 (Title of Class of Securities) Check the following box if a fee is being paid with this \|_\| statement. (A fee is not required only if the filing person: (1) has a previous statement on file reporting beneficial ownership of more than five percent of the class of securities described in Item 1; and (2) has filed no amendment subsequent thereto reporting beneficial ownership of five percent or less of such class.) The remainder of this cover page shall be filled out for a reporting person's initial filing on this form with respect to the subject class of securities, and for any subsequent amendment containing information which would alter the disclosures provided in a prior cover page. The information required in the remainder of this cover page shall not be deemed to be "filed" for the purpose of Section 18 of the Securities Exchange Act of 1934 ("Act") or otherwise subject to the liabilities of that section of the Act but shall be subject to all other provisions of the Act (however, see the Notes). CUSIP NO. 03789910 13G PAGE 2 OF 5 PAGES 1 NAME OF REPORTING PERSON S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON Massachusetts Financial Services Company ("MFS") 2 CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP (a) / / (b) / / 4 CITIZENSHIP OR PLACE OF ORGANIZATION NUMBER OF 5 SOLE VOTING POWER SHARES 3,204,490 shares of common stock OWNED BY 6 SHARED VOTING POWER REPORTING 7 SOLE DISPOSITIVE POWER PERSON 3,278,390 shares of common stock 9 AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 3,278,390 shares of common stock of which 2,558,700 shares are also beneficially owned by MFS Series Trust II - MFS Emerging Growth Fund (see page 3) and 719,690 shares are also owned by certain other non-reporting entities. 10 CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (9) EXCLUDES CERTAIN SHARES* 11 PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW 9 12 TYPE OF REPORTING PERSON* SEE INSTRUCTION BEFORE FILLING OUT! CUSIP NO. 03789910 13G PAGE 3 OF 5 PAGES 1 NAME OF REPORTING PERSON S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON MFS Series Trust II - MFS Emerging Growth Fund ("MEG") 2 CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP (a) / / (b) / / 4 CITIZENSHIP OR PLACE OF ORGANIZATION NUMBER OF 5 SOLE VOTING POWER OWNED BY 6 SHARED VOTING POWER REPORTING 7 SOLE DISPOSITIVE POWER 9 AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON 2,558,700 shares of common stock (as noted on page 2, item 9, MFS is also a beneficial owner of these 2,558,700 shares). 10 CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (9) EXCLUDES CERTAIN SHARES* 11 PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW 9 12 TYPE OF REPORTING PERSON* SEE INSTRUCTION BEFORE FILLING OUT! SCHEDULE 13G PAGE 4 OF 5 PAGES ITEM 1: (a) NAME OF ISSUER: (b) ADDRESS OF ISSUER'S PRINCIPAL EXECUTIVE OFFICES: 4551 West 107th Street, Suite 100 ITEM 2: (a) NAME OF PERSON FILING: Massachusetts Financial Services Company ("MFS") (b) ADDRESS OF PRINCIPAL BUSINESS OFFICE OR, IF NONE, RESIDENCE: For MFS, see Item 4 on page 2; for MEG, see Item 4 on Page 3 (d) TITLE OF CLASS OF SECURITIES: ITEM 3: For MFS, see Item 12 on page 2; for MEG, see Item 12 on page 3 ITEM 4: (a) AMOUNT BENEFICIALLY OWNED: For MFS, see Item 9 on page 2; for MEG, see Item 9 on page 3 For MFS, see Item 11 on page 2; for MEG, see Item 11 on page 3 (c) NUMBER OF SHARES AS TO WHICH SUCH PERSON HAS: For MFS, see Items 5 and 7 on page 2 * This Schedule 13G is filed pursuant to Rule 13d-1(f) on behalf of MFS Series Trust II - MFS Emerging Growth Fund ("MEG") (see page 3 and Exhibit 1 attached hereto). SCHEDULE 13G PAGE 5 OF 5 PAGES ITEM 5: OWNERSHIP OF FIVE PERCENT OR LESS OF A CLASS: ITEM 6: OWNERSHIP OF MORE THAN FIVE PERCENT ON BEHALF OF ANOTHER PERSON: ITEM 7: IDENTIFICATION AND CLASSIFICATION OF THE SUBSIDIARY WHICH ACQUIRED THE SECURITY BEING REPORTED ON BY THE PARENT HOLDING COMPANY: ITEM 8: IDENTIFICATION AND CLASSIFICATION OF MEMBERS OF THE GROUP: ITEM 9: NOTICE OF DISSOLUTION OF GROUP: By signing below I certify that to the best of my knowledge and belief, the securities referred to above were acquired in the ordinary course of business and were not acquired for the purpose of and do not have the effect of changing or influencing the control of the issuer of such securities and were not acquired in connection with or as a participant in any transaction having such purposes or effect. After reasonable inquiry and to the best of my knowledge and belief, I certify that the information set forth in this statement is true, complete and correct. MFS EMERGING GROWTH FUND, a series of 500 BOYLSTON STREET o BOSTON o MASSACHUSETTS 02116 This letter is to memorialize our agreement that you shall file all statements on Schedule 13G required to be filed on behalf of MFS Emerging Growth Fund, a series of MFS Series Trust II, pursuant to Rule 13d-1 under the Securities Exchange Act of 1934. If the foregoing is acceptable to you, please sign and return to us the enclosed copy of this letter.	SC 13G/A	SC 13G/A	1996-01-12T00:00:00	1996-01-12T14:33:16
0000845613-96-000002	0000845613-96-000002_0000.txt	(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES For the quarterly period ended JUNE 30, 1995 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE CHANGE ACT OF 1934 For the transition period from TO FRANKLIN SELECT REAL ESTATE INCOME FUND (Exact name of registrant as specified in its charter) CALIFORNIA 94-3095938 (State or other jurisdiction of incorporation or organization) (I.R.S. P. O. BOX 7777, SAN MATEO, CALIFORNIA 94403-7777 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (415) 312-2000 Former name, former address and former fiscal year, if changed since last report Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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. Common Stock Shares Outstanding as of June 30, 1995, Series A: 5,383,297 Common Stock Shares Outstanding as of June 30, 1995, Series B: 185,866 PART I - FINANCIAL INFORMATION and Analysis of Financial Condition Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the Financial Statements and Notes thereto. COMPARISON OF THE SIX MONTH PERIODS ENDED JUNE 30, 1995 AND 1994 Net income for the six month period ended June 30, 1995 increased $108,000, or 16%, compared to 1994 due to the following factors: an increase in rental revenue of $60,000; an increase in interest and dividends of $59,000; an increase in depreciation and amortization of $22,000; a decrease in operating expenses of $8,000; an increase in related party expenses of $45,000; a decrease in general and administrative expense of $35,000 and a decrease in loss on sale of mortgage-backed securities of $13,000. Explanations of the material changes are as follows: Rental revenue for the six months period ended June 30, 1995 increased $60,000, or 3%, primarily due to increased rental revenue at the Shores Office Complex, as a result of an increase in average occupancy and rental rates. The average occupancy rate at the Shores Office Complex during the six month periods ended June 30, 1995 and 1994 was 98% and 93%, respectively. The occupancy rate at the Data General Building was 100% for both periods. Interest and dividend income for the six month period ended June 30, 1995 increased $59,000, or 34%, due to higher yields realized on investments in mortgage-backed securities. Total expenses for the six month period ended June 30, 1995, increased by $11,000, or 1%, from $1,711,000 in 1994 to $1,722,000. The increase in total expenses is attributable to the following factors: an increase in depreciation and amortization of $22,000, or 3%; a decrease in operating expenses of $8,000, or 1%; an increase in related party expenses of $45,000, or 25%; a decrease in general and administrative expense of $35,000, or 27%; and a decrease in loss on sale of mortgage-backed securities of $13,000. Depreciation and amortization increased $22,000 for the six month period ended June 30, 1995, reflecting tenant improvement costs at the Shores Office Complex related to new leases commencing in late 1994. Operating expenses for the six month period ended June 30, 1995 decreased $8,000, primarily due to a decrease in property tax expense at the Data General Building. Related party expense for the six months period ended June 30, 1995 increased $45,000, primarily due to an increase in advisory fees related to the conversion of the Company to an infinite life REIT on October 1, 1994. General and administrative expense for the six month period ended June 30, 1995 decreased $35,000 primarily due to a decrease in nonrecurring costs associated with listing the Company's stock on the American Stock Exchange in January, 1994 of $27,000. PART I - FINANCIAL INFORMATION and Analysis of Financial Condition The Company's principal source of capital for the acquisition and major renovation of properties has been the proceeds from the initial public offering of its stock. The Company's funds from operations have been its principal source of capital for minor property improvements, leasing costs and the payment of quarterly dividends. At June 30, 1995, the Company's cash reserves, including mortgage-backed securities, aggregated $8,348,000. The Company is currently examining the possibility of raising additional capital through arranging debt financing on its existing portfolio. Any capital raised in this manner would be used to acquire additional properties and for other corporate purposes. As of June 30, 1995, the Company had no formal borrowing arrangements with a bank and has no long-term debt. Each of the Company's properties is owned free and clear of mortgage indebtedness. Management continues to evaluate other properties for acquisition by the Company. In the short-term and in the long term, management believes that the Company's current sources of capital will continue to be adequate to meet both its operating requirements and the payment of dividends. Net cash flow provided by operating activities for the six month period ended June 30, 1995 was $1,439,000 which was substantially unchanged from the same period in 1994. Although net income increased during the period by $108,000, it was substantially offset by increases in accounts receivable and leasing commissions. Funds from Operations for the three month period ended June 30, 1995 increased $117,000, or 8%, to $1,547,000 compared to the same period in 1994. The increase is primarily due to the improvement in net income as described under "Results of Operations" above. The Company believes that Funds from Operations is helpful in understanding a property portfolio in that such calculation reflects income from operating activities and the properties' ability to support general operating expenses and interest expense before the impact of certain activities, such as gains and losses from property sales and changes in the accounts receivable and accounts payable. However, it does not measure whether income is sufficient to fund all of the Company's cash needs including principal amortization, capital improvements and distributions to shareholders. Funds from Operations should not be considered an alternative to net income or any other GAAP measurement of performance or as an alternative to cash flows from operating, investing, or financing activities as a measure of liquidity. As defined by the National Association of Real Estate Investment Trusts, Funds from Operations is net income ( computed in accordance with GAAP ), excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization, and after adjustment for unconsolidated joint ventures. PART I - FINANCIAL INFORMATION and Analysis of Financial Condition LIQUIDITY AND CAPITAL RESOURCES (Continued) The Company's management believes that inflation may have a positive effect on the Company's property portfolio, but this effect generally will not be fully realized until such properties are sold or exchanged. The Company's policy of negotiating leases which incorporate operating expense "pass-through" provisions is intended to protect the Company against increased operating costs resulting from inflation. Dividends are declared quarterly at the discretion of the Board of Directors. The Company's present dividend policy is to at least annually evaluate the current dividend rate in light of anticipated tenant turnover over the next two or three years, the estimated level of associated improvements and leasing commissions, planned capital expenditures, any debt service requirements and the Company's other working capital requirements. After balancing these considerations, and considering the Company's earnings and cash flow, the level of its liquid reserves and other relevant factors, the Company seeks to establish a dividend rate which: i) provides a stable dividend which is sustainable despite short term fluctuations in property cash flows; ii) maximizes the amount of cash flow paid out as dividends consistent with the above listed objective; and iii)complies with the Internal Revenue Code requirement that a REIT annually pay out as dividends not less than 95% of its taxable income. During the six-month period ended June 30, 1995, the Company declared dividends totaling $1,184,000. Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FRANKLIN SELECT REAL ESTATE INCOME FUND By: /S/ DAVID P. GOSS	10-Q/A	10-Q	1996-01-12T00:00:00	1996-01-11T21:14:08
0000950147-96-000010	0000950147-96-000010_0000.txt	[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1995 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from______ to________ (Exact name of registrant as specified in its charter) (State or other jurisdiction of (I.R.S. Employer Identification No.) 40 Lowndes Street, London, England SW1X 9HX N/A (Address of principal executive offices) (Zip Code) (010 44 171) 823 1032 (Registrant's telephone number, including area code) 555 Fifth Avenue, New York (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether 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 registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days. Yes X No ___ 24,999,236 shares, $.01 par value, as of March 31, 1995 (Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date) Part I - Financial Information (unaudited) Consolidated Balance Sheet March 31, 1995 and December 31, 1994.................................................. 3 three months ended March 31, 1994 and 1995............................. 5 Consolidated Statements of Cash Flows three months ended March 31, 1994 and 1995............................. 6 Notes to Financial Statements.......................................... 7 Management's Discussion and Analysis of Financial Condition and Results of Operations ................................... 8 Part II - Other Information............................................... 9 The financial statements are unaudited. However, the management of registrant believes that all necessary adjustments (which include only normal recurring adjustments) have been reflected to present fairly the financial position of registrant at March 31, 1995 and December 31, 1994 and the results of its operations and the changes in its financial position for the three months ended March 31, 1994 and 1995 and the results of its operations for three months ended March 31, 1994 and 1995. LITTLE PRINCE PRODUCTIONS LIMITED AND SUBSIDIARY Cash and cash equivalents $ 7,583 $ 5,241 Investment in U.S. Government Bond Fund 3,400 10,900 Prepaid expenses and taxes 612 612 Loan to officer of company 2,000 2,000 Amount due from Riparian Securities Limited 2,770 2,770 Due from former partner in Joint Venture 18,930 18,930 Total current assets 35,295 40,453 PROPERTY AND EQUIPMENT - AT COST Furniture, fixtures and equipment -- -- Less: Accumulated depreciation -- -- Net property and equipment -- -- Production and distribution rights 6,875 7,500 Investment in joint ventures 3,728 3,728 Total other assets 10,603 11,228 LITTLE PRINCE PRODUCTIONS LIMITED AND SUBSIDIARY Accounts payable $ 159,145 $ 159,145 Provision for legal fees 18,500 20,000 Accrued audit fees 13,500 27,500 Provision for secretarial services 7,500 7,500 Short term loans from major shareholder 31,515 -- Total current liabilities 230,160 214,145 Minority shareholders' interests -- -- Common stock $0.01 par value Issued and outstanding - 24,999,236 shares 249,992 249,992 Additional paid-in capital 3,006,891 3,006,891 Total shareholders' deficit -184,262 -162,464 EQUITY $ 45,898 $ 51,681 LITTLE PRINCE PRODUCTIONS LIMITED AND SUBSIDIARY Net sales $ 4,500 $ 213 Loss from continuing operations -21,902 -19,039 Loss from continuing operations before provision for Provision for income taxes -- -- Loss from continuing operations after provision for Loss from discontinued operations -- -324,878 Gain on disposal of subsidiary -- 287,428 Loss per share (cents) -0.09 -0.40 Average number of shares outstanding 24,999,236 13,999,236 LITTLE PRINCE PRODUCTIONS LIMITED AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS Net loss $-21,798 $ -56,304 Adjustments to reconcile net loss to Net Cash Provided by Operating Activities: Change in Asset and Liabilities: Accounts Receivable and Other Debtors -- 72,185 Increase/(Decrease) in Liabilities: Accounts payable and Accrued Expenses -15,500 149,427 Adjustment on disposal of subsidiary -- -287,428 NET CASH - OPERATING ACTIVITIES -36,673 285,228 INVESTING ACTIVITIES: Proceeds on disposal of subsidiary -- 1 Proceeds on disposal of US Government Bonds 7,500 -- NET CASH - INVESTING ACTIVITIES 7,500 1 New short term loans 31,515 -- Repayment of loans -- -315,283 Cash released on disposal of subsidiary -- -2,290 NET CASH - FINANCING ACTIVITIES 31,515 -298,949 AND CASH EQUIVALENTS 2,342 -13,720 CASH AND CASH EQUIVALENTS - CASH AND CASH EQUIVALENTS - END 7,583 16,213 LITTLE PRINCE PRODUCTIONS LIMITED AND SUBSIDIARY The balance sheet as of March 31, 1995, the statements of operations for the three months ended March 31, 1994 and 1995, and the statement of cash flows for the three months ended March 31, 1994 and 1995 have been prepared by registrant without audit. The accompanying unaudited interim financial statements include all adjustments (consisting only of those of a normal recurring nature) necessary for a fair statement of the results for the interim periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in registrant's Form 10-K for the year ended December 31, 1994. LITTLE PRINCE PRODUCTIONS LIMITED AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS On August 22, 1994, in order to substantially reduce the deficit on shareholders equity, registrant exchanged agreements with Riparian Securities Limited ("Riparian"), its legal advisors and the then officers and directors of the company, whereby 11,000,000 shares in the common stock of the company were to be issued for $495,146. Of this total consideration, $32,500 was for cash with the remaining $462,656 applied to the cancellation of liabilities. These agreements were completed on October 3, 1994. These agreements are more fully discussed in Registrant's 10-K for the year ended December 31, 1994. On January 17, 1995 Riparian transferred its entire holding to the Patchouli Foundation ("Patchouli"), a Liechtenstein Stiftung and as at March 31, 1995 Patchouli owned 25% of the issued and outstanding common stock of the company. In order to meet the excess of continuing operating costs of Registrant over income, including those costs associated with meeting the regulatory requirements of Registrant, $6,500 was realized from the sale of investments at book value. In addition, Patchouli advanced funds by way of loans to Registrant totalling $31,515. As well as meeting costs arising in the quarter to March 31, 1995, $15,500 of these funds were applied to reduce the outstanding liabilities for legal and audit fees that were unpaid at December 31, 1994. Management does not believe that registrant has the ability to raise adequate resources from its existing Revenue operations. Registrant is therefore dependent upon increasing its authorized share capital in order to acquire a suitable business to satisfy the minimum financial criteria for inclusion in the National Association of Security Dealers, Inc. automated quotation system as previously stated in Registrant's Form 10-K for the year ended December 31, 1994. Management intends to call a meeting of Registrant's shareholders for the purpose of, among other things, increasing the amount of authorized capital stock. Registrant had no material commitments for capital expenditure at either March 31, 1995 or December 31, 1994. Income in the quarter arose from fees received from the licensing of various theatrical productions. This income did not reflect any change in the business of Registrant but typified the nature of the business and timing of the income generated. Throughout the quarter ended March 31, 1995 management's primary task has been to deal with the preparation and completion of the various financial and regulatory documentation which Registrant has been required to file, some of which were overdue. The majority of the operating costs of $26,402 incurred in the quarter related specifically to the audit, accounting and legal costs associated with the preparation of the aforementioned documentation. LITTLE PRINCE PRODUCTIONS LIMITED AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) All documentation has now been completed and management is now concentrating on trying to identify a suitable business to purchase as a long term investment. Additional funding will be sought in such amounts as are required to conclude such a purchase once it has been identified. Further details of management's intended direction for the company are discussed in the Registrant's Form 10-K filed in respect of the year ended December 31, 1994. On December 18, 1990, an action against the Parent company commenced before the Tribunal de Grande Instance of Paris, France. The Plaintiff was seeking a judicial declaration of the termination of the agreement to engage in the exploitation of certain ancillary and subsidiary rights in connection with the literary work entitled "The Little Prince," an illustrated story by the French author, Antoine de Saint-Exupery (the "Agreement"), together with reimbursement of all sums received and damages and legal fees of approximately $200,000. In February 1992, an agreement was reached to settle the above matter whereby the Parent Company would receive $200,000 in return for giving up certain foreign rights as follows: $50,000 payable upon full performance of the Settlement Agreement and four payments of $25,000 every 3 months thereafter with a final payment of $50,000 by November 1993. All monies have now been received. Accrued legal expenses thereon of $150,692 were payable. The settlement also stipulates that the Parent must abandon the corporate name "Little Prince Productions Ltd." within 18 months from February 6, 1992. As at the date of this report, the name of the company has not been changed nor has any action been commenced by the plaintiff. Submission of vote to Security Holders No matters have been submitted to the vote of Security Holders in the quarter. Exhibits and Reports on Form 8-K Exhibits filed herewith: None Forms 8-K filed in quarter: None Pursuant to the requirements of the Securities Exchange Act of 1934, registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. P. N. Chapman, Chief Financial Officer, duly authorized to sign this report on its behalf	10-Q/A	10-Q	1996-01-12T00:00:00	1996-01-11T18:23:00
0000950109-96-000200	0000950109-96-000200_0008.txt	THIS AGREEMENT is made as of ______________________, 1995 by and between PNC BANK, NATIONAL ASSOCIATION, a national banking association ("PNC Bank"), and WEISS TREASURY FUND, a Massachusetts business trust (the "Fund"). W I T N E S S E T H: WHEREAS, the Fund is registered as an open-end management investment company under the Investment Company Act of 1940, as amended (the "1940 Act"); WHEREAS, the Fund wishes to retain PNC Bank to provide custodian services to its investment portfolios listed on Exhibit A attached hereto and made a part hereof, as such Exhibit A may be amended from time to time (each a "Portfolio"), and PNC Bank wishes to furnish custodian services, either directly or through an affiliate or affiliates, as more fully described herein. NOW, THEREFORE, In consideration of the premises and mutual covenants herein contained, and intending to be legally bound hereby, the parties hereto agree as follows: 1. DEFINITIONS. AS USED IN THIS AGREEMENT: (a) "1933 Act" means the Securities Act of 1933, as amended. (b) "1934 Act" means the Securities Exchange Act of 1934, as amended. (c) "Authorized Person" means any officer of the Fund and any other person duly authorized by the Fund's Board of Trustees to give Oral and Written Instructions on behalf of the Fund and listed on the Authorized Persons Appendix attached hereto and made a part hereof or any amendment thereto as may be received by PNC Bank. An Authorized Person's scope of authority may be limited by the Fund by setting forth such limitation in the Authorized Persons Appendix. (d) "Book-Entry System" means Federal Reserve Treasury book-entry system for United States and federal agency securities, its successor or successors, and its nominee or nominees and any book -entry system maintained by an exchange registered with the SEC under the 1934 Act. (e) "CEA" means the Commodities Exchange Act, as amended. (f) "Oral Instructions" mean oral instructions received by PNC Bank from an Authorized Person or from a person reasonably believed by PNC Bank to be an Authorized Person. (g) "PNC Bank" means PNC Bank, National Association or a subsidiary or affiliate of PNC Bank, National Association. (h) "SEC" means the Securities and Exchange Commission. (i) "Securities Laws" mean the 1933 Act, the 1934 Act, the 1940 Act and the CEA. (j) "Shares" mean the shares of beneficial interest of any series or class of the Fund. (i) any and all securities and other investment items which the Fund may from time to time deposit, or cause to be deposited, with PNC Bank or which PNC Bank may from time to time hold for the Fund; (ii) all income in respect of any of such securities or other (iii) all proceeds of the sale of any of such securities or (iv) all proceeds of the sale of securities issued by the Fund, which are received by PNC Bank from time to time, from or on behalf of the Fund. (k) "Written Instructions" mean written instructions signed by two Authorized Persons and received by PNC Bank. The instructions may be delivered by hand, mail, tested telegram, cable, telex or facsimile sending device. 2. APPOINTMENT. The Fund hereby appoints PNC Bank to provide custodian services to the Fund, on behalf of each of its investment portfolios (each, a "Portfolio"), and PNC Bank accepts such appointment and agrees to furnish such appointment and agrees to furnish such services. 3. DELIVERY OF DOCUMENTS. The Fund has provided or, where applicable, will provide PNC Bank with the following: (a) certified or authenticated copies of the resolutions of the Fund's Board of Trustees, approving the appointment of PNC Bank or its affiliates to provide services; (b) a copy of the Fund's most recent effective registration (c) a copy of each Portfolio's advisory agreements; (d) a copy of the distribution agreement with respect to each class (e) a copy of each Portfolio's administration agreement if PNC Bank is not providing the Portfolio with such services; (f) copies of any shareholder servicing agreements made in respect of the Fund or a Portfolio; and (g) certified or authenticated copies of any and all amendments or supplements to the foregoing. PNC Bank undertakes to comply with all applicable requirements of the Securities Laws and any laws, rules and regulations of governmental authorities having jurisdiction with respect to the duties to be performed by PNC Bank hereunder. Except as specifically set forth herein, PNC Bank assumes no responsibility for such compliance by the Fund or any Portfolio. (a) Unless otherwise provided in this Agreement, PNC Bank shall act only upon Oral and Written Instructions. (b) PNC Bank shall be entitled to rely upon any Oral and Written Instructions it receives from an Authorized Person (or from a person reasonably believed by PNC Bank to be an Authorized Person) pursuant to this Agreement. PNC Bank may assume that any Oral or Written Instructions received hereunder are not in any way inconsistent with the provisions of organizational documents of the Fund or of any vote, resolution or proceeding of the Fund's Board of Trustees or of the Fund's shareholders, unless and until PFPC receives Written Instructions to the contrary. (c) The Fund agrees to forward to PNC Bank Written Instructions confirming Oral Instructions (except where such Oral Instructions are given by PNC Bank or its affiliates) so that PNC Bank receives the Written Instructions by the close of business on the next day that such Oral Instructions are received. The fact that such confirming Written Instructions are not received by PNC Bank shall in no way invalidate the transactions or enforceability of the transactions authorized by the Oral Instructions. Where Oral or Written Instructions reasonably appear to have been received from an Authorized Person, PNC Bank liability to the Fund in acting upon such Oral or Written Instructions provided that PNC Bank's actions comply with the other provisions of this Agreement. 6. RIGHT TO RECEIVE ADVICE. (a) Advice of the Fund. If PNC Bank is in doubt as to any action it should or should not take, PNC Bank may request directions or advice, including Oral or Written Instructions, from the Fund. (b) Advice of Counsel. If PNC Bank shall be in doubt as to any question of law pertaining to any action it should or should not take, PNC Bank may request advice at its own cost from such counsel of its own choosing (who may be counsel for the Fund, the Fund's investment adviser or PNC Bank, at the option of PNC Bank). (c) Conflicting Advice. In the event of a conflict between directions, advice or Oral or Written Instructions PNC Bank receives from the Fund, and the advice it receives from counsel, PNC Bank shall be entitled to rely upon and follow the advice of counsel. In the event PNC Bank so relies on the advice of counsel, PNC Bank remains liable for any action or omission on the part of PNC Bank which constitutes willful misfeasance, bad faith, gross negligence or reckless disregard by PNC Bank of any duties, obligations or responsibilities set forth in this Agreement. (d) Protection of PNC Bank. PNC Bank shall be protected in any action it takes or does not take in reliance upon directions, advice or Oral or written Instructions it receives from the Fund or from counsel and which PNC Bank believes, in good faith, to be consistent with those directions, advice or Oral or Written Instructions. Nothing in this section shall be construed so as to impose an obligation upon PNC Bank (i) to seek such directions, advice or Oral or Written Instructions, or (ii) to act in accordance with such directions, advice or Oral or Written Instructions unless, under the terms of other provisions of this Agreement, the same is a condition of PNC Bank's properly taking or not taking such action. Nothing in this subsection shall excuse PNC Bank when an action or omission on the part of PNC Bank constitutes willful misfeasance, bad faith, gross negligence or reckless disregard by PNC Bank of any duties, obligations or responsibilities set forth in this Agreement. 7. RECORDS; VISITS. The books and records pertaining to the Fund and any Portfolio, which are in the possession or under the control of PNC Bank, shall be the property of the Fund. Such books and records shall be prepared and maintained as required by the 1940 Act and other applicable securities laws, rules and regulations. The Fund and Authorized Persons shall have access to such books and records at all times during PNC Bank's normal business hours. Upon the reasonable request of the Fund, copies of any such books and records shall be provided by PNC Bank to the Fund or to an authorized representative of the Fund, at the Fund's expense. 8. CONFIDENTIALITY. PNC Bank agrees on its own behalf and that of its employees to keep confidential all records of the Fund and information relating to the Fund and its shareholders (past, present and future), unless the release of such records or information is otherwise consented to, in writing, by the Fund. The Fund agrees that such consent shall not be unreasonably withheld and may not be withheld where PNC Bank may be exposed to civil or criminal contempt proceedings or when required to divulge such information or records to duly constituted authorities. 9. COOPERATION WITH ACCOUNTANTS. PNC Bank shall cooperate with the Fund's independent public accountants and shall take all reasonable action in the performance of its obligations under this Agreement to ensure that the necessary information is made available to such accountants for the expression of their opinion, as required by the Fund. 10. DISASTER RECOVERY. PNC Bank shall enter into and shall maintain in effect with appropriate parties one or more agreements making reasonable provisions for emergency use of electronic data processing equipment. In the event of equipment failures, PNC Bank shall, at no additional expense to the Fund, take reasonable steps to minimize service interruptions. PNC Bank shall have no liability with respect to the loss of data or service interruptions caused by equipment failure provided such loss or interruption is not covered by PNC Bank's own willful misfeasance, bad faith, gross negligence or reckless disregard of its duties or obligations under this Agreement. 11. COMPENSATION. As compensation for custody services rendered by PNC Bank during the term of this Agreement, the Fund, on behalf of each of the Portfolios, will pay to PNC Bank a fee or fees as may be agreed to in writing from time to time by the Fund and PNC Bank. 12. INDEMNIFICATION. The Fund, on behalf of each Portfolio, agrees to indemnify and hold harmless PNC Bank and its affiliates from all taxes, charges, expenses, assessments, claims and liabilities (including, without limitation, liabilities arising under the Securities Laws and any state and foreign securities and blue sky laws, and amendments thereto, and expenses, including (without limitation) attorneys' fees and disbursements, arising directly or indirectly from any action or omission to act which PNC Bank takes (i) at the request or on the direction of or in reliance on the advice of the Fund or (ii) upon Oral or Written Instructions. Neither PNC Bank, nor any of its affiliates, shall be indemnified against any liability (or any expenses incident to such liability) arising out of PNC Bank's or its affiliates' own willful misfeasance, bad faith, gross negligence or reckless disregard of its duties under this Agreement. 13. RESPONSIBILITY OF PNC BANK. (a) PNC Bank shall be under no duty to take any action on behalf of the Fund or any Portfolio except as specifically set forth herein or as may be specifically agreed to by PNC Bank in writing. PNC Bank shall be obligated to exercise care and diligence in the performance of its duties hereunder, to act in good faith and to use its best efforts, within reasonable limits, in performing services provided for under this Agreement. PNC Bank shall be liable for any damages arising out of PNC Bank's performance of or failure to perform its duties under this agreement to the extent such damages arise out of PNC Bank's willful misfeasance, bad faith, gross negligence or reckless disregard of its duties under this Agreement. (b) Without limiting the generality of the foregoing or of any other provision of this Agreement, (i) PNC Bank shall not be under any duty or obligation to inquire into and shall not be liable for (A) the validity or invalidity or authority or lack thereof of any Oral or Written Instruction, notice or other instrument which conforms to the applicable requirements of this Agreement, and which PNC Bank reasonably believes to be genuine; or (B) subject to section 10, delays or errors or loss of data occurring by reason of circumstances beyond PNC Bank's control, including acts of civil or military authority, national emergencies, fire, flood, catastrophe, acts of God, insurrection, war, riots or failure of the mails, transportation, communication or power supply. (c) Notwithstanding anything in this Agreement to the contrary, PNC Bank shall have no liability to the Fund or to any Portfolio for any consequential, special or indirect losses or damages which the Fund may incur or suffer by or as a consequence of PNC Bank's performance of the services provided hereunder, whether or not the likelihood of such losses or damages was known by PNC Bank. (a) Delivery of the Property. The Fund will deliver or arrange for delivery to PNC Bank, all the Property owned by the Portfolios, including cash received as a result of the distribution of Shares, during the period that is set forth in this Agreement. PNC Bank will not be responsible for such property until actual receipt. (b) Receipt and Disbursement of Money. PNC Bank, acting upon Written Instructions, shall open and maintain separate accounts in the Fund's name using all cash received from or for the account of the Fund, subject to the terms of this Agreement. In addition, upon Written Instructions, PNC Bank shall open separate custodial accounts for each separate series or Portfolio of the Fund (collectively, the "Accounts") and shall hold in the Accounts all cash received from or for the Accounts of the Fund specifically designated to each separate series or Portfolio. PNC Bank shall make cash payments from or for the Accounts of a Portfolio only for: (i) purchases of securities in the name of a Portfolio or PNC Bank or PNC Bank's nominee as provided in sub-section (j) and for which PNC Bank has received a copy of the broker's or dealer's confirmation or payee's invoice, as appropriate; (ii) purchase or redemption of Shares of the Fund delivered to (iii) payment of, subject to Written Instructions, interest, taxes, administration, accounting, distribution, advisory, management fees or similar expenses which are to be borne by a Portfolio; (iv) payment to, subject to receipt of Written Instructions, the Fund's transfer agent, as agent for the shareholders, an amount equal to the amount of dividends and distributions stated in the Written Instructions to be distributed in cash by the transfer agent to shareholders, or, in lieu of paying the Fund's transfer agent, PNC Bank may arrange for the direct payment of cash dividends and distributions to shareholders in accordance with procedures mutually agreed upon from time to time by and among the Fund, PNC Bank and the Fund's transfer agent. (v) payments, upon receipt of Written Instructions, in connection with the conversion, exchange or surrender of securities owned or subscribed to by the Fund and held by or (vi) payments of the amounts of dividends received with respect (vii) payments made to a sub-custodian pursuant to provisions in sub-section (c) of this Section; and (viii) payments, upon Written Instructions, made for other proper Fund purposes. PNC Bank is hereby authorized to endorse and collect all checks, drafts or other orders for the payment of money received as (c) Receipt of Securities; Subcustodians. (i) PNC Bank shall hold all securities received by it for the Accounts in a separate account that physically segregates such securities from those of any other persons, firms or corporations, except for securities held in a Book-Entry System. All such securities shall be held or disposed of only upon Written Instructions of the Fund pursuant to the terms of this Agreement. PNC Bank shall have no power or authority to assign, hypothecate, pledge or otherwise dispose of any such securities or investments, except upon the express terms of this Agreement and upon Written Instructions, accompanied by a certified resolution of the Fund's Board of Trustees, authorizing the transaction. In no case may any member of the Fund's Board of Trustees, or any officer, employee or agent of the Fund withdraw any securities. At PNC Bank's own expense and for its own convenience, PNC Bank may enter into sub-custodian agreements with other United States banks or trust companies to perform duties described in this sub-section (c). Such bank or trust company shall have an aggregate capital, surplus and undivided profits, according to its last published report, of at least one million dollars ($1,000,000), if it is a subsidiary or affiliate of PNC Bank, or at least twenty million dollars ($20,000,000) if such bank or trust company is not a subsidiary or affiliate of PNC Bank. In addition, such bank or trust company must be qualified to act as custodian and agree to comply with the relevant provisions of the 1940 Act and other applicable rules and regulations. Any such arrangement will not be entered into without prior written notice to the Fund. PNC Bank shall remain responsible for the performance of all of its duties as described in this Agreement and shall hold each Portfolio harmless from its own acts or omissions, under the standards of care provided for herein, or the acts and omissions of any sub-custodian chosen by PNC Bank under the terms of this sub-section (c). (d) Transactions Requiring Instructions. Upon receipt of Oral or Written Instructions and not otherwise, PNC Bank, directly or through the use of the Book-Entry System, shall: (i) deliver any securities held for a Portfolio against the receipt of payment for the sale of such securities; (ii) execute and deliver to such persons as may be designated in such Oral or Written Instructions, proxies, consents, authorizations, and any other instruments whereby the authority of a Portfolio as owner of any securities may be (iii) deliver any securities to the issuer thereof, or its agent, when such securities are called, redeemed, retired or otherwise become payable; provided that, in any such case, the cash or other consideration is to be delivered to PNC (iv) deliver any securities held for a Portfolio against receipt of other securities or cash issued or paid in connection with the liquidation, reorganization, refinancing, tender offer, merger, consolidation or recapitalization of any corporation, or the exercise of any conversion privilege; (v) deliver any securities held for a Portfolio to any committee or other person in connection with the recapitalization or sale of assets of any corporation, and receive and hold under the terms of this Agreement such certificates of deposit, interim receipts or other instruments or documents as may be issued to it to evidence (vi) make such transfer or exchanges of the assets of the Portfolios and take such other steps as shall be stated in said Oral or Written Instructions to be for the purpose of effectuating a duly authorized plan of liquidation, reorganization, merger, consolidation or recapitalization of (vii) release securities belonging to a Portfolio to any bank or trust company for the purpose of a pledge or hypothecation to secure any loan incurred by the Fund on behalf of that Portfolio; provided, however, that securities shall be released only upon payment to PNC Bank of the monies borrowed, except that in cases where additional collateral is required to secure a borrowing already made subject to proper prior authorization, further securities may be released for that purpose; and repay such loan upon redelivery to it of the securities pledged or hypothecated therefor and upon surrender of the note or notes evidencing (viii) release and deliver securities owned by a Portfolio in connection with any repurchase agreement entered into on behalf of the Fund, but only on receipt of payment therefor; and pay out moneys of the Fund in connection with such repurchase agreements, but only upon the delivery of the (ix) release and deliver or exchange securities owned by the Fund in connection with any conversion of such securities, pursuant to their terms, into other securities; (x) release and deliver securities owned by the Fund for the purpose of redeeming in kind shares of the Fund upon delivery thereof to PNC Bank; and (xi) release and deliver or exchange securities owned by the Fund for other corporate purposes. PNC Bank must also receive a certified resolution describing the nature of the corporate purpose and the name and address of the person(s) to whom delivery shall be made when such action is pursuant to sub-paragraph (d). (e) Use of Book-Entry System. The Fund shall deliver to PNC Bank certified resolutions of the Fund's Board of Trustees approving, authorizing and instructing PNC Bank on a continuous basis, to deposit in the Book-Entry System all securities belonging to the Portfolios eligible for deposit therein and to utilize the Book-Entry System to the extent possible in connection with settlements of purchases and sales of securities by the Portfolios, and deliveries and returns of securities loaned, subject to repurchase agreements or used as collateral in connection with borrowings. PNC Bank shall continue to perform such duties until it receives Written or Oral Instructions authorizing PNC Bank shall administer the Book-Entry System as follows: (i) With respect to securities of each Portfolio which are maintained in the Book-Entry System, the records of PNC Bank shall identify by Book-Entry or otherwise those securities belonging to each Portfolio. PNC Bank shall furnish to the Fund a detailed statement of the Property held for each Portfolio under this Agreement at least monthly and from time to time and upon written request. (ii) Securities and any cash of each Portfolio deposited in the Book-Entry System will at all times be segregated from any assets and cash controlled by PNC Bank in other than a fiduciary or custodian capacity but may be commingled with other assets held in such capacities. PNC Bank and its sub- custodian, if any, will pay out money only upon receipt of securities and will deliver securities only upon the receipt of money. (iii) All books and records maintained by PNC Bank which relate to the Fund's participation in the Book-Entry System will at all times during PNC Bank's regular business hours be open to the inspection of Authorized Persons, and PNC Bank will furnish to the Fund all information in respect of the services rendered as it may require. PNC Bank will also provide the Fund with such reports on its own system of internal control as the Fund may reasonably request from time to time. (f) Registration of Securities. All Securities held for a Portfolio which are issued or issuable only in bearer form, except such securities held in the Book-Entry System, shall be held by PNC Bank in bearer form; all other securities held for a Portfolio may be registered in the name of the Fund on behalf of that Portfolio, PNC Bank, the Book-Entry System, a sub- custodian, or any duly appointed nominees of the Fund, PNC Bank, Book-Entry System or sub-custodian. The Fund reserves the right to instruct PNC Bank as to the method of registration and safekeeping of the securities of the Fund. The Fund agrees to furnish to PNC Bank appropriate instruments to enable PNC Bank to hold or deliver in proper form for transfer, or to register in the name of its nominee or in the name of the Book-Entry System, any securities which it may hold for the Accounts and which may from time to time be registered in the name of the Fund on behalf of a Portfolio. (g) Voting and Other Action. Neither PNC Bank nor its nominee shall vote any of the securities held pursuant to this Agreement by or for the account of a Portfolio, except in accordance with Written Instructions. PNC Bank, directly or through the use of the Book-Entry System, shall execute in blank and promptly deliver all notices, proxies and proxy soliciting materials to the registered holder of such securities. If the registered holder is not the Fund on behalf of a Portfolio, then Written or Oral Instructions must designate the person who owns such securities. (h) Transactions Not Requiring Instructions. In the absence of contrary Written Instructions, PNC Bank is authorized to take the following actions: (i) Collection of Income and Other Payments. (A) collect and receive for the account of each Portfolio, all income, dividends, distributions, coupons, option premiums, other payments and similar items, included or to be included in the Property, and, in addition, promptly advise each Portfolio of such receipt and credit such income, as collected, to each Portfolio's (B) endorse and deposit for collection, in the name of the Fund, checks, drafts, or other orders for the payment (C) receive and hold for the account of each Portfolio all securities received as a distribution on the Portfolio's securities as a result of a stock dividend, share split-up or reorganization, recapitalization, readjustment or other rearrangement or distribution of rights or similar securities issued with respect to any securities belonging to a Portfolio and held by PNC (D) present for payment and collect the amount payable upon all securities which may mature or be called, redeemed, become payable on the date such securities become (E) take any action which may be necessary and proper in connection with the collection and receipt of such income and other payments and the endorsement for collection of checks, drafts, and other negotiable instruments. (A) deliver or cause to be delivered Property against payment or other consideration or written receipt therefor in the following cases: (1) for examination by a broker or dealer selling for the account of a Portfolio in accordance with (2) for the exchange of interim receipts or temporary securities for definitive securities; and (3) for transfer of securities into the name of the Fund on behalf of a Portfolio or PNC Bank or nominee of either, or for exchange of securities for a different number of bonds, certificates, or other evidence, representing the same aggregate face amount or number of units bearing the same interest rate, maturity date and call provisions, if any; provided that, in any such case, the new securities are to be delivered to PNC Bank. (B) Unless and until PNC Bank receives Oral or Written Instructions to the contrary, PNC Bank shall: (1) pay all income items held by it which call for payment upon presentation and hold the cash received by it upon such payment for the account (2) collect interest and cash dividends received, with notice to the Fund, to the account of each (3) hold for the account of each Portfolio all stock dividends, rights and similar securities issued with respect to any securities held by PNC Bank; (4) execute as agent on behalf of the Fund all necessary ownership certificates required by the Internal Revenue Code or the Income Tax Regulations of the United States Treasury Department or under the laws of any state now or hereafter in effect, inserting the Fund's name, on behalf of a Portfolio, on such certificate as the owner of the securities covered thereby, to the extent it may lawfully do so. (i) PNC Bank shall upon receipt of Written or Oral Instructions establish and maintain segregated accounts on its records for and on behalf of each Portfolio. Such accounts may be used to transfer cash and securities, including securities in the Book-Entry System: (A) for the purposes of compliance by the Fund with the procedures required by a securities or option exchange, providing such procedures comply with the 1940 Act and any releases of the SEC relating to the maintenance of segregated accounts by registered investment companies; (B) Upon receipt of Written Instructions, for other proper corporate purposes. (ii) PNC Bank shall arrange for the establishment of IRA custodian accounts for such shareholders holding Shares through IRA accounts, in accordance with the Fund's prospectuses, the Internal Revenue Code of 1986, as amended (including regulations promulgated thereunder), and with such other procedures as are mutually agreed upon from time to time by and among the Fund, PNC Bank and the Fund's transfer agent. (j) Purchases of Securities. PNC Bank shall settle purchased securities upon receipt of Oral or Written Instructions from the Fund or its investment advisers that specify: (i) the name of the issuer and the title of the securities, including CUSIP number if applicable; (ii) the number of shares or the principal amount purchased and (iii) the date of purchase and settlement; (iv) the purchase price per unit; (v) the total amount payable upon such purchase; (vi) the Portfolio involved; and (vii) the name of the person from whom or the broker through whom the purchase was made. PNC Bank shall upon receipt of securities purchased by or for a Portfolio pay out of the moneys held for the account of the Portfolio the total amount payable to the person from whom or the broker through whom the purchase was made, provided that the same conforms to the total amount payable as set forth in such Oral or Written Instructions. (k) Sales of Securities. PNC Bank shall settle sold securities upon receipt of Oral or Written Instructions from the Fund that specify: (i) the name of the issuer and the title of the security, including CUSIP number if applicable; (ii) the number of shares or principal amount sold, and accrued (iii) the date of trade and settlement; (iv) the sale price per unit; (v) the total amount payable to the Fund upon such sale; (vi) the name of the broker through whom or the person to whom the sale was made; and (vii) the location to which the security must be delivered and delivery deadline, if any; and PNC Bank shall deliver the securities upon receipt of the total amount payable to the Portfolio upon such sale, provided that the total amount payable is the same as was set forth in the Oral or Written Instructions. Subject to the foregoing, PNC Bank may accept payment in such form as shall be satisfactory to it, and may deliver securities and arrange for payment in accordance with the customs prevailing among dealers in securities. (i) PNC Bank shall furnish to the Fund the following reports: (A) such periodic and special reports as the Fund may (B) a monthly statement summarizing all transactions and entries for the account of each Portfolio, listing each Portfolio securities belonging to each Portfolio with the adjusted average cost of each issue and the market value at the end of such month and stating the cash account of each Portfolio including disbursements; (C) the reports required to be furnished to the Fund pursuant to Rule 17f-4; and (D) such other information as may be agreed upon from time to time between the Fund and PNC Bank. (ii) PNC Bank shall transmit promptly to the Fund any proxy statement, proxy material, notice of a call or conversion or similar communication received by it as custodian of the Property. PNC Bank shall be under no other obligation to inform the Fund as to such actions or events. (m) Collections. All collections of monies or other property in respect, or which are to become part, of the Property (but not the safekeeping thereof upon receipt by PNC Bank) shall be at the sole risk of the Fund. If payment is not received by PNC Bank within a reasonable time after proper demands have been made, PNC Bank shall notify the Fund in writing, including demand letters, any written responses, memoranda of all oral responses and shall await instructions from the Fund. PNC Bank shall not be obliged to take legal action for collection unless and until reasonably indemnified to its satisfaction. PNC Bank shall also notify the Fund as soon as reasonably practicable whenever income due on securities is not collected in due course and shall provide the Fund with periodic status reports of such income collected after a reasonable time. 15. DURATION AND TERMINATION. This Agreement shall continue until terminated by the Fund or by PNC Bank on sixty (60) days' prior written notice to the other party. In the event this Agreement is terminated (pending appointment of a successor to PNC Bank or vote of the shareholders of the Fund to dissolve or to function without a custodian of its cash, securities or other property), PNC Bank shall not deliver cash, securities or other property of the Portfolios to the Fund. It may deliver them to a bank or trust company of PNC Bank's choice, having an aggregate capital, surplus and undivided profits, as shown by its last published report, of not less than twenty million dollars ($20,000,000), as a custodian for the Fund to be held under terms similar to those of this Agreement. PNC Bank shall not be required to make any such delivery or payment until full payment shall have been made to PNC Bank of all of its fees, compensation, costs and expenses. PNC Bank shall have a security interest in and shall have a right of setoff against the Property as security for the payment of such fees, compensation, costs and expenses. 16. NOTICES. All notices and other communications, including Written Instructions, shall be in writing or by confirming telegram, cable, telex or facsimile sending device. If notice is sent during regular business hours, by confirming telegram, cable, telex or facsimile sending device, it shall be deemed to have been given immediately. If notice is sent by first-class mail, it shall be deemed to have been given five days after it has been mailed. If notice is sent by messenger, it shall be deemed to have been given on the day it is delivered. Notices shall be addressed (a) if to PNC Bank at Airport Business Center, International Court 2, 200 Stevens Drive, Lester, Pennsylvania 19113, marked for the attention of the Custodian Services Department (or its successor) (b) if to the Fund, at 4176 Burns Road, Palm Beach Gardens, FL 33410, Attn:________________ or (c) if to neither of the foregoing, at such other address as shall have been given by like notice to the sender of any such notice or other communication by the other party. 17. AMENDMENTS. This Agreement, or any term hereof, may be changed or waived only by a written amendment, signed by the party against whom enforcement of such change or waiver is sought. 18. DELEGATION; ASSIGNMENT. PNC Bank may assign its rights and delegate its duties hereunder to any wholly-owned direct or indirect subsidiary of PNC Bank, National Association or PNC Bank Corp., provided that (i) PNC Bank gives the Fund thirty (30) days' prior written notice; (ii) the delegate (or assignee) agrees with PNC Bank and the Fund to comply with all relevant provisions of the 1940 Act; and (iii) PNC Bank and such delegate (or assignee) promptly provide such information as the Fund may request, and respond to such questions as the Fund may ask, relative to the delegation (or assignment), including (without limitation) the capabilities of the delegate (or assignee). 19. COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 20. FURTHER ACTIONS. Each party agrees to perform such further acts and execute such further documents as are necessary to effectuate the purposes hereof. (a) Entire Agreement. This Agreement embodies the entire agreement and understanding between the parties and supersedes all prior agreements and understandings relating to the subject matter hereof, provided that the parties may embody in one or more separate documents their agreement, if any, with respect to delegated duties and Oral Instructions. (b) Captions. The captions in this Agreement are included for convenience of reference only and in no way define or delimit any of the provisions hereof or otherwise affect their construction or effect. (c) Governing Law. This Agreement shall be deemed to be a contract made in Pennsylvania and governed by Pennsylvania law, without regard to principles of conflicts of law. (d) Partial Invalidity. If any provision of this Agreement shall be held or made invalid by a court decision, statute, rule or otherwise, the remainder of this Agreement shall not be affected thereby. (e) Successors and Assigns. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns. (f) Facsimile Signatures. The facsimile signature of any party to this Agreement shall constitute the valid and binding execution hereof by such party. (g) Massachusetts Business Trust Disclaimer. The Fund is organized as a Massachusetts business trust, and references in this Agreement to the Fund mean and refer to the Trustees from time to time serving under its Declaration of Trust on file with the Secretary of State of the Commonwealth of Massachusetts, as the same may be amended from time to time, pursuant to which the Fund conducts its business. It is expressly agreed that the obligations of the Fund hereunder shall not be binding upon any of the Trustees, shareholders, nominees, officers, agents or employees of the Fund, as provided in said Declaration of Trust. Moreover, if the Fund has more than one series, no series of the Fund other than the series on whose behalf a specified transaction shall have been undertaken shall be responsible for the obligations of the Fund, and persons engaging in transactions with the Fund shall look only to the assets of that series to satisfy those obligations. The execution and delivery of this Agreement has been authorized by the Trustees and signed by an authorized officer of the Fund, acting as such, and neither such authorization by such Trustees nor such execution and delivery by such officer shall be deemed to have made by and of them but shall bind only the trust property of the Fund as provided in such Declaration of Trust. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the day and year first above written. THIS EXHIBIT A, dated as of ____________________, 1995, is Exhibit A to that certain Custodian Services Agreement dated as of _____________________, 1995 between PNC Bank, National Association and Weiss Treasury Fund. Weiss Treasury Only Money Market Fund	N-1/A	EX-99.2	1996-01-12T00:00:00	1996-01-11T17:32:37
0000950117-96-000032	0000950117-96-000032_0000.txt	Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report (Date of earliest event reported) January 10, 1996 (Exact name of registrant as specified in its charter) (State or other jurisdic- (Commission (IRS Employer tion of incorporation) File Number) Identification No.) Lilly Corporate Center, Indianapolis, Indiana 46285 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (317) 276-2000 (Former name or former address, if changed since last report) Item 7. Financial Statements and Exhibits. (1) Form of Underwriting Agreement, dated as of January 5, 1996, among Eli Lilly and Company and Morgan Stanley & Co. Incorporated, Goldman, Sachs & Co. and J.P. Morgan Securities Inc. relating to the issuance and sale by Eli Lilly and Company of $200,000,000 aggregate principal amount of its 6.57% Notes Due 2016 and $300,000,000 aggregate principal amount of its 6.77% Notes Due 2036. (4.1) Form of 6.57% Note Due 2016 (Book-Entry) was filed with the Commission as Exhibit 1.1 to registration statement on Form 8-A on January 10, 1996 and is incorporated herein by this reference. (4.2) Form of 6.77% Note Due 2036 (Book-Entry) was filed with the Commission as Exhibit 1.2 to registration statement on Form 8-A on January 10, 1996 and is incorporated herein by this reference. (24) Consent of Ernst & Young LLP. Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.	8-K	8-K	1996-01-12T00:00:00	1996-01-12T15:10:21
0000950170-96-000013	0000950170-96-000013_0000.txt	U.S. SECURITIES AND EXCHANGE COMMISSION [X] Form 10-Q and Form 10-QSB [ ] Form 10-K and Form 10-KSB [ ] Form 20-F [ ] Form 11-K [ ] Form N-SAR [ ] Transition Report on Form 10-K [ ] Transition Report on Form 20-F [ ] Transition Report on Form 11-K [ ] Transition Report on Form 10-Q [ ] Transition Report on Form N-SAR For the Transition Period Ended: Nothing in this Form shall be construed to imply that the Commission has verified any information contained herein. If the notification relates to a portion of the filing checked above, identify the Item(s) to which the notification relates: N/A Address of Principal Executive Office (Street and Number) City, State and Zip Code WEST PALM BEACH, FLORIDA 33407 PART II--RULES 12B-25(B) AND (C) If the subject report could not be filed without unreasonable effort or expense and the registrant seeks relief pursuant to Rule 12b-25(b), the following should be completed. (Check box if appropriate) [X] (a) The reasons described in reasonable detail in Part III of this form could not be eliminated without unreasonable [ ] (b) The subject annual report, semi-annual report, transition report on Form 10-K, Form 20-F, 11-K or Form N-SAR, or portion thereof will be filed on or before the fifteenth calendar day following the prescribed due date; or the subject quarterly report or transition report on Form 10-Q, or portion thereof will be filed on or before the fifth calendar day following the prescribed due date; and [ ] (c) The accountant's statement or other exhibit required by Rule 12b-25(c) has been attached if applicable. THE PREPARATION OF THE QUARTERLY REPORT ON FORM 10-QSB FOR THE QUARTER ENDED NOVEMBER 30, 1995 WAS DELAYED DUE TO A COMPUTER FAILURE SUFFERED BY THE REGISTRANT. IN ADDITION, DUE TO REGISTRANT'S FINANCIAL SITUATION, IT HAS LIMITED RESOURCES AND PERSONNEL AVAILABLE TO ASSIST IN THE PREPARATION OF SUCH FORM 10-QSB. (1) Name and telephone number of person to contact in regard to this (2) Have all other periodic reports required under Section 13 or 15(d) of the Securities Exchange Act of 1934 or Section 30 of the Investment Company Act of 1940 during the preceding 12 months or for such shorter period that the registrant was required to file such report(s) been filed? If the answer is no, identify report(s). [X] Yes [ ] No (3) Is it anticipated that any significant change in results of operations from the corresponding period for the last fiscal year will be reflected by the earnings statements to be included in the subject report or portion thereof? [X] Yes [ ] No If so: attach an explanation of the anticipated change, both narratively and quantitatively, and if appropriate, state the reasons why a reasonable estimate of the results cannot be made. REGISTRANT REPORTED NET LOSSES OF $249,000.00 AND $78,000.00 FOR THE NINE MONTHS AND THREE MONTHS ENDED NOVEMBER 30, 1994, RESPECTIVELY. REGISTRANT EXPECTS TO REPORT NET LOSSES OF APPROXIMATELY $260,000.00 AND $97,000.00 FOR THE NINE MONTHS AND THREE MONTHS ENDED NOVEMBER 30, 1995, RESPECTIVELY. (Name of Registrant as specified in Charter) has caused this notification to be signed on its behalf by the undersigned thereunto duly authorized. Date: JANUARY 12, 1996 By: /s/ SHEVACH SARAF SHEVACH SARAF, CHAIRMAN OF THE BOARD,	NT 10-Q	NT 10-Q	1996-01-12T00:00:00	1996-01-12T16:00:13
0000950130-96-000107	0000950130-96-000107_0000.txt	AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 12, 1996 FOR REGISTRATION UNDER THE SECURITIES ACT OF 1933 OF SECURITIES OF UNIT INVESTMENT TRUSTS REGISTERED ON FORM N-8B-2 A. EXACT NAME OF TRUST: C. COMPLETE ADDRESS OF DEPOSITOR'S PRINCIPAL EXECUTIVE OFFICES: 388 Greenwich Street, 23rd floor New York, New York 10013 D. NAME AND COMPLETE ADDRESS OF AGENT FOR SERVICE: New York, New York 10013 PIERRE DE SAINT PHALLE, ESQ. 450 Lexington Ave. New York, New York 10017 E. TITLE AND AMOUNT OF SECURITIES BEING REGISTERED: AN INDEFINITE NUMBER OF UNITS OF BENEFICIAL INTEREST PURSUANT TO RULE 24f-2 PROMULGATED UNDER THE INVESTMENT COMPANY ACT OF 1940, AS AMENDED. F. PROPOSED MAXIMUM AGGREGATE OFFERING PRICE TO THE PUBLIC OF THE SECURITIES BEING REGISTERED: G. AMOUNT OF FILING FEE: $500 (AS REQUIRED BY RULE 24f-2) H. APPROXIMATE DATE OF PROPOSED SALE TO PUBLIC: AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THE REGISTRATION STATEMENT. [X] Check box if it is proposed that this filing will become effective immediately upon filing pursuant to Rule 487. TRUST California Trust 147 Florida Trust 73 INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. IN THE OPINION OF COUNSEL UNDER EXISTING LAW, INTEREST INCOME TO THE TRUSTS AND TO UNIT HOLDERS (EXCEPT IN CERTAIN INSTANCES DEPENDING UPON THE UNIT HOLDERS) IS EXEMPT FROM REGULAR FEDERAL INCOME TAX AND FROM CERTAIN STATE AND LOCAL PERSONAL INCOME TAXES, TO THE EXTENT INDICATED, IN THE STATE FOR WHICH A STATE TRUST IS NAMED. CAPITAL GAINS, IF ANY, ARE SUBJECT TO TAX. THE TAX EXEMPT SECURITIES TRUST consists of separate underlying unit investment trusts designated as California Trust 147, Florida Trust 73 and New York Trust 151, (the "California Trust," the "Florida Trust" and the "New York Trust", respectively) (the "Trusts" or the "Trust" as the context requires and in the case of a Trust designated by a state name, the "State Trust" or the "State Trusts," as the context requires). Each Trust was formed to obtain for its Unit holders tax-exempt interest income and conservation of capital through investment in a professionally selected, fixed portfolio of municipal bonds rated at the time of deposit in the category A or better by Standard & Poor's Ratings Group, a division of McGraw-Hill, Inc. ("Standard & Poor's"), Moody's Investors Service, Inc. ("Moody's"), Fitch Investors Service, Inc. ("Fitch") or Duff & Phelps Credit Rating Co. ("Duff & Phelps"). (See "Portfolio of Securities".) Each State Trust comprises a fixed portfolio of interest-bearing obligations issued primarily by or on behalf of the state for which such State Trust is named and counties, municipalities, authorities or political subdivisions thereof. Interest on all bonds in each Trust is in the opinion of counsel under existing law, with certain exceptions, exempt from regular Federal income taxes (see Part B, "Taxes") and from certain state and local personal income taxes in the state for which a State Trust is named, but may be subject to other state and local taxes. (See discussions of State and local THE PUBLIC OFFERING PRICE of the Units of each Trust during the initial public offering period is equal to the aggregate offering price of the underlying bonds in the Trust's portfolio divided by the number of Units outstanding in such Trust, plus a sales charge. The Public Offering Price of the Units of each Trust following the initial public offering period is equal to the aggregate bid price of the underlying bonds in the Trust's portfolio divided by the number of Units outstanding in such Trust, plus a sales charge. During the initial public offering period the sales charge is equal to 4.70% of the Public Offering Price (4.932% of the aggregate offering price of the bonds per Unit) for each Trust, and following the initial public offering period this charge will be equal to 5.00% of the Public Offering Price (5.263% of the aggregate bid price of the bonds per Unit) for each Trust. See Part B, "Public Offering-- Distribution of Units" for a description of the initial public offering period. If the Units had been available for sale on January 11, 1996, the Public Offering Price per Unit (including the sales charge) would have been $1,010.81, $1,047.07 and $1,033.06 for the California Trust, Florida Trust and New York Trust, respectively. In addition, there will be added an amount equal to accrued interest commencing on the day after the Date of Deposit through the date of settlement (normally three business days after purchase). THE SPONSOR, although not obligated to do so, intends to maintain a market for the Units of the Trusts at prices based upon the aggregate bid price of the underlying bonds, as more fully described under "Public Offering--Market for Units" in Part B. If such a market is not maintained, a Unit holder will be able to dispose of his Units through redemption, at prices that are also based upon the aggregate bid price of the underlying bonds. Units can be sold at any time without fee or penalty. MONTHLY DISTRIBUTIONS of principal and interest received by each Trust will be made on or shortly after the fifteenth day of each month to holders of record on the first day of that month. For further information regarding the distributions by each Trust, see "Summary of Essential Information." THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The date of this Prospectus is January 12, 1996 SUMMARY OF ESSENTIAL INFORMATION AS OF JANUARY 11, 1996 + The first day of each month, The Chase Manhattan Bank DISTRIBUTION DATES** The fifteenth day of each Kenny S & P Evaluation Services, a division of EVALUATION TIME J.J. Kenny Co., Inc. As of 1:00 P.M. on the Date of 4:00 P.M. New York Time. DATE OF DEPOSIT AND OF TRUST The Evaluator will receive a fee of $.29 per bond per "Evaluator--Responsibility" Each Trust will terminate on the sale or other disposition of the last Bond held in the Trust. Maximum of $.25 per $1,000 face amount of the underlying Bonds. + The Date of Deposit. The Date of Deposit is the date on which the Trust Agreement was signed and the deposit with the Trustee was made. * The actual date of termination of each trust may be considerably earlier (see Part B, "Amendment and Termination of the Trust Agreement-- Termination"). The first monthly income distribution of $2.93, $3.02 and $3.02 for the California Trust, Florida Trust and New York Trust, respectively, will be made on February 15, 1996. * In addition to this amount, the Sponsor may be reimbursed for bookkeeping and other administrative expenses not exceeding its actual costs. * Accrued interest will be commencing on the day after the Date of Deposit through the date of settlement (normally three business days after purchase). This figure will also include accrued interest from the day after the Date of Deposit to the date of settlement (normally three business days after purchase) and the net of cash on hand in the relevant Trust, accrued expenses of such Trust and amounts distributable to holders of record of Units of such Trust as of a date prior to the computation date, on a pro rata share basis. (See Part B, "Redemption of Units--Computation of Redemption Price per Unit.") * Per $1,000 principal amount of Bonds, plus expenses. (See Part B, "Rights of Unit Holders--Distribution of Interest and Principal.") ** Each Trust (and therefore the investors) will bear all or a portion of its organizational costs--including costs of preparing the registration statement, the trust indenture and other closing documents and the initial audit of the Trust--as is common for mutual funds. Historically, the Sponsors of unit investment trusts have paid all the costs of establishing those trusts. Advertising and selling expenses will be paid by the Underwriters at no cost to a Trust. *** The Estimated Current Return is calculated by dividing the Estimated Net Annual Interest Income per Unit by the Public Offering Price per Unit. The Estimated Net Annual Interest Income per Unit will vary with changes in fees and expenses of the Trustee and the Evaluator and with the principal prepayment, redemption, maturity, exchange or sale of Bonds while the Public Offering Price will vary with changes in the offering price of the underlying Bonds; therefore, there is no assurance that the present Estimated Current Return indicated above will be realized in the future. The Estimated Long-Term Return is calculated using a formula which (1) takes into consideration, and factors in the relative weightings of, the market values, yields (which takes into account the amortization of premiums and the accretion of discounts) and estimated retirements of all of the Bonds in the Trust and (2) takes into account the expenses and sales charge associated with each Unit. Since the market values and estimated retirements of the Bonds and the expenses of the Trust will change, there is no assurance that the present Estimated Long- Term Return as indicated above will be realized in the future. The Estimated Current Return and Estimated Long-Term Return are expected to differ because the calculation of the Estimated Long-Term Return reflects the estimated date and amount of principal returned while the Estimated Current Return calculations include only Net Annual Interest Income and Public Offering Price as of the Date of Deposit. The effect of the delay in the payment to Unit holders for the first few months of Trust operations, which results in a lower true return to Unit holders, is not reflected in either calculation (a projected cash flow statement as of the Date of Deposit is available upon request from the Trustee). PORTFOLIO SUMMARY AS OF DATE OF DEPOSIT The Portfolio of the California Trust contains 15 issues of Bonds of issuers located in the State of California. All of the issues are payable from the income of specific projects or authorities and are not supported by the issuer's power to levy taxes. Although income to pay such Bonds may be derived from more than one source, the primary sources of such income and the percentage of the Bonds in this Trust deriving income from such sources are as follows: hospital and health care facilities: 28.9%; power facilities: 12.2%; transportation facilities: 10.1%; educational facilities: 19.9%; tax allocation: 13.6%; lease rental payments: 15.3%. The Trust is considered to be concentrated in hospital and health care facilities issues.+ (See Part B, "Tax Exempt Securities Trust--Risk Factors" for a brief summary of additional considerations relating to certain of these issues.) 3.5% of the Bonds in this Trust are insured as to timely payment of principal and interest by certain insurance companies MBIA, 3.5%) (see Part B, "Tax Exempt Securities Trust-- Risk Factors--Insurance"). Twelve Bonds in this Trust have been issued with an "original issue discount." (See Part B, "Taxes.") The average life to maturity of the Bonds in the California Trust is 25.1 years. As of the Date of Deposit, 80.1% of the Bonds in this Trust are rated by Standard & Poor's (3.5% rated AAA, 8.7% rated AA and 67.9% rated A); 19.9% are rated A by Moody's. For a description of the meaning of the applicable rating symbols as published by the rating agencies, see Part B, "Bond Ratings." It should be emphasized, however, that the ratings of the rating agencies represent their opinions as to the quality of the Bonds which they undertake to rate, and that these ratings are general and are not absolute standards of quality and may change from time to time. 15.4% of the Bonds in the California Trust were acquired from the Sponsor as sole underwriter or from an underwriting syndicate in which the Sponsor participated, or otherwise from the Sponsor's own organization. (See Part B, "Public Offering--Sponsor's and Underwriters' Profits.") The Portfolio of the Florida Trust contains 8 issues of Bonds of issuers located in the State of Florida. All of the issues are payable from the income of specific projects or authorities and are not supported by the issuer's power to levy taxes. Although income to pay such Bonds may be derived from more than one source, the primary sources of such income and the percentage of the Bonds in this Trust deriving income from such sources are as follows: hospital and health care facilities: 40.7%; power facilities: 28.4%; educational facilities: 8.2%; water and sewer facilities: 12.4%; correctional facilities: 10.3%. The Trust is considered to be concentrated in hospital and health care facilities and power facilities issues.+ (See Part B, "Tax Exempt Securities Trust--Risk Factors" for a brief summary of additional considerations relating to certain of these issues.) 19.8% of the Bonds in this Trust are insured as to timely payment of principal and interest by certain insurance companies (AMBAC, 10.3%; and MBIA, 9.5%) (see Part B, "Tax Exempt Securities Trust--Risk Factors--Insurance"). Eight Bonds in this Trust have been issued with an "original issue discount." (See Part B, "Taxes.") The average life to maturity of the Bonds in the Florida Trust is 25.4 years. As of the Date of Deposit, 79.8% of the Bonds in this Trust are rated by Standard & Poor's (19.8% rated AAA, 39.5% rated AA and 20.5% rated A); 20.2% are rated A by Moody's. For a description of the meaning of the applicable rating symbols as published by the rating agencies, see Part B, "Bond Ratings." It should be emphasized, however, that the ratings of the rating agencies represent their opinions as to the quality of the Bonds which they undertake to rate, and that these ratings are general and are not absolute standards of quality and may change from time to time. None of the Bonds in the Florida Trust were acquired from the Sponsor as sole underwriter or from an underwriting syndicate in which the Sponsor participated, or otherwise from the Sponsor's own organization. (See Part B, "Public Offering--Sponsor's and Underwriters' Profits.") * Percentages computed on the basis of the aggregate offering price of the Bonds in the Trust on the Date of Deposit. + A Trust is considered to be "concentrated" in a particular category when the Bonds in that category constitute 25% or more of the aggregate offering price of the Bonds in the Trust. The Portfolio of the New York Trust contains 14 issues of Bonds of issuers located in the State of New York and the Commonwealth of Puerto Rico. Of the Bonds in this Trust, one was issued by an issuer in the Commonwealth of Puerto Rico (representing 4.8%* of the Bonds in the Trust) and was issued to finance water and sewer facilities. Three of the issues (representing approximately 14.4% of the Bonds in the Trust) are general obligations of governmental entities and are backed by the taxing power of those entities. The remaining issues are payable from the income of specific projects or authorities and are not supported by the issuer's power to levy taxes. Although income to pay such Bonds may be derived from more than one source, the primary sources of such income and the percentage of the Bonds in this Trust deriving income from such sources are as follows: hospital and health care facilities: 41.0%; housing facilities: 3.1%; educational facilities: 24.5%; correctional facilities: 12.2%. The Trust is considered to be concentrated in hospital and health care facilities issues.+ (See Part B, "Tax Exempt Securities Trust--Risk Factors" for a brief summary of additional considerations relating to certain of these issues.) Nine Bonds in this Trust have been issued with an "original issue discount." (See Part B, "Taxes.") The average life to maturity of the Bonds in the New York Trust is 29.2 years. As of the Date of Deposit, 44.2% of the Bonds in this Trust are rated by Standard & Poor's (10.3% rated AAA, 24.0% rated AA and 9.9% rated A); 55.8% are rated A by Fitch. For a description of the meaning of the applicable rating symbols as published by the rating agencies, see Part B, "Bond Ratings." It should be emphasized, however, that the ratings of the rating agencies represent their opinions as to the quality of the Bonds which they undertake to rate, and that these ratings are general and are not absolute standards of quality and may change from time to time. None of the Bonds in the New York Trust were acquired from the Sponsor as sole underwriter or from an underwriting syndicate in which the Sponsor participated, or otherwise from the Sponsor's own organization. (See Part B, "Public Offering--Sponsor's and Underwriters' Profits.") * Percentages computed on the basis of the aggregate offering price of the Bonds in the Trust on the Date of Deposit. + A Trust is considered to be "concentrated" in a particular category when the Bonds in that category constitute 25% or more of the aggregate offering price of the Bonds in the Trust. The names and addresses of the Underwriters and the number of Units to be sold by them are as follows: To the Sponsor, Trustee and Unit Holders of Tax Exempt Securities Trust, California Trust 147, Florida Trust 73 and New York Trust 151: We have audited the accompanying statements of financial condition, including the portfolios of securities, of each of the respective trusts constituting Tax Exempt Securities Trust, California Trust 147, Florida Trust 73 and New York Trust 151 as of January 11, 1996. These financial statements are the responsibility of the Trustee (see note 6 to the statements of financial condition). Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the statements of financial condition are free of material misstatement. An audit of a statement of financial condition includes examining, on a test basis, evidence supporting the amounts and disclosures in that statement of financial condition. Our procedures included confirmation with the Trustee of an irrevocable letter of credit deposited on January 11, 1996 for the purchase of securities, as shown in the statements of financial condition and portfolios of securities. An audit of a statement of financial condition also includes assessing the accounting principles used and significant estimates made by the Trustee, as well as evaluating the overall statement of financial condition presentation. We believe that our audits of the statements of financial condition provide a reasonable basis for our opinion. In our opinion, the statements of financial condition referred to above present fairly, in all material respects, the financial position of each of the respective trusts constituting Tax Exempt Securities Trust, California Trust 147, Florida Trust 73 and New York Trust 151 as of January 11, 1996, in conformity with generally accepted accounting principles. AS OF DATE OF DEPOSIT, JANUARY 11, 1996 (1) Aggregate cost to each Trust of the Bonds listed under the Portfolios of Securities on the immediately following pages is based on offering prices as of 1:00 P.M. on January 11, 1996, the Date of Deposit, determined by the Evaluator on the basis set forth in Part B, "Public Offering--Offering Price." Morgan Guaranty Trust Company of New York issued an irrevocable letter of credit in the aggregate principal amount of $14,000,000 which was deposited with the Trustee for the purchase of $12,500,000 principal amount of Bonds pursuant to contracts to purchase such Bonds at the Sponsor's aggregate cost of $12,233,696 plus $129,415 representing accrued interest thereon through the Date of Deposit. (2) The Indenture provides that the Trustee will advance amounts equal to the accrued interest on the underlying securities of each Trust (net of accrued expenses) through the Date of Deposit and that such amounts will be distributed to the Sponsor as Unit holder of record on such date, as set forth in Part B, "Rights of Unit Holders--Distribution of Interest and Principal." (3) Organizational costs to be paid by the Trusts have been deferred and will be amortized over five years. (4) Aggregate public offering price (exclusive of interest) computed on 5,000, 2,500 and 5,000 Units of California Trust, Florida Trust and New York Trust, respectively, on the basis set forth in Part B, "Public Offering-- Offering Price." (5) Sales charge of 4.70% computed on 5,000, 2,500 and 5,000 Units of California Trust, Florida Trust and New York Trust, respectively, on the basis set forth in Part B, "Public Offering--Offering Price." (6) The Trustee has custody of and responsibility for all accounting and financial books, records, financial statements and related data of each Trust and is responsible for establishing and maintaining a system of internal controls directly related to, and designed to provide reasonable assurance as to the integrity and reliability of, financial reporting of each Trust. The Trustee is also responsible for all estimates and accruals reflected in each Trust's financial statements. The Evaluator determines the price for each underlying Bond included in each Trust's Portfolio of Securities on the basis set forth in Part B, "Public Offering--Offering Price." CALIFORNIA TRUST 147--PORTFOLIO OF SECURITIES AS OF JANUARY 11, 1996 The Notes following the Portfolios are an integral part of each Portfolio of Securities. FLORIDA TRUST 73--PORTFOLIO OF SECURITIES AS OF JANUARY 11, 1996 The Notes following the Portfolios are an integral part of each Portfolio of Securities. NEW YORK TRUST 151--PORTFOLIO OF SECURITIES AS OF JANUARY 11, 1996 The Notes following the Portfolios are an integral part of each Portfolio of Securities. NOTES TO PORTFOLIOS OF SECURITIES (1)For a description of the meaning of the applicable rating symbols as published by Standard & Poor's Ratings Group, a division of McGraw-Hill, Inc., Moody's Investors Service() and Fitch Investor Services, Inc.(), see Part B, "Bond Ratings". (2) There is shown under this heading the year in which each issue of Bonds initially is redeemable and the redemption price for that year; unless otherwise indicated, each issue continues to be redeemable at declining prices thereafter, but not below par. "SF" indicates a sinking fund has been or will be established with respect to an issue of Bonds. The prices at which Bonds may be redeemed or called prior to maturity may or may not include a premium and, in certain cases, may be less than the cost of the Bonds to a Trust. Certain Bonds in a Portfolio, including Bonds listed as not being subject to redemption provisions, may be redeemed in whole or in part other than by operation of the stated redemption or sinking fund provision under certain unusual or extraordinary circumstances specified in the instruments setting forth the terms and provisions of such Bonds. For example, see discussion of obligations of housing authorities in Part B, "Tax Exempt Securities Trust--Portfolio." (3) Contracts to purchase Bonds were entered into during the period August 16, 1995, through January 11, 1996, with the final settlement date on January 17, 1996. The Profit to the Sponsor on Deposit totals $40,419, $24,961 and $60,445 for the California Trust, Florida Trust and New York Trust, respectively. (4) Evaluation of the Bonds by the Evaluator is made on the basis of current offering prices for the Bonds. The current offering prices of the Bonds are greater than the current bid prices of the Bonds. The Redemption Price per Unit and the public offering price of the Units in the secondary market are determined on the basis of the current bid prices of the Bonds. (See Part B, "Public Offering--Offering Price" and "Rights of Unit Holders--Redemption of Units.") Yield of Bonds was computed on the basis of offering prices on the date of deposit. The aggregate bid price of the Bonds in the California Trust, Florida Trust and New York Trust on January 11, 1996, was $4,795,629, $2,484,655 and $4,899,297, respectively. NOTE THAT PART B OF THIS PROSPECTUS MAY NOT BE DISTRIBUTED UNLESS ACCOMPANIED BY PART A. For over 20 years, Tax Exempt Securities Trust has specialized in quality municipal bond investments designed to meet a variety of investment objectives and Tax situations. Tax Exempt Securities Trust is a convenient and cost effective alternative to individual bond purchases. Each Trust is one of a series of similar but separate unit investment trusts created under the laws of the State of New York by a Trust Indenture and Agreement and related Reference Trust Agreement dated the Date of Deposit (collectively, the "Trust Agreement"), of Smith Barney Inc., as Sponsor, The Chase Manhattan Bank (National Association), as Trustee, and J.J. Kenny Co., Inc., as Evaluator. Each Trust containing Bonds of a State for which such Trust is named (a "State Trust") and each National Trust, Selected Term Trust, Long-Intermediate Term Trust, Intermediate Term Trust, Short-Intermediate Term Trust and Short Term Trust are referred to herein as the "Trust" or "Trusts," unless the context requires otherwise. On the Date of Deposit, the Sponsor deposited contracts and funds (represented by a certified check or checks and/or an irrevocable letter or letters of credit, issued by a major commercial bank) for the purchase of certain interest-bearing obligations (the "Bonds") and/or Units of preceding Series of Tax Exempt Securities Trust (such Bonds and Units of preceding Series of Tax Exempt Securities Trust, if any, (the "Deposited Units") being referred to herein collectively as the "Securities"). The Trustee thereafter delivered to the Sponsor registered certificates of beneficial interest (the "Certificates") representing the units (the "Units") comprising the entire ownership of each Trust, which Units are being offered hereby. References to multiple Trusts in Part B herein should be read as references to a single Trust if Part A indicates the creation of only one Trust. Notwithstanding the availability of the above-mentioned certified check or checks and/or irrevocable letter or letters of credit, it is expected that the Sponsor will pay for the Bonds as the contracts for their purchase become due. A substantial portion of such contracts have not become due by the date of this Prospectus. To the extent Units are sold prior to the settlement of such contracts, the Sponsor will receive the purchase price on such Units prior to the time at which they pay for Bonds pursuant to such contracts and have the use of such funds during this period. A tax-exempt unit investment trust provides many of the same benefits as individual bond purchases, while the Unit holder avoids the complexity of analyzing, selecting and monitoring a multi-bond portfolio. The objectives of a Trust are tax-exempt income and conservation of capital through an investment in a diversified portfolio of municipal bonds. There is, of course, no guarantee that a Trust's objectives will be achieved since the payment of interest and the preservation of principal are dependent upon the continued ability of the issuers of the bonds to meet such obligations. Subsequent to the Date of Deposit, the ratings of the Bonds set forth in Part A--"Portfolio of Securities" may decline due to, among other factors, a decline in creditworthiness of the issuer of said Bonds. The Sponsor's investment professionals select Bonds for the Trust portfolios from among the 200,000 municipal bond issues that vary according to bond purpose, credit quality and years to maturity. The following factors, among others, were considered in selecting the Bonds for each Trust: (1) the Bonds are obligations of the states, counties, territories or municipalities of the United States and authorities or political subdivisions thereof, so that the interest on them will, in the opinion of recognized bond counsel to the issuing governmental authorities, be exempt from Federal tax (including alternative minimum tax) under existing law to the extent described in "Taxes", (2) all the Bonds deposited in a State Trust are obligations of the State for which such Trust is named or of the counties, territories or municipalities of such State, and authorities or political subdivisions thereof, or of the Territory of Guam or the Commonwealth of Puerto Rico, so that the interest on them will, in the opinion of recognized bond counsel to the issuing governmental authorities, be exempt from Federal income tax under existing law to the extent described in "Taxes" and from state income taxes in the state for which such State Trust is named to the extent described in Part C, (3) the Bonds are rated A or better by a major bond rating agency, (4) the Bonds were chosen in part on the basis of their respective maturity dates and offer a degree of call protection, (5) the Bonds are diversified as to purpose of issue and location of issuer, except in the case of a State Trust where the Bonds are diversified only as to purpose of issue, and (6) in the opinion of the Sponsor, the Bonds are fairly valued relative to other bonds of comparable quality and maturity. The Bonds in the Portfolio of a Trust were chosen in part on the basis of their respective maturity dates. The Bonds in each Trust will have a dollar- weighted average portfolio maturity as designated in Part A--"Portfolio Summary as of Date of Deposit." For the actual maturity date of each of the Bonds contained in a Trust, which date may be earlier or later than the dollar-weighted average portfolio maturity of the Trust, see Part A, "Portfolio of Securities." A sale or other disposition of a Bond by the Trust prior to the maturity of such Bond may be at a price which results in a loss to the Trust. The inability of an issuer to pay the principal amount due upon the maturity of a Bond would result in a loss to the Trust. In the event that any contract for the purchase of any Bond fails, the Sponsor is authorized under the Trust Agreement, subject to the conditions set forth below, to instruct the Trustee to acquire other securities (the "Replacement Bonds") for inclusion in the Portfolio of the affected Trust. Any Replacement Bonds must be deposited not later than the earlier of (i) the first monthly Distribution Date of the Trust and (ii) 90 days after such Trust was established. The cost and aggregate principal amount of a Replacement Bond may not exceed the cost and aggregate principal amount of the Bond which it replaces. In addition, a Replacement Bond must (1) be a tax-exempt bond; (2) have a fixed maturity or disposition date comparable to the Bond it replaces; (3) be purchased at a price that results in a yield to maturity and in a current return, in each case as of the execution and delivery of the Trust Agreement, which is approximately equivalent to the yield to maturity and current return of the Bond which it replaces; (4) be purchased within twenty days after delivery of notice of the failed contracts; and (5) be rated in a category A or better by Standard & Poor's, Moody's, Fitch, or Duff & Phelps. Whenever a Replacement Bond has been acquired for a Trust, the Trustee shall, within five days thereafter, notify all Unit holders of such Trust of the acquisition of the Replacement Bond. In the event that a contract to purchase Bonds fails and Replacement Bonds are not acquired, the Trustee will, not later than the second monthly Distribution Date, distribute to Unit holders the funds attributable to the failed contract. The Sponsor will, in such a case, refund the sales charge applicable to the failed contract. If less than all the funds attributable to a failed contract are applied to purchase Replacement Bonds, the remaining moneys will be distributed to Unit holders not later than the second monthly Distribution Date. Moreover, the failed contract will reduce the Estimated Net Annual Income per Unit, and may lower the Estimated Current Return and Estimated Long-Term Return. Certain Bonds in a Trust may have been purchased by the Sponsor on a "when, as and if issued" basis; that is, they had not yet been issued by their governmental entity on the Date of Deposit (although such governmental entity had committed to issue such Bonds). Contracts relating to such "when, as and if issued" Bonds are not expected to be settled by the first settlement date for Units. In the case of these and/or certain other Bonds, the delivery of the Bonds may be delayed ("delayed delivery") or may not occur. Unit holders who purchased their Units of a Trust prior to the date such Bonds are actually delivered to the Trustee may have to make a downward adjustment in the tax basis of their Units for interest accruing on such "when, as and if issued" or "delayed delivery" Bonds during the interval between their purchase of Units and delivery of such Bonds, since the Trust and the Unit holders will not be reimbursing the Sponsor for interest accruing on such "when, as and if issued" or "delayed delivery" Bonds during the period between the settlement date for the Units and the delivery of such Bonds into the Trust. (See "Taxes.") Such adjustment has been taken into account in computing the Estimated Current Return and Estimated Long-Term Return set forth herein, which is slightly lower than Unit holders may receive after the first year. (See Part A, "Summary of Essential Information.") To the extent that the delivery of such Bonds is delayed beyond their respective expected delivery dates, the Estimated Current Return and Estimated Long-Term Return for the first year may be lower than indicated in the "Summary of Essential Information" in Part A. Most of the Bonds in the Portfolio of a Trust are subject to redemption prior to their stated maturity date pursuant to sinking fund or call provisions. (See Part A--"Portfolio Summary as of Date of Deposit" for information relating to the particular Trust described therein.) In general, a call or redemption provision is more likely to be exercised when the offering price valuation of a bond is higher than its call or redemption price, as it might be in periods of declining interest rates, than when such price valuation is less than the bond's call or redemption price. To the extent that a Bond was deposited in a Trust at a price higher than the price at which it is redeemable, redemption will result in a loss of capital when compared with the original public offering price of the Units. Conversely, to the extent that a Bond was acquired at a price lower than the redemption price, redemption will result in an increase in capital when compared with the original public offering price of the Units. Monthly distributions will generally be reduced by the amount of the income which would otherwise have been paid with respect to redeemed bonds. The Estimated Current Return and Estimated Long-Term Return of the Units may be affected by such redemptions. Each Portfolio of Securities in Part A contains a listing of the sinking fund and call provisions, if any, with respect to each of the Bonds in a Trust. Because certain of the Bonds may from time to time under certain circumstances be sold or redeemed or will mature in accordance with their terms and the proceeds from such events will be distributed to Unit holders and will not be reinvested, no assurance can be given that a Trust will retain for any length of time its present size and composition. NEITHER THE SPONSOR NOR THE TRUSTEE SHALL BE LIABLE IN ANY WAY FOR ANY DEFAULT, FAILURE OR DEFECT IN ANY BOND. The Portfolio of the Trust may consist of some Bonds whose current market values were below face value on the Date of Deposit. A primary reason for the market value of such Bonds being less than face value at maturity is that the interest coupons of such Bonds are at lower rates than the current market interest rate for comparably rated Bonds, even though at the time of the the interest coupons thereon represented then prevailing interest rates on comparably rated Bonds then newly issued. Bonds selling at market discounts tend to increase in market value as they approach maturity when the principal amount is payable. A market discount tax-exempt Bond held to maturity will have a larger portion of its total return in the form of taxable ordinary income and less in the form of tax-exempt income than a comparable Bond bearing interest at current market rates. Under the provisions of the Internal Revenue Code in effect on the date of this Prospectus any ordinary income attributable to market discount will be taxable but will not be realized until maturity, redemption or sale of the Bonds or Units. As set forth under "Portfolio Summary as of Date of Deposit", the Trust may contain or be concentrated in one or more of the classifications of Bonds referred to below. A Trust is considered to be "concentrated" in a particular category when the Bonds in that category constitute 25% or more of the aggregate value of the Portfolio. (See Part A--"Portfolio Summary as of Date of Deposit" for information relating to the particular Trust described therein.) An investment in Units of the Trust should be made with an understanding of the risks that these investments may entail, certain of which are described below. GENERAL OBLIGATION BONDS. Certain of the Bonds in the Portfolio may be general obligations of a governmental entity that are secured by the taxing power of the entity. General obligation bonds are backed by the issuer's pledge of its full faith, credit and taxing power for the payment of principal and interest. However, the taxing power of any governmental entity may be limited by provisions of state constitutions or laws and an entity's credit will depend on many factors, including an erosion of the tax base due to population declines, natural disasters, declines in the state's industrial base or inability to attract new industries, economic limits on the ability to tax without eroding the tax base and the extent to which the entity relies on Federal or state aid, access to capital markets or other factors beyond the entity's control. As a result of the recent recession's adverse impact upon both their revenues and expenditures, as well as other factors, many state and local governments are confronting deficits and potential deficits which are the most severe in recent years. Many issuers are facing highly difficult choices about significant tax increases and/or spending reductions in order to restore budgetary balance. Failure to implement these actions on a timely basis could force the issuers to depend upon market access to finance deficits or cash flow needs. In addition, certain of the Bonds in the Trust may be obligations of issuers (including California issuers) who rely in whole or in part on ad valorem real property taxes as a source of revenue. Certain proposals, in the form of state legislative proposals or voter initiatives, to limit ad valorem real property taxes have been introduced in various states, and an amendment to the constitution of the State of California, providing for strict limitations on ad valorem real property taxes, has had a significant impact on the taxing powers of local governments and on the financial conditions of school districts and local governments in California. It is not possible at this time to predict the final impact of such measures, or of similar future legislative or constitutional measures, on school districts and local governments or on their abilities to make future payments on their outstanding debt obligations. INDUSTRIAL DEVELOPMENT REVENUE BONDS ("IDRS"). IDRs, including pollution control revenue bonds, are tax-exempt securities issued by states, municipalities, public authorities or similar entities ("issuers") to finance the cost of acquiring, constructing or improving various projects, including pollution control facilities and certain industrial development facilities. These projects are usually operated by corporate entities. IDRs are not general obligations of governmental entities backed by their taxing power. Issuers are only obligated to pay amounts due on the IDRs to the extent that funds are available from the unexpended proceeds of the IDRs or receipts or revenues of the issuer under arrangements between the issuer and the corporate operator of a project. These arrangements may be in the form of a lease, installment sale agreement, conditional sale agreement or loan agreement, but in each case the payments to the issuer are designed to be sufficient to meet the payments of amounts due on the IDRs. IDRs are generally issued under bond resolutions, agreements or trust indentures pursuant to which the revenues and receipts payable under the issuer's arrangements with the corporate operator of a particular project have been assigned and pledged to the holders of the IDRs or a trustee for the benefit of the holders of the IDRs. In certain cases, a mortgage on the underlying project has been assigned to the holders of the IDRs or a trustee as additional security for the IDRs. In addition, IDRs are frequently directly guaranteed by the corporate operator of the project or by another affiliated company. Regardless of the structure, payment of IDRs is solely dependent upon the creditworthiness of the corporate operator of the project or corporate guarantor. Corporate operators or guarantors that are industrial companies may be affected by many factors which may have an adverse impact on the credit quality of the particular company or industry. These include cyclicality of revenues and earnings, regulatory and environmental restrictions, litigation resulting from accidents or environmentally-caused illnesses, extensive competition (including that of low-cost foreign companies), unfunded pension fund liabilities or off-balance sheet items, and financial deterioration resulting from leveraged buy-outs or takeovers. However, certain of the IDRs in the Portfolio may be additionally insured or secured by letters of credit issued by banks or otherwise guaranteed or secured to cover amounts due on the IDRs in the event of default in payment by an issuer. HOSPITAL AND HEALTH CARE FACILITY BONDS. The ability of hospitals and other health care facilities to meet their obligations with respect to revenue bonds issued on their behalf is dependent on various factors, including the level of payments received from private third-party payors and government programs and the cost of providing health care services. A significant portion of the revenues of hospitals and other health care facilities is derived from private third-party payors and government programs, including the Medicare and Medicaid programs. Both private third-party payors and government programs have undertaken cost containment measures designed to limit payments made to health care facilities. Furthermore, government programs are subject to statutory and regulatory changes, retroactive rate adjustments, administrative rulings and government funding restrictions, all of which may materially decrease the rate of program payments for health care facilities. Certain special revenue obligations (i.e., Medicare or Medicaid revenues) may be payable subject to appropriations by state legislatures. There can be no assurance that payments under governmental programs will remain at levels comparable to present levels or will, in the future, be sufficient to cover the costs allocable to patients participating in such programs. In addition, there can be no assurance that a particular hospital or other health care facility will continue to meet the requirements for participation in such programs. The costs of providing health care services are subject to increase as a result of, among other factors, changes in medical technology and increased labor costs. In addition, health care facility construction and operation is subject to federal, state and local regulation relating to the adequacy of medical care, equipment, personnel, operating policies and procedures, rate- setting, and compliance with building codes and environmental laws. Facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with the various standards necessary for licensing and accreditation. These regulatory requirements are subject to change and, to comply, it may be necessary for a hospital or other health care facility to incur substantial capital expenditures or increased operating expenses to effect changes in its facilities, equipment, personnel and services. Hospitals and other health care facilities are subject to claims and legal actions by patients and others in the ordinary course of business. Although these claims are generally covered by insurance, there can be no assurance that a claim will not exceed the insurance coverage of a health care facility or that insurance coverage will be available to a facility. In addition, a substantial increase in the cost of insurance could adversely affect the results of operations of a hospital or other health care facility. The Clinton Administration may impose regulations which could limit price increases for hospitals or the level of reimbursements for third-party payors or other measures to reduce health care costs and make health care available to more individuals, which would reduce profits for hospitals. Some states, such as New Jersey, have significantly changed their reimbursement systems. If a hospital cannot adjust to the new system by reducing expenses or raising rates, financial difficulties may arise. Also, Blue Cross has denied reimbursement for some hospitals for services other than emergency room services. The lost volume would reduce revenues unless replacement patients were found. Certain hospital bonds may provide for redemption at par at any time upon the sale by the issuer of the hospital facilities to a non-affiliated entity, if the hospital becomes subject to ad valorem taxation, or in various other circumstances. For example, certain hospitals may have the right to call bonds at par if the hospital may be legally required because of the bonds to perform procedures against specified religious principles or to disclose information that is considered confidential or privileged. Certain FHA-insured bonds may provide that all or a portion of these bonds, otherwise callable at a premium, can be called at par in certain circumstances. If a hospital defaults upon a bond obligation, the realization of Medicare and Medicaid receivables may be uncertain and, if the bond obligation is secured by the hospital facilities, legal restrictions on the ability to foreclose upon the facilities and the limited alternative uses to which a hospital can be put may severely reduce its collateral value. The Internal Revenue Service is currently engaged in a program of intensive audits of certain large tax-exempt hospital and health care facility organizations. Although these audits have not yet been completed, it has been reported that the tax-exempt status of some of these organizations may be revoked. At this time, it is uncertain whether any of the hospital and health care facility bonds held by the Trust will be affected by such audit proceedings. SINGLE FAMILY AND MULTI-FAMILY HOUSING BONDS. Multi-family housing revenue bonds and single family mortgage revenue bonds are state and local housing issues that have been issued to provide financing for various housing projects. Multi-family housing revenue bonds are payable primarily from the revenues derived from mortgage loans to housing projects for low to moderate income families. Single-family mortgage revenue bonds are issued for the purpose of acquiring from originating financial institutions notes secured by mortgages on residences. Housing obligations are not general obligations of the issuer although certain obligations may be supported to some degree by Federal, state or local housing subsidy programs. Budgetary constraints experienced by these programs as well as the failure by a state or local housing issuer to satisfy the qualifications required for coverage under these programs or any legal or administrative determinations that the coverage of these programs is not available to a housing issuer, probably will result in a decrease or elimination of subsidies available for payment of amounts due on the issuer's obligations. The ability of housing issuers to make debt service payments on their obligations will also be affected by various economic and non-economic developments including, among other things, the achievement and maintenance of sufficient occupancy levels and adequate rental income in multi-family projects, the rate of default on mortgage loans underlying single family issues and the ability of mortgage insurers to pay claims, employment and income conditions prevailing in local markets, increases in construction costs, taxes, utility costs and other operating expenses, the managerial ability of project managers, changes in laws and governmental regulations and economic trends generally in the localities in which the projects are situated. Occupancy of multi-family housing projects may also be adversely affected by high rent levels and income limitations imposed under Federal, state or local programs. All single family mortgage revenue bonds and certain multi-family housing revenue bonds are prepayable over the life of the underlying mortgage or mortgage pool, and therefore the average life of housing obligations cannot be determined. However, the average life of these obligations will ordinarily be less than their stated maturities. Single-family issues are subject to mandatory redemption in whole or in part from prepayments on underlying mortgage loans; mortgage loans are frequently partially or completely prepaid prior to their final stated maturities as a result of events such as declining interest rates, sale of the mortgaged premises, default, condemnation or casualty loss. Multi-family issues are characterized by mandatory redemption at par upon the occurrence of monetary defaults or breaches of covenants by the project operator. Additionally, housing obligations are generally subject to mandatory partial redemption at par to the extent that proceeds from the sale of the obligations are not allocated within a stated period (which may be within a year of the date of issue). To the extent that these obligations were valued at a premium when a Holder purchased Units, any prepayment at par would result in a loss of capital to the Holder and, in any event, reduce the amount of income that would otherwise have been paid to Holders. The tax exemption for certain housing revenue bonds depends on qualification under Section 143 of the Internal Revenue Code of 1986, as amended (the "Code"), in the case of single family mortgage revenue bonds or Section 142(a)(7) of the Code or other provisions of Federal law in the case of certain multi-family housing revenue bonds (including Section 8 assisted bonds). These sections of the Code or other provisions of Federal law contain certain ongoing requirements, including requirements relating to the cost and location of the residences financed with the proceeds of the single family mortgage revenue bonds and the income levels of tenants of the rental projects financed with the proceeds of the multi-family housing revenue bonds. While the issuers of the bonds and other parties, including the originators and servicers of the single- family mortgages and the owners of the rental projects financed with the multi- family housing revenue bonds, generally covenant to meet these ongoing requirements and generally agree to institute procedures designed to ensure that these requirements are met, there can be no assurance that these ongoing requirements will be consistently met. The failure to meet these requirements could cause the interest on the bonds to become taxable, possibly retroactively to the date of issuance, thereby reducing the value of the bonds, subjecting the Holders to unanticipated tax liabilities and possibly requiring the Trustee to sell the bonds at reduced values. Furthermore, any failure to meet these ongoing requirements might not constitute an event of default under the applicable mortgage or permit the holder to accelerate payment of the bond or require the issuer to redeem the bond. In any event, where the mortgage is insured by the Federal Housing Administration, its consent may be required before insurance proceeds would become payable to redeem the mortgage bonds. POWER FACILITY BONDS. The ability of utilities to meet their obligations with respect to revenue bonds issued on their behalf is dependent on various factors, including the rates they may charge their customers, the demand for a utility's services and the cost of providing those services. Utilities, in particular investor-owned utilities, are subject to extensive regulations relating to the rates which they may charge customers. Utilities can experience regulatory, political and consumer resistance to rate increases. Utilities engaged in long-term capital projects are especially sensitive to regulatory lags in granting rate increases. Any difficulty in obtaining timely and adequate rate increases could adversely affect a utility's results of operations. The demand for a utility's services is influenced by, among other factors, competition, weather conditions and economic conditions. Electric utilities, for example, have experienced increased competition as a result of the availability of other energy sources, the effects of conservation on the use of electricity, self-generation by industrial customers and the generation of electricity by co-generators and other independent power producers. Also, increased competition will result if federal regulators determine that utilities must open their transmission lines to competitors. Utilities which distribute natural gas also are subject to competition from alternative fuels, including fuel oil, propane and coal. The utility industry is an increasing cost business making the cost of generating electricity more expensive and heightening its sensitivity to regulation. A utility's costs are influenced by the utility's cost of capital, the availability and cost of fuel and other factors. In addition, natural gas pipeline and distribution companies have incurred increased costs as a result of long-term natural gas purchase contracts containing "take or pay" provisions which require that they pay for natural gas even if natural gas is not taken by them. There can be no assurance that a utility will be able to pass on these increased costs to customers through increased rates. Utilities incur substantial capital expenditures for plant and equipment. In the future they will also incur increasing capital and operating expenses to comply with environmental legislation such as the Clean Air Act of 1990, and other energy, licensing and other laws and regulations relating to, among other things, air emissions, the quality of drinking water, waste water discharge, solid and hazardous substance handling and disposal, and siting and licensing of facilities. Environmental legislation and regulations are changing rapidly and are the subject of current public policy debate and legislative proposals. It is increasingly likely that some or many utilities will be subject to more stringent environmental standards in the future that could result in significant capital expenditures. Future legislation and regulation could include, among other things, regulation of so-called electromagnetic fields associated with electric transmission and distribution lines as well as emissions of carbon dioxide and other so-called greenhouse gases associated with the burning of fossil fuels. Compliance with these requirements may limit a utility's operations or require substantial investments in new equipment and, as a result, may adversely affect a utility's results of operations. The electric utility industry in general is subject to various external factors including (a) the effects of inflation upon the costs of operation and construction, (b) substantially increased capital outlays and longer construction periods for larger and more complex new generating units, (c) uncertainties in predicting future load requirements, (d) increased financing requirements coupled with limited availability of capital, (e) exposure to cancellation and penalty charges on new generating units under construction, (f) problems of cost and availability of fuel, (g) compliance with rapidly changing and complex environmental, safety and licensing requirements, (h) litigation and proposed legislation designed to delay or prevent construction of generating and other facilities, (i) the uncertain effects of conservation on the use of electric energy, (j) uncertainties associated with the development of a national energy policy, (k) regulatory, political and consumer resistance to rate increases and (l) increased competition as a result of the availability of other energy sources. These factors may delay the construction and increase the cost of new facilities, limit the use of, or necessitate costly modifications to, existing facilities, impair the access of electric utilities to credit markets, or substantially increase the cost of credit for electric generating facilities. The Sponsor cannot predict at this time the ultimate effect of such factors on the ability of any issuers to meet their obligations with respect to Bonds. The National Energy Policy Act ("NEPA"), which became law in October, 1992, makes it mandatory for a utility to permit non-utility generators of electricity access to its transmission system for wholesale customers, thereby increasing competition for electric utilities. NEPA also mandated demand-side management policies to be considered by utilities. NEPA prohibits the Federal Energy Regulatory Commission from mandating electric utilities to engage in retail wheeling, which is competition among suppliers of electric generation to provide electricity to retail customers (particularly industrial retail customers) of a utility. However, under NEPA, a state can mandate retail wheeling under certain conditions. There is concern by the public, the scientific community, and the U.S. Congress regarding environmental damage resulting from the use of fossil fuels. Congressional support for the increased regulation of air, water, and soil contaminants is building and there are a number of pending or recently enacted legislative proposals which may affect the electric utility industry. In particular, on November 15, 1990, legislation was signed into law that substantially revises the Clean Air Act (the "1990 Amendments"). The 1990 Amendments seek to improve the ambient air quality throughout the United States by the year 2000. A main feature of the 1990 Amendments is the reduction of sulphur dioxide and nitrogen oxide emissions caused by electric utility power plants, particularly those fueled by coal. Under the 1990 Amendments the U.S. Environmental Protection Agency ("EPA") must develop limits for nitrogen oxide emissions by 1993. The sulphur dioxide reduction will be achieved in two phases. Phase I addresses specific generating units named in the 1990 Amendments. In Phase II the total U.S. emissions will be capped at 8.9 million tons by the year 2000. The 1990 Amendments contain provisions for allocating allowances to power plants based on historical or calculated levels. An allowance is defined as the authorization to emit one ton of sulphur dioxide. The 1990 Amendments also provide for possible further regulation of toxic air emissions from electric generating units pending the results of several federal government studies to be conducted over the next three to four years with respect to anticipated hazards to public health, available corrective technologies, and mercury toxicity. Electric utilities which own or operate nuclear power plants are exposed to risks inherent in the nuclear industry. These risks include exposure to new requirements resulting from extensive federal and state regulatory oversight, public controversy, decommissioning costs, and spent fuel and radioactive waste disposal issues. While nuclear power construction risks are no longer of paramount concern, the emerging issue is radioactive waste disposal. In addition, nuclear plants typically require substantial capital additions and modifications throughout their operating lives to meet safety, environmental, operational and regulatory requirements and to replace and upgrade various plant systems. The high degree of regulatory monitoring and controls imposed on nuclear plants could cause a plant to be out of service or on limited service for long periods. When a nuclear facility owned by an investor-owned utility or a state or local municipality is out of service or operating on a limited service basis, the utility operator or its owners may be liable for the recovery of replacement power costs. Risks of substantial liability also arise from the operation of nuclear facilities and from the use, handling, and possible radioactive emissions associated with nuclear fuel. Insurance may not cover all types or amounts of loss which may be experienced in connection with the ownership and operation of a nuclear plant and severe financial consequences could result from a significant accident or occurrence. The Nuclear Regulatory Commission has promulgated regulations mandating the establishment of funded reserves to assure financial capability for the eventual decommissioning of licensed nuclear facilities. These funds are to be accrued from revenues in amounts currently estimated to be sufficient to pay for decommissioning costs. The ability of state and local joint action power agencies to make payments on bonds they have issued is dependent in large part on payments made to them pursuant to power supply or similar agreements. Courts in Washington, Oregon and Idaho have held that certain agreements between the Washington Public Power Supply System ("WPPSS") and the WPPSS participants are unenforceable because the participants did not have the authority to enter into the agreements. While these decisions are not specifically applicable to agreements entered into by public entities in other states, they may cause a reexamination of the legal structure and economic viability of certain projects financed by joint power agencies, which might exacerbate some of the problems referred to above and possibly lead to legal proceedings questioning the enforceability of agreements upon which payment of these bonds may depend. WATER AND SEWER REVENUE BONDS. Water and sewer bonds are generally payable from user fees. The ability of state and local water and sewer authorities to meet their obligations may be affected by failure of municipalities to utilize fully the facilities constructed by these authorities, economic or population decline and resulting decline in revenue from user charges, rising construction and maintenance costs and delays in construction of facilities, impact of environmental requirements, failure or inability to raise user charges in response to increased costs, the difficulty of obtaining or discovering new supplies of fresh water, the effect of conservation programs and the impact of "no growth" zoning ordinances. In some cases this ability may be affected by the continued availability of Federal and state financial assistance and of municipal bond insurance for future bond issues. UNIVERSITY AND COLLEGE BONDS. The ability of universities and colleges to meet their obligations is dependent upon various factors, including the size and diversity of their sources of revenues, enrollment, reputation, management expertise, the availability and restrictions on the use of endowments and other funds, the quality and maintenance costs of campus facilities, and, in the case of public institutions, the financial condition of the relevant state or other governmental entity and its policies with respect to education. The institution's ability to maintain enrollment levels will depend on such factors as tuition costs, demographic trends, geographic location, geographic diversity and quality of the student body, quality of the faculty and the diversity of program offerings. Legislative or regulatory action in the future at the Federal, state or local level may directly or indirectly affect eligibility standards or reduce or eliminate the availability of funds for certain types of student loans or grant programs, including student aid, research grants and work-study programs, and may affect indirect assistance for education. LEASE RENTAL BONDS. Lease rental bonds are issued for the most part by governmental authorities that have no taxing power or other means of directly raising revenues. Rather, the authorities are financing vehicles created solely for the construction of buildings (administrative offices, convention centers and prisons, for example) or the purchase of equipment (police cars and computer systems, for example) that will be used by a state or local government (the "lessee"). Thus, the bonds are subject to the ability and willingness of the lessee government to meet its lease rental payments which include debt service on the bonds. Willingness to pay may be subject to changes in the views of citizens and government officials as to the essential nature of the finance project. Lease rental bonds are subject, in almost all cases, to the annual appropriation risk, i.e., the lessee government is not legally obligated to budget and appropriate for the rental payments beyond the current fiscal year. These bonds are also subject to the risk of abatement in many states--rental bonds cease in the event that damage, destruction or condemnation of the project prevents its use by the lessee. (In these cases, insurance provisions and reserve funds designed to alleviate this risk become important credit factors). In the event of default by the lessee government, there may be significant legal and/or practical difficulties involved in the reletting or sale of the project. Some of these issues, particularly those for equipment purchase, contain the so-called "substitution safeguard", which bars the lessee government, in the event it defaults on its rental payments, from the purchase or use of similar equipment for a certain period of time. This safeguard is designed to insure that the lessee government will appropriate the necessary funds even though it is not legally obligated to do so, but its legality remains untested in most, if not all, states. CAPITAL IMPROVEMENT FACILITY BONDS. The Portfolio of a Trust may contain Bonds which are in the capital improvement facilities category. Capital improvement bonds are bonds issued to provide funds to assist political subdivisions or agencies of a state through acquisition of the underlying debt of a state or local political subdivision or agency which bonds are secured by the proceeds of the sale of the bonds, proceeds from investments and the indebtedness of a local political subdivision or agency. The risks of an investment in such bonds include the risk of possible prepayment or failure of payment of proceeds on and default of the underlying debt. SOLID WASTE DISPOSAL BONDS. Bonds issued for solid waste disposal facilities are generally payable from tipping fees and from revenues that may be earned by the facility on the sale of electrical energy generated in the combustion of waste products. The ability of solid waste disposal facilities to meet their obligations depends upon the continued use of the facility, the successful and efficient operation of the facility and, in the case of waste-to-energy facilities, the continued ability of the facility to generate electricity on a commercial basis. All of these factors may be affected by a failure of municipalities to fully utilize the facilities, an insufficient supply of waste for disposal due to economic or population decline, rising construction and maintenance costs, any delays in construction of facilities, lower-cost alternative modes of waste processing and changes in environmental regulations. Because of the relatively short history of this type of financing, there may be technological risks involved in the satisfactory construction or operation of the projects exceeding those associated with most municipal enterprise projects. Increasing environmental regulation on the federal, state and local level has a significant impact on waste disposal facilities. While regulation requires more waste producers to use waste disposal facilities, it also imposes significant costs on the facilities. These costs include compliance with frequently changing and complex regulatory requirements, the cost of obtaining construction and operating permits, the cost of conforming to prescribed and changing equipment standards and required methods of operation and, for incinerators or waste-to-energy facilities, the cost of disposing of the waste residue that remains after the disposal process in an environmentally safe manner. In addition, waste disposal facilities frequently face substantial opposition by environmental groups and officials to their location and operation, to the possible adverse effects upon the public health and the environment that may be caused by wastes disposed of at the facilities and to procedures. Waste disposal facilities benefit from laws which require waste to be disposed of in a certain manner but any relaxation of these laws could cause a decline in demand for the facilities' services. Finally, waste-to-energy facilities are concerned with many of the same issues facing utilities insofar as they derive revenues from the sale of energy to local power utilities (see Power Facility Bonds above). MORAL OBLIGATION BONDS. The Trust may also include "moral obligation" bonds. If an issuer of moral obligation bonds is unable to meet its obligations, the repayment of the bonds becomes a moral commitment but not a legal obligation of the state or municipality in question. Even though the state may be called on to restore any deficits in capital reserve funds of the agencies or authorities which issued the bonds, any restoration generally requires appropriation by the state legislature and accordingly does not constitute a legally enforceable obligation or debt of the state. The agencies or authorities generally have no taxing power. REFUNDED BONDS. Refunded Bonds are typically secured by direct obligations of the U.S. Government, or in some cases obligations guaranteed by the U.S. Government, placed in an escrow account maintained by an independent trustee until maturity or a predetermined redemption date. These obligations are generally noncallable prior to maturity or the predetermined redemption date. In a few isolated instances to date, however, bonds which were thought to be escrowed to maturity have been called for redemption prior to maturity. AIRPORT, PORT AND HIGHWAY REVENUE BONDS. Certain facility revenue bonds are payable from and secured by the revenues from the ownership and operation of particular facilities, such as airports (including airport terminals and maintenance facilities), bridges, marine terminals, turnpikes and port authorities. For example, the major portion of gross airport operating income is generally derived from fees received from signatory airlines pursuant to use agreements which consist of annual payments for airport use, occupancy of certain terminal space, facilities, service fees, concessions and leases. Airport operating income may therefore be affected by the ability of the airlines to meet their obligations under the use agreements. The air transport industry is experiencing significant variations in earnings and traffic, due to increased competition, excess capacity, increased aviation fuel costs, deregulation, traffic constraints, the recent recession and other factors. As a result, several airlines are experiencing severe financial difficulties. Several airlines including America West Airlines have sought protection from their creditors under Chapter 11 of the Bankruptcy Code. In addition, other airlines such as Midway Airlines Inc., Eastern Airlines, Inc. and Pan American Corporation have been liquidated. However, Continental Airlines and Trans World Airlines have emerged from bankruptcy. The Sponsor cannot predict what effect these industry conditions may have on airport revenues which are dependent for payment on the financial condition of the airlines and their usage of the particular airport facility. Furthermore, proposed Legislation would provide the U.S. Secretary of Transportation with the temporary authority to freeze airport fees upon the occurrence of disputes between a particular airport facility and the airlines utilizing that facility. Similarly, payment on bonds related to other facilities is dependent on revenues from the projects, such as use fees from ports, tolls on turnpikes and bridges and rents from buildings. Therefore, payment may be adversely affected by reduction in revenues due to such factors and increased cost of maintenance or decreased use of a facility, lower cost of alternative modes of transportation or scarcity of fuel and reduction or loss of rents. SPECIAL TAX BONDS. Special tax bonds are payable from and secured by the revenues derived by a municipality from a particular tax such as a tax on the rental of a hotel room, on the purchase of food and beverages, on the rental of automobiles or on the consumption of liquor. Special tax bonds are not secured by the general tax revenues of the municipality, and they do not represent general obligations of the municipality. Therefore, payment on special tax bonds may be adversely affected by a reduction in revenues realized from the underlying special tax due to a general decline in the local economy or population or due to a decline in the consumption, use or cost of the goods and services that are subject to taxation. Also, should spending on the particular goods or services that are subject to the special tax decline, the municipality may be under no obligation to increase the rate of the special tax to ensure that sufficient revenues are raised from the shrinking taxable base. TAX ALLOCATION BONDS. Tax allocation bonds are typically secured by incremental tax revenues collected on property within the areas where redevelopment projects, financed by bond proceeds are located ("project areas"). Such payments are expected to be made from projected increases in tax revenues derived from higher assessed values of property resulting from development in the particular project area and not from an increase in tax rates. Special risk considerations include: reduction of, or a less than anticipated increase in, taxable values of property in the project area, caused either by economic factors beyond the Issuer's control (such as a relocation out of the project area by one or more major property owners) or by destruction of property due to natural or other disasters; successful appeals by property owners of assessed valuations; substantial delinquencies in the payment of property taxes; or imposition of any constitutional or legislative property tax rate decrease. TRANSIT AUTHORITY BONDS. Mass transit is generally not self-supporting from fare revenues. Therefore, additional financial resources must be made available to ensure operation of mass transit systems as well as the timely payment of debt service. Often such financial resources include Federal and state subsidies, lease rentals paid by funds of the state or local government or a pledge of a special tax such as a sales tax or a property tax. If fare revenues or the additional financial resources do not increase appropriately to pay for rising operating expenses, the ability of the issuer to adequately service the debt may be adversely affected. CONVENTION FACILITY BONDS. The Portfolio of a Trust may contain Bonds of issuers in the convention facilities category. Bonds in the convention facilities category include special limited obligation securities issued to finance convention and sports facilities payable from rental payments and annual governmental appropriations. The governmental agency is not obligated to make payments in any year in which the monies have not been appropriated to make such payments. In addition, these facilities are limited use facilities that may not be used for purposes other than as convention centers or sports facilities. PUERTO RICO. The Portfolio may contain bonds of issuers which will be affected by general economic conditions in Puerto Rico. Puerto Rico's unemployment rate remains significantly higher than the U.S. unemployment rate. Furthermore, the economy is largely dependent for its development upon U.S. policies and programs that are being reviewed and may be eliminated. The Puerto Rican economy is affected by a number of Commonwealth and Federal investment incentive programs. For example, Section 936 of the Internal Revenue Code (the "Code") provides for a credit against Federal income taxes for U.S. companies operating on the island if certain requirements are met. The Omnibus Budget Reconciliation Act of 1993 imposes limits on such credit, effective for tax years beginning after 1993. In addition, from time to time proposals are introduced in Congress which, if enacted into law, would eliminate some or all of the benefits of Section 936. Although no assessment can be made at this time of the precise effect of such limitation, it is expected that the limitation of Section 936 credits would have a negative impact on Puerto Rico's economy. Aid for Puerto Rico's economy has traditionally depended heavily on Federal programs, and current Federal budgetary policies suggest that an expansion of aid to Puerto Rico is unlikely. An adverse effect on the Puerto Rican economy could result from other U.S. policies, including a reduction of tax benefits for distilled products, further reduction in transfer payment programs such as food stamps, curtailment of military spending and policies which could lead to a stronger dollar. In a plebiscite held in November, 1993, the Puerto Rican electorate chose to continue Puerto Rico's Commonwealth status. Previously proposed legislation, which was not enacted, would have preserved the federal tax exempt status of the outstanding debts of Puerto Rico and its public corporations regardless of the outcome of the referendum, to the extent that similar obligations issued by states are so treated and subject to the provisions of the Code currently in effect. There can be no assurance that any pending or future legislation finally enacted will include the same or similar protection against loss of tax exemption. The November 1993 plebiscite can be expected to have both direct and indirect consequences on such matters as the basic characteristics of future Puerto Rico debt obligations, the markets for these obligations, and the types, levels and quality of revenue sources pledged for the payment of existing and future debt obligations. Such possible consequences include, without limitation, legislative proposals seeking restoration of the status of Section 936 benefits otherwise subject to the limitations discussed above. However, no assessment can be made at this time of the economic and other effects of a change in federal laws affecting Puerto Rico as a result of the November 1993 plebiscite. INSURANCE. Certain Bonds (the "Insured Bonds") may be insured or guaranteed by AMBAC Indemnity Corporation ("AMBAC"), Asset Guaranty Reinsurance Company ("Asset Guaranty"), Capital Guaranty Insurance Company ("CGIC"), Capital Markets Assurance Corp. ("CAPMAC"), Connie Lee Insurance Company ("Connie Lee"), Financial Guaranty Insurance Company "Financial Guaranty"), Financial Security Assurance Inc. ("FSA"), or MBIA Insurance Corporation ("MBIA") (collectively, the "Insurance Companies"). The claims-paying ability of each of these companies, unless otherwise indicated, is rated AAA by Standard & Poor's or another acceptable national rating service. The ratings are subject to change at any time at the discretion of the rating agencies. In determining whether to insure bonds, the Insurance Companies severally apply their own standards. The cost of this insurance is borne either by the issuers or previous owners of the bonds or by the Sponsor. The insurance policies are non- cancellable and will continue in force so long as the Insured Bonds are outstanding and the insurers remain in business. The insurance policies guarantee the timely payment of principal and interest on but do not guarantee the market value of the Insured Bonds or the value of the Units. The insurance policies generally do not provide for accelerated payments of principal or, except in the case of any portfolio insurance policies, cover redemptions resulting from events of taxability. If the issuer of any Insured Bond should fail to make an interest or principal payment, the insurance policies generally provide that the Trustee or its agent shall give notice of nonpayment to the Insurance Company or its agent and provide evidence of the Trustee's right to receive payment. The Insurance Company is then required to disburse the amount of the failed payment to the Trustee or its agent and is thereafter subrogated to the Trustee's right to receive payment from the issuer. The following are brief descriptions of certain of the insurance companies that may insure or guarantee certain Bonds. The financial information presented for each company has been determined on a statutory basis and is unaudited. AMBAC is a Wisconsin-domiciled stock insurance company, regulated by the Insurance Department of the State of Wisconsin, and licensed to do business in various states, with admitted assets of approximately $2,204,000,000 and policyholders' surplus of approximately $792,000,000 as of March 31, 1995. AMBAC is a wholly-owned subsidiary of AMBAC Inc., a financial holding company which is publicly owned following a complete divestiture by Citibank during the first quarter of 1992. Asset Guaranty is a New York State insurance company licensed to write financial guarantee, credit, residual value and surety insurance. Asset Guaranty commenced operations in mid-1988 by providing reinsurance to several major monoline insurers. Asset Guaranty also issued limited amounts of primary financial guaranty insurance, but not in direct competition with the primary mono-line companies for which it acts as a reinsurer. The parent holding company of Asset Guaranty, Asset Guarantee Inc. (AGI), merged with Enhance Financial Services (EFS) in June, 1990 to form Enhance Financial Services Group Inc. (EFSG). The two main, 100%-owned subsidiaries of EFSG, Asset Guaranty and Enhance Reinsurance Company (ERC), share common management and physical resources. After an initial public offering completed in February 1992 and the sale by Merrill Lynch & Co. of its stake, EFSG is 49.8%-owned by the public, 29.9% by US West Financial Services, 14.1% by Manufacturers Life Insurance Co. and 6.2% by senior management. Both ERC and Asset Guaranty are rated "AAA" for claims paying ability by Duff & Phelps. ERC is rated triple-A for claims-paying ability by both S&P and Moody's. Asset Guaranty received a "AA" claims-paying-ability rating from S&P during August 1993, but remains unrated by Moody's. As of March 31, 1995 Asset Guaranty had admitted assets of approximately $166,000,000 and policyholders' surplus of approximately $77,000,000. CAPMAC commenced operations in December, 1987 as the second monoline financial guaranty insurance company (after FSA) organized solely to insure non-municipal obligations. CAPMAC, a New York corporation, is a wholly-owned subsidiary of CAPMAC Holdings, Inc. (CHI), which was sold in 1992 by Citibank (New York State) to a group of 12 investors led by the following: Dillon Read's Saratoga Partners II; L.P. (Saratoga), an acquisition fund; Caprock Management, Inc., representing Rockefeller family interests; Citigrowth Fund, a Citicorp venture capital group; and CAPMAC senior management and staff. These groups control approximately 70% of the stock of CHI. CAPMAC had traditionally specialized in guaranteeing consumer loan and trade receivable asset-backed securities. Under the new ownership group CAPMAC intends to become involved in the municipal bond insurance business, as well as their traditional non- municipal business. As of March 31, 1995 CAPMAC's admitted assets were approximately $210,000,000 and its policyholders' surplus was approximately $138,000,000. CGIC, a monoline bond insuror headquartered in San Francisco, California, was established in November 1986 to assume the financial guaranty business of United States Fidelity and Guaranty Company ("USF&G"). It is a wholly-owned subsidiary of Capital Guaranty Corporation ("CGC") whose stock is owned by: Constellation Investments, Inc., an affiliate of Baltimore Gas & Electric, Fleet/Norstar Financial Group, Inc., Safeco Corporation, Sibag Finance Corporation, an affiliate of Siemens AG, and USF&G, the 8th largest property/casualty company in the U.S. as measured by net premiums written, and CGC management. As of March 31, 1995, CGIC had total admitted assets of approximately $309,000,000 and policyholders' surplus of approximately $171,000,000. Connie Lee is a wholly owned subsidiary of College Construction Loan Insurance Association ("CCLIA"), a government-sponsored enterprise established by Congress to provide American academic institutions with greater access to low-cost capital through enhancement. Connie Lee, the operating insurance company, was incorporated in 1987 and began business as a reinsurer of tax- exempt bonds of colleges, universities, and teaching hospitals with a concentration on the hospital sector. During the fourth quarter of 1991 Connie Lee began underwriting primary bond insurance which will focus largely on the college and university sector. CCLIA's founding shareholders are the U.S. Department of Education, which owns 36% of CCLIA, and the Student Loan Marketing Association ("Sallie Mae"), which owns 14%. The other principal owners are: Pennsylvania Public School Employees' Retirement System, Metropolitan Life Insurance Company, Kemper Financial Services, Johnson family funds and trusts, Northwestern University, Rockefeller & Co., Inc. administered trusts and funds, and Stanford University. Connie Lee is domiciled in the state of Wisconsin and has licenses to do business in 47 states and the District of Columbia. As of March 31, 1995, its total admitted assets were approximately $195,000,000 and policyholders' surplus was approximately $108,000,000. Financial Guaranty, a New York stock insurance company, is a wholly-owned subsidiary of FGIC Corporation which is wholly-owned by General Electric Capital Corporation. The investors in the FGIC Corporation are not obligated to pay the debts of or the claims against Financial Guaranty. Financial Guaranty commenced its business of providing insurance and financial guarantees for a variety of investment instruments in January 1984 and is currently authorized to provide insurance in 49 states and the District of Columbia. It files reports with state regulatory agencies and is subject to audit and review by those authorities. As of March 31, 1995, its total admitted assets were approximately $2,172,000,000 and its policyholders' surplus was approximately $963,000,000. FSA is a monoline property and casualty insurance company incorporated in New York in 1984. It is a wholly-owned subsidiary of Financial Security Assurance Holdings Ltd., which was acquired in December 1989 by US West, Inc., the regional Bell Telephone Company serving the Rocky Mountain and Pacific Northwestern states. U.S. West is currently seeking to sell FSA. FSA is licensed to engage in the surety business in 42 states and the District of Columbia. FSA is engaged exclusively in the business of writing financial guaranty insurance on both tax-exempt and non-municipal securities. As of March 31, 1995, FSA had policyholders' surplus of approximately $341,000,000 and total admitted assets of approximately $806,000,000. MBIA is the principal operating subsidiary of MBIA Inc. The principal shareholders of MBIA Inc. were originally Aetna Casualty and Surety Company, The Fund American Companies, Inc., subsidiaries of CIGNA Corporation and Credit Local de France, CAECL, S.A. These principal shareholders now own approximately 13% of the outstanding common stock of MBIA Inc., following a series of four public equity offerings over a five-year period. As of March 31, 1995, MBIA had admitted assets of approximately $3,504,000,000 and policyholders' surplus of approximately $1,132,000,000. Insurance companies are subject to regulation and supervision in the jurisdictions in which they do business under statutes which delegate regulatory, supervisory and administrative powers to state insurance commissioners. This regulation, supervision and administration relate, among other things, to: the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature of and limitations on investments; deposits of securities for the benefit of policyholders; approval of policy forms and premium rates; periodic examinations of the affairs of insurance companies; annual and other reports required to be filed on the financial condition of insurers or for other purposes; and requirements regarding reserves for unearned premiums, losses and other matters. Regulatory agencies require that premium rates not be excessive, inadequate or unfairly discriminatory. Insurance regulation in many states also includes "assigned risk" plans, reinsurance facilities, and joint underwriting associations, under which all insurers writing particular lines of insurance within the jurisdiction must accept, for one or more of those lines, risks unable to secure coverage in voluntary markets. A significant portion of the assets of insurance companies is required by law to be held in reserve against potential claims on policies and is not available to general creditors. Although the Federal government does not regulate the business of insurance, Federal initiatives can significantly impact the insurance business. Current and proposed Federal measures which may significantly affect the insurance business include pension regulation (ERISA), controls on medical care costs, minimum standards for no-fault automobile insurance, national health insurance, personal privacy protection, tax law changes affecting life insurance companies or the relative desirability of various personal investment vehicles and repeal of the current antitrust exemption for the insurance business. (If this exemption is eliminated, it will substantially affect the way premium rates are set by all property-liability insurers.) In addition, the Federal government operates in some cases as a co-insurer with the private sector insurance companies. Insurance companies are also affected by a variety of state and Federal regulatory measures and judicial decisions that define and extend the risks and benefits for which insurance is sought and provided. These include judicial redefinitions of risk exposure in areas such as products liability and state and Federal extension and protection of employee benefits, including pension, workers' compensation, and disability benefits. These developments may result in short-term adverse effects on the profitability of various lines of insurance. Longer-term adverse effects can often be minimized through prompt repricing of coverages and revision of policy terms. In some instances, these developments may create new opportunities for business growth. All insurance companies write policies and set premiums based on actuarial assumptions about mortality, injury, the occurrence of accidents and other insured events. These assumptions, while well supported by past experience, necessarily do not take account of future events. The occurrence in the future of unforeseen circumstances could affect the financial condition of one or more insurance companies. The insurance business is highly competitive and with the deregulation of financial service businesses, it should become more competitive. In addition, insurance companies may expand into non-traditional lines of business which may involve different types of risks. The above financial information relating to the Insurance Companies has been obtained from publicly available information. No representation is made as to the accuracy or adequacy of the information or as to the absence of material adverse changes since the information was made available to the public. LITIGATION AND LEGISLATION. To the best knowledge of the Sponsor, there is no litigation pending as of the Initial Date in respect of any Bonds which might reasonably be expected to have a material adverse effect upon the Trust. At any time after the Initial Date of Deposit, litigation may be initiated on a variety of grounds, or legislation may be enacted, with respect to Bonds in the Trust. Litigation, for example, challenging the issuance of pollution control revenue bonds under environmental protection statutes may affect the validity of Bonds or the tax-free nature of their interest. While the outcome of litigation of this nature can never be entirely predicted, opinions of bond counsel are delivered on the date of issuance of each Bond to the effect that the Bond has been validly issued and that the interest thereon is exempt from Federal income tax. In addition, other factors may arise from time to time which potentially may impair the ability of issuers to make payments due on the Bonds. Under the Federal Bankruptcy Act, a political subdivision or public agency or instrumentality of any state, including municipalities, may proceed to restructure or otherwise alter the terms of its obligations, including those of the type comprising the Trust's Portfolio. The Sponsor is unable to predict what effect, if any, this legislation might have on the Trust. From time to time Congress considers proposals to tax the interest on state and local obligations, such as the Bonds. The Supreme Court clarified in South Carolina v. Baker (decided April 20, 1988) that the U.S. Constitution does not prohibit Congress from passing a nondiscriminatory tax on interest on state and local obligations. This type of legislation, if enacted into law, could adversely affect an investment in Units. Holders are urged to consult their own tax advisers. TAX EXEMPTION. In the opinion of bond counsel rendered on the date of issuance of each Bond, the interest on each Bond is excludable from gross income under existing law for regular Federal income tax purposes (except in certain circumstances depending on the Holder) but may be subject to state and local taxes. As discussed under Taxes below, interest on some or all of the Bonds may become subject to regular Federal income tax, perhaps retroactively to their date of issuance, as a result of changes in Federal law or as a result of the failure of issuers (or other users of the proceeds of the Bonds) to comply with certain ongoing requirements. Moreover, the Internal Revenue Service is expanding its examination program with respect to tax-exempt bonds. The expanded examination program will consist of, among other measures, increased enforcement against abusive transactions, (including the expected issuance of audit guidelines) and expanded compliance achieved by means of expected revisions to the tax-exempt bond information return forms. At this time, it is uncertain whether the tax exempt status of any of the Bonds would be affected by such proceedings, or whether such effect, if any, would be retroactive. In certain cases, a Bond may provide that if the interest on the Bond should ultimately be determined to be taxable, the Bond would become due and payable by its issuer, and, in addition, may provide that any related letter of credit or other security could be called upon if the issuer failed to satisfy all or part of its obligation. In other cases, however, a Bond may not provide for the acceleration or redemption of the Bond or a call upon the related letter of credit or other security upon a determination of taxability. In those cases in which a Bond does not provide for acceleration or redemption or in which both the issuer and the bank or other entity issuing the letter of credit or other security are unable to meet their obligations to pay the amounts due on the Bond as a result of a determination of taxability, the Trustee would be obligated to sell the Bond and, since it would be sold as a taxable security, it is expected that it would have to be sold at a substantial discount from current market price. In addition, as mentioned above, under certain circumstances Holders could be required to pay income tax on interest received prior to the date on which the interest is determined to be taxable. On the Date of Deposit, each Unit in a Trust represented a fractional undivided interest in the principal and net income of such Trust as is set forth in Part A, "Summary of Essential Information." If any Units are redeemed after the date of this Prospectus by the Trustee, the principal amount of Bonds in the affected Trust will be reduced by an amount allocable to redeemed Units and the fractional undivided interest in the affected Trust represented by each unredeemed Unit will be increased. Units will remain outstanding until redeemed upon tender to the Trustee by any Unit holder, which may include the Sponsor, or until the termination of the Trust Agreement. (See "Amendment and Termination of the Trust Agreement-- The following discussion addresses only the tax consequences of Units held as capital assets and does not address the tax consequences of Units held by dealers, financial institutions or insurance companies. In the opinion of Davis Polk & Wardwell, special counsel for the Sponsor, under existing law: The Trusts are not associations taxable as corporations for Federal income tax purposes, and income received by the Trusts will be treated as the income of the Unit holders ("Holders") in the manner set forth below. Each Holder of Units of a Trust will be considered the owner of a pro rata portion of each Bond in the Trust under the grantor trust rules of Sections 671-679 of the Internal Revenue Code of 1986, as amended (the "Code"). In order to determine the face amount of a Holder's pro rata portion of each Bond on the Date of Deposit, see "Aggregate Principal" under "Portfolio of Securities". The total cost to a Holder of his Units, including sales charges, is allocated to his pro rata portion of each Bond, in proportion to the fair market values thereof on the date the Holder purchases his Units, in order to determine his tax cost for his pro rata portion of each Bond. In order for a Holder who purchases his Units on the Date of Deposit to determine the fair market value of his pro rata portion of each Bond on such date, see "Cost of Securities to Trust" under "Portfolio of Securities". Each Holder of Units of a Trust will be considered to have received the interest on his pro rata portion of each Bond when interest on the Bond is received by the Trust. In the opinion of bond counsel (delivered on the date of issuance of each Bond), such interest will be excludable from gross income for regular Federal income tax purposes (except in certain limited circumstances referred to below). Amounts received by a Trust pursuant to a bank letter of credit, guarantee or insurance policy with respect to payments of principal, premium or interest on a Bond in the Trust will be treated for Federal income tax purposes in the same manner as if such amounts were paid by the issuer of the Bond. The Trusts may contain Bonds which were originally issued at a discount ("original issue discount"). The following principles will apply to each Holder's pro rata portion of any Bond originally issued at a discount. In general, original issue discount is defined as the difference between the price at which a debt obligation was issued and its stated redemption price at maturity. Original issue discount on a tax-exempt obligation issued after September 3, 1982, is deemed to accrue as tax-exempt interest over the life of the obligation under a formula based on the compounding of interest. Original issue discount on a tax-exempt obligation issued before July 2, 1982 is deemed to accrue as tax-exempt interest ratably over the life of the obligation. Original issue discount on any tax-exempt obligation issued during the period beginning July 2, 1982 and ending September 3, 1982 is also deemed to accrue as tax-exempt interest over the life of the obligation, although it is not clear whether such accrual is ratable or is determined under a formula based on the compounding of interest. If a Holder's tax cost for his pro rata portion of a Bond issued with original issue discount is greater than its "adjusted issue price" but less than its stated redemption price at maturity (as may be adjusted for certain payments), the Holder will be considered to have purchased his pro rata portion of the Bond at an "acquisition premium." A Holder's adjusted tax basis for his pro rata portion of a Bond issued with original issue discount will include original issue discount accrued during the period such Holder held his Units. Such increases to the Holder's tax basis in his pro rata portion of the Bond resulting from the accrual of original issue discount, however, will be reduced by the amortization of any such acquisition premium. If a Holder's tax basis for his pro rata portion of a Bond in the Holder's Trust exceeds the redemption price at maturity thereof (subject to certain adjustments), the Holder will be considered to have purchased his pro rata portion of the Bond with "amortizable bond premium". The Holder is required to amortize such bond premium over the term of the Bond. Such amortization is only a reduction of basis for his pro rata portion of the Bond and does not result in any deduction against the Holder's income. Therefore, under some circumstances, a Holder may recognize taxable gain when his pro rata portion of a Bond is disposed of for an amount equal to or less than his original tax basis therefor. A Holder will recognize taxable gain or loss when all or part of his pro rata portion of a Bond in his Trust is disposed of by the Trust for an amount greater or less than his adjusted tax basis. Any such taxable gain or loss will be capital gain or loss, except that any gain from the disposition of a Holder's pro rata portion of a Bond acquired by the Holder at a "market discount" (i.e., where the Holder's original basis for his pro rata portion of the Bond (plus any original issue discount which will accrue thereon until its maturity) is less than its stated redemption price at maturity) would be treated as ordinary income to the extent the gain does not exceed the accrued market discount. Capital gains are generally taxed at the same rate as ordinary income. However, the excess of net long- term capital gains over net short-term capital losses may be taxed at a lower rate than ordinary income for certain noncorporate taxpayers. A capital gain or loss is long-term if the asset is held for more than one year and short-term if held for one year or less. The deduction of capital losses is subject to limitations. A Holder will also be considered to have disposed of all or part of his pro rata portion of each Bond when he sells or redeems all or some of his Units. Under Section 265 of the Code, a Holder (except a corporate Holder) is not entitled to a deduction for his pro rata share of fees and expenses of a Trust because the fees and expenses are incurred in connection with the production of tax-exempt income. Further, if borrowed funds are used by a Holder to purchase or carry Units of any Trust, interest on such indebtedness will not be deductible for Federal income tax purposes. In addition, under rules used by the Internal Revenue Service, the purchase of Units may be considered to have been made with borrowed funds even though the borrowed funds are not directly traceable to the purchase of Units. Similar rules may be applicable for state tax purposes. From time to time proposals are introduced in Congress and state legislatures which, if enacted into law, could have an adverse impact on the tax-exempt status of the Bonds. It is impossible to predict whether any legislation in respect of the tax status of interest on such obligations may be proposed and eventually enacted at the Federal or state level. The foregoing discussion relates only to Federal income taxes. Depending on their state of residence, Holders may be subject to state and local taxation and should consult their own tax advisers in this regard. * * * * Interest on certain tax-exempt bonds issued after August 7, 1986 will be a preference item for purposes of the alternative minimum tax ("AMT"). The Sponsor believes that interest (including any original issue discount) on the Bonds should not be subject to the AMT for individuals or corporations under this rule. A corporate Holder should be aware, however, that the accrual or receipt of tax-exempt interest not subject to the AMT may give rise to an alternative minimum tax liability (or increase an existing liability) because the interest income will be included in the corporation's "adjusted current earnings" for purposes of the adjustment to alternative minimum taxable income required by Section 56(g) of the Code and will be taken into account for purposes of the environmental tax on corporations under Section 59A of the Code, which is based on an alternative minimum taxable income. In addition, interest on the Bonds must be taken into consideration in computing the portion, if any, of social security benefits that will be included in an individual's gross income and subject to Federal income tax. Holders are urged to consult their own tax advisers concerning an investment in Units. At the time of issuance of each Bond, an opinion relating to the validity of the Bond and to the exemption of interest thereon from regular Federal income taxes was or will be rendered by bond counsel. Neither the Sponsor nor Davis Polk & Wardwell have made or will make any review of the proceedings relating to the issuance of the Bonds or the basis for these opinions. The tax exemption is dependent upon the issuer's (and other users') compliance with certain ongoing requirements, and the opinion of bond counsel assumes that these requirements will be complied with. However, there can be no assurance that the issuer (and other users) will comply with these requirements, in which event the interest on the Bond could be determined to be taxable retroactively to the date of issuance. In the case of certain of the Bonds, the opinions of bond counsel indicate that interest on such Bonds received by a "substantial user" of the facilities being financed with the proceeds of such Bonds, or persons related thereto, for periods while such Bonds are held by such a user or related person, will not be exempt from regular Federal income taxes, although interest on such Bonds received by others would be exempt from regular Federal income taxes. "Substantial user" is defined under U.S. Treasury Regulations to include only a person whose gross revenue derived with respect to the facilities financed by the issuance of bonds is more than 5% of the total revenue derived by all users of such facilities, or who occupies more than 5% of the usable area of such facilities or for whom such facilities or a part thereof were specifically constructed, reconstructed or acquired. "Related persons" are defined to include certain related natural persons, affiliated corporations, partners and partnerships. Similar rules may be applicable for state tax purposes. After the end of each calendar year, the Trustee will furnish to each Holder an annual statement containing information relating to the interest received by the Trust on the Bonds, the gross proceeds received by the Trust from the disposition of any Bond (resulting from redemption or payment at maturity of any Bond or the sale by the Trust of any Bond), and the fees and expenses paid by the Trust. The Trustee will also furnish annual information returns to each Holder and to the Internal Revenue Service. Holders are required to report to the Internal Revenue Service the amount of tax-exempt interest received during the year. All or some portion of the expenses incurred in establishing each Trust, including the cost of the initial preparation of documents relating to a Trust, Federal and State registration fees, the initial fees and expenses of the Trustee, legal expenses and any other out-of-pocket expenses will be paid by the Trust, and amortized over five years. Any balance of the expenses incurred in establishing a Trust, as well as advertising and selling expenses and other out-of-pocket expenses will be paid at no cost to the Trusts. TRUSTEE'S, SPONSOR'S AND EVALUATOR'S FEES The Trustee will receive for its ordinary recurring services to a Trust an annual fee in the amount set forth under Part A, "Summary of Essential Information." For a discussion of the services performed by the Trustee pursuant to its obligations under the Trust Agreement, see "Rights of Unit Holders." The Trustee will receive the benefit of any reasonable cash balances in the Income and Principal Accounts. There are no management fees and the Sponsor earns only a nominal Portfolio Supervision fee (the "Supervision Fee"), which is earned for Portfolio supervisory services. This fee is based upon the greatest face amount of Bonds in the Trust at any time during the calendar year with respect to which the fee is being computed. The Supervision Fee, which is not to exceed the amount set forth in Part A-- "Summary of Essential Information", may exceed the actual costs of providing Portfolio supervisory services for such Trust, but at no time will the total amount the Sponsor receives for Portfolio supervisory services rendered to all series of Tax Exempt Securities Trust in any calendar year exceed the aggregate cost to them of supplying such services in such year. In addition, the Sponsor may also be reimbursed for bookkeeping and other administrative services provided to the Trust in amounts not exceeding their costs of providing these services. The Evaluator will receive a fee in the amount set forth under Part A, "Summary of Essential Information," for each evaluation of the Bonds in a Trust. For a discussion of the services performed by the Evaluator pursuant to its obligations under the Trust Agreement, see "Evaluator--Responsibility" and "Public Offering--Offering Price." Any of such fees may be increased without approval of the Unit holders by amounts not exceeding proportionate increases in consumer prices for services as measured by the United States Department of Labor's Consumer Price Index entitled "All Services Less Rent" or, if such Index is no longer published, in a similar Index to be determined by the Trustee and the Sponsor. The following additional charges are or may be incurred by a Trust: all expenses of the Trustee (including fees and expenses of counsel and auditors) incurred in connection with its activities under the Trust Agreement, including reports and communications to Unit holders; expenses and costs of any action undertaken by the Trustee to protect a Trust and the rights and interests of the Unit holders; fees of the Trustee for any extraordinary services performed under the Trust Agreement; indemnification of the Trustee for any loss or liability accruing to it without gross negligence, bad faith or willful misconduct on its part, arising out of or in connection with its acceptance or administration of a Trust; to the extent lawful, expenses (including legal, accounting and printing expenses) of maintaining registration or qualification of the Units and/or a Trust under Federal or state securities laws subsequent to initial registration so long as the Sponsor maintains a market for the Units and all taxes and other governmental charges imposed upon the Bonds or any part of a Trust (no such taxes or charges are being levied or made or, to the knowledge of the Sponsor, contemplated). The above expenses, including the Trustee's fee, when paid by or owing to the Trustee, are secured by a lien on the Trust. In addition, the Trustee is empowered to sell Bonds in order to make funds available to pay all expenses. During the initial public offering period, the Public Offering Price of the Units of a Trust is determined by adding to the Evaluator's determination of the aggregate OFFERING price of the Bonds per Unit a sales charge equal to a percentage of the Public Offering Price of the Units of the Trust, as set forth in the table below. After the initial public offering period, the Public Offering Price of the Units of a Trust will be determined by adding to the Evaluator's determination of the aggregate BID price of the Bonds per Unit a sales charge equal to 5.00% of the Public Offering Price (5.263% of the aggregate bid price of the Bonds per Unit). A proportionate share of accrued and undistributed interest on the Bonds in a Trust at the date of delivery of the Units of such Trust to the purchaser is also added to the Public Offering Price. (See "Rights of Unit Holders--Distribution of Interest and Principal.") During the initial public offering period, the sales charge and dealer concession for the Trusts will be reduced as follows: The Sponsor may at any time change the amount by which the sales charge is reduced, or discontinue the discount completely. + The reduced sales charge is also applied on a dollar basis utilizing a breakpoint equivalent in the above table of $1,000 for one Unit, etc. Pursuant to employee benefit plans, Units of a Trust are available to employees of the Sponsor, during the initial public offering period, at a Public Offering Price equal to the Evaluator's determination of the aggregate offering price of the Bonds of a Trust per Unit plus a sales charge of 1.25% of the Public Offering Price and after the initial public offering period, at a Public Offering Price equal to the Evaluator's determination of the aggregate bid price of the Bonds of a Trust per Unit plus a sales charge of 1.25% of the Public Offering Price. Sales through such plans to employees of the Sponsor result in less selling effort and selling expenses than sales to the general public. During the initial public offering period, the aggregate offering price of the Bonds is determined by the Evaluator (1) on the basis of current offering prices for the Bonds, (2) if offering prices are not available for any Bonds, on the basis of current offering prices for comparable securities, (3) by appraisal, or (4) by any combination of the above. Such determinations are made each business day as of the Evaluation Time set forth in the "Summary of Essential Information," in Part A, effective for all sales made subsequent to the last preceding determination. Following the initial public offering period, the aggregate bid price of the Bonds (which is used to calculate the price at which the Sponsor repurchases and sells Units in the secondary market and the Redemption Price at which Units may be redeemed) will be determined by the Evaluator (1) on the basis of the current bid prices for the Bonds, (2) if bid prices are not available for any Bonds, on the basis of current bid prices of comparable securities, (3) by appraisal, or (4) by any combination of the above. Such determinations will be made each business day as of the Evaluation Time set forth in the "Summary of Essential Information," in Part A, effective for all sales made subsequent to the last preceding determination. The term "business day," as used herein shall exclude * Current offering or bid prices of the Deposited Units, if any, are based on prevailing weekly evaluations of the obligations underlying such Deposited Units. Saturdays, Sundays and any day on which the New York Stock Exchange is closed. The difference between the bid and offering prices of the Bonds may be expected to average approximately 1 1/2% of principal amount. In the case of actively traded securities, the difference may be as little as 1/2 of 1%, and in the case of inactively traded securities such difference will usually not exceed 3%. The price at which Units may be repurchased by the Sponsor in the secondary market could be less than the price paid by the Unit holder. On the Date of Deposit for each Trust the aggregate current offering price of such Bonds per Unit exceeded the bid price of such Bonds per Unit by the amounts set forth under "Summary of Essential Information" in Part A. For information relating to the calculation of the Redemption Price per Unit, which is also based upon the aggregate bid price of the underlying Bonds and which may be expected to be less than the Public Offering Price per Unit, see "Rights of Unit Holders-- Redemption of Units." During the initial public offering period Units of a Trust will be distributed to the public at the Public Offering Price determined in the manner provided above (see "Public Offering--Offering Price") through the Underwriters and dealers. The initial public offering period is 30 days unless all Units of a Trust are sold prior thereto, in which case the initial public offering period terminates with the sale of all Units. So long as all Units initially offered have not been sold, the Sponsor may extend the initial public offering period for up to four additional successive 30-day periods. Upon completion of the initial public offering, Units which remain unsold or which may be acquired in the secondary market (see "Public Offering--Market for Units") may be offered by this Prospectus at the Public Offering Price determined in the manner provided above (see "Public Offering--Offering Price"). It is the Sponsor's intention to qualify Units of a Trust for sale through the Underwriters and dealers who are members of the National Association of Securities Dealers, Inc. Units of a State Trust will be offered for sale only in the State for which the Trust is named, except that Units of a New York Trust will also be offered for sale to residents of the State of Connecticut, the State of Florida and the Commonwealth of Puerto Rico. Units will initially be sold to dealers at prices which represent a concession equal to the amount designated in the tables under "Public Offering--Offering Price" herein, for a Trust with an unreduced sales charge as specified in Part A--"The Public Offering Price." The Sponsor reserves the right to change the amount of the concession to dealers from time to time. After the initial offering period the dealer concession is negotiated on a case-by-case basis. Sales will be made only with respect to whole Units, and the Sponsor reserves the right to reject, in whole or in part, any order for the purchase of Units. A purchaser does not become a Unit holder (Certificate holder) or become entitled to exercise the rights of a Unit holder (including the right to redeem his Units) until he has paid for his Units. Generally, such payment must be made within five business days after an order for the purchase of Units has been placed. The price paid by a Unit holder is the Public Offering Price in effect at the time his order is received, plus accrued interest (see "Public Offering--Method of Evaluation"). This price may be different from the Public Offering Price in effect on any other day, including the day on which he made payment for the Units. Following the initial public offering period the Sponsor, although not obligated to do so, presently intends to maintain a market for the Units of a Trust and continuously to offer to purchase such Units at prices based upon the aggregate bid price of the underlying Bonds. For information relating to the method and frequency of the Evaluator's determination of the aggregate bid price of the underlying Bonds, see "Public Offering--Method of Evaluation." The Sponsor may cease to maintain such a market at any time and from time to time without notice if the supply of Units of a Trust of this Series exceeds demand or for any other reason. In this event the Sponsor may nonetheless purchase Units, as a service to Unit holders, at prices based on the current Redemption Price of those Units. In the event that a market is not maintained for the Units of a Trust, a Unit holder of such Trust desiring to dispose of his Units may be able to do so only by tendering such Units to the Trustee for redemption at the Redemption Price, which is based upon the aggregate bid price of the underlying Bonds. The aggregate bid price of the underlying Bonds of a Trust may be expected to be less than the aggregate offering price. Unit holders may elect to exchange any or all of their Units of this series for units of one or more of any series of Tax Exempt Securities Trust (the "Exchange Trust") available for sale in the state in which the Unit holder resides at a Public Offering Price for the units of the Exchange Trust to be acquired based on a fixed sales charge of $25 per unit. The Sponsor reserves the right to modify, suspend or terminate this plan at any time without further notice to Unit holders. Therefore, there is no assurance that a market for units will in fact exist on any given date on which a Unit holder wishes to sell his Units of this series and thus there is no assurance that the Exchange Option will be available to a Unit holder. Exchanges will be effected in whole units ONLY. If the proceeds from the Units being surrendered are less than the cost of a whole number of units being acquired, the exchanging Holder will be permitted to add cash in an amount to round up to the next highest number of whole units. An exchange of Units pursuant to the Exchange Option for units of an Exchange Trust will generally constitute a "taxable event" under the Code, i.e., a Holder will recognize a gain or loss at the time of exchange. However, an exchange of Units of this Trust for units of any other series of the Tax Exempt Securities Trust which are grantor trusts for U.S. Federal income tax purposes will not constitute a taxable event to the extent that the underlying securities in each trust do not differ materially either in kind or in extent. Unit holders are urged to consult their own tax advisors as to the tax consequences to them of exchanging Units in particular cases. Units of the Exchange Trust will be sold under the Exchange Option at the bid prices of the underlying securities in the particular portfolio involved per unit plus a fixed charge of $25 per unit. As an example, assume that a Unit holder, who has three units of a trust with a current price of $1,020 per unit based on the bid prices of the underlying securities, desires to exchange his Units for units of a series of an Exchange Trust with a current price of $880 per unit based on the bid prices of the underlying securities. In this example, the proceeds from the Unit holder's units will aggregate $3,060. Since only whole units of an Exchange Trust may be purchased under the Exchange Option, the Unit holder would be able to acquire four units in the Exchange Trust for a total cost of $3,620 ($3,520 for the units and $100 for the sales charge). Distributions of interest and principal, if any, are made to Unit holders monthly. The Unit holder will have the option of either receiving his monthly income check from the Trustee or participating in one of the reinvestment programs offered by the Sponsor provided such Unit holder meets the minimum qualifications of the reinvestment program and such program lawfully qualifies for sale in the jurisdiction in which the Unit holder resides. Upon enrollment in a reinvestment program, the Trustee will direct monthly interest distributions and principal distributions, if any, to the reinvestment program selected by the Unit holder. Since the Sponsor has arranged for different reinvestment alternatives, Unit holders should contact the Sponsor for more complete information, including charges and expenses. The appropriate prospectus will be sent to the Unit holder. The Unit holder should read the prospectus for a reinvestment program carefully before deciding to participate. Participation in the reinvestment program will apply to all Units of a Trust owned by a Unit holder and may be terminated at any time by the Unit holder, or the program may be modified or terminated by the Trustee or the program's Sponsor. For their services the Underwriters (see Part A, "Underwriting") receive a commission based on the sales charge of a particular Trust (see "Public Offering--Offering Price") as adjusted pursuant to the Agreement Among Underwriters. The Sponsor receives a gross commission equal to the applicable sales charge for any Units they have underwritten, and receive the difference between the applicable sales charge and the Underwriter's commission for the remainder of the Units. In addition, the Sponsor may realize profits or sustain losses, as the case may be, in the amount of any difference between the cost of the Bonds to a Trust (which is based on the aggregate offering price of the underlying Bonds on the Date of Deposit) and the purchase price of such Bonds to the Sponsor (which is the cost of the Bonds at the time they were acquired for the account of a Trust and the cost of the Deposited Units at the time they were acquired by the Sponsor). (See Part A, "Portfolio of Securities"--Note (3).) Under certain circumstances, an Underwriter may be entitled to share in such profits, if any, realized by the Sponsor. The Sponsor may also realize profits or sustain losses with respect to Bonds deposited in a Trust which were acquired from its own organization or from underwriting syndicates of which it was a member. During the initial public offering period the Underwriters also may realize profits or sustain losses as a result of fluctuations after the Date of Deposit in the offering prices of the Bonds and hence in the Public Offering Price received by the Underwriters for Units. Cash, if any, made available to the Sponsor prior to the anticipated first settlement date for the purchase of Units may be used in the Sponsor's businesses to the extent permitted by applicable regulations and may be of use to the Sponsor. In maintaining a market for the Units of a Trust (see "Public Offering-- Market for Units"), the Sponsor will also realize profits or sustain losses in the amount of any difference between the price at which they buy such Units and the price at which they resell or redeem such Units (see "Public Offering-- Offering Price"). Ownership of Units of a Trust is evidenced by registered certificates executed by the Trustee and the Sponsor. Certificates are transferable by presentation and surrender to the Trustee properly endorsed or accompanied by a written instrument or instruments of transfer. Certificates may be issued in denominations of one Unit or any multiple thereof. A Unit holder may be required to pay $2.00 per certificate reissued or transferred, and to pay any governmental charge that may be imposed in connection with each such transfer or interchange. For new certificates issued to replace destroyed, stolen or lost certificates, the Unit holder must furnish indemnity satisfactory to the Trustee and must pay such expenses as the Trustee may incur. Mutilated certificates must be surrendered to the Trustee for replacement. DISTRIBUTION OF INTEREST AND PRINCIPAL Interest and principal received by a Trust will be distributed on each monthly Distribution Date on a pro rata basis to Unit holders in such Trust of record as of the preceding Record Date. All distributions will be net of applicable expenses and funds required for the redemption of Units and, if applicable, reimbursements to the Trustee for interest payments advanced to Unit holders on previous Monthly Distribution Dates. (See Part A, "Summary of Essential Information," "Tax Exempt Securities Trust--Expenses and Charges" and "Rights of Unit Holders--Redemption of Units.") The Trustee will credit to the Interest Account of a Trust all interest received by such Trust, including that part of the proceeds of any disposition of Bonds of such Trust which represents accrued interest. Other receipts will be credited to the Principal Account of a Trust. The pro rata share of the Interest Account and the pro rata share of cash in the Principal Account represented by each Unit of a Trust will be computed by the Trustee each month as of the Record Date. (See Part A, "Summary of Essential Information.") Proceeds received from the disposition of any of the Bonds subsequent to a Record Date and prior to the next succeeding Distribution Date will be held in the Principal Account and will not be distributed until the following Distribution Date. The distribution to the Unit holders as of each Record Date will be made on the following Distribution Date or shortly thereafter and shall consist of an amount substantially equal to one-twelfth of such holders' pro rata share of the estimated annual income to the Interest Account after deducting estimated expenses (the "Monthly Income Distribution") plus such holders' pro rata share of the cash balance in the Principal Account computed as of the close of business on the preceding Record Date. Persons who purchase Units between a Record Date and a Distribution Date will receive their first distribution on the second Distribution Date following their purchase of Units. No distribution need be made from the Principal Account if the balance therein is less than an amount sufficient to distribute $1.00 per Unit. The Monthly Income Distribution per Unit initially will be in the amount shown under Part A, "Summary of Essential Information" for a Trust and will change as the income and expenses of such Trust change and as Bonds are exchanged, redeemed, paid or sold. Normally, interest on the Bonds in the Portfolio of a Trust is paid on a semi-annual basis. Because Bond interest is not received by a Trust at a constant rate throughout the year, any Monthly Income Distribution may be more or less than the amount credited to the Interest Account as of the Record Date. In order to eliminate fluctuations in Monthly Income Distributions resulting from such variances, the Trustee is required by the Trust Agreement to advance such amounts as may be necessary to provide Monthly Income Distributions of approximately equal amounts. The Trustee will be reimbursed, without interest, for any such advances from funds available from the Interest Account on the next ensuing Record Date or Record Dates, as the case may be. If all or a portion of the Bonds for which advances have been made subsequently fail to pay interest when due, the Trustee may recoup advances made by it in anticipation of receipt of interest payments on such Bonds by reducing the amount distributed per Unit in one or more Monthly Interest Distributions. If units are redeemed subsequent to such advances by the Trustee, but prior to receipt by the Trustee of actual notice of such failure to pay interest, the amount of which was so advanced by the Trustee, each remaining Unit holder will be subject to a greater pro rata reduction in his Monthly Interest Distribution than would have occurred absent such redemptions. Funds which are available for future distributions, payments of expenses and redemptions are in accounts which are non-interest bearing to Unit holders and are available for use by The Chase Manhattan Bank (National Association), pursuant to normal banking procedures. The Trustee is entitled to the benefit of any reasonable cash balances in the Income and Principal Accounts. Because of the varying interest payment dates of the Bonds comprising a Trust Portfolio, accrued interest at any point in time will be greater than the amount of interest actually received by a Trust and distributed to Unit holders. This excess accrued but undistributed interest amount will be added to the value of the units on any purchase made after the Date of Deposit. If a Unit holder sells all or a portion of his Units a portion of his sale proceeds will be allocable to his proportionate share of the accrued interest. Similarly, if a Unit holder redeems all or a portion of his Units, the Redemption Price per Unit which he is entitled to receive from the Trustee will also include his accrued interest on the Bonds. (See "Rights of Unit Holders--Redemption of Units--Computation of Redemption Price per Unit.") The Trustee is also entitled to withdraw from the Interest Account, and to the extent funds are not sufficient therein, from the Principal Account, on one or more Record Dates as may be appropriate, amounts sufficient to recoup advances which it has made in anticipation of the receipt by the Trust of interest in respect of Bonds which subsequently fail to pay interest when due. As of the first day of each month the Trustee will deduct from the Interest Account of a Trust and, to the extent funds are not sufficient therein, from the Principal Account of such Trust, amounts necessary to pay the expenses of such Trust. (See "Tax Exempt Securities Trust--Expenses and Charges.") The Trustee also may withdraw from said accounts such amounts, if any, as it deems necessary to establish a reserve for any governmental charges payable out of a Trust. Amounts so withdrawn shall not be considered a part of the Trust's assets until such time as the Trustee shall return all or any part of such amounts to the appropriate account. In addition, the Trustee may withdraw from the Interest Account and the Principal Account such amounts as may be necessary to cover redemption of Units by the Trustee. (See "Rights of Unit Holders--Redemption of Units.") The Trustee has agreed to advance to a Trust the amount of accrued interest due on the Bonds of such Trust from their respective issue dates or previous interest payment dates through the Date of Deposit. This accrued interest amount will be paid to the Sponsor as the holder of record of all Units on the first settlement date for the Units. Consequently, when the Sponsor sells Units of a Trust, the amount of accrued interest to be added to the Public Offering Price of the Units purchased by an investor will include only accrued interest from the day after the Date of Deposit through the date of settlement of the investor's purchase (normally three business days after purchase), less any distributions from the Interest Account. The Trustee will recover its advancements to a Trust (without interest or other cost to such Trust) from interest received on the Bonds deposited in such Trust. The Trustee shall furnish Unit holders in connection with each distribution a statement of the amount of interest, if any, and the amount of other receipts, if any, which are being distributed, expressed in each case as a dollar amount per Unit. In the event that the issuer of any of the Bonds fails to make payment when due of any interest or principal and such failure results in a change in the amount which would otherwise be distributed as a monthly distribution, the Trustee will, with the first such distribution following such failure, set forth in an accompanying statement, the issuer and the Bond, the amount of the reduction in the distribution per Unit resulting from such failure, the percentage of the aggregate principal amount of Bonds which such Bond represents and, to the extent then determined, information regarding any disposition or legal action with respect to such Bond. Within a reasonable time after the end of each calendar year, the Trustee will furnish to each person who at any time during the calendar year was a Unit holder of record, a statement (1) as to the Interest Account: interest received (including amounts representing interest received upon any disposition of Bonds), deductions for payment of applicable taxes and for fees and expenses of a Trust, redemptions of Units and the balance remaining after such distributions and deductions, expressed both as a total dollar amount and as a dollar amount representing the pro rata share of each Unit outstanding on the last business day of such calendar year; (2) as to the Principal Account: the dates of disposition of any Bonds and the net proceeds received therefrom (excluding any portion representing interest), deductions for payments of applicable taxes and for fees and expenses of a Trust, redemptions of Units, and the balance remaining after such distributions and deductions, expressed both as a total dollar amount and as a dollar amount representing the pro rata share of each Unit outstanding on the last business day of such calendar year; (3) a list of the Bonds held and the number of Units outstanding on the last business day of such calendar year; (4) the Redemption Price per Unit based upon the last computation thereof made during such calendar year; and (5) amounts actually distributed during such calendar year from the Interest Account and from the Principal Account, separately stated, expressed both as total dollar amounts and as dollar amounts representing the pro rata share of each Unit outstanding. The accounts of a Trust shall be audited not less frequently than annually by independent auditors designated by the Sponsor, and the report of such auditors shall be furnished by the Trustee to Unit holders upon request. The Trustee shall keep available for inspection by Unit holders at all reasonable times during usual business hours, books of record and account of its transactions as Trustee including records of the names and addresses of Unit holders, certificates issued or held, a current list of Bonds in the Portfolio of a Trust and a copy of the Trust Agreement. Units may be tendered to the Trustee for redemption at its unit investment trust office at 770 Broadway, New York, New York 10003, upon payment of any relevant tax. At the present time there are no specific taxes related to the redemption of the Units. No redemption fee will be charged by the Sponsor or the Trustee. Units redeemed by the Trustee will be cancelled. Certificates for Units to be redeemed must be properly endorsed or accompanied by a written instrument of transfer. Unit holders must sign exactly as their name appears on the face of the certificate with the signature guaranteed by an officer of a national bank or trust company or by a member of either the New York, Midwest or Pacific Stock Exchange. In certain instances the Trustee may require additional documents such as, but not limited to, trust instruments, certificates of death, appointments as executor or administrator or certificates of corporate authority. Within seven calendar days following such tender, the Unit holder will be entitled to receive in cash an amount for each Unit tendered equal to the Redemption Price per Unit computed as of the Evaluation Time set forth in the "Summary of Essential Information" in Part A on the date of tender. (See "Redemption of Units--Computation of Redemption Price per Unit.") The "date of tender" is deemed to be the date on which Units are received by the Trustee, except as regards Units received after the close of trading on the New York Stock Exchange, the date of tender is the next day on which such Exchange is open for trading, and such Units will be deemed to have been tendered to the Trustee on such day for redemption at the Redemption Price computed on that day. For information relating to the purchase by the Sponsor of Units tendered to the Trustee for redemption at prices in excess of the Redemption Price, see "Redemption of Units--Purchase by the Sponsor of Units Tendered for Redemption." Accrued interest paid on redemption shall be withdrawn from the Interest Account, or, if the balance therein is insufficient, from the Principal Account. All other amounts paid on redemption shall be withdrawn from the Principal Account. The Trustee is empowered to sell Bonds in order to make funds available for redemption. Such sales, if required, could result in a sale of Bonds by the Trustee at a loss. To the extent Bonds are sold, the size and diversity of a Trust will be reduced. The Trustee reserves the right to suspend the right of redemption and to postpone the date of payment of the Redemption Price per Unit for any period during which the New York Stock Exchange is closed, other than weekend and holiday closings, or trading on that Exchange is restricted or during which (as determined by the Securities and Exchange Commission) an emergency exists as a result of which disposal or evaluation of the underlying Bonds is not reasonably practicable, or for such other periods as the Securities and Exchange Commission has by order permitted. COMPUTATION OF REDEMPTION PRICE PER UNIT--The Redemption Price per Unit of a Trust is determined by the Trustee on the basis of the bid prices of the Bonds in such Trust as of the Evaluation Time on the date any such determination is made. The Redemption Price per Unit of a Trust is each Unit's pro rata share, determined by the Trustee, of: (1) the aggregate value of the Bonds in such Trust on the bid side of the market (determined by the Evaluator as set forth below), (2) cash on hand in such Trust (other than funds covering contracts to purchase Bonds), and accrued and unpaid interest on the Bonds as of the date of computation, less (a) amounts representing taxes or governmental charges payable out of such Trust, (b) the accrued expenses of such Trust, and (c) cash held for distribution to Unit holders of such Trust of record as of a date prior to the evaluation. The Evaluator may determine the value of the Bonds in the Trust (1) on the basis of current bid prices for the Bonds, (2) if bid prices are not available for any Bonds, on the basis of current bid prices for comparable securities, (3) by appraisal, or (4) by any combination of the above. The difference between the bid and offering prices of the Bonds may be expected to average approximately 1 1/2% of principal amount. In the case of actively traded securities, the difference may be as little as 1/2 of 1%, and in the case of inactively traded securities such difference usually will not exceed 3%. The price at which Units may be redeemed could be less than the price paid by the Unit holder. On the Date of Deposit for each Trust the aggregate current offering price of such Bonds per Unit exceeded the bid price of such Bonds per Unit by the amounts set forth under Part A, "Summary of Essential Information." PURCHASE BY THE SPONSOR OF UNITS TENDERED FOR REDEMPTION--The Trust Agreement requires that the Trustee notify the Sponsor of any tender of Units for redemption. So long as the Sponsor maintains a bid in the secondary market, the Sponsor, prior to the close of business on the second succeeding business day, will purchase any Units tendered to the Trustee for redemption at the price so bid by making payment therefor to the Unit holder in an amount not less than the Redemption Price not later than the day on which the Units would otherwise have been redeemed by the Trustee. (See "Public Offering--Market for Units.") The offering price of any Units resold by the Sponsor will be the Public Offering Price determined in the manner provided in this Prospectus. (See "Public Offering--Offering Price.") Any profit resulting from the resale of such Units will belong to the Sponsor which likewise will bear any loss resulting from a lower offering or redemption price subsequent to their acquisition of such Units. (See "Public Offering--Sponsor's and Underwriters' Smith Barney Inc., 1345 Avenue of the Americas, New York, New York 10105 ("Smith Barney"), was incorporated in Delaware in 1960 and traces its history through predecessor partnerships to 1873. Smith Barney, an investment banking and securities broker-dealer firm, is a member of the New York Stock Exchange, Inc. and other major securities and commodities exchanges, the National Association of Securities Dealers, Inc. and the Securities Industry Association. Smith Barney is an indirect wholly-owned subsidiary of The Travelers Inc. Smith Barney or an affiliate is investment adviser, principal underwriter or distributor of 60 open-end investment companies and investment manager of 12 closed-end investment companies. Smith Barney also sponsors all Series of Corporate Securities Trust, Government Securities Trust, Harris, Upham Tax- Exempt Fund and Tax Exempt Securities Trust, and acts as sponsor of most Series of Defined Assets Funds. The Sponsor has acted previously as managing underwriter of other investment companies. In addition to participating as a member of various underwriting and selling groups or as agent of other investment companies, the Sponsor also executes orders for the purchase and sale of securities of investment companies and sells securities to such companies in its capacity as broker or dealer in securities. The Sponsor is liable for the performance of its obligations arising from its responsibilities under the Trust Agreement, but will be under no liability to Unit holders for taking any action or refraining from any action in good faith or for errors in judgment or responsible in any way for depreciation or loss incurred by reason of the sale of any Bonds, except in cases of willful misfeasance, bad faith, gross negligence or reckless disregard of its obligations and duties. (See "Sponsor--Responsibility" below.) Although the Trusts are not actively managed as mutual funds are, the portfolios are reviewed periodically on a regular cycle. The Sponsor is empowered to direct the Trustee to dispose of Bonds when certain events occur that adversely affect the value of the Bonds, including default in payment of interest or principal, default in payment of interest or principal on other obligations of the same issuer, institution of legal proceedings, default under other documents adversely affecting debt service, decline in price or the occurrence of other market or credit factors, or decline in projected income pledged for debt service on revenue Bonds and advanced refunding that, in the opinion of the Sponsor, may be detrimental to the interests of the Unit holders. The Sponsor intends to provide portfolio services for each Trust in order to determine whether the Trustee should be directed to dispose of any such Bonds. It is the responsibility of the Sponsor to instruct the Trustee to reject any offer made by an issuer of any of the Bonds to issue new obligations in exchange and substitution for any Bonds pursuant to a refunding or refinancing plan, except that the Sponsor may instruct the Trustee to accept such an offer or to take any other action with respect thereto as the Sponsor may deem proper if the issuer is in default with respect to such Bonds or in the judgment of the Sponsor the issuer will probably default in respect to such Bonds in the foreseeable future. Any obligations so received in exchange or substitution will be held by the Trustee subject to the terms and conditions of the Trust Agreement to the same extent as Bonds originally deposited thereunder. Within five days after the deposit of obligations in exchange or substitution for underlying Bonds, the Trustee is required to give notice thereof to each Unit holder, identifying the Bonds eliminated and the Bonds substituted therefor. Except as stated in this and the preceding paragraph, the acquisition by a Trust of any securities other than the Bonds initially deposited in the Trust is prohibited. If the Sponsor resigns or otherwise fails or becomes unable to perform its duties under the Trust Agreement, and no express provision is made for action by the Trustee in such event, the Trustee may appoint a successor sponsor or terminate the Trust Agreement and liquidate the Trusts. The Trustee is The Chase Manhattan Bank (National Association), a national banking association with its principal executive officer located at 1 Chase Manhattan Plaza, New York, New York 10081 and its unit investment trust office at 770 Broadway, New York, New York 10003. The Trustee is subject to supervision by the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Board of Governors of the Federal Reserve System. In connection with the storage and handling of certain Bonds deposited in the Trust, the Trustee may use the services of The Depository Trust Company. These services may include safekeeping of the Bonds and coupon-clipping, computer book-entry transfer and institutional delivery services. The Depository Trust Company is a limited purpose trust company organized under the Banking Law of the State of New York, a member of the Federal Reserve System and a clearing agency registered under the Securities Exchange Act of 1934. The Trustee shall not be liable or responsible in any way for depreciation or loss incurred by reason of the disposition of any moneys, securities or certificates or in respect of any evaluation or for any action taken in good faith reliance on prima facie properly executed documents except in cases of willful misfeasance, bad faith, gross negligence or reckless disregard for its obligations and duties. In addition, the Trustee shall not be personally liable for any taxes or other governmental charges imposed upon or in respect of a Trust which the Trustee may be required to pay under current or future law of the United States or any other taxing authority having jurisdiction. (See "Tax Exempt Securities Trust-- Portfolio.") For information relating to the responsibilities and indemnification of the Trustee under the Trust Agreement, reference is made to the material set forth under "Rights of Unit Holders", "Sponsor--Resignation" and "Other Charges." By executing an instrument in writing and filing the same with the Sponsor, the Trustee and any successor may resign. In such an event the Sponsor is obligated to appoint a successor trustee as soon as possible. If the Trustee becomes incapable of acting or becomes bankrupt or its affairs are taken over by public authorities, the Sponsor may remove the Trustee and appoint a successor as provided in the Trust Agreement. Such resignation or removal shall become effective upon the acceptance of appointment by the successor trustee. If no successor has accepted the appointment within thirty days after notice of resignation, the retiring trustee may apply to a court of competent jurisdiction for the appointment of a successor. The resignation or removal of a trustee becomes effective only when the successor trustee accepts its appointment as such or when a court of competent jurisdiction appoints a successor trustee. The Evaluator is Kenny S&P Evaluation Services, a division of J.J. Kenny Co., Inc., with main offices located at 65 Broadway, New York, New York 10006. The Trustee, Sponsor and Unit holders may rely on any evaluation furnished by the Evaluator and shall have no responsibility for the accuracy thereof. Determination by the Evaluator under the Trust Agreement shall be made in good faith upon the basis of the best information available to it; provided, however, that the Evaluator shall be under no liability to the Trustee, the Sponsor, or Unit holders for errors in judgment. But this provision shall not protect the Evaluator in cases of willful misfeasance, bad faith, gross negligence or reckless disregard of its obligations and duties. The Trust Agreement requires the Evaluator to evaluate the Bonds of a Trust on the basis of their bid prices on the last business day of June and December in each year, on the day on which any Unit of such Trust is tendered for redemption and on any other day such evaluation is desired by the Trustee or is requested by the Sponsor. For information relating to the responsibility of the Evaluator to evaluate the Bonds on the basis of their offering prices, see "Public Offering--Offering Price." The Evaluator may resign or may be removed by the joint action of the Sponsor and the Trustee, and in such event, the Sponsor and the Trustee are to use their best efforts to appoint a satisfactory successor. Such resignation or removal shall become effective upon the acceptance of appointment by a successor evaluator. If upon resignation of the Evaluator no successor has accepted appointment within thirty days after notice of resignation, the Evaluator may apply to a court of competent jurisdiction for the appointment of a successor. AMENDMENT AND TERMINATION OF THE TRUST AGREEMENT The Sponsor and the Trustee have the power to amend the Trust Agreement without the consent of any of the Unit holders when such an amendment is (1) to cure any ambiguity or to correct or supplement any provision of the Trust Agreement which may be defective or inconsistent with any other provision contained therein, or (2) to make such other provisions as shall not adversely affect the interests of the Unit holders; provided, that the Trust Agreement is not amended to increase the number of Units issuable thereunder or to permit the deposit or acquisition of securities either in addition to or in substitution for any of the Bonds initially deposited in a Trust, except for the substitution of certain refunding securities for such Bonds or to permit the Trustee to engage in business or investment activities not specifically authorized in the Trust Agreement as originally adopted. In the event of any amendment, the Trustee is obligated to notify promptly all Unit holders of the substance of such amendment. The Trust Agreement provides that if the principal amount of Bonds held in Trust is less than 50% of the principal amount of the Bonds originally deposited in such Trust, the Trustee may in its discretion and will, when directed by the Sponsor, terminate such Trust. A Trust may be terminated at any time by 100% of the Unit holders. However, in no event may a Trust continue beyond the Mandatory Termination Date set forth under Part A, "Summary of Essential Information." In the event of termination, written notice thereof will be sent by the Trustee to all Unit holders. Within a reasonable period after termination, the Trustee will sell any Bonds remaining in the affected Trust, and, after paying all expenses and charges incurred by such Trust, will distribute to each Unit holder, upon surrender for cancellation of his certificate for Units, his pro rata share of the balances remaining in the Interest and Principal Account of such Trust. The legality of the Units has been passed upon by Davis Polk & Wardwell, 450 Lexington Avenue, New York, New York 10017, as special counsel for the Sponsor. The statements of financial condition and the portfolios of securities included in this Prospectus have been audited by KPMG Peat Marwick LLP, independent auditors, as indicated in their report with respect thereto, and is included herein in reliance upon the authority of said firm as experts in accounting and auditing. All ratings shown under Part A, "Portfolio of Securities", except those identified otherwise, are by Standard & Poor's. A Standard & Poor's corporate or municipal bond rating is a current assessment of the creditworthiness of an obligor with respect to a specific debt obligation. This assessment of creditworthiness may take into consideration obligors such as guarantors, insurers, or lessees. The bond rating is not a recommendation to purchase or sell a security, inasmuch as it does not comment as to market price or suitability for a particular investor. The ratings are based on current information furnished to Standard & Poor's by the issuer and obtained by Standard & Poor's from other sources it considers reliable. The ratings may be changed, suspended or withdrawn as a result of changes in, or unavailability of, such information. The ratings are based, in varying degrees, on the following considerations: I. Likelihood of default--capacity and willingness of the obligor as to the timely payment of interest and repayment of principal in accordance with the terms of the obligation; II. Nature of and provisions of the obligation; and +As described by the rating agencies. III. Protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization or other arrangement under the laws of bankruptcy and other laws affecting creditors' rights. AAA--This is the highest rating assigned by Standard & Poor's to a debt obligation and indicates an extremely strong capacity to pay interest and repay principal. AA--Bonds rated AA have a very strong capacity to pay interest and repay principal, and in the majority of instances they differ from AAA issues only in small degrees. A--Bonds rated A have a strong capacity to pay interest and repay principal, although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than bonds in higher-rated categories. BBB--Bonds rated BBB are regarded as having an adequate capacity to pay interest and repay principal. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to weakened capacity to pay interest and repay principal for bonds in this category than for bonds in the higher-rated categories. Plus (+) or Minus (-): To provide more detailed indications of credit quality, the ratings from "AA" to "BB" may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. Provisional Ratings: The letter "p" following a rating indicates the rating is provisional. A provisional rating assumes the successful completion of the project being financed by the issuance of the bonds being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful and timely completion of the project. This rating, however, while addressing credit quality subsequent to completion, makes no comment on the likelihood of, or the risk of default upon failure of, such completion. Accordingly, the investor should exercise his own judgment with respect to such likelihood and risk. Conditional rating(s), indicated by "Con" are given to bonds for which the continuance of the security rating is contingent upon Standard & Poor's receipt of an executed copy of the escrow agreement or closing documentation confirming investments and cash flows and/or the security rating is conditional upon the issuance of insurance by the respective insurance company. A brief description of the applicable Moody's rating symbols and their meanings is as follows: Aaa--Bonds which are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge". Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa--Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high grade bonds. Aa bonds are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in Aaa securities. A--Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. Baa--Bonds which are rated Baa are considered as medium grade obligations: i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Rating symbols may include numerical modifiers "1," "2," or "3." The numerical modifier "1" indicates that the security ranks at the high end, "2" in the mid-range, and "3" nearer the low end of the generic category. These modifiers of rating symbols "Aa," "A" and "Baa" are to give investors a more precise indication of relative debt quality in each of the historically defined categories. AAA--These bonds are considered to be investment grade and of the highest quality. The obligor has an extraordinary ability to pay interest and repay principal, which is unlikely to be affected by reasonably foreseeable events. AA--These bonds are considered to be investment grade and of high quality. The obligor's ability to pay interest and repay principal, while very strong, is somewhat less than for AAA rated securities or more subject to possible change over the term of the issue. A--These bonds are considered to be investment grade and of good quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. BBB--These bonds are considered to be investment grade and of satisfactory quality. The obligor's ability to pay interest and repay principal is considered to be adequate. Adverse changes in economic conditions and circumstances, however are more likely to weaken this ability than bonds with higher ratings. A "+" or a "-" sign after a rating symbol indicates relative standing in its rating. AAA--Highest credit quality. The risk factors are negligible, being only slightly more than for risk-free U.S. Treasury debt. AA--High credit quality. Protection factors are strong. Risk is modest but may vary slightly from time to time because of economic conditions. A--Protection factors are average but adequate. However, risk factors are more variable and greater in periods of economic stress. A "+" or a "-" sign after a rating symbol indicates relative standing in its rating. FEDERAL TAX FREE VS. TAXABLE INCOME This table shows the approximate yields which taxable securities must earn in various income brackets to produce, after Federal income tax, returns equivalent to specified tax-exempt bond yields. The table is computed on the theory that the taxpayer's highest bracket tax rate is applicable to the entire amount of any increase or decrease in his or her taxable income resulting from a switch from taxable to tax-exempt securities or vice versa. The table reflects projected Federal income tax rates and the tax brackets for the 1995 taxable year. Because the Federal rate brackets are subject to adjustment based on changes in the Consumer Price Index, the taxable equivalent yields for subsequent years may vary somewhat from those indicated in the table. Use this table to find your tax bracket. Read across to determine the approximate taxable yield you would need to equal a return free of Federal income tax. Note: This table reflects the following: 1 Taxable income equals adjusted gross income less personal exemptions of $2,500 less the standard deduction of $6,550 on a joint or total itemized deductions, whichever is greater. However under the provisions of the Omnibus Budget Reconciliation Act of 1990, itemized deductions are reduced by 3% of the amount of a taxpayer's AGI over $114,700. This is reflected in the brackets above by higher effective federal tax rates. Furthermore, personal exemptions are phased out for the amount of a taxpayer's AGI over $114,700 for single taxpayers and $172,050 for married taxpayers filing jointly. This letter provision is not incorporated into the above brackets. 2 The combined effective rate is computed under the assumption that taxpayers itemize their deductions on their federal tax returns. 3 Interest earned on municipal obligations may be subject to the federal alternative minimum tax. This provision is not incorporated into the table. 4 The taxable equivalent yield table does not incorporate the affect of graduated rate structures in determining yields. Instead, the tax rates used are the highest rates applicable to the income levels indicated within each bracket. Sales material may compare tax-equivalent yields of long-term municipal bonds to long-term U.S. Treasury bonds and to the Bond Buyer Revenue Bond Index. Such information is based on past performance and is not indicative of future results. Yields on taxable investment are generally higher than those of tax- exempt securities of comparable maturity. While income from municipal bonds is exempt from federal income taxes, income from Treasuries is exempt from state and local taxes. Since Treasuries are considered to have the highest possible credit quality, the difference in yields is somewhat narrower than if compared to corporate bonds with similar ratings and maturities. NOTE: PART C OF THIS PROSPECTUS MAY NOT BE DISTRIBUTED UNLESS ACCOMPANIED BY PARTS A AND B. TAX EXEMPT SECURITIES TRUST--THE STATE TRUSTS Potential purchasers of the Units of a State Trust should consider the fact that the Trust's Portfolio consists primarily of Bonds issued by the state for which such State Trust is named or its municipalities or authorities and realize the substantial risks associated with an investment in such Bonds. Each State Trust is subject to certain additional risk factors. The Sponsor believes the discussions of risk factors summarized below describe some of the more significant aspects of the State Trusts. The sources of such information are the official statements of issuers as well as other publicly available documents. While the Sponsor has not independently verified this information, it has no reason to believe that such information is not correct in all material respects. Investment in a State Trust should be made with an understanding that the value of the underlying Portfolio may decline with increases in interest rates. Since the start of the 1990-91 fiscal year, California has faced the worst economic, fiscal and budget conditions since the 1930s. Construction, manufacturing (especially aerospace), exports and financial services, among others, have all been severely affected. Job losses have been the worst of any post-war recession and have continued through the end of 1993. Employment levels are expected to stabilize before net employment starts to increase, and pre-recession job levels are not expected to be reached for several more years. Unemployment is expected to remain above 9% through 1994. The recession has seriously affected State tax revenues, which basically mirror economic conditions. It has also caused increased expenditures for health and welfare programs. The State has also been facing a structural imbalance in its budget with the largest programs supported by the General Fund--K-12 schools and community colleges, health, welfare and corrections-- growing at rates higher than the growth rates for the principal revenue sources of the General Fund. (The General Fund, the State's main operating fund, consists of revenues which are not required to be credited to any other fund.) As a result, the State has experienced recurring budget deficits. The State Controller reports that expenditures exceeded revenues for four of the five fiscal years ending with 1991-92, and were essentially equal in 1992-93. By June 30, 1993, according to the Department of Finance, the State's Special Fund for Economic Uncertainties had a deficit, on a budget basis, of approximately $2.8 billion. (Special Funds account for revenues obtained from specific revenue sources, and which are legally restricted to expenditures for specified purposes.) The 1993-94 Budget Act incorporated a Deficit Reduction Plan to repay this deficit over two years. The original budget for 1993-94 reflected revenues which exceeded expenditures by approximately $2.8 billion. As a result of continuing recession, the excess of revenues over expenditures for the fiscal year is now expected to be only about $500 million. Thus, the accumulated budget deficit at June 30, 1994 is now estimated by the Department of Finance to be approximately $2 billion, and the deficit will not be retired by June 30, 1995 as planned. The accumulated budget deficits over the past several years, together with expenditures for school funding which have not been reflected in the budget, and the reduction of available internal borrowable funds, have combined to significantly deplete the State's cash resources to pay its ongoing expenses. In order to meet its cash needs, the State has had to rely for several years on a series of external borrowings, including borrowings past the end of a fiscal year. The State's tax revenue clearly reflects sharp declines in employment, income and retail sales on a scale not seen in over 50 years. The May 1994 revision to the 1994-95 Governor's Budget (the "May Revision"), released May 20, 1994, assumes that the State will start recovery from recessionary conditions in 1994, with a modest upturn beginning in 1994 and continuing into 1995, a year later than predicted in the May 1993 Department of Finance economic projection. Pre-recession job levels are not expected to be reached until 1997. However, there is growing evidence that California is showing signs of an economic turnaround, and the May Revision is revised upward from the Governor's January Budget forecast. Since the Governor's January Budget forecast, 1993 non-farm employment has been revised upward by 31,000 jobs. Employment in the early months of 1994 has shown encouraging signs of growth, several months sooner than was contemplated in the January Budget forecast. Between December 1993 and April 1994, payrolls are up by 50,000 jobs. On January 17, 1994 the Northridge earthquake, measuring an estimated 6.8 on the Richter Scale, struck Los Angeles. Significant property damage to private and public facilities occurred in a four-county area including northern Los and parts of Orange and San Bernadino Counties, which were declared as State and federal disaster areas by January 18. Current estimates of total property damage (private and public) are in the range of $20 billion or more, but these estimates are still subject to change. Despite such damage, on the whole, the vast majority of structures in the areas, including large manufacturing and commercial buildings and all modern high-rise offices, survived the earthquake with minimal or no damage, validating the cumulative effect of strict building codes and thorough preparation for such emergency by the State and local agencies. Damage to State-owned facilities included transportation corridors and facilities such as Interstate Highways 5 and 10 and State Highways 14, 118 and 210. Most of the major highways (Interstates 5 and 10) have now been reopened. The campus at California State University Northridge (very near the epicenter) suffered an estimated $350 million damage, resulting in the temporary closure of the campus. It reopened using borrowed facilities elsewhere and many temporary structures. There was also some damage to the University of California at Los Angeles and to the Van Nuys State Office Building (now open after a temporary closure). Overall, except for the temporary road and bridge closures, and CSU-Northridge, the earthquake did not and is not expected to significantly affect State government operations. The State in conjunction with the federal government is committed to providing assistance to local governments, individuals and businesses suffering damage as a result of the earthquake, as well as to provide for the repair and replacement of State-owned facilities. The federal government has provided substantial earthquake assistance. The President immediately allocated some available disaster funds, and Congress has approved additional funds for a total of $9.5 billion of federal funds for earthquake relief, including assistance to homeowners and small businesses, and costs for repair of damaged public facilities. It is now estimated that the overall effect of the earthquake on the regional and State economy will not be serious. The earthquake may have dampened economic activity briefly during late January and February, but the rebuilding efforts are now adding a small measure of stimulus. Sectors which are now contributing to California's recovery include construction and related manufacturing, wholesale and retail trade, transportation and several service industries such as amusements and recreation, business services and management consulting. Electronics is showing modest growth and the rate of decline in aerospace manufacturing is slowly diminishing. These trends are expected to continue, and by next year, must of the restructuring in the finance and utilities industries should be nearly completed. As a result of these factors, average 1994 non-farm employment is now forecast to maintain 1993 levels compared to a projected 0.6% decline in the Governor's January Budget forecast. 1995 employment is expected to be up 1.6% compared to 0.7% in the January Budget forecast. The Northridge earthquake resulted in a downward revision of this year's personal income growth--from 4% in the Governor's January Budget forecast to 3.6%. However, this decline is more than explained by the $5.5 billion charge against rental and proprietor's income--equal to 0.8% of total income-- reflecting uninsured damage from the quake. Next year, without the quake's effects, income is projected to grow 6.1% compared to 5% projected in the January Budget forecast. Without the quake's effects, income was little changed in the May Revision compared to the January Budget forecast. The housing forecast remains essentially unchanged from the January Budget forecast. Although existing sales have strengthened and subdivision surveys indicated increased new home sales, building permits are up only slightly from recession lows. Gains are expected in the months ahead, but higher mortgage interest rates will dampen the upturn. Essentially, the Northridge earthquake adds a few thousand housing units to the forecast, but this effect is offset by higher interest rates. Interest rates represent one of several downside risks to the forecast. The rise in interest rates has occurred more rapidly than contemplated in the Governor's January Budget forecast. In addition to affecting housing, higher rates may also dampen consumer spending, given the high percentage of California homeowners with adjustable-rate mortgages. The May Revision forecast includes a further rise in the Federal Funds rate to nearly 5% by the beginning of 1995. Should rates rise more steeply, housing and consumer spending would be adversely affected. The unemployment upturn is still tenuous. The Employment Development Department revised down February's employment gain and March was revised to a small decline. Unemployment rates in California have been volatile since January, ranging from 10.1% to a low of 8.6%, with July's figure at 9%. The small sample size coupled with changes made to the survey instrument in January contributed to this volatility. The Governor's Budget, introduced on January 8, 1993, proposed General Fund expenditures of $37.3 billion, with projected revenues of $39.9 billion. To balance the budget in the face of declining revenues, the Governor proposed a series of revenue shifts from local government, reliance on increased federal aid, and reductions in State spending. The May Revision of the Governor's budget, released on May 20, 1993, projected the State would have an accumulated deficit of about $2.75 billion by June 30, 1993, essentially unchanged from the prior year. The Governor proposed to eliminate this deficit over an 18-month period. Unlike previous years, the Governor's Budget and May Revision did not calculate a "gap" to be closed, but rather set forth revenue and expenditure forecasts and proposals designed to produce a balanced budget. The 1993-94 Budget Act was signed by the Governor on June 30, 1993, along with implementing legislation. The Governor vetoed about $71 million in spending. With enactment of the Budget Act, the State carried out its regular cash flow borrowing program for the fiscal year with the issuance of $2 billion of revenue anticipation notes maturing June 28, 1994. The 1993-94 Budget Act was predicated on revenue and transfer estimates of $40.6 billion, $400 million below 1992-93 (and the second consecutive year of actual decline). The principal reasons for declining revenue were the continued weak economy and the expiration (or repeal) of three fiscal steps taken in 1991--a half cent temporary sales tax, a deferral of operating loss carry forwards, and repeal by initiative of a sales tax on candy and snack foods. The 1993-94 Budget Act also assumed Special Fund revenues of $11.9 billion, an increase of 2.9% over 1992-93. The 1993-94 Budget Act included General Fund expenditures of $38.5 billion (a 6.3% reduction from projected 1992-93 expenditures of $41.1 billion), in order to keep a balanced budget within the available revenues. The Budget also included Special Fund expenditures of $12.1 billion, a 4.2% increase. The Budget Act reflected the following major adjustments: 1. Changes in local government financing to shift about $2.6 billion in property taxes from cities, counties, special districts and redevelopment agencies to school and community college districts. The property tax losses for cities and counties were offset in part by additional sales tax revenues and relief from some state mandated programs. Litigation by local governments challenging this shift has so far been unsuccessful. In November 1993 the voters approved the permanent extension of the 0.5% sales tax for local public safety purposes. 2. The Budget projected K-12 Proposition 98 funding on a cash basis at the same per-pupil level as 1992-93 by providing schools a $609 million loan payable from future years' Proposition 98 funds. 3. The Budget assumed receipt of $692 million in aid to the State from the federal government to offset health and welfare costs associated with foreign immigrants living in the State. About $411 million of this amount was one-time funding. Congress ultimately appropriated only $450 million. 4. Reductions of $600 million in health and welfare programs. 5. A 2-year suspension of the renters' tax credit ($390 million expenditure reduction in 1993-94). 6. Miscellaneous one-time items, including deferral of payment to the Public Employees Retirement Fund ($339 million) and a change in accounting for debt service from accrual to cash basis, saving $107 million. Administration reports during the course of the 1993-94 fiscal year have indicated that, although economic recovery appears to have started in the second half of the fiscal year, recessionary conditions continued longer than had been anticipated when the 1993-94 Budget Act was adopted. Overall, revenues for the 1993-94 fiscal year were about $800 million lower than original projections, and expenditures were about $780 million higher, primarily because of higher health and welfare caseloads, lower property taxes, which require greater State support for K-14 education to make up the shortfall, and lower than anticipated federal government payments for immigration-related costs. The most recent reports, however, in May and June 1994, indicated that revenues in the second half of the 1993-94 fiscal year have been very close to the projections made in the Governor's Budget of January 10, 1994, which is consistent with a slow turnaround in the economy. During the 1993-94 fiscal year, the State implemented the Deficit Reduction Plan, which was a part of the 1993-94 Budget Act, by issuing $1.2 billion of revenue anticipation warrants in February 1994, maturing December 21, 1994. This borrowing reduced the cash deficit at the end of the 1993-94 fiscal year. Nevertheless, because of the $1.5 billion variance from the original Budget Act assumption, the General Fund ended the fiscal year at June 30, 1994 carrying forward an accumulated deficit of approximately $2 billion. Because of the revenue shortfall and the State's reduced internal borrowing cash resources, in addition to the $1.2 billion of revenue anticipation warrants issued as part of the Deficit Reduction Plan, the State issued an additional $2 billion of revenue anticipation warrants, maturing July 26, 1994, which were needed to fund the State's obligations and expenses through the end of the 1993-94 fiscal year. The 1994-95 fiscal year represents the fourth consecutive year the Governor and Legislature were faced with a very difficult budget environment to produce a balanced budget. Many program cuts and budgetary adjustments have already been made in the last three years. The Governor's May Revision to his Budget proposal recognized that the accumulated deficit could not be repaid in one year, and proposed a two-year solution. The May Revision sets forth revenue and expenditure forecasts and revenue and expenditure proposals which result in operating surpluses for the budget for both 1994-95 and 1995-96, and lead to the elimination of the accumulated deficit, estimated at about $2 billion at June 30, 1994, by June 30, 1996. The 1994-95 Budget Act, signed by the Governor on July 8, 1994, projects revenues and transfers of $41.9 billion, about $2.1 billion higher than revenues in 1993-94. This reflects the Administration's forecast of an improved economy. Also included in this figure is the projected receipt of about $360 million from the Federal Government to reimburse the State for the cost of incarcerating undocumented immigrants. The State will not know how much the Federal Government will actually provide until the Federal fiscal year 1995 Budget is completed, which is expected to be by October 1994. The Legislature took no action on a proposal in the Governor's January Budget to undertake expansion of the transfer of certain programs to counties, which would also have transferred to counties 0.5% of the State's current sales tax. The Budget Act projects Special Fund revenues of $12.1 billion, a decrease of 2.4% from 1993-94 estimated levels. The 1994-95 Budget Act projects General Fund expenditures of $40.9 billion, an increase of $1.6 billion over 1993-94. The Budget Act also projects Special Fund expenditures of $13.7 billion, a 5.4% increase over 1993-94 estimated expenditures. The principal features of the Budget Act were the following: 1. Receipt of additional federal aid in 1994-95 of about $400 million for costs of refugee assistance and medical care for undocumented aliens, thereby offsetting a similar General Fund cost. The State will not know how much of these funds it will receive until the Federal fiscal year 1994 Budget is passed. 2. Reductions of approximately $1.1 billion in health and welfare programs. 3. A General Fund increase of approximately $38 million in support for the University of California and $65 million for the California State University. It is anticipated that student fees for both the U.C. and the C.S.U will increase up to 10%. 4. Proposition 98 funding for K-14 schools is increased by $526 million from the 1993-94 levels, representing an increase for enrollment growth and inflation. Consistent with previous budget agreements, Proposition 98 funding provides approximately $4,217 per student for K-12 schools, equal to the level in the past three years. 5. Legislation enacted with the Budget Act clarifies laws passed in 1992 and 1993 requiring counties and other local agencies to transfer funds to local school districts, thereby reducing State aid. Some counties had implemented programs providing less moneys to schools if there were redevelopment agencies projects. The legislation bans this method of transfers. 6. The Budget Act provides funding for anticipated growth in the State's prison inmate population, including provisions for implementing recent legislation (the so-called "Three Strikes" law) which requires mandatory life sentences for certain third-time felony offenders. 7. Additional miscellaneous cuts ($500 million) and fund transfers ($255 million) totalling in the aggregate approximately $755 million. The 1994-95 Budget Act contains no tax increases. Under legislation enacted for the 1993-94 Budget, the renters' tax credit was suspended for 1993 and 1994. A ballot proposition to permanently restore the renters' credit after this year failed at the June 1994 election. The Legislature enacted a further one-year suspension of the renters' tax credit, saving about $390 million in the 1995-96 fiscal year. The 1994-95 Budget assumes that the State will use a cash flow borrowing program in 1994-95 which combines one-year notes and warrants. Issuance of the warrants allows the State to defer repayment of approximately $1 billion of its accumulated budget deficit into the 1995-96 fiscal year. THE FOREGOING DISCUSSION OF THE 1993-94 AND 1994-95 FISCAL YEAR BUDGETS IS BASED IN LARGE PART ON STATEMENTS MADE IN A RECENT "PRELIMINARY OFFICIAL STATEMENT" DISTRIBUTED BY THE STATE OF CALIFORNIA. IN THAT DOCUMENT, THE STATE INDICATED THAT ITS DISCUSSION OF THE 1994-95 FISCAL YEAR BUDGET IS BASED ON ESTIMATES AND PROJECTIONS OF REVENUES AND EXPENDITURES FOR THE CURRENT FISCAL YEAR AND MUST NOT BE CONSTRUED AS STATEMENTS OF FACT. THE STATE NOTED FURTHER THAT THE ESTIMATES AND PROJECTIONS ARE BASED UPON VARIOUS ASSUMPTIONS WHICH MAY BE AFFECTED BY NUMEROUS FACTORS, INCLUDING FUTURE ECONOMIC CONDITIONS IN THE STATE AND THE NATION, AND THAT THERE CAN BE NO ASSURANCE THAT THE ESTIMATES WILL BE ACHIEVED. The State is subject to an annual appropriations limit imposed by Article XIIIB of the State Constitution (the "Appropriations Limit"), and is prohibited from spending "appropriations subject to limitation" in excess of the Appropriations Limit. Article XIIIB, originally adopted in 1979, was modified substantially by Propositions 98 and 111 in 1988 and 1990, respectively. "Appropriations subject to limitation" are authorizations to spend "proceeds of taxes," which consist of tax revenues and certain other funds, including proceeds from regulatory licenses, user charges or other fees to the extent that such proceeds exceed the reasonable cost of providing the regulation, product or service. The Appropriations Limit is based on the limit for the prior year, adjusted annually for certain changes, and is tested over consecutive two-year periods. Any excess of the aggregate proceeds of taxes received over such two-year period above the combined Appropriation Limits for those two years is divided equally between transfers to K-14 districts and refunds to taxpayers. Exempted from the Appropriations Limit are debt service costs of certain bonds, court or federally mandated costs, and, pursuant to Proposition 111, qualified capital outlay projects and appropriations or revenues derived from any increase in gasoline taxes and motor vehicle weight fees above January 1, 1990 levels. Some recent initiatives were structured to create new tax revenues dedicated to specific uses and expressly exempted from the Article XIIIB limits. The Appropriations Limit may also be exceeded in cases of emergency arising from civil disturbance or natural disaster declared by the Governor and approved by two-thirds of the Legislature. If not so declared and approved, the Appropriations Limit for the next three years must be reduced by the amount of the excess. Article XIIIB, as amended by Proposition 98 on November 8, 1988, also establishes a minimum level of state funding for school and community college districts and requires that excess revenues up to a certain limit be transferred to schools and community college districts instead of returned to the taxpayers. Determination of the minimum level of funding is based on several tests set forth in Proposition 98. During fiscal year 1991-1992 revenues were smaller than expected, thus reducing the payment owed to schools in 1991-92 under alternate "test" provisions. In response to the changing revenue situation, and to fully fund the Proposition 98 guarantee in the 1991- 1992 and 1992-1993 fiscal years without exceeding it, the Legislature enacted legislation to reduce 1991-92 appropriations. The amount budgeted to schools but which exceeded the reduced appropriation was treated as a non-Proposition 98 short-term loan in 1991-92. As part of the 1992-93 Budget, $1.083 billion of the amount budgeted to K-14 schools was designated to "repay" the prior year loan, thereby reducing cash outlays in 1992-93 by that amount. To maintain per- average daily attendance ("ADA") funding, the 1992-93 Budget included loans of $732 million to K-12 schools and $241 million to community colleges, to be repaid from future Proposition 98 entitlements. The 1993-94 Budget also provided new loans of $609 million to K-12 schools and $178 million to community colleges to maintain ADA funding. These loans have been combined with the 1992-93 fiscal year loans into one loan of $1.760 billion, to be repaid from future years' Proposition 98 entitlements, and conditioned upon maintaining current funding levels per pupil at K-12 schools. A Sacramento County Superior Court in California Teachers' Association, et al. v Gould, et al., has ruled that the 1992-93 loans to K-12 schools and community colleges violate Proposition 98. The impact of the court's ruling on the State budget and funding for schools is unclear and will remain unclear until the Court's written ruling, which is currently being prepared, is issued. The 1994-95 Budget Act has appropriated $14.4 billion of Proposition 98 funds for K-14 schools, exceeding the minimum Proposition 98 guaranty by $8 million to maintain K-12 funds per pupil at $4,217. Based upon State revenues, growth rates and inflation factors, the 1994-95 Budget Act appropriations an additional $286 million within Proposition 908 for the 1993-94 fiscal year to reflect a need in appropriations for school district and county officers of education, as well as an anticipated deficiency in special education funding. Because of the complexities of Article XIIIB, the ambiguities and possible inconsistencies in its terms, the applicability of its exceptions and exemptions and the impossibility of predicting future appropriations, the Sponsor cannot predict the impact of this or related legislation on the bonds in the Trust Portfolio. Other Constitutional amendments affecting state and local taxes and appropriations have been proposed from time to time. If any such initiatives are adopted, the State could be pressured to provide additional financial assistance to local governments or appropriate revenues as mandated by such initiatives. Propositions such as Proposition 98 and others that may be adopted in the future, may place increasing pressure on the State's budget over future years, potentially reducing resources available for other State programs, especially to the extent the Article XIIIB spending limit would restrain the States's ability to fund such other programs by raising taxes. As of July 1, 1994, the State had over $18.39 billion aggregate amount of its general obligation bonds outstanding. General obligation bond authorizations in aggregate amount of approximately $5.16 billion remained unissued as of July 1, 1994. The State also builds and acquires capital facilities through the use of lease purchase borrowing. As of June 30, 1994, the State had approximately $5.09 billion of outstanding Lease-Purchase Debt. In addition to the general obligation bonds, State agencies and authorities had approximately $23.3 billion aggregate principal amount of revenue bonds and notes outstanding as of June 30, 1994. Revenue bonds represent both obligations payable from State revenue-producing enterprises and projects, which are not payable from the General Fund, and conduit obligations payable only from revenues paid by private users of facilities financed by such revenue bonds. Such enterprises and projects include transportation projects, various public works and exposition projects, educational facilities (including the California State University and University of California systems), housing, health facilities and pollution control facilities. The State is a party to numerous legal proceedings, many of which normally occur in governmental operations. In addition, the State is involved in certain other legal proceedings that, if decided against the State, might require the State to make significant future expenditures or impair future revenue sources. Examples of such cases include challenges to certain vehicle license fees, and challenges to the State's use of Public Employee Retirement System funds to offset future State and local pension contributions. Other cases which could significantly impact revenue or expenditures involve reimbursement to school districts for voluntary school desegregation and state mandated costs, challenges to Medi-Cal eligibility, recovery for flood damages, and liability for toxic waste cleanup. Because of the prospective nature of these proceedings, it is not presently possible to predict the outcome of such litigation or estimate the potential impact on the ability of the State to pay debt service on its obligation. On June 20, 1994, the United States Supreme Court, in two companion cases, upheld the validity of California's prior method of taxing multinational corporations under a "unitary" method of accounting for their worldwide earnings, thus avoiding tax refunds of approximately $1.55 billion by the State, and enabling the State to collect $620 million in previous assessments. Barclays Bank PLC v. Franchise Tax Board concerned foreign corporations, and Colgate-Palmolive v. Franchise Tax Board concerned domestic corporations. On July 15, 1994, Standard & Poor's Corporation ("Standard & Poor's"), Moody's Investors Service, Inc. ("Moody's"), and Fitch Investors Service, Inc. ("Fitch") all downgraded their ratings of California's general obligation bonds. These bonds are usually sold in 20- to 30-year increments and used to finance the construction of schools, prisons, water systems and other projects. The ratings were reduced by Standard & Poor's from "A+" to "A", by Moody's from "Aa" to "A1", and by Fitch from "AA" to "A". Since 1991, when it had a "AAA" rating, the State's rating has been downgraded three times by all three ratings agencies. All three agencies cite the 1994-95 Budget Act's dependence on a "questionable" federal bailout to pay for the cost of illegal immigrants, the Propositions 98 guaranty of a minimum portion of State revenues for kindergarten through community college, and the persistent deficit requiring more borrowing as reasons for the reduced rating. Another concern was the State's reliance on a standby mechanism which could trigger across-the-board reductions in all State programs, and which could disrupt State operations, particularly in fiscal year 1995-96. However, a Standard & Poor's spokesman stated that, although the lowered ratings means California is a riskier borrower, Standard & Poor's anticipates that the State will pay off its debts and not default. There can be no assurance that such ratings will continue for any given period of time or that they will not in the future be further revised. As a result of Orange County's Chapter 9 bankruptcy filing on December 6, 1994, Moody's has suspended the County's bond ratings, and Standard & Poor's has cut its rating of all Orange County debt from "AA-" to "CCC", a level below investment grade and an indication of high risk and uncertainty. Fitch does not rate Orange County bonds. It is anticipated that as Orange County's credit and bond ratings fall, it will have difficulty in getting loans or selling its bonds to raise money. Additionally, the County's bankruptcy filing could affect about 180 municipalities, school districts, and other municipal entities which entrusted billions of dollars to Orange County to invest. Standard & Poor's has informed such entities that they have been placed on negative credit watch, the usual step prior to a downgrade of credit rating. The Sponsor believes the information summarized above describes some of the more significant aspects relating to the California Trust. The sources of such information are Preliminary Official Statements and Official Statements relating to the State's general obligation bonds and the State's revenue anticipation notes, or obligations of other issuers located in the State of California, or other publicly available documents. Although the Sponsor has not independently verified this information, it has no reason to believe that such information is not correct in all material respects. In the opinion of Messrs. Adams, Duque & Hazeltine, Los Angeles, California, special counsel on California tax matters, under existing law: The California Trust is not an association taxable as a corporation under the income tax laws of the State of California; The income, deductions and credits against tax of the California Trust will be treated as the income, deductions and credits against tax of the holders of Units in the California Trust under the income tax laws of the Interest on the bonds held by the California Trust to the extent that such interest is exempt from taxation under California law will not lose its character as tax-exempt income merely because that income is passed through to the holders of Units; however, a corporation subject to the California franchise tax is required to include that interest income in its gross income for purposes of determining its franchise tax liability; Each holder of a Unit in the California Trust will have a taxable event when the California Trust disposes of a bond (whether by sale, exchange, redemption, or payment at maturity) or when the Unit holder redeems or sells his Units. The total tax cost of each Unit to a holder of a Unit in the California Trust is allocated among each of the bond issues held in the California Trust (in accordance with the proportion of the California Trust comprised by each bond issue) in order to determine the holder's per Unit tax cost for each bond issue, and the tax cost reduction requirements relating to amortization of bond premium will apply separately to the per Unit tax cost of each bond issue. Therefore, under some circumstances, a holder of a Unit may realize taxable gain when the California Trust which issued such Unit disposes of a bond or the holder's Units are sold or redeemed for an amount equal to or less than his original cost of the bond Each holder of a Unit in the California Trust is deemed to be the owner of a pro rata portion of the California Trust under the personal property tax laws of the State of California; and Each Unit holder's pro rata ownership of the bonds held by the California Trust, as well as the interest income therefrom, is exempt from California personal property taxes. In 1980, Florida was the seventh most populous state in the U.S. The State has grown dramatically since then and as of April 1, 1994, ranks fourth with an estimated population of 13.9 million. Florida's attraction, as both a growth and retirement state, has kept net migration fairly steady with an average of 235,600 new residents a year from 1985 through 1994. The U.S. average population increase since 1984 is about 1% annually, while Florida's average annual rate of increase is about 2.3%. Florida continues to be the fastest growing of the eleven largest states. This strong population growth is one reason the State's economy is performing better than the nation as a whole. In addition to attracting senior citizens to Florida as a place for retirement, the State is also recognized as attracting a significant number of working age individuals. Since 1985, the prime working age population (18-44) has grown at an average annual rate of 2.2%. The share of Florida's total working age population (18-59) to total State population is approximately 54%. This share is not expected to change appreciably into the twenty-first century. The State's personal income has been growing strongly the last several years and has generally out performed both the U.S. as a whole and the southeast in particular, according to the U.S. Department of Commerce and the Florida Consensus Economic Estimating Conference. This is because Florida's population has been growing at a very strong pace and, since the early 70's, the State's economy has diversified so as to provide a broader economic base. As a result, Florida's real per capita personal income has tracked closely with the national average and has tracked above the southeast. From 1985 through 1994, the State's real per capita income rose an average 5.2% a year, while the national real per capita income increased at an average 5.1%. Because Florida has a proportionately greater retirement age population, property income (dividends, interest, and rent) and transfer payments (Social Security and pension benefits, among other sources of income) are relatively more important sources of income. For example, Florida's total wages and salaries and other labor income in 1994 was 61.5% of total personal income, while a similar figure for the nation for 1990 was 72.6%. Transfer payments are typically less sensitive to the business cycle than employment income and, therefore, act as stabilizing forces in weak economic periods. The State's per capita personal income in 1994 of $21,677 was slightly below the national average of $21,809 and significantly ahead of that for the southeast United States, which was $19,649. Real personal income in the State is estimated to increase 4.6% in 1995-96 and 3.8% in 1996-97. Real personal income per capita in the State is projected to grow at 2.7% in 1995-96 and 1.9% in 1996-97. The Florida economy appears to be performing in line with the U.S economy and is expected to experience steady if unspectacular growth. Since 1985, the State's population has increased an estimated 26.1%. In that same period, Florida's total non-farm employment has grown by approximately 37.9%. Since 1985, the job creation rate in the State is almost twice that of the nation as a whole. Contributing to this is State's rapid rate of growth in employment and income is international trade. Changes to its economy have also contributed to the State's strong performance. The State is now less dependent on employment from construction, construction related manufacturing, and resource based manufacturing, which have declined as a proportion of total State employment. The State's private sector employment is 86.4% of total non- farm employment. While the southeast and the nation have a greater proportion of manufacturing jobs, which tend to pay higher wages, service jobs tend to be less sensitive to swings in the business cycle. The State has a concentration of manufacturing jobs in high-tech and high value-added sectors, such as electrical and electronic equipment, as well as printing and publishing. These type of manufacturing jobs tend to be less cyclical. The State's unemployment rate throughout the 1980's tracked below the nation's. As the State's economic growth has slowed, its unemployment rate has tracked above the national average. The average rate in the State since 1985 is 6.3%. The national average is 6.4%. According to the U.S. Department of Commerce, the Florida Department of Labor and Employment Security, and the Florida Consensus Economic Estimating Conference (together the "Organization") the State's unemployment rate was 6.6% during 1994. As of November 1995, the Organization estimates that the unemployment rate will be 5.6% for 1995-96 and 5.7% in 1996-97. The State's economy is expected to decelerate along with the nation, but is expected to outperform the nation as a whole. Total non-farm employment in Florida is expected to grow at an increase of 3.2% in 1995-96 and rise 3.0% in 1996-97. Trade and services, the two largest, account for more than half of the total non-farm employment. Employment in the service sectors should experience an increase of 5.3% in 1995-96, while growing 4.5% in 1996-97. Trade is expected to expand 3.4% in 1996 and 3.0% in 1997. The service sector is now the State's largest employment category. The State's economy has in the past been highly dependent on the construction industry and construction related manufacturing. This dependency has declined in recent years and continues to do so as a result of continued diversification of the State's economy. For example, in 1980, total contract construction employment as a share of total non-farm employment was just about 7.5%, and in 1994, the share had edged downward to 5%. This trend is expected to continue as the State's economy continues to diversify. Florida, nevertheless, has a dynamic construction industry, with single and multi-family housing starts accounting for about 8.5% of total U.S. housing starts in 1994 while the State's population is 5.3% of the U.S. total population. Florida's housing starts since 1985 averaged 148,500 a year. A driving force behind the State's construction industry has been the State's rapid rate of population growth. Although the State currently is the fourth most populous state, its annual population growth is now projected to decline as the number of people moving into the State is expected to hover near the mid 235,000 range annually throughout the 1990's. This population trend should provide fuel for business and home builders to keep construction activity lively in Florida for some time to come. However, other factors do influence the level of construction in the State. For example, federal tax reform in 1986 and other changes to the federal income tax code have eliminated tax deduction for owners of more than two residential real estate properties and have lengthened depreciation schedules on investment and commercial properties. Economic growth and existing supplies of homes and buildings also contribute to the level of construction in the State. Single and multi-family housing starts in 1995-96 are projected to reach a combined level of 113,200, increasing to 115,100 next year. Lingering recessionary effects on consumers and tight credit are some of the reasons for relatively slow core construction activity, as well as lingering effects from the 1986 tax reform legislation discussed above. Total construction expenditures are forecasted to increase 4.0% this year and increase 5.3% next year. The State has continuously been dependent on the highly cyclical construction and construction related manufacturing industries. While that dependency has decreased, the State is still somewhat at the mercy of the construction and construction related manufacturing industries. The construction industry is driven to a great extent by the State's rapid growth in population. There can be no assurance that population growth will continue throughout the 1990's in which case there could be an adverse impact on the State's economy through the loss of construction and construction related manufacturing jobs. Also, recent increases in interest rates could significantly adversely impact the financing of new construction within the State, thereby adversely impacting unemployment and other economic factors within the State. In addition, available commercial office space has tended to remain high over the past few years. So long as this glut of commercial rental space continues, construction of this type of space will likely continue to remain slow. Tourism is one of State's most important industries. Approximately 39.9 million tourists visited the State in 1994, as reported by the Florida Department of Commerce. In terms of business activities and State tax revenues, tourists in Florida in 1994 represented an estimated 4.5 million additional residents. Visitors to the State tend to arrive slightly more by air than by car. The State's tourist industry over the years has become more sophisticated, attracting visitors year-round and, to a degree, reducing its seasonality. Tourist arrivals are expected to increase by 1.3% this year and 4.3% next year. Tourist arrivals to Florida by air are expected to decrease by 0.5% this year and increase by 4.6% next year, while arrivals by car are expected to rise 3.2% in 1995-96 and 4.9% in 1996-97. By the end of the State's current fiscal year, 41.4 million domestic and international tourists are expected to have visited the State. In 1996-97, tourist arrivals should approximate 43.2 million. Estimated fiscal year 1995-96 General Reserve plus Working Capital and Budget Stabilization funds available to the State total $15,149.12 million, a 2.2% increase over 1994-95. Of the total General Revenue plus Working Capital and Budget Stabilization funds available to the State, $14,456.7 million of that is Estimated Revenues (excluding the Andrew impact) which represents an increase of 5.9% over the previous year's Estimated Revenues. With effective General Revenues plus Working Capital Fund and Budget Stabilization appropriations at $14,824.0 million, unencumbered reserves at the end of 1995-96 are estimated at $325.1 million. Estimated, fiscal year 1996-97 General Reserve plus Working Capital and Budget Stabilization funds available total $15,717.8 million, a 3.8% increase over 1995-96. The $15,262.3 million in Estimated Revenues represents an increase of 5.6% over the previous year's Estimated Revenues. In fiscal year 1994-95, approximately 66% of the State's total direct revenue to its three operating funds were derived from State taxes and fees, with Federal grants and other special revenue accounting for the balance. State sales and tax, corporate income tax, intangible personal property tax, and beverage tax amounted to 67%, 7%, 4%, and 4%, respectively, of total General Revenue Funds available during fiscal 1994-95. In that same year, expenditures for education, health and welfare, and public safety amounted to approximately 49%, 32%, and 11%, respectively, of total expenditures from the General Revenue Fund. The State's sales and use tax (6%) currently accounts for the State's single largest source of tax receipts. Slightly less than 10% of the State's sales and use tax is designated for local governments and is distributed to the respective counties in which collected for use by the counties, and the municipalities therein. In addition to this distribution, local governments may (by referendum) assess a 0.5% or a 1.0% discretionary sales surtax within their county. Proceeds from this local option sales tax are earmarked for funding local infrastructure programs and acquiring land for public recreation or conservation or protection of natural resources as provided under applicable Florida law. Certain charter counties have other taxing powers in addition, and non-consolidated counties with a population in excess of 800,000 may levy a local option sales tax to fund indigent health care. It alone cannot exceed 0.5% and when combined with the infrastructure surtax cannot exceed 1.0%. For the fiscal year ended June 30, 1995, sales and use tax recipients (exclusive of the tax on gasoline and special fuels) totalled $10,672.0 million, an increase of 6.0% over fiscal year 1993-1994. The second largest source of State tax receipts is the tax on motor fuels. However, these revenues are almost entirely dedicated trust funds for specific purposes and are not included in the State's General Revenue Fund. The State imposes an alcoholic beverage, wholesale tax (excise tax) on beer, wine, and liquor. This tax is one of the State's major tax sources, with revenues totalling $437.3 million in fiscal year ending June 30, 1995. Alcoholic beverage tax receipts decreased 1.0% from the previous years total. The revenues collected from this tax are deposited into the State's General Revenue Fund. The State imposes a corporate income tax. All receipts of the corporate income tax are credited to the General Revenue Fund. For the fiscal year ended June 30, 1995, receipts from this source were $1,063.5 million, an increase of 1.5% from fiscal year 1993-94. The State imposes a documentary stamp tax on deeds and other documents relating to realty, corporate shares, bonds, certificates of indebtedness, promissory notes, wage assignments, and retail charge accounts. The documentary stamp tax collections totalled $695.3 million during fiscal year 1994-95, an 11.4% decrease from the previous fiscal year. Beginning in fiscal year 1993-94, 62.63% of these taxes are to be deposited to the General Revenue Fund. The State imposes a gross receipts tax on electric, natural gas, and telecommunications services. All gross receipts utilities tax collections are credited to the State's Public Education Capital Outlay and Debt Service Trust Fund. In fiscal year 1993-94, this amounted to $508.4 million. The State imposes an intangible personal property tax on stocks, bonds, including bonds secured by liens in Florida real property, notes, governmental leaseholds, and certain other intangibles not secured by a lien on Florida real property. The annual rate of tax is 2 mils. Second, the State imposes a non- recurring 2 mil tax on mortgages and other obligations secured by liens on Florida real property. In fiscal year 1994-95, total intangible personal property tax collections were $818.0 million, a 2.1% decrease from the prior year. Of the net tax proceeds, 66.5% are distributed to the General Revenue Fund. The State's severance tax taxes, oil, gas, and sulphur production, as well as the severance of phosphate rock and other solid minerals. total collections from severance taxes total $61.2 million during fiscal year 1994-95, up 1.1%, from the previous year. Currently, 58% of this amount is transferred to the General Revenue Fund. The State began its own lottery in 1988. State law requires that lottery revenues be distributed 50% to the public in prizes, 38.0% for use in enhancing education, and the balance, 12.0%, for the costs of administering the lottery. Fiscal year 1994-95 lottery ticket sales totalled $2.19 billion, providing education with approximately $853.2 million. The Florida Trust will not be subject to the Florida income tax imposed by Chapter 220 so long as the Florida Trust transacts no business in Florida or has no income subject to federal income taxation. In addition, political subdivisions of Florida do not impose any income taxes. Non-Corporate Unit holders will not be subject to any Florida income taxation on income realized by the Florida Trust. Corporate Unit holders with commercial domiciles in Florida will be subject to Florida income taxation on income realized by the Trust. Other corporate Unit holders will be subject to Florida income taxation on income realized by the Florida Trust only to the extent that the income realized is other than "non-business income" as defined by Chapter 220. At the end of fiscal 1994, approximately $6.07 billion in principal amount of debt secured by the full faith and credit of the State was outstanding. In addition, since July 1, 1994, the State issued about $1.17 billion in principal amount of full faith and credit bonds. The State Constitution and statutes mandate that the State budget, as a whole, and each separate fund within the State budget, be kept in balance from currently available revenues each fiscal year. If the Governor or Comptroller believes a deficit will occur in any State fund, by statute, he must certify his opinion to the Administrative Commission, which then is authorized to reduce all State agency budgets and releases by a sufficient amount to prevent a deficit in any fund. Additionally, the State Constitution prohibits issuance of State obligations to fund State operations. Currently under litigation are several issues relating to State actions or State taxes that put at risk substantial amounts of General Revenue Fund monies. Accordingly, there is no assurance that any of such matters, individually or in the aggregate, will not have a material adverse affect on the State's financial position. Florida law provides preferential tax treatment to insurers who maintain a home office in the State. Certain insurers challenged the constitutionality of this tax preference and sought a refund of taxes paid. Recently, the Florida Supreme Court ruled in favor of the State. This case and others, along with pending refund claims, total about $150 million. Previously the State imposed a $295 fee on the issuance of certificates of title for motor vehicles previously titled outside the State. Plaintiffs sued the State alleging that this fee violates the Commerce Clause of the U.S. Constitution. The Circuit Court in which the case was filed granted summary judgment for the plaintiffs, enjoined further collection of the impact fee and ordered refunds to all those who have paid the fee since the collection of the fee went into effect. In the State's appeal of the lower Court's decision, the Florida Supreme Court ruled that this fee was unconstitutional under the Commerce Clause. Thus, the Supreme Court approved the lower court's order enjoining further collection of the fee and requiring refund of the previously collected fees. The refund exposure of the State has been estimated to be in excess of $188 million. The State maintains a bond rating of Aa, AA, and AA from Moody's Investors Service, Standard & Poors Corporation, and Fitch, respectively, on the majority of its general obligation bonds, although the rating of a particular series of revenue bonds relates primarily to the project, facility, or other revenue source from which such series derives funds for repayment. While these ratings and some of the information presented above indicate that the State is in satisfactory economic health, there can be no assurance that there will not be a decline in economic conditions or that particular Bonds purchased by the Trust will not be adversely affected by any such changes. The sources for the information presented above include official statements and financial statements of the State of Florida. While the Sponsor has not independently verified this information, the Sponsor has no reason to believe that the information is not correct in all material respects. Florida Trust Units will be subject to Florida estate tax if owned by Florida residents and may be subject to Florida estate tax if owned by other decedents at death. However, the Florida estate tax is limited to the amount of the credit allowable under the applicable Federal Revenue Act (currently Section 2011 [and in some cases Section 2102] of the Internal Revenue Code of 1986, as amended) for death taxes actually paid to the several states. Neither the Bonds nor the Units will be subject to the Florida ad valorem property tax or Florida sales or use tax. Neither the Florida Trust nor the Units will be subject to Florida intangible personal property tax. Neither the issuance and sale of the Units by the Florida Trust nor the transfer of Units by a Unit holder will subject either the Florida Trust or the Unit holders to Florida documentary stamp tax. For the purposes of the foregoing opinion, the following terms have the following meanings: (a) "Non-Corporate Unit holder"--a Unit holder of the Florida Trust who is an individual not subject to the Florida state income tax on corporations, under Chapter 220, Florida Statutes ("Chapter 220"). (b) "Corporate Unit holder"--a Unit holder of the Florida Trust that is a corporation subject to the Florida state income tax on corporations under Chapter 220. RISK FACTORS--Prospective investors should consider the financial difficulties and pressures which the State of New York and several of its public authorities and municipal subdivisions have undergone. The following briefly summarizes some of these difficulties and the current financial situation, based principally on certain official statements currently available; copies may be obtained without charge from the issuing entity. NEW YORK STATE. In recent fiscal years, there have been extended delays in adopting the State's budget, repeated revisions of budget projections, significant revenue shortfalls (as well as increased expenses) and year-end borrowing to finance deficits. These developments reflect faster long-term growth in State spending than revenues and that the State was earlier and more severely affected by the recent economic recession than most of the rest of the country, as well as its substantial reliance on non-recurring revenue sources. The State's general fund incurred cash basis deficits of $775 million, $1,081 million and $575 million, respectively, for the 1990-92 fiscal years. Measures to deal with deteriorating financial conditions included transfers from reserve funds, recalculating the State's pension fund obligations (subsequently ruled illegal), hiring freezes and layoffs, reduced aid to localities, sales of State property to State authorities, and additional borrowings (including issuance of additional short-term tax and revenue anticipation notes payable out of impounded revenues in the next fiscal year). The general fund realized a $671 million surplus for fiscal year ended March 31, 1993, and a $1.54 billion surplus for the fiscal year ended March 31, 1994. Disbursements exceeded receipts by $241 million for the fiscal year ended March 31, 1995. Approximately $5.2 billion of State general obligation debt was outstanding at March 31, 1995. State supported debt (restated to reflect LGAC's assumption of certain obligations previously funded through issuance of short-term debt) was $27.9 billion at March 31, 1995, up from $9.8 billion in 1986. S&P reduced its ratings of the State's general obligation bonds on January 13, 1992 to A- (its lowest rating for any state). Moody's reduced its ratings of State general obligation bonds from A1 to A on June 6, 1990 and to Baa1, its rating of $14.2 billion of appropriation-backed debt of the State and State agencies (over two- thirds of the total debt) on January 6, 1992. In May 1991 (nearly 2 months after the beginning of the 1992 fiscal year), the State Legislature adopted a budget to close a projected $6.5 billion gap (including repayment of $905 million of fiscal 1991 deficit notes). Measures included $1.2 billion in new taxes and fees, $0.9 billion in non-recurring measures and about $4.5 billion of reduced spending by State agencies aid to localities and school districts, and Medicaid cost containment measures. After the Governor vetoed $0.9 billion in spending, the State adopted $0.7 billion in additional spending, together with various measures including a $100 million increase in personal income taxes and $180 million of additional non- recurring measures. Due primarily to declining revenues and escalating Medicaid and social service expenditures, $0.4 billion of administrative actions, $531 million of year-end short-term borrowing and a $44 million withdrawal from the Tax Stabilization Reserve Fund were required to meet the State's cash flow needs. The State budget to close a projected $4.8 billion gap for the State's 1993 fiscal year (including repayment of the fiscal 1992 short-term borrowing) contained a combination of $3.5 billion of spending reductions (including measures to reduce Medicaid and social service spending, as well as further employee layoffs, reduced aid to municipalities and schools and reduced support for capital programs), deferral of scheduled tax reductions, and some new and increased fees. Nonrecurring measures aggregated $1.18 billion. To close a projected budget gap of nearly $3 billion for the fiscal year ended March 31, 1994, the State budget contained various measures including further deferral of scheduled income tax reductions, some tax increases, $1.6 billion in spending cuts, especially for Medicaid, and further reduction of the State's work force. The budget increased aid to schools, and included a formula to channel more aid to districts with lower-income students and high property tax burdens. State legislation requires deposit of receipts from the petroleum business tax and certain other transportation-related taxes into funds dedicated to transportation purposes. Nevertheless, $516 million of these monies were retained in the general fund during this fiscal year. The Division of the Budget has estimated that non-recurring income items other than the $671 million surplus from the 1993 fiscal year aggregated $318 million. The budget for the fiscal year ended March 31, 1995, increased spending by 3.8% (greater than inflation for the first time in six years). It provided a tax credit for low income families and increased aid to education, especially in the poorer districts. The State reduced coverage and placed additional restrictions on certain health care services. Over $1 billion resulted from postponement of scheduled reductions in personal income taxes for a fifth year and in taxes on hospital income; another $1.5 billion came from non-recurring measures. The Governor in January 1995 instituted $188 million in spending reductions (including a hiring freeze) and $71 million of other measures to address a widening gap. More than two months after the fiscal year that began April 1, 1995, the State adopted a budget to close a projected gap of approximately $5 billion, including a reduction in income and business taxes. The financial plan projects nearly $1.6 billion in savings from cost containment, disbursement reestimates and reduced funding for social welfare programs and $2.2 billion from State agency actions. Approximately $1 billion of the gap-closing measures are non- recurring and some of the revenue and cost-cutting estimates are considered optimistic. A suit was filed seeking to block introduction of the State's new lottery game, expected to produce $80-200 million in annual revenues.The State Comptroller sued to prevent reallocation of $110 million of reserves from a special pension fund and has projected gaps of $2.7 billion for fiscal 1997 and $3.9 billion for fiscal 1998 (substantially above the Governor's projections), reflecting in part the last two years of the Governor's proposal to reduce personal income taxes by 20% over three years. State and other estimates are subject to uncertainties including the effects of Federal tax legislation and economic developments. In October, the Governor released a plan to reduce State spending by $148 million to offset risks that have developed, including proposed reductions in Federal aid and possible adverse court decisions. A $290 million surplus was projected in December 1995. The Governor has proposed a budget for the State's fiscal year commencing April 1, 1996 to address a projected $3.9 billion budget gap. It would eliminate 7,400 State jobs (largely through buyouts) to save $250 million annually and reduce Medicaid ($1.1 billion), welfare ($240 million) and higher education ($256 million) spending, but would reduce taxes by $2.1 billion, increase prison, road and bridge construction and divert $100 million of State lottery proceeds from education to reduce property taxes. The proposal may be significantly affected by resolution of the current Federal budget impasse. Non-recurring savings are estimated at $123 million. The proposed reductions are likely to add financial pressure to State municipalities. Mayor Guiliani criticized the proposed use of a $1.3 billion windfall from proposed Federal changes in Medicaid funding to close the State's gap rather than reducing municipal Medicaid costs. The proposed budget would also move the State to cash accounting but would increase use of appropriation-backed debt. The State normally adjusts its cash basis balance by deferring until the first quarter of the succeeding fiscal year substantial amounts of tax refunds and other disbursements. For many years, it also paid in that quarter more than 40% of its annual assistance to local governments. Payment of these annual deferred obligations and the State's accumulated deficit was substantially financed by issuance of short-term tax and revenue anticipation notes shortly after the beginning of each fiscal year. The New York Local Government Assistance Corporation ("LGAC") was established in 1990 to issue $4.7 billion of long-term bonds over several years, payable from a portion of the State sales tax, to fund certain payments to local governments traditionally funded through the State's annual seasonal borrowing. The legislation will normally prevent State seasonal borrowing until an equal amount of LGAC bonds are retired. The State's last seasonal borrowing, in May 1993, was $850 million. Voters in November 1995 failed to ratify a proposed constitutional amendment which would have eliminated lease-purchase and contractual financing. The Governor has prepared a constitutional amendment to require the State to adopt balanced budgets. Generally accepted accounting principles ("GAAP") for municipal entities apply modified accrual accounting and give no effect to payment deferrals. On an audited GAAP basis, the State's government funds group recorded operating deficits of $1.2 billion and $1.4 billion for the 1990 and 1991 fiscal years. For the same periods the general fund recorded deficits (net of transfers from other funds) of $0.7 billion and $1.0 billion. Reflecting $1.6 billion, $881 million, $875 million and $315 million of payments by LGAC to local governments out of proceeds from bond sales, the general fund realized surpluses of $1.7 billion, $2.1 billion and $0.9 billion for the 1992, 1993 and 1994 fiscal years and a deficit of $1.4 billion for the fiscal year ended March 31, 1995, for an accumulated deficit of $3.3 billion. The Governor projects a $1.4 billion budget gap for fiscal 1998 and $1 billion for fiscal 1999. For decades, the State's economy has grown more slowly than that of the rest of the nation as a whole. Part of the reason for this decline has been attributed to the combined State and local tax burden, which is among the highest in the nation. The State's dependence on Federal funds and sensitivity to changes in economic cycles, as well as the high level of taxes, may continue to make it difficult to balance State and local budgets in the future. The total employment growth rate in the State has been below the national average since 1984. The State lost 524,000 jobs in 1990-1992. It regained approximately 185,000 jobs between November 1992 and June 1995. New York City (the "City"). The City is the State's major political subdivision. In 1975, the City encountered severe financial difficulties, including inability to refinance $6 billion of short-term debt incurred to meet prior annual operating deficits. The City lost access to the public credit markets for several years and depended on a variety of fiscal rescue measures including commitments by certain institutions to postpone demands for payment, a moratorium on note payment (later declared unconstitutional), seasonal loans from the Federal government under emergency congressional legislation, Federal guarantees of certain City bonds, and sales and exchanges of bonds by The Municipal Assistance Corporation for the City of New York ("MAC") to fund the City's debt. MAC has no taxing power and pays its obligations out of sales taxes imposed within the City and per capita State aid to the City. The State has no legal obligation to back the MAC bonds, although it has a "moral obligation" to do so. MAC is now authorized to issue bonds only for refunding outstanding issues and up to $1.5 billion should the City fail to fund specified transit and school capital programs. The State also established the Financial Control Board ("FCB") to review the City's budget, four-year financial plans, borrowings and major contracts. These were subject to FCB approval until 1986 when the City satisfied statutory conditions for termination of such review. The FCB is required to reimpose the review and approval process in the future if the City were to experience certain adverse financial circumstances. The City's fiscal condition is also monitored by a Deputy State Comptroller. From 1989 to 1993, the gross city product declined by 10.1% and employment, by almost 11%, while the public assistance caseload grew by over 25%. Unemployment averaged 10.8% in 1992, 10.1% in 1993 and 8.7% in 1994. While the City's unemployment rate averaged 8.1% for the first eleven months of 1995, it is still above the State and the nation as a whole. The number of persons on welfare exceeds 1.1 million, the highest level since 1972, and one in seven residents is currently receiving some form of public assistance. While the City, as required by State law, has balanced its budgets in accordance with GAAP since 1981, this has required exceptional measures in recent years. City expenditures have grown faster than revenues each year from 1986 through 1994, masked in part by a large number of non-recurring gap closing actions. To eliminate potential budget gaps of $1-$3 billion each year since 1988 the City has taken a wide variety of measures. In addition to increased taxes and productivity increases, these have included hiring freezes and layoffs, reductions in services, reduced pension contributions, and a number of nonrecurring measures such as bond refundings, transfers of surplus funds from MAC, sales of City property and tax receivables. The FCB concluded that the City has neither the economy nor the revenues to do everything its citizens have been accustomed to expect. The City closed a budget gap for the 1993 fiscal year (estimated at $1.2 billion) through actions including service reductions, productivity initiatives, transfer of $0.5 billion surplus from the 1992 fiscal year and $100 million from MAC. A November 1992 revision offset an additional $561 million in projected expenditures through measures including a refunding to reduce current debt service costs, reduction in the reserve and an additional $81 million of gap closing measures. Over half of the City's actions to eliminate the gap were non-recurring. The Financial Plan for the City's 1994 fiscal year relied on increases in State and Federal aid, as well as the 1993 $280 million surplus and a partial hiring freeze, to close a gap resulting primarily from labor settlements and decline in property tax revenues. The Plan contained over $1.3 billion of one- time revenue measures including bond refundings, sale of various City assets and borrowing against future property tax receipts. Interim expenditure reductions of approximately $300 million were implemented. The FCB reported that although a $98 million surplus was projected for the year (the surplus was actually $81 million), a $312 million shortfall in budgeted revenues and $904 million of unanticipated expenses (including an unbudgeted increase of over 3,300 in the number of employees and a record level of overtime), net of certain increased revenues and other savings, resulted in depleting prior years' surpluses by $326 million. The City's original Financial Plan for the fiscal year ended June 30, 1995 proposed to eliminate a projected $2.3 billion budget gap through measures including reduction of the City's workforce (achieved in substantial part through voluntary severance packages funded by MAC), increased State and Federal aid, a bond refinancing, reduced contributions to City pension funds and sale of certain City assets. The Mayor's proposals include efforts toward privatization of certain City services and agencies, greater control of independent authorities and agencies, and reducing social service expenditures. He also sought concessions from labor unions representing City employees. As several of these measures failed to be implemented, the City experienced lower than anticipated tax collections and higher than budgeted costs (particularly overtime and liability claims) during the year, and various alternative an aggregate of more than $3 billion of gap closing measures. $1.9 billion of these were non-recurring and, in the case of a second bond refinancing, will increase City expenses for future years. Reduced maintenance of City infrastructure could also lead to increased future expenses. In December 1994, the City Council rejected the Mayor's recommendations, adopted its own budget revisions and sued to enforce them; the suit was dismissed and the Mayor impounded funds to achieve his proposed expense reductions. The City projected a $3.1 billion budget gap for the fiscal year that began July 1, 1995, attributed to the large use of non-recurring measures in the 1995 fiscal year, a $500 million decline in tax revenues and a $630 million shortfall in anticipated State aid, as well as higher Medicaid and agency spending, failure to negotiate increased lease payments for City airports, additional funding for pensions and State failure to adopt a tort reform measure. The Financial Plan approved in June has reduced a wide range of City services; City agency and labor savings are projected at $1.2 billion and $600 million respectively. The City Comptroller identified $0.7 to $1.0 billion of risks for the current fiscal year, including anticipated State and Federal aid increases, savings in welfare expenditures through increased fraud detection, proposed gap closing measures by the Board of Education and a substantial projected deficit for the Health and Hospitals Corporation, labor concessions (including health insurance costs) and increased rental payments for the City's airports. Estimates of non-recurring measures range from $500-800 million. The Mayor proposed selling the City's water system to the New York Water Board, which would issue $2.3 billion of bonds for the purpose. The sale has been blocked by the City Comptroller, who refuses to sign documents required unless the City commits to use $800 million from the bond sale, which would be available to the City after defeasing outstanding City water and sewer bonds, only for capital projects. In November 1995 the Mayor and the City Council sued the Comptroller, alleging that his refusal is unauthorized.The sale also would finance $200 million of capital spending by the Board of Education. Issuance of bonds by the Water Board would also permit the City to issue more bonds as it approaches its debt limit. The Mayor recently invited bids from non-profit entities for long-term leases on three City hospitals. However, questions have been raised whether the plan would provide adequate care for the indigent and whether City Council approval is needed. In October 1995 S&P reduced its rating on Health and Hospitals Corporation debt to BBB- (its lowest investment-grade rating), citing City failure to articulate a coherent strategy for the hospital system. Following conflicts with the City's Board of Education and the previous Chancellor, the Mayor recently proposed to disband the board and replace the Chancellor with an Education Commissioner which he would appoint. These proposals would require implementing legislation by the State. The City Council President subsequently proposed a Superintendent appointed jointly by the Mayor and the Council. The Mayor has imposed fingerprinting and workfare requirements for certain welfare recipients. A recently filed suit seeks injunction to suspend the City's Eligibility Verification Review program which began in January 1995 to detect welfare fraud. Other proposals including mandatory managed care programs for Medicaid recipients have been blocked. Most of the proposed gap-closing measures depend on cooperation of Federal or State governments, of which there can be no assurance. The City Comptroller predicted that certain reductions in Medicaid and welfare expenditures may lead to job reductions and higher costs for other programs. In November 1995 the Mayor submitted a revised fiscal plan which would reduce expenses by $100 million in the current fiscal year; another $123 million would be obtained from a debt refinancing. The State Comptroller noted that use of one-time resources nearly doubled (to $1.4 billion) from the plan approved in June. The revision reduces reliance on further union concessions and increases the reserve by $100 million. In January 1996 the Mayor ordered preparation of $100 million additional reductions in agency spending for the current fiscal year to offset higher social service spending and projected reductions in State and Federal aid. The November revision also projects $1.36 billion, $2.3 billion and $2.7 billion budget gaps for the next three fiscal years. The Mayor stated that the Governor's December 1995 budget proposal will provide only $150 million of the $675 million requested to close the City's fiscal 1997 budget gap. The City Comptroller has identified risks of $2-2.5 billion, $2.8-$3.3 billion and $2.9- 3.4 billion for those years, respectively. Fiscal monitors have commented that the City needs to take significant additional actions to work toward structural balance. A major uncertainty is the City's labor costs, which represent about 50% of its total expenditures. Contracts with virtually all of the City's labor unions expire in 1995, and the current Financial Plan assumes no further wage increases. A tentative agreement with labor leaders in June 1995 proposes to realize $440 million of the $600 million in savings sought for the current fiscal year, mostly from reduced health care costs and spreading out City contributions to pension funds. Certain of these actions will increase City costs in future years. The agreement did not include layoffs or changes in productivity or work rules. Substantially better than anticipated earnings on City pension funds in the latest fiscal year will allow the City to reduce pension fund contributions over the next several years. In November 1995, the City reached tentative five-year agreements with the United Federation of Teachers and with unions representing 140,000 City civilian employees. The proposed contracts would postpone wage increases for two years, and would protect members (other than hospital and certain other workers) from layoffs through 1998, but do not provide any significant productivity savings. However, the civil unions pledged to cooperate with the Mayor on competing with private companies to provide services and on use of welfare recipients for routine work. The contracts would cost an estimated $772 million and $830 million additional, respectively, over the last three years. The teachers rejected the first contract, and the other contract is subject to ratification by members. The Mayor in December signed legislation increasing the salaries of 64 elected officials by up to 28%. The City would also be adversely affected by a labor- sponsored proposal to increase the minimum wages paid by contractors serving the City. Budget balance may also be adversely affected by the effect of the economy on economically sensitive taxes. Reflecting the downturn in real estate prices and increasing defaults, estimates of property tax revenues have been reduced. If the City's ability to issue additional general obligation bonds could be limited. The City also faces uncertainty in its dependence on State aid. Other uncertainties include additional expenditures to combat deterioration in the City's infrastructure (such as bridges, schools and water supply), costs of developing alternatives to ocean dumping of sewage sludge (which the City expects to defray through increased water and sewer charges), cost of the AIDS epidemic and problems of drug addiction and homelessness. Under an agreement reached in October 1995 with towns in the City's upstate watershed area, the City would spend $1 billion over the next five years to implement regulations and other measures (including $350 million to help these communities reduce pollution), to protect the quality of the City's water supply, to avert constructing water filtration facilities at an estimated cost of up to $8 billion. The cost is expected to be defrayed by increased water charges. Elimination of any additional budget gaps will require various actions, including by the State, a number of which are beyond the City's control. The City sold $1.8 billion, $2.2 billion and $2.4 billion of short-term notes, respectively, during the 1994, 1995 and current fiscal years. At June 30, 1995, there were outstanding $23.3 billion of City bonds (not including City debt held by MAC), $4.0 billion of MAC bonds and $1.1 billion of City- related public benefit corporation indebtedness, each net of assets held for debt service. Standard & Poor's and Moody's during the 1975-80 period either withdrew or reduced their ratings of the City's bonds. S&P reduced its rating of the City's general obligation debt to BBB+ on July 10, 1995, citing the City's economy, substantial retention of non-recurring revenues and optimistic revenue projections in the latest budget. Moody's rates City bonds Baa1. City- related debt almost doubled since 1987, although total debt declined as a percentage of estimated full value of real property. The City's financing program projects long-term financing during fiscal years 1996-1999 to aggregate $15.2 billion, including $1 billion from the proposed sale of the City's water system. An additional $0.8 billion is to be derived from other sources, principally use of restricted cash balances. Assuming sale of the City's water system, from fiscal year 1999 through fiscal year 2005, debt service is estimated to average 18.2% of tax revenues, up from 12.3% in fiscal year 1990 and 14% in fiscal year 1995. If the sale is not consummated, the debt service ratio would increase. The City's latest Ten Year Capital Strategy plans capital expenditures of $45.6 billion during 1994-2003 (93% of be City funded). OTHER NEW YORK LOCALITIES. In 1993, other localities had an aggregate of approximately $17.7 billion of indebtedness outstanding. In recent years, several experienced financial difficulties. A March 1993 report by Moody's Investors Service concluded that the decline in ratings of most of the State's largest cities in recent years resulted from the decline in the State's manufacturing economy. $105 million of that was for deficit financing. Any reductions in State aid to localities may cause additional localities to experience difficulty in achieving balanced budgets. County executives have warned that reductions in State aid to localities to fund future State tax reductions are likely require increased local taxes. If special local assistance were needed from the State in the future, this could adversely affect the State's as well as the localities' financial condition. Most localities depend on substantial annual State appropriations. Legal actions by utilities to reduce the valuation of their municipal franchises, if successful, could result in localities becoming liable for substantial tax refunds. STATE PUBLIC AUTHORITIES. In 1975, after the Urban Development Corporation ("UDC"), with $1 billion of outstanding debt, defaulted on certain short-term notes, it and several other State authorities became unable to market their securities. Since 1975 the State has provided substantial direct and indirect financial assistance to UDC, the Housing Finance Agency ("HFA"), the Corporation and other authorities. Practical and legal limitations on these agencies' ability to pass on rising costs through rents and fees could require further State appropriations. 18 State authorities had an aggregate of $70.3 billion of debt outstanding at September 30, 1994. At March 31, 1995, approximately $0.4 billion of State public authority obligations was State- guaranteed, $7.0 billion was moral obligation debt (including $4.6 billion of MAC debt) and $22.7 billion was financed under lease-purchase or contractual obligation financing arrangements with the State. Various authorities continue to depend on State appropriations or special legislation to meet their budgets. The Metropolitan Transportation Authority ("MTA"), which oversees operation of the City's subway and bus system by the City Transit Authority (the "TA") and operates certain commuter rail lines, has required substantial State and City subsidies, as well as assistance from several special State taxes. Measures to balance the TA's 1993 budget included increased funding by the City, increased bridge and tunnel tolls and allocation of part of the revenues from the petroleum business tax. The New York City Transit Financial plan submitted in May 1995 projects a TA deficit of $150 million for 1995 (reflecting a $113 million reduction in City funding), and cash basis budget gaps of $262 million, $547 million, $673 million and $731 million for 1996 through 1999. An MTA budget gap of $388 million is projected for 1996. In August 1995, the MTA Chairman proposed an ambitious program of fare increases (20% for the TA) and a five-year program of $2.85 billion in expense reductions which he urged was needed to restore the MTA budget to a sound financial basis. Fares were increased in November 1995. In a draft budget released in October 1995, the TA proposed to eliminate an additional 1600 jobs in 1996, in addition to 1500 jobs already eliminated. The workforce serving the commuter railroads would also be reduced. Substantial claims have been made against the TA and the City for damages from a 1990 subway fire and a 1991 derailment. The MTA infrastructure, especially in the City, needs substantial rehabilitation. In December 1993, a $9.5 billion MTA Capital Plan was finally approved for 1992-1996; however, $500 million was contingent on increased contributions from the City which it has declined to approve. In November 1995 the MTA board approved a $12 million capital plan for 1996 through 1999, which includes $4.5 billion to be raised by bonds backed by fares and a portion of the State's petroleum business tax, as well as excess revenues of the Triborough Bridge and Tunnel Authority. The plan does not contemplate further fare increases until 2000. the plan is subject to approval by the State's Capital Project Review Board. The plan also projects $2.85 billion in expense reductions over the five years. Critics have whether many of the projected labor and other savings can be achieved. It is anticipated that the MTA and the TA will continue to require significant State and City support. Moody's reduced its rating of certain MTA obligations to Baa on April 14, 1992. LITIGATION. The State and the City are defendants in numerous legal proceedings, including challenges to the constitutionality and effectiveness of various welfare programs, alleged torts and breaches of contract, condemnation proceedings and other alleged violations of laws. Adverse judgments in these matters could require substantial financing not currently budgeted. For example, in addition to real estate certiorari proceedings, claims in excess of $286 billion were outstanding against the City at June 30, 1994, for which it estimated its potential future liability at $2.6 billion. City settlements were $275 million in fiscal 1994, up from $247 million the preceding year and $175 million in fiscal 1990. It was recently reported that settlement of claims against the City for the effects of lead poisoning may cost $500 million during the next several years. Another action seeks a judgment that, as a result of an overestimate by the State Board of Equalization and Assessment, the City's 1992 real estate tax levy exceeded constitutional limits. In March 1993, the U.S. Supreme Court ruled that if the last known address of a beneficial owner of accounts held by banks and brokerage firms cannot be ascertained, unclaimed funds therein belong to the state of the broker's incorporation rather than where its principal office is located. New York agreed to pay $351 million by the 2003 fiscal year. Final adverse decisions in any of these cases could require extraordinary appropriations at either the State or City level or both. In the opinion of Davis Polk & Wardwell, special counsel for the Sponsor, under existing New York law: Under the income tax laws of the State and City of New York, the Trust is not an association taxable as a corporation and income received by the Trust will be treated as the income of the Holders in the same manner as for Federal income tax purposes. Accordingly, each Holder will be considered to have received the interest on his pro rata portion of each Bond when interest on the Bond is received by the Trust. In the opinion of bond counsel delivered on the date of issuance of the Bond, such interest will be exempt from New York State and City personal income taxes except where such interest is subject to Federal income taxes (see Taxes). A noncorporate Holder of Units of the Trust who is a New York State (and City) resident will be subject to New York State (and City) personal income taxes on any gain recognized when he disposes of all or part of his pro rata portion of a Bond. A noncorporate Holder who is not a New York State resident will not be subject to New York State or City personal income taxes on any such gain unless such Units are attributable to a business, trade, profession or occupation carried on in New York. A New York State (and City) resident should determine his tax basis for his pro rata portion of each Bond for New York State (and City) income tax purposes in the same manner as for Federal income tax purposes. Interest income on, as well as any gain recognized on the disposition of, a Holder's pro rata portion of the Bonds is generally not excludable from income in computing New York State and City corporate franchise taxes. TAX FREE VS. TAXABLE INCOME The following tables show the approximate yields which taxable securities must earn in various income brackets to equal tax exempt yields under combined Federal and state individual income tax rates. This table reflects projected Federal income tax rates and tax brackets for the 1996 taxable year and state income tax rates that were available on the date of the Prospectus. Because the Federal rate brackets are subject to adjustment based on changes in the Consumer Price Index, the taxable equivalent yields for subsequent years may be lower than indicated. A table is computed on the theory that the taxpayer's highest bracket tax rate is applicable to the entire amount of any increase or decrease in taxable income (after allowance for any resulting change in state income tax) resulting from a switch from taxable to tax-free securities or vice versa. Variations between state and Federal allowable deductions and exemptions are generally ignored. The state tax is thus computed by applying to the Federal taxable income bracket amounts shown in the table the appropriate state rate for those same dollar amounts. For example, a married couple living in the State of California and filing a Joint Return with $53,000 in taxable income for the 1996 tax year would need a taxable investment yielding 9.06% in order to equal a tax-free return of 6.00%. Use the appropriate table to find your tax bracket. Read across to determine the approximate taxable yield you would need to equal a return free of Federal income tax and state income tax. * The amounts shown represent 1996 Federal tax rates and 1995 California tax rates. California has not yet published 1996 tax rates. The income amount shown is income subject to Federal income tax reduced by adjustments to income, exemptions, and itemized deductions (including the deduction for state income tax). If the standard deduction had been taken for Federal income tax purposes in order to reach the amount shown in the table, the taxable equivalent yield required to equal a specified tax-exempt yield would be at least as great as that shown in the table. It is assumed that the investor is not subject to the alternative minimum tax. Where applicable, investors should take into account the provisions of the Code under which the benefit of certain itemized deductions and the benefit of personal exemptions are limited in the case of higher income individuals. Under the Code, an individual taxpayer with adjusted gross income in excess of a $117,950 threshold amount is subject to an overall limitation on certain itemized deductions, requiring a reduction equal to the lesser of (i) 3% of adjusted gross income in excess of the $117,950 threshold amount or (ii) 80% of the amount of such itemized deductions otherwise allowable. The benefit of each personal exemption is phased out for married taxpayers filing a joint return with adjusted gross income in excess of $176,950 and for single taxpayers with adjusted gross income in excess of $117,950. Personal exemptions are phased out at the rate of two percentage points for each $2,550 (or fraction thereof) of adjusted gross income in excess of the applicable threshold amount. California has adopted provisions corresponding to the Federal law provisions limiting the benefit of certain itemized deductions and phasing out the benefit of personal exemptions. However, the California threshold amounts and percentage reductions differ from those applicable under Federal law. The Federal and California tax brackets, the threshold amounts at which itemized deductions are subject to reduction, and the range over which personal exemptions are phased out will be adjusted for inflation. The State of Florida does not impose tax based on income. See Note 5, below. Note: This table reflects the following: 1 Taxable income equals adjusted gross income ("AGI") less personal exemptions of $2,550 less the standard deduction of $6,700 on a joint return or total itemized deductions, whichever is greater. However, itemized deductions are reduced by 3% of the amount of a taxpayer's AGI over $117,950. This is reflected in the brackets above by higher effective federal tax rates. Furthermore, personal exemptions are phased out for the amount of a taxpayer's AGI over $117,950 for single taxpayers and $176,950 for married taxpayers filing jointly. This latter provision is not incorporated into the above brackets. 2 The combined effective rate is computed under the assumption that taxpayers itemize their deductions on their federal income tax return. 3 Interest earned on municipal obligations may be subject to the federal alternative minimum tax. This provision is not incorporated into the table. 4 The taxable equivalent yield table does not incorporate the effect of graduated rate structures in determining yields. Instead, the tax rates used are the highest rates applicable to the income levels indicated within each bracket. 5 The State of Florida does not impose tax based on income. Instead, Florida utilizes an intangible tax system whereby the tax is determined based on the value of investment securities and other intangibles held by the taxpayer. Municipal obligations issued within the State of Florida generally are not subject to the intangible tax. Note: This table reflects the following: 1 Taxable income equals adjusted gross income ("AGI") less personal exemptions of $2,550 less the standard deduction of $6,700 on a joint return or total itemized deductions, whichever is greater. However, itemized deductions are reduced by 3% of the amount of a taxpayer's AGI over $117,950. This is reflected in the brackets above by higher effective federal tax rates. Furthermore, personal exemptions are phased out for the amount of a taxpayer's AGI over $117,950 for single taxpayers and $176,950 for married taxpayers filing jointly. This latter provision is not incorporated into the above brackets. 2 The combined effective rate is computed under the assumption that taxpayers itemize their deductions on their federal income tax returns. 3 Interest earned on municipal obligations may be subject to the federal alternative minimum tax. This provision is not incorporated into the table. 4 The taxable equivalent yield table does not incorporate the effect of graduated rate structures in determining yields. Instead, the tax rates used are the highest rates applicable to the income levels indicated within each bracket. Note: This table reflects the following: 1 Taxable income equals adjusted gross income ("AGI") less personal exemptions of $2,550 less the standard deduction of $6,700 on a joint return or total itemized deductions, whichever is greater. However, itemized deductions are reduced by 3% of the amount of a taxpayer's AGI over $117,950. This is reflected in the brackets above by higher effective federal tax rates. Furthermore, personal exemptions are phased out for the amount of a taxpayer's AGI over $117,950 for single taxpayers and $176,950 for married taxpayers filing jointly. This latter provision is not incorporated into the above brackets. 2 The combined effective rate is computed under the assumption that taxpayers itemize their deductions on their federal income tax returns. 3 Interest earned on municipal obligations may be subject to the federal alternative minimum tax. This provision is not incorporated into the table. 4 The taxable equivalent yield table does not incorporate the effect of graduated rate structures in determining yields. Instead, the tax rates used are the highest rates applicable to the income levels indicated within each bracket. THIS PROSPECTUS CONTAINS INFORMATION CONCERNING THE TRUST AND THE SPONSOR, BUT DOES NOT CONTAIN ALL THE INFORMATION SET FORTH IN THE REGISTRATION STATEMENTS AND EXHIBITS RELATING THERETO, WHICH THE TRUST HAS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION, WASHINGTON, D.C., UNDER THE SECURITIES ACT OF 1933 AND THE INVESTMENT COMPANY ACT OF 1940, AND TO WHICH REFERENCE IS HEREBY MADE. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, SECURITIES IN ANY STATE TO ANY PERSON TO WHOM IT IS NOT LAWFUL TO MAKE SUCH OFFER IN SUCH STATE. NEW YORK, NEW YORK 10013 PART II. ADDITIONAL INFORMATION NOT REQUIRED IN PROSPECTUS A. The following information relating to the Depositor is incorporated by reference to the SEC filings indicated and made a part of this Registration Statement. The Sponsor undertakes that it will not instruct the Trustee to accept from (i) any insurance company affiliated with the Sponsor, in settlement of any claim, less than an amount sufficient to pay any principal or interest (and, in the case of a taxability redemption, premium) then due on any Security in accordance with the municipal bond guaranty insurance policy attached to that Security or (ii) any affiliate of the Sponsor who has any obligation with respect to any Security, less than the full amount due pursuant to the obligation, unless those instructions have been approved by the Securities and Exchange Commission pursuant to Rule 17d-1 under the Investment Company Act of 1940. THE REGISTRATION STATEMENT ON FORM S-6 COMPRISES THE FOLLOWING PAPERS AND DOCUMENTS: The facing sheet of Form S-6. The Cross-Reference Sheet (incorporated by reference to the Cross-Reference Sheet to the Registration Statement of Tax Exempt Securities Trust, Series 384, 1933 Act File No. 33-50915). The Prospectus. Additional Information not included in the Prospectus (Part II). Consent of Independent Auditors. The registrant, Tax Exempt Securities Trust, California Trust 147, Florida Trust 73 and New York Trust 151, hereby identifies Series 1, Series 357 and National Trust 208 of the Tax Exempt Securities Trust for purposes of the representations required by Rule 487 and represents the following: (1) That the portfolio securities deposited in the series as to the securities of which this Registration Statement is being filed do not differ materially in type or quality from those deposited in such previous (2) That, except to the extent necessary to identify the specific portfolio securities deposited in, and to provide essential financial information for, the series with respect to the securities of which this Registration Statement is being filed, this Registration Statement does not contain disclosures that differ in any material respect from those contained in the registration statements for such previous series as to which the effective date was determined by the Commission or the staff; and (3) That is has complied with Rule 460 under the Securities Act of 1933. PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT HAS DULY CAUSED THIS REGISTRATION STATEMENT OR AMENDMENT THERETO TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED, IN THE CITY OF NEW YORK, AND STATE OF NEW YORK, ON THE 12TH DAY OF JANUARY, 1996. Signatures appear on page II-4. A majority of the members of the Board of Directors of Smith Barney Inc. has signed this Registration Statement or Amendment to the Registration Statement pursuant to Powers of Attorney authorizing the person signing this Registration Statement or Amendment to the Registration Statement to do so on behalf of such members. /s/ George S. Michinard, Jr. By ................................. By the following persons, who constitute a majority of the directors of Smith Barney Inc.: /s/ George S. Michinard, Jr. By .................................. * Pursuant to Powers of Attorney filed under the 1933 Act file Numbers 33- 56722 and 33-51999.	487	487	1996-01-12T00:00:00	1996-01-12T16:52:44
0000950146-96-000032	0000950146-96-000032_0002.txt	RE: Credit Agreement dated August 1, 1994, as amended (the "Credit Agreement") by and between Oakhurst Company, Inc. (the "Borrower") and Integra Bank This letter shall constitute notice that the borrower is in violation of Section 6.14(a)(ii) of the Credit Agreement which reqires the borrower to maintain "Consolidated Tangible Net Worth not less than $1,000,000 at the end of each of its fiscal quarters." The Borrower's failure to cure the foregoing violation to the Bank's reasonable satisfaction within fifteen (15) days after the date of this letter will constitute an Event of Default under Section 8.03 of the Credit Agreement. The Borrower has advised the Bank that it will not be able to cure the aforesaid covenant violation and has therefore requested the Bank to modify the covenant requirements. Capitalized terms used in this letter and not otherwise defined shall have the meanings ascribed thereto in the Credit Agreement. The Bank has considered the borrower's request and, subject to the further provisions of this letter, the Bank has agreed to modify Section 6.14(a)(ii) of the Credit Agreement so that the Borrower will now be required to maintain a consolidated net worth not less than $6,500,000; for purposes of the foregoing, "consolidated net worth" shall mean (i) the total shareholder's equity (including capital stock, additional paid-in capital and retained earnings after deducting treasury stock) which would appear on a consolidated balance sheet of the Borrower prepared in accordance with GAAP, minus (ii) any tax deferrals. The foregoing modification is being granted by the Bank with the express understanding and agreement of the Borrower that: (i) the Bank does not intend to extend the Revolving Credit Expiration Date (ii) the Revolving Credit Loans and all indebtedness and obligations of Steel City to the Bank will be immediately due and payable in full on the (iii) the Borrower will immediately begin to solicit loan commitments from alternate financing sources for the Borrower and Steel City, so that all indebtedness and obligations of the Borrower and Steel City to the Bank will be refinanced as soon as possible, but in any event no later than July 31, 1996, and (iv) if the Borrower has not refinanced the outstanding principal balance of the Revolving Credit Loans by February 28, 1996, then commencing on March 1, 1996, the outstanding principal balance of the Revolving Credit Loans will bear interest at a rate per annum equal to the Prime Rate plus two and one-half percent (2.5%). Except to the extent specifically provided for above, this letter does not constitute a modification, alteration, release,limitation or waiver of any default, breach, right, power, remedy or privilege under the Loan Documents. The Bank expressly reserves all rights and remedies previously available to it under the Loan Documents against the Borrower and the Subsidiaries and, except to the extent provided for herein, the Bank may at any time exercise its rights and remedies. Please signify your consent to the foregoing by signing below where indicated and returning a signed copy to me. Vice President - Corporate Banking cc: Charles F. O'Hanlon, III The foregoing is agreed to this 9th day of January, 1996.	S-1	EX-10.16	1996-01-12T00:00:00	1996-01-12T09:22:26
0000950109-96-000198	0000950109-96-000198_0012.txt	EXHIBIT 1. A. (6) (b) JOHN HANCOCK VARIABLE LIFE INSURANCE COMPANY The principal office and principal place of business of the Company in the Commonwealth of Massachusetts shall be located in the City of Boston, Suffolk County. SECTION 1. ANNUAL MEETING. The annual meeting of the shareholders shall be held on the 2nd Wednesday following the 2nd Monday in April in each year at the hour of 2:00 P.M., for the purpose of electing directors and for the transaction of such other business as may come before the meeting. If the day fixed for the annual meeting shall be a legal holiday, such meeting shall be held on the next succeeding business day. If the election of directors shall not be held on the day designated herein for any annual meeting, or at any adjournment thereof, the board of directors shall cause the election to be held at a meeting of the shareholders as soon thereafter as conveniently may be. SECTION 2. SPECIAL MEETINGS. Special meetings of the shareholders may be called by the chairman of the board, the vice chairman of the board, the president, a majority of the board of directors or by the holders of not less than one-fifth of all the outstanding shares of the corporation. SECTION 3. PLACE OF MEETING. The board of directors may designate any place, either within or without the Commonwealth of Massachusetts as the place of meeting for any annual meeting or for any special meeting. A waiver of notice signed by all shareholders may designate any place, either within or without the Commonwealth of Massachusetts, as the place for the holding of such meeting. If no designation is made, or if a special meeting be otherwise called, the place of meeting shall be the principal office of the corporation in the Commonwealth of Massachusetts. SECTION 4. NOTICE OF MEETINGS. Written or printed notice stating the place, day and hour of the meeting, and in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered not less than ten nor more than forty days before the date of the meeting, or in the case of a merger or consolidation not less than twenty nor more than forty days before the meeting, either personally or by mail, to each shareholder of record entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail, addressed to the shareholder at his address as it appears on the records of the corporation, with postage thereon prepaid. SECTION 5. CLOSING OF TRANSFER BOOKS OR FIXING OF RECORD DATE. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders, or shareholders entitled to receive payment of any dividend, or in order to make determination of shareholders for any other proper purpose, the board of directors of the corporation may provide that the stock transfer books shall be closed for a stated period but not to exceed, in any case, forty days. If the stock transfer books shall be closed for the purpose of determining shareholders entitled to notice of or to vote at a meeting of shareholders, such books shall be closed for at least ten days, or in the case of a merger or consolidation, at least twenty days, immediately preceding such meeting. In lieu of closing the stock transfer books, the board of directors may fix in advance a date as the record date for any such determination of shareholders, such date in any case to be not more than forty days and, for a meeting of shareholders, not less than ten days, or in the case of a merger or consolidation, not less than twenty days, immediately preceding such meeting. If the stock transfer books are not closed and no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders, or shareholders entitled to receive payment of a dividend, the date on which notice of the meeting is mailed or the date on which the resolution of the board of directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders. SECTION 6. VOTING LISTS. The agent having charge of the transfer books for shares of the corporation shall make, at least ten days before each meeting of shareholders, a complete list of the shareholders entitled to vote at such meeting, arranged in alphabetical order, with the address of and the number of shares held by each, which list, for a period of ten days prior to such meeting, shall be kept on file at the principal office of the corporation and shall be subject to inspection by any shareholder at any time during usual business hours. Such list shall also be produced and kept open at the time and place of the meeting and shall be subject to the inspection of any shareholder during the whole time of the meeting. The original share ledger or transfer book, or a duplicate thereof kept in this Commonwealth, shall be prima facie evidence as to who are the shareholders entitled to examine such list or share ledger or transfer book or to vote at any meeting of shareholders. SECTION 7. QUORUM. A majority of the outstanding shares of the corporation, represented in person or by proxy, shall constitute a quorum at any meeting of shareholders; provided, that if less than a majority of the outstanding shares are represented at said meeting, a majority of the shares so represented may adjourn the meeting from time to time without further notice. If a quorum is present, the affirmative vote of the majority of the shares represented at the meeting shall be the act of the shareholders. SECTION 8. PROXIES. At all meetings of shareholders, a shareholder may vote by proxy executed in writing by the shareholder or by his duly authorized attorney-in-fact. Such proxy shall be filed with the corporation before or at the time of the meeting. No proxy shall be valid after eleven months from the date of its execution, unless otherwise provided in the proxy. SECTION 9. VOTING OF SHARES. Each outstanding share shall be entitled to one vote upon each matter submitted to vote at a meeting of shareholders. SECTION 10. VOTING OF SHARES BY CERTAIN HOLDERS. Shares standing in the name of another corporation, domestic or foreign, may be voted by such officer, agent, or proxy as the by-laws of such corporation may prescribe, or, in the absence of such provision, as the board of directors of such corporation may determine. Shares standing in the name of a deceased person, a minor ward or an incompetent person, may be voted by his administrator, executor, court appointed either in person or by proxy without a transfer of such shares into the name of such administrator, executor, court appointed guardian or conservator. Shares standing in the name of a trustee may be voted by him, either in person or by proxy. Shares standing in the name of a receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such receiver without the transfer thereof into his name if authority so to do be contained in an appropriate order of the court by which such receiver was appointed. A shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred. Shares of its own stock belonging to this corporation shall not be voted, directly or indirectly, at any meeting and shall not be counted in determining the total number of outstanding shares at any given time, but shares of its own stock held by it in a fiduciary capacity may be voted and shall be counted in determining the total number of outstanding shares at any given time. SECTION 11. INSPECTORS. At any meeting of shareholders, the chairman of the meeting may, or upon the request of any shareholder shall, appoint one or more persons as inspectors for such meeting. Such inspectors shall ascertain and report the number of shares represented at the meeting, based upon their determination of the validity and effect of proxies; count all votes and report the results; and do such other acts as are proper to conduct the election and voting with impartiality and fairness to all the shareholders. Each report of an inspector shall be in writing and signed by him or by a majority of them if there be more than one inspector acting at such meeting. If there is more than one inspector, the report of a majority shall be the report of the inspectors. The report of the inspector or inspectors on the number of shares represented at the meeting and the results of the voting shall be prima facie evidence thereof. SECTION 12. VOTING BY BALLOT. Voting on any question or in any election may be viva voce unless the presiding officer shall order or any shareholder shall demand that voting be by ballot. SECTION 1. GENERAL POWERS. The business and affairs of the corporation shall be managed by its board of directors. The board of directors shall annually elect a chairman of the board, a vice chairman of the board, a president, a secretary, a treasurer and such other officers as these by-laws may provide. The board of directors shall at each annual meeting of the corporation submit a full statement of the transactions of the corporation during the previous year and of its financial condition. SECTION 2. NUMBER, TENURE AND QUALIFICATIONS. The number of directors of the corporation shall be not less than five nor more than nine. Each director shall hold office until the next annual meeting of shareholders or until his successor shall have been elected and qualified. SECTION 3. REGULAR MEETINGS. A regular meeting of the board of directors shall be held without other notice than this by-law, immediately after, and at the same place as, the annual meeting of shareholders. The board of directors may provide, by resolution, the time and place, either within or without the Commonwealth of Massachusetts, for the holding of additional regular meetings without other notice than such resolution. SECTION 4. SPECIAL MEETINGS. Special meetings of the board of directors may be called by or at the request of the chairman of the board, the vice chairman of the board, the president or any two directors. The person or persons authorized to call special meetings of the board of directors may fix any place, either within or without the Commonwealth of Massachusetts, as the place for holding any special meeting of the board of directors called by them. SECTION 5. NOTICE. Notice of any special meeting shall be given at least five days previous thereto by written notice delivered personally or mailed to each director at his business address, or by telegram. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail so addressed, with postage thereon prepaid. If notice be given by telegram, such notice shall be deemed to be delivered when the telegram is delivered to the telegram company. Any director may waive notice of any meeting. The attendance of a director at any meeting shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express purpose of objecting to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the board of directors need be specified in the notice or waiver of notice of such meeting. SECTION 6. QUORUM. A majority of the number of directors then in office, but no less than four in number, shall constitute a quorum for transaction of business at any meeting of the board of directors, provided, that if less than majority of such number of directors is present at said meeting, a majority of the directors present may adjourn the meeting from time to time without further notice. SECTION 7. MANNER OF ACTING. The act of the majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors. SECTION 8. ACTION WITHOUT A MEETING. Any action required or permitted to be taken at any meeting of the board of directors may be taken without a meeting if written consents thereto are signed by all members of the board of directors and such written consents are filed with the minutes of proceedings of the board. SECTION 9. VACANCIES. Any vacancy occurring in the board of directors and any directorship to be filled by reason of an increase in the number of directors, may be filled by the directors or by the shareholders at an annual meeting or at a special meeting of shareholders called for that purpose. SECTION 10. COMPENSATION. The board of directors, by the affirmative vote of a majority of directors then in office, and irrespective of any personal interest of any of its members, shall have authority to establish reasonable compensation of all directors for service to the corporation as directors, officers or otherwise. By resolution of the board of directors the directors may be paid their expenses, if any, of attendance at each meeting of the board. EXECUTIVE COMMITTEE AND OTHER COMMITTEES SECTION 1. HOW CONSTITUTED. By resolution adopted by the board of directors, the board may designate one or more committees, including an executive committee, each consisting of at least three directors. Each member of a committee shall be a director and shall hold office during the pleasure of the board. The chairman of the board, the vice chairman of the board and the president shall be members of the executive committee. SECTION 2. POWERS OF THE EXECUTIVE COMMITTEE. Unless otherwise provided by resolution of the board of directors, the executive committee shall, during the intervals between meetings of the board of directors, have and may exercise all of the powers of the board of directors in the management of the business and affairs of the corporation except the power to declare a dividend, to authorize the issuance of stock, or to recommend to shareholders any action requiring shareholders' approval. SECTION 3. OTHER COMMITTEES OF THE BOARD OF DIRECTORS. To the extent provided by resolution of the board, other committees shall have and may exercise any of the powers that may lawfully be granted to the executive committee. SECTION 4. PROCEEDINGS, QUORUM AND MANNER OF ACTING. In the absence of appropriate resolution of the board of directors, each committee may adopt such rules and regulations governing its proceedings, quorum and manner of acting as it shall deem proper and desirable, provided that the quorum shall not be less than two directors. In the absence of any member of any such committee, the members thereof present at any meeting, whether or not they constitute a quorum, may appoint a member of the board of directors to act in the place of such absent member. SECTION 5. OTHER COMMITTEES. The board of directors may appoint other committees, each consisting of one or more persons, who need not be directors. Each such committee shall have such powers and perform such duties as may be assigned to it from time to time by the board of directors, but shall not exercise any power which may lawfully be exercised only by the board of directors or a committee thereof. SECTION 1. NUMBER. The officers of the corporation shall be a chairman of the board, a vice chairman of the board, a president, one or more vice presidents (the number thereof to be determined by the board of directors), a controller, a treasurer, and a secretary, and such assistant controllers, treasurers, secretaries or other officers as may be elected or appointed by the board of directors. Any two or more offices may be held by the same person except that the chairman, vice chairman and president cannot also serve simultaneously as secretary of the corporation, but no person shall execute, acknowledge or verify any instrument in more than one capacity if such instrument is required by law, the Articles of Organization or these by-laws to be executed, acknowledged or verified by two or more officers. The chairman of the board, vice chairman and the president shall be selected from among the directors and may hold such offices only so long as they continue to be directors. No other officer need be a director. SECTION 2. ELECTION AND TERM OF OFFICE. The officers of the corporation shall be elected annually by the board of directors at the first meeting of the board of directors held after each annual meeting of shareholders. If the election of officers shall not be held at such meeting, such election shall be held as soon thereafter as conveniently may be. Vacancies may be filled or new offices filled at any meeting of the board of directors. Each officer shall hold office until his successor shall have been duly elected and shall have qualified or until his death or until he shall resign or shall have been removed in the manner hereinafter provided. Election or appointment of an officer or agent shall not of itself create contract rights. SECTION 3. REMOVAL. Any officer or agent elected or appointed by the board of directors may be removed by the board of directors whenever in its judgment the best interest of the corporation would be served thereby, but such removal shall be without prejudice to the contract rights, if any, or the person so removed. SECTION 4. VACANCIES. A vacancy in any office because of death, resignation, removal, disqualification or otherwise, may be filled by the board of directors for the unexpired portion of the term. SECTION 5. CHAIRMAN OF THE BOARD. The chairman of the board shall be the chief executive officer of the corporation, shall preside at all shareholders' meetings and at all meetings of the board of directors and shall be ex officio a member of all committees of the board of directors, except the audit committee, if any. Subject to the supervision of the board of directors, he shall have general charge of the business, affairs and property of the corporation and its officers, employees and agents. He shall sign (unless the vice chairman of the board, the president or a vice president shall have signed) certificates representing the stock of the corporation authorized for issuance by the board of directors and shall have such other powers and perform such other duties as may be assigned to him from time to time by the board of directors. SECTION 6. VICE CHAIRMAN OF THE BOARD. The vice chairman of the board shall assist the chief executive officer of the corporation in his duties and, at the request of or in the absence or disability of the chairman of the board, he shall preside at all shareholders' meetings and at all meetings of the board of directors and shall in general exercise the powers and perform the duties of the chairman of the board. He shall sign (unless the chairman of the board, the president or a vice president shall have signed) certificates representing the stock of the corporation authorized for issuance by the board of directors and shall have such other powers and perform such other duties as may be assigned to him from time to time by the chairman of the board or the board of directors. SECTION 7. PRESIDENT. The president shall be the chief operating officer of the corporation. In the event of the absence or disability of both the chairman of the board and the vice chairman of the board, he shall preside at all shareholders' meetings and at all meetings of the board of directors and shall in general exercise the powers and perform the duties of both. Subject to the supervision of the board of directors and such direction and control as the chairman of the board and the vice chairman of the board may exercise, he shall have general charge of the operations of the corporation and its officers, employees and agents. He shall sign (unless the chairman or the vice chairman of the board or a vice president shall have signed) certificates representing the stock of the corporation authorized the board of directors may for issuance by the board of directors. Except as otherwise order, he may sign in the name and on behalf of the corporation all deeds, mortgages, bonds, contracts, instruments or agreements. He shall exercise such other powers and perform such other duties as from time to time may be assigned to him by the board of directors. SECTION 8. VICE PRESIDENT. The board of directors shall, from time to time, designate and elect one or more vice presidents who shall have such powers and perform such duties as from time to time may be assigned to them by the board of directors or the president. At the request or in the absence or disability of the president, the vice president (or, if there are two or more vice presidents, then the senior of the vice presidents present and able to act) may perform all the duties of the president and, when so acting, shall have all the powers of and be subject to all the restrictions upon the president. Any vice president may sign (unless the president or another vice president shall have signed) certificates representing stock of the corporation authorized for issuance by the board of directors. SECTION 9. CONTROLLER AND ASSISTANT CONTROLLERS. The controller shall be the principal accounting officer of the corporation and shall have general charge of the books of account of the corporation. He shall cause to be prepared annually a full and correct statement of the affairs of the corporation, including a balance sheet and a financial statement of operations for the preceding fiscal year. He shall perform all the duties incident to the office of controller and such other duties as from time to time may be assigned to him by the chairman or by the board of directors. Any assistant controller may perform such duties of the controller as the controller or the board of directors may assign and, in the absence of the controller, he may perform all of the duties of the controller. SECTION 10. TREASURER AND ASSISTANT TREASURER. The treasurer shall be the principal financial officer of the corporation and shall have general charge of the finances of the corporation. Except as otherwise provided by the board of directors, he shall have general supervision of the funds and property of the corporation. He shall sign (unless an assistant treasurer or secretary or assistant secretary shall have signed) all certificates of stock of the corporation authorized for issuance by the board of directors. He shall render to the board of directors, whenever directed by the board, a report relating to his custody of the funds and property of the corporation and of all his transactions as treasurer; and as soon as possible after the close of each fiscal year he shall make and submit to the board of directors a like report for such fiscal year. He shall perform all the duties incident to the office of treasurer and such other duties as from time to time may be assigned to him by the chairman or the board of directors. Any assistant treasurer may perform such duties of the treasurer as the treasurer or the board of directors may assign, and, in the absence of the treasurer, he may perform all the duties of the treasurer. SECTION 11. SECRETARY AND ASSISTANT SECRETARY. The secretary shall (a) keep the minutes of the shareholders' and of the board of directors' meetings in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these by-laws or as required by law; (c) be custodian of the corporate records and of the seal of the corporation and see the seal of the corporation is affixed to all certificates for shares prior to the issue thereof and to all documents, the execution of which on behalf of the corporation under its seal is duly authorized in accordance with the provisions of these by-laws;(d) keep a register of the post-office address of each shareholder which shall be furnished to the secretary by such shareholder; (e) sign with the chairman, vice chairman, president, or a vice president, certificates for shares of the corporation, the issue of which shall have been authorized by resolution of the board of directors; (f) have general charge of the stock transfer books of the corporation; (g) in general perform all duties incident to the office of secretary and such other duties as from time to time may be assigned to him by the chairman or by the board of directors. Any assistant secretary may perform such duties of the secretary as the secretary or the board of directors may assign, and, in the absence of the secretary, he may perform all the duties of the secretary. SECTION 12. SUBORDINATE OFFICERS. The board of directors from time to time may appoint such other officers or agents as it may deem advisable, each of whom shall have such title, hold office for such period, have such authority and perform such duties as the board of directors may determine. The board of directors from time to time may delegate to one or more officers or agents the power to appoint any such subordinate officers or agents and to prescribe their respective rights, terms of office, authorities and duties. SECTION 13. REMUNERATION. The salaries or other compensation of the officers of the corporation shall be fixed from time to time by resolution of the board of directors, except that the board of directors may by resolution delegate to any person or group of persons the power to fix the salaries or other compensation of any subordinate officers or agents appointed in accordance with the provisions of Section 12 hereof. No officer shall be prevented from receiving a salary by reason of the fact that he is also a director of the corporation. SECTION 14. The board of directors may require any officer or agent of the corporation to execute a bond to the corporation in such sum and with such surety or sureties as the board of directors may determine, conditioned upon the faithful performance of his duties to the corporation, Any secretary, treasurer, assistant secretary and assistant treasurer of the corporation shall, in accordance with the applicable provisions of the Massachusetts General Laws, give a bond, with surety, payable to the corporation conditioned upon the faithful performance of his or her duties and that such bond be executed by such officer before performing any duties of his or her office. SECTION 15. COMMISSIONS. No person shall be eligible as an elective or appointed officer who has any interest in commissions or other compensation based on premiums or considerations paid to the corporation on any policy or contract, or on any extension of conversion thereof, unless such policy, contract, extension or conversion was written and effective prior to his election or appointment. CONTRACTS, LOANS, CHECKS AND DEPOSITS SECTION 1. CONTRACTS. The board of directors may authorize any officer or officers, agent or agents, to enter into any contract or execute and deliver and instrument in the name of and on behalf of the corporation, and such authority may be general or confined to specific instances. SECTION 2. LOANS. No loans shall be contracted on behalf of the corporation and no evidences of indebtedness shall be issued in its name unless authorized by a resolution of the board of directors. Such authority may be general or confined to specific instances. SECTION 3. CHECKS, DRAFTS, ETC. All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the corporation, shall be signed by such officer or officers, agent or agents of the corporation and in such manner as shall from time to time be determined by resolution of the board of directors. SECTION 4. DEPOSITS. All funds of the corporation not otherwise employed shall be deposited from time to time to the credit of the corporation in such banks, trust companies or other depositories as the board of directors may select. CERTIFICATES FOR SHARES AND THEIR TRANSFER SECTION 1. CERTIFICATES FOR SHARES. Certificates representing shares of the corporation shall be in such form as may be determined by the board of directors. Such certificates shall be signed by the chairman of the board, the vice chairman of the board, the president or a vice president and by the secretary or an assistant secretary and shall be sealed with the seal of the corporation. All certificates for shares shall be consecutively numbered or otherwise identified. The name of the person to whom the shares represented thereby are issued, with the number of shares and date of issue, shall be entered on the books of the corporation. All certificates surrendered to the corporation for transfer shall be cancelled and no new certificate shall be issued until the former certificate for a like number of shares shall have been surrendered and cancelled, except that in case of a lost, destroyed or mutilated certificate, a new one may be issued therefor upon such terms and indemnity to the corporation as the board of directors may prescribe. SECTION 2. TRANSFERS OF SHARES. Transfers of shares of the corporation shall be made only on the books of the corporation by the holder of record thereof or by his legal representative, who shall furnish proper evidence of authority to transfer, or by his attorney thereunto authorized by power of attorney duly executed and filed with the secretary of the corporation, and on surrender for cancellation of the certificate for such shares. The person in whose name shares stand on the books of the corporation shall be deemed the owner thereof for all purposes as regards the corporation. The fiscal year of the corporation shall begin on the first day of January in each year and end on the last day of December in each year. Whenever any notice whatever is required to be given under the provisions of these by-laws or under the provisions of the Articles of Incorporation, a waiver thereof in writing, signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be deemed equivalent to the giving of such notice. The corporation shall, except as hereinafter provided and subject to limitations of law, indemnify each director, former director, officer and former officer, and his heirs and legal representatives, for and against all loss, liability and expense, whether heretofore or hereafter imposed upon or incurred by him in connection with any pending or future action, suit, proceeding or claim in which he may be involved, or with which he may be threatened, by reason of any alleged act or omission as a director or officer of the corporation. Such loss, liability and expense shall include, but not be limited to, judgments, fines, court costs, reasonable attorneys' fees and the cost of reasonable settlements. Such indemnification shall not cover (a) loss, liability or expense imposed or incurred in connection with any item or matter as to which such director or officer shall be finally adjudicated not to have acted in good faith in the reasonable belief that his action was in the best interest of the corporation or (h) loss, liability or expense imposed or incurred in connection with any item or matter which shall be settled without final adjudication unless such settlement shall have been approved as in the best interests of the corporation by vote of the board of directors at a meeting in which no director participates against whom any suit, proceeding or claim on the same or similar grounds is then pending or threatened, or in the event no such vote can be taken, unless, in the opinion of independent counsel selected by or in a manner determined by the board of directors, there is no reasonable ground not to approve such settlement as being in the best interests of the corporation. As part of such indemnification, the corporation may pay expenses incurred in defending any such action, suit, proceeding or claim in advance of the final disposition thereof upon receipt of an undertaking by the person indemnified to repay such payment if he should be determined not to be entitled to indemnification hereunder. The foregoing rights of indemnification shall be in addition to any rights to which any director, former director, officer, or former officer, heirs or legal representatives may otherwise be lawfully entitled. These by-laws may not be altered, amended or repealed prior to the issuance of a certificate of authority to the company, except by written consent of subscribers representing at least two-thirds of the shares subscribed, and the approval of the Commissioner of Insurance of Massachusetts. After a certificate of authority is issued, the power to make, amend or repeal these by-laws shall be vested in the board of directors. Adopted this 25th day of February, 1979. Certified to be a true copy of the By-Laws of John Hancock Variable Life Insurance Company as adopted at the Initial Meeting of Incorporators and as amended from time to time, up to and including the date set forth below.	485BPOS	EX-99.A.6.B	1996-01-12T00:00:00	1996-01-11T17:42:34
0000950115-96-000013	0000950115-96-000013_0009.txt	EMPLOYMENT AGREEMENT dated as of June 26, 1995, between MEDIQ Incorporated, a Delaware corporation ("MEDIQ"), and Michael F. Sandler (the "Executive"). WHEREAS, Executive is currently the Senior Vice President of Finance and Chief Financial Officer of MEDIQ; and WHEREAS, MEDIQ recognizes, in addition to Executive's other duties, the significant responsibility of Executive with respect to assisting in the possible sale of MEDIQ; and WHEREAS, MEDIQ acknowledges and recognizes that it would serve the best interests of MEDIQ to assure itself of the continued employment of the Executive as its Senior Vice President of Finance and Chief Financial Officer and the assistance of Executive in maximizing the value received for MEDIQ in any potential sale and that the compensation provided for herein represents the fair value of the services to be provided by Executive with respect to maximizing such value and with respect to the other services to be provided hereunder; and WHEREAS, MEDIQ acknowledges and recognizes that it will receive significant benefit from Executive continuing his employment with MEDIQ; and WHEREAS, Executive desires to continue his employment with MEDIQ on the terms and conditions provided in this Agreement. NOW THEREFORE, in consideration of the premises and the mutual covenants and agreements contained herein and intending to be legally bound hereby, the parties hereto agree as follows: SECTION 1. CAPACITY AND DUTIES 1.1 Employment; Acceptance of Employment. MEDIQ hereby employs Executive and Executive hereby accepts employment by MEDIQ for the period and upon the terms and conditions hereinafter set forth. (a) Executive shall be employed by MEDIQ as Senior Vice President of Finance and Chief Financial Officer and shall perform such other executive duties and shall have such executive authority, consistent with his position as may from time to time be specified by the Board of "Board"). From the date hereof until a Sale Event (as hereinafter defined) occurs or any such sale or divestiture is finally abandoned by the Board, Executive shall report directly to the Board or any duly authorized committee thereof having authority over such proposed sale or divestiture. Following any Sale Event or abandonment of such sale or divestiture by the Board, Executive shall report as to all matters hereunder to the Chief Executive Officer of MEDIQ. In the event that this Agreement is assigned to a liquidating trust (the "Trust") by MEDIQ as contemplated under Section 6.4, Executive shall agree to serve as an executive employee of the Trust with, to the fullest extent possible, executive duties and authority consistent with his position at MEDIQ and, in such capacity, shall report directly to the trustees of the Trust. (b) Executive shall devote his full working time, energy, skill and best efforts to the performance of his duties hereunder, in a manner which will faithfully and diligently further the business and interests of MEDIQ, and shall not be employed by or participate or engage in or be a part of in any manner the management or operation of any business enterprise other than MEDIQ (and the other subsidiaries or affiliates of MEDIQ on whose boards of directors Executive currently sits) without the prior written consent of the Board, which consent may be granted or withheld in its sole discretion. SECTION 2. TERM OF EMPLOYMENT 2.1 Term. The initial term of Executive's employment hereunder shall commence on the date hereof, shall continue until June 30, 1997 and shall thereafter automatically be renewed from year to year unless and until either party shall give notice of his or its election to terminate Executive's employment at least 60 days prior to the end of the then-current term, unless earlier terminated as hereinafter provided. Such initial term, and each renewal term are hereafter referred to collectively as the "Contract Period." As compensation for Executive's services hereunder, MEDIQ shall pay to Executive a salary at the annual rate of $250,000 (the "Base Salary"). Such Base Salary shall be payable in accordance with MEDIQ's regular payroll practices in effect from time to time. Such Base Salary shall be subject to increase based on normal periodic merit review by the Compensation Committee of the Board of Directors of MEDIQ (the "Compensation Committee") or the appropriate governing body of the Trust, as applicable in accordance with the corporate policies of MEDIQ (such annual base salary, including the foregoing adjustments, if any, is hereinafter referred to as the "annual base salary"). 3.2 Performance Bonus. During the Contract Period, Executive may receive an annual performance bonus at the sole discretion of the Compensation Committee or the appropriate governing body of the Trust, as applicable in accordance with the corporate policies of MEDIQ. 3.3 Employee Benefits. In addition to the compensation provided for in Section 3.1, Executive shall be entitled during the term of his employment to participate in all of MEDIQ's employee benefit plans and benefit programs as may from, time to time be provided for other employees of MEDIQ whose duties, responsibilities, and compensation are reasonably comparable to those of Executive including without limitation (a) Executive shall be entitled to thirty (30) business days vacation per year, (b) MEDIQ shall provide Executive with an automobile in accordance with the terms of MEDIQ's executive benefits plan (the reasonable expenses of which automobile shall be borne by MEDIQ), (c) MEDIQ shall cause Executive to be included at "Level A" in its Incentive Compensation Plan, a copy of which is attached hereto as Exhibit A, and (d) Executive shall be covered as an insured under such Directors' and Officers' Liability insurance as MEDIQ maintains generally for its Officers and Directors. If Executive becomes a participant in any employee benefit plan, practice or policy of MEDIQ or its affiliates, Executive shall be given credit under such plan for all service in the employ of MEDIQ and any predecessors thereto or affiliates thereof prior to the date hereof for purposes of eligibility and vesting, benefit accrual and for all other purposes for which such service is either taken into account or recognized under the terms of such plan, practice or policy. 3.4 Expense Reimbursement. During the term of his employment, MEDIQ shall reimburse Executive for all reasonable expenses incurred by him in accordance with its regular reimbursement policies as in effect from time to time and upon receipt of itemized vouchers therefor and such other supporting information as MEDIQ may reasonably require. (a) If, during the Applicable Period (as herein defined), a Sale Event (as hereafter defined) occurs, Executive shall be entitled to receive a one-time bonus calculated as provided in paragraph (b) below. For the purposes of this Agreement, a "Sale Event" means any sale or divestiture of, by or involving MEDIQ including a sale of substantially all of MEDIQ's stock or assets (including through merger, tender, exchange or otherwise, including distributions of MEDIQ's assets to its stockholders or into a liquidating trust and including, without limitation, a sale or divestiture to the Management Group (as defined in Section 6.10 hereof)), in either case in one or more transactions. Executive's bonus shall be paid in cash within 10 days after the consummation of a Sale Event. The term "Applicable Period" shall mean (a) the Contract Period and (b) the one-year period thereafter in the event Section 4.1, 4.2 or 4.4 hereof is applicable. (b) Executive's bonus payable upon a Sale Event shall be based on the fair market value per share ("Share Value") received by MEDIQ's stockholders in the transaction. In the event that MEDIQ's stockholders receive a Share Value of $6.50 or more, Executive's bonus shall equal $500,000 plus an additional $1,000 for each additional $.01 by which the Share Value received by MEDIQ's stockholders exceeds $6.50. In the event that the stockholders receive Share Value of less than $6.50 upon a Sale Event, Executive shall receive a bonus in the amount of $200,000 plus any additional bonus at the sole discretion of the Board. If the Sale Event includes or consists of a distribution of MEDIQ's assets to its stockholders or into the Trust, for purposes of calculating Executive's bonus hereunder, MEDIQ's stockholders will be deemed to have received Share Value equal to the fair market value of Such assets, net of liabilities assumed (the "Net Proceeds"), at the time they are distributed. If the distribution is into the Trust, such Share Value will be deemed to be increased by any increase in the Net Proceeds from the date of distribution into the Trust until the date of distribution from the Trust to MEDIQ's Shareholders, whether or not such subsequent distribution occurs during the Applicable Period. In the event of such deemed increase in the Share Value, Executive's bonus will be recalculated hereunder and any additional amounts payable to him shall be paid to him within ten days of each such distribution from the Trust. With respect to any distribution of non-cash assets, if the parties are unable to agree on the value of the Net Proceeds upon which Executive's bonus shall be based, the Board of Directors and Executive shall select an investment banking firm, reasonably acceptable to each of them, to make such determination. The expenses of the investment banking firm shall be borne by MEDIQ, unless the investment banking firm shall determine that the Executive's position regarding the value of the Net Proceeds was unreasonable under the circumstances, in which case such fees and expenses shall be shared equally between MEDIQ and Executive. (c) Executive acknowledges that a Sale Event may not occur, that the Board may determine not to pursue a Sale Event, that such a transaction can occur only upon proper authorization of the Board, or a duly constituted committee thereof, and accordingly there can be no assurance that any bonus will become payable to Executive under this Section. SECTION 4. TERMINATION OF EMPLOYMENT 4.1 Death of Executive. Executive's employment hereunder shall immediately terminate upon his death, upon which MEDIQ shall not thereafter be obligated to make any further payments hereunder other than amounts (including salary, bonuses, expense reimbursement, etc.) earned or accrued as of the date of Executive's death in accordance with generally accepted accounting principles ("GAAP") and except as otherwise provided in Section 3.5 hereof. 4.2 Disability of Executive. If Executive, in the reasonable opinion of a physician selected by the Board, is unable, for any reason, to perform his duties hereunder for a period of 180 consecutive days then the Board shall have the right to terminate Executive's employment upon 30 days' prior written notice to Executive at any time during the continuation of such inability, in which event MEDIQ shall not thereafter be obligated to make any further payments hereunder other than amounts (including salary, bonuses, expense reimbursement, etc.) earned or accrued under this Agreement as of the date of such termination in accordance with GAAP and except as otherwise provided in Section 3.5 hereof. 4.3 Termination for Cause. Executive's employment hereunder shall terminate immediately upon notice that MEDIQ is terminating Executive for "cause" (as defined herein), in which event MEDIQ shall not thereafter be obligated to make any further payments hereunder other than amounts (including salary, bonuses, expense reimbursement, etc.) earned or accrued under this Agreement as of the date of such termination in accordance with GAAP. As used herein, "cause" shall mean the following, which for purposes of subsections (v) through (ix) shall not have been corrected after notice and a reasonable opportunity to cure: (i) misconduct involving dishonesty which (ii) fraud, theft or misappropriation or (iii) conviction of any felony, crime involving fraud or misrepresentation, or of any other crime (whether or not connected with his employment) the effect of which is likely to adversely affect (iv) illegal possession or use of any (v) Executive's failure to materially Perform his duties under this Agreement; (vi) repeated and consistent failure of Executive to be present at work during normal business hours unless the absence is because of a disability determined pursuant to Section 4.2; (vii) willful violation of any reasonable express direction or any reasonable rule or regulation incompetence, or misconduct in the performance of, or gross neglect of, Executive's duties hereunder; or (ix) use of alcohol or other drugs which interferes with the performance by Executive of his duties. (i) Executive's employment is terminated by MEDIQ for any reason other than cause or the death or (ii) this Agreement is not renewed by MEDIQ at the end of any Contract Period on terms and conditions no less favorable to Executive than those in effect at such time, or Executive's employment is terminated by Executive for "Good Reason" (as defined herein): MEDIQ shall within 10 days thereafter pay Executive all amounts due under Sections 3.1, 3.2 (if such bonus has been agreed to) 3.3, 3.4 and 3.5 (including Base Salary, benefits, expense reimbursements and compensation for unused vacation time) earned or accrued as of the date of such termination in accordance with GAAP and a lump sum payment equal to Executive's then current Base Salary for the then- remaining Contract Period and a period of one year thereafter, discounted to present value at the Prime Rate, not to exceed 12% in effect on the date of non-renewal or termination as published in the Wall Street Journal. Executive shall continue to receive from MEDIQ until the expiration of the period of one year after the end of the Contract Period then in effect his then current incentive compensation and employee benefits Executive would have received had he continued employment and such event had not occurred. Upon making such payments, MEDIQ shall have no further obligation to Executive hereunder except as otherwise provided in Section 3.5. (b) As used herein, the term "Good Reason" shall mean the following: (i) material breach of MEDIQ's material obligations under this Agreement, not corrected after notice and a reasonable opportunity to cure; (ii) any change in Executive's Base Salary, title, any material change in Executive's duties or authority (except solely to accommodate the reasonable requirements of the Trust), and any material change in Executive's employee benefits; or (iii) MEDIQ's requiring Executive to be based at a location outside a 35-mile radius of Pennsauken, New Jersey, except for reasonably required travel on MEDIQ's business. (c) There shall be no requirement on the part of Executive to seek other employment in order to be entitled to the full amount of any payments or benefits to be made pursuant to this Agreement or any other agreement between Executive and MEDIQ, and no compensation or other benefits from any such other employment shall reduce the payment obligations of MEDIQ under this Section 4.4. 5.1 Confidentiality. Executive acknowledges a duty of confidentiality owed to MEDIQ and shall not, at any time during or after his employment by MEDIQ, retain in writing, use, divulge, furnish, or make accessible to anyone, without the express authorization of the Board, any trade secret, private or confidential information or knowledge of MEDIQ or any of its affiliates obtained or acquired by him while so employed. All computer software, telephone lists, customer lists, price lists, contract forms, catalogs, books, records, and files acquired while an employee of MEDIQ, are acknowledged to be the property of MEDIQ and shall not be duplicated, removed from MEDIQ's possession or made use of other than in pursuit of MEDIQ's business and, upon termination of employment for any reason, Executive shall deliver to MEDIQ, without further demand, all copies thereof which are then in his possession or under his control. 5.2 Inventions and Improvements. During the term of his employment, Executive shall promptly communicate to MEDIQ all ideas, discoveries and inventions which are or may be useful to MEDIQ or its business. Executive acknowledges that all ideas, discoveries, inventions, and improvements which are made, conceived, or reduced to practice by him and every item of knowledge relating to MEDIQ's business interests (including potential business interests) gained by him during his employment hereunder are the property of MEDIQ, and irrevocably assigns all such ideas, discoveries, inventions, improvements, and knowledge to MEDIQ for its sole use and benefit, without additional compensation. The provisions of this Section shall apply whether such ideas, discoveries, inventions, improvements or knowledge are conceived, made or gained by him alone or with others, whether during or after usual working hours, whether on or off the job, whether applicable to matters directly or indirectly related to MEDIQ's business interests (including potential business interests), and whether or not within the specific realm of his duties. Executive shall, upon request of MEDIQ, at any time during or after his employment with MEDIQ, sign all instruments and documents requested by MEDIQ arid otherwise cooperate with MEDIQ to protect its right to such ideas, discoveries, inventions, improvements, and knowledge, including applying for, obtaining, and enforcing patents and copyrights thereon in any and all countries. 5.3 Injunctive and Other Relief. (a) Executive acknowledges and agrees that the covenants contained herein are fair and reasonable in light of the consideration paid hereunder, and that damages alone may not be an adequate remedy for any breach by Executive of his covenants contained herein and accordingly expressly agrees that, in addition to any other remedies which MEDIQ may have, MEDIQ shall be entitled to injunctive relief in any court of competent jurisdiction for any breach or threatened breach of any such covenants by Executive. Nothing contained herein shall prevent or delay MEDIQ from seeking, in any court of competent jurisdiction, specific performance or other equitable remedies in the event of any breach or intended breach by Executive of any of its obligations hereunder. (b) Notwithstanding the equitable relief available to MEDIQ, the Executive, in the event of a breach of his covenants contained in Section 5 hereof, understands and agrees that the uncertainties and delay inherent in the legal process could result in a continuing breach for some period of time, and therefore, continuing injury to MEDIQ until and unless MEDIQ can obtain such equitable relief. Therefore, in addition to such equitable relief, MEDIQ shall be entitled to monetary damages for any such period of breach until the termination of such breach, in an amount deemed reasonable to cover all actual losses, plus all monies received by Executive as a result of said breach and all reasonable costs and attorneys' fees incurred by MEDIQ in enforcing this Agreement. If Executive should use or reveal to any other person or entity any confidential information, this will be considered a continuing violation on a daily basis for so long a period of time as such confidential information is made use of by Executive or any such other person or entity. (a) All disputes arising out of or relating to this Agreement which cannot be settled by the parties shall promptly be submitted to and determined by a single arbitrator in Philadelphia, Pennsylvania, pursuant to the rules and regulations then obtaining of the American Arbitration Association; provided that nothing herein shall preclude MEDIQ from seeking, in any court of competent jurisdiction, damages, specific performance or other equitable remedies in the case of any breach or threatened breach by Executive of Section 5 hereof. The decision of the arbitrator shall be final and binding upon the parties, and judgement upon such decision may be entered in any court of competent jurisdiction. (b) Discovery shall be allowed pursuant to the intendment of the United States Federal Rules of Civil Procedure and as the arbitrators determine appropriate under the circumstances. (c) Such arbitrator shall be required to apply the contractual provisions hereof in deciding any matter submitted to it and shall not have any authority, by reason of this Agreement or otherwise, to render a decision that is contrary to the mutual intent of the parties as set forth in this Agreement. 6.2 Prior Employment. Executive represents and warrants that he is not a party to any other employment, non-competition or other agreement or restriction which could interfere with his employment with MEDIQ or his rights and obligations hereunder; and that his execution of this Agreement and the performance of his duties hereunder will not breach the provisions of any contract, agreement, or understanding to which he is party or any duty owed by him to any other person. 6.3 Severability. The invalidity or inenforceability of any particular provision or part of any provision of this Agreement shall not affect the other provisions or parts hereof. If any provision hereof is determined to be invalid or unenforceable by a court of competent jurisdiction, Executive shall negotiate in good faith to provide MEDIQ with protection as nearly equivalent to that found to be invalid or unenforceable and if any such provision shall be so determined to be invalid or unenforceable by reason of the duration or geographical scope of the covenants contained therein, such duration or geographical scope, or both, shall be considered to be reduced to a duration or geographical scope to the extent necessary to cure such invalidity. 6.4 Assignment. This Agreement shall not be assignable by Executive, and shall be assignable by MEDIQ only to any person or entity which becomes a successor in interest (by purchase of assets or stock, or by merger, or otherwise) to MEDIQ in the business or substantially all of the business presently operated by it or to any liquidating trust into which substantially all of the assets of MEDIQ are transferred. Subject to the foregoing, this Agreement and the rights and obligations set forth herein shall inure to the benefit of, and be binding upon, the parties hereto and each of their respective permitted successors, assigns, heirs, executors and administrators. 6.5 Notices. All notices hereunder shall be in writing and shall be sufficiently given if hand-delivered, sent by documented overnight delivery service or registered or certified mail, postage prepaid, return receipt requested or by telegram, fax or telecopy (confirmed by U.S. mail), receipt acknowledged, addressed as set forth below or to such other person and/or at such other address as may be furnished in writing by any party hereto to the other. Any such notice shall be deemed to have been given as of the date received, in the case of personal delivery, or on the date shown on the receipt or confirmation therefor, in all other cases. Any and all service of process and any other notice in any such action, suit or proceeding shall be effective against any party if given as provided in this Agreement; provided that nothing herein shall be deemed to affect the right of any party to serve process in any other manner permitted by law. Attention: Michael J. Rotko, Esq. 1100 Philadelphia National Bank Building Attention: William M. Goldstein, Esq. 3000 Two Logan Square, 18th and Arch Streets 6.6 Entire Agreement and Modification. This Agreement constitutes the entire agreement between the parties hereto with respect to the matters contemplated herein and supersedes all prior agreements and understandings with respect thereto, including, without limitation, the Employment Agreement dated November 14, 1988, as amended (except the provision thereof regarding stock options). Any amendment, modification, or waiver of this Agreement shall not be effective unless in writing. Neither the failure nor any delay on the part of any party to exercise any right, remedy, power or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right, remedy, power or privilege preclude any other or further exercise of the same or of any other right, remedy, power, or privilege with respect to any occurrence be construed as a waiver of any right, remedy, power, or privilege with respect to any other occurrence. 6.7 Governing Law. This Agreement is made pursuant to, and shall be construed and enforced in accordance with, the internal laws of the State of New Jersey (and United States federal law, to the extent applicable), without giving effect to otherwise applicable principles of conflicts of law. 6.8 Headings; Counterparts. The headings of paragraphs in this Agreement are for convenience only and shall not affect its interpretation. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original and all of which, when taken together, shall be deemed to constitute but one and the same Agreement. 6.9 Further Assurances. Each of the parties hereto shall execute such further instruments and take such other actions as any other party shall reasonably request in order to effectuate the purposes of this Agreement. 6.10 MEDIQ Acknowledgements. MEDIQ acknowledges that as of the date hereof it has no claims of any kind against Executive arising out of or relating in any manner to Executive's participation in the management-led buy-out group including Bernard Korman (the "Management Group"). Except as set forth in the letter between MEDIQ Acquisition Corporation ("MAC") and Dillon, Read & Co., Inc. dated January 18, 1995 (the "Dillon, Read Letter"), recognizing the importance of Executive's fiduciary obligations to MEDIQ with respect to the sale of MEDIQ, Executive shall not, from the date hereof, during the term of his employment hereunder, enter into any agreement or discussions to acquire an equity interest in any potential purchaser of MEDIQ, including the Management Group, nor shall Executive disclose to the Management Group any information relating to a Sale Event, until such time as a definitive agreement for a Sale Event is executed or Sale Event occurs, whichever first occurs. After the first to occur of a Sale Event or the execution of a definitive agreement for a Sale Event, Executive may negotiate and agree with potential purchasers of MEDIQ, including the Management Group, to obtain an equity interest in and an executive and board position with such purchaser. 6.11 Executive's Acknowledgements. Executive represents and warrants that, except for the Dillon Read Letter described in Section 6.10, he has no agreement or relationship with the Management Group requiring him to render to or perform services on behalf of such Group or that imposes any fiduciary obligation on Executive with respect to such Management Group. Executive further represents and warrants that he is not an officer or director of any entity controlled by the Management Group. 6.12 Legal Fees. MEDIQ shall pay all reasonable legal fees at the normal hourly rates of Pepper, Hamilton & Scheetz incurred by Executive in connection with the preparation, negotiation and execution of this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written.	10-K405	EX-10.8	1996-01-12T00:00:00	1996-01-12T11:57:13
0000950130-96-000094	0000950130-96-000094_0000.txt	(Pursuant to Section 13(e) of the Securities Exchange Act of 1934) TRUMP HOTELS & CASINO RESORTS, INC. TRUMP HOTELS & CASINO RESORTS HOLDINGS, L.P. THCR MERGER CORP. TAJ MAHAL HOLDING CORP. (Name of Persons Filing Statement) (Title of Class of Securities) (CUSIP Number of Class of Securities) c/o Trump Hotels & Casino Resorts, Inc. Mississippi Avenue and The Boardwalk (Name, Address and Telephone Number of Person(s) Authorized to Receive Notices and Communications on Behalf of Person(s) Filing Statement) This statement is filed in connection with (check the appropriate box): a. [ ] The filing of solicitation materials or an information statement subject to Regulation 14A [17 CFR 240.14a-1 to 240.14b-1], Regulation 14C [17 CFR 240.14c-1 to 240.14c-101] or Rule 13e-3(c) [(S) 240.13e(c)] under the Securities Exchange Act of 1934. b. [X] The filing of a registration statement under the Securities Act of 1933. c. [ ] A tender offer. d. [ ] None of the above. Check the following box if the soliciting materials or information statement referred to in checking box (a) are preliminary copies: [ ]. Amount of Filing Fee: $ 8,100 * For purposes of calculating filing fee only. This amount assumes the purchase of 1,350,000 shares of Taj Mahal Holding Corp. Class A Common Stock, par value $ .01 per share, at $30 per share. The amount of the filing fee calculated in accordance with Rule 0-11 promulgated under the Securities Exchange Act of 1934, as amended, equals 1/50 of one percent of the value of shares to be purchased. [X] Check box if any part of the fee is offset as provided by Rule 0- 11(a)(2) and identify the filing with which the offsetting fee was previously paid. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. Form or Registration No.: S-4 Filing Party: Trump Hotels & Casino Resorts, Inc. Date Filed: January 11, 1996 This Rule 13e-3 Transaction Statement (as it may be amended, the "Statement") is being filed by Trump Hotels & Casino Resorts, Inc., a Delaware corporation ("THCR"), Trump Hotels & Casino Resorts Holdings, L.P., a Delaware limited partnership ("THCR Holdings"), Donald J. Trump, individually ("Trump"), TM/GP Corporation, a New Jersey corporation ("TM/GP"), THCR Merger Corp., a Delaware corporation ("Merger Sub") and Taj Mahal Holding Corp., a Delaware corporation ("Taj Holding"), in connection with the proposed merger (the "Merger") of Merger Sub with and into Taj Holding, pursuant to the Agreement and Plan of Merger, dated as of January 8, 1996 (the "Merger Agreement"), among THCR, Taj Holding and Merger Sub. THCR, THCR Holdings, Trump, TM/GP and Merger Sub are each affiliates of Taj Holding and its affiliated entities. The cross reference sheet below is being supplied pursuant to General Instruction F to Schedule 13E-3 and shows the location of the information required to be included in response to the items of this Statement in the Joint Proxy Statement-Prospectus of THCR and Taj Holding (the "Proxy Statement- Prospectus") which forms a part of the Registration Statement on Form S-4 (the "Registration Statement"), filed concurrently herewith with the Securities and Exchange Commission (the "SEC") in connection with the Merger. The information in the Proxy Statement-Prospectus including all annexes thereto, a copy of which is attached hereto as Exhibit (17)(d), is hereby expressly incorporated herein by reference and the responses to each item are qualified in their entirety by the provisions of the Proxy Statement-Prospectus and such annexes. A copy of the Merger Agreement is included as Annex A to the Proxy Statement-Prospectus. Capitalized terms used but not defined herein shall have the respective meanings ascribed to them in the Proxy Statement-Prospectus. Item in Schedule 13E-3 Caption in Proxy Statement-Prospectus Item 1(a) Cover Page; SUMMARY - Corporate and Financial Item 1(b) Cover Page; THE TAJ HOLDING SPECIAL MEETING; MARKET PRICE AND DIVIDEND DATA - Taj Holding Item 1(c)-(d) MARKET PRICE AND DIVIDEND DATA - Taj Holding Item 2(a)-(d), (g) Cover Page; Available Information; SUMMARY; BUSINESS OF THCR; BUSINESS OF TAJ HOLDING; MANAGEMENT OF THCR; MANAGEMENT OF TAJ Item 3(a)(2) SPECIAL FACTORS - Background of the Merger Transaction; Item 3(b) SPECIAL FACTORS - Background of the Merger Transaction; SPECIAL FACTORS - Related Merger Transactions Item 4(a)-(b) SUMMARY; SPECIAL FACTORS - Background of the Merger Transaction; SPECIAL FACTORS - Purpose and Structure of the Merger Transaction; SPECIAL FACTORS - Related Merger Transactions; SPECIAL FACTORS - Interests of Certain Persons in the Merger Transaction; THE MERGER Item 5(a)-(g) SUMMARY - The Merger Agreement; SPECIAL Item in Schedule 13E-3 Caption in Proxy Statement-Prospectus of the Merger Transaction; Operations of Taj Associates After the Merger Transaction; THE MERGER AGREEMENT; MANAGEMENT OF TAJ Item 6(a) SPECIAL FACTORS - Related Merger Transactions; SPECIAL FACTORS - Sources and Uses of Funds in the Merger Transaction Item 6(b) UNAUDITED PRO FORMA FINANCIAL INFORMATION; THE TAJ HOLDING SPECIAL MEETING - Item 6(c) RISK FACTORS - Holding Company Structure; Risk in Refinancing and Repayment of Financing; SPECIAL FACTORS - Related Merger Item 7(a)-(c) SUMMARY - General; SPECIAL FACTORS - Background of the Merger Transaction; SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction; SPECIAL FACTORS - Purpose and Structure of the Merger Transaction Item 7(d) SUMMARY; RISK FACTORS; SPECIAL FACTORS; Item in Schedule 13E-3 Caption in Proxy Statement-Prospectus COMPARISON OF STOCKHOLDER RIGHTS; CERTAIN FEDERAL INCOME TAX CONSIDERATIONS; SPECIAL TAX CONSIDERATIONS FOR FOREIGN SHAREHOLDERS Item 8(a) SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Item 8(b) SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction; SPECIAL FACTORS - Opinions of the Financial Advisors; ANNEX C Item 8(c) SUMMARY - The Special Meetings - Votes Required; Record Date; SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction; THE TAJ HOLDING SPECIAL MEETING - Required Vote Item 8(d) SPECIAL FACTORS - Background of the Merger Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness Item 8(e) SUMMARY - Recommendations of the Boards of Directors; SPECIAL FACTORS - Background of the Merger Transaction; SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness Item in Schedule 13E-3 Caption in Proxy Statement-Prospectus Item 9(a)-(c) SUMMARY - Opinions of Financial Advisors; SPECIAL FACTORS - Background of the Merger Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction; SPECIAL FACTORS - Opinions of the Financial Advisors Item 10(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF TAJ HOLDING Item 11 SUMMARY; SPECIAL FACTORS - Background of the Merger Transaction; SPECIAL FACTORS - FACTORS - Interests of Certain Persons in the Merger Transaction; THE TAJ HOLDING SPECIAL MEETING - Required Vote; THE MERGER AGREEMENT; BUSINESS OF TAJ HOLDING - Certain Item 12(a) SUMMARY - The Special Meetings; THE TAJ HOLDING SPECIAL MEETING - Required Vote Item 12(b) SUMMARY - Recommendations of the Boards of Directors; SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Item in Schedule 13E-3 Caption in Proxy Statement-Prospectus Item 13 (a) SUMMARY - Dissenting Stockholders' Rights of Item 13(b) - (c) Not Applicable Item 14(a) SUMMARY - Summary Financial Information of Taj Holding; UNAUDITED PRO FORMA FINANCIAL INFORMATION OF TAJ ASSOCIATES; TAJ HOLDING'S CONSOLIDATED FINANCIAL STATEMENTS AND NOTES Item 14(b) SUMMARY - Summary Financial Information of Taj Holding; UNAUDITED PRO FORMA FINANCIAL Item 15(a) - (b) SUMMARY - Recommendations of the Boards of Directors; SUMMARY - Opinions of Financial Advisors; SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction; SPECIAL FACTORS - Opinions of the Financial Advisors; SPECIAL FACTORS - Certain Effects of the Merger Transaction; Operations of Taj Associates After the Merger Transaction; THE THCR SPECIAL MEETING - Solicitation of Proxies; THE TAJ HOLDING SPECIAL MEETING - Solicitation of Item 16 The information set forth in the Item 17(a) Indenture, by and between Trump Taj Mahal Funding, Inc., as issuer, Trump Taj Mahal Associates, as guarantor and First Bank National Association, as Trustee, in connection with the issuance of $750,000,000 aggregate principal amount of Notes, due Item 17(b)(1) Opinion of Rothschild, Inc., dated January 8, 1996 (incorporated herein by reference to Annex C to the Proxy Statement-Prospectus Item 17(b)(2) Report by Rothschild, Inc. to the To be filed by amendment. Item in Schedule 13E-3 Caption in Proxy Statement-Prospectus Board of Directors of Trump Taj Mahal Holding Corp., dated January 8, 1996 Item 17(b)(3) Opinion of Donaldson, Lufkin & Jenrette Securities Corporation, dated January 8, 1996 (incorporated herein by reference to Annex B to the Proxy Statement-Prospectus included in Exhibit 17(d) hereto) Item 17(b)(4) Report by Donaldson, Lufkin & Jenrette Securities Corporation to the Board of Directors of Trump Hotels & Casino Resorts, Inc., dated January 4, 1996 Item 17(b)(5) Appraisal of the Trump Taj Mahal Casino Resort, dated March 18, 1994, by Appraisal Item 17(b)(6) Appraisal of the Specified Parcels, dated December 21, 1995, by Appraisal Group Item 17(c)(1) Agreement and Plan of Merger, dated as of January 8, 1996, among Trump Hotels & Casino Resorts, Inc., Taj Mahal Holding Corp. and THCR Merger Corp. (incorporated herein by reference to Annex A to the Proxy Item 17(c)(2) Agreement, dated October 6, 1995, by and among Hamilton Partners, L.P., Prudential Management, Inc., Grace Brothers Ltd., SC Fundamental Value Fund, L.P. and SC Fundamental Value BVI Ltd. and Trump Taj Mahal Associates, Trump Taj Mahal Funding, Inc. and Trump Taj Mahal Holding Corp. Item 17(c)(3) Letter of Donald J. Trump to Taj Mahal Holding Corp., dated January 8, 1996 Item 17(d) Joint Proxy Statement - Prospectus of Trump Item in Schedule 13E-3 Caption in Proxy Statement-Prospectus Inc. and Taj Mahal Holding Corp., Subject to Completion, dated January 11, 1996 (included in the Registration Statement on Form S-4, filed by Trump Hotels & Casino Resorts, Inc. with the Securities and Exchange Commission Item 17(e) Section 262 of the Delaware General Corporation Law (incorporated herein by reference to Annex D to the Proxy Statement- Prospectus included in Exhibit 17(d) hereto) ITEM 1. Issuer and Class of Security Subject to the Transaction. (a) The information set forth in "Cover Page," and "SUMMARY - Corporate and Financial Structure and Organization" in the Proxy Statement-Prospectus is incorporated herein by reference. (b) The information set forth in "Cover Page," "THE TAJ HOLDING SPECIAL MEETING" and "MARKET PRICE AND DIVIDEND DATA - Taj Holding" in the Proxy Statement-Prospectus is incorporated herein by reference. (c) - (d) The information set forth in "MARKET PRICE AND DIVIDEND DATA - Taj Holding" in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 2. Identity and Background. (a) - (d), (g) The information set forth in "Cover Page," "Available Information," "SUMMARY," "BUSINESS OF THCR," "BUSINESS OF TAJ HOLDING," "MANAGEMENT OF THCR" and "MANAGEMENT OF TAJ HOLDING" in the Proxy Statement-Prospectus is incorporated herein by reference. (e) and (f) None of THCR, Trump, Merger Sub, TM/GP or Taj Holding or, to the best of their knowledge, no executive officer, director or controlling person of THCR, Merger Sub, TM/GP or Taj Holding (i) has been convicted in a criminal proceeding (excluding traffic violations or similar misdemeanors) or (ii) has been a party to a civil proceeding of a judicial or administrative body of competent jurisdiction and as a result of such proceeding was or is subject to a judgment, decree or final order enjoining further violations of, or prohibiting activities subject to, federal or state securities laws or finding any violation with respect to such laws. ITEM 3. Past Contacts, Transactions or Negotiations. (a)(1) The information set forth in "CERTAIN TRANSACTIONS" in the Proxy Statement-Prospectus is incorporated herein by reference. (a)(2) The information set forth in "SPECIAL FACTORS - Background of the Merger Transaction" and "THE MERGER AGREEMENT" in the Proxy Statement-Prospectus is incorporated herein by reference. (b) The information set forth in "SPECIAL FACTORS - Background of the Merger Transaction" and "SPECIAL FACTORS - Related Merger Transactions" in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 4. Terms of the Transaction. (a)-(b) The information set forth in "SUMMARY," "SPECIAL FACTORS - Background of the Merger Transaction," "SPECIAL FACTORS - Purpose and Structure of the Merger Transaction," "SPECIAL FACTORS - Related Merger Transactions," "SPECIAL FACTORS -Interests of Certain Persons in the Merger Transaction," "THE MERGER AGREEMENT," and ANNEX A in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 5. Plans or Proposals of the Issuer or Affiliate. (a) - (g) The information set forth in "SUMMARY - The Merger Agreement," "SPECIAL FACTORS - Certain Effects of the Merger Transaction; Operations of Taj Associates After the Merger Transaction," "THE MERGER AGREEMENT" and "MANAGEMENT OF TAJ HOLDING - General" in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 6. Source and Amounts of Funds or Other Consideration. (a) The information set forth in "SPECIAL FACTORS - Related Merger Transactions" and "SPECIAL FACTORS - Sources and Uses of Funds in the Merger Transaction" in the Proxy Statement-Prospectus is incorporated herein by reference. (b) The information set forth in "UNAUDITED PRO FORMA FINANCIAL INFORMATION" and "THE TAJ HOLDING SPECIAL MEETING - Solicitation of Proxies" in the Proxy Statement-Prospectus is incorporated herein by reference. (c) The information set forth in "RISK FACTORS - Holding Company Structure; Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing" and "SPECIAL FACTORS - Related Merger Transactions" in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 7. Purpose(s), Alternatives, Reasons and Effects. (a) - (c) The information set forth in "SUMMARY - General," "SPECIAL FACTORS - Background of the Merger Transaction," "SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction" and "SPECIAL FACTORS - Purpose and Structure of the Merger Transaction" in the Proxy Statement-Prospectus is incorporated herein by reference. (d) The information set forth in "SUMMARY," "RISK FACTORS," "SPECIAL FACTORS," "COMPARISON OF STOCKHOLDER RIGHTS," "CERTAIN FEDERAL INCOME TAX CONSIDERATIONS" and "SPECIAL TAX CONSIDERATIONS FOR FOREIGN SHAREHOLDERS" in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 8. Fairness of the Transaction. (a) The information set forth in "SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction" in the Proxy Statement- Prospectus is incorporated herein by reference. (b) The information set forth in "SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction," "SPECIAL FACTORS - Opinions of the Financial Advisors" and ANNEX C in the Proxy Statement- Prospectus is incorporated herein by reference. (c) The information set forth in "SUMMARY - The Special Meetings - Votes Required; Record Date," "SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction" and "THE TAJ HOLDING SPECIAL MEETING - Required Vote" in the Proxy Statement-Prospectus is incorporated herein by reference. (d) The information set forth in "SPECIAL FACTORS - Background of the Merger Transaction" and "SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction" in the Proxy Statement-Prospectus is incorporated herein by reference. (e) The information set forth in "SUMMARY - Recommendations of the Boards of Directors," "SPECIAL FACTORS - Background of the Merger Transaction" and "SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction" in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 9. Reports, Opinions, Appraisals and Certain Negotiations. (a) - (c) The information set forth in "SUMMARY - Opinions of Financial Advisors," "SPECIAL FACTORS - Background of the Merger Transaction," "SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction" and "SPECIAL FACTORS - Opinions of the Financial Advisors" in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 10. Interest in Securities of the Issuer. (a) The information set forth in "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF TAJ HOLDING" in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 11. Contracts, Arrangements or Understandings with Respect to the Issuer's Securities. The information set forth in "SUMMARY," "SPECIAL FACTORS - Background of the Merger Transaction," "SPECIAL FACTORS - Related Merger Transactions," "SPECIAL FACTORS - Interests of Certain Persons in the Merger Transaction," "THE TAJ HOLDING SPECIAL MEETING - Required Vote," "THE MERGER AGREEMENT," "BUSINESS OF TAJ HOLDING - Certain Indebtedness" and ANNEX A in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 12. Present Intention and Recommendation of Certain Persons with Regard to the Transaction. (a) The information set forth in "SUMMARY - The Special Meetings" and "THE TAJ HOLDING SPECIAL MEETING - Required Vote" in the Proxy Statement-Prospectus is incorporated herein by reference. (b) The information set forth in "SUMMARY - Recommendations of the Boards of Directors" and "SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction" in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 13. Other Provisions of the Transaction. (a) The information set forth in "SUMMARY - Dissenting Stockholders' Rights of Appraisal" and "DISSENTING STOCKHOLDERS' RIGHTS OF APPRAISAL" in the Proxy Statement-Prospectus is incorporated herein by reference. (b) - (c) Not applicable. (a) The information set forth in "SUMMARY - Summary Financial Information of Taj Holding," "UNAUDITED PRO FORMA FINANCIAL INFORMATION," "SELECTED HISTORICAL FINANCIAL INFORMATION OF TAJ ASSOCIATES" and "TAJ HOLDING'S CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO" in the Proxy Statement-Prospectus is incorporated herein by reference. (b) The information set forth in "SUMMARY - Summary Financial Information of Taj Holding," "UNAUDITED PRO FORMA FINANCIAL INFORMATION" and "SELECTED HISTORICAL FINANCIAL INFORMATION OF TAJ ASSOCIATES" in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 15. Persons and Assets Employed, Retained or Utilized. (a) - (b) The information set forth in "SUMMARY - Recommendations of the Boards of Directors," "SUMMARY - Opinions of Financial Advisors," "SPECIAL FACTORS - Recommendations of the Board of Directors; Reasons for the Merger Transaction; Fairness of the Merger Transaction," "SPECIAL FACTORS - Opinions of the Financial Advisors," "SPECIAL FACTORS - Certain Effects of the Merger Transaction; Operations of Taj Associates After the Merger Transaction," "THE THCR SPECIAL MEETING - Solicitation of Proxies" and "THE TAJ HOLDING SPECIAL MEETING - Solicitation of Proxies" in the Proxy Statement-Prospectus is incorporated herein by reference. The information set forth in the Proxy Statement-Prospectus is incorporated herein by reference. ITEM 17. Material to be Filed as Exhibits. (a) Indenture, by and between Trump Taj Mahal Funding, Inc., as issuer, Trump Taj Mahal Associates, as guarantor and First Bank National Association, as Trustee, in connection with the issuance of $750,000,000 aggregate principal amount of Notes, due 20__. (b)(1) Opinion of Rothschild, Inc., dated January 8, 1996 (incorporated herein by reference to Annex C to the Proxy Statement-Prospectus included in Exhibit 17(d) hereto). To be filed by amendment. (b)(2) Report by Rothschild, Inc. to the Board of Directors of Trump Taj Mahal Holding Corp., dated January 8, 1996. (b)(3) Opinion of Donaldson, Lufkin & Jenrette Securities Corporation, dated January 8, 1996 (incorporated herein by reference to Annex B to the Proxy Statement-Prospectus included in Exhibit 17(d) hereto). (b)(4) Report by Donaldson, Lufkin & Jenrette Securities Corporation to the Board of Directors of Trump Hotels & Casino Resorts, Inc., dated January 4, 1996. (b)(5) Appraisal of the Trump Taj Mahal Casino Resort, dated March 18, 1994, by Appraisal Group International. (b)(6) Appraisal of the Specified Parcels, dated December 21, 1995, by Appraisal Group International. (c)(1) Agreement and Plan of Merger, dated as of January 8, 1996, among Trump Hotels & Casino Resorts, Inc., Taj Mahal Holding Corp. and THCR Merger Corp. (incorporated herein by reference to Annex A to the Proxy Statement-Prospectus included in Exhibit 17(d) hereto). (c)(2) Agreement, dated October 6, 1995, by and among Hamilton Partners, L.P., Prudential Securities, Inc., Putnam Investment Management, Inc., Grace Brothers Ltd., SC Fundamental Value Fund, L.P. and SC Fundamental Value BVI Ltd. and Trump Taj Mahal Associates, Trump Taj Mahal Funding, Inc. and Trump Taj Mahal Holding Corp. (c)(3) Letter of Donald J. Trump to Taj Mahal Holding Corp., dated January 8, 1996. (d) Joint Proxy Statement - Prospectus of Trump Hotels & Casino Resorts, Inc. and Taj Mahal Holding Corp., Subject to Completion, dated January 11, 1996 (included in the Registration Statement on Form S-4, filed by Trump Hotels & Casino Resorts, Inc. with the Securities and Exchange Commission on January 11, 1996). (e) Section 262 of the Delaware General Corporation Law (incorporated herein by reference to Annex D to the Proxy Statement-Prospectus included in Exhibit 17(d) hereto). After due inquiry and to the best of my knowledge and belief, I certify that the information set forth in this statement is true, complete and correct. TRUMP HOTELS & CASINO RESORTS, INC. By: /s/ Nicholas L. Ribis Title: President, Chief Executive Officer and TRUMP HOTELS & CASINO RESORTS HOLDINGS, L.P. By: Trump Hotels & Casino Resorts, Inc., By: /s/ Nicholas L. Ribis Title: President, Chief Executive Officer and By: /s/ Nicholas L. Ribis Title: President, Chief Executive Officer and Treasurer By: /s/ Nicholas F. Moles By: /s/ Nicholas F. Moles Exhibit 17(b)(2) Report by Rothschild, Inc. to the Board of Directors of Trump Taj Mahal Holding Corp., dated January 8, 1996 Exhibit 17(b)(4) Report by Donaldson, Lufkin & Jenrette Securities Corporation to the Board of Directors of Trump Hotels & Casino Resorts, Inc., dated January 4, 1996 Exhibit 17(b)(5) Appraisal of the Trump Taj Mahal Casino Resort, dated March 18, 1994, by Appraisal Exhibit 17(b)(6) Appraisal of the Specified Parcels, dated December 21, 1995, by Appraisal Group Exhibit 17(c)(2) Agreement, dated October 6, 1995, by and among Hamilton Partners, L.P., Prudential Management, Inc., Grace Brothers Ltd., SC Fundamental Value Fund, L.P. and SC Fundamental Value BVI Ltd. and Trump Taj Mahal Associates, Trump Taj Mahal Funding, Inc. and Trump Taj Mahal Holding Corp. Exhibit 17(c)(3) Letter of Donald J. Trump to Taj Mahal Holding Corp., dated January 8, 1996 Exhibit 17(d) Joint Proxy Statement - Prospectus of Trump Hotels & Casino Resorts, Inc. and Taj Mahal Holding Corp., Subject to Completion, dated January 11, 1996 (included in the Registration Statement on Form S-4, filed by Trump Hotels & Casino Resorts, Inc. with the Securities and Exchange Commission on January 11, 1996)	SC 13E3	SC 13E3	1996-01-12T00:00:00	1996-01-11T17:58:48
0000950133-96-000022	0000950133-96-000022_0001.txt	Form of Subscription Form by which beneficial owners of the Registrant's Common Stock may exercise their non-transferable Subscription Rights and Over-Subscription Privilege THIS OFFER EXPIRES AT 5:00 PM EASTERN STANDARD TIME ON _________, 1996* As a stockholder of Allied Capital Corporation on January 22, 1996, the Record Date for the Company's rights offering, you have been issued subscription rights equal to the number of shares of common stock held by you on the Record Date. Pursuant to the Primary Subscription, you are entitled to exercise your Subscription Rights to purchase one (1) additional share of Allied Capital Corporation for every seven (7) Subscription Rights held at an Estimated Price of $_____ and according to the terms and conditions set forth in the Company's Prospectus dated ___________, 1996. The terms and conditions of the rights offering (the "Offer") set forth in the Prospectus are incorporated herein by reference. Capitalized terms not defined herein have the meanings attributed to them in the Prospectus. In accordance with the Over-Subscription Privilege, as a Record Date stockholder, you are also entitled to subscribe for additional Shares if, after all Primary Subscriptions have been fulfilled, Shares are available and you have fully exercised all Subscription Rights issued to you. If there are insufficient Shares remaining to satisfy all requests pursuant to the Over-Subscription Privilege, the available shares will be allocated in proportion to the number of Subscription Rights originally issued to you. The Company may also, at its sole discretion, elect to increase the number of Shares available in the Offer by up to 15% in order to satisfy requests for additional Shares pursuant to the Over-Subscription Privilege. SAMPLE CALCULATION OF PRIMARY SUBSCRIPTION HOW TO EXERCISE SUBSCRIPTION RIGHTS In order to Exercise your Subscription Rights, you must either (a) complete and sign this Subscription Form on the back and return it together with payment of the Estimated Subscription Price for the shares, or (b) present a properly completed Notice of Guaranteed Delivery, in either case to the Subscription Agent, American Stock Transfer and Trust Company, before 5:00 pm, Eastern Standard Time, on February 23, 1996 * (the "Expiration Date"). FULL PAYMENT OF THE ESTIMATED SUBSCRIPTION PRICE PER SHARE FOR ALL SHARES SUBSCRIBED FOR PURSUANT TO BOTH THE PRIMARY SUBSCRIPTION AND THE OVER-SUBSCRIPTION PRIVILEGE MUST ACCOMPANY THIS SUBSCRIPTION FORM AND MUST BE MADE PAYABLE IN UNITED STATES DOLLARS BY MONEY ORDER OR CHECK DRAWN ON A BANK LOCATED IN THE UNITED STATES AND MADE PAYABLE TO ALLIED CAPITAL CORPORATION. ALTERNATIVELY, IF A NOTICE OF GUARANTEED DELIVERY IS USED, A PROPERLY COMPLETED AND EXECUTED SUBSCRIPTION FORM MUST BE RECEIVED BY THE SUBSCRIPTION AGENT NO LATER THAN THE CLOSE OF BUSINESS ON THE THIRD (3RD) BUSINESS DAY FOLLOWING THE EXPIRATION DATE AND FULL PAYMENT, AS DESCRIBED IN THE NOTICE OF GUARANTEED DELIVERY, IS RECEIVED NO LATER THAN THE TENTH (10TH) BUSINESS DAY FOLLOWING THE CONFIRMATION DATE. PLEASE SEE "PAYMENT FOR SHARES" IN THE PROSPECTUS FOR ADDITIONAL INFORMATION. Delivery of shares subscribed to pursuant to the Primary Subscription and Over-Subscription Privilege will be made within thirty (30) days following the Expiration Date of the Offer. See "Delivery of Shares" in the Prospectus for additional information. THESE SUBSCRIPTION RIGHTS ARE NON-TRANSFERABLE. In order to exercise your Subscription Rights, you must complete Part 1 and Part 2 below. Complete Part 3 only if applicable. PART 1 - If you choose to subscribe for Shares, plesae complete the following: / / I wish to subscribe for the following number of shares pursuant to the Primary Subscription: / / I wish to exercise my Over-Subscription Privilege (b): (a) Please note: $_______ per share is an estimated price only. The Subscription Price will be determined on ___________, 1996, the Pricing Date (which is the same date as the Expiration Date, unless extended), and could be higher or lower depending on changes in the share price of the common stock as quoted on the Nasdaq National Market. (b) You can only over-subscribe if you have fully exercised your Primary Subscription. PART 2 - I acknowledge that I have received the Prospectus for this Offer and I hereby irrevocably subscribe for the number of Shares indicated above on the terms and conditions set out in the Prospectus. I understand and agree that I will be obligated to pay an additional amount to the Company if the Subscription Price as determined on the Pricing Date is in excess of the $______ Estimated Subscription Price per share. I hereby agree that if I fail to pay in full for the shares for which I have subscribed, the Company may exercise any of the remedies provided for in the Prospectus. Printed Name: Telephone number:( ) Please note that all stock certificates and refund checks, if any, will be delivered to the address of record, which is the address to which the materials for this offering were delivered. If you wish to change the address of record, please provide separate written instructions, sign the instructions, and deliver them to the Subscription Agent. PART 3 - The following broker-dealer is hereby designated as having been instrumental in the exercise of the rights hereby exercised:	N-2/A	EX-99.D.2	1996-01-12T00:00:00	1996-01-12T16:11:53
0000950129-96-000034	0000950129-96-000034_0002.txt	<DESCRIPTION>OPINION OF JAMES M. SHELGER As General Counsel and Secretary of Service Corporation International, a Texas corporation (the "Company"), I am familiar with the registration under the Securities Act of 1933, as amended, of 4,175,000 shares of the Company's common stock, $1.00 par value (the "Shares"), to be offered upon the terms and subject to the conditions set forth in the Company's 1993 Long-Term Incentive Stock Option Plan, as amended (the "Plan"). In connection therewith, I have examined the Amended and Restated Articles of Incorporation of the Company, as amended, the By-laws of the Company, the Plan, records of relevant corporate proceedings with respect to the offering of the Shares and such other documents and instruments as I have deemed necessary or appropriate for the expression of the opinion contained herein. I have also reviewed the Company's Registration Statement on Form S-8 to be filed with the Securities and Exchange Commission with respect to the Shares (the "Registration Statement"). I have assumed the authenticity and completeness of all records, certificates and other instruments submitted to me and the correctness of all statements of fact contained therein. Based on the foregoing and having regard for such legal considerations as I have deemed relevant, I am of the opinion that the Shares have been duly authorized and, when issued in accordance with the terms of the Plan, will be validly issued, fully paid and non-assessable. I hereby consent to the filing of this opinion as an exhibit to the Registration Statement.	S-8	EX-5.1	1996-01-12T00:00:00	1996-01-12T14:43:05
0000950112-96-000053	0000950112-96-000053_0001.txt	NEW YORK, NEW YORK 10017 MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED SMITH BARNEY INC. DEAN WITTER REYNOLDS INC. C/O MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED We have acted as special counsel for you, as sponsors (the 'Sponsors') of Monthly Payment Series--564 of Municipal Investment Trust Fund, Defined Asset Funds (the 'Fund'), in connection with the issuance of units of fractional undivided interest in the Fund (the 'Units') in accordance with the Trust Indenture relating to the Fund (the 'Indenture'). We have examined and are familiar with originals or copies, certified or otherwise identified to our satisfaction, of such documents and instruments as we have deemed necessary or advisable for the purpose of this opinion. Based upon the foregoing, we are of the opinion that (i) the execution and delivery of the Indenture and the issuance of the Units have been duly authorized by the Sponsor and (ii) the Units, when duly issued and delivered by the Sponsors and the Trustee in accordance with the Indenture, will be legally issued, fully paid and non-assessable. We hereby consent to the use of this opinion as Exhibit 3.1 of the Registration Statement relating to the Units filed under the Securities Act of 1933 and to the use of our name in such Registration Statement and in the related prospectus under the headings 'Taxes' and 'Miscellaneous--Legal	487	EX-99.2OPINCOUNSEL	1996-01-12T00:00:00	1996-01-12T08:17:26
0000065195-96-000002	0000065195-96-000002_0001.txt	Ernst & Young LLP 200 Clarnedon St. Phone: 617 266-2000 Boston, Fax: 617 266 5843 The Board of Directors and Stockholders We have audited the balance sheet of National Northeast Corporation as of December 31, 1994, and the related statements of income, changes in stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of National Northeast Corporation for the year ended December 31, 1993, and the balance sheet as of February 28, 1992 (date of inception) were audited by other auditors, whose report dated March 4, 1994, expressed an unqualified opinion on those statements. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 1994 financial statements referred to above present fairly, in all material respects, the financial position of National Northeast Corporation at December 31, 1994, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. As discussed in note 4 to the financial statements, in 1994 the Company changed its method of accounting for certain inventories from the first-in, first-out (FIFO) method to the last-in, first-out (LIFO) method. /s/ Ernst & Young LLP December 31 1992 (date of Current assets: Cash and cash equivalents (Note 3) 628,654 695 2,209 of $70,887 in 1994 and $50,000 in (Note 6) 2,730,639 1,707,480 1,175,378 Inventories (Note 4) 585,463 664,652 370,809 Prepaid expenses and other current assets 28,168 50,121 990 Total current assets 3,972,924 2,422,948 1,549,386 Machinery and equipment, net (Notes 5 and 6) 871,285 702,047 687,039 Total assets $4,865,834 $3,156,600 $2,236,425 Liabilities and stockholders' equity -Current liabilities: Accounts payable (Note 3) $2,717,391 $1,474,115 $889,658 Accrued expenses 149,990 79,933 14,931 note payable (Note 6) 144,952 133,839 86,433 Short term note payable (Note 6) 144,797 Note payable - related party 250,000 State income taxes payable 38,076 9,874 Total current liabilities 3,050,409 1,697,761 1,385,819 Subordinated note payable (Note 6) 198,225 343,181 600,606 Total liabilities 3,248,634 2,040,942 1,986,425 Commitments (Notes 7 and 8) Common stock, no par value; 1,000 shares authorized, issued and outstanding 250,000 250,000 250,000 Retained earnings: Total stockholders' equity 1,617,200 1,115,658 250,000 Total liabilities and stockholders' equity$4,865,834 $3,156,600 $2,236,425 See accompanying notes. Cost of sales 12,214,457 8,816,907 Selling, general and administrative exp. 2,550,678 1,887,441 Income from operations 1,158,404 938,316 Other income(expense), net 43,082 (2,722) Income before income taxes 1,166,744 891,532 Provision for state income taxes 65,202 36,052 Net income $ 1,101,542 $ 855,480 Statements of Changes in Stockholders' Equity Balance at December 31, 1992 1,000 $250,000 $ 510,178 $ 760,178 Distribution to stockholders (500,000) (500,000) Balance at December 31, 1993 1,000 250,000 865,658 1,115,658 Distribution to stockholders (600,000) (600,000) Balance at December 31, 1994 1,000 $250,000 $1,367,200 $1,617,200 Net income $ 1,101,542 $ 855,480 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of organization costs 9,980 9,980 Gain on disposal of machinery and equipment (6,855) Changes in operating assets and liabilities: prepaid expenses and other current assets 21,953 (31,417) State income taxes payable 28,202 (12,134) Net cash provided by operating activities 1,455,100 239,549 proceeds from disposal of machinery and equipment 16,027 Net cash used in investing activities (386,979) (235,390) Principal payments on subordinated debt (133,843) (123,586) Checks not presented for payment 293,681 259,299 Distribution to stockholders (600,000) (500,000) Net cash used in financing activities (440,162) (364,287) Net increase(decrease) in cash and cash equivalents 627,959 (360,128) Cash and cash equivalents, beginning of year 695 360,823 Cash and cash equivalents, end of year $ 628,654 $ 695 Supplemental disclosure of cash flow information: Interest paid $ 34,742 $ 44,062 Income taxes paid $ 37,000 $ 48,186 National Northeast Corporation (the Company) is a custom extruder, fabricator and assembler of aluminum. The Company, previously known as National Northeast Acquisition, Inc., purchased substantially all of the assets and assumed certain liabilities of National Northeast Corporation pursuant to an asset purchase agreement dated February 28, 1992. Consideration paid consisted of $500,000 in cash, a $144,797 short-term non interest bearing note and a $833,840 five-year non interest bearing note. The acquisition has been accounted for by the purchase method of accounting and, accordingly, the purchase price of $1,331,836 (adjusted to reflect the interest-free terms of the five-year note) has been allocated to the assets acquired of $2,236,425 and the liabilities assumed of $904,589 based upon the estimated fair value at the date of acquisition. The resulting net asset value approximated the purchase price. 3. Summary of Significant Accounting Policies The Company recognizes revenue upon shipment of goods to customers. During fiscal years 1994 and 1993, the three largest customers accounted for approximately 51% and 54% of product sales, respectively. The Company considers all highly liquid investments with maturities of 90 days or less at the time of acquisition to be cash equivalents. Under the Company's cash management program, checks issued are not considered reductions of cash or accounts payable balances until presented to the bank for payment. At December 31, 1994 and December 31, 1993, checks not presented for payment amounted to $492,217 and $198,536, respectively. Other assets include organization costs which are being amortized over a five-year period using the straight-line method. Notes to Financial Statements (continued) 3. Summary of Significant Accounting Polices (continued) Machinery and equipment are stated at cost. Depreciation is computed using the straight-line method over a five year period which is considered to be the estimated useful lives of the various assets. The cost of improvements is capitalized in the appropriate fixed asset accounts, while maintenance and repairs are expensed as incurred. On disposition of assets, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in the results of operations. The Company purchases tools and dies for extrusion and fabrication and expenses these costs as incurred. Tooling expense during the years ended December 31, 1994 and December 31, 1993 was $294,215 and $262,613, respectively. The Company has elected to have its income taxed directly to its stockholders in accordance with the "5" Corporation provisions of the Internal Revenue Code. Therefore, there is no provision for federal income taxes. The Company continues to pay state income taxes to those states that do not recognize "S" Corporation provisions of the Internal Revenue Code. The Company values its inventory at the lower of cost or market Effective January 1, 1994, the Company elected to change its method of accounting for the material component of inventory from the fast-in, fast-out (FIFO) method to the last-in, last-out (LIFO) method. Management believes the LIFO method will more fairly present its results of operations by reducing the effect of inflationary cost increases in inventory and thus match current costs with current revenues. Other components of inventory, amounting to approximately $156,000 at December 31, 1994, continue to be accounted for on the FIFO method. The effect of the change in inventory methods in 1994 was a reduction to inventory and net income of $300,000. The Company intends to apply to the Internal Revenue Service to change to the LIFO method of inventory valuation for income tax reporting purposes also. Notes to Financial Statements (continued) The composition of inventories was as follows: Raw materials $245,273 $588,345 $265,692 Work in process 227,789 45,356 82,109 Finished goods 112,401 30,951 23,008 (a) As noted above, the material component of inventory is valued on the LIFO method as of December 31, 1994 and on the FIFO method as of December 31, 1993 and February 28, 1992. Machinery and equipment consists of the following: Machinery, equipment, and improvements $1,284,879 $931,655 $635,171 Furniture and office equipment 96,496 66,276 51,868 Less accumulated depreciation 510,090 295,884 Notes to Financial Statements (continued) In connection with the asset purchase, the Company issued a non interest bearing $835,840 promissory note to the seller, payable in sixty equal installments of $13,931 commencing April I, 1992. The final payment on the subordinated note will occur in March 1997. This note is subordinated to the revolving loan agreement and is collateralized by all machinery and equipment included in the purchased assets. The Company recorded the note at an 8% discount to reflect the interest- free terms of the note. For the years ended December 31, 1994 and 1993, $33,325 and $43,582, respectively, of discount was recorded as interest expense. The remaining discount of $32,951 is included in the outstanding balance at December 31, 1994. On March 12, 1992, the Company entered into a demand revolving loan agreement with a bank:. On June 30, 1993, the amount available under the revolving loan agreement was amended to the lesser of $ 1,500,000 or the sum of 35% of inventory (not to exceed $300,000) plus 80% of accounts receivable. On December 12, 1994, the amount available under the revolving loan agreement was further amended to the lesser of $2,500,000 or the sum of 50% of inventory (not to exceed $500,000) plus 85% of accounts receivable. The loan's interest rate is equal to the bank's base rate plus 1/2% (9% at December 31, 1994). Borrowings under the agreement are collateralized by inventories and receivables. During 1994 and 1993 the weighted average borrowings outstanding were approximately $23,000 and $6,700 and the weighted average interest rate was approximately 6.6% and 7%, respectively. At December 31, 1994 and December 31, 1993 there were no amounts outstanding under this agreement. Notes to Financial Statements (continued) The Company leases its facilities under an operating lease expiring in 1997. The annual future minimum lease payments are as follows: Rental expense under this lease amounted to $60,000 for each of the years ended December 31, 1994 and 1993. Pursuant to the terms of the lease agreement, the Company has the option at any time during the lease term to purchase the building at a price of $926,477. Should the Company elect to exercise this option, all previous rent payments will reduce the purchase price. Total rent payments through December 31, 1994 were $170,000 which would reduce the purchase price to $756,477 at December 31,1994. At December 31, 1993, the Company had outstanding commitments to purchase raw materials for approximately $409,000. The Company had no significant outstanding purchase commitments at December 31, 1994. National Northeast Corporation has guaranteed the borrowings of National Southeast Aluminum Corporation from a bank under a revolving line of credit The revolving line of credit agreement permits borrowings up to the lesser of $1,500,000 or a variable amount dependent on inventory and accounts receivable balances. At December 31, 1994, $866,540 was outstanding in accordance with the terms of the revolving line of credit agreement. Notes to Financial Statements (continued) The Company's majority stockholder receives a management fee in the amount of approximately 1% of net sales for services rendered. During the year ended December 31, 1994 and December 31, 1993, management fees amounted to $177,843 and $130,675, of which $24,313 and $10,897 were included in accounts payable at December 31, 1994 and December 31, 1993 respectively. Stockholders/officers received $1,323,457 and $880,368 in bonuses during the years ended December 31, 1994 and December 31, 1993, respectively. Accounts payable and accrued expenses include a payable to stockholders amounting to $66,894 at December 31, 1994. Prepaid expenses and other current assets included a receivable from stockholders amounting to $27,017 at December 31, 1993. The original purchase of the assets of the Company was partially financed by a $250,000 note payable to a related patty. Interest was charged at the rate of 10% per annum. All amounts due under this note have been paid in fall. The stockholders of National Northeast Corporation also own a majority interest in National Southeast Aluminum Corporation ("NSE"). NSE began operations on June 1, 1994 in Winter Haven, Florida. National Northeast Corporation and certain stockholders of the Company and NSE perform accounting and managerial services for NSE for a fee equal to approximately 3% of NSE sales, of which 1.5% is payable to the Company and 1.5% is payable to the stockholders. The gross management fees incurred by NSE for the period ended December 31, 1994 amounted to $82,368. A receivable from NSE for management fees of $17,180 is included in accounts receivable at December 31, 1994. During 1994 the Company purchased approximately $335,000 of extruded aluminum from NSE. At December 31, 1994, $109,398 payable to NSE is included in accounts payable. Notes to Financial Statements (continued) 10. Related Party Transactions (continued) When consistent with the Company's cash management objectives and as permitted by the Company's loan agreements, National Northeast Corporation may provide short teem loans to NSE. During 1994, the average amount outstanding related to these short term loans amounted to approximately $203,000 and the weighted average interest rate was approximately 8.7%. Interest earned on these borrowings amounted to approximately $ 10,500 for the year ended December 31, 1994. At December 31, 1994 there were no principal amounts outstanding from NS El. Interest receivable related to these loans amounted to $2,875 at December 31, 1994. In December 1994, the Company sold machinery and equipment with a net book value of $2,454 to NSE. A receivable from NSE of $2,454 for this equipment is included in accounts receivable at December 31, 1994.	8-K	EX-99	1996-01-12T00:00:00	1996-01-12T17:21:09
0000950152-96-000077	0000950152-96-000077_0002.txt	1. ESTABLISHMENT OF PLAN. Durametallic Corporation ("Durametallic") proposes to grant to directors, corporate officers and other key employees of Durametallic and its subsidiaries options to purchase shares of Durametallic's Common Stock, $5 par value ("Common Stock"), and authorize the granting of tax benefit rights. The options and rights will be granted pursuant to the plan set forth herein and known as the DURAMETALLIC CORPORATION 1991 STOCK OPTION PLAN (the "Plan"). 2. PURPOSE OF PLAN. The purpose of the Plan is to provide directors, officers and key employees of Durametallic and its subsidiaries with an increased incentive to make significant and extraordinary contributions to the long-term performance and growth of Durametallic and its subsidiaries, to join the interests of such persons with the interests of Durametallic shareholders through the opportunity for increased stock ownership, and to attract and retain directors and employees of exceptional ability. It is intended that certain options to be granted to employees under the Plan may not qualify and that certain options may qualify as "incentive stock options" as defined in Section 422A(b) of the Internal Revenue Code of 1986, as amended (the "Code") and the terms of the Plan shall be interpreted in accordance with the incention stated in the option agreement. 3. SHARES SUBJECT TO PLAN. A maximum of fifty thousand (50,000) shares of Common Stock (subject to adjustment in accordance with Paragraph 15 below) may be subject to the exercise of options granted under the Plan. Such shares shall be authorized shares and may be either unissued or treasury shares. If an option is cancelled, surrendered, modified, exchanged for a substitute option, or expires or terminates during the term of the Plan but prior to the exercise of the option in full, the shares subject to but not delivered under such option shall be available for options subsequently granted. 4. ADMINISTRATION BY COMMITTEE. The Plan shall be administered by the Stock Option Committee (the "Committee") consisting of at least two members of the Board of Directors of Durametallic who are not also employees of Durametallic. Except for options granted to non-employee directors under this Paragraph 4, the Committee shall determine the persons to be granted options and rights, the amount of stock and rights to be optioned to each such person, and the terms of the options and rights to be granted. Options and rights shall be granted by the Committee and may be amended by the Committee consistent with the Plan, provided that no such amendment may become effective without the consent of the optionee except to the extent that such amendment operates solely to the benefit of the optionee. Options shall be granted to non-employee directors on the date of adoption of this plan according to the attached schedule, and no discretionary options shall be granted to such directors under the Plan. The price shall be 100% of the market value as of the date of the grant. The options shall be for a term of 10 years with a three year installment vesting schedule beginning one year from the grant date. No other options shall be granted to non-employee directors without an amendment of the plan adopting a new formula for such grants. The Committee shall have full power and authority to interpret the provisions of the Plan and to supervise the administration of the Plan. All determinations and selections made by the Committee regarding the Plan shall be final and conclusive. The Committee shall hold its meetings at such times and places as it shall deem advisable. Action may be taken by a written instrument signed by all the members of the Committee, and any action so taken shall be fully as effective as if it had been taken at a meeting duly called and held. The Committee may designate one of its members to sign options on behalf of the Committee and may appoint a secretary to keep minutes of its meetings. The Committee shall make such rules and regulations for the conduct of its business as it shall deem advisable. The members of the Committee shall be paid reasonable fees for their services. 5. INDEMNIFICATION OF COMMITTEE MEMBERS. Each person who is or shall have been a member of the Committee shall be indemnified and held harmless by Durametallic from and against any cost, liability or expense imposed or incurred in connection with such person's or the Committee's taking or failing to take any action under the Plan. Each such person shall be justified in relying on information furnished in connection with the Plan's administration by any appropriate person or persons. 6. ELIGIBILITY. Only directors, corporate officers and other key employees of Durametallic or a subsidiary corporation of Durametallic shall be eligible to participate in the Plan. The Committee shall determine whether or not a given individual is eligible to participate in the Plan. A person who has been granted an option or right under the Plan or any other stock option plan of Durametallic or any subsidiary corporation may be granted additional options and rights. The term "subsidiary" shall, for purposes of this Plan, be defined in the same manner as such term is defined in Section 425(f) of the Code. 7. OPTION PRICE. The per share option price shall be equal to not less than one hundred percent (100%) of the market value of the stock on the date of grant. The date of grant of an option shall be the date as of which the option is authorized by the Committee. The Committee shall determine the market value of the Common Stock as of the date of grant by taking into consideration Durametallic's then-current net worth, prospective earning power and dividend-paying capacity, and other relevant factors, provided, however, that if the stock is publicly traded, the Committee may rely on the trading prices on the date of determination or the most recent preceding date for which information is available. 8. INCENTIVE STOCK OPTIONS FOR TEN PERCENT STOCKHOLDERS. No option granted to any person who at the time of such grant owns more than 10% of the total combined voting power of all classes of stock of Durametallic or any of its subsidiaries may be designated as an incentive stock option, unless such option issued to such individual provides an exercise price equal to at least 110% of the market value of the Common Stock (as market value is defined in Paragraph 7), and the exercise of such option after the expiration of five years from the date of grant of the option is prohibited by its terms. 9. LIMIT ON INCENTIVE STOCK OPTION GRANTS. The maximum number of options first exercisable during any calendar year by a participant under this and all stock option plans of Durametallic and any parent or subsidiary corporations that can qualify as incentive stock options is specified in Section 422A(d) of the Code. As of the date of adoption of the Plan, that an aggregate fair market value of $100,000 determined on the date of grant. Options issued or which become exercisable in excess of the applicable limit will not qualify as incentive stock options. In the event of the acceleration of vesting of incentive stock options for any reason, which acceleration causes any participant to exceed this limit, Durametallic may designate the shares to be treated as having been acquired under incentive stock options. 10. TAX BENEFIT RIGHTS. The Committee may grant tax benefit rights to encourage participants to exercise their options and provide certain tax benefits to Durametallic. A tax benefit right shall entitle a participant to receive from Durametallic or a subsidiary a cash payment not to exceed the amount calculated by multiplying the ordinary income, if any, realized by the participant for federal tax purposes as a result of the exercise of a non-qualified stock option, or the disqualifying disposition of shares acquired under an incentive stock option, by the maximum federal income tax rate (including any surtax or similar charge or assessment) for corporations. A tax benefit right may be granted only with respect to a stock option issued and outstanding or to be issued under the Plan or any other plan of Durametallic or its subsidiaries which has been approved by the shareholders as of the date of this Plan and may be granted concurrently with or after the grant of the stock option. Such rights with respect to outstanding options shall be issued only with the consent of the participant if the effect would be to disqualify an incentive stock option, change the date of grant or the exercise price, or otherwise impair the participant's existing options. A stock option to which a tax benefit right has been attached shall not be exercisable by an officer subject to Section 16 of the Securities Exchange Act of 1934 for a period of six months from the date of the grant of the tax benefit right. The Committee shall determine the terms and conditions of any tax benefit right granted and the participants to whom such rights will be granted with respect to options under the Plan or any other plan of Durametallic. The Committee may amend, cancel, limit the term of or limit the amount payable under a tax benefit right at any time prior to exercise of the related option. The net amount of a tax benefit right, subject to withholding, may be used to pay a portion of the option price unless otherwise provided by the Committee. 11. TERMS OF OPTIONS AND RIGHTS; LIMITS ON EXERCISABILITY. Options and rights shall be evidenced by written agreements containing such terms and conditions, consistent with the provisions of this Plan, as the Committee shall from time to time determine. Options shall be exercisable for such periods as may be fixed by the Committee, not to exceed fifteen years from the grant thereof, but no option designated as an incentive stock option shall be exercisable after the expiration of ten years from the date of grant. At the time of the exercise of an option the option holder, if requested by the Committee, must represent to Durametallic that the shares are being acquired for investment and not with a view to the sale or distribution thereof. No option shall be exercisable within six months of the date or grant. The Committee may in its descretion require a participant to continue the participant's service with Durametallic and its subsidiaries for a certain length of time prior to the options becoming exercisable and may eliminate such delayed vesting provisions, subject to the restrictions of Paragraph 9. The Committee may condition the grant of an option to an employee of Durametallic or any of its subsidiary corporations on the execution of an employment contract by the employee, on the execution of any other contract or waiver, or upon the taking of any other action that the Committee in its discretion deems appropriate. The Committee may also vary, among the participants and among options and rights granted to the same participant, any and all of the terms and conditions of options and rights granted under the Plan. Unless the option agreement provides otherwise, unexpired options with delayed vesting shall be immediately exercisable in their entirety in the event of a change of control. "Change in control" means a change in control after the date of grant of the option of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14a promulgated under the Securities Exchange Act of 1934, as amended, provided that, without limitation, such change in control shall be deemed to have occurred if during any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board of Directors cease for any reason to constitute at least a majority thereof (unless the election or nomination for election by Durametallic shareholders of each new director was approved by a vote of at least two-thirds (2/3) of the directors then still in office who were directors at the beginning of the period). Notwithstanding the foregoing, a public offering of the stock shall not be deemed to be a change in control. If the option is an incentive stock option, the One Hundred Thousand Dollar ($100,000) limitation of Paragraph 9 shall not apply in the event of such acceleration, and any options in excess of the One Hundred Thousand Dollar ($100,000) vesting limitation under Section 422A of the Internal Revenue Code which had been incentive stock options shall be non-qualified stock options. 12. MEDIUM AND TIME OF PAYMENT. The exercise price for each share purchased pursuant to an option granted under the Plan shall be payable in cash or, if the Committee consents, in shares of Common Stock (including Common Stock to be received upon a simultaneous exercise) or other consideration equivalent to cash. When appropriate arrangements are made with a broker or other institution, payment may be made by a properly executed exercise notice directing delivery of shares to a broker together with irrevocable instructions to the broker to promptly deliver to Durametallic the amount of sale or loan proceeds to pay the exercise price. The time and terms of payment may be amended with the consent of the participant before or after exercise of the option, but such amendment shall not reduce the option price. The Committee may from time to time authorize payment of all or a portion of the option price in the form of a promissory note or installments, with or without interest or security, according to such terms as the Committee may approve. The Board of Directors may restrict or suspend the power of the Committee to permit such loans and may require that adequate security be provided. 13. TRANSFERABILITY OF OPTIONS AND RIGHTS. Options and rights granted under this Plan may not be transferred except by will or the laws of descent and distribution. During the lifetime of the participant, options and tax benefit rights may be exercised only by that participant, the participant's guardian or the participant's legal representative. 14. TERMINATION OF EMPLOYMENT. If a participant is no longer employed by or a director of Durametallic or its subsidiaries for any reason other than the participant's death, disability, termination after a change in control as defined in Paragraph 11, or termination for cause, the participant may exercise options or stock appreciation rights for a period of three months after such termination of employment or director status, but only to the extent the participant was entitled to exercise the options or rights on the date of termination, unless the terms of such option or right provide otherwise. For purposes of the Plan the following shall not be deemed a termination of employment (a) a transfer of an employee from Durametallic to any subsidiary of Durametallic; (b) a leave of absence, duly authorized in writing by Durametallic, for military service or for any other purpose approved by Durametallic if the period of such leave does not exceed 90 days; and (c) a leave of absence in excess of 90 days, duly authorized in writing by Durametallic, provided that the employee's right to reemployment is guaranteed either by statute or contract, and (d) a termination of employment with continued service as a director. If a participant ceases to be employed by or a director of Durametallic or one of its subsidiaries due to the participant's termination after a change in control as defined in Paragraph 11, the participant may exercise an option during the remaining term of the option, but only to the extent that the participant was entitled to exercise the option on the date of such event, unless the terms of such option or right provide otherwise. If a participant dies or becomes disabled (within the meaning of Section 22(e)(3) of the Code) causing termination, either while an employee or director of Durametallic or after the termination of the participant's employment or directorship (other than for cause) but during the time when the participant could have excercised options under the Plan, options issued to the participant shall be exercisable by the participant, by the personal representative of such participant, or by any other successor to the interest of the participant for one year after such participant's disablility or death, to the extent that the participant was entitled to excercise the option on the date of death or termination of employment or directorship, whichever first occurred, unless the terms of such option provide otherwise. If a participant is terminated for cause the participant shall have no further right to exercise any option previously granted. Nothing in the Plan or in any option or right shall interfere with or limit in any way the right of Durametallic or its subsidiaries to terminate a participant's employment at any time, nor confer upon any participant any right to continue in the employ of Durametallic or any of its subsidiaries. 15. ADJUSTMENTS. If the number of shares of Common Stock outstanding changes by reason of a stock dividend, stock split, recapitalization, merger, reorganization, consolidation, combination or exchange of shares, the aggregate number and class of shares available under the Plan and subject to each option, together with the option prices, shall be appropriately adjusted. If any rights to purchase stock of Durametallic are granted by the Board of Directors as a dividend, then unless and until such rights expire or become invalid, such rights shall attach to shares or stock subject to options under the Plan on the later of the record date for such dividend or the date an option is granted under the Plan. No fractional shares shall be issued pursuant to the Plan, and any fractional shares resulting from adjustments shall be eliminated from the respective options. If Durametallic is acquired by another corporation, or is otherwise merged into or consolidated with another corporation, all outstanding options shall become immediately exercisable just prior to the effective date of the merger, combination, consolidation or other corporate event, subject to the restrictions of Paragraphs 9 and 11. 16. TAX WITHHOLDING. Durametallic or a subsidiary shall make such provisions as it shall deem appropriate for the withholding of any taxes determined to be required to be withheld in connection with the grant or exercise of options or tax benefit rights under the Plan or the disqualifying disposition of stock issued pursuant to incentive stock options granted under including the withholding of Common Stock to be received upon exercise or delivery to Durametallic of previously owned Common Stock to satisfy the withholding requirement. 17. APPLICABILITY OF PLAN TO OUTSTANDING STOCK OPTIONS. This Plan shall not affect the terms and conditions of any stock options or related rights heretofore granted to any employee of Durametallic or any subsidiary corporation of Durametallic under any other stock option plan, except that tax benefit rights may be granted as provided in this Plan. 18. LISTING AND REGISTRATION OF SHARES. Each option shall be subject to the requirement that if at any time the Committee shall determine, in its discretion, that the listing, registration or qualification of the shares covered thereby upon any securities exchange or under any state or federal law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, the granting of such option or the issue or purchase of shares thereunder, such option may not be exercised in whole or in part unless and until such listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Committee. 19. EFFECTIVE DATE OF PLAN. The Plan shall take effect June 21, 1991. Options granted hereunder and designated as incentive stock options shall not be exercisable prior to one year from the effective date of this Plan, and if shareholder approval of the Plan is not received prior to that date, the options shall continue in force but shall not be incentive stock options. Unless earlier terminated by the Board of Directors, the Plan shall terminate on the day immediately preceding the tenth anniversary of its effective date. No option shall be granted under this Plan after such date. 20. TERMINATION AND AMENDMENT. The Board of Directors may terminate the Plan at any time, or may from time to time amend the Plan as it deems proper and in the best interests of Durametallic, provided that if shareholders have approved on the Plan, no such amendment may (i) materially increase either the benefits to participants under the Plan or the number of shares that may be issued under the Plan, (ii) materially modify the eligibility requirements set forth in Paragraph 6, (iii) reduce the option price (except pursuant to adjustments under Paragraph 15), or (iv) modify the formula grant provisions of Paragraph 4 with respect to non-employee directors more than once in any six month period. No amendment shall impair any outstanding option without the consent of the participant, except according to the terms of the option. SCHEDULE OF OPTIONS TO NON-EMPLOYEE DIRECTORS Name Option # Shares Price/share Paul D. Jackson NQ-1 1000 $ 74.07 Robert W. McClain NQ-2 2000 $ 74.07 Carl D. Wisner NQ-3 750 $ 74.07 Merle H. Armstrong NQ-4 250 $ 74.07 The Durametallic Corporation 1991 Stock Option Plan (the "Plan") is hereby amended to add the following to Paragraph 4 of the Plan: Options shall be granted to nonemployee directors on the day of adoption of this Amendment No. 1 according to the following schedule, at the indicated option price per share. The options shall be for a term of six years and shall vest as of the date which is three years from the date of the adoption of this Amendment No. 1. No other options shall be granted to nonemployee directors without an amendment of the Plan adopting a new formula for such grants. Approved by the Board of Directors on December 23, 1994.	S-8 POS	EX-4.5	1996-01-12T00:00:00	1996-01-12T11:23:00
0000950130-96-000108	0000950130-96-000108_0002.txt	TO TENDER SHARES OF COMMON STOCK PURSUANT TO THE OFFER TO PURCHASE A WHOLLY OWNED SUBSIDIARY OF THE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 12:00 MIDNIGHT, NEW YORK CITY TIME, ON FRIDAY, FEBRUARY 9, 1996, UNLESS THE OFFER IS EXTENDED. LAC ACQUISITION CORPORATION HAS AGREED, SUBJECT TO THE TERMS AND CONDITIONS OF THE OFFER, TO EXTEND THE OFFER UNTIL IMMEDIATELY AFTER THE TIME OF THE SPIN- OFF RECORD DATE (AS DEFINED IN THE OFFER TO PURCHASE). The Depositary for the Offer is: FIRST CHICAGO TRUST COMPANY OF NEW YORK By Mail: By Hand or By Overnight TENDERS & EXCHANGES Courier: P.O. BOX 2559--SUITE TENDERS & EXCHANGES 4660--LORAL 14 WALL STREET, SUITE JERSEY CITY, NEW JERSEY 4680--LORAL NEW YORK, NEW YORK 10005 DELIVERY OF THIS LETTER OF TRANSMITTAL TO AN ADDRESS OTHER THAN AS SET FORTH ABOVE, DOES NOT CONSTITUTE A VALID DELIVERY. THE INSTRUCTIONS ACCOMPANYING THIS LETTER OF TRANSMITTAL SHOULD BE READ CAREFULLY BEFORE THIS LETTER OF TRANSMITTAL IS COMPLETED. This Letter of Transmittal is to be completed by stockholders either if certificates are to be forwarded herewith or if delivery is to be made by book- entry transfer to the Depositary's account at The Depository Trust Company ("DTC"), the Midwest Securities Trust Company ("MSTC") or the Philadelphia Depository Trust Company ("PDTC"), which are hereinafter collectively referred to as the "Book-Entry Transfer Facilities," pursuant to the procedures set forth in Section 3 of the Offer to Purchase (as defined below). Stockholders whose certificates are not immediately available or who cannot deliver their certificates and all other documents required hereby to the Depositary prior to the Expiration Date (as defined in Section 1 of the Offer to Purchase) or who cannot comply with the book-entry transfer procedures on a timely basis must tender their Shares (as defined below) according to the guaranteed delivery procedure set forth in Section 3 of the Offer to Purchase. See Instruction 2. Delivery of documents to a Book-Entry Transfer Facility does not constitute delivery to the Depositary. [_CHECK]HERE IF TENDERED SHARES ARE BEING DELIVERED BY BOOK-ENTRY TRANSFER MADE TO THE ACCOUNT MAINTAINED BY THE DEPOSITARY WITH DTC, MSTC OR PDTC AND COMPLETE THE FOLLOWING: Name of Tendering Institution _______________________________________________ Check Box of Book-Entry Transfer Facility (check one): [_] DTC [_] MSTC [_] PDTC [_] CHECK HERE IF TENDERED SHARES ARE BEING DELIVERED PURSUANT TO A NOTICE OF GUARANTEED DELIVERY SENT TO THE DEPOSITARY PRIOR TO THE DATE HEREOF AND COMPLETE THE FOLLOWING: Name(s) of Registered Owner(s) ______________________________________________ Window Ticket Number (if any) _______________________________________________ Date of Execution of Notice of Guaranteed Delivery __________________________ Name of Institution that Guaranteed Delivery ________________________________ Check Box of Book-Entry Transfer Facility if Delivered by Book-Entry Transfer (check one): [_] DTC [_] MSTC [_] PDTC Account Number (if delivered by Book-Entry Transfer) _______________________ BOXES ABOVE FOR USE BY ELIGIBLE INSTITUTIONS ONLY * Need not be completed by stockholders tendering by book-entry transfer. **Unless otherwise indicated, it will be assumed that all Shares evidenced by any certificates delivered to the Depositary are being tendered. See Instruction 4. NOTE: SIGNATURES MUST BE PROVIDED BELOW PLEASE READ THE ACCOMPANYING INSTRUCTIONS CAREFULLY The undersigned hereby tenders to LAC Acquisition Corporation (the "Purchaser"), a New York corporation and a wholly owned subsidiary of Lockheed Martin Corporation, a Maryland corporation ("Parent"), the above-described shares of common stock (the "Common Stock"), par value $0.25 per share, of Loral Corporation, a New York corporation (the "Company"), and the associated preferred stock purchase rights (the "Rights", and together with the Common Stock (the "Shares") at $38.00 per Share, net to the seller in cash, without interest, upon the terms and subject to the conditions set forth in the Offer to Purchase, dated January 12, 1996 (the "Offer to Purchase"), receipt of which is hereby acknowledged, and in this Letter of Transmittal (which, together with the Offer to Purchase, constitutes the "Offer"). The Rights were issued pursuant to a Rights Agreement, dated as of January 10, 1996, between the Company and Bank of New York, as amended, and are currently evidenced by and trade with certificates evidencing the Common Stock. The undersigned understands that Purchaser reserves the right to transfer or assign, in whole or in part from time to time or to one or more direct or indirect wholly owned subsidiaries of Parent, the right to purchase Shares tendered pursuant to the Offer. Subject to and effective upon acceptance for payment of the Shares tendered herewith in accordance with the terms and subject to the conditions of the Offer, the undersigned hereby sells, assigns and transfers to, or upon the order of, the Purchaser all right, title and interest in and to all of the Shares that are being tendered hereby (and any and all other Shares or other securities or property (other than regular quarterly cash dividends of not more than $0.08 per Share) issued or issuable in respect thereof on or after January 12, 1996, other than the Spinco Shares distributed in respect of the Shares in connection with the Spin-Off (as such terms are defined in the Offer to Purchase)) such other Shares, securities or property other than the Shares being referred to herein as the "Other Securities" and irrevocably appoints the Depositary the true and lawful agent and attorney-in-fact of the undersigned with respect to such Shares and any such Other Securities with full power of substitution (such power of attorney being deemed to be an irrevocable power coupled with an interest), to (a) deliver certificates for such Shares (and any such Other Securities), or transfer ownership of such Shares on the account books maintained by any of the Book-Entry Transfer Facilities (and any such Other Securities), together in any such case with all accompanying evidences of transfer and authenticity, to or upon the order of the Purchaser, upon receipt by the Depositary, as the undersigned's agent, of the purchase price (adjusted, if appropriate, as provided in the Offer to Purchase), (b) present such Shares and any such Other Securities for transfer on the books of the Company and (c) receive all benefits and otherwise exercise all rights of beneficial ownership of such Shares and any such Other Securities, all in accordance with the terms of the Offer. The undersigned hereby irrevocably appoints Frank H. Menaker, Jr. and Lillian M. Trippett, and each of them or any other designees of the Purchaser, the attorneys and proxies of the undersigned, each with full power of substitution, to exercise such voting and other rights as each such attorney and proxy or his substitute shall, in his sole discretion, deem proper, and otherwise act (including pursuant to written consent) with respect to all of the Shares tendered hereby which have been accepted for payment by the Purchaser prior to the time of such vote or action and any and all Other Securities issued or issuable in respect thereof on or after January 12, 1996), which the undersigned is entitled to vote at any meeting of stockholders of the Company (whether annual or special and whether or not an adjourned meeting), or written consent in lieu of such meeting, or otherwise. This proxy is coupled with an interest in the Shares tendered hereby and is irrevocable and is granted in consideration of, and is effective upon, the acceptance for payment of such Shares by the Purchaser in accordance with the terms of the Offer. Such acceptance for payment shall revoke all prior proxies granted by the undersigned with respect to such Shares and any such Other Securities and no subsequent proxies may be given (and if given will be deemed not to be effective) with respect thereto by the undersigned. The Purchaser reserves the right to require that, in order for Shares to be deemed validly tendered, immediately upon the Purchaser's acceptance for payment of such Shares, the Purchaser is able to exercise full voting and other rights of a record holder or beneficial holder, including rights in respect of acting by written consent, with respect to such Shares and Other Securities. The undersigned hereby represents and warrants that the undersigned has full power and authority to tender, sell, assign and transfer the Shares tendered hereby (and any and all Other Securities issued or issuable in respect thereof on or after January 12, 1996), and that when the same are accepted for payment by the Purchaser, the Purchaser will acquire good, marketable and unencumbered title thereto, free and clear of all liens, restrictions, charges and encumbrances, and the same will not be subject to any adverse claim. The undersigned, upon request, will execute and deliver any signature guarantees or additional documents deemed by the Depositary or the Purchaser to be necessary or desirable to complete the sale, assignment and transfer of the Shares tendered hereby and any and all such Other Securities. In addition, the undersigned shall promptly remit and transfer to the Depositary for the account of the Purchaser any such Other Securities issued to the undersigned on or after January 12, 1996, in respect of the Shares tendered hereby, accompanied by appropriate documentation of transfer, and pending such remittance or appropriate assurance thereof, the Purchaser shall be entitled to all rights and privileges as owner of any such Other Securities and may withhold the entire purchase price or deduct from the purchase price the amount or value thereof, as determined by the Purchaser in its sole discretion. All authority herein conferred or agreed to be conferred shall survive the death or incapacity of the undersigned, and any obligation of the undersigned hereunder shall be binding upon the successors, assigns, heirs, executors, administrators and legal representatives of the undersigned. Except as stated in the Offer to Purchase, this tender is irrevocable. The undersigned understands that tenders of Shares pursuant to any one of the procedures described in Section 3 of the Offer to Purchase and in the instructions hereto will constitute a binding agreement between the undersigned and the Purchaser upon the terms and subject to the conditions of the Offer. The undersigned recognizes that under certain circumstances set forth in the Offer to Purchase, the Purchaser may not be required to accept for payment any of the Shares tendered hereby. Unless otherwise indicated herein under "Special Payment Instructions," please issue the check for the purchase price and/or return any certificates for Shares not tendered or not accepted for payment in the name(s) of the registered holder(s) appearing under "Description of Shares Tendered." Similarly, unless otherwise indicated under "Special Delivery Instructions," please mail the check for the purchase price and/or return any certificates for Shares not tendered or accepted for payment (and accompanying documents, as appropriate) to the address(es) of the registered holder(s) appearing under "Description of Shares Tendered." In the event that both the Special Delivery Instructions and the Special Payment Instructions are completed, please issue the check for the purchase price and/or return any certificates for Shares not purchased (together with accompanying documents as appropriate) in the name(s) of, and deliver said check and/or return such certificates to, the person or persons so indicated. Stockholders tendering Shares by book-entry transfer may request that any Shares not accepted for payment be returned by crediting such account maintained at DTC, MSTC or PDTC as such stockholder may designate by making an appropriate entry under "Special Payment Instructions." The undersigned recognizes that the Purchaser has no obligation pursuant to the Special Payment Instructions to transfer any Shares from the name of the registered holder(s) thereof if the Purchaser does not accept for payment any of the Shares so tendered. SPECIAL PAYMENT INSTRUCTIONS SPECIAL DELIVERY INSTRUCTIONS (SEE INSTRUCTIONS 1, 5, 6 AND 7) (SEE INSTRUCTIONS 5 AND 7) To be completed ONLY if To be completed ONLY if certificates for Shares not certificates for Shares not tendered or not purchased and/or tendered or not purchased and/or the check for the purchase price of the check for the purchase price of Shares purchased are to be issued Shares purchased are to be sent to in the name of someone other than someone other than the undersigned the undersigned. or to the undersigned at an address other than that appearing under "Description of Shares Tendered." Issue: [_] Check [_] Certificate(s) to: Name _______________________________ Issue: [_] Check [_] Certificate(s) (Please Print) to: (Tax Identification or Social ------------------------------------ Security Number) (Include Zip Code) (See Substitute Form W-9 Included (Tax Identification or Social ------------------------------------ (See Substitute Form W-9 Included (ALSO COMPLETE SUBSTITUTE FORM W-9 ON REVERSE SIDE) (MUST BE SIGNED BY REGISTERED HOLDER(S) EXACTLY AS NAME(S) APPEAR(S) ON STOCK CERTIFICATE(S) OR ON A SECURITY POSITION LISTING OR BY PERSON(S) AUTHORIZED TO BECOME REGISTERED HOLDER(S) BY CERTIFICATES AND DOCUMENTS TRANSMITTED HEREWITH. IF SIGNATURE IS BY TRUSTEE, EXECUTOR, ADMINISTRATOR, GUARDIAN, ATTORNEY- IN-FACT, AGENT, OFFICER OF A CORPORATION OR ANY OTHER PERSON ACTING IN A FIDUCIARY OR REPRESENTATIVE CAPACITY, PLEASE PROVIDE THE FOLLOWING INFORMATION. Area Code and Telephone Number ________________________ Tax Identification or Social Security Number __________ (See Substitute Form W-9 Below) (IF REQUIRED--SEE INSTRUCTIONS 1 AND 5) Area Code and Telephone Number ________________________ FORMING PART OF THE TERMS AND CONDITIONS OF THE OFFER 1. GUARANTEE OF SIGNATURES. Signatures on all Letters of Transmittal must be guaranteed by a recognized member of a Medallion Signature Guarantee Program (each of the foregoing being referred to as an "Eligible Institution"), unless (i) this Letter of Transmittal is signed by the registered holder(s) of Shares (which term, for the purposes of this document, shall include any participant in a Book-Entry Transfer Facility whose name appears on a security position listing as the owner of Shares) and such holder(s) has (have) not completed either the box entitled "Special Delivery Instructions" or the box entitled "Special Payment Instructions" on this Letter of Transmittal or (ii) such shares are tendered for the account of an Eligible Institution. See Instruction 5. 2. DELIVERY OF LETTER OF TRANSMITTAL AND CERTIFICATES; GUARANTEED DELIVERY PROCEDURES. This Letter of Transmittal is to be completed by stockholders either if certificates for Shares are to be forwarded herewith or if a tender of Shares is to be made pursuant to the procedures for delivery by book-entry transfer set forth in Section 3 of the Offer to Purchase. Certificates for all physically tendered Shares, or confirmation ("Book-Entry Confirmation") of any book-entry transfer into the Depositary's account at DTC, MSTC or PDTC of Shares delivered by book-entry transfer as well as a properly completed and duly executed Letter of Transmittal, must be received by the Depositary, at one of the addresses set forth herein prior to the Expiration Date (as defined in Section 1 of the Offer to Purchase). Stockholders whose certificates are not immediately available or who cannot deliver their certificates and all other required documents to the Depositary prior to the Expiration Date or who cannot comply with the book-entry transfer procedures on a timely basis may tender their Shares by properly completing and duly executing a Notice of Guaranteed Delivery pursuant to the guaranteed delivery procedure set forth in Section 3 of the Offer to Purchase. Pursuant to such procedure, (i) such tender must be made by or through an Eligible Institution, (ii) a properly completed and duly executed Notice of Guaranteed Delivery, substantially in the form provided by the Purchaser, must be received by the Depositary (as provided in (iii) below) prior to the Expiration Date and (iii) the certificates for all physically tendered Shares (or Book-Entry Confirmation with respect to such Shares), as well as a properly completed and duly executed Letter of Transmittal (or a facsimile thereof) with any required signature guarantees and any other documents required by this Letter of Transmittal, must be received by the Depositary within five New York Stock Exchange, Inc. trading days after the date of execution of such Notice of Guaranteed Delivery, all as provided in Section 3 of the Offer to Purchase. THE METHOD OF DELIVERY OF THIS LETTER OF TRANSMITTAL, CERTIFICATES FOR SHARES AND ALL OTHER REQUIRED DOCUMENTS, INCLUDING DELIVERY THROUGH ANY BOOK-ENTRY TRANSFER FACILITY, IS AT THE OPTION AND RISK OF THE TENDERING STOCKHOLDER AND THE DELIVERY WILL BE DEEMED MADE ONLY WHEN ACTUALLY RECEIVED BY THE DEPOSITARY. IF DELIVERY IS BY MAIL, IT IS RECOMMENDED THAT SUCH CERTIFICATES AND DOCUMENTS BE SENT BY REGISTERED MAIL, PROPERLY INSURED, WITH RETURN RECEIPT REQUESTED. IN ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO INSURE TIMELY DELIVERY. No alternative, conditional or contingent tenders will be accepted and no fractional Shares will be purchased. All tendering stockholders, by execution of this Letter of Transmittal (or facsimile thereof), waive any right to receive any notice of the acceptance of their Shares for payment. 3. INADEQUATE SPACE. If the space provided herein is inadequate, the certificate numbers and/or the number of Shares should be listed on a separate signed schedule attached hereto. 4. PARTIAL TENDERS. (Not applicable to stockholders who tender by book-entry transfer.) If fewer than all the Shares evidenced by any certificate submitted are to be tendered, fill in the number of Shares which are to be tendered in the box entitled "Number of Shares Tendered." In such case, new certificate(s) for the remainder of the Shares that were evidenced by the old certificate(s) will be sent to the registered holder, unless otherwise provided in the appropriate box on this Letter of Transmittal, as soon as practicable after the Expiration Date. All Shares represented by certificates delivered to the Depositary will be deemed to have been tendered unless otherwise indicated. 5. SIGNATURES ON LETTER OF TRANSMITTAL, STOCK POWERS AND ENDORSEMENTS. If this Letter of Transmittal is signed by the registered holder(s) of the Shares tendered hereby, the signature(s) must correspond exactly with the name(s) as written on the face of the certificate(s) without alteration, enlargement or any change whatsoever. If any of the Shares tendered hereby are held of record by two or more persons, all such persons must sign this Letter of Transmittal. If any tendered Shares are registered in different names on several certificates, it will be necessary to complete, sign and submit as many separate Letters of Transmittal as there are different registrations of certificates. If this Letter of Transmittal or any certificates or stock powers are signed by a trustee, executor, administrator, guardian, attorney-in-fact, agent, officer of a corporation or any person acting in a fiduciary or representative capacity, such person should so indicate when signing, and proper evidence satisfactory to the Purchaser of such person's authority so to act must be submitted. If this Letter of Transmittal is signed by the registered holder(s) of the Shares evidenced by certificates listed and transmitted hereby, no endorsements of certificates or separate stock powers are required unless payment is to be made to or certificates for Shares not tendered or purchased are to be issued in the name of a person other than the registered holder(s). Signatures on such certificates or stock powers must be guaranteed by an Eligible Institution. If this Letter of Transmittal is signed by a person other than the registered holder(s) of the Shares, evidenced by certificates listed and transmitted hereby, the certificates must be endorsed or accompanied by appropriate stock powers, in either case signed exactly as the name or names of the registered holder or holders appear on the certificates. Signatures on such certificates or stock powers must be guaranteed by an Eligible Institution. 6. STOCK TRANSFER TAXES. Except as set forth in this Instruction 6, the Purchaser will pay or cause to be paid any stock transfer taxes with respect to the transfer and sale of Shares to it or its order pursuant to the Offer. If, however, payment of the purchase price is to be made to, or if certificates for Shares not tendered or purchased are to be registered in the name of, any person other than the registered holder(s), or if certificates for tendered shares are registered in the name of any person other than the person(s) signing this letter of transmittal, the amount of any stock transfer taxes (whether imposed on the registered holder(s) or such other person) payable on account of the transfer to such person will be deducted from the purchase price unless satisfactory evidence of the payment of such taxes or exemption therefrom is submitted. EXCEPT AS PROVIDED IN THIS INSTRUCTION 6, IT WILL NOT BE NECESSARY FOR TRANSFER TAX STAMPS TO BE AFFIXED TO THE CERTIFICATE(S) LISTED IN THIS LETTER OF TRANSMITTAL. 7. SPECIAL PAYMENT AND DELIVERY INSTRUCTIONS. If the check is to be issued in the name of and/or certificates for Shares not tendered or not purchased are to be returned to a person other than the signer of this Letter of Transmittal or if a check is to be sent and/or such certificates are to be returned to someone other than the signer above, the appropriate boxes on this Letter of Transmittal should be completed. Stockholders tendering Shares by book-entry transfer may request that Shares not purchased be credited to such account maintained at any of the Book-Entry Transfer Facilities as such stockholder may designate under "Special Delivery Instructions". If no such instructions are given, any such Share not purchased will be returned by crediting the account at the Book-Entry Transfer Facilities designated above. 8. REQUEST FOR ASSISTANCE OR ADDITIONAL COPIES. Requests for assistance may be directed to, or additional copies of the Offer to Purchase and this Letter of Transmittal may be obtained from, the Information Agent or Dealer Manager at the telephone numbers and addresses set forth below. Stockholders may also contact their broker, dealer, commercial bank or trust company. 9. WAIVER OF CONDITIONS. Except as otherwise provided in the Offer to Purchase, the Purchaser reserves the right in its sole discretion to waive in whole or in part at any time or from time to time any of the specified conditions of the Offer or any defect or irregularity in tender with regard to any Shares tendered. 10. SUBSTITUTE FORM W-9. The tendering stockholder is required to provide the Depositary with a correct Taxpayer Identification Number ("TIN"), generally the stockholder's social security or employer identification number, on Substitute Form W-9, which is provided under "Important Tax Information" below, and to certify whether he or she is subject to backup withholding of federal income tax. If a tendering stockholder is subject to backup withholding, he or she must cross out item (2) of the Certification Box on Substitute Form W-9. Failure to provide the information on Substitute Form W-9 may subject the tendering stockholder to 31% federal income tax withholding on the payment of the purchase price. If the tendering stockholder has not been issued a TIN and has applied for a number or intends to apply for a number in the near future, he or she should write "Applied For" in the space provided for the TIN in Part I, sign and date the Substitute Form W-9 and sign and date the Certificate of Awaiting Taxpayer Identification Number. If "Applied For" is written in Part I and the Depositary is not provided with a TIN within 60 days, the Depositary will withhold 31% of payments for surrendered Shares thereafter until a TIN is provided to the Depositary. IMPORTANT: THIS LETTER OF TRANSMITTAL (OR A FACSIMILE HEREOF) TOGETHER WITH CERTIFICATES (OR BOOK-ENTRY CONFIRMATION) AND ALL OTHER REQUIRED DOCUMENTS OR THE NOTICE OF GUARANTEED DELIVERY MUST BE RECEIVED BY THE DEPOSITARY ON OR PRIOR TO THE EXPIRATION DATE (AS DEFINED IN THE OFFER TO PURCHASE). Under federal tax law, a stockholder whose tendered Shares are accepted for payment is required to provide the Depositary (as payor) with such stockholder's correct TIN on Substitute Form W-9 below. If such stockholder is an individual, the TIN is his Social Security Number. If the Depositary is not provided with the correct TIN or an adequate basis for exemption, the stockholder may be subject to a $50 penalty imposed by the Internal Revenue Service. In addition, payments that are made to such stockholder with respect to Shares purchased pursuant to the Offer may be subject to backup withholding in an amount equal to 31% of the gross proceeds resulting from the Offer. Certain stockholders (including, among others, all corporations and certain foreign individuals) are not subject to these backup withholding and reporting requirements. In order for a foreign individual to qualify as an exempt recipient, that stockholder must submit an IRS Form W-8, signed under penalties of perjury, attesting to that individual's exempt status. Such statements can be obtained from the Depositary. See the enclosed Guidelines for Certification of Taxpayer Identification Number on Substitute Form W-9 for additional instructions. If backup withholding applies, the Depositary is required to withhold 31% of any payments made to the stockholder. Backup withholding is not an additional tax. Rather, the tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund may be obtained. PURPOSE OF SUBSTITUTE FORM W-9 To prevent backup withholding on payments that are made to a stockholder with respect to Shares purchased pursuant to the Offer, the stockholder is required to notify the Depositary of his correct TIN by completing the Substitute Form W-9 contained herein certifying that the TIN provided on the Substitute Form W- 9 is correct (or that such stockholder is awaiting a TIN) and that (1) the stockholder is exempt from backup withholding, (2) the stockholder has not been notified by the Internal Revenue Service that he is subject to backup withholding as a result of failure to report all interest or dividends, or (3) the Internal Revenue Service has notified the stockholder that he or she is no longer subject to backup withholding. WHAT NUMBER TO GIVE THE DEPOSITARY The stockholder is required to give the Depositary the social security number or employer identification number of the record owner of the Shares. If the Shares are in more than one name or are not in the name of the actual owner, consult the enclosed Guidelines for Certification of Taxpayer Identification Number on Substitute Form W-9 for additional guidance on which number to report. If the tendering stockholder has not been issued a TIN and has applied for a number or intends to apply for a number in the near future, he or she should write "Applied For" in the space provided for the TIN in Part I, sign and date the Substitute Form W-9 and sign and date the Certificate of Awaiting Taxpayer Identification Number. If "Applied For" is written in Part I and the Depositary is not provided with a TIN within 60 days, the Depositary will withhold 31% of all payments of the purchase price until a TIN is provided to the Depositary. PAYOR'S NAME: FIRST CHICAGO TRUST COMPANY OF NEW YORK SUBSTITUTE TIN IN THE BOX AT RIGHT AND DATING BELOW: FORM W-9 Social Security Number Internal Revenue Service OR ____________________ Payor's Request for Taxpayer Identification No. Identificatin Number (TIN) (If Awaiting TIN write PART II--For Payees NOT subject to backup withholding, see the enclosed Guidelines for Certification of Taxpayer Identification Number on Substitute Form W-9 and complete as instructed therein. CERTIFICATION--Under the penalties of perjury, I certify that: (1) The number shown on this form is my correct taxpayer identification number (or I am waiting for a number to be issued to me), and (2) I am not subject to backup withholding because either (a) I am exempt from backup withholding, (b) I have not been notified by the Internal Revenue Service ("IRS") that I am subject to backup withholding as a result of a failure to report all interest or dividends, or (c) the IRS has notified me that I am no longer subject to backup withholding. CERTIFICATION INSTRUCTIONS--You must cross out item (2) above if you have been notified by the IRS that you are subject to backup withholding because of underreporting interest or dividends on your tax return. However, if after being notified by the IRS that you were subject to backup withholding you received another notification from the IRS that you are no longer subject to backup withholding, do not cross out item (2). (Also see instructions in the Signature ____________________________ Date ___, 1996 NOTE: FAILURE TO COMPLETE AND RETURN THIS FORM MAY RESULT IN BACKUP WITHHOLDING OF 31% OF ANY PAYMENTS MADE TO YOU PURSUANT TO THE OFFER. PLEASE REVIEW THE ENCLOSED GUIDELINES FOR CERTIFICATION OF TAXPAYER IDENTIFICATION NUMBER ON SUBSTITUTE FORM W-9 FOR ADDITIONAL DETAILS. YOU MUST COMPLETE THE FOLLOWING CERTIFICATE IF YOU WROTE "APPLIED FOR" IN PART I OF SUBSTITUTE FORM W-9 CERTIFICATE OF AWAITING TAXPAYER IDENTIFICATION NUMBER I certify under the penalties of perjury that a taxpayer identification number has not been issued to me, and either (a) I have mailed or delivered an application to receive a taxpayer identification number to the appropriate Internal Revenue Service Center or Social Security Administration Officer, or (b) I intend to mail or deliver an application in the near future. I understand that if I do not provide a taxpayer identification number within sixty (60) days, 31% of all reportable payments made to me thereafter will be withheld until I provide a number. The Information Agent for the Offer is: MORROW & CO INC., INC. 909 Third Avenue, 20th Floor New York, New York 10022 Call Toll Free: (800) 566-9058 Banks and Brokerage Firms, please call: (800) 622-5200 The Dealer Manager for the Offer is: BEAR, STEARNS & CO. INC. New York, New York 10167 Call Toll Free: (800) 726-9849	SC 14D1	EX-99.(A)(2)	1996-01-12T00:00:00	1996-01-12T17:26:30
0000912057-96-000445	0000912057-96-000445_0002.txt	[Logo] RAYMOND G. KENNEDY, CFA 777 South Figueroa Street, Suite 2950 213 486-5376 Fax: 213 623-9764 Reference is made to the Note Agreement between Tab Products Co. (the "Company") and The Prudential Insurance Company of America ("Prudential") dated as of (i) March 20, 1992 (the "1992 Agreement"), pursuant to which the Company issued and sold and Prudential purchased the Company's 8.73% Senior Notes due March 20, 2001 in the principal amount of $15,000,000 and (ii) October 7, 1993 (the "1993 Agreement"), pursuant to which the Company issued and sold and Prudential purchased the Company's 6.90% Senior Guaranteed Notes due September 20, 2002. The 1992 Agreement and the 1993 Agreement are together are together referred to as the "Agreements," and each is an "Agreement." Capitalized terms used herein and not otherwise defined shall have the meanings ascribed to them in the applicable Agreement. Pursuant to the request of the Company and the provisions of paragraph 11C of each Agreement, Prudential and the Company agree with respect to each Agreement as follows: 1. Paragraph 6L of each Agreement is hereby amended and restated in its entirety to read as follows: "6.L. FIXED CHARGE COVERAGE. Permit its Fixed Charge Coverage Ratio calculated at the end of each fiscal quarter commencing with the fiscal quarter ending May 30, 1994, on the basis of the consolidated results of operations of the Company and its Subsidiaries, to be less than (A) 1.15 from May 30, 1994 through and including May 30, 1997; (B) 1.00 from May 31, 1997 through February 28, 1998, inclusive; and (C) 1.15 at all times from and after March 1, 1998." 2. Notwithstanding anything to the contrary contained in the Agreements, for purposes of calculating the Fixed Charge Coverage Ratio, for the periods ending November 30, 1995, through May 31, 1996, capital expenditures of the Company or any Subsidiary shall not be subtracted from Consolidated Net Earnings. If you agree with the foregoing, please sign below and return a copy of this letter to the undersigned. Upon such execution, this letter shall become a binding agreement between the Company and Prudential amending the 1992 Agreement and the 1993 Agreement in the manner and to the extent herein provided. Execpt as otherwise set forth herein, the 1992 Agreement and the 1993 Agreement shall each continue unmodified and in full force and effect. By /s/ Raymond G. Kennedy By: /s/ Robert J. Sexton The undersigned, as a guarantor of the 6.90% Notes pursuant to its Guaranty thereof dated October 7, 1993, expressly agrees with and consents to the amendments set forth in this letter and confirms that its Guaranty remains in full force and effect as originally executed and is expressly reaffirmed hereby.	10-Q	EX-10.35	1996-01-12T00:00:00	1996-01-12T14:40:09
0000950152-96-000093	0000950152-96-000093_0000.txt	/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 1994 / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to (Exact name of registrant as specified in its charter) (State or other jurisdiction (I.R.S. Employer of incorporation or Identification Number) 3500 Payne Avenue, Cleveland, Ohio 44114 (Address of principal executive offices) (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if 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 APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock - $1 Par Value 5,295,556 Shares Outstanding as of February 10, 1995 DECEMBER 31, 1994 AND SEPTEMBER 30, 1994 See accompanying notes to consolidated condensed financial statements CONSOLIDATED CONDENSED STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED DECEMBER 31, 1994 and 1993 See accompanying notes to consolidated condensed financial statements CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED DECEMBER 31, 1994 and 1993 See accompanying notes to consolidated condensed financial statements NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (1) Certain prior year amounts have been reclassified to conform to the 1995 classifications. (2) The consolidated financial statements included in this report have been prepared by the Company from the consolidated statements of HMI Industries Inc. and its subsidiaries. In the opinion of the Company, these consolidated financial statements contain all of the adjustments necessary to present fairly the financial position as of December 31, 1994 and September 30, 1994, the results of operations and cash flows for the three months ended December 31, 1994 and 1993. Independent public accountants have not examined these statements. These consolidated financial statements should be read in conjunction with the financial statements and the notes included in the Company's latest annual report on Form 10-K. (3) The Company is contingently liable under a Conditional Purchase Agreement to a Netherlands bank in the amount of $1,175,000. If the contingent liability were called upon by the bank, the Company would take possession of certain finished goods and work in process inventories and sell them into existing markets. (4) Inventories at December 31, 1994 and September 30, 1994 consist of the following: (5) Effective October 1, 1993, the Company adopted Financial Accounting Standard (FAS) No. 109, "Accounting for Income Taxes". The adoption of this accounting principle resulted in the recognition of a ONE TIME CUMULATIVE TAX BENEFIT of $719,016 or $0.15 per share during the quarter ended December 31, 1993. The statement has been applied prospectively and prior year financial statements were not restated. (6) Inventory analysis revealed that costs in the Tubular operations were understated by some items previously sold under contract and due to erroneous accounting entries. Accordingly, cost of goods sold as reported of $21,509,054 has been restated to reflect these items. These adjustments totaled $178,629 for the first quarter resulting in cost of goods sold for the quarter of $21,687,683. OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIQUIDITY AND CAPITAL RESOURCES - MATERIAL CHANGES IN FINANCIAL POSITION The working capital balance at December 31, 1994 was $21,841,000 a decrease of 5% from the September 30, 1994 balance of $22,941,000. The effect of foreign exchange is primarily limited to the Canadian and Mexican operations. The Consolidated Statements of Cash Flows incorporates the effects of foreign exchange in each of the categories presented. The impact of the devaluation in Mexico in late December, 1994 in the amount of $1,180,000 has been reflected as a component of equity based on the nature of the Company's investment and intended timing of repayment of the amounts due. The value of the Mexican Peso versus the US dollar has continued to fluctuate since December 31, 1994. In managements' opinion, the amount of additional adjustments, if any, would not have a material effect on consolidated shareholders' equity. The Company's cash decreased by $261,000 for the three months ended December 31, 1994. Trade receivables decreased by $140,000, inventories increased by $1,890,000 and trade payables decreased by $1,140,000. The decrease in cash is primarily due to the annual December contributions for the Company sponsored bonus and profit sharing plans. Inventories have increased primarily as a result of a build up for the scheduled shipments for the quarter commencing January 1, 1995, especially in the Manufactured Products Division where inventories were up approximately $1,150,000. In December, due to the strong level of orders for their products, these operations did not observe the traditional shut down periods during the holidays. The Mexican Consumer Goods operation is still displaying strong growth, although the previously mentioned devaluation adjustment offset the growth in finance contracts receivable by $943,000. The Company acquired all of the assets of the HRS Division of Reckitt & Colman Canada, Inc. in December, 1993 for $4,875,000.The acquisition was financed by the Company's line of credit. The purchase price included $3,375,000 which was assigned to certain license agreements related to use of trade marks in the US and Canada. The amount is being amortized over 18 months to 4 years. Unamortized balances are reflected in the accompanying balance sheets. The acquisition agreement also provides for a contingent Earn Out of $1,875,000 to be paid out over a 10 year period dependent upon business expansion and revenue generation. At December 31, 1994, $5,000,000 of the unsecured, 9.86%, seven year private placement notes were outstanding. This debt was obtained in 1990 to finance the acquisition of Bliss Manufacturing Company. A portion of the Company's line of credit ($5,000,000) has been classified as long term based on the agreement with the bank dated July 1994. Capital expenditures during the three months ended December 31, 1994 were $422,000 as compared to $259,000 in the previous year. Outlays in the Consumer Goods Division include $49,000 for tooling additions and improvements, $39,000 for computer software and $77,000 for new steam cleaning equipment for the HRS operations. Future capital expenditure commitments include $250,000 for the 1995 completion of a new filter cone manufacturing machine. Additions in the Manufactured Products Division include $30,000 for tubular fabrication machinery and equipment and $137,000 for machinery and equipment, $50,000 for building improvements and $38,000 for vehicles and office equipment for the industrial and commercial stamping operations. The machinery and equipment additions at Bliss Manufacturing Co. were added to meet specific customer demands, increase both capacity and efficiencies and enable Bliss to meet increased demand overall. The outstanding balance on the Company's line of credit was $11,678,000 at December 31, 1994. The increase in the amount outstanding is principally due to the previously mentioned payment of bonus and profit sharing plan contributions, inventory increases and accounts payable reductions. Management believes the Company's long term liquidity needs will continue to be met by cash flow from operations, its access to the line of credit and its potential to borrow from existing debt sources. Net Sales - Net product sales increased from $28,611,000 for the three months ended December 31, 1993 to $32,068,000 for the current quarter, an improvement of 12%. Sales increases in the Consumer Products and Manufactured Products Division for the current quarter compared to the 1993 quarter were 7% and 13%, respectively. The existing Consumer Goods Division's markets continue to grow and the additional HRS sales contribute to this increase. A new filtration product introduced at the annual meeting in January, 1995 was enthusiastically received and will allow the Company access to new markets of allergy and dust sensitive household members. Sales in the Commercial and Industrial Stamping operations continue to increase due to increased capacity through the addition of specific equipment and as a result of the operation's ability to accommodate customer requirements on short-term notice. Gross Profit - Gross profit for the quarter ended December 31, 1994 was $10,380,000 or 32.4% as compared to $8,725,000 or 30.5% in the 1993 period. The improvement of the Mexican operation and the addition of the HRS operations have contributed to improved gross margins in the Consumer Goods Division. The gross margins in the manufactured Products Division have improved by 1.9% primarily as a result of the increased productivity at the Commercial and Industrial Stamping operations. The Company remains committed to utilizing available capacity in the Tubular Products Group and thereby increase sales and return on assets. Selling, General and Administrative Expenses - Selling, general and administrative expenses as a percent of sales were 23.6% as compared to 21.6% for the three months ended December 31, 1994 and 1993, respectively. The increase in these costs reflects the growth in the Mexican operations and the addition of HRS in December 1993, both of which while contributing higher gross margins, also have higher selling costs. Financing Revenue - Financing revenue represents the interest and fees generated by the Company's Health-Mor Acceptance Corporation and Mexican subsidiaries generated on the contracts financed. Interest expense - The 9.86%, seven year, unsecured Term Notes, comprise $160,000 and $192,000 of the three month interest expense for the quarters ended December 31, 1994 and 1993, respectively. The balance of the interest expense was comprised principally of short term borrowing interest of $181,000 (compared to $110,000 in 1993). Trademark amortization - These expenses represent the allocation of the amounts paid for the rights to use specific trademarks arising from the acquisition of HRS over periods ranging from eighteen months to four years as previously discussed. Acquisition related costs - These costs represent amortization of non-compete Agreements arising in the course of the Company's acquisitions. Accounting change for Income Taxes - The Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 109 - Accounting for Income Taxes which became effective for the Company in the current fiscal year. The cumulative effect of the change in accounting principle was $719,016 and is included in the results for the three months ended December 31, 1994. This item should not be considered a continuing item. PART II - OTHER INFORMATION AND SIGNATURE PART II - OTHER INFORMATION Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned there to duly authorized.	10-Q/A	10-Q	1996-01-12T00:00:00	1996-01-12T17:30:33
0000950130-96-000108	0000950130-96-000108_0012.txt	January 7, 1996 [LOGO - JP MORGAN] Attention: Mr. Walter E. Skowronski We understand that Lockheed Martin Corporation (the "Borrower"), directly or indirectly through a wholly owned subsidiary, intends to purchase the common stock of "Wings" in a transaction to be agreed to by the respective Boards of Directors of the Borrower and "Wings" (the "Transaction"). The financing for such purchase would be effected by a syndicated loan financing. You have requested J.P. Morgan Securities Inc. ("JPMSI") to arrange and BA Securities, Inc. ("BASI") to co-arrange financing in the syndicated bank market for an amount up to $10,000,000,000 for the Borrower in connection with the Transaction (the "Proposed Financing"). By separate letters dated as of the date hereof, each of Morgan Guaranty Trust Company of New York and Bank of America National Trust and Savings Association have committed to provide up to $1,375,000,000 of the Proposed Financing (the "Commitment Letters"). In response to your request in connection with the Transaction and the Proposed Financing, please be advised that we are highly confident that we will be able to arrange a syndicate of lenders for the balance of the maximum aggregate amount of the Proposed Financing on the terms contemplated by the Commitment Letters. The foregoing is based upon our knowledge and experience in the loan syndication market and subject to the assumptions set forth below. Our view is based on and subject to, among other factors, (i) our consideration of the information the Borrower has supplied to us to date (without any independent investigation) and our consideration of the information available concerning the Borrower and "Wings" under the Securities Exchange Act of 1934; (ii) the absence of adverse changes in the relevant markets or in the regulatory environment, and the absence of any domestic or international event, act or occurrence ("Disruption"), that in our reasonable judgment is likely to materially and adversely affect the syndication of the Proposed Financing; it being understood that there can be no assurance that such markets or regulatory environment will not so change, or that such Disruption will not occur, in the future; (iii) our present understanding of the terms upon which the Borrower intends to effect the Transaction (including the terms contemplated by the Commitment Letters); (iv) representations by the Borrower to us of its cooperate with us in structuring an appropriate credit facility; (v) our current understanding of the proposed capital structure and investment grade status of the Borrower after giving effect to any financing referred to herein; (vi) the absence of material adverse changes in the financial condition, business, assets, or results of operations of the Borrower or "Wings" and (vii) any necessary actions by or restrictions of federal, state, or other governmental agencies or regulatory authorities in connection with the Transaction. Please be advised that this letter is not a commitment to obtain financing for the Transaction and creates no obligation on our part in connection therewith. This letter is intended solely for the use of the Borrower and not any other person and may not be used or relied upon by, or disclosed, referred to or communicated by you (in whole or in part) to any third party for any purpose whatsoever (except to your professional advisors, "Wings" and its professional advisors for their purposes in evaluating the Borrower's proposal with respect to the Transaction and as may otherwise be required by law in the opinion of your counsel), except with our prior written permission and except that you may disclose the contents of this letter and include a copy of the letter in your Schedule 14D-1 to be filed with the Securities and Exchange Commission and the Offer to Purchase included therein. We look forward to working with you on this transaction. By: /s/ Michael C. Mauer	SC 14D1	EX-99.(B)(4)	1996-01-12T00:00:00	1996-01-12T17:26:30
0000950103-96-000018	0000950103-96-000018_0001.txt	OF SOUTHERN PERU COPPER CORPORATION THIS AGREEMENT AMONG CERTAIN STOCKHOLDERS OF SOUTHERN PERU COPPER CORPORATION dated as of January 2, 1996 (the "Agreement"), is entered into by and among Southern Peru Copper Corporation (the "Corporation"), Southern Peru Limited, ASARCO Incorporated, Cerro Trading Company, Inc. and Phelps Dodge Overseas Capital Corporation. WHEREAS, the Corporation, in a proposed reorganization to be effected in connection with the Exchange Offer (as defined below), will become the holding company of Southern Peru Limited, a Delaware corporation formerly known as Southern Peru Copper Corporation ("SP Limited"); WHEREAS, the Corporation proposes to offer its common stock, par value one cent ($0.01) per share (the "Common Stock"), for any and all outstanding labor shares (the "Labor Shares") of the branch (the "Branch") of SP Limited pursuant to a registered exchange offer (the "Exchange Offer") on the terms and subject to the conditions described in the prospectus (the "Prospectus") included in the Corporation's Registration Statement on Form S-4, File No. 33-97790, filed with the Securities and Exchange Commission on October 4, 1995, as such Prospectus may be supplemented or amended; WHEREAS, the Corporation, in connection with the consummation of the Exchange Offer, proposes to amend and restate its Certificate of Incorporation (as amended and restated in the manner set forth by Exhibits A-1, A-2 and B hereto, the "Restated Certificate") to provide, among other things, for 100,000,000 shares of authorized capital stock, par value one cent ($0.01) per share, initially designated as (i) 68,750,833 shares of Class A Common Stock, par value one cent ($0.01) per share (the "Class A Common Stock") and (ii) 31,249,167 shares of Common Stock (the Common Stock together with the Class A Common Stock, the "Common Shares"); WHEREAS, pursuant to the Restated Certificate, the Founding Stockholders and their Affiliates (as such terms are defined below) will hold all the issued and outstanding shares of Class A Common Stock and, pursuant to the Restated Certificate, any transfer of shares of Class A Common Stock to (or ownership by) persons other than Founding Stockholders or their Affiliates will result in an automatic conversion of the transferred shares into Common WHEREAS, pursuant to the Restated Certificate and the By-Laws of the Corporation (as adopted in the form attached hereto as Exhibit C, the "By-Laws"), the holders of Class A Common Stock, voting as a class, shall be entitled to elect thirteen members of the Board of Directors of the Corporation, one of whom shall be the President of the Corporation; WHEREAS, (i) the parties hereto desire to provide for certain rights and obligations relating to the designation for nomination and removal of Directors and the filling of vacancies on the Board of Directors and (ii) the Founding Stockholders desire to provide for the governance of their (and their Affiliates) continuing relations as holders of the Class A Common Stock WHEREAS, in connection with the adoption of the Restated Certificate, the parties hereto desire to terminate certain existing agreements among themselves as holders of SP Limited's outstanding common NOW, THEREFORE, the parties hereto agree as follows: "Affiliate" of a Person shall mean any Person (other than the Corporation) that directly or indirectly through one or more intermediaries controls, is controlled by, or is under common control with, the first Person. For the purposes of the above definition, the term "control" (including, with correlative meaning, the terms "controlled by" and "under common control with") shall mean the possession, directly or indirectly, of more than 50% of the then outstanding voting stock entitled to elect directors of such Person. "Person" shall mean any natural person, firm, partnership, association, corporation, company, trust, business trust, joint venture, unincorporated organization or government or any department or agency thereof. "Founding Stockholder" shall mean each of ASARCO Incorporated, Cerro Trading Company, Inc. and Phelps Dodge Overseas Capital Corporation and their respective successors and assigns qualifying pursuant to Section 4.3 hereof; provided that each of Cerro Trading Company, Inc. and Phelps Dodge Overseas Capital Corporation shall remain a Founding Stockholder for purposes hereof only for such time as it would also qualify as an Affiliate of The Marmon Corporation or Marmon Holdings, Inc. or Phelps Dodge Corporation, or their respective successors, as the case may be. "1955 Stockholders' Agreement" means the Agreement dated September 30, 1955 between American Smelting and Refining Company, Cerro de Pasco Corporation, Newmont Mining Corporation, Phelps Dodge Corporation and Southern Peru Copper Corporation (now known as SP Limited), and their respective successors, as amended and as in effect as of the date hereof as to all parties except Newmont Mining Corporation and its successors. II. DIRECTOR DESIGNATION AND VOTING AGREEMENTS 2.1 Board of Directors. The Founding Stockholders hereby agree and agree to take all necessary action in order that: (a) The Board of Directors of the Corporation shall consist of fifteen persons, one of whom shall be the President of the Corporation. (b) The holders of Class A Common Stock, voting as a class, shall be entitled to elect thirteen Directors, one of whom shall be the President of the Corporation. (c) Each Founding Stockholder will have the right to nominate that number of twelve Directors which is in proportion to the percentage of Class A Common Stock then owned by it (or its Affiliates) out of the aggregate Class A Common Stock then owned by all holders of Class A Common Stock (without any minimum required number of shares), rounded to the nearest whole number (with 0.5 being rounded up). In the event that the foregoing rounding procedure would permit the Founding Stockholders as a group to nominate (i) more than twelve Directors, then the Founding Stockholder whose fractional interest in a number shall represent the smallest fraction of a whole number that was rounded up shall not be entitled to nominate a Director with respect to that fractional interest or (ii) less than twelve Directors, then the Founding Stockholder whose fractional interest in a number shall represent the largest fraction of a whole number that was rounded down shall be entitled to nominate a Director with respect to that fractional interest. In the event the procedure described in the immediately preceding sentence would not result in twelve Directors being nominated by the Founding Stockholders as a group, the procedure described in the foregoing sentence shall be repeated among the Founding Stockholders not affected by the previous application of such procedure, as may be necessary to achieve the required result. (d) The Founding Stockholders will nominate the President of the Corporation then holding such office for election to the Board of Directors. (e) At all meetings of the Board of Directors, the presence of eight Directors shall be necessary to constitute a quorum for the transaction of business and the affirmative vote of a majority of the Directors present at a meeting at which a quorum of Directors is present shall be necessary for the adoption of any resolution or the taking of any action. 2.2 Agreement to Vote for Directors. The Founding Stockholders agree to vote all shares of Class A Common Stock now or hereafter owned by them, or that they have the right to vote (the "Voting Shares"), at any regular or special meeting of stockholders of the Corporation, or in lieu of any such meeting, to give their written consent, to the election or removal of Directors of the Corporation so as to elect Directors in accordance with the provisions of Section 2.1. The Founding Stockholders agree to vote their Voting Shares for the removal (including removal without cause) of any Director (and for the replacement of such Director pursuant to Section 2.1(c)) upon receipt of written instructions requesting such action from a Founding Stockholder entitled to designate such Director; provided that a replacement Director shall have been concurrently designated by such Founding Stockholder entitled to designate the replacement Director and such replacement Director shall be elected to the Board of Directors concurrently with the vote for removal of the Director proposed to be replaced. 2.3 Specification of Designees. In order to maintain representation on the Board of Directors in proportion to the rights of the respective Founding Stockholders to elect Directors as set forth under Section 2.1(c) (as such proportions may change from time to time as a result of transfer or conversion of Class A Common Stock or otherwise), the Corporation agrees to take all action necessary from time to time to call a meeting of stockholders or solicit written consents for the purpose of the election or removal of Directors. The Secretary of the Corporation shall deliver written notice of any such proposed corporate or stockholder action for the election or removal of Directors to the Founding Stockholders not later than fifteen (15) days prior to the date on which nominations or designees to the Board of Directors will be required to be received by the Corporation. Within ten (10) days of the receipt of any such notice from the Corporation, the Founding Stockholders shall notify the Corporation of the identity of their respective Board designees. The foregoing time periods may be shortened upon receipt of a written waiver from all Founding Stockholders, provided that the Corporation and the Founding Stockholders shall have been notified of the identity of all proposed Board designees. 2.4 Agreement of Founding Stockholders to Vote. The Founding Stockholders agree to vote all of their Voting Shares for the election or removal of Directors in accordance with the provisions of Sections 2.1, 2.2 and 2.3 at any regular or special meeting of stockholders of the Corporation, or in lieu of any such meeting, to give their written consent when requested by the Secretary of the Corporation to any such election or removal. In advance of any such meeting or any solicitation of such written consent, the Secretary of the Corporation shall give uniform instructions (identifying any Directors proposed to be elected or removed) to each Founding Stockholder and requesting it to vote its Voting Shares so as to accomplish the purposes of Sections 2.1, 2.2 and 2.3. To the extent any Founding Stockholder fails to so cast a vote or so provide its consent with respect to any of its Voting Shares, such Founding Stockholder hereby irrevocably appoints the Secretary of the Corporation the proxy of such Founding Stockholder, with full power of substitution, to vote in accordance with this Agreement all of the Voting Shares that the undersigned Founding Stockholder shall be entitled to vote. Each such proxy shall be considered coupled with an interest and is given by each Founding Stockholder in consideration of the proxies and the other covenants of the other Founding Stockholders set forth herein. 2.5 Shares Legend. Certificates representing Class A Common Stock shall bear the following legend until termination of this Agreement: "THE SHARES OF CLASS A COMMON STOCK REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO PROVISIONS CONTAINED IN THE AGREEMENT AMONG CERTAIN STOCKHOLDERS OF SOUTHERN PERU COPPER CORPORATION DATED AS OF JANUARY 2, 1996, A COPY OF WHICH IS ON FILE IN THE OFFICE OF THE SECRETARY OF SOUTHERN PERU COPPER CORPORATION." III. TERMINATION OF 1955 STOCKHOLDERS' AGREEMENT 3.1 Termination of Prior Agreement. Upon the effectiveness of this Agreement, the 1955 Stockholders' Agreement shall be terminated and none of the provisions of such agreement shall have any further force or effect. 4.1 Effective Date. This Agreement shall become effective upon the effectiveness of the exchange by the Founding Stockholders of shares of Common Stock of SP Limited for shares of Class A Common Stock of the Corporation. 4.2 Termination. (a) This Agreement shall terminate (and, pursuant to the Restated Certificate, the Class A Common Stock shall automatically be converted into Common Stock) if at any time the number of shares of Class A Common Stock owned by the Founding Stockholders and their Affiliates (in the aggregate) shall not represent at least 35% of the outstanding Common Shares. (b) In addition, the rights and obligations of any Founding Stockholder under this Agreement shall terminate in the event such Founding Stockholder (including any of its Affiliates to which it has assigned rights or obligations hereunder) ceases to own shares of Class A Common Stock. 4.3 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of and be enforceable by the respective successors and assigns of the parties hereto; provided that (i) the Corporation may not assign or transfer any of its rights or obligations hereunder without the prior written consent of the Founding Stockholders and (ii) each Founding Stockholder may assign or transfer its rights or obligations hereunder only to its Affiliates, for such period as such Founding Stockholder remains a Founding Stockholder hereunder and such Affiliates remain Affiliates of such Founding Stockholder, and only if such Affiliates agree in writing to be bound by the terms hereof. Any transferee or subsequent transferee of all of the shares of Class A Common Stock now held by Cerro Trading Company, Inc. which acquires such shares in compliance with the preceding sentence shall be deemed to be a Founding Stockholder hereunder, and this Agreement shall not be affected by any change in the ownership of the stock or assets of Cerro Trading Company, Inc. or any subsequent transferor of such Class A Common shares after it no longer owns such shares of Class A Common Stock. 4.4 Improper Transfer. Any attempt to sell, assign, transfer, grant or sell a participation in, pledge or otherwise dispose of any shares of Class A Common Stock not in compliance with this Agreement shall be null and void and neither the Corporation nor any transfer agent shall give any effect in the Corporation's stock records to such attempted sale, assignment, transfer, grant or sale of a participation, pledge or other disposition. 4.5 Amendments. Any provision of this Agreement may be amended and the observance thereof may be waived with the prior written consent of the Founding Stockholders. 4.6 Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 4.7 Titles and Subtitles. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. 4.8 Notices. Any notice required or permitted under this Agreement shall be given in writing and shall be deemed effectively given (i) five (5) days after deposit with the United States Postal Service, by registered or certified mail, postage prepaid, or (ii) if sent by telecopier, when sent and an appropriate electronic message confirming receipt by the addressee has been received, in each case, addressed to the party to be notified at the address or telecopier number indicated for such party on the signature page hereof, or at such other address or telecopier number as such party may hereafter designate by advance written notice to the other parties, except that any communication with respect to a change of address shall be deemed to be given when received by the party to whom such communication is addressed. 4.9 Severability. If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be excluded from this Agreement and the balance of this Agreement shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 4.10 Entire Agreement. This Agreement constitutes the entire agreement among the parties pertaining to the subject matter contained herein and supersedes all prior agreements and understandings of the parties. 4.11 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, without reference to the principles of conflicts of laws thereunder. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. SOUTHERN PERU COPPER SOUTHERN PERU LIMITED CORPORATION (formerly Southern Peru Copper By /s/ Charles G. Preble By /s/ Charles G. Preble Name: Charles G. Preble Name: Charles G. Preble 180 Maiden Lane 180 Maiden Lane New York, New York 10038 New York, New York 10038 Telecopier Number: Telecopier Number: By /s/ Richard de J. Osborne By /s/ J. Steven Whisler Name: Richard de J. Osborne Name: J. Steven Whisler 180 Maiden Lane Phoenix, Arizona 85004 New York, New York 10038 Telecopier Number: By /s/ Robert A. Pritzker IN WITNESS WHEREOF, the undersigned have executed this Agreement for the limited purpose of terminating the 1955 Stockholders' Agreement pursuant to Section 3.1 hereof as of the date of the effectiveness of this Agreement. THE MARMON CORPORATION CERRO COAL TRADING COMPANY By /s/ Robert A. Pritzker By /s/ Robert A. Pritzker Name: Robert A. Pritzker Name: Robert A. Pritzker Title: President & CEO Title: Presdident 25 West Washington Street, 25 West Washington Street, Chicago, IL 60606 Chicago, IL 60606 Telecopier Number: Telecopier Number: By /s/ J. Steven Whisler Ownership of Class A Common Stock The following table sets forth information regarding ownership of Class A Common Stock as of the date hereof. Pursuant to the terms of the Corporation's Restated Certificate, in connection with any sale of shares of Class A Common Stock to persons other than Founding Stockholders or their Affiliates, transferred shares shall be auto-matically converted into shares of Common Stock. Shares of Percentage of Percentage of Class A Class A Outstanding Name of Stockholder Common Stock Common Stock Common Shares ASARCO Incorporated 43,348,949 63.0% 54.1% Cerro Trading Company, Inc. 14,228,088 20.7 17.8 Capital Corporation 11,173,796 16.3 13.9	SC 13D	EX-99.1	1996-01-12T00:00:00	1996-01-12T14:27:42
0000950109-96-000212	0000950109-96-000212_0000.txt	FOR REGISTRATION OF CERTAIN CLASSES OF SECURITIES PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 (Exact name of registrant as specified in its charter) (State of incorporation or organization) (IRS Employer Identification No.) 470 Main Street, Fitchburg, Massachusetts 01420 (Address of principal executive offices) (Zip Code) Securities to be registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on to be so registered which each class is to be registered Securities to be registered pursuant to Section 12(g) of the Act: Rights to Purchase Series A Item 1. Description of Securities to be Registered. On January 5, 1996, the Board of Directors of The Safety Fund Corporation (the "Company") distributed one Right for each outstanding share of the Company's Common Stock, par value $5.00 per share (the "Common Stock"). The Rights will be issued to the holders of record of Common Stock outstanding on January 5, 1996, and with respect to Common Stock issued thereafter until the Distribution Date (as defined below) and, in certain circumstances, with respect to Common Stock issued after the Distribution Date. Each Right, when it becomes exercisable as described below, will entitle the registered holder to purchase from the Company one one-thousandth (1/1000th) of a share of Series A Participating Cumulative Preferred Stock, par value $10.00 per share, of the Company (the "Preferred Shares") at a price of $65 (the "Purchase Price"). The description and terms of the Rights are set forth in a Rights Agreement dated as of January 5, 1996 (the "Rights Agreement"), between the Company and Fleet National Bank of Massachusetts, as Rights Agent (the "Rights Agent"). Until the earlier of (i) such time as the Company learns that a person or group (including any affiliate or associate of such person or group) has acquired, or has obtained the right to acquire, Beneficial Ownership (as defined below) of an amount equal to or greater than such person's or group's Ownership Threshold (as defined below) of the outstanding Capital Shares (as defined below) (such person or group being an "Acquiring Person"), and (ii) such date, if any, as may be designated by the Board of Directors of the Company following the commencement of, or first public disclosure of an intent to commence, a tender or exchange offer for outstanding Capital Shares which could result in such person or group becoming the Beneficial Owner of an amount equal to or greater than such person's or group's Ownership Threshold of the outstanding Capital Shares (the earlier of such dates being called the "Distribution Date"), the Rights will be evidenced by the certificates for Capital Shares registered in the names of the holders thereof (which certificates shall also be deemed to be Right Certificates, as defined below) and not by separate Right Certificates. Therefore, until the Distribution Date, the Rights will be transferred with and only with the Capital Shares. "Beneficial Ownership", when used with reference to the ownership of securities, means (i) securities which a person, or any of such person's associates and affiliates, is deemed to "beneficially own" under Securities and Exchange Commission Rule 13d-3, (ii) securities which a person, or any of such person's associates and affiliates, has the right to acquire or the right to vote pursuant to any agreement, arrangement or understanding (whether written or oral) and (iii) securities Beneficially Owned by any person with which such person, or any of such person's associates and affiliates, has any agreement, arrangement or understanding (whether written or oral), or is acting in concert or with conscious parallel behavior, for the purpose of acquiring, holding, voting or disposing of any securities of the company. In the case of clause (iii), the Safety Fund Board of Directors may attribute Beneficial Ownership of securities to any person if the Safety Fund Board determines in good faith that such an agreement, arrangement or understanding exists or that such actions in concert or with conscious parallel behavior have occurred. A person will not be deemed to Beneficially Own any Capital Shares solely by virtue of the receipt by such person of a revocable proxy or consent given to such person pursuant to a definitive proxy statement filed with the Securities and Exchange Commission and otherwise in accordance with the rules and regulations under the Securities Exchange Act of 1934. "Capital Shares", when used with reference to the Company prior to a business combination, shall mean the shares of Common Stock or any other shares of capital stock of the Company into which the Common Stock shall be reclassified or changed. "Ownership Threshold" means, with respect to any person, the Beneficial Ownership of the greater of (i) 15% of the Capital Shares at any time outstanding or (ii) the percentage of the aggregate of the outstanding Capital Shares Beneficially Owned by such person on the date the Rights Plan is implemented, plus in the case of this clause (ii) 1% of the Capital Shares outstanding on such date. As soon as practicable following the Distribution Date, separate certificates evidencing the Rights ("Right Certificates") will be mailed to holders of record of the Capital Shares as of the close of business on the Distribution Date (and to each initial record holder of certain Common Stock originally issued after the Distribution Date), and such separate Right Certificates alone will thereafter evidence the Rights. The Rights are not exercisable until the Distribution Date and will expire on January 5, 2006 (the "Expiration Date") unless earlier redeemed by the Company as described below. The number of Preferred Shares or other securities issuable upon exercise of a Right, the Purchase Price, the Redemption Price (as defined below) and the number of Rights associated with each outstanding Capital Share are all subject to adjustment by the Board of Directors of the Company in the event of any change in the Capital Shares or the Preferred Shares, whether by reason of stock dividends, stock splits, recapitalizations, mergers, consolidations, combinations or exchanges of securities, split-ups, split-offs, spin-offs, liquidations, other similar changes in capitalization, any distribution or issuance of cash, assets, evidences of indebtedness or subscription rights, options or warrants to holders of Capital Shares or Preferred Shares, as the case may be (other than distribution of the Rights or regular quarterly cash dividends) or otherwise. The Preferred Shares are authorized to be issued in fractions which are an integral multiple of one one-thousandth (1/1000th) of a Preferred Share. The Company may, but is not required to, issue fractions of shares upon the exercise of Rights, and, in lieu of fractional shares, the Company may issue certificates or utilize a depository arrangement as provided by the terms of the Preferred Shares and, in the case of fractions other than one one-thousandth (1/1000th) of a Preferred Share or integral multiples thereof, may make a cash payment based on the market price of such shares. At such time as there is an Acquiring Person, the Rights will entitle each holder (other than such Acquiring Person (or any affiliate or associate of such Acquiring Person)) of a Right to purchase, for the Purchase Price, that number of one one-thousandths (1/1000ths) of a Preferred Share equivalent to the number of Capital Shares which at the time of such event would have a market value of twice the Purchase Price. In the event the Company is acquired in a merger or other business combination by an Acquiring Person or an associate or affiliate of an Acquiring Person that is a publicly traded corporation or 50% or more of the Company's assets or assets representing 50% or more of the Company's revenues or cash flow are sold, leased, exchanged or otherwise transferred (in one or more transactions) to an Acquiring Person or an associate or affiliate of an Acquiring Person that is a publicly traded corporation, each Right will entitle its holder (subject to the next paragraph) to purchase, for the Purchase Price, that number of common shares of such corporation which at the time of the transaction would have a market value of twice the Purchase Price. In the event the Company is acquired in a merger or other business combination by an Acquiring Person or an associate or affiliate of an Acquiring Person that is not a publicly traded entity or 50% or more of the Company's assets or assets representing 50% or more of the Company's revenues or cash flow are sold, leased, exchanged or otherwise transferred (in one or more transactions) to an Acquiring Person or an associate or affiliate of an Acquiring Person that is not a publicly traded entity, each Right will entitle its holder (subject to the next paragraph) to purchase, for the Purchase Price, at such holder's option, (i) that number of shares of the surviving corporation in the transaction with such entity (which surviving corporation could be the Company) which at the time of the transaction would have a book value of twice the Purchase Price, (ii) that number of shares of such entity which at the time of the transaction would have a book value of twice the Purchase Price or (iii) if such entity has an affiliate which has publicly traded common shares, that number of common shares of such affiliate which at the time of the transaction would have a market value of twice the Purchase Price. Any Rights that are at any time Beneficially Owned by an Acquiring Person (or any affiliate or associate of an Acquiring Person) will be null and void and nontransferable and any holder of any such Right (including any purported transferee or subsequent holder) will be unable to exercise or transfer any such Right. At any time after a person or a group becomes an Acquiring Person, the Board of Directors of the Company may exchange all or part of the then outstanding Rights (other than Rights that have become null and void and nontransferable as described above) for consideration per Right consisting of one-half of the securities that otherwise would have been issuable to the holder of each Right upon exercise thereof. The Board of Directors of the Company may also issue, in substitution for Preferred Shares, Common Stock having an equivalent market value to the Preferred Shares if, at such time, the Company has a sufficient number of Common Stock issued but not outstanding or authorized but unissued. At any time prior to the earlier of (i) such time as a person becomes an Acquiring Person and (ii) the Expiration Date, the Board of Directors of the Company may redeem the Rights in whole, but not in part, at a price (in cash or Common Stock or other securities of the Company deemed by the Board of Directors to be at least equivalent in value) of $.01 per Right, subject to adjustment as provided in the Rights Agreement (the "Redemption Price"). Immediately upon the action of the Board of Directors of the Company electing to redeem the Rights, and without any further action and without any notice, the right to exercise the Rights will terminate and the only right of the holders of Rights will be to receive the Redemption Price. Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Company, including, without limitation, the right to vote or to receive dividends. At any time prior to the Distribution Date, the Company may, without the approval of any holder of the Rights, supplement or amend any provision of the Rights Agreement (including the date on which the Distribution Date shall occur, the time during which the Rights may be redeemed or the terms of the Preferred Shares), except that no supplement or amendment shall be made which reduces the Redemption Price (other than pursuant to certain adjustments therein) or provides for an earlier Expiration Date. The Rights have certain antitakeover effects. The Rights will cause substantial dilution to a person or group that attempts to acquire the Company without conditioning the offer on substantially all the Rights being acquired. The Rights will not interfere with any merger or other business combination pursuant to certain all-cash tender offers for all outstanding Capital Shares or with a third party approved by the Board of Directors of the Company since the Board of Directors of the Company may, at its option, at any time prior to any person becoming an Acquiring Person, redeem all but not less than all of the then outstanding Rights at the Redemption Price. The Rights Agreement specifying the terms of the Rights, the Certificate of Vote of Directors Establishing a Series of Class of Stock of the Preferred Shares specifying the terms of the Preferred Shares (Exhibit A to the Rights Agreement) and the form of Right Certificate (Exhibit B to the Rights Agreement) are filed herewith as exhibits. The foregoing description of the Rights does not purport to be complete and is qualified in its entirety by reference to such exhibits, which are incorporated herein by reference. 1. Rights Agreement dated as of January 5, 1996, between The Safety Fund Corporation and Fleet National Bank of Massachusetts, as Rights Agent. 2. Form of Certificate of the Vote of Directors Establishing a Series of a Class of Shares (which is attached as Exhibit A to the Rights Agreement filed as Exhibit 1 hereto). 3. Form of Right Certificate (which is attached as Exhibit B to the Rights Agreement filed as Exhibit 1 hereto). Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: January 12, 1996 By:/s/ Christopher W.Bramley President and Chief Executive Officer	8-A12B	8-A12B	1996-01-12T00:00:00	1996-01-12T16:04:09
0000820206-96-000001	0000820206-96-000001_0000.txt	(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES For the quarterly period ended JUNE 30, 1995 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE CHANGE ACT OF 1934 For the transition period from to FRANKLIN REAL ESTATE INCOME FUND (Exact name of registrant as specified in its charter) (State or other jurisdiction of incorporation or organization) (I.R.S. Employer P. O. BOX 7777, SAN MATEO, CALIFORNIA 94403-7777 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (415) 312-2000 Former name, former address and former fiscal year, if changed since last report Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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 Common Stock Shares Outstanding as of June 30, 1995, Series A: 3,999,514 Common Stock Shares Outstanding as of June 30, 1995, Series B: 319,308 PART I - FINANCIAL INFORMATION and Analysis of Financial Condition Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the Financial Statements and Notes thereto. COMPARISON OF THE SIX MONTH PERIODS ENDED JUNE 30, 1995 AND 1994 Net income for the six month period ended June 30, 1995 increased $128,000, or 17%, as compared to the same period in 1994 due to the following factors: an increase in rental revenue of $133,000; an increase in interest and dividends of $3,000; a decrease in other income of $6,000; an increase in interest expense of $31,000; an increase in depreciation and amortization of $26,000; an increase in operating expenses of $65,000; an increase in related party expenses of $9,000; a decrease in general and administrative expense of $61,000, and a decrease in loss on the sale of mortgage-backed securities of $68,000. Explanations of the material changes are as follows: Rental revenue for the six month period ended June 30, 1995 increased $133,000, or 6%, primarily due to the recognition of rental income from the Glen Cove Shopping Center acquired on January 31, 1994 and improved occupancy and rental rates at the Shores Office Complex. The average occupancy rate of net rentable square feet for the six month periods ended June 30, 1995 and 1994 at the Shores Office Complex was 98% and 93%; at the Northport Buildings 98% and 97%, and at the Mira Loma Shopping Center 81% and 82%, respectively. Average occupancy during 1995 at the Glen Cove Center was 97%. Total expenses increased for the six month period ended June 30, 1995 by $2,000, or .1%, from $1,407,000 in 1994 to $1,409,000. The increase in total expenses is attributable to the following factors: an increase in interest expense of $31,000; an increase in depreciation and amortization of $26,000, or 5%; an increase in operating expenses of $65,000, or 14%; an increase in related party expense of $9,000, or 9%; a decrease in general and administrative expense of $61,000, or 41%, and a decrease in loss on sale of mortgage-backed securities of $68,000 or 100%. Interest expense increased $31,000 reflecting the issuance of an unsecured loan payable in January, 1994, related to the acquisition of the Glen Cove Center. This loan was converted into a secured mortgage note in June, 1994. Depreciation and amortization increased $26,000 and operating expenses increased $65,000 reflecting the acquisition of rental property in January, 1994 and increased bad debt expense at one of the Fund's properties. Related party expense increased $9,000 as a result of an increase in property management fees due to the increases in rental revenue at the Partnership's properties. General and administrative expense decreased $61,000 due to a decrease in non-recurring consulting fees and legal expenses. PART I - FINANCIAL INFORMATION and Analysis of Financial Condition Loss on sale of mortgage-backed securities decreased $68,000 due to the sale of mortgage-backed securities in January, 1994. The proceeds were used to invest in rental property. The Company's principal source of capital for the acquisition of properties was the proceeds from the initial public offering of its stock. The Company completed its property acquisition phase in 1994 and no further acquisitions are anticipated. The Company's funds from operations have been its principal source of capital for property improvements, leasing costs and the payments of quarterly dividends. At June 30, 1995, the Company's cash reserves, including mortgage backed securities, aggregated $1,746,000. As of June 30, 1995, one of the Company's properties was subject to secured financing with an outstanding balance of approximately $1,959,000. Otherwise, the Company's properties are owned free of any indebtedness. Interest on the note accrues at a variable rate of 1.5% in excess of the Union Bank Reference Rate. Monthly installments of principal and interest commenced August 1, 1994, and continue until maturity of the note on May 1, 1999. Principal installments are payable in the amount of $3,700 per month. The note may be prepaid in whole or in part at any time without penalty. For the foreseeable future, management believes that the Company's current sources of capital will continue to be adequate to meet both its operating requirements and the payment of dividends. Net cash flow provided by operating activities for the six month period ended June 30, 1995 decreased $199,000 to $1,275,000 compared to the same period in 1994. Although net income increased $128,000 in 1995, cash flow was reduced primarily due to the collection of a $258,000 receivable in 1994 which increased that year's cash flow, and due to an increase in leasing commissions paid by the Funds from Operations for the six month period ended June 30, 1995 increased $154,000, or 12%, to $1,471,000 compared to the same period in 1994. The increase is primarily due to the improvement in net income as described under "Results of Operations" above. The Company believes that Funds from Operations is helpful in understanding a property portfolio in that such calculation reflects income from operating activities and the properties' ability to support general operating expenses and interest expense before the impact of certain activities, such as gains and losses from property sales and changes in the accounts receivable and accounts payable. However, it does not measure whether income is sufficient to fund all of the Company's cash needs including principal amortization, capital improvements and distributions to shareholders. Funds from Operations should not be considered an alternative to net income or any other GAAP measurement of performance or as an alternative to cash flows from operating, investing, or financing activities as a measure of liquidity. As defined by the National Association of Real Estate Investment Trusts, Funds from Operations is net income ( computed in accordance with GAAP ), excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization, and after adjustment for unconsolidated joint ventures. PART I - FINANCIAL INFORMATION and Analysis of Financial Condition LIQUIDITY AND CAPITAL RESOURCES (Continued) The Company's management believes that inflation may have a positive effect on the Company's property portfolio, but this effect generally will not be fully realized until such properties are sold or exchanged. On some leases, the Company collects overage rents based on increased sales and increased base rentals as a result of cost of living adjustments. The Company's policy of negotiating leases which incorporate operating expense "pass-through" provisions is intended to protect the Company against increased operating costs resulting from inflation. Dividends are declared quarterly at the discretion of the Board of Directors. The Company's present dividend policy is to at least annually evaluate the current dividend rate in light of anticipated tenant turnover over the next two or three years, the estimated level of associated improvements and leasing commissions, planned capital expenditures, any debt service requirements and the Company's other working capital requirements. After balancing these considerations, and considering the Company's earnings and cash flow, the level of its liquid reserves and other relevant factors, the Company seeks to establish a dividend rate which: i) provides a stable dividend which is sustainable despite short term fluctuations in property cash flows; ii) maximizes the amount of cash flows paid out as dividends consistent with the above listed objective; and iii) complies with the Internal Revenue Code requirement that a REIT annually pay out as dividends not less than 95% of its taxable income. For the six-month period ended June 30, 1995, the Company declared dividends totaling $1,000,000. Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FRANKLIN REAL ESTATE INCOME FUND By: /S/ DAVID P. GOSS	10-Q/A	10-Q	1996-01-12T00:00:00	1996-01-11T20:01:03
0000950115-96-000013	0000950115-96-000013_0011.txt	EMPLOYMENT AGREEMENT dated as of June 20, 1995, between MEDIQ Incorporated, a Delaware corporation ("MEDIQ"), MEDIQ/PRN Life Support Services, Inc., a Delaware corporation, and PRN Holdings, Inc., a Delaware corporation (together "MEDIQ/PRN"), and Jay M. Kaplan (the "Executive"). WHEREAS, Executive is currently the Senior Vice President and Chief Financial Officer of MEDIQ/PRN; and WHEREAS, MEDIQ recognizes, in addition to Executive's other duties, the significant responsibility of Executive with respect to assisting in the WHEREAS, MEDIQ acknowledges and recognizes that it would serve the best interests of MEDIQ to assure itself of the continued employment of the Executive as Senior Vice President and Chief Financial Officer of MEDIQ/PRN and the assistance of Executive in maximizing the value received for MEDIQ/PRN in any potential sale and that the compensation provided for herein represents the fair value of the services to be provided by Executive with respect to maximizing such value and with respect to the other services to be provided hereunder; and WHEREAS, MEDIQ/PRN acknowledges and recognizes that it will receive significant benefit from Executive continuing his employment with MEDIQ/PRN; and WHEREAS, Executive desires to continue his employment with MEDIQ/PRN and to render services to MEDIQ (while it owns MEDIQ/PRN) and MEDIQ/PRN on the terms and conditions provided in this Agreement. NOW THEREFORE, in consideration of the premises and the mutual covenants and agreements contained herein and intending, to be legally bound hereby, the parties hereto agree as follows: SECTION 1. CAPACITY AND DUTIES 1.1 Employment; Acceptance of Employment. MEDIQ/PRN hereby employs Executive and Executive hereby accepts employment by MEDIQ/PRN for the period and upon the terms and conditions hereinafter set forth. (a) Executive shall be employed by MEDIQ/PRN as the Senior Vice President and Chief Financial Officer of MEDIQ/PRN and shall perform such other executive duties and shall have such executive authority, consistent with his position as may from time to time be specified by the President of MEDIQ/PRN. From the date hereof until a Sale Event (as hereinafter defined) occurs or any such sale or divestiture is finally abandoned by the Board, Executive shall report directly and exclusively to the Board of Directors of MEDIQ or any duly authorized committee thereof having authority over such proposed sale or divestiture. Following any Sale Event or abandonment of such sale or divestiture by the Board, Executive shall report as to all matters hereunder to the President of MEDIQ/PRN. (b) Executive shall devote his full working time, energy, skill and best efforts to the performance of his duties hereunder, in a manner which will faithfully and diligently further the business and interests of MEDIQ and MEDIQ/PRN, and shall not be employed by or participate or engage in or be a part of in any manner the management or operation of any business enterprise other than MEDIQ or MEDIQ/PRN without the prior written consent of the Board, which consent may be granted or withheld in its sole discretion. SECTION 2. TERM OF EMPLOYMENT 2.1 Term. The initial term of Executive's employment hereunder shall be eighteen months commencing on the date hereof and shall thereafter automatically be renewed from year to year unless and until either party shall give notice of his or its election to terminate Executive's employment at least 60 days prior to the end of the then-current term, unless earlier terminated as hereinafter provided. Such initial term, and each renewal term are hereafter referred to collectively as the "Contract Period." As compensation for Executive's services hereunder, MEDIQ/PRN shall pay to Executive a salary at the annual rate of $165,000 (the "Base Salary"). Such Base Salary shall be payable in accordance with MEDIQ/PRN's regular payroll practices in effect from time to time. Such Base Salary shall be subject to increase based on normal periodic merit review by the Compensation Committee of the Board of Directors of MEDIQ (the "Compensation Committee") in accordance with the corporate policies of MEDIQ and MEDIQ/PRN (such annual base salary, including the foregoing adjustments, if any, is hereinafter referred to as the "annual base salary"). 3.2 Performance Bonus. During the Contract Period, Executive shall be entitled to receive an annual performance bonus in accordance with the corporate bonus plan and policies of MEDIQ/PRN as approved by the Compensation Committee. 3.3 Employee Benefits. In addition to the compensation provided for in Section 3.1, Executive shall be entitled during the term of his employment to participate in all of MEDIQ/PRN's employee benefit plans and benefit programs as may from time to time be provided for other employees of MEDIQ/PRN whose duties, responsibilities, and compensation are reasonably comparable to those of Executive. If Executive becomes a participant in any employee benefit plan, practice or policy of MEDIQ/PRN or its affiliates, Executive shall be given credit under such plan for all service in the employ of MEDIQ/PRN and any predecessors thereto or affiliates thereof prior to the date hereof, for purposes of eligibility and vesting, benefit accrual and for all other purposes for which such service is either taken into account or recognized under the terms of such plan, practice or policy. 3.4 Vacation. Executive shall be entitled to vacations which shall not be less than the annual vacation period to which Executive is presently entitled. 3.5 Expense Reimbursement. During the term of his employment, MEDIQ/PRN shall reimburse Executive for all reasonable expenses incurred by him in accordance with its regular reimbursement policies as in effect from time to time and upon receipt of itemized vouchers therefor and such other supporting information as MEDIQ/PRN may reasonably require. (a) If, during the term of this Agreement, a Sale Event (as hereafter defined) occurs, Executive shall be entitled to receive a one-time bonus calculated as provided in paragraph (b) below. For the purposes of this Agreement, a "Sale Event" means any sale or divestiture of MEDIQ/PRN, including a sale of substantially all of its stock (including through merger, tender, exchange or otherwise) or assets, in either case in one or more related transactions. Executive's bonus shall be paid in cash within 30 days after the consummation of a Sale Event. (b) Executive's bonus payable upon a Sale Event shall equal the sum of (i) .025% of the aggregate purchase price paid for MEDIQ/PRN up to a maximum aggregate purchase price of $375,000,000 plus (ii) if the aggregate purchase price paid for MEDIQ/PRN exceeds $375,000,000, .15% of any purchase price in excess of $375,000,000. For purposes of calculating the bonus, the aggregate purchase price shall equal the sum of (x) the total cash consideration paid for MEDIQ/PRN (including, without limitation, in respect of any warrants or other security of MEDIQ or MEDIQ/PRN), plus (y) the fair market value of any securities or other property received as consideration for MEDIQ/PRN (including, without limitation, in respect of any warrants or other security of MEDIQ or MEDIQ/PRN), plus (z) the aggregate amount (including without limitation, accrued but unpaid interest and the unpaid amount of any capital leases) of any aggregate liabilities of MEDIQ/PRN assumed or refinanced by the purchaser in connection with the completion of the acquisition, other than current liabilities taken into account in computing the working capital of MEDIQ/PRN (except for current liabilities for indebtedness for money borrowed (including accrued but unpaid interest or capital leases)). The aggregate purchase price on which Executive's bonus is to be calculated is hereafter called "Enterprise Value" of MEDIQ/PRN. In the event of any dispute between Executive and MEDIQ regarding the Enterprise Value of MEDIQ/PRN on which Executive's bonus shall be calculated, the Board and Executive shall select an investment banking firm, reasonably acceptable to each of them, to make the determination of the Enterprise Value of MEDIQ/PRN. The fees and expenses of the investment banking firm incurred in making such determination shall be borne by MEDIQ, unless the investment banking firm shall determine that the Executive's position regarding the calculation of Enterprise Value was unreasonable under the circumstances, in which case such fees and expenses shall be shared equally between MEDIQ and Executive. (c) Executive acknowledges that a Sale Event may not occur, that the Board may determine not to pursue a Sale Event, that such a transaction can occur only upon proper authorization of the Board, or a duly constituted committee thereof, and accordingly there can be no assurance that any bonus will become payable to Executive under this Section. (d) In the event that MEDIQ/PRN is sold or deemed sold as part of an overall transaction involving the sale or other divestiture of all of MEDIQ and/or its other partly or wholly owned subsidiaries, Executive's bonus shall be paid based on the Enterprise Value of MEDIQ/PRN implicit in such transaction if such Enterprise Value is readily ascertainable. If the Enterprise Value of MEDIQ/PRN is not readily ascertainable in such transaction, and the parties are unable to agree on the portion of the purchase price representing the Enterprise Value of MEDIQ/PRN on which Executive's bonus shall be calculated, the Board and Executive shall select an investment banking firm reasonably acceptable to each of them, to make such determination. The expenses of the investment banking firm incurred in making such determination shall be borne by MEDIQ, unless the investment banking firm shall determine that the Executive's position regarding the calculation of Enterprise Value was unreasonable under the circumstances, in which case such fees and expenses shall be shared equally between MEDIQ and Executive. SECTION 4. TERMINATION OF EMPLOYMENT 4.1 Death of Executive. Executive's employment hereunder shall immediately terminate upon his death, upon which MEDIQ/PRN shall not thereafter be obligated to make any further payments hereunder other than amounts (including salary, bonuses, expense reimbursement, etc.) earned or accrued as of the date of Executive's death in accordance with generally accepted accounting principles ("GAAP"). 4.2 Disability of Executive. If Executive, in the reasonable opinion of a physician selected by the Board, is unable, for any reason, to perform his duties hereunder for a period of 180 consecutive days then the Board shall have the right to terminate Executive's employment upon 30 days' prior written notice to Executive at any time during the continuation of such inability, in which event MEDIQ/PRN shall not thereafter be obligated to make any further payments hereunder other than amounts (including salary, bonuses, expense reimbursement, etc.) earned or accrued under this Agreement as of the date of such termination in accordance with GAAP. 4.3 Termination for Cause. Executive's employment shall terminate immediately upon notice that MEDIQ/PRN is terminating Executive for "cause" (as defined herein), in which event MEDIQ/PRN shall not thereafter be obligated to make any further payments hereunder other than amounts (including salary, bonuses, expense reimbursement, etc.) earned or accrued under this Agreement as of the date of such termination in accordance with GAAP. As used herein "cause" shall include, without limitation the following, not corrected after notice and a reasonable opportunity to cure: (ii) fraud, theft or misappropriation or, embezzlement of MEDIQ or MEDIQ/PRN's funds; (iii) conviction of any felony, crime involving fraud or misrepresentation, or of any other crime (whether or not connected with his employment) the effect of which is likely to adversely affect MEDIQ, MEDIQ/PRN or their affiliates; (iv) material breach of Executive's (v) repeated and consistent failure of Executive to be present at work during normal business hours unless the absence is because of a disability determined pursuant to Section 4.2; (vi) willful violation of any express direction or any rule or regulation established by the Board; (vii) gross incompetence in the performance of, or gross neglect of, Executive's duties hereunder; (viii) illegal possession or use of any (ix) use of alcohol or other drugs which interferes with the performance by Executive of his duties. (i) Executive's employment is terminated by MEDIQ/PRN for any reason other than cause or the death or (ii) this Agreement is not renewed by MEDIQ/PRN at the end of any Contract Period on terms and conditions no less favorable to Executive than those in effect at such time, MEDIQ/PRN shall immediately pay Executive all amounts due under Section 3.1, 3.2, 3.3 and 3.4 (including Base Salary, Executive Benefits, expense reimbursements and compensation for unused vacation time) earned or accrued as of the date of such termination in accordance with GAAP. In such event, Executive shall also continue to receive his then current Base Salary and employee benefits from MEDIQ/PRN for eighteen months following the date of termination. Upon making such payments, MEDIQ and MEDIQ/PRN shall have no further obligation to Executive hereunder. 5.1 Confidentiality. Executive acknowledges a duty of confidentiality owed to MEDIQ and MEDIQ/PRN and shall not, at any time during or after his employment by MEDIQ/PRN, retain in writing, use, divulge, furnish, or make accessible to anyone, without the express authorization of the Board, any trade secret, private or confidential information or knowledge of MEDIQ, MEDIQ/PRN or any of their affiliates obtained or acquired by him while so employed. All computer software, telephone lists, customer lists, price lists, contract forms, catalogs, books, records, and files acquired while an employee of MEDIQ/PRN, are acknowledged to be the property of MEDIQ/PRN and shall not be duplicated, removed from MEDIQ/PRN's possession or made use of other than in pursuit of MEDIQ/PRN's business and, upon termination of employment for any reason, Executive shall deliver to MEDIQ/PRN, without further demand, all copies thereof which are then in his possession or his control. 5.2 Inventions and Improvements. During the term of his employment, Executive shall promptly communicate to MEDIQ/PRN all ideas, discoveries and inventions which are or may be useful to MEDIQ/PRN or its business. Executive acknowledges that all ideas, discoveries, inventions, and improvements which are made, conceived, or reduced to practice by him and every item of knowledge relating to MEDIQ/PRN's business interests (including potential business interests) gained by him during his employment hereunder are the property of MEDIQ/PRN, and Executive hereby irrevocably assigns all such ideas, discoveries, inventions, improvements, and knowledge to MEDIQ/PRN for its sole use and benefit, without additional compensation. The provisions of this Section shall apply whether such ideas, discoveries, inventions, improvements or knowledge are conceived, made or gained by him alone or with others, whether during or after usual working hours, whether on or off the job, whether applicable to matters directly or indirectly related to MEDIQ/PRN's business interests (including potential business interests), and whether or not within the specific realm of his duties. Executive shall, upon request of MEDIQ/PRN, at any time during or after his employment with MEDIQ/PRN, sign all instruments and documents requested by MEDIQ/PRN and otherwise cooperate with MEDIQ/PRN to protect its right to such ideas, discoveries, inventions, improvements, and knowledge, including applying for, obtaining, and enforcing patents and copyrights thereon in any and all countries. 5.3 Injunctive and Other Relief. (a) Executive acknowledges and agrees that the covenants contained herein are fair and reasonable in light of the consideration paid hereunder, and that damages alone shall not be an adequate remedy for any breach by Executive of his covenants contained herein and accordingly expressly agrees that, in addition to any other remedies which MEDIQ/PRN may have, MEDIQ/PRN shall be entitled to injunctive relief in any court of competent jurisdiction for any breach or threatened breach of any such covenants by Executive. Nothing contained herein shall prevent or delay MEDIQ/PRN from seeking, in any court of competent jurisdiction, specific performance or other equitable remedies in the event of any breach or intended breach by Executive of any of its obligations hereunder. (b) Notwithstanding the equitable relief available to MEDIQ/PRN, the Executive, in the event of a breach of his covenants contained in Section 5 hereof, understands and agrees that the uncertainties and delay inherent in the legal process would result in a continuing breach for some period of time, and therefore, continuing injury to MEDIQ/PRN until and unless MEDIQ/PRN can obtain such equitable relief. Therefore, in addition to such equitable relief, MEDIQ/PRN shall be entitled to monetary damages for any such period of breach until the termination of such breach, in an amount deemed reasonable to cover all actual and consequential losses, plus all monies received by Executive as a result of said breach and all costs and attorneys' fees incurred by MEDIQ/PRN in enforcing this Agreement. If Executive should use or reveal to any other person or entity any confidential information, this will be considered a continuing violation on a daily basis for so long a period of time as such confidential information is made use of by Executive or any such other person or entity. (a) All disputes arising out of or relating to this Agreement which cannot be settled by the parties shall promptly be submitted to and determined by a single arbitrator in Philadelphia, Pennsylvania, pursuant to the rules and regulations then obtaining of the American Arbitration Association; provided that nothing herein shall preclude MEDIQ or MEDIQ/PRN from seeking, in any court of competent jurisdiction, damages, specific performance or other equitable remedies in the case of any breach or threatened breach by Executive of Section 5 hereof. The decision of the arbitrator shall be final and binding upon the parties, and judgement upon such decision may be entered in any court of competent jurisdiction. (b) Discovery shall be allowed pursuant to the intendment of the United States Federal Rules of Civil Procedure and as the arbitrators determine appropriate under the circumstances. (c) Such arbitrator shall be required to apply the contractual provisions hereof in deciding any matter submitted to it and shall not have any authority, by reason of this Agreement or otherwise, to render a decision that is contrary to the mutual intent of the parties as set forth in this Agreement. 6.2 Prior Employment. Executive represents and warrants that he is not a party to any other employment, non- competition or other agreement or restriction which could interfere with his employment with MEDIQ/PRN or his or MEDIQ/PRN's rights and obligations hereunder; and that his execution of this Agreement and the performance of his duties hereunder will not breach the provisions of any contract, agreement, or understanding to which is party or any duty owed by him to any other person. 6.3 Severability. The invalidity or unenforceability of any particular provision or part of any provision of this Agreement shall not affect the other provisions or parts hereof. If any provision hereof is determined to be invalid or unenforceable by a court of competent jurisdiction, Executive shall negotiate in good faith to provide MEDIQ and MEDIQ/PRN with protection as nearly equivalent to that found to be invalid or unenforceable and if any such provision shall be so determined to be invalid or unenforceable by reason of the duration or geographical scope of the covenants contained therein, such duration or geographical scope, or both, shall be considered to be reduced to a duration or geographical scope to the extent necessary to cure such invalidity. 6.4 Assignment. This Agreement shall not be assignable by Executive, and shall be assignable by MEDIQ or MEDIQ/PRN only to any person or entity which may become a successor in interest (by purchase of assets or stock, or by merger, or otherwise) to MEDIQ or MEDIQ/PRN in the business or a portion of the business presently operated by it. Subject to the foregoing, this Agreement and the rights and obligations set forth herein shall inure to the benefit of, and be binding upon, the parties hereto and each of their respective permitted successors, assigns, heirs, executors and administrators. 6.5 Notices. All notices hereunder shall be in writing and shall be sufficiently given if hand-delivered, sent by documented overnight delivery service or registered or certified mail, postage prepaid, return receipt requested or by telegram, fax or telecopy (confirmed by U.S. mail), receipt acknowledged, addressed as set forth below or to such other person and/or at such other address as may be furnished in writing by any party hereto to the other. Any such notice shall be deemed to have been given as of the date received, in the case of personal delivery, or on the date shown on the receipt or confirmation therefor, in all other cases. Any and all service of process and any other notice in any such action, suit or proceeding shall be effective against any party if given as provided in this Agreement; provided that nothing herein shall be deemed to affect the right of any party to serve process in (any other manner permitted by law. (a) If to MEDIQ or MEDIQ/PRN: Attention: Michael J. Rotko, Esq. 1100 Philadelphia National Bank Building Attention: William M. Goldstein, Esq. 6.6 Entire Agreement and Modification. This Agreement constitutes the entire agreement between the parties hereto with respect to the matters contemplated herein and supersedes all prior agreements and understandings with respect thereto. Any amendment, modification, or waiver of this Agreement shall not be effective unless in writing. Neither the failure nor any delay on the part of any party to exercise any right, remedy, power or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right, remedy, power or privilege preclude any other or further exercise of the same or of any other right, remedy, power, or privilege with respect to any occurrence be construed as a waiver of any right, remedy, power, or privilege with respect to any other occurrence. 6.7 Governing Law. This Agreement is made pursuant to, and shall be construed and enforced in accordance with, the internal laws of the State of New Jersey (and United States federal law, to the extent applicable), without giving effect to otherwise applicable principles of conflicts of law. 6.8 Headings; Counterparts. The headings of paragraphs in this Agreement are for convenience only and shall not affect its interpretation. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original and all of which, when taken together, shall be deemed to constitute but one and the same Agreement. 6.9 Further Assurances. Each of the parties hereto shall execute such further instruments and take such other actions as any other party shall reasonably request in order to effectuate the purposes of this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. MEDIQ/PRN Life Support Services, Inc.	10-K405	EX-10.10	1996-01-12T00:00:00	1996-01-12T11:57:13

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